El Salvador economic notes - May 2024
Also, a comment on El Salvador's Bitcoin because including it means more people will click on the article.
Game theory: In the game of chicken, two cars race at each other until one turns away and loses a small bit of reputation or they crash and both lose with disastrous consequences. One of the ways to "win" at chicken is to lock the steering wheel and disable your ability to turn the car. This forces the other side to decide if they will turn their car and lose reputation points or if they will crash and allow both sides to lose far worse.
In his game of chicken against the IMF, El Salvador President Nayib Bukele has made a clause in the country's most recent bond a version of that steering wheel lock. The bond says that if El Salvador doesn't receive a significant ratings upgrade or an IMF deal before October 2025, the amount of interest on the bond will increase by several percentage points. For more on the bond, read this article from FT and listen to this podcast.
The ratings upgrade isn't going to happen. The ratings agencies won't decide El Salvador is magically fiscally solvent and boost the country by four levels. We can just ignore that option.
That leaves the potential for an IMF deal. This bond clause puts pressure on the IMF to give El Salvador a deal. If they don't, El Salvador faces tens of millions of dollars in additional interest payments per year. That increase is probably not enough to push El Salvador into default, but it will be a substantial additional burden on the country’s already strained finances.
Bukele can and will claim that this clause is proof that the country is committed to improving its fiscal situation. Uruguay issued a bond linking interest rates to countering deforestation. Why can’t El Salvador issue a bond promising better fiscal management in exchange for lower interest rates? Connecting bond interest rates to better fiscal management can be positive. The IMF often demands better fiscal management for its own agreements. Why shouldn't El Salvador's bonds create incentives for the country to better manage its finances?
The IMF wouldn't mind this logic except El Salvador chose the existence of an IMF agreement as its measurement of success or failure rather than all the other measurements that impact its fiscal situation. Between now and October 2025, the IMF must decide whether to give El Salvador new support. If they fail to do so, they will be blamed for the increased financial costs of the bond, making it even harder to bail out in the future. Any sort of financial crisis in El Salvador could spill over into other countries in Central America, making the IMF's job that much harder. However, if the IMF appear to cede to El Salvador's pressure and agree to a deal, other countries may attempt similar bond clauses.
This clause also creates odd incentives for others in the system. While the IMF wants its agreements to be perceived as only based on the merits, there are always political implications. This clause makes those political implications worth a lot more money. For example, if a pro-Bukele politician were elected president of the United States, the pressure on the IMF to cut a deal could be substantial. Alternatively, a wealthy opponent of Bukele could try to lobby the Fund against a deal as a way of harming the Salvadoran president and destabilizing his government. Neither of those scenarios generates stable macroeconomic policies.
In the IMF's view, they always have apolitical technocrats provide careful and neutral consideration of these agreements and the terms for how to reach a deal are clear. In many Latin Americans' views, the IMF has its witches conduct a private ritual seance and there is no logic to its decisions. The truth is probably somewhere between those two extremes. Either way, El Salvador's threat on this bond and the potential for pressures coming from others due to this clause should force the IMF to rethink its public position on the negotiation.
The best response for the IMF in this game of chicken is to come in with their own version of the steering wheel lock. Set the specific budget and economic numbers that El Salvador must hit to get an agreement, make those public, and don't move an inch on negotiations. Then, it's up to El Salvador to hit or not hit those targets. That strategy by the IMF would send a message to any other country or populist leader that is tempted to implement this sort of bond clause. Doing so makes the IMF less flexible, not more, in negotiations.
Bukele already has the region's attention for many other reasons. Other governments are watching this IMF negotiation with significant interest. This bond is only a billion dollars, but the implications are big if it creates any complication or leverage over the IMF.
Comment on Bitcoin
For the past few years, my theory has been that the IMF is less concerned about the issue that El Salvador holds and uses Bitcoin and more concerned about how that Bitcoin policy is managed. They aren't thrilled with a country using cryptocurrency, but they can differentiate between how to do it well and how to run it like a scam. Until quite recently, Bukele managed El Salvador's Bitcoin like his own personal slush fund.
In March, Bukele put the country's Bitcoin into an official Treasury wallet and began making the trades more public. There are still many issues, but the Salvadoran government is much closer to professional management and more transparency in its Bitcoin policy today than it was at the beginning of 2024. Bukele has benefitted from Bitcoin prices surging this year, and while we all love to focus on the exact amount of money involved, the price is less important than the audit sheet and the management of these reserves. This is something the IMF can work with.