Moody's downgrades El Salvador's rating in part due to bitcoin adoption

Rating agency Moody's Investors Service has downgraded the government of El Salvador's rating due to uncertainty surrounding the possibility of fresh financing from the International Monetary Fund (IMF) after the country adopted bitcoin as legal tender.

On 9 June, El Salvador's legislative assembly approved the world's first law to make bitcoin legal tender in the country, such that both the US dollar and bitcoin are now legal currency for settling transactions.

According to reports, the Central American country is in talks with IMF for a nearly $1 billion financing agreement. Meanwhile, IMF has been warning its member countries that the risks and costs of making cryptocurrencies legal tender outweigh the benefits.

“The most direct cost of widespread adoption of a crypto asset such as bitcoin is to macroeconomic stability…As a national currency, crypto assets—including bitcoin—come with substantial risks to macro-financial stability, financial integrity, consumer protection, and the environment,” IMF said in a recent blog.

Moody’s, in its rating action report released on Thursday, lowered El Salvador's long-term foreign-currency issuer, and senior unsecured ratings to Caa1 and maintained the negative outlook.

“The negative outlook on the Caa1 rating reflects Moody's view that the fiscal position remains vulnerable and susceptible to financing shocks that could jeopardize the sovereign's repayment capacity ahead of the challenging redemption schedule on its external market debt beginning in January 2023,” IMF said.

“Limited availability of funding alternatives for the sovereign and uncertainty surrounding the possibility of fresh financing from the IMF suggest that the sovereign will continue to face liquidity pressures in future years despite the authorities' willingness to enact measures to achieve further, gradual fiscal consolidation,” it added.

Even as Moody's has incorporated the potential funding flows from a possible IMF programme in its analysis of El Salvador's funding prospects for 2022, the rating agency believed that even if an agreement is reached with the IMF on a financing programme, issues involving the sovereign's high cost of funding are unlikely to be fully addressed by official funding flows.

The other driver behind the rating downgrade is a deterioration in the quality of policymaking that has intensified implementation risks to the authorities' fiscal adjustment plans and increased uncertainty about financing prospects.

According to IMF, some policy decisions reflect weakened governance in El Salvador, raising tensions with international partners—including the US—and jeopardizing progress towards an agreement with the fund.