Rating Action Commentary
ֳ Downgrades El Salvador's Long-Term IDR to 'CCC' from 'B-'
Wed 09 Feb, 2022 - 5:10 PM ET
ֳ - New York - 09 Feb 2022: ֳ has downgrade El Salvador's Long-Term Foreign Currency Issuer Default Rating (IDR) to 'CCC' from 'B-'.
A full list of rating actions follows at the end of this rating action commentary.
Key Rating Drivers
The downgrade reflects heightened financing risks stemming from increased reliance on short-term debt, an USD800 million Eurobond repayment due in January 2023, a still-high fiscal deficit, limited scope for additional local market financing, uncertain access to additional multilateral funding and external market financing given high borrowing costs. Furthermore, debt to GDP is expected to rise to 86.9% in 2022 after modest improvement in 2021, increasing concerns around debt sustainability over the medium term.
In ֳ's view, weakening of institutions and concentration of power in the presidency have increased policy unpredictability, and the adoption of bitcoin as legal tender has added uncertainty about the potential for an IMF program that would unlock financing for 2022-2023.
Despite the authorities stated commitment to service debt, El Salvador faces increasing risks from high and growing financing needs in 2022-2023. ֳ estimates total financing needs of USD4.85 billion in 2022 (16% of GDP), rising to USD5.4 billion in 2023 (18% of GDP). ֳ expects El Salvador's 2022 fiscal deficit to narrow marginally to 5.5% of GDP from 5.7% of GDP in 2021. Short-term debt has risen sharply over the last two years with Cetes and Letes short-term debt increasing to USD2.6 billion in January 2022 from USD896 million at YE 2019, adding to 2022 funding needs.
The government faces only USD305 million in external debt amortizations in 2022, but faces close to USD1.2 billion in 2023 (with a USD800 million Eurobond due in January 2023). ֳ estimated a financing gap of USD1.2 billion in 2022, assuming the rollover of short-term debt and nearly USD1 billion the government has identified in multilateral disbursements and pension-related debt issuance. The gap rises to USD2.5 billion in 2023.
Financing options in the local market are limited, given that the government has nearly reached the legal upper limit of USD1.6 billion in short-term Letes debt. The government has also issued almost USD1.3 billion in one-year Cetes in the local market over the last year. The local private pension funds and banks have limited appetite for increasing their exposure to such instruments. In fact, Letes auctions in January 2022 were not fully subscribed.
The large stock of short-term debt will complicate the government's debt service capacity, increasing roll-over risks. Although ֳ expects the sovereign to meet near-term debt service payments, financing constraints will become more onerous as the year progresses. The government faces a bunching of short-term debt maturities in August-October 2022, with a total of nearly USD1.3 billion due in these three months.
External financing options are also uncertain. Rates in the external bond markets are prohibitive (15%+). There is a high degree of uncertainty surrounding other sources of external financing, such as additional multilateral funding, given doubts surrounding an IMF program, as well as the capacity to issue "bitcoin backed bonds" through new distribution channels.
The government has been in extended discussions with the IMF for nearly a year for a possible USD1.3 billion three-year program; however, there are important differences between the two sides in many key areas, in ֳ's view. A deal would help cover the government's financing gap and likely unlock other multilateral loans. It would also help provide more clarity on the government's medium-term fiscal strategy.
The recently published IMF Article IV recommends a fiscal adjustment of 4pp of GDP to put the debt burden on a steady downward path, strengthening the medium-term fiscal framework, improvements in governance in reporting and audits, implementing revised anti- money laundering laws, and removing bitcoin as legal tender while improving regulation and oversight of the virtual currency system.
The 2021 improvement in the fiscal deficit to 5.7% of GDP from 10.1% in 2020 was largely a result of the sharp increase in tax revenues, which grew by 27%, reflecting the recovery in VAT and import tax receipts and successful anti-tax evasion measures. On the expenditure side, the government reduced pandemic related spending in 2021, which were partially offset by higher capital expenditures and interest costs. Debt to GDP fell to 84.5% in 2021 from 89,2% in 2020, largely as a result of the sharp rebound in economic growth.
The economy grew by an estimated 10.5%, after contraction of 7.9% in 2020, with reopening of the economy and strong remittance growth (27%). However, ֳ expects economic growth to slow significantly to 3.5% in 2022, still above potential, thereby adding to the uncertainty of the strength of future government revenue growth. The government is planning to introduce revenue enhancing measures but there is uncertainty regarding their scale and implementation.
Debt to GDP is slated to rise again in 2022 to 86.9% of GDP and continue to rise over the forecast period, raising concerns around debt sustainability over the medium term. Moreover, interest to revenues is set to rise to 20% in 2022 from 18% in 2021. However, almost 25% of the total public debt is related to pensions with low fixed rates and a captive market, as private pension funds are mandated to buy the Certificados de inversion previsional (CIP) debt.
El Salvador's ratings are supported by higher human development and governance indicators compared to peers, and history of relative macroeconomic and financial stability, anchored by official dollarization. However, high government debt, recent history of default on local pension related debt and low growth potential constrain the ratings.
ESG - Governance: El Salvador has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) has in ֳ's proprietary Sovereign Rating Model. El Salvador has a medium WBGI percentile ranking of 39.1%, reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Public Finances—Increased signs of a probable default event, such as a severe liquidity stress and reduced capacity to access financing.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Public Finances--A sustained easing of financing constraints through progress in unlocking predictable sources of financing.
Public Finances--A fiscal adjustment consistent with improvement in public debt sustainability.
Sovereign Rating Model (SRM) and Qualitative Overlay (QO)
In accordance with the rating criteria for ratings in the 'CCC' range and below, ֳ's sovereign rating committee has not used the SRM and QO to explain the ratings, which are instead guided by the rating definitions.
ֳ's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. ֳ's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within ֳ's criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit /site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
El Salvador has an ESG Relevance Score of '5' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in ֳ's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As El Salvador has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
El Salvador has an ESG Relevance Score of '5' for Rule of Law, Institutional, Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in ֳ's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As El Salvador has a percentile rank below 50 for the respective Governance Indicators, this has a negative impact on the credit profile.
El Salvador has an ESG Relevance Score of '4' for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As El Salvador has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
El Salvador has an ESG Relevance Score of '4' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for El Salvador, as for all sovereigns. As El Salvador has a fairly recent default and restructuring of public pension related debt in 2017, this has a negative impact on the credit profile.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on ֳ's ESG Relevance Scores, visit .
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Country Ceiling Model, v1.7.2 (1)
- Debt Dynamics Model, v1.3.1 (1)
- Macro-Prudential Indicator Model, v1.5.0 (1)
- Sovereign Rating Model, v3.12.2 (1)
ADDITIONAL DISCLOSURES
ENDORSEMENT STATUS
| El Salvador | EU Endorsed, UK Endorsed |