Moody’s raises El Salvador’s credit rating to Caa1 from Caa3

El Salvador achieves improved financial stability

The credit rating upgrade results from a substantial decrease in credit risks from very high-risk levels for sovereign debt. Given the lower probability of liquidity stress episodes, this significant development should reassure the audience about the country’s improved financial stability. El Salvador’s credit rating improvement reflects the nation’s efforts to strengthen its financial standing.

The agency highlights the positive impact of liability management operations, particularly the debt buyback carried out in April 2024. This operation has significantly reduced external debt amortizations through 2027, providing a reassuring sign of the country’s sound financial management. The Government of El Salvador has taken specific actions to improve its credit rating. It has expanded the maturity profile of its domestic debt, reducing its dependence on short-term instruments by issuing longer-term promissory notes to local banks. Debt restructuring operations, together with moderate and relatively stable fiscal deficits, have also played a significant role in reducing the Salvadoran Government’s overall financing needs. These measures have been pivotal in the credit rating upgrade.

Moody’s underlines the positive shift in El Salvador’s financial landscape, pointing out that new financing options have been opened with access to international capital markets and better market confidence. This development instills confidence in the country’s economic growth potential. “Overall, April’s transactions helped sovereign debt regain market access and reduce its funding needs through 2027, keeping liquidity risks under control.”

While the credit rating upgrade is a positive development, it’s essential to acknowledge the remaining challenges. Financing capacity “remains somewhat limited based on the cost at which El Salvador can currently access external markets,” the fact that official dollarization limits the availability of a lender of last resort, and the lack of a program of the International Monetary Fund (IMF) that can provide and catalyze financing at more affordable rates. Local financing options are also limited, as the domestic market is shallow, and banks have high exposure to public debt. This balanced view will help the audience understand the complete picture of El Salvador’s economic situation. El Salvador’s credit rating continues to incorporate “weak institutions and governance, as well as a relatively high susceptibility to event risk, reflecting the government’s limited access to cross-border financing.”

Finally, Moody’s indicates that the stable outlook balances the positive developments that have led to a more favorable debt profile. The above could reduce liquidity-related credit risks more significantly than currently assessed and improve domestic security, supporting increased investment prospects and further economic growth.

How can El Salvador’s credit rating be boosted further?

To further increase El Salvador’s credit rating beyond Caa1, the government should implement a multifaceted strategy addressing short-term liquidity and long-term structural issues. Here are the key steps the government should consider:

Strengthen Fiscal Discipline and Transparency

Implement Fiscal Reforms: Strengthen revenue collection through tax reforms, including broadening the tax base, improving tax compliance, and reducing tax evasion. Implement expenditure rationalization measures to ensure efficient use of public funds.

Enhance Budgetary Transparency: Improve fiscal transparency and accountability by publishing detailed budget reports and spending reviews. This will help build market confidence and credibility with investors.

Diversify Financing Sources

Engage with International Financial Institutions: Renew efforts to secure a program with the International Monetary Fund (IMF). An IMF program could provide El Salvador access to lower-cost financing and catalyze additional financial support from other international donors and investors.

Develop Local Capital Markets: Foster the development of local capital markets to reduce reliance on external debt. This can include encouraging domestic savings and investment, improving financial infrastructure, and enhancing regulatory frameworks to attract local investors.

Enhance Debt Management

Optimize Debt Maturity Profiles: Continue extending debt maturities to reduce rollover risks. The government should issue more long-term debt instruments while reducing reliance on short-term borrowing.

Liability Management Operations: Conduct further debt buybacks and swaps to manage debt levels and smooth repayment schedules. This can help mitigate refinancing risks and reduce the overall debt burden.

Improve Institutional Quality and Governance

Strengthen Legal and Regulatory Frameworks: Enhance the rule of law, improve contract enforcement, and protect property rights to build a more favorable business environment. This can help attract foreign direct investment (FDI) and support economic growth.

Combat Corruption: Implement robust anti-corruption measures to improve governance and institutional quality. Transparent governance practices can enhance investor confidence and reduce the perceived risk of doing business in El Salvador.

Boost Economic Growth and Diversification

Invest in Infrastructure and Human Capital: Increase public investment in transportation, energy, and telecommunications infrastructure. Additionally, it will improve education and healthcare to build a more skilled and productive workforce.

Promote Economic Diversification: Encourage economic diversification by supporting sectors with high growth potential, such as tourism, agriculture, and technology. Reducing dependence on a few sectors can enhance financial stability and resilience.

Enhance Security and Stability

Improve Domestic Security: Address issues related to crime and violence, which are significant impediments to investment and economic activity. Enhancing security can create a more conducive environment for business and tourism, fostering economic growth.

In conclusion, while the recent upgrade of El Salvador’s credit rating to Caa1 from Caa3 by Moody’s is a testament to the country’s improved financial stability and proactive debt management, significant challenges still need to be addressed to achieve further rating enhancements. El Salvador can build on its current momentum by strengthening fiscal discipline, diversifying financing sources, enhancing debt management, improving institutional quality and governance, boosting economic growth, and enhancing security. Implementing these strategies will improve El Salvador’s credit rating and pave the way for sustained economic stability and growth, fostering a more favorable environment for investment and development in the years to come.