The Big Idea
El Salvador | Higher beta
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The recent spike in oil prices is clearly inconvenient for El Salvador’s budget and broader economy, but this shouldn’t overcomplicate policy management. There are buffers in strong remittances, US preferential trade access and higher domestic liquidity. There are also no external market funding needs or channels to domestic financial market contagion from global financial markets. More clarity in relations with the International Monetary Fund would help reduce the sovereign’s market beta and remains my base case scenario.
There has been a reassessment of Central America’s vulnerability to external shocks, especially to a spike in oil prices. As a net energy importer, its external and even fiscal accounts—depending on subsidies—are clearly vulnerable. Oil imports represent 13% of El Salvador’s total imports and around 0.3% of budgeted subsidies for 2025 with ultimately some potential impact on growth under dollarization and on the IMF’s fiscal targets.
But there are buffers. Remittances still remain a source of liquidity on a stock and flow basis after the accumulation of bank deposits through last year. This has translated into a surge in domestic investment into primary construction and growth of 3.4% year-over-year in 2025 compared to 1.8% in 2024 and 2.5% trend growth. Workers remittances are still above trend at 12% year-over-year in January against 17.8% year-over-year in 2025 and 2.5% year-over-year in 2024. El Salvador was also the first country in the western hemisphere to negotiate a reciprocal tariff agreement with the US with leading indicators of potential foreign direct investment inflows. There is also a slower pace of fiscal adjustment after frontloading 1.9% of GDP in 2025 with another 1.1% of GDP consolidation programmed for this year. The less external supportive environment may add some policy stress, but the Bukele administration has already shown its commitment fiscal adjustment through last year,
Funding needs remain low with reliance on multilateral funds this year and the local markets. The local banks now have broader access for liquidity on reducing their exposure to sovereign debt from 12.5% to 9% of bank assets. However, the base case remains for fiscal adjustment and lower overall gross financing needs and broader credit to the private sector. There are no plans to revisit Eurobond markets until 2027. The small stock of Eurobonds outstanding also should discourage the correlation trade to external risk (relative to benchmark liquid credits). There is also the segmentation of local markets with no cross-border flows that would spillover to domestic financial contagion to the real economy.
El Salvador bonds are now back at recent worst absolute and relative value levels with underperformance to similarly illiquid but higher rated credits like Honduras and the Bahamas. This higher market beta is understandable for the lower credit ratings and the vulnerability of the Central American credits to the shock on oil prices. However, the oil price shock may only be temporary with optionality for lower structural prices under the context of more stable political regimes from oil producing nations. The reaffirmation of IMF relations could also provide an anchor to reassure against external shocks to reassure for effective policy management and lower market borrowing needs. The still low credit ratings remain a disadvantage against external uncertainty with a faster track for rating upgrades dependent upon the successful IMF program through March 2028.
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