The Big Idea
Ecuador | Still underappreciated
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.
Ecuador’s bonds have finally bounced off distressed levels. A headline from President Guillermo Lasso reaffirming that tax reform would avoid constitutional challenges and a suspension of the comptroller’s Pandora Papers investigation proved the catalysts. But the market still does not seem to appreciate the successful management of the Lasso administration, which may prove transformational for the economy. The country has shifted toward higher trend growth, likely beginning next year with progress on 3% of GDP fiscal consolidation. Investors should hold a high conviction overweight and target the yields closer to 8% than 10%.
There is typically a lift to investor sentiment after approval of controversial reform, especially for a country with a credibility deficit and a track record of heterodox policy management. The logic suggests that the positive shock to consumer and business sentiment would mitigate the downside risks to growth from the demand shock of fiscal austerity. Eurobonds haven’t yet shown the euphoria that should be expected after approval of potentially transformational tax reform and successful policy management under the Lasso administration. Perhaps this reflects the thin year end liquidity or concerns of policy reversal from the latent social and political pressures.
There was also some relief this past week on that front. First, the Pandora Papers investigation was dropped on insufficient evidence. Second, the Pachakutik party that initially submitted a repeal of tax reform later announced goodwill for collaboration. President Lasso also announced that the tax reform would not be vulnerable to legal challenges. Perhaps markets are waiting to make sure there isn’t any fallout or pushback for policy reversal. The rule of thumb is that a strong leader with high approval ratings should have significant political clout. There have been several incidents over the past few weeks that should reassure. PSC and ID deputies blocked the impeachment threat from UNES. And then surprisingly, UNES indirectly assisted President Lasso on the approval of tax reform. After having survived so many policy mistakes under former President Moreno, there should be appreciation and recognition of the political adeptness of President Lasso.
Next on the agenda is labor reform. The fast-track legislative process probably isn’t the right plan after the tax reform experience. That explains the recent decision to push the reform into next year. This is logical. The Lasso administration needs to adopt a different political strategy for the unreliable coalition. There is flexibility with no urgency to approve this reform under the IMF program. The near-term strategy is to build consensus across society for either bullying the legislature to respond to public opinion or bypassing legislative authority and seeking direct support through a referendum. The bottom line is that high near 70% informal employment demand labor market flexibility. The direct appeal to the majority under-employed and bypassing the special interests in the legislature reaffirms a referendum approach. There is room for optimism for progress next year. The challenge for the Lasso administration is to maintain their high 60% popularity with hopefully the benefit of the cyclical economic recovery.
The investment reform is not as straightforward. There were already some slick oil reforms embedded into the umbrella tax reform including migration from service contracts to production-sharing contracts, private sector concessions for exploration or exploitation of oil fields and the delegation of public fields to the private sector. There is probably still some necessary revisions to the hydrocarbon law and it’s not clear what other specific reforms will require legislative or referendum approval.
Our main takeaway is that 10% yields do not reflect the positive credit momentum. The tax reform alone should have been a positive shock to immunize against external risk factors and push yields back to recent lows. There is no other country approving tax reform and no other country that will be able to deliver an impressive 3% of GDP fiscal consolidation from 2021 to 2022. This would exceed 2019 pre-pandemic levels to tackle the worse debt ratios. Ecuador is also unique for its strong IMF relations through next year, thanks to having approved the one structural benchmark this year that will reassure on fiscal performance criteria next year. Ecuador remains our top pick on the low liquidity risks (restructured debt and multilateral support) and the improving solvency risks (economic reform momentum). Our preference has been the 5% ECUA’30 that should benefit not only from the bullish curve steepening but also from higher current yield over a lengthy multi-phase economic reform process.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.