The fall of Bitcoin brings El Salvador closer to default

In the 80s, El Salvador’s economy suffered from galloping inflation, which peaked at 31.9% in 1986. To normalize the situation, the government took drastic measures: in 1994, the national currency was pegged to the US dollar, and by 2003, the Salvadoran colon was withdrawn from circulation.

Dollarization of the economy helped to cope with inflation, but caused a number of other problems. For example, the demand for the quality of products has increased, since the country could not benefit from the low exchange rate of the national currency. And the outflow of labor has also increased (mainly in the USA).

The growth of immigrants’ remittances to their relatives in El Salvador in 2019 reached 1/5 of GDP or $6 billion. This revealed another problem — high commission costs in favor of American payment systems. The President of El Salvador, Naib Bukele, calls the high fees for dollar transactions one of the leading reasons for the adoption of Bitcoin as the second official currency. So, sending cash from Los Angeles via Western Union will exceed $15, and in the Bitcoin system, transferring any amount from anywhere in the world will now cost $1.3.

The risk of El Salvador’s default lies in a difficult time to conduct currency experiments.

The country’s international debt is $800 million due in January 2023. Bukele counted on the IMF’s help in debt restructuring, but the fund last year negatively responded to the idea of introducing Bitcoin and refused to help El Salvador implement it.

El Salvador’s insistence on crypto innovations did not appeal to the IMF, which is likely to lead to the refusal of financial assistance this year. After giving Bitcoin an official status, credit default swaps (insurance for investors) increased fourfold.

Naib Bukele urgently needs to find funds to refinance the debt in 2022. His last hope is connected with the issue of 10-year bonds in the amount of $1 billion denominated in Bitcoin.

However, the correction of Bitcoin and its strong volatility raise great doubts about El Salvador’s ability to attract investors with a new financial instrument. El Salvador’s own investments in Bitcoin are now in negative territory, since the bulk of purchases occurred in the fourth quarter of last year.

Without the help of the IMF and with the ongoing correction of Bitcoin, the default of El Salvador becomes almost inevitable. Last year, Moody’s downgraded the country’s credit rating to Caa1 (very high risk of default on credit obligations).