Cryptocurrency crash leaves El Salvador with no easy way out of deepening crisis

Reuters accounts show that El Salvador’s big bet on bitcoin, which the Central American country has been buying since September, has soured in recent weeks as the cryptocurrency’s defeat shaves more than a third of the value of the government’s holdings.

Under the leadership of populist president Neb Bukele, a vocal purported coin fan, El Salvador has done everything on Bitcoin, not only becoming the first country in the world to adopt it as a legal tender but also drawing up plans for a volcano-powered crypto-mining center and planning to issue its first sovereign bond linked to the coin.

With global borrowing costs rising and large debt repayments on the horizon, El Salvador is experiencing financial problems other than the effect of a currency swoon. But the crypto slump has also closed some potential slopes from the crisis, including the now-deferred bitcoin bond.

“The government’s financial problems are not because of bitcoin, but have been made worse by bitcoin,” said Ricardo Castaneda, chief economist and country coordinator for El Salvador and Honduras at the Central American Institute of Fiscal Studies (ICEFI). For the government, he said, “Bitcoin is no longer a solution and has become part of the problem.”

Bitcoin is down 45% since El Salvador officially adopted it in early September, and 26% from its May highs as crypto assets were swept away in a risk-free investment environment.

The combined market capitalization of all cryptocurrencies recently fell to $1.2 trillion, less than half what it was last November, based on data from CoinMarketCap.

El Salvador’s debt reached $24.4 billion in December, from $19.8 billion at the end of 2019, after the Bukele administration committed millions of dollars to dealing with the COVID-19 pandemic and its economic impacts over the past two years.

The International Monetary Fund estimates that the current account deficit related to remittances and an externally dependent economy will fluctuate near $2 billion through 2025.

But the adoption of bitcoin has caused friction with multilateral lenders such as the International Monetary Fund, with Finance Minister Alejandro Zelaya saying last year that the government was seeking $1.3 billion.

The fund recommended that El Salvador give up Bitcoin completely. An International Monetary Fund official said on Wednesday that any credit line transaction must address risks including “those related to the adoption of bitcoin as legal tender as well as risks related to economic governance.”

Rating agencies have warned that bitcoin adoption could facilitate money laundering, and more importantly, bitcoin’s risk gave bond investors another reason to demand higher returns.

As of Wednesday, they were seeking a record high premium of 2,445 basis points on US Treasuries.

Bukele’s moves to centralize power, from dismissing all of the country’s top justices to a mandate to seek immediate re-election despite constitutional term limits, helped raise the risk premium.

According to Siobhan Morden, Latin America Head of Fixed Income Strategy at Amherst Pierpont, “If there is no potential for Bitcoin dividend growth or innovative Bitcoin funding, Bukele management will have to prioritize spending and select financing options.”

Reuters’ calculations of a paper loss of $36 million in bitcoin, enough to make at least some coupon payments, are based on Bukele’s tweets and an estimate of prices on the dates of purchase. The government spent about $104.2 million on 2,301 coins that are now worth $67.9 million just using Wednesday’s volume-weighted average price.

The country must provide $329 million in interest on its international bonds this year in addition to $800 million in bonds due in January.

Castaneda ICEFI listed financing options including Central and Latin American development banks – CABEI and CAF, respectively – as potential reforms to fund the $800 million installment due in January. Another option, he said, is to nationalize the country’s pension fund to cover the fiscal deficit – which can be done by transferring the public’s savings to a government account.

Polina Kordiavko, head of emerging markets at BlueBay Asset Management, said El Salvador’s debt restructuring is “inevitable” if the country continues its “current policy mix.” “The debt in El Salvador can be sustained with the right program (the International Monetary Fund). But they have to act now.”

The country’s finance minister, Zelaya, declined to comment for this story.

El Salvador’s bonds are trading between 43.5 cents and 34 cents on the dollar excluding a January maturity of 75 cents, reflecting cautious optimism that the country might pay that amount back.

The cost of insuring investors against defaulting on El Salvador’s sovereign debt over the next five years on Wednesday hit its highest level since 2020, according to Standard & Poor’s Global data.

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