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El Salvador’s bitcoin gambit has heaped fresh pressure on the country’s debt market after investors began selling its bonds earlier this year on rising concerns about the government of President Nayib Bukele.
On the first day of El Salvador’s trailblazing adoption of bitcoin as legal tender, the cryptocurrency’s global price slumped by more than 10 per cent. Undeterred, Bukele tweeted that his small central American nation had increased its holdings. “Buying the dip. 150 new coins added. #Bitcoinday,” he wrote, adding a winking emoji.
Bond traders were not impressed. A fresh round of selling this week pushed the yield on long-dated Salvadoran debt issued in dollars close to 11 per cent while shorter maturities were offering up to 14 per cent. Prior to Bukele announcing the crypto move in June, Salvadoran long-dated yields were around 8.5 per cent.
In a further sign of market stress, the yield curve on El Salvador’s bonds inverted on Tuesday, meaning that short-dated debt was priced below long-dated debt. “That in itself is never a good sign,” said Dean Tyler, head of global markets at BancTrust. “It shows people are starting to question the viability of the shorter end of the curve.”
Investors were not convinced by the risky and expensive bet on bitcoin by what is one of the poorer countries in the western hemisphere with an annual GDP of $25bn. The coin’s value has swung from $10,000 to $64,000 in the past year, and is back down at $46,000 now. Bukele’s rushed plan to introduce the volatile digital asset for everyday transactions made headlines around the world.
“If I told you I’m now going to pay your salary in bitcoin, you’d have a lot of questions,” said Michael Schlein, chief executive of Accion, a non-profit that invests in tech for financial inclusion. “The notion of poor people keeping savings in crypto is absurd. It’s wildly volatile and you’re talking about the most vulnerable people in the world.”
But traders said the latest slump in Salvadoran bond prices was not only down to nerves over what could prove to be a reckless crypto gamble; money managers are also troubled by the president’s attempts to increase his power.
Late on Friday night the Salvadoran supreme court ruled that the president could seek a second consecutive term — a decision condemned by the US. It comes months after the Bukele-controlled congress fired five supreme court justices and replaced them with loyalists.
“The market had priced in the bitcoin news,” said Kevin Daly, investment director at Aberdeen Standard. “The news that really shook the market was [Bukele’s] gerrymandering things to run for re-election.”
This, he said, had pushed the risk premium demanded by investors for holding Salvadoran debt to the highest level of any solvent emerging market.
Siobhan Morden, head of Latin America fixed income at Amherst Pierpont, said the court ruling had complicated the chances of El Salvador agreeing a new IMF programme and securing access to much-needed external funds for its dollarised economy.
“It’s all about the Bukele risk premium,” she said. “It’s all centralised decision-making and he’s not surrounded by a top-notch team of technocrats.”
The IMF has opposed the adoption of bitcoin as legal tender, citing risks to financial stability, consumer protection and the environment.
“The most direct cost of widespread adoption of a cryptoasset such as Bitcoin is to macroeconomic stability . . . Monetary policy would lose bite. Central banks cannot set interest rates on a foreign currency,” it wrote in July.
“Without robust anti-money laundering and combating the financing of terrorism measures, cryptoassets can be used to launder ill-gotten money, fund terrorism and evade taxes,” it added.
El Salvador needs $3.5bn-$4bn in foreign funding a year to finance its deficit, cover the costs of coping with the pandemic and roll over existing debt. The government has said that the introduction of bitcoin as legal tender would cost around $200m initially.
It last issued a bond in July 2020 but has not been able to tap the market again since, Morden added. “Bukele is still running a fiscal deficit of about double the pre-Covid level and debt is 90 per cent of GDP.”
With a large debt repayment of $800m looming in January 2023, Bukele has limited room for manoeuvre. Morden said a recent increase in the country’s IMF allocation of special drawing rights — a reserve asset that allows the lender to supplement member countries’ official reserves — would provide short-term relief but after that, the government might be forced to turn to its own citizens to fund itself.
“The locals are the lenders of last resort,” she said. “But if they aren’t willing to lend, there may be a shift towards coercive lending” such as potentially nationalising private pensions, or even capital controls.
Or, as Daly put it: “There’s a real risk this all ends in tears.”