Portfolio Strategy

September 25, 2020

The Big Idea

El Salvador | Liquidity watch

Siobhan Morden | September 25, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The El Salvador carry trade suffered a setback lately, its debt vulnerable to external contagion and without an explicit International Monetary Fund anchor of the sort helping stabilize Costa Rica. Its Eurobond weakness does not translate into higher financing risks since El Salvador has already completed its financing program this year. But multilateral loan approvals have been on a slow track in El Salvador’s legislature with only $335 million of financing provided through July against $1.6 billion programmed and $1.3 billion approved by multilateral lenders.

This pipeline of funds should provide a cushion for either a carryover of funds for next year or forced adjustment for a lower fiscal deficit this year.  El Salvador would not likely default on 0.23% of GDP in coupon payments in the fourth quarter of this year, especially when there are still financing options and low rollover risks this year.  The country’s higher yields at 9% should, in itself, start to offer an anchor to its debt pricing. It has also underperformed compared to other ‘B’ credits, now trading much wider to Costa Rica and nearly converging with Ecuador.

The market stress suggests that El Salvador has lost market access, with yields close to double digits.  However, this does not translate into higher liquidity risks or rationalize the current spread premium on the curve.  The latest fiscal data through July show a 26% year-over-year surge in spending. Its counter-cyclical stimulus has gone beyond the 9.8% year-over-year loss in tax revenues for a cumulative central government deficit of 5.3% of GDP. That compares to a 1% of GDP deficit for the same period last year.

The liquidity risks are more easily managed for smaller countries with smaller gross financing needs.  There has not been sufficient transparency, and there has been much criticism on the inefficiency of budgetary management through the Covid-19 crisis.  The LETES have provided near maximum financing at $471 million, at the legal limit. And LETES has provided what appears to be just rollover financing without any incremental financing in the past few months, explaining the recent $645 million of CETES issuance under a controversial decree.  The $1 billion Eurobond issuance provided for the surge in spending for July 2020 and for a majority of the $3.6 billion financing program this year.  The financing options for the fourth quarter this year should shift back to multilateral loans or some fiscal restraint to minimize the fiscal deterioration—perhaps a deficit closer to 10% of GDP than 12% of GDP.  There has been legislative approval of only $685 million of multilateral loans against the program of $1.6 billion and legislative approval pending for the near $1 billion remaining (Exhibit 1). The financing strategy should continue to rely upon multilateral and domestic funds until after the midterm elections on February 28, 2021, when the strategy will then have to shift to a more effective solution on debt sustainability with a formal IMF program.  This suggests still positive optionality of event risk ahead of formal IMF negotiations while the Bukele administration continues to muddle through on still manageable small gross financing needs into next year.

Exhibit 1: Sources of funding for El Salvador

Source:  https://www.mh.gob.sv/downloads/pdf/700-UC-XX-2020-COV19.pdf,https://www.asamblea.gob.sv/

Siobhan Morden
Santander Investment Securities
1 (212) 692-2539
siobhan.morden@santander.us

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