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11-Apr-2017 20:40 EDT
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On April 11, 2017, S&P Global Ratings lowered its long-term foreign- and local-currency sovereign credit ratings on El Salvador to 'CCC-' from 'B-'. The ratings are on CreditWatch with negative implications. At the same time, we lowered the short-term foreign- and local-currency sovereign credit ratings to 'C' from 'B'.
Our 'AAA' transfer and convertibility (T&C) assessment is unchanged.
El Salvador's Congress recently failed to approve a budgetary allocation that was needed to cover payment of financial commitments for pension-related debt. As a result, the government missed payments on financial obligations coming from the Certificates for Pension Investments (CIPs) due between April 7 and April 10, 2017, adding up to $28.8 million.
Because the CIP's maturities have no stated grace period, we treat these obligations as having an imputed five-business-day grace period as per our criteria (see "Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings," Oct. 24, 2013). We are placing both long-term ratings on CreditWatch negative given that we could further lower them to 'SD' (selective default) if the political stalemate continues to block the approvals for budget allocation during the following week and, therefore, the government remains unable to fund these missed payments.
Political polarization has heightened over the last year, resulting in an uncertain policy environment, including diminished willingness and capability to maintain timely debt payments. This deteriorating political environment continues to erode El Salvador's credit quality. The government's budget for 2017, which was passed earlier this year, did not contain any allocations for servicing the CIP debt, due in part to political brinksmanship between the governing Frente Farabundo Marti para la Liberacion Nacional (FMLN) and the opposition Alianza Republicana Nacionalista (ARENA). The political stalemate between the FMLN and ARENA diminishes the likelihood of a new agreement on fiscal policy, including reforms to the pension system, before Congressional elections scheduled for March of next year.
Pension-related obligations have weighed largely on El Salvador's fiscal and debt assessments and therefore on El Salvador's rating history since Congress implemented pension reform in 1998. The annual shortfall of the pension system is about 2% of GDP, and pension-related debt represents about 25% of total general government debt. Pension-related financial obligations are issued through a Pension Trust established in 2006 and managed by the National Development Bank (BANDESAL). The Pension Trust makes debt payments to holders of CIPs through transfers from El Salvador's Ministry of Finance.
El Salvador's 2017 fiscal budget contains allocations to pay external debt maturities and short-term debt called LETES (Letras del Tesoro) due this year.
The government is currently on time with the debt service of these obligations. However, we foresee higher risks coming from the lack of additional debt authorizations in Congress for the following six months, which would tighten the government's liquidity position.
Our issuer credit ratings focus on the obligor's capacity and willingness to meet its financial commitments as they come due. They do not apply to any specific financial obligation, as they do not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation.
We project that the current account deficit is likely to exceed 5% of GDP in the next three years, contributing to weaker external liquidity. We also expect that foreign direct investment (FDI) may decline from its already modest levels due to continued political stalemate. We estimate that the country's gross external financing needs will exceed 100% of current account receipts and usable reserves in the next couple of years as well. Net general government debt is likely to surpass 60% of GDP in 2017-2019 compared with less than 55% of GDP in 2013.
Our ratings on El Salvador reflect the sovereign's limited fiscal flexibility, lack of monetary flexibility, and low per capita income (which we estimate at just above US$4,400 in 2016), with expected GDP real growth to remain around 1.3% for 2017-2020. We believe that the government has limited ability to raise additional revenues and that the country suffers from a shortfall in basic services and infrastructure.
El Salvador lacks its own currency and has forgone having a lender of last resort for its banking system. Our T&C assessment remains at 'AAA' because of our view that the country will maintain the U.S. dollar as its currency.
Failure to make payment on the CIPs within five business days from their due date would lead to a downgrade to 'SD'. We expect to resolve the CreditWatch by the middle of next week, based on the outcome of political negotiations.
The ratings could stabilize at 'CCC-' if successful negotiations result in the full payment of the CIPs within the imputed grace period. We would likely maintain the rating at the 'CCC-' level subsequent to such payments being made because of the high level of political polarization in the country. The rating could improve to the higher 'CCC' category if the government and opposition parties were to reach agreement on fiscal policy that boosts access to liquidity and reduces the sovereign's risk of default in the coming 12 months.