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Rating Action:

Moody's changes outlook on El Salvador's ratings to positive from stable; affirms B3 ratings

 The document has been translated in other languages

12 Mar 2020

New York, March 12, 2020 -- Moody's Investors Service, ("Moody's") has today changed the outlook on the Government of El Salvador's ratings to positive from stable. Concurrently, Moody's has affirmed the B3 issuer and long-term senior unsecured debt ratings.

The key factors driving the change in outlook are:

1. Materially reduced government liquidity risks

2. Improved business conditions that could lift private investment and economic growth

The affirmation of El Salvador's B3 sovereign ratings reflect high government debt ratios and a rising interest burden, as well as our view that El Salvador's institutions remain weak, given low fiscal policy effectiveness, in relation to its fiscal responsibility law, and weak rule of law. Persistent domestic security challenges as well as a history of political confrontations between the executive and legislative branches are incorporated into the current rating. El Salvador's B3 ratings also reflect economic dependence on remittances and low-value added exports to the US. Dollarization eliminates the risk of exchange rate shocks to the government balance sheet, but limits the authorities' policy options.

The long-term foreign-currency bond ceiling and the long-term foreign-currency deposit ceiling remain unchanged at B1. The short-term foreign currency bond and deposit ceilings remain at Not Prime.

RATINGS RATIONALE

RATIONALE FOR THE POSITIVE OUTLOOK

FIRST DRIVER: MATERIALLY REDUCED GOVERNMENT LIQUIDITY RISKS

The new administration was able to secure the necessary votes in the legislative assembly to pass its budget proposal last December and also to contract long-term debt to fund this year's fiscal deficit. This was a significant development since President Nayib Bukele, who took office in June 2019, has only a small party representation in the legislative assembly and a two-thirds majority vote is required to secure long-term financing.

For three consecutive years (2018-20), under two different administrations, the executive and the legislative branches have demonstrated they can work together to approve fully-funded budgets. In the past, animosity and political differences prevented parties from reaching agreements that were required to authorize budgets and long-term financing. This condition led to increased liquidity risks as it forced the government to issue higher amounts of short-term debt (LETES), prioritize payments and ultimately tested local banks' capacity to absorb rising levels of LETES.

Government liquidity risks are now significantly lower as the government is able to issue long-term debt in global financial markets and, consequently, has a reduced need to rely on LETES for budget financing. LETEs have hovered around $800-900 million for two years, although they reached $1 billion this January. Additionally, El Salvador faces a relatively benign debt amortization schedule over the next few years with not large debt payments coming due until 2023. Long-term debt amortizations will amount to about $500 million (1.8% of GDP) annually in 2020-22 and will increase in 2023 with a $1.1 billion (4.0% of GDP) Eurobond payment coming due that year.

SECOND DRIVER: IMPROVED BUSINESS CONDITIONS THAT COULD LIFT PRIVATE INVESTMENT AND ECONOMIC GROWTH

El Salvador's relatively weak economic growth over the past decade, with GDP increasing at an average annual rate of 2.4% in 2010-19, is in part attributable to low investment rates which at 15% of GDP in 2010-19 compare with the B-rated median of 23%.

The new administration has taken steps to jumpstart private investment. In addition to improved dialogue with the business community, the authorities have reduced red tape and regulatory bottlenecks in order to improve business conditions. The government set up a new ministry dedicated to facilitate private sector investment, a decision that denotes an attitude which is in stark contrast with the approach followed by previous administrations.

The administration has also placed special attention in taking action to improve security. With evidence indicating that progress has been made on this front, this has been a key consideration behind companies decisions to conduct business in areas that were previously off limits.

If these initiatives are maintained, the ensuing positive momentum could support higher investment levels in the coming years contributing to lift growth above El Salvador's current 2% potential growth rate.

RATIONALE TO AFFIRM B3 RATINGS

The recommendation to affirm the B3 ratings takes into account an economy with relatively low GDP growth rates, dependent on remittances and low-value added exports to the US, in addition to historically low levels of investment. High government debt ratios and a rising interest burden are also important parts of our rating assessment. While the fiscal deficit has gradually narrowed since 2014, reflecting improvements in the primary balance, adverse fiscal trends do not support debt stabilization. The government's interest bill has risen considerably as a result of a growing debt stock, increased reliance on high-yield short-term instruments (LETES) and high risk premia. Although interest rates on LETES have fallen, we expect interest paid on pension-related debt to increase over the next few years.

The B3 rating also reflects our view that El Salvador's institutions remain weak, given low fiscal policy effectiveness, with weak compliance to their fiscal responsibility law, rule of law and security challenges and a history of political confrontations between the executive and legislative branches that in the future could prevent progress on needed reforms to address economic and fiscal challenges.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Moody's takes account of the impact of environmental (E), social (S), and governance (G) factors when assessing sovereign issuers' economic, institutional and fiscal strength and their susceptibility to event risk. In the case of El Salvador, the materiality of ESG to the credit profile is as follows.

El Salvador is significantly exposed to Environmental Risks, as its geography is dominated by a region known as the Dry Corridor, characterized by recurrent drought and heavy precipitation events that lead to flooding and landslides. The steady rise in frequency and severity of drought and other climate-related shocks pose a threat to the country's agriculture sector, which employs 21% of the country's population. As such, weather events can significantly influence El Salvador's key credit metrics, such as GDP growth volatility, household incomes and agricultural export earnings.

Social risks also inform El Salvador's credit profile. El Salvador's homicide rate is one of the highest in the Western Hemisphere and is emblematic of the country's weak domestic security, a key driver behind significant out-migration of its residents to the US. While remittances from foreign nationals supports economic activity, high levels of violence and insecurity stunt the country's investment levels, productivity and long-term growth potential.

In terms of governance, El Salvador exhibits low scores on institutional factors, as measured by the Worldwide Governance Indicators, with rule of law representing the country's most significant challenge.

WHAT COULD CHANGE THE RATING UP

Upward pressure on El Salvador's credit profile could emerge if, despite transient episodes of political tension, there is continued evidence that the executive and legislative branches are able to establish a working relationship that prevents an escalation of government liquidity risks as experienced in the past. Evidence that medium-term growth prospects are improving with economic activity reporting annual rates above El Salvador's current potential growth of 2% would also support ratings upward movement. A period of up to 18 months may be needed to assess these conditions as well as the credit impact of an evolving political landscape on government liquidity risks.

WHAT COULD CHANGE THE RATING DOWN

Downward pressure on the credit profile would emerge if there were a return of political confrontations that constrained government access to long-term financing, potentially compromising the refinancing of upcoming debt maturities. Signs that fiscal trends will continue to deteriorate and debt metrics will continue to rise steadily would also strain El Salvador's credit profile.

GDP per capita (PPP basis, US$): 8,041 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.5% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.4% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -2.7% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -4.8% (2018 Actual) (also known as External Balance)

External debt/GDP: 63.9% (2018 Actual)

Economic resiliency: ba3

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 10 March 2020, a rating committee was called to discuss the rating of the Government of El Salvador. The main points raised during the discussion were: The issuer has become less susceptible to event risks. Other views raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Ariane Ortiz-Bollin
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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