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Ecuador | Cash flow stress

| November 13, 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.

Debt relief alone is no solution for countries struggling with external shock and high structural fiscal deficits. Cash flow remains a problem for all emerging markets ‘B’ credits, and Ecuador is no exception. Tax collection through October disappointed and reversed the optimism of the previous months while the Google mobility index shows recent stagnation. And then there are the approaching February 2021 general elections.

The $2 billion in International Monetary Fund loans were quickly disbursed in late September and quickly reallocated for pent-up spending.  The weak tax collection increases Ecuador’s dependence on multilateral and bilateral loans.  Minister of Economy and Finance Pozo suggests delays on the $1.7 billion China loans and mentions the prospects of a “reactivation bond,” which is perhaps a social bond.   It is also critical that President Moreno delivers on the IMF pre-requisites, including approval of anti-corruption legislation before year-end with a first vote potentially next week.  This will set the tone for legislative cooperation and broader political support for the IMF program. The high beta and low cash prices on Ecuador’s debt have allowed for month-to-date outperformance, but these gains are only sustainable so long as the economic team delivers on the IMF reform agenda and secures necessary funding to lower election-risk premium.

It is all about cash flow management.  The weaker tax collection for October reinforces the importance of sourcing sufficient external credit. There was a disappointing 33% year-over-yaer contraction in October taxes and a reversal from the previous months’ improving momentum. There has also been no apparent progress on the commitment from China on $1.7 billion in loans, while Minister Pozo mentions the prospect of “reactivation bond” through IDB Invest. There have not been any follow-up details, though restricted access to capital markets suggests perhaps launching another social bond and targeting captive ESG demand.  This may unnerve Eurobond holders on the subordination to what has become a senior status security on the social bond’s exemption of the debt restructuring.  However, the substitution for the China loans suggests equal priority status. The intercreditor equity is also a secondary concern. More important near-term is sourcing sufficient funds to ward off a populist backlash ahead of February 2021 general elections.   The economic recovery is critical for not only a smooth policy transition but also for lower social and political backlash to the ambitious IMF fiscal adjustment program.

The latest treasury data show a total of $2.1 billion in external credit so far in the fourth quarter of 2020, mostly$2 billion in IMF loans. That contrasts with official estimates of $7.3 billion in the fourth quarter that includes $1.55 billion from IADB/WB/CAF, $1.7 billion from China and $4 billion from the IMF, including September and December equal disbursements. There was also some marginal relief on payment in kind of $500 million with local notes for domestic liabilities. There have been few details on the $1.55 billion expected from the IADB/WB/CAF in the fourth quarter while officials suggest delays on the $1.7 billion China loan until next year. Minister Pozo did mention a scheduled board vote for the $500 million loan from the World Bank on November 24 and disbursement 10 days afterwards. This reinforces the importance of the $500 million World Bank disbursement, the prospects for another social bond and the second $2 billion IMF tranche for December.

The eligibility of the IMF loan disbursements requires enactment of the anti-corruption legislation before end December and enactment of the central bank’s legal framework (COMYF) before end January. These are the two initiatives that require legislative cooperation and that have been formulated and discussed since last year.  Minister Pozo mentions that the anti-corruption legislation was already submitted earlier this year with the challenge now refocusing the deputies away from the election cycle and back to reform. The Justice committee has begun review with  first of the two debates possibly next week for final approval in December.

It’s a tight timeframe, but there are no other alternatives than negotiating sufficient support for these structural benchmarks. The legislative approval would show broader societal support and a litmus test for more controversial reforms next year.  If we assume policy continuity through the election cycle with a team of competent technocrats, the increasing challenge will focus on political finesse for a country that already benefits from an economic framework and trial-and-error on previous measures. This political transition depends upon stable IMF relations and a sufficient influx of funds in the fourth quarter that would reduce budget stress and backlash for a populist candidate.

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