By Rodrigo Campos and Nelson Renteria

NEW YORK/SAN SALVADOR An agreement between El Salvador and a group of private local banks to reprofile its short-term debt has helped extend a stellar rally in its international bonds, which have returned more than 90% this year.

The government announced this week that it accepted the proposal by eight private banks to extend the maturities of short term local bills into new two, three, five and seven year notes.

The size of the operation is approximately $1.45 billion, the finance ministry told Reuters.

El Salvador's debt repurchases last year and a still-light payments calendar were behind a rally that shrank the premium to hold Salvadoran government debt from above 3,200 basis points in July last year to about 1,000 a year later.

Spreads now sit at around 750 bps, the tightest since mid-2021 and the country's dollar-denominated bonds are the top performer in the index.

"The agreement with the private banks is another demonstration that the government is willing to take pain domestically to continue meeting its external obligations," said Nathalie Marshik, a managing director for Latin America fixed income at BNP Paribas.

"This is positive for global bonds and explains the rally continuation."

Adding to the rally was an announcement last week of a seven-year strategic partnership between the government of President Nayib Bukele and Google Cloud that aims to digitalize the government and modernize health and education.

Katrina Butt, a senior economist at AllianceBernstein, said that even as the size of the investment is yet to be made public, "Google Cloud's announcement could significantly improve macro fundamentals in El Salvador over time".

A better relationship with the United States completes the bullish sentiment, as a fallout between the two governments in 2021 was an initial trigger of investor angst.

On Thursday, the U.S. Embassy announced the re-establishment of Peace Corps operations in the Central American country. A similar announcement in November 2020 did not come to pass.

The bond rally is driven by the news as well as indications of improvements in El Salvador's relations with the U.S. according to Shamaila Khan, head of fixed income for emerging markets and Asia Pacific at UBS Asset Management.

"Though outperformance of El Salvador has been impressive we think the carry is still attractive given the low default risk."

BNP's Marshik said the next leg of the rally could come from good news on El Salvador's relationship with the International Monetary Fund - where the United States is the largest shareholder.

The IMF did not respond to a request for comment on the state of the relationship or whether the country has recently requested a program.

Salvadoran bonds were yielding 12% and above as of Friday, according to LSEG Eikon data. A bond maturing in 2025 with about $350 million outstanding was last trading at 91.25 cents on the dollar, up from under 27 cents in mid 2022.

"Yields at 11%-12% are maybe a few points away from fully normalizing for accessing Eurobond markets," said in a Friday note Siobhan Morden, a managing director for the Latin America fixed income strategy at Santander US Capital Markets.

(Reporting by Rodrigo Campos and Nelson Renteria; Editing by Angus MacSwn)