El Salvador’s progress with the IMF has soured since May, when Bukele’s party took over the assembly and fired five top judges and the attorney general. His policies, including the adoption of Bitcoin as legal tender, have been repeatedly criticized by the multilateral lender.
“This announcement cements the ‘anything-but-the-IMF’ path,” said Nathalie Marshik, a Stifel Nicolaus & Co. managing director. Bonds are falling “as the market reassesses possible recovery value lower on unpredictability of policies.”
The nation’s debt is trading in distressed territory, with investors now demanding 1,168 basis points in extra yield to hold El Salvador’s dollar bonds over U.S. Treasuries, according to JPMorgan Chase & Co. data. While the plan to sell new, tokenized bonds could offer the government some breathing room, it also adds to uncertainties and potential risks.
For Siobhan Morden, head of Latin America fixed income strategy at Amherst Pierpont Securities, the announcement of the Bitcoin bond is a sign that the nation is doubling down on its own funding and growth.
“Innovative financing is not in itself a solution,” she wrote in a note Monday.
The nation’s next big payment to external creditors isn’t due until January 2023. The $1 billion in the tokenized bonds could give the government a respite, as talks with the IMF for a $1.3 billion loan were downgraded to an annual Article IV review that concluded before the offering was announced Nov. 20.
“Given Bitcoin’s high price volatility, its use as a legal tender entails significant risks to consumer protection, financial integrity, and financial stability,” the IMF’s statement on the 2021 Article IV Mission said. “Its use also gives rise to fiscal contingent liabilities.”
The proposed 10-year tokenized Bitcoin bond is expected to pay 6.5% annually, with an added dividend of 50% of any Bitcoin gains once El Salvador has recouped its original investment, according to Blockstream Corp. Chief Strategy Officer Samson Mow, who announced the plan on stage with Bukele during a Bitcoin conference. Those dividends will either be paid in dollars or the cryptocurrency Tether, a so-called stablecoin meant to be a dollar proxy, he said.
As soon as legislation is in place allowing the new bond, the nation will release a prospectus, Mow said. For now, the biggest challenge is how little is known.
For the Bitcoin crowd, it may be a more risk-averse bet, said Carlos de Sousa, a portfolio manager at Vontobel Asset Management in Zurich. The 50% dividend the bond plans to pay if the price of the crypto currency rises, may look appealing if investors aren’t penalized for any Bitcoin weakening — but it’s too soon to know without a prospectus, he said.
“If you have too much money on Bitcoin and you’d like to de-risk, this instrument, conditional that you can only share gains and not losses, gives you a 25% upside but no Bitcoin downside, of course, at the cost of El Salvador’s default risk,” he said. “But since it’s for retail investors, maybe the sovereign default risk is not something they’re focused on.”
And there’s a chance the bond can win over pockets of investment on Wall Street.
“Institutional investors tend to overlook certain risks as long as they meet their goals for returns,” said Luis Gonzali, co-head of investments at Franklin Templeton Mexico. “‘I can’t buy Bitcoin, but I can buy junk.’ It’s a way to get around mandates in their funds. Technically, you’re not buying Bitcoin, just junk.”
Still, the note would mark a new way for governments to borrow externally and could bring more retail investors into the emerging-market debt space.
“The money will come in,” Mow said during an interview on Bloomberg Television, when asked whether institutional investors will be prohibited from buying the securities. Mow said he has already talked to a potential buyer who wanted to purchase as much as $20 million of the issue.
The 6.5% coupon wouldn’t be enough to compensate for the risks associated with El Salvador, assuming the bonds price at or near par, said Jared Lou, a money manager at William Blair in New York.
“It seems like a desperation move, showing Bukele is moving away from Western institutions,” said Lou. The existing bonds will continue to make new lows, but “the market is a bit broken now.”