THE bloodbath in the digital currencies markets continued on Thursday, raising concerns about whether El Salvador, which made the cryptocurrency legal tender last year, will be able to meet its next debt payment.
Global markets have been roiled by the uncertainty of the war in Ukraine, rising inflation and the US Federal Reserve’s decision to raise interest rates, causing the price of the most popular cryptocurrency in the world to plummet more than 50 per cent from its all-time highs.
The decline has fed doubt into the minds of investors about bonds of the Government of El Salvador, resulting in their prices falling 40 per cent below their original value.
Last September, Salvadoran President Nayib Bukele announced that El Salvador would become the first country in the world to accept Bitcoin as legal tender, alongside the US dollar. Bukele was undeterred even after warnings from ratings agencies that the volatility of the cryptocurrency would impact the country’s already fragile public finances. In October, he announced that the Government had purchased nearly US$25 million worth of Bitcoin. The following month, Fitch Ratings, an American credit rating agency, warned in a report: “Widespread adoption of Bitcoin has been limited by its inherent price volatility, the domestic banking sector’s low financial inclusion and the lack of broad Internet availability.”
Despite its low adoption among the population, the decision to make Bitcoin legal tender had an immediate impact on the Central American country. The International Monetary Fund (IMF), which could provide financing to help the Bukele Government to meet its next foreign debt payment in January 2023, urged the country to remove Bitcoin as legal currency as this exposes the State coffers to the price volatility of the cryptocurrency. Bukele’s insistence on keeping it as legal tender complicated his negotiations with the IMF.
The ups and downs of the market, coupled with the weakening of institutions in El Salvador, led several credit agencies to downgrade the country’s rating, which is largely used by the market to assess the likelihood of debt default. A low rating means that the Government has to pay creditors higher interest rates as it is considered higher risk. While a credit rating of CCC, described as “junk” in the industry, prevents a country from accessing global markets to issue more debt. In February, Fitch downgraded El Salvador’s rating to this level, while the credit agency Moody’s made the same decision in May.
In a statement, Fitch explained: “The downgrade reflects heightened financing risks stemming from increased reliance on short-term debt, a US$800 million euro bond repayment due in January 2023, a still-high fiscal deficit, limited scope for additional local market financing, uncertain access to additional multilateral funding and external market financing given high borrowing costs.”
The firm added that debt to gross domestic product (GDP) is expected to rise to 86.9 per cent in 2022, “increasing concerns around debt sustainability over the medium term.”
“In Fitch’s view, weakening of institutions and concentration of power in the presidency have increased policy unpredictability, and the adoption of Bitcoin as legal tender has added uncertainty about the potential for an IMF program that would unlock financing for 2022-2023,” the report stated.
For its part, Moody’s warned in May that “even if the Government finds a way to manage near-term financing pressures from the upcoming 2023 bond maturity, Moody’s view is that the sovereign will continue to face funding pressures that would compromise its ability to service its debt commitments in full.”
Still undeterred, Bukele on Tuesday revealed plans for the construction of Bitcoin City, which will be constructed in the south-east of the Central American country.
The project, which was announced in November 2021, seeks to create a smart city fully based on the use of Bitcoin as a cryptocurrency. Bukele shared on Twitter illustrations and scale models of the metropolis, but he did not clarify when construction will begin.
El Salvador was going to fund the project with US$1 billion in bonds. These public debt securities would be secured with Bitcoin instead of a fiat currency. These so-called volcano bonds were meant to be issued in March, but the date has been pushed back to September.
Bukele also announced on Tuesday that his Government had bought 500 Bitcoins, its largest purchase of the cryptocurrency to date. The news comes as Bitcoin has plummeted more than 50 per cent from its all-time highs. For the first time since July 31, the price of Bitcoin has fallen below US$31,000. In his message on Twitter, Bukele said the Government had purchased its latest Bitcoins at an average price of US$30,744.
Bloomberg agency estimates that El Salvador has bought 2,301 Bitcoins since it became legal tender in September 2021. These tokens currently have a total value of US$74 million, well below the US$103 million Bukele paid for them.