Reuters: Cryptocurrency crash adds to El Salvador's debt woes, return to mainstream seen as a lifeline

On June 5th, El Salvador once again postponed its Bitcoin-related bond plans. Salvadoran Finance Minister Alejandro Zelaya stated that due to the Ukraine-Russia war causing Bitcoin prices to be "troubled," it is not the time to launch "Volcano Bonds" (Bitcoin bonds) yet.

Reuters recently commented on El Salvador's Bitcoin legal tender implementation, addressing the issues of nearly six months of inflation and Bitcoin volatility. Below is the Reuters original translation:

"Financial Issues Not Because of Bitcoin, But Made Worse by Bitcoin"

Since implementing the dual-track system of Bitcoin and the US dollar in September 2021, El Salvador has continued to purchase Bitcoin.

Recently, due to the sharp drop in the price of Bitcoin causing a significant loss in market value, the government's asset value has decreased by more than one-third. El Salvador not only faces a currency depreciation crisis but also bears the burden of substantial debt pressure due to the global rise in borrowing costs caused by inflation and other fiscal issues. This is also why El Salvador has yet to launch "volcano bonds" tied to Bitcoin.

According to Ricardo Castaneda, a senior economist and national coordinator for El Salvador and Honduras at the Central American Institute for Fiscal Studies (ICEFI), "El Salvador's financial problems are not because of Bitcoin, but have become worse because of Bitcoin." He believes that for the government, Bitcoin is no longer a solution but has become part of the problem.

Initially under the leadership of El Salvador's President Nayib Bukele, El Salvador fully supported Bitcoin, becoming the first country globally to adopt Bitcoin as legal tender. They also drafted plans for a cryptocurrency mining center powered by volcanoes and the issuance of the first sovereign bond linked to Bitcoin.

Bitcoin Market Value Eroded, El Salvador's Debt Soars

Since officially adopting Bitcoin in early September last year, Bitcoin has fallen by 45%, dropping 26% from its peak in May last year, as cryptocurrency assets have been overshadowed in the inflation-hedging investment environment.

According to CoinMarketCap data, the total market value of all cryptocurrencies recently fell to $1.2 trillion, less than half of the $2.8 trillion in November last year.

As of December last year, El Salvador's debt stood at $24.4 billion, higher than the $19.8 billion at the end of 2019.

According to estimates by the International Monetary Fund (IMF), by 2025, El Salvador's remittances and reliance on external financing will maintain a current account deficit of around $2 billion.

Due to adopting Bitcoin, El Salvador has had disputes with multilateral creditors like the IMF. Last year, the country's finance minister, Alejandro Zelaya, stated that the government was seeking $1.3 billion in financing from the IMF, but the IMF suggested that El Salvador must abandon its policy of using Bitcoin as legal tender.

An official from the IMF stated on January 1 that any lending transaction must address risks, including "the adoption of Bitcoin as legal tender and risks related to economic governance."

International rating agencies, such as Moody's, have warned that the adoption of Bitcoin may facilitate money laundering. Importantly, the risks associated with Bitcoin give bond investors reason to demand higher returns.

As of Wednesday, El Salvador's debt spread against US Treasuries had surged to over 2,500 basis points, a record high.

Reuters analysis suggests that Nayib Bukele's authoritarian measures, from dismissing all senior judges of the country's highest court to seeking immediate re-election through authorized means, have contributed to the increased risk premium.

Experts believe that despite El Salvador's towering debt, there is still hope, but a return to the IMF plan is necessary.

Siobhan Morden, head of Latin America fixed-income strategy at financial services company Amherst Pierpont, stated, "If there is no Bitcoin growth dividend or potential for innovative Bitcoin financing, then the Bukele government will have to consider spending priorities and determine financing schemes."

According to estimates from Nayib Bukele's tweets and purchase date prices, El Salvador has lost at least $36 million due to Bitcoin depreciation, losses that could have covered interest payments.

This year, El Salvador must repay $329 million in interest on international bonds and an $800 million bond due in January.

ICEFI has listed financing options, including the Central American and Latin American Development Bank, as possible options for payment of the $800 million bond due in January. Another option is to nationalize the country's pension fund to cover fiscal deficits, transferring people's savings to government accounts.

Polina Kurdyavko, head of emerging markets at BlueBay Asset Management, the largest European fixed-income credit and alternative investment strategy management company, stated that if El Salvador continues with its current policy mix (i.e., Bitcoin), debt restructuring is inevitable. "With the right (IMF) plan, El Salvador's debt could be sustainable. But they must act now."

El Salvador's bond-to-US dollar exchange rate trades between 43.5 cents and 34 cents, but the bond due in January is at 75 cents, reflecting El Salvador's optimistic attitude towards being able to make this payment.

According to Standard & Poor's Global data, the cost of insurance against a sovereign default in El Salvador over the next five years has hit the highest level since 2020.

This article is authorized for reprint from Horizon News Network