Fitch Downgrades El Salvador's Ratings to 'BB'; Outlook Negative

Fitch Ratings today has downgraded El Salvador's long-term foreign and local currency Issuer Default Ratings (IDRs) to 'BB' from 'BB+'. The Outlook on these ratings is Negative. Fitch has affirmed El Salvador's short-term IDR of 'B' and the Country Ceiling of 'BBB-'.

The rating downgrade and Negative Outlook reflect a structural shift in the country's fiscal and growth trajectory. Fitch expects El Salvador's economy to contract by -2.5% in 2009, with downside risks. Moreover, optimism regarding El Salvador's growth prospects has diminished as potential investments have been postponed due to political and economic uncertainty. This will weigh on El Salvador's macroeconomic outlook over Fitch's rating horizon with 0% GDP growth forecast for 2010 and 1% in 2011.

'The sharp economic impact of declining remittances, reduced external demand and weaker FDI prospects has demonstrated El Salvador's vulnerability to the U.S. downturn,' said Casey Reckman, Associate Director in Fitch's Sovereign Group.

A considerable revenue shock owing to economic recession will combine with continued spending pressures to result in a fiscal deficit of over 5% of GDP in 2009. While the majority of countries in the 'BB' category will experience growing deficits and larger debt burdens during the current global downturn, El Salvador's starting position is weaker than most. In addition, at 38% of GDP in 2008, non-financial public sector debt approaches the 10-year 'BB' category median of 42%. However, given the limited policy flexibility afforded by dollarization and narrowness of the economy, Fitch would prefer these indicators be stronger than category medians.

'A weak macroeconomic outlook along with fiscal deficits around 5% of GDP over the forecast period places the sovereign's debt dynamics on a deteriorating trajectory unless measures are enacted to boost revenues and contain expenditure,' Reckman said. Fitch forecasts gross and net non-financial public sector debt to increase to 52% and 50% of GDP, respectively, by 2011. Moreover, non-financial public sector debt as a proportion of revenue already compares poorly with the 'BB' median over the last 10 years and is expected to increase to 346% by 2011 from 208% in 2008.

Greater multilateral support and some easing of domestic financing constraints should allow the sovereign to meet its 2009 financing needs. However, the 2010 financing picture remains dependent on fiscal prudence, maintenance of domestic investor confidence and continued multilateral support. Beyond 2010, renewed access to international capital markets could become necessary for meeting heftier financing needs, including the US$650 million Eurobond maturing in 2011. President Mauricio Funes and his party will require continued cooperation from opposition assembly members to garner the 2/3 majority approval for additional long-term borrowing in support of its financing needs.

Monetary stability underpinned by official dollarization, a good track record on structural reforms and a relatively solid financial sector support El Salvador's ratings. Despite political and economic stress, the financial system remained resilient throughout the recent pre-electoral period and notably smooth political transition.

Sustained fiscal slippage, a more difficult financing outlook and resurgent political gridlock could reinforce downward pressure on El Salvador's sovereign ratings. On the other hand, stronger growth, fiscal consolidation and easing of financing constraints could help uphold El Salvador's sovereign creditworthiness.

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