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El Salvador’s rating could be negatively affected, says S&P Global

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‍In February 2018, the Government of El Salvador announced that it was adopting Bitcoin as legal tender. This is a very significant development given the economic and financial challenges facing the country. The adoption of Bitcoin as legal tender has both negative and positive implications for credit rating, S&P. On the one hand, this will likely limit demand for U.S. dollars among foreign investors who previously purchased large quantities of El Salvadorian colones to buy bitcoins through intermediaries with local trust accounts in the U.S., Canada, and Europe(excluding Russia and China); while on the other hand, it will provide an alternative means of exchange to address concerns about double digit inflation, which had risen to almost 20% by May 2018 as a result of external shocks such as weaker commodity prices, drought in agricultural areas and a lack of transparency from government agencies regarding tax collection and budgeting. The adoption of Bitcoin as legal tender does not impact whether we assign a “Caa” or “B2” rating to this sovereign issuer; however, it may be a negative implication for our future outlook if it results in intensifying political risks within the country or impacts its ability to service its debt obligations because local businesses have less access to international capital markets.(END)

El Salvador’s Economic and Financial Environment

El Salvador is a small, low-income economy that has typically been dependent on foreign aid and remittances from overseas Salvadorans. The country faces many economic and financial challenges, including a fragile state-owned electricity provider, high crime rates, high levels of poverty and weak infrastructure. The country’s economy is highly dependent on the U.S., its main trading partner. The economy also depends on agriculture and manufacturing (garments, textiles, and chemicals), which employ a large percentage of the work force. El Salvador has a history of unstable political conditions and poor economic performance since the end of civil war in 1992. While the country’s GDP per capita is low, the country is ranked 16th in the world in terms of remittances received from abroad.

Bitcoin as Legal Tender

The government’s adoption of Bitcoin as legal tender has both negative and positive implications for credit rating, S&P. On the one hand, this will likely limit demand for U.S. dollars among foreign investors who previously purchased large quantities of El Salvadorian colones to buy bitcoins through intermediaries with local trust accounts in the U.S., Canada, and Europe(excluding Russia and China); while on the other hand, it will provide an alternative means of exchange to address concerns about double digit inflation, which had risen to almost 20% by May 2018 as a result of external shocks such as weaker commodity prices, drought in agricultural areas and a lack of transparency from government agencies regarding tax collection and budgeting.

Implications for Credit Rating

The adoption of Bitcoin as legal tender does not impact whether we assign a “Caa” or “B2” rating to this sovereign issuer; however, it may be a negative implication for our future outlook if it results in intensifying political risks within the country or impacts its ability to service its debt obligations because local businesses have less access to international capital markets.(END)

Impacts of Bitcoin Adoption on the Financial System/Utilities

The adoption of Bitcoin as legal tender may cause a contraction in demand for the country’s currency, the colón, which has already been declining in recent years. This could have a negative impact on the country’s government, utilities and businesses that have been receiving revenues in colones and making payments in colones. A decrease in the demand for colones would also result in a decrease in the net foreign outflow of colones, which would be positive for the country’s balance of payments. However, a decrease in the demand for colones would also increase the amount of U.S. dollars that the country needs to supply to the market to maintain the exchange rate between the two currencies.

Short-term implications for local businesses

The adoption of Bitcoin as legal tender may require businesses that have been receiving revenues in colones and making payments in colones to adapt to the new legal framework. Government agencies and commercial banks are expected to be responsible for regulating and supervising the use and implementation of the new legal framework for the adoption of Bitcoin as legal tender. Businesses that have been receiving revenues in colones and making payments in colones, but that are unable to adapt, may face liquidity and solvency challenges. In this scenario, businesses that have been receiving revenues in colones and making payments in colones will have to find a way to exchange their cash/colones for U.S. dollars.

Conclusion

The adoption of Bitcoin as legal tender does not impact whether we assign a “Caa” or “B2” rating to this sovereign issuer; however, it may be a negative implication for our future outlook if it results in intensifying political risks within the country or impacts its ability to service its debt obligations because local businesses have less access to international capital markets.