El Salvador Moves Closer to $1.3B IMF Loan Deal, Adjusts Bitcoin Policy

El Salvador is expected to reach an agreement with the IMF in the next two to three weeks regarding a $1.3bn loan program. The agreement is set to involve changes to the country's pioneering use of Bitcoin as legal tender, as well as reductions in government deficits, according to two sources familiar with the talks.

An IMF mission has arrived in San Salvador to finalize the deal with President Nayib Bukele’s government. This agreement is also expected to unlock an additional $1bn from the World Bank and $1bn from the Inter-American Development Bank over the coming years, the sources said, according to the Financial Times.

This lending package, which would require approval from the IMF board, marks El Salvador’s return to the international financial system after years of relative isolation. This isolation followed the country’s adoption of Bitcoin as legal tender in June 2021, making it the world’s first country to do so.

The IMF opposed El Salvador’s move to adopt Bitcoin, citing potential risks to financial stability and integrity, and has urged the government to discontinue using the cryptocurrency as legal tender.

As part of the agreement being finalized with the IMF, El Salvador would eliminate the legal obligation for businesses to accept Bitcoin as payment, making it voluntary instead. The government would also commit to reducing its budget deficit by 3.5 percentage points of GDP over three years, through a mix of spending cuts and tax increases. Additionally, El Salvador would pass an anti-corruption law and increase its reserves from $11bn to $15bn, one of the sources said.

Bukele made a bold move in his first term by launching a crackdown on violent gangs that had terrorized the country with murder and extortion. Using state of emergency powers, he jailed 82,000 suspects indefinitely pending trial and built the Centre for the Confinement of Terrorists (CECOT), a giant maximum-security prison. This crackdown led to a significant decline in the murder rate, and Bukele’s popularity surged. He was re-elected for a second term this year with an overwhelming 85 percent of the vote and near-total control of Congress.

The Biden administration had previously sanctioned several officials close to Bukele for alleged corruption and criticized his government during his first term, but has recently shifted toward closer relations.

Bukele has also built strong ties with U.S. president-elect Donald Trump and billionaire Elon Musk. He has sought to rebrand the small, impoverished nation as a cryptocurrency and surfing paradise. While he is known for making Bitcoin legal tender, his ambitious "Bitcoin City," powered by geothermal energy from a volcano, remains unrealized.

Most Salvadorans, however, have not embraced Bitcoin for daily transactions, preferring to use the U.S. dollar, which is also legal tender in the country. Despite this, the government has built up cryptocurrency reserves, with Bukele buying Bitcoin during price dips. Last month, he shared on social media that El Salvador’s reserves were valued at over $600 million, representing a 127 percent increase. "You can call it our first #Bitcoin piggy bank," he posted. "It’s not much, but it’s honest work."

In his second term, the president has focused on reviving El Salvador’s economy and attracting foreign investment. The country’s financial outlook has improved significantly, with its risk rating dropping from 3,500 basis points above U.S. Treasuries in July 2022 to just 398 basis points last week.

El Salvador’s sovereign bonds are now trading closer to face value, following a significant rally that closed the steep discount they once traded at. Bukele remarked last week on the unusual correlation between Bitcoin and sovereign bonds, stating: “This is the first time in history that Bitcoin has driven sovereign bonds up in traditional markets.”