April 25, 2024

There Might Be a Default in El Salvador’s Debt Repayments Due to Bitcoin Crisis

Early Sunset

El Salvador’s economic big leap in making Bitcoin one of the country’s legal tenders has hit a huge obstacle. The price of the global leader among cryptocurrencies has fallen by more than 50% from its all-time height. 

Bitcoin fell as a result of the decline in the global money and stock markets due to uncertainties caused by the war in Ukraine. Other factors that affect the global financial markets include skyrocketing inflation across borders as well as the decision US Federal Reserve to increase interest rates.

As a result of all these events, the bonds issued by the government of El Salvador are currently selling at 40% of their initial prices. Investors are now starting to lose faith in the government’s ability to meet up with its debt obligations. 

The country’s president, Nayib Bukele, had said in September that El Salvador is going to be the world’s first country to take Bitcoin as a legal tender side-by-side with the US Dollar. Some international agencies, however, cautioned that such a decision along with Bitcoin’s volatility has the potential of wreaking havoc on El Salvador’s fragile economy.

Nevertheless, President Bukele stood steadfast in his decision. He announced last October that the government had expended about $25 million in the pursuit of the project. Fitch, an American rating firm, issued a warning in November via a report where it stated that the general usage of Bitcoin is limited by the swing of its prices. Other factors that obstructed the wide usage are poor inclusiveness from local banks, as well as the lack of internet for all.

In spite of the low rate of acceptance, the move to make Bitcoin a legal tender had an immediate impact on the country. The IMF encouraged El Salvador to step back on its Bitcoin policy as it would open its finances up to the volatility of cryptocurrency prices. All negotiations of IMF with the government were obstructed by insistence on keeping the Bitcoin policy.

Declining Rating of El Salvador

The instability of the market El Salvador has come to rely on and the worsening of public financial institutions caused a rating fall-out. Many financial agencies have reduced the country’s financial ratings and creditworthiness. These ratings are usually used to measure the likelihood of defaulting on debts.  

When a country has low grades, it means that it has to pay a higher interest rate to its creditors as it is seen as a bigger risk. A rating of CCC in the lending industry stops a country from going into the market to secure more debts.

The credit rating of El Salvador, as categorized by Fitch in February, was below the CCC level. Moody’s, another rating agency, did the same in the month of May.

Moody issued a caution to the government of El Salvador in May about its Bitcoin policy. It said that even if the government is able to manage short-term challenges, the sovereign might still suffer pressure from funding. It will then jeopardize the country’s capacity to pay off its debts completely.  

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