Ecuador | Moving forward

Siobhan Morden | October 29, 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.

Prospects for Ecuador’s sovereign debt continue to look good. President Guillermo Lasso’s administration has made it through a freeze on fuel prices with no significant social unrest so far while negotiations continue with coalition allies. Then there’s the potential bounce on submission of tax reform and further potential gains once approved. The tax reform is a litmus test of the Lasso administration’s ability to reach political consensus on economic reform. Approval of tax reform should put labor reform on a positive trajectory and add momentum to the initial phase of the revised International Monetary Fund program and to the administration’s honeymoon.  It’s a race against time as Lasso’s popularity has peaked ahead of a controversial and difficult agenda. But initial optimism should unwind the current skepticism around Ecuador’s sovereigns that are near the low end of the 6-month trading range.

This is not October 2019 and CONAIE is not hijacking the reform agenda. The demand for gasoline price cuts does not have the same attention as October 2019 since prices have been gradually rising for 14 months without the mistake of the price shock proposal of the Moreno administration. The CONAIE and FUT protests did not amount to much with only an estimated 1,500 in Quito. And it was nothing close to the devastating social unrest of October 2019.  The indigenous groups and unions remain an important influence on politics and policy. However, neither group has the same leverage to destabilize. The local officials have learned what to do and what not to do on managing these protests, such as not fleeing the presidential palace. There has also been extensive debate over the past few years on the controversial topic of fuel subsidies.  The public opinion has shifted against distortive, regressive, and expensive subsidies that promote excessive consumption of fossil fuels and run counter to the environmentally friendly agenda of the indigenous community. There is also no tolerance for the aggressive activism that undermines civil order and damages both private and public property. The small-scale protests of October 27 suggest declining leverage and influence on the Lasso administration and broader public opinion.

The attention now shifts to the Pachakutik and ID and whether there is basis for a working political coalition. The submission of tax reform slips into this week.  This is actually a signal of productive negotiations. The political strategy is to perhaps pre-negotiate support prior to submission. The submission itself will then have a high probability of approval.  The Lasso administration also probably wanted to wait out the protests to monitor what if any influence it would have on the political parties. The freeze on gasoline prices was probably enough of a political concession to Pachakutik that will immunize consumers against any further price spikes, though admittedly at current levels that are close to free market prices.

President Lasso is leveraging his high approval ratings and relying on the autocratic constitutional opportunities that are the residual legacy of the Correa administration. The threat of bypassing legislative authority with a referendum and the risk of snap elections remains serious leverage to force cooperation. The Assembly, with fractured parties and weak leaders, polls at much lower ratings compared to the Lasso administration.  The prospect for snap elections remains the backup plan if the Lasso administration cannot build a coalition for tax and labor reforms.

The reform momentum presents a buying opportunity. There is now more momentum for reform beginning with submission of tax reform. Lasso’s coalition should prevent a majority 51% rejection of tax reform within the fast-track 30 days. The local headlines suggest a potential coalition of 76 votes including BAN, Pachakutik, ID and the independents with the challenge to prevent the 61 deputies of UNES/PSC to reach 70 to reject the reform.

Ecuador bond prices have been within a fairly narrow trading range through the Lasso administration with current levels closer to the low end of the range. This suggests asymmetric optionality to again retest the upside of those price ranges, if not finally break above resistance levels if momentum on tax reform builds further momentum on approval of the labor reform later this year. Investors should prefer the 5% ECUA’30 on the higher current yield and on prospects of bullish curve steepening, especially after the recent underperformance.  The markets remain overly skeptical on the reform agenda and underestimate the political acumen of the Lasso administration.  There is a narrow window to maximize on the reform agenda with the popularity of the Lasso administration already having peaked and with remaining unresolved tensions with CONAIE, the Pandora papers controversy and the public relations management of an unpopular and controversial economic reform agenda.

Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539