The Big Idea
El Salvador | Event risks
This material is a Marketing Communication and does not constitute Independent Investment Research.
El Salvador hasn’t completed an International Monetary Fund board review within six months or reached composite ‘B/B2’ credit ratings. The shortfall on these tests as of April 3 would allow for a step up on the April 17 coupon payment from an annualized 0.25% to 4%. This isn’t much of a higher financial burden since the coupon payment increases from $2 million to $20 million. And the weak IMF relations seem more an inconvenience with the markets looking for maximum policy flexibility at a moment of heightened external risk. The backstop of IMF support provides a buffer against external contagion and could explain the difference between the performance of Honduras and El Salvador last month, two similarly rated credits with IMF programs.
Eurobonds were unscathed on the trigger from the macro test for a step-up annual coupon from 0.25% to 4%. Maybe this is because the event risk has already been well discounted after months of discussion and full adjustment of IO bond prices to almost two full payments at the higher coupon. There is also the important differentiation between external contagion versus IMF relations with the former much more relevant. The IMF relations are important, especially for broadening the policy buffers to immunize against external contagion and lowering the market beta. But it is the actual external contagion itself that is more impactful than the market beta. This is why El Salvador is now the full beneficiary to the turnaround in external risk with a short covering bounce to start the month.
The negative event risks now may shift to positive event risks ahead of the IMF spring meetings. The topic of the IMF program should dominate every investor discussion. This should provide the opportunity to reassure investors about the motivations from both sides to quickly reconcile. It’s also important to recognize why these relations have reached an impasse. There shouldn’t be much if any flexibility on the Bitcoin restrictions but, conversely, there should be flexibility to relax the timeframe for pension reform (considering higher sensitivity of the economy to the oil shock ahead of elections). This current impasse doesn’t seem like relevant ‘deal risk’ considering the reputational losses for both sides on a program cancellation versus the benefits of program success to expedite credit rating upgrades and FDI inflows. It’s also important to remember that the fiscal adjustment represents the crux of any IMF program. This is where there has been clear success for the frontloaded 1.9% of GDP fiscal adjustment last year.
The IMF technical assistance and positive spillover to investor sentiment would be useful considering the context of a protracted oil shock with downside risks to growth. This is particularly relevant on a more difficult phase of the fiscal adjustment process with a high dependence on cyclical revenues and difficulty for more pro-cyclical spending cutbacks into an election cycle. This growth-friendly adjustment strategy should motivate for a resolution.
The latest fiscal data from January through February will require a considerable primary surplus for March to meet the first quarter 2026 target. The adjustment mechanism has typically been capex but will also probably require cutbacks to current spending considering the need to bridge a $112 million primary surplus in Jan-Feb to $300 million in the first quarter of 2026. This fiscal performance will become even more critical if there isn’t a resolution to the impasse at the month end release of the March fiscal data. There is less room for error under weak investor sentiment. Similar to the success of meeting the quarterly targets last year, there should commitment to meet the program targets this year.
The follow-through recovery on El Salvador credit risk will require a supportive external backdrop as well as confirmation of IMF negotiations and follow-through success on meeting the fiscal targets next month. If we assume goodwill on both sides, then the IMF Spring meetings should provide the opportunity to reassure investors. There is still excess risk premium on referencing El Salvador to B/BB rated regional peers, especially oil importers like Honduras and the Bahamas. The unwind of the IMF deal risk should allow for recovery back to early March levels (when IO bonds traded at lower levels and El Salvador traded at tighter valuations relative to peers).
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