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Fitch Ratings-New York-01 February 2017: Fitch Ratings has downgraded El Salvador's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to 'B' from 'B+'. The Rating Outlook was revised to Negative from Stable. The issue ratings on El Salvador's senior unsecured Foreign and Local Currency bonds are also downgraded to 'B'. The Country Ceiling is downgraded to 'BB-' from 'BB'. The Short-Term Foreign Currency IDR is affirmed at 'B'.
KEY RATING DRIVERS
The downgrade reflects El Salvador's continuing high level of political polarization with a prolonged period of congressional gridlock that has severely limited the government's financing options and hindered meaningful fiscal measures to arrest the deterioration of public finances. The Negative Outlook reflects persisting risks to meeting financing needs for 2017 in the absence of a political agreement that unlocks additional external borrowing.
Fiscal policy negotiations between the two main political parties broke down in January 2017 over disagreements on the 2017 budget. The political polarization between the government-led FMLN party and the main opposition ARENA party has prevented the government from issuing external debt since September 2014. A 2/3 majority of the Congress is needed to authorize external debt issuance, requiring agreement from the opposition. As a result, the government has relied mostly on the issuance of local short-term debt (Letes), which reached $1.07 billion as of end-December 2016 from $794 at year-end 2015. The legal limit of Letes issuance is $1.34 billion. Furthermore, government arrears have accumulated due to the lack of financing options and the resulting liquidity crunch.
Fitch estimates El Salvador's 2017 financing needs at $1.3 billion (excluding short-term debt). Fitch's base-case scenario assumes it will be financed through some combination of external debt and local issuance. A further build-up of arrears can occur given the financing constraints the government is confronting. El Salvador has no long-term amortization of external commercial debt until 2019. Tax and pension reform measures require only a simple majority vote of the legislature and can help reduce financing needs, although the election cycle can hurt prospects for getting these measures approved in congress.
In November 2016, the government and ARENA reached a partial agreement that included a Fiscal Responsibility Law (calling for a 3% of GDP adjustment over three years) and authorization of $550 million in external issuance. However, a final agreement over specific fiscal measures remains elusive. Failure to reach an agreement in a timely fashion, most likely under the auspices of an IMF program, could further constrain financing flexibility and result in a disorderly adjustment with significant damage to public finances and the overall economy.
El Salvador's fiscal deficit fell to 2.5% of GDP in 2016 from 3.3% in 2015 partly as result of fiscal restraint and relatively buoyant tax revenues, which grew by an estimated 6% in 2016, although there was some build-up of government arrears as well.
El Salvador's GDP growth remains low compared to that of its peers, with five-year average GDP growth at just 2% compared to a 'B ' median of 4.1%. El Salvador's growth is estimated at 2.5% in 2016, similar to the growth rate in 2015. Fitch expects growth of over 2% in 2017-18. However, the continuation of such a modest rate of growth is insufficient to generate employment, reduce poverty or stabilize the general government debt dynamics. Political polarization, security concerns, and high emigration levels undermine the business climate and hinder investment prospects and growth.
Fiscal deficits and weak growth are leading to a steadily increasing debt burden, to an expected 62.8% of GDP in 2017 up from 61.6% in 2016 and 60% in 2015. Furthermore, the interest burden is expected to continue to rise, growing to nearly 14% of revenues in 2017 from 12.9% in 2016.
The 'B' ratings are supported by El Salvador's macroeconomic stability underpinned by full dollarization of the economy, adequately capitalized banking system and unblemished sovereign repayment record. The country has a higher income per capita, social development and governance indicators than peers. The banking sector remains sound due to prudent regulation, although the weak economy could affect asset quality and profitability.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns El Salvador a score equivalent to a rating of 'BB' on the Long-Term FC IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
--Structural: Minus 1 notch to reflect the deep political polarization in El Salvador that has made fiscal and financing agreements difficult to reach.
--Public Finances: Minus 1 notch to reflect El Salvador's narrow tax base and budgetary rigidities that make fiscal consolidation difficult to achieve, as well as the government's increasing reliance on short-term debt to meet its substantial financing needs and the difficulty of obtaining authorization for external debt issuance.
--Macroeconomics: Minus 1 notch to reflect El Salvador's weaker potential growth prospects relative to the 'B' median, with important repercussions for public finances.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to a negative rating action are:
--Hardening financing constraints in domestic or international markets.
--Failure to break the political impasse resulting in heightened financing challenges and a further build-up in government arrears.
The Rating Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a positive rating change. Future developments that could, individually or collectively, result in a stabilization of the Outlook include:
--An easing of political tensions that improves financing flexibility and reduces short-term debt
--Fiscal adjustment (including a possible IMF agreement) that improves prospects for debt stabilization.
--Improvements in the political and business environment that support growth and investment prospects.
KEY ASSUMPTIONS
--The sovereign will continue to prioritize debt service, finance itself through treasury bills and tap the international capital markets.
--U.S. economic growth continues to support economic and external forecasts. Furthermore, oil prices rise only gradually, to $45 in 2017 and $55 in 2018, helping contain imports, utility subsidies and consumer prices.
--Monetary policy normalization in the U.S. proceeds in a gradual and orderly manner, not resulting in external financing constraints for El Salvador in 2016-2018.
Contact:
Fitch Ratings-New York-01 February 2017: Fitch Ratings has downgraded El Salvador's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to 'B' from 'B+'. The Rating Outlook was revised to Negative from Stable. The issue ratings on El Salvador's senior unsecured Foreign and Local Currency bonds are also downgraded to 'B'. The Country Ceiling is downgraded to 'BB-' from 'BB'. The Short-Term Foreign Currency IDR is affirmed at 'B'.
KEY RATING DRIVERS
The downgrade reflects El Salvador's continuing high level of political polarization with a prolonged period of congressional gridlock that has severely limited the government's financing options and hindered meaningful fiscal measures to arrest the deterioration of public finances. The Negative Outlook reflects persisting risks to meeting financing needs for 2017 in the absence of a political agreement that unlocks additional external borrowing.
Fiscal policy negotiations between the two main political parties broke down in January 2017 over disagreements on the 2017 budget. The political polarization between the government-led FMLN party and the main opposition ARENA party has prevented the government from issuing external debt since September 2014. A 2/3 majority of the Congress is needed to authorize external debt issuance, requiring agreement from the opposition. As a result, the government has relied mostly on the issuance of local short-term debt (Letes), which reached $1.07 billion as of end-December 2016 from $794 at year-end 2015. The legal limit of Letes issuance is $1.34 billion. Furthermore, government arrears have accumulated due to the lack of financing options and the resulting liquidity crunch.
Fitch estimates El Salvador's 2017 financing needs at $1.3 billion (excluding short-term debt). Fitch's base-case scenario assumes it will be financed through some combination of external debt and local issuance. A further build-up of arrears can occur given the financing constraints the government is confronting. El Salvador has no long-term amortization of external commercial debt until 2019. Tax and pension reform measures require only a simple majority vote of the legislature and can help reduce financing needs, although the election cycle can hurt prospects for getting these measures approved in congress.
In November 2016, the government and ARENA reached a partial agreement that included a Fiscal Responsibility Law (calling for a 3% of GDP adjustment over three years) and authorization of $550 million in external issuance. However, a final agreement over specific fiscal measures remains elusive. Failure to reach an agreement in a timely fashion, most likely under the auspices of an IMF program, could further constrain financing flexibility and result in a disorderly adjustment with significant damage to public finances and the overall economy.
El Salvador's fiscal deficit fell to 2.5% of GDP in 2016 from 3.3% in 2015 partly as result of fiscal restraint and relatively buoyant tax revenues, which grew by an estimated 6% in 2016, although there was some build-up of government arrears as well.
El Salvador's GDP growth remains low compared to that of its peers, with five-year average GDP growth at just 2% compared to a 'B ' median of 4.1%. El Salvador's growth is estimated at 2.5% in 2016, similar to the growth rate in 2015. Fitch expects growth of over 2% in 2017-18. However, the continuation of such a modest rate of growth is insufficient to generate employment, reduce poverty or stabilize the general government debt dynamics. Political polarization, security concerns, and high emigration levels undermine the business climate and hinder investment prospects and growth.
Fiscal deficits and weak growth are leading to a steadily increasing debt burden, to an expected 62.8% of GDP in 2017 up from 61.6% in 2016 and 60% in 2015. Furthermore, the interest burden is expected to continue to rise, growing to nearly 14% of revenues in 2017 from 12.9% in 2016.
The 'B' ratings are supported by El Salvador's macroeconomic stability underpinned by full dollarization of the economy, adequately capitalized banking system and unblemished sovereign repayment record. The country has a higher income per capita, social development and governance indicators than peers. The banking sector remains sound due to prudent regulation, although the weak economy could affect asset quality and profitability.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns El Salvador a score equivalent to a rating of 'BB' on the Long-Term FC IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
--Structural: Minus 1 notch to reflect the deep political polarization in El Salvador that has made fiscal and financing agreements difficult to reach.
--Public Finances: Minus 1 notch to reflect El Salvador's narrow tax base and budgetary rigidities that make fiscal consolidation difficult to achieve, as well as the government's increasing reliance on short-term debt to meet its substantial financing needs and the difficulty of obtaining authorization for external debt issuance.
--Macroeconomics: Minus 1 notch to reflect El Salvador's weaker potential growth prospects relative to the 'B' median, with important repercussions for public finances.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to a negative rating action are:
--Hardening financing constraints in domestic or international markets.
--Failure to break the political impasse resulting in heightened financing challenges and a further build-up in government arrears.
The Rating Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a positive rating change. Future developments that could, individually or collectively, result in a stabilization of the Outlook include:
--An easing of political tensions that improves financing flexibility and reduces short-term debt
--Fiscal adjustment (including a possible IMF agreement) that improves prospects for debt stabilization.
--Improvements in the political and business environment that support growth and investment prospects.
KEY ASSUMPTIONS
--The sovereign will continue to prioritize debt service, finance itself through treasury bills and tap the international capital markets.
--U.S. economic growth continues to support economic and external forecasts. Furthermore, oil prices rise only gradually, to $45 in 2017 and $55 in 2018, helping contain imports, utility subsidies and consumer prices.
--Monetary policy normalization in the U.S. proceeds in a gradual and orderly manner, not resulting in external financing constraints for El Salvador in 2016-2018.
Contact:
