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Fitch lowers El Salvador's ratings as political gridlock knocks finances

Fitch Ratings on Feb. 1 downgraded the sovereign ratings of El Salvador, reflecting an ongoing political gridlock which is taking a toll on the country's finances.

Fitch lowered the country's long-term foreign and local currency issuer default ratings to B from B+, while revising the outlook to negative from stable. The rating agency also downgraded El Salvador's country ceiling to BB- from BB and maintained its short-term foreign currency issuer default rating at B.

In downgrading the ratings, Fitch said the country faces a "continuing high level of political polarization with a prolonged period of congressional gridlock that has severely limited the government's financing options and hindered meaningful fiscal measures to arrest the deterioration of public finances."

Fiscal policy negotiations between El Salvador's two major political parties failed last month due to disagreements over the 2017 budget, leaving the country with few options for its financing needs, which Fitch estimates to be about $1.3 billion. The rating agency expects that the country will use a combination of external debt and local issuances to garner it's financing; however, it also noted that political gridlock in El Salvador has prevented the government from issuing external debt for nearly 3.5 years.

In the meantime, "government arrears have accumulated due to the lack of financing options and the resulting liquidity crunch," Fitch noted, predicting that the amount past-due debts could grow further.

"Failure to reach an agreement in a timely fashion, most likely under the auspices of an IMF program, could further constrain financing flexibility and result in a disorderly adjustment with significant damage to public finances and the overall economy," the rating agency noted.

Fitch expects El Salvador's GDP to grow above 2% in 2017 and 2018, while growth for 2016 is seen at 2.5%, similar to the growth rate in 2015. However, this expansion is not enough to stabilize the general government debt dynamics, the rating agency noted.

Meanwhile, the fiscal deficit declined to 2.5% of GDP in 2016 from 3.3% in 2015 due to fiscal restraint and relatively larger tax revenues.

Still, the B ratings of El Salvador mirrors macroeconomic stability anchored by the full dollarization of the economy, a well-capitalized banking system and an intact sovereign repayment record, Fitch said. "The banking sector remains sound due to prudent regulation, although the weak economy could affect asset quality and profitability," Fitch added.