Ecuador | Pandemic politics

Siobhan Morden | August 6, 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 impressive vaccination surge over the past few weeks has led to quick convergence with other countries in the region. The current pace suggests the country should reach the new Lasso administration’s campaign promise of 50% vaccination rate by the end of August. This was an important priority and a necessary boost to political capital to keep the political honeymoon going.  This now sets the stage for assessing the execution risks of the country’s International Monetary Fund program. By the end of September, the market should get a closer look at the program’s reform calendar and the political strategy for legislative cooperation.  Ecuador will enter a defining moment later this year for solidifying political support for economic reform.  For Eurobond holders, the level of commitment to debt sustainability should determine whether yields break to new lower levels.

The IMF event risk remains the binary determinant for most if not all the high yielder sovereigns.  However, it is not so much about the deal risk for an IMF agreement but rather the execution risk.  The restructured Eurobonds backload the payments, and future repayments consequently dependent on a successful economic reform agenda.  There are no near-term liquidity risks for the postponed debt payments, but rather it’s the solvency risks that most influence Eurobond performance. The success or failure of the economic reform agenda will determine whether Eurobond yields can break out of the 8.5% to 9.5% range.

The official rhetoric suggests a final staff level agreement this month and a release of the staff report after the IMF board review in September. This will provide the guidelines and calendar to assess the execution risks.  The challenge for the Lasso administration is to pursue both a political and economic agenda.  There are high expectations for a comprehensive and credible economic agenda under the technocrat influence of a well-respected economic team and the IMF staff.  The hard part is designing an economic program that is both socially and politically viable amid the reality of a post-pandemic shock that requires gradual and backloaded fiscal austerity. Costa Rica should serve as a template with a clear departure from the proposed 3% VAT hike after the social backlash in Colombia.  The execution risks will depend on a politically feasible program and the political strategy to reach a workable legislative coalition.

There is an overhang of skepticism for a culturally populist country possibly unaware of what’s necessary to defend popular dollarization after the violent 2019 social backlash following elimination of energy subsidies. The Lasso administration should be well aware of the social and political constraints after the trial and error of the Moreno administration and Lasso’s narrow victory against the populist Correista candidate.  However, the market should also recognize the progress of the Moreno administration to successfully liberalize gasoline prices, structurally reduce the fiscal deficit and push through central bank, budgetary and monetary reform.  There was successful legislative cooperation for the IMF program through a politically tense election cycle and weak Moreno administration. However, it is now a more difficult phase of adjustment. There is a weaker legislative coalition and continuing pushback from CONAEI on subsidies.  The economic reform agenda should include more controversial tax and labor reforms while the legislature is much more fractured with the ruling BAN party representation of only 18%.

It is not clear what the political strategy will reach a workable majority with the Pachakutik and Democratic Left parties. These are not obvious allies for their center-left ideologies. President Lasso will have to leverage his high 70% popularity, launch a public awareness campaign, and emphasize progressive and socially inclusive reforms. The successful vaccination campaign should also provide some initial momentum. The Costa Rica IMF program again suggests a potential template for a political strategy that lowers execution risks. It is difficult not have to have some optimism in the next phase of an IMF program with initial political capital for the economic reform agenda.  This makes us constructive on the credit on soon entering into a critical phase to assess execution risks.