El Salvador: Moody's Upgrades Debt Rating

The key factor driving the rating upgrade is the significant reduction of the government liquidity risks, as political agreements have led to Congress´approval of long-term government financing and pension reform.

Monday, February 26, 2018

Risk rating firm Moody's announced on Friday, February 23 that El Salvador's debt was rated B3, which represents an improvement from the previous rating of Caa1. However, the country is still considered an issuer with risk of not fulfilling its obligations. 

While Caa1 meant 'substantial risk', B3 indicates that buying debt issued by El Salvador is considered a 'highly speculative' investment. 

From a statement issued by Moody's:

New York, February 23, 2018 -- Moody's Investors Service ("Moody's") has today upgraded the Government of El Salvador's long-term issuer and senior unsecured debt ratings to B3 from Caa1. The outlook remains stable.

The key factors driving the rating upgrade are:

1. Significantly reduced government liquidity risks as political agreements have led to legislative assembly approval of long-term government financing and pension reform.


2. Materially diminished risk that political brinkmanship would lead to missed debt payments.

The stable outlook on El Salvador's B3 rating reflects balanced risks. On the upside, now that liquidity risks have diminished, El Salvador's credit profile fundamentals will assume a greater significance. Moody's expects the debt-to-GDP ratio to stabilize this year as a result of improved fiscal dynamics following the approval of pension reform and economic growth above potential. On the downside, debt will stabilize at a higher level relative to the median of B-rated peers. Although high liquidity risks have materially subsided, medium-term rollover risks persist as an agreement in the legislative assembly to refinance an upcoming bond payment due in December 2019 is still pending.

Moody's has also raised the long-term foreign-currency bond ceiling and the long-term foreign-currency deposit ceiling to B1 from B2. The short-term foreign currency bond and deposit ceilings remain unchanged at Not Prime. These ceilings act as a cap on ratings that can be assigned to the foreign-currency obligations of entities domiciled in the country.

RATINGS RATIONALE
RATIONALE FOR UPGRADE TO B3
SIGNIFICANTLY REDUCED GOVERNMENT LIQUIDITY RISKS
Government liquidity risks are significantly lower because the legislative assembly approved $350.1 million in long-term financing to cover the government's needs in 2018, in tandem with approving the $5.5 billion budget in January.

During 2016-17, failures to reach meaningful agreements between the two main political parties to issue long-term debt raised government liquidity risks -- a qualified (two-thirds) majority in the legislative assembly is required for long-term debt approval. As a result, the government was forced to prioritize debt-service payments over other spending, under-execute its budget and incur arrears with suppliers. Additionally, the government had to increasingly rely on short-term debt (LETES) to cover its financing needs (which does not require legislative approval), testing local banks' capacity to absorb additional amounts of government paper.

After an agreement was reached on this year's budget and its financing, the government will no longer have to rely on these measures to meet its payment obligations. Moreover, contrary to what had been observed in the past, this year's budget does not underestimate expenditure or excludes revenue or expenditure accounts and incorporates realistic financing needs. In the past, budgets were artificially balanced to avoid the need to request approval for long-term debt issuance in the assembly. This year $350 million in long-term financing was approved to cover the 2018 deficit as part of the budget negotiations. The government is negotiating with a multilateral development bank a loan in budgetary support to cover this amount.

The likelihood that banks will have to absorb additional amounts of short-term debt (LETES) has considerably diminished. The headquarters of many Salvadorian banks are no longer requesting that local banks reduce their LETES exposure and banks are willing to maintain their exposures. LETEs peaked at $1.07 billion in December 2016 but have come down standing at $745 million as of December 2017. The government is now exploring a solution to retire part of the outstanding LETES to reduce the interest expense.
Moody's expects the government and the opposition will reach an agreement later this year or in early 2019 to approve long-term debt issuance to refinance the $800 million bond due in December 2019.

MATERIALLY LOWER RISK THAT POLITICAL BRINKMANSHIP WILL LEAD TO A MISSED DEBT PAYMENT
Political conditions that led to animosity between the main political parties and prevented agreements in the legislative assembly have taken a turn for the better. Despite being in the middle of legislative elections campaigning, El Salvador's political environment has become less confrontational and the views of the government and the opposition are much more aligned when it comes to fiscal and debt management. Political parties have been working together despite their differences, reaching agreements on pension reform (September 2017), long-term debt issuance (October 2017) and, more recently in January 2018, approval of this year's budget and its accompanying financing.

Moody's believes this shift in political dynamics was prompted by the missed pension-related payment in April 2017, its market consequences, and the determination of the government and the opposition to avoid another similar episode. The passage of pension reform broke the long-standing political impasse and facilitated the subsequent legislative agreements, particularly because it reduced fiscal deficits and made budget negotiations less difficult.

Lastly, the Constitutional Court played a role in forcing the parties to reach agreements in the legislative assembly. Two court rulings from July 2017 forced the government to fund pension-related obligations and blocked one of the avenues the government was pursuing to increase funding options without having to negotiate in the assembly.

RATIONALE FOR THE STABLE OUTLOOK
The stable outlook indicates risks to El Salvador's rating are balanced. On the upside, the pension reform will reduce pension-related government spending by around 0.9% of GDP annually, moving the fiscal deficit toward 2.5% of GDP in the coming years from 3.3% in 2015, according to Moody's estimates. Fiscal savings associated to pension reform will be lasting, as well as targeted cuts in energy subsidies implemented in 2016. Coupled with moderately stronger economic growth, this should contribute to improve the debt trend. As a result, the rating agency expects the debt-to-GDP ratio to stabilize around 62% of GDP in 2018. On the downside, debt will stabilize at a higher level relative to the median of B-rated peers (estimated at 57% of GDP) and even though liquidity risks have subsided, medium-term rollover risks remain as there is still an agreement pending in the assembly to refinance an upcoming bond payment due in December 2019.

WHAT COULD CHANGE THE RATING UP
Upward pressure on the B3 rating could come from continued fiscal restraint that could lead to a declining trend in debt metrics. Sustained economic growth, above El Salvador's potential rate of 2%, would also support an improvement in the sovereign's credit profile. A track record of political agreements in the legislative assembly that further eases liquidity risks would add positive pressure to the rating, particularly if related to approval of debt issuance to refinance upcoming debt payments.

WHAT COULD CHANGE THE RATING DOWN
Downward pressure on the B3 rating could come from a return of political confrontations as it would constrain government access to long-term financing, potentially compromising the refinancing of upcoming debt maturities. Signs that fiscal trends deteriorate and debt metrics continue to rise would also add negative pressure to the rating.

More on this topic

El Salvador Still at Risk of Default

August 2017

El Salvador's 'CCC' Long-Term ratings reflect Fitch's assessment that political polarization complicating the sovereign's ability to meet its financing gap for 2017-2018, continues, highlighting the risk for default.

From a statement issued by Fitch Ratings:

Fitch Ratings-New York-28 July 2017: Fitch Ratings has affirmed El Salvador's Long-Term Foreign and Local Currency IDRs at 'CCC'.

Moody's Downgrades El Salvador

November 2016

Arguing a significant increase in liquidity risk and political divisions that are preventing approval of an issuance of long-term debt, the rating agency has downgraded the rating and changed the outlook to negative.

From a press release issued by Moody's:

New York, November 07, 2016 -- Moody's Investors Service has today downgraded El Salvador's issuer and long-term debt ratings to B3 from B1 and assigned a negative outlook to the ratings, concluding the review for possible downgrade initiated on 11 August.

El Salvador: Moody's Downgrades Rating to B1

August 2016

The government's inability to stop the growth of debt in the context of low economic growth and a high fiscal deficit is the reason for the reduction in the rating.

From a press release by Moodys:

New York, August 11, 2016 -- Moody's Investors Service has today downgraded El Salvador's issuer and debt ratings to B1 from Ba3 and placed the ratings on review for further downgrade.

Moody's Changes Outlook on El Salvador's Ratings from Stable to Negative

November 2015

Moody's has changed the outlook of the sovereign debt rating from stable to negative, noting the limited ability of the government to control the increased public spending and the high fiscal deficit.

From the press release by Moody's:

New York, November 19, 2015 -- Moody's Investors Service has today affirmed El Salvador's Ba3 foreign currency issuer and senior unsecured ratings and changed the outlook to negative from stable.

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