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El Salvador is Likely to Default on Debt Payments as Bitcoin Bleeds

The experiment in El-Salvador to make bitcoin a legal tender encountered a hurdle. The price of the most popular cryptos globally has dropped more than 50% from all-time highs.

This has happened due to the slump in global markets triggered by the uncertainty over the war in Ukraine, growing inflation, and the US Federal Reserve’s decision to hike interest rates.

Because of these developments, the government of El-Salvador’s bonds is now trading at 40% of their original value. Investors have now begun to mistrust its ability to meet its next debt payment.

President Nayib Bukele of El-Salvador stated in September that the country would be the first in the world to accept bitcoin as lawful currency alongside the US dollar. Rating agencies warned that the cryptocurrency’s volatility would wreak havoc on the country’s already precarious public finances.

But Bukele was undeterred. He said in October that the state had spent approximately $25 million on bitcoin. The American rating agency, Fitch, warned the following month in a report that widespread use of bitcoin has been limited by its intrinsic price swings, the local banking sector’s poor financial inclusiveness, and the absence of widespread internet availability.

Despite its low acceptance rate, making bitcoin legal currency had an instant effect on this Central American country. The International Monetary Fund (IMF), which could help the Bukele government meet its next international debt payment in January 2023, has encouraged the country to eliminate bitcoin as a legal tender because it exposes state coffers to cryptocurrency price volatility. The IMF’s negotiations with Bukele were hindered by his insistence on preserving it as legal tender.

El- Salvador’s plummeting ratings

The market’s ups and downs and the deterioration of El-Salvador’s institutions prompted numerous credit rating agencies to downgrade the country’s rating. The market mostly utilizes these ratings to gauge the possibility of debt default.

A low grade means the government must pay higher interest rates to creditors since it is deemed a larger risk. A credit rating of CCC referred to in the industry as “junk” hinders a country from accessing international markets to issue additional debt.

El Salvador’s credit rating was lowered to the CCC category by Fitch in February, and Moody’s did the same in May.

Fitch gave the following reasons for the downgrade:

  1. Growing dependence on short-term debt
  2. An $800 million Eurobond payback is due in January 2023
  3. A large budget deficit
  4. Limited opportunity for new local market financing
  5. Uncertain access to extra multilateral funding, and
  6. High borrowing rates.

As per Fitch, the debt-to-GDP ratio is predicted to climb to 86.9% in 2022, further growing concerns about medium-term debt sustainability.

The researcher also claimed that weakening institutions and the centralization of power in the president had exacerbated policy uncertainty. The endorsement of bitcoin as legal tender has raised doubts about the IMF’s capacity to unlock funds for 2022-2023.

Moodys, another important rating and analysis agency, has also cautioned in May about the situation in Al-Salvador. Even if the Al-Salvadorian government manages near-term financing challenges from the upcoming 2023 bond maturity, the sovereign will continue to suffer funding pressures. This will jeopardize the country’s ability to discharge its debt obligations completely.