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Ecuador | Critical central bank reform

| March 5, 2021

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 legislature has again rejected a central bank reform bill with no clear recourse for the weak Moreno administration. This is an important setback not just for the International Monetary Fund loan in April but for policy after political transition. Resistance to central bank reform shows a political establishment leaning toward domestic over external financing and toward populism and policy heterodoxy. Central bank reform is probably also a red line for the IMF with the current program at risk and dim prospects for renewal after elections. The bearish outlook for central bank reform reaffirms a core underweight on Ecuador with potential for further underperformance, new price lows and higher policy risk after elections.

Central bank reform once again suffered another defeat with the legislative committee rejecting it due to legal inconsistencies.  Finance Minister Pozo responded saying that it is not the committee’s role to assess the constitutionality of any legislation but rather the courts. The rejected bill is now in limbo with unclear recourse for the weak Moreno administration, the COMYF legislation already having missed its January deadline.  The mid-April $400 million IMF loan disbursement is now at risk, with the exceptional access program particularly sensitive to “institutional and political capacity to deliver adjustment” on what has been increasingly uncertain political commitment to the policy framework.

The suspension of the IMF program would compromise Ecuador’s 2021 funding program; $1.5 billion in IMF loans as well as possibly another $3.1 billion of other multilateral disbursements represent more than half of the country’s gross financing needs this year. The cash flow stress should exert immediate pressure on the next administration. There have already been meetings between candidate Arauz and the IMF; however, headlines suggest no common ground for quickly revising the economic program.  Central bank reform should represent a red line on IMF relations.  Central bank reform is more important for what it represents—defense of dollarization and commitment to fiscal discipline.

The political resistance to economic reform may reflect the strength of Correismo and the threat of retaliation from the frontrunner candidate.  Andres Arauz has been a staunch opponent of the “privatization” of the central bank and continues to insist on central bank financing for social subsidies and public investment. Central bank reform would reduce the political influence over banking regulations, with more technocrat control of the monetary regulatory agency and central bank board.

Why is the central bank reform so important?  The proposed reform includes:

  • Sufficient liquidity coverage of USD deposits (not just private sector banks)
  • Technocrat appointees to the central bank and the monetary and financial regulatory council, with legislative approval
  • Prohibition of central bank deficit financing to the treasury.

The political opposition to central bank reform is a worrisome sign of future policy risk with a shift towards domestic financing either from the central bank or forced investment from the banking sector. The budget stress does not allow for a smooth transition, especially if the IMF program is suspended without a second review.  The next administration will have to quickly decide on where and how to source funds, and that may immediately expose an underlying heterodox or orthodox policy bias. There could be some immediate relief if political transition coincides with the IMF SDR allocation with potential allotment of $1.3 billion to Ecuador.  However, this would only provide temporary relief for what is probably a backlog of arrears and high gross $8 billion to $10 billion annual financing needs.

The markets seem to be recently shifting towards a cautious credit view with Eurobond prices making new lows lately and bonds testing $40 support level for the lowest cash price bonds.  Our interpretation is Correista/Kirchnerista policies should translate into similar 15% to 18% Kirchnerista yields that would deeply discount future debt payments. The new price lows for the ECUA’40 should suggest a narrowing of the price differential to the high cash price ECUA’30 as distressed prices may undermine the potential for carry returns.

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