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Rating Action:

Moody's downgrades El Salvador's rating to Caa1, maintains negative outlook

30 Jul 2021

New York, July 30, 2021 -- Moody's Investors Service ("Moody's") has today downgraded the Government of El Salvador's long-term foreign-currency issuer and senior unsecured ratings to Caa1 from B3. The outlook remains negative.

The key drivers the downgrade were:

1) Market access for the sovereign is likely to remain constrained ahead of a challenging debt amortization schedule beginning in 2023.

2) A deterioration in the quality of policymaking that has intensified implementation risks to the authorities' fiscal adjustment plans and increased uncertainty about financing prospects.

The negative outlook on the Caa1 rating reflects Moody's view that the fiscal position remains vulnerable and susceptible to financing shocks that could jeopardize the sovereign's repayment capacity ahead of the challenging redemption schedule on its external market debt beginning in January 2023. Limited availability of funding alternatives for the sovereign and uncertainty surrounding the possibility of fresh financing from the International Monetary Fund (IMF) suggest that the sovereign will continue to face liquidity pressures in future years despite the authorities' willingness to enact measures to achieve further, gradual fiscal consolidation.

Concurrently, Moody's also lowered El Salvador's foreign-currency country ceiling to B2 from B1 maintaining the existing two-notch gap between the sovereign rating and the foreign-currency ceiling to reflect the deteriorating predictability of institutions and government policies, weak policy effectiveness and the government's relatively large share in the country's total external debt. Moody's does not assign a local currency country ceiling for El Salvador because the country is fully dollarized.

RATINGS RATIONALE

RATIONALE FOR THE DOWNGRADE OF THE RATINGS TO Caa1

FIRST DRIVER: MARKET ACCESS FOR THE SOVEREIGN IS LIKELY TO REMAIN CONSTRAINED AHEAD OF A CHALLENGING DEBT AMORTIZATION SCHEDULE BEGINNING IN 2023

A persistently high cost of market funding and the need to access markets to rollover maturing debt highlight risks to repayment capacity ahead of a series of external bond amortizations beginning in January 2023, given already low debt affordability metrics. High yields on the sovereign's outstanding debt issuances, illustrated by an EMBIG sovereign spread of 805 as of 28 July 2021, and a reliance on short-term domestic sources of financing have been partly responsible for the sovereign's tight liquidity position as there has not yet been a formal agreement on an International Monetary Fund (IMF) program to alleviate funding constraints, and to lend credibility and anchor market confidence such that the maturing market debt can be rolled over at sustainable rates.

Although Moody's has incorporated the potential funding flows from a possible IMF program in its analysis of El Salvador's funding prospects for 2022, the rating agency believes that even if an agreement is reached with the IMF on a financing program, issues involving the sovereign's high cost of funding are unlikely to be fully addressed by official funding flows. Elevated interest expenditures on debt service will continue to weigh on fiscal performance, constraining the sovereign's liquidity position ahead of a challenging amortization schedule. Moody's estimates indicate that the ratio of interest payment-to-government revenue was 17.8% in 2020 well above the 8.4% median for B-rated sovereigns and higher than the 13.3% median for Caa-rated sovereigns. Moreover, its projections indicate that the interest burden is likely remain above peer medians through at least 2024.

SECOND DRIVER: A DETERIORATION IN THE QUALITY OF POLICYMAKING THAT HAS INTENSIFIED IMPLEMENTATION RISKS TO THE AUTHORITIES' FISCAL ADJUSTMENT PLANS AND INCREASED UNCERTAINTY ABOUT FINANCING PROSPECTS

The sovereign's liquidity situation for 2021 has improved as a result of a 26.3% increase in central government revenues in January-May 2021 relative to the same period in 2020, reflecting a strong economic rebound supported by a 45.3% growth in remittance inflows in January-June 2021 versus the same period last year. Moody's forecasts that economic growth will be in the order of 4.5% in 2021, with upside risks from continued high remittance inflows that would support domestic demand, following a contraction of 7.9% in 2020. Despite these improved conditions, a series of policy decisions have undermined governance and institutional strength, delaying negotiations with the IMF, generating uncertainty and adding further challenges to debt sustainability and market access.

On 4 June, the government withdrew from the International Commission against Impunity in El Salvador after the Organization of American States, which established the commission to fight corruption, appointed a member of the political opposition as an advisor. Before that, on 1 May, the newly sworn-in Legislative Assembly, where President Nayib Bukele's party Nuevas Ideas holds a supermajority (56 of 84 total seats), voted to remove and replace five Supreme Court justices. More controversially, on 9 June the Legislative Assembly approved the world's first law to make Bitcoin (a cryptocurrency) legal tender in the country, such that both the US dollar and Bitcoin are now legal currency for settling transactions.

In Moody's opinion, these measures reflect weakened governance in El Salvador, raising tensions with international partners -- including the United States (Aaa stable) -- and jeopardizing progress toward an agreement with the IMF. In this context, risks associated to El Salvador's need to access sufficient external financing ahead of bond redemptions beginning in January 2023 have materially increased.

RATIONALE FOR NEGATIVE OUTLOOK

The negative outlook reflects Moody's view that risks to El Salvador's credit profile are skewed to the downside. This is based on Moody's opinion that the fiscal position remains vulnerable and susceptible to financing shocks that could jeopardize the sovereign's repayment capacity ahead of the challenging redemption schedule on its external market debt beginning in January 2023, particularly if market access remains constrained.

Although the authorities are likely to continue enacting measures to achieve further, gradual fiscal consolidation, public debt ratios remain elevated at 89.2% of GDP as of the end-2020. Given large financing needs, which Moody's estimates will be in excess of 15% of GDP in 2022, and upcoming debt redemptions in subsequent years, identifying sources of financing against a backdrop of tight liquidity will be a key credit challenge. Even if an agreement with the IMF unlocks fresh multilateral financing, implementation risks and policy missteps could undermine market sentiment, potentially increasing risks to bondholders.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

El Salvador's ESG Credit Impact Score is highly negative (CIS-4), reflecting moderate exposure to environmental risk, highly negative exposure to social risks and a very highly negative governance issuer profile score (IPS) with limited financial resilience.

El Salvador's exposure to environmental risks is moderately negative (E-3 IPS), related to physical climate change and limited natural capital. El Salvador's geography is dominated by a region known as the Dry Corridor, characterized by heavy precipitation events that lead to flooding and landslides and occasional droughts. The steady rise in the frequency and severity of droughts and other climate-related shocks poses a threat to the country's agriculture sector, which employs 16% of the country's population. Extreme weather events can influence El Salvador's key credit metrics, such as GDP growth volatility, household incomes and agricultural export earnings.

Exposure to social risks is highly negative (S-4 IPS). Despite a recent decline, El Salvador's homicide rate remains among the highest in the Western Hemisphere. While remittances from El Salvadorans living abroad support about 20% of economic activity, which boosts consumption, high levels of violence and insecurity stunt the country's investment levels, productivity and long-term growth potential.

The influence of governance on El Salvador's credit profile is very highly negative (G-5 IPS) reflecting its weak government effectiveness, rule of law and control of corruption. A deteriorating predictability of institutions and government policies also undermines the governance issuer profile score.

GDP per capita (PPP basis, US$): 8,422 (2020 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -8.5% (2020 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.5% (2020 Actual)

Gen. Gov. Financial Balance/GDP: -8.8% (2020 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.5% (2020 Actual) (also known as External Balance)

External debt/GDP: 74.% (2020 Actual)

Economic resiliency: b1

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

On 28 July 2021, a rating committee was called to discuss the rating of the El Salvador, Government of. The main points raised during the discussion were: The issuer's institutions and governance strength, have materially decreased. Other views raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

WHAT COULD CHANGE THE RATINGS UP

Steady progress on consolidating central government finances that substantially reduces financing needs and improves market access at materially lower funding rates, or multilateral funding in amounts large enough to fully cover government financing needs in 2021-23, including upcoming external market debt redemptions, could lead to an upgrade of the sovereign's rating.

WHAT COULD CHANGE THE RATINGS DOWN

Downward pressure on the sovereign's credit profile would emerge if the sovereign is unable to secure multilateral financing, including from the IMF, large enough to materially ease liquidity pressures. The persistence of funding costs at a level that compromises debt sustainability would put additional downward pressure on El Salvador's credit profile increasing the risk of losses to bondholders.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, 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 further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288435.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

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.

Jaime Reusche
VP - Senior Credit Officer
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

Alejandro Olivo
MD-Sovereign/Sub Sovereign
Sovereign Risk Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

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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