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Ecuador | Multilateral relations

| May 8, 2020

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.

Ecuador has little choice under intense cash flow stress other than to seek debt relief and avoid a hard default with bondholders. The same pressure does not apply to striking another formal IMF program. This implies higher execution risk if Ecuador’s economic team moves forward with debt restructuring but without a formal IMF program. The restructuring has to happen in a tight timeframe in light of the economic uncertainty over the coming months.

Good multilateral relations are critical for not only providing near-term financing for Ecuador but also as a medium-term resource for a country that had lost market access earlier this year. A new IMF program could provide a boost of confidence about a sustainable and credible medium-term economic outlook through debt negotiations with bondholders. The release of the IMF’s $642 million rapid financing instrument and the waiver on the fiscal data irregularities shows a normalization of relations with the IMF after the suspension of the Extended Fund Facility last year.  However, a normalization of IMF relations doesn’t necessarily imply a successor IMF program.  The timing and context for a new program is not ideal.  It’s also true that the timing for a debt restructuring is not ideal.

There was a normalization of IMF relations after the board disbursed the $642 million rapid financing instrument and issued a follow up report on the data irregularities that caused a suspension in the EFF program last year. The access to the emergency IMF funds should provide welcome reprieve to this year’s budget, with other multilaterals expected to follow under other emergency funding facilities.

However, prospects for a successor IMF program are still unclear.  It was curious that there was no follow-up staff report, similar to El Salvador and Costa Rica, to provide policy discussions, support and appraisal. There was no future guidance on the context for a successor IMF program.  The IMF mentions budgetary relief from “securing additional medium-term debt relief and financing on favorable terms from official bilateral creditors and other stakeholders” without mentioning a specific formal IMF program. The EFF could theoretically recommence after resolving the data irregularities, especially if there is progress on the prior structural benchmarks of medium-term reform. The budget finance reform is now making its way through the legislature on a 30-day fast track. However, there is not the same solidarity among the political establishment to embrace an ambitious economic reform that would provide the substitute for near-term pro-cyclical fiscal adjustment. It also stands to reason that resolving unintentional statistical deficiencies and resolving the breach of Article VIII does not create a strong basis for future relations, especially for the setback of upwardly revised fiscal deficits.

The primary constraint on Ecuador is the need to recognize a higher fiscal deficit with no context for austerity through a global pandemic.  The political establishment is probably reluctant to embrace economic reform under the current intense social and political pressures, and the Moreno administration lost credibility after a disappointing fiscal performance last year.  There is no obvious context for an IMF program during the election cycle. The country cannot realistically pre-commit the next administration to a medium-term economic program.  The near-term priority focuses on social crisis spending and not medium-term fiscal austerity. There is no societal debate about the necessity of an IMF program or commitment from the presidential candidates for a future program. The intensity of the economic crisis increases the risks of anti-IMF backlash. This does not rule out maybe a compromise short term SBA, especially under the influence of strong US diplomatic relations.  Although not ideal, it would provide a framework through the election cycle and potential medium-term guidance for investors. The alternative is that Ecuador alone restructures its debt

It’s an ambitious agenda to deliver investor consultations in May to June, a successor IMF program in mid-June and a debt sustainability transaction in June to July.  The signposts for IMF relations may depend upon the outcome of the budget reform legislation with a second vote next week. If there are no formal announcements anytime soon, then it’s difficult to assess whether a program will be reached within the targeted mid-June framework.

Does this impair bondholder negotiations? It could increase the risk for a higher discount rate on future debt repayment. However, this was probably already the case given the uncertainty of oil prices and policy management following elections. The pandemic creates an inconvenient timeframe for medium-term debt repayment assessment, but almost any reasonable framework is a better alternative than no framework or a disorderly, hard default. The latest official guidance was for a formal proposal with investor consultations in May to June. If the stakes are higher under dollarization to avoid a default, then Ecuador should look to Argentina as an example of what not to do. This implies a pragmatic approach with bondholder negotiations that would have to commence fairly quickly to meet the tight deadline.

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