El Salvador’s state finances are trembling

Mexico City, Zurich In view of the recent upheavals on the crypto markets after the bankruptcy of the FTX exchange, concerns about public finances and the savings of the population are growing in El Salvador. Head of state and Bitcoin fan Nayib Bukele introduced Bitcoin as the official means of payment in the country in September 2021 and began to use tax money to build up a Bitcoin reserve for the state budget.

The Bitcoin, of which there will never be more than 21 million pieces, stands for the opposite of FTX. There, investors could place bets on thousands of cryptocoins, the money supply of which was practically unlimited. “Some get it, some don’t,” says Bukele.

Experts who see something like Russian fiscal roulette in the rise of bitcoin to become the official currency of the country are feeling uneasy about the latest developments approved. Ricardo Castaneda from the Central American Institute for Fiscal Studies (ICEFI) warns of a national bankruptcy. He assumes that bitcoin in El Salvador has lost around 67 percent in value since its introduction.

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Castaneda estimates the loss to government finances at around $70 million so far. “That’s the full budget of the Department of Agriculture.” And that’s in a country where half the population is food insecure.

El Salvador is the smallest country in Central America and about the size of Hesse. According to the World Bank, a quarter of the population lives in poverty. A lack of internet access and a lack of smartphones exclude a large part of the population from paying with Bitcoin from the outset.

Possible savings of millions through Bitcoin

Bukele, who sees himself as the “CEO” of a country, sold Bitcoin as the ideal way to become independent of the international financial system and to reduce many costs for the population. With the new means of payment, people should pay at gas stations and in supermarkets. The taxes should also be paid in this way.

Above all, the transfers of the millions of Salvadorans abroad should be made in the virtual currency in order to save transaction costs. El Salvador has introduced its own Bitcoin wallet, Chivo, for this purpose.

El Salvador has not had its own currency for around 20 years. The official currency, the El Salvador colón, was abolished in 2001 and replaced by the US dollar.

>> Read here: Bitcoin President Bukele is reaching for total power in El Salvador

From the point of view of Gregor von Bergen, an expert in payment transactions at the consulting firm Capco in Zurich, the idea behind the Bitcoin introduction still makes sense. “Many people in El Salvador have no access to the traditional banking system.” In addition, remittances from Salvadorans working abroad account for around 25 percent of gross domestic product.

Anti-Bitcoin protests in El Salvador

Resistance to the adoption of cryptocurrency as a means of payment is growing.

(Photo: Reuters)

Von Bergen estimates that, based on 2020 payment flows, a total of $400 million in fee savings could be achieved if all home transfers were processed through the Bitcoin Lightning network. “The success of the project depends on how many people actually take advantage of the opportunity,” says von Bergen.

So far, however, success has been limited: According to the central bank, just two percent of migrants use the virtual platform to transfer money to families at home. The balance after 14 months of Bitcoin in El Salvador is sobering.

With the FTX bankruptcy, the Bitcoin project threatens to become a complete flop, as economist Castaneda explains. “The recent losses are almost a death knell for the government’s hope that Bitcoin will prevail in El Salvador in the long term and be accepted by the population,” he underlines. “By now, at the latest, people have experienced the volatility of the currency firsthand.”

>> Read here: Supermodels, sports stars, professional investors – who are among the biggest losers after the FTX bankruptcy

The authoritarian head of state Bukele still wants to get the country’s 6.5 million inhabitants to use the cryptocurrency. “A paradoxical situation could arise,” says Castaneda. “El Salvador was the first country in the world to adopt bitcoin as legal tender, but it’s quite possible that it’s also the country where the vast majority of the population is giving the payment the cold shoulder.”

Shop window in El Salvador

Warning example for other countries

The case of El Salvador could also serve as a cautionary tale for other states that are considering introducing Bitcoin as legal tender and currency reserve. These include Panama or the Central African Republic. Edoardo Beretta, economist at the University of Lugano, sees the introduction of Bitcoin in the tradition of dollar-based exchange rate systems, which were particularly widespread in Latin America. “South America has always sought monetary stability and is therefore more open to alternative monetary solutions.”

However, it is questionable whether Bitcoin can fulfill this function. There is no doubt that Bitcoin was a profitable investment for those who got in early, says economist Beretta. “But from a macroeconomic perspective, cryptocurrencies do not increase the wealth of an economy because they have no real value. However, the same applies to the excessive money creation by the banking system.”

>> Read here: Bitcoin continues to tumble below $20,000

The fact that El Salvador entered the crypto rally almost at its peak is now costing the country dearly. In January the government has to pay off international debts of 667 million dollars, analysts say the Central American country could become insolvent.

Earlier this year, Bukele asked the International Monetary Fund (IMF) for funding. The multilateral organization declined, urging Bukele to reconsider introducing Bitcoin as legal tender.

According to Salvadoran Vice President Félix Ulloa, China now wants to buy the country’s foreign debt. A corresponding proposal is being examined by the government, he said at the beginning of November. Shortly thereafter, Bukele announced that El Salvador had signed a free trade agreement with the government in Beijing.

More: The collapse of the FTX exchange shows that the crypto industry is built on sand.

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