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Ecuador | Approaching deadlines

| November 15, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

There is a lot at stake in the next few days and weeks for Ecuador’s economic program and IMF relations.  Ecuador has to approve tax reform as well as clarify the new fuel subsidy scheme as part of the budget deadline for approval on November 30. More importantly, IMF support hinges on subsidy savings and tax hikes as prerequisites for the next disbursements. IMF funds would relieve some expected December cash flow pressure, and IMF support would help counter recent credit underperformance. The Moreno administration should deliver over the next few weeks.  It seems strongly committed to fiscal discipline partly because there are scarce financing options without IMF support. The possibility of executive vetoes and decrees lowers execution risk as long as the Moreno administration can negotiate and manage the social risks.

The Economic Growth Law has not made much progress in the National Assembly ahead of the November 17 deadline.  It’s an ambitious bill that was submitted under the urgent status legislation track with only 30 days to review more than 400 articles including tax reform, central bank reform and public finance reform.  The Moreno administration doesn’t have a strong coalition, but there also are not enough votes for a two-thirds majority to reject an executive veto. There is some talk about archiving the bill, and a formal request from some parties, including some members from Alianza Pais, for President Moreno to withdraw the bill. However, this request shows that the opposition does not have the votes to reject it outright. It’s also not within the legal framework to archive or withdraw legislation submitted under the urgent status criteria.

The various opposition factions seem in disarray. There is hard pushback from the Social Christians and CONAIE while other groups recommend splitting, modifying or partly approving the legislation. If you approve only part of the bill, then the executive can return it to congress and then you need 92 votes to overturn it. Meanwhile, Minister Martinez reiterates flexibility to negotiate.   If there are not enough votes to approve or reject , then the paralysis suggests automatic approval when the deadline expires. This passive approval undermines the authority of the National Assembly and is the source of much headline noise over the past few days. The controversial tax hikes also add to the tension. However, there is not much recourse if there is only weak consensus among the opposition. The automatic approval would provide an important boost in tax revenues  of roughly $700 million, which would reduce the 2020 budgeted deficit from 3.1% of GDP to 2.5% of GDP while also providing additional economic reform necessary for the IMF program.

The next steps focus on the revised fuel subsidy scheme. It was an important step to eliminate all fuel subsidies as the most important show of Moreno administration commitment to fiscal discipline.  Backtracking was necessary in response to the social backlash; however, the economic team remains committed given the inclusion of partial subsidy cuts in the 2020 budget released October 30. It’s important to see the follow-through to know whether the targeted $660 million in savings are realistic.  There have been weeks of consultative meetings and apparently many proposals but nothing yet concrete. Economic officials continue to suggest an imminent announcement.

It seems likely that the IMF will remain sidelined until there is clarity on fuel subsidies and tax reform as a goodwill show of commitment to the program.  It’s not clear whether a new mission will be necessary before automatically disbursing the second and third loan tranches on December 15 since much of the original program has shifted after recent proposals for only half of the original estimates of 1.5% of GDP in tax revenues and 1.6% of GDP in subsidy savings.  The IMF would probably provide some immediate supportive public statements. But disbursing funds could be more complicated if another mission is required to review all the recent changes.  This could impact cash flow stress with the economic team motivated to seek release of funds before year-end bonus payments.

It’ll also be important to contain the fallout from minority opposition groups like the labor unions and indigenous associations.  This may explain the delays on announcing the revised subsidy scheme for the importance of managing public relations and public security in the aftermath. The tensions remain as CONAIE adopts an increasingly militant approach to promote an alternative economic agenda instead of negotiating on fuel subsidies.  There have also been threats from other minority groups like the Federacion Unica Nacional de Afiliados al Seguro Social Campesino to protest against the Economic Growth Law.  However, President Moreno and the military leadership have made it clear that there is no tolerance for these groups to take to the streets, and the inconvenienced general public have no tolerance for more protest after the extensive damage to public and private property last month.

The information vacuum on the issues lately has left Ecuador bonds vulnerable.  The clock is now running for action on tax reform and fuel subsidies. This should allow for supportive headlines from the IMF reaffirming commitment as a lender of last resort and anchoring bond prices.  This is the most important step forward to stabilize the economy.

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