Will El Salvador default on its sovereign debt in 2023? – Cryptocurrencies

*By Franki Muci

Because of El Salvador’s $800 million sovereign bond due January 2023 and an implied probability of default of 48%, international financial markets think there is a chance that the Central American country will stop scheduled payments in eight months, just over a year after adopting Bitcoin (BTC) as legal tender.

El Salvador has stubbornly low economic growth, a large fiscal deficit, and nearly 90% of GDP in expensive public debt (costing 5% a year compared to 1.5% in the US). Without major changes in economic policy, the country risks a dangerous default.

Most practitioners and academics agree that sovereign default has great costs. This is especially true in dollarized countries like El Salvador, where non-government payments can trigger a bank run. As in other emerging markets, local banks, insurance companies and pension funds in El Salvador have a lot of domestic debt and some foreign government debt on their balance sheets.

Even if President Nayib Bukele’s government only defaulted on the country’s external debt, the domestic debt would become riskier (and less valuable), causing price-marking losses on both types of bonds, which would eat into the debt protections of banks and would damage balance sheets throughout the financial system.

In this scenario, a large minority of Salvadorans may want to deposit their dollars in cash or safe US banks rather than relatively riskier domestic banks. Large withdrawals or outflows of cash to the US can damage domestic banks’ liquidity and potentially drive weaker banks into insolvency. El Salvador’s monetary authority cannot print US dollars to calm panic or bail out failed institutions (only the Federal Reserve, the US central bank, can), so the Fed would have to use its limited reserves worth $3, 4 billion – or 12% of the country’s GDP – to manage stress.

Given the risks and costs of sovereign default, it makes sense that El Salvador wants to keep paying. The government seems eager to continue servicing the debt, at least for now. In March, the country’s finance minister, Alejandro Zelaya, insisted the nation’s default risk “is zero” and said the government remains committed to paying in all scenarios.

On Monday (13), Zelaya said that not even the drop in Bitcoin, which caused El Salvador’s crypto reserves to drop to $46.2 million – less than half of the $104 million the country invested in cryptocurrency over the course of the year. over the last 10 months – affect the country’s fiscal position.

President Nayib Bukele has announced 10 BTC purchases since September 2021, holding a total of 2,301 Bitcoins purchased at an average price of $45,171. The most recent purchase was on May 9, when Bukele bought 500 coins for $15.3 million, or an average price of $30,744 each. Zelaya said that this amount is less than 0.5% of the government budget. He also stated that any losses so far have not been realized because the country has not sold any of its currencies.

Bukele aims to be re-elected in two years, in June 2024, and to rule for another five years after that. His approval ratings are sky-high (85%) and his control over the media and legal system is increasing, virtually guaranteeing a victory at the polls.

Bukele’s options

Bukele’s management has issued more than a quarter of all foreign bonds, selling $1.1 billion worth of notes in 2019 and $1 billion in 2020. If Bukele starts to run out of cash and has to default, he could do so in 2025, when another $800 million major title wins. But for now, at least El Salvador can probably keep paying.

Otherwise, Bukele could simply get a program with the International Monetary Fund (IMF) and raise hundreds of millions of dollars in cheap financing to finance the government, which the IMF would gradually disburse in exchange for reforms.

The IMF would likely call for fiscal consolidation – tax increases and spending cuts – and then the debt-to-GDP ratio would tend to fall over the medium term. It would also require crypto reform, amending the Bitcoin Act to contain macro risks. All of this is doable – because of Bukele’s popularity and his overwhelming majority in Congress. Furthermore, it is its heavy security policy that has made it extremely popular, not the Bitcoin Act, which may change with limited political repercussions.

More speculatively, El Salvador may get some funding from major players in the crypto space, the so-called “whales”, who want to keep alive the idea of ​​“the adoption of Bitcoin (as legal tender) by a nation-state”. Stablecoin issuer Tether, cryptocurrency exchange Bitfinex or others could extend support with a direct loan to the government, buying domestic bonds or simply depositing US dollars with banks in El Salvador, which institutions could use to buy government debt.

For now, the country has options. Not great options, but they do exist. All of this leads me to conclude that El Salvador is unlikely to default in 2023.

*Franki Muci is a member of the LSE School of Public Policy. His research interests include economic growth policy and public finance management.

About Yadunandan Singh

Born in 1992, Yadunandan approaches the world of video games thanks to two sacred monsters like Diablo and above all Sonic, strictly in the Sega Saturn version. Ranging between consoles and PCs, he is particularly fond of platform titles and RPGs, not disdaining all other genres and moving in the constant search for the perfect balance between narration and interactivity.

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