Ecuador | Approval strategy

Siobhan Morden | September 24, 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. This material does not constitute research.

The Lasso administration has confirmed its plan to take a shock-and-awe approach by submitting an omnibus bill to Ecuador’s Assembly after returning from the recent UN meetings. This seems almost predestined to fail. After all, the Moreno administration’s omnibus reform bill failed in November 2019 when deputies complained that they could not possibly review multiple complex reforms within a 30-day maximum timeframe.  But perhaps that is the strategy.  Make a feeble attempt with the legislature to deflect any autocratic criticism, but instead seek approval of the reform agenda through a popular referendum.

This is the most practical approach for the marginal 18% support in the legislature against the 74% popular support among voters.  This suggests a bumpy initial process but still optimism that the Lasso administration understands the political challenges and intends to leverage his popularity for a successful reform agenda. This reaffirms our constructive view on the credit; however, we also expect only slow progress through the planning months of a referendum. This translates into a range trade that prioritizes carry returns with the 5% ECUA’30 offering the highest current yield.

The latest guidance on the reform agenda suggests an ambitious omnibus legislation that includes labor reform, tax reform and other reforms to boost private investment in strategic sectors like oil and mining. The local headlines suggest progressive reforms; however there has been no lengthy negotiations with the legislature or a broader marketing campaign.  It just doesn’t seem politically feasible that the Lasso administration will garner more than 50% support on an ambitious and complex agenda, especially with controversial labor and tax reforms.  It’s also difficult to forget the political mistakes of the Moreno administration on the omnibus Economic Growth Law in November 2019 when deputies archived the bill on the complaint that 30 days was insufficient to review many complex reforms including over 400 articles of tax reform, central bank reform and public finance reform. The market backlash was extreme with bond prices declining 15 points in the immediate aftermath.

The Lasso administration also faces only marginal 18% support without any success on any of the recent legislation that’s been submitted over the past few months. The legislative submission may just reflect the first stage in a longer process that makes a feeble attempt to cooperate with the Assembly but yet recognizes the constraints of obstructionist Correista block and uncooperative culturally leftist majority.  The autocratic backlash of a popular referendum may also be limited with most voters increasingly disillusioned after the many corruption scandals within the legislature.

The popular referendum is the more important strategy for approval of the reform agenda with months to prepare allowing for a marketing campaign and the momentum of still strong 74% popularity after an effective vaccination campaign.   The referendums are somewhat controversial for bypassing the legislative authority, but if there is no cooperation and consistent rejection of President Lasso’s agenda, then it’s the next obvious recourse.  President Lasso probably understands that he needs to quickly capitalize at the peak of his popularity on what typically is a process of gradual decline throughout the mandate and plans to send the omnibus legislation under the 30-day urgent economic status that would allow a referendum possibly in February 2022.

The last referendum in February 2018 it was an overwhelming victory for President Moreno on restoring democratic checks/balances with presidential term limits.  The process includes the following: “Referenda may be introduced by 1) citizens by collecting a specified number of signatures or 2) the President. Constitutional amendment proposals require signatures representing 8% of those registered to vote while referendums introduced by citizens on other matters require signatures representing 5% of the electorate. The President may advise the National Elections Commission (CNE) to convene a referendum on any matter. Once the allotted signatures are reached or the President requests a referendum, the language of the proposed question must found to be constitutional by the Constitutional Court. It is then sent to the CNE after which the CNE has 15 days to call for a referendum to take place within the next 60 days. The referendum is passed by an absolute majority of valid votes.”

It took four months to launch the referendum after President Moreno issued an executive decree and submitted the questions to the constitutional court for review in October 2017.  The successful results coincided with still strong popularity for President Moreno, coming off a peak at 75% in July 2017 but still high at 61% in February 2018 at above the majority threshold. The timeframe would be similar for President Lasso for perhaps launching a referendum in February 2022. President Lasso will not only have to sustain his popularity through the planning months of a referendum but also tackle a more controversial economic as opposed to a political reform agenda. This will require relatively weak reforms that are progressive (impacting only highest tax brackets) and socially inclusive with an important consultation and debate across all sectors. The economic recovery should also provide some tailwinds. The progress on the reform agenda will determine whether bond yields will break out to a new lower range with debt sustainability dependent upon structural reforms that will reduce the fiscal deficit, improve trend growth, and strengthen dollarization.  Ecuador bonds may remain in limbo for the next few months through the referendum while monitoring the strength of the economic recovery and the approval ratings for President Lasso.