Bitcoin bond sell flop deepens El Salvador debt market rout
(Bloomberg) — For five months now, Salvadoran President Nayib Bukele has been trying to sell a Bitcoin-backed bond to international investors. This, he insisted, is a better option than turning to multilateral lenders in Washington for more conventional financing.
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It does not work. Bukele, a staunch supporter of cryptocurrencies, has yet to receive a single penny of the billion dollars he seeks, and that – along with stalled talks with the International Monetary Fund – heightens creditors’ concern over the fact that the country will fail to repay an $800 million bond early next year.
The country’s debt prices crashed in April, falling 15.1%, a rout only surpassed by bonds in war-torn Ukraine. El Salvador’s benchmark bonds due 2032 are now yielding 24%, a level that suggests investors are bracing for a default.
Since scrapping talks with the IMF and adopting bitcoin as an official tender last year, investors have soured on El Salvador bonds, concerned not just about the ability to keep up to date of its debt, but also by the will to continue to pay under the eccentric of 40 years. Bukele who displayed authoritarian tendencies. And now, as the January debt deadline nears, the 78-cent price on the notes shows that many bondholders are losing confidence.
“If Bukele has given up the possibility of financing on the bond market, why continue to service the debt?” said Jared Lou, portfolio manager at William Blair Investment Mgmt LLC in New York. “If re-elected in 2024, Bukele would have little incentive to pay bond debt, or offer high recovery value on existing debt. These challenges make it difficult for El Salvador to find a floor.
While plans to raise $1 billion with a Bitcoin-backed bond were unconventional at best, some investors remained hopeful that it might at least bring money into government coffers. It is unclear at this stage whether the transaction will go through.
Neither the office of the presidency nor the Ministry of Finance responded to requests for comment on the drop in bond prices. In recent comments, the finance minister and central bank president said there was “no risk” the country would default.
El Salvador planned to issue so-called volcanic bonds by March using blockchain technology and use half of the proceeds to buy Bitcoin. The sale, however, languished, and the government has yet to even introduce a digital securities bill to Congress necessary for its issuance.
Although the proceeds may not necessarily be used to pay the January installment, if successful, subsequent transactions could be a source of funding in the future.
It was part of a larger plan to lure crypto enthusiasts and digital nomads to live in a community called Bitcoin City that would be powered by geothermal power plants on a nearby volcano.
The IMF, often a lender of last resort, has urged the government to reverse its adoption of cryptocurrency, saying it poses significant risks to financial stability. Talks with the country for an expanded funding facility have stalled and the multilateral lender said it needs to assess bitcoin risks before accepting a loan.
Fitch downgraded El Salvador to CCC in February, citing increased reliance on short-term debt, limited funding sources and a growing public debt burden that is expected to reach 87% of gross domestic product in 2022.
The extra yield demanded by investors to hold the country’s bonds relative to US Treasuries has exploded to 22 percentage points this month, well above the 10 percentage point threshold for the debt to be considered as in trouble. Its 2050 bond is now trading at 37 cents from 96 cents a year ago. There are approximately $3.3 billion in reserves at the central bank.
“El Salvador needs tax reform and probably an IMF program that could provide new funds and alleviate some of the debt burden in the short term, but at the moment reaching an agreement seems like a battle. difficult.” said William Snead, a strategist at BBVA in New York, who expects the government to pay bail in January.
And then there are other issues that weigh on credit.
Bukele recently sought and was granted emergency powers to crack down on gangs following a series of murders, tweeting pictures of tattooed men he said were detained gang members. More than 16,000 people were arrested in the operation which has alarmed human rights groups about the lack of due process. Diplomatic relations with the United States have also frayed.
And like many poor developing countries, El Salvador is being hit by soaring food and energy import costs just as the US Federal Reserve begins to hike rates.
The speed of the deterioration surprised many investors and strategists, including Nathalie Marshik, managing director of fixed income at Stifel Nicolaus & Co., who took an investor trip to the country in February.
“If you told me after I got back from my trip that bonds would go down 15 points, I wouldn’t believe you,” she said. “It’s a combination of factors.”
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