The Big Idea
El Salvador | Unwinding deal risk
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El Salvador’s recent announcement of Bitcoin restrictions has given a bounce to its sovereign bond prices as one of the risks to a deal with the International Monetary Funds unwinds. A deal with El Salvador should soon get IMF board approval likely next month. The debate then shifts from IMF deal risk to IMF execution risks and the potential trajectory of El Salvador from the ‘B’ to ‘BB’ rating category. If the Bitcoin restrictions were the worst of the IMF negotiations, the chances are good that everything else should be smooth sailing.
The approval of the Bitcoin restrictions was a quiet and efficient process that lines up with the country’s intent to seek IMF board approval in early February. The earlier concerns about the Bitcoin recommendations reflect the market’s failure to appreciate the difference between a political and economic agenda of the Bukele administration. It’s completely consistent to promote Bitcoin tourism while also adding some restrictions on select Bitcoin activities. That complies with IMF recommendations without compromising the pro-Bitcoin ideology. Bitcoin still remains legal tender, with a nuance redefinition of “curso legal” instead of “moneda legal”, and President Bukele should still have the support from the hardcore Bitcoin community. This is what makes him an astute politician with the highest approval ratings in the region. The nuances of successfully negotiating the IMF program also raises the question about the next phase of execution risks.
If the Bukele administration is committed to the IMF program, then execution risks should be low. The quick approval of the Bitcoin legal revisions is an example of the efficiency of the centralized decision-making process. High approval ratings and broad support among the political establishment reduces administrative barriers on IMF program compliance. This stands in contrast to most countries with the majority of the IMF risks in El Salvador front-loaded as opposed to back-loaded. If the Bitcoin legal revisions remove the last barriers for final approval of an IMF program, then this should validate the latest gains with yields again breaking below 9%.
There is not much clarity on the IMF program specifics with the full release of the staff report typically coming about four weeks after board approval. The staff mission press release focuses on several areas: fiscal policy, good governance and transparency, reserves and digital assets. The prior conditions on Bitcoin restrictions were quickly met this week. The Bukele administration should probably move forward with the same efficiency on the good governance and transparency criteria as well as reforms for the banking sector. This is all probably low execution risks assuming an efficient approval process and minimal pushback or controversy over these measures.
The more controversial part of any IMF program is the fiscal adjustment recommendations. This is always difficult but more so for countries that prioritize pro-growth policy management. There was some back-and-forth on negotiations, with agreement for an adjustment that depends on spending restraint and more efficient tax collection. The cumulative fiscal adjustment targets 3.5%-of-GDP in savings over the next three years with front-loaded “high quality measures, worth 1.5%-of-GDP in 2025, already included within the budget.” There is actually some margin of flexibility on these target assumptions, with the budget targeting slightly higher spending restraint. The final months for 2024 already show commitment to fiscal consolidation. Tax collection remains robust at a 8% year-over-year gain through November 2024 despite economic deceleration. If we exclude the one-off severance payments, there has been a sharp deceleration in spending (mostly wages) as well as a slowdown in capex. There has also been a pronounced slowdown in the pension debt accumulation, suggesting a slower pace of deficit financing from the pension accounts. This track record increases the likelihood of complying with lower spending across wages, transfers and goods and services within the 2025 budget.
The bounce in bond prices this week shifts El Salvador total returns back into positive territory month-to-date with still favorable expectations of low beta and high carry returns throughout this year. The low execution risks of an IMF program should lower the volatility with the total returns, shifting towards carry and a slow path toward credit rating upgrades. The current valuations already fully reflect the current ‘B’ ratings with lower yields a function of the gradual fiscal consolidation that will allow for lower debt ratios.
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