Ecuador | Waiting for the IMF
admin | August 21, 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’s debt restructuring settlement was postponed to the September 1 deadline, and there has not been any guidance from the International Monetary Fund on the status of negotiations. The latest official communication is that negotiations continue. However, it is not clear the IMF respects the urgency of the September 1 deadline.
It seems reasonable to expect a compromise solution with a 12-month IMF Stand-By Arrangement and limited funds of $1.4 billion, with $800 million for this year. This may prove insufficient to close Ecuador’s funding gap and would require creative sources for external credit. The upside surprise would be a more ambitious 3-year Extended Fund Facility with significant front-loaded funds under exceptional access; however, that seems improbable given the uncertain election cycle that may compromise the required “institutional and political capacity to deliver that adjustment.” The compromise solution probably includes a small SBA program and low level of IMF commitment and engagement until there is clarity following elections.
A less complicated 12-month SBA could allow for a fast-track approach while delays could allow additional consent solicitations and SEC filings to avoid a technical default. The new economic team should come up to speed fairly quickly under the template of the staff notes from the IMF Rapid Financing Arrangement. The main target should focus on the fiscal accounts; however it’s unclear what realistically can be achieved at early stage of recovery from the pandemic and heading into the February and runoff April 2021 elections. It’s probably just a cut-and-paste from the current economic program for a team that now has newfound respect in the investor community for conservative crisis management. There have already been many a priori actions including successful Eurobond restructuring, liberalization of energy subsidies, approval of budget reform and commitment of net expenditure cutbacks. The IMF program may instead prioritize liquidity management to minimize financing shocks as opposed to insisting on any ambitious targets over the next few months.
The challenge focuses on budgetary management. It’s an interesting comparison of fiscal performance in 1H20 against other dollarized and quasi-dollarized economies like El Salvador and Costa Rica. There are two important distinctions:
- Ecuador’s budget has been hit hardest on multiple fronts including lower tax revenues, lower oil revenues, higher social and health spending needs and loss of revenues on asset monetization revenues.
- Ecuador’s larger gross financing needs, based on a larger economy, reduces flexibility for counter-cyclical spending, especially under the constraints of dollarization. Dollarization reinforces fiscal discipline for the larger countries as you cannot spend what you cannot borrow. This translates into higher liquidity risks and more efficient spending for restricted access to external credit.
There was not much if any room for counter-cyclical stimulus after a 20.8% year-over-year decline in revenues in 1H20 and a subsequent blowout from a central government fiscal deficit of 4.1% of GDP in 2019 to an estimated 7.9% of GDP in 2020 post Covid shock. The gross financing needs and liquidity stress remain a constraint for 2H20 with the IMF probably only providing only partial relief. The estimated shortfall of $4 billion after IMF disbursements of $800 million this year remain a serious constraint and are based on optimistic $15.6 billion revenue assumptions (against $7.9 billion in 1H20) as well as $2.7 billion programmed cutbacks in spending. The revenues may come under additional pressure with cutbacks mostly concentrated in 2H20 after the flat spending so far through 1H20. The IMF role may have to offer technical advice on more efficient spending or sourcing alternative funds. The IMF program will have to assume a closed funding gap for this year under hopefully realistic sources.
The staff notes on the RFI disbursement could provide an interesting preview for the preliminary 2021 fiscal targets with what looks like a fairly standard formula of gradual convergence towards debt sustainability on an uncertain path for global economic recovery. The NFPS primary deficit is expected to improve from 4.5% of GDP in 2020 to 1.5% of GDP in 2021 that reverts back to trend (near balance) in 2022 and then heavy lifting for a 2.4% of GDP primary surplus in 2024. The IMF recommends “rollback of pandemic spending” and “ambitious expenditure rationalization and a growth-friendly tax reform.”
This path for debt sustainability is dependent upon the budget stress in 2H20 and the subsequent fallout on the election cycle. There is some optimism in the latest Cedatos polls with 17.2% support for center right candidate Lasso that may consolidate the support of 16% from former VP Otto that has decided not to run. The radical candidates including CONAIE President Jaime Vargas and former President Correa are less threatening as Vargas decided not to run and Correa may soon face disqualification. Meanwhile, the Correista candidate polls only at 11.2%. It’s too early to draw conclusions; however the frontrunner status of Lasso bodes well against a fractured race of 11 presidential candidates and the marginalization of the most radical candidates. The success on sourcing external credit is a leading indicator for these political trends with a subsequent binary impact on credit risk.