Event

In the last weekend of February 2021, El Salvador held legislative elections. The ‘Nuevas Ideas’ (NI) party won these elections by a landslide. The party now even holds two thirds of the seats, also known as a supermajority. This election result is quite stunning, not least as it is the first time the NI party runs in the election. Indeed, incumbent President Bukele – a populist – founded the party and registered it in 2018 but that was too late to participate in the previous legislative election. Hence, President Bukele, when taking office on 1 June 2019, didn’t hold any seats in the Legislative Assembly, until now. The result suggests that Bukele will be the country’s most powerful leader in three decades as he will be able to control the parliament with a supermajority. Holding this supermajority, the NI party will have a far-reaching ability to elect an attorney general and Supreme Court judges, and approve budgets and constitutional reforms. Nevertheless, the high concentration of power will be a test for the relatively young democracy.

Impact

The success of NI doesn’t come as a surprise. In the past years, Bukele’s anti-establishment platform has won strong support from an electorate disillusioned with the traditional governing parties that ruled the Central American country since the end of the civil war in 1992. Furthermore, popular support for Bukele is anchored in the perception that he will tackle cronyism and interest groups being favoured by the ‘establishment’. That being said, Bukele has shown authoritarian tendencies. He occupied parliament with soldiers in February 2020 to force the parliament to approve a security loan deal. He later used the army to enforce quarantine during the Covid-19 pandemic. Nonetheless, his handling the Covid-19 pandemic has resulted in high levels of popular support as El Salvador has so far had a lower number of Covid-19 infections and related deaths than many of its neighbours.

The president faces unprecedented economic and fiscal challenges posed by the Covid-19 crisis, while security concerns related to resurgent killings remain pronounced. Following the global Covid-19 outbreak, the World Bank (January 2021) expects El Salvador’s economy to have contracted by 7.2% in 2020, a deep recession. The country enacted one of the most stringent and strict containment measures in the world, severely curtailing economic activity. As long as the Covid-19 pandemic is not under control, economic activity is expected to remain subdued due to containment measures. Indeed as a second Covid-19 wave is currently raging through Latin America, only a moderate recovery is in the cards this year (4.3% of real GDP growth according to the World Bank). That being said, the recovery will mainly depend on evolutions in the USA (as El Salvador is highly dependent on export revenues and remittances from there), the trajectory of the ongoing Covid-19 pandemic, vaccination effectiveness and the inoculation roll-out (which is fairly slow in Latin America).

Furthermore, El Salvador turned to the IMF last year and, for the first time in three decades, borrowed from the multilateral institution to alleviate its external financing needs. The country enjoyed access under the rapid financing instrument, a loan without the IMF’s usual conditions. Indeed, a drop in FDI in combination with lower current account revenues (tourism for example) and the fiscal stimuli package to dampen the impact of Covid-19 resulted in high external financing needs. Furthermore, the market sentiment towards El Salvador worsened last year mainly as public finances deteriorated. Indeed, the fiscal deficit widened to a staggering 13.3% of GDP in 2020 (according to the IMF’s October 2020 WEO) due to rising interest payments, lower tax revenues and the stimuli package. Together with the recession, the deficit is expected to have driven up the public debt stock to almost 90% of GDP by the end of 2020, though mainly covered by a jump in domestic borrowing. According to the IMF’s October 2020 projections, the fiscal deficit will remain high over the coming years (around 7% of GDP) amid rising interest payments (on average above 5% of GDP in the 2021-2024 period), and push the public debt stock beyond 100% of GDP as of 2024, a very high level. Looking forward, external financing needs are likely to remain high while financial-market appetite is likely to be relatively muted. Hence, a loan from the IMF in the form of a fully fledged IMF programme (and related conditionality) might be necessary in order to maintain financial-market access and rein in public finances.

Credendo downgraded the MLT political risk classification for El Salvador from category 4/7 to 5/7 in November 2020. The deterioration of the public finances together with the prospect of weak fiscal-policy performance, the increasing external debt ratios, the rise of external debt-service burden – which is projected to remain substantial – and the deep recession mainly drove the downgrade.   

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com