El Salvador's Payment to Clear First 2023 Hurdle for Distressed EM

El Salvador's government, which has been touting Bitcoin, is set to deliver on a $604 million bond maturing this week. This turn of events leaves investors in distressed emerging-market debt with only one more big maturity to worry about this year.

The Central American nation is widely expected to repay creditors on Tuesday after receiving a last-minute loan and undertaking two bond buybacks. The maturing note, which now hovers just below par, has soared by 34 cents from an all-time low in July. This represents a massive recovery for the nation, and creditors are confident that they will be repaid in full.

"It's likely that they have been able to cobble together enough resources from cash reserves and multilateral lending to make that bond payment," said Sarah Glendon, a senior analyst at Columbia Threadneedle Investments in New York.

El Salvador's president, Nayib Bukele, is seen as a stabilizing force by many investors, and this has helped the country's dollar debt to rally by an average of 24% this year. This is the best performance of any emerging economy tracked in a key Bloomberg index so far in 2023.

This month, the Central American Bank for Economic Integration loaned the country $450 million. This may have helped seal the deal.

The successful bond repayment alone won’t alleviate all of Wall Street’s concerns. Investors have been burned by the symbolic firing of several top judges, the nation’s risky bets on Bitcoin and the lack of a deal with the International Monetary Fund. Plus, Bukele is gearing up for a controversial re-election bid in 2024. While the bond repayment is a positive step, there are still many concerns that need to be addressed in order to gain the confidence of investors.

Money managers are still demanding more than 14 percentage points of extra yield over US Treasuries to hold the nation’s dollar bonds, according to JPMorgan Chase & Co. data. This is well above the threshold for distress. Credit-default swaps, meantime, are flashing an 80% chance of default by 2027.

El Salvador's next major bond maturity isn't until 2025, which leaves investors to focus on other areas of risk in the meantime. Tunisia is the only other non-defaulted, distressed emerging market with a major foreign, hard-currency bond maturing this year, so it's likely to be the focus of attention for now.

The North African nation is facing a €500 million debt that is set to mature in October. However, last month Fitch Ratings forecast that a combination of IMF aid and funding from other sources will cover the government’s funding gap.

Emerging markets are expected to outperform this year as central banks ease up on aggressive rate-hiking cycles, inflation cools down, and China reopens its economy. This bullish outlook is shared by many on Wall Street.

El Salvador and Tunisia are both scheduled to make key payments on their foreign debt in the near future. El Salvador's payment is due on May 15, while Tunisia's is due on June 1. Both countries are working to ensure that they can meet their obligations, and they have been in close contact with their creditors to keep them updated on their progress.

Jitania Kandhari, a money manager at Morgan Stanley Investment Management, said that while some frontier markets are concerning, the overall level of foreign ownership of debt has decreased because more debt has been issued locally and bought by domestic investors. She added that she sees less risk compared to the past, and is less concerned about fiscal issues that have historically worked against the emerging market asset class.

In smaller and more vulnerable emerging and frontier markets, risk can balloon quickly. There are still 15 nations with bond yields that trade at an excess of 10 percentage points over US Treasuries, the threshold for debt to be considered distressed and at a higher risk of default. These nations are at a greater risk of defaulting on their debt, which can have serious implications for their economies.

According to Aviva Investors, Pakistan is at especially high risk of defaulting in 2023, especially if the country’s IMF program goes off track. While the nation has no major foreign bond maturities this year, it does have interest payments due as soon as March.

The fate of other nations will depend on their ability to grow their economies and regain access to financial markets, according to Aviva Investors money managers and analysts.