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

* Leek Franki Muci

Due to El Salvador’s $800 million sovereign bond maturing in January 2023 and an implied probability of default of 48%, international financial markets believe there is a chance that the country of America central halts scheduled payments in eight months, just over a year after Bitcoin’s adoption (BTC) as legal tender.

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

Most practitioners and academics agree that sovereign default has high costs. This is especially true in dollarized countries like El Salvador, where non-governmental 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 public debt on their balance sheets.

Even if President Nayib Bukele’s government only defaulted on the country’s external debt, domestic debt would become riskier (and less valuable), leading to price losses on both types of bonds, which would undermine the protection of bank debt and harm the balance. leaves throughout the financial system.

In this scenario, a large minority of Salvadorans might want to deposit their dollars in cash or in safe US banks rather than relatively riskier domestic banks. Large cash withdrawals or outflows to the United States can harm the liquidity of domestic banks and potentially drive weaker banks into insolvency. El Salvador’s monetary authority cannot print US dollars to calm panic or bail out failing institutions (only the Federal Reserve, the US central bank, can), so the Fed would have to use its limited reserves to worth $3.4 billion – or 12% of the country’s GDP – to manage stress.

Given the risks and costs of a sovereign default, it makes sense that El Salvador would want to keep paying. The government seems keen on continuing to service the debt, at least for now. In March, the country’s finance minister, Alejandro Zelaya, insisted that the country’s default risk “is zero” and said the government remained committed to paying out under all scenarios.

On Monday (13), Zelaya said that 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 has invested in crypto -currency over the year over the past 10 months – affect the country’s fiscal situation.

President Nayib Bukele announced 10 purchases of BTC 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 purchased 500 pieces for $15.3 million, an average price of $30,744 each. Zelaya said this amount represents less than 0.5% of the government budget. He also said that so far no loss has been realized as the country has not sold any of its currencies.

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

Bukele options

Bukele’s management 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 in major titles won. But for now, at least El Salvador can probably keep paying.

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

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

More speculatively, El Salvador could obtain 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 state- nation”. ”. Stablecoin issuer Tether, cryptocurrency exchange Bitfinex or others could expand their support with a direct loan to the government, buying domestic bonds or simply depositing US dollars with banks in El Salvador, which the institutions could use to buy government debt.

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

*Franki Muci is a Fellow of the LSE School of Public Policy. His research interests focus on economic growth policy and public financial management.

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