El Salvador’s default-threatening political gridlock may find IMF solution

18 August 2016

by Pablo Dominguez, and Mariana Santibanez

 

El Salvador’s FMLN party-led government may find the International Monetary Fund (IMF) an ally in overcoming a political impasse that is pushing the Central American sovereign to the edge of a debt payment default. Bondholders and the country’s main opposition party want the multilateral to play a supervisory role in the government’s fiscal policy, a congresswoman and a buysider said.

 

“The IMF can oversee that the [fiscal] goals to avoid a default are met,” congress member Carmen Elena Calderon told Debtwire. Calderon, secretary of the parliament’s treasury and budget committee, is a member of the Arena opposition party, the largest block in congress.

 

The country’s Supreme Court recently confirmed the overturn of a 2015 law that had granted the government permission to issue up to USD 900m in international bonds for a much-needed refinancing of short-term debt. In anticipation of this definitive setback, the government introduced earlier this year another proposal to issue USD 1.2bn in bonds.

 

In order for a law approving a bond issuance to be passed, it needs to gather the support of at least two-thirds of the El Salvador 84-member congress. The left-wing FMLN, however, only holds 31 seats, and needs the votes of Arena’s 35 members.

 

Along with the bond issuance, parliamentary approval of financing totaling USD 571m from the World Bank, Inter-American Development Bank (IDB) and Central American Bank for Economic Integration (CABEI) has also been halted, according to Calderon.

 

With the goal of overcoming the political stalemate, the FMLN government and Arena have created a bipartisan dialogue group, Calderon noted. The group has held three or four meetings so far, added Calderon, one of Arena’s three members in the group.

 

“They [the government] were forced to sit down with us because they need 56 votes,” Calderon noted, referring to the approval of the bond issuance and the multilateral financing.

 

However, Arena’s potential support for the government’s debt plans likely won’t come for free.

 

“They will need to accept our conditions in order for the bond issuance to be approved,” Calderon asserted.

 

The government and Arena are currently negotiating a new law for fiscal responsibility, according to Calderon. Officials will present a draft of the law during a meeting of the bipartisan group scheduled for Friday, Calderon said. During the following week, both parties will analyze the draft and will present their respective comments at a meeting to be held Friday, 26 August, she added.

 

As a prerequisite for the approval of the law for fiscal responsibility, Arena is demanding that the government agree with the IMF on an austerity program, with specific adjustments. Although Calderon said that it’s the government’s role to decide where the adjustments will be made, Arena is advocating a cut in public servants’ salaries. Arena also seeks new measures to spur growth, as well as details on the investment plan through the end of the presidency term, she added.

 

“In order to get the international issuance, they [El Salvador’s government] need to have an agreed framework that is enforceable to a degree, and to do that they need to have an IMF agreement,” Andrew Stanners, EM debt portfolio analyst at Aberdeen Asset Management, told Debtwire. “The [Arena] opposition party probably won’t let them issue until they sign with the IMF – so they can’t issue until the opposition is satisfied,” Stanners added.

 

However, it’s unclear whether the government is in ongoing talks with the IMF.

 

“We have requested that the government be in contact with the IMF, but we don’t know whether they are,” Calderon said. “It doesn’t have time left – the [2017] budget must be presented in September, and we won’t accept a budget that includes [fiscal] lies.”

 

Nelson Fuentes, director for economic and fiscal policy at the Ministry of Treasury, didn’t return a query for comments. Fuentes was part of a group assisting a delegation of the IDB last week, according to an official at the ministry.

 

Even if the government and the IMF reach an agreement, it will be critical to know the specifics of the deal, according to Calderon and Stanners.

 

“Basically, we need to know what the program looks like and make sure the opposition is happy,” Stanners said. “In the longer term, this program is expected to last until the next elections and that will provide El Salvador with the ability to come to the market.”

 

Risk of default as local market debt options get exhausted

 

Due to its inability to sell bonds in the international market, the government has lately resorted to the issuance of short-term notes in the domestic market, known as LETES. The amount of outstanding LETES is USD 950m, according to Calderon and Stanners.

 

“The interest rate charged on the LETES started going up because of the amount of debt outstanding, and pressure is starting to build once they pushed above USD 800m,” Stanners said.

 

Although El Salvador has reserves to make payments on USD-denominated debt, the sovereign is running out of people from whom it can borrow, according to Stanners.

 

The government can still borrow locally for another year, but there have been rising concerns that the political block to the issuance of international bonds is leading to the potential for some kind of technical default, Stanners added.

 

“The problem is that LETES repayments are approaching and they [the government] don’t know how to service them,” Calderon warned. “Payments are due during the last months of the year, and there’s no money available for that.”

 

Bonds jump on expectation of IMF deal

 

Despite the political deadlock, El Salvador international bonds rallied in the past few months. The USD 1bn 7.65% senior unsecured bonds due 2035, for example, have jumped from 85 as recently as 23 May to 104.95 today, to yield 7.165%, according to MarketAxess. At the front end of the curve, the bond with the closest maturity, due 2019, is yielding less than 5%.

 

Moody’s cut El Salvador’s rating to B1 from Ba3 earlier this month, and put the rating on review for further downgrade. S&P and Fitch rate El Salvador B+.

 

“The IMF announcement is a game changer,” Stanners said. “The prospect of an IMF program with some fiscal consolidation and the subsequent issuance has resulted in a very strong rally.”

 

Should the government finally reach an agreement with the IMF, the market would be “relatively supportive” and the borrower wouldn’t have problems to issue the bonds, according to Stanners.

 

“They have a long maturity curve and they probably want to keep liabilities a long way away,” Stanners said. “In terms of pricing, they should roughly price to where the El Salvador curve is,” with some concession, he added.