The Big Idea

Ecuador | Fiscal performance

| April 22, 2022

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.

The 10% to 11% yields on Ecuador’s sovereign debt discount the country’s latest fiscal performance and reflect plenty of uncertainty. There is uncertainty about whether the temporary oil windfall becomes permanent and about whether the Lasso administration can deliver pro-growth economic reform through a popular referendum. But Ecuador’s fiscal results show commitment to spending restraint and strong  non-oil and tax revenues just as President Lasso accelerates plans for a reform referendum.  These high yields underestimate the momentum for economic reform and the effective policy management of the Lasso administration.

There is almost no comparison between 2020 and 2021. Ecuador has come out of pandemic shock and transitioned from a fiscal deficit of $6.9 billion to $3.17 billion. The underlying trends remain supportive. The oil revenue boom was impressive last year and still supportive this year.  However, it’s worth highlighting the impressive performance of non-oil revenues in light of another year of expected economic recovery and the benefit of tax reform. Spending restraint was an important contribution to fiscal consolidation last year with an 8.7% year-over-year decline in current spending and an important 4.4% year-over-year reduction in the salary burden. The spending would have been lower if it weren’t for the spike in capex. Multilateral lenders remained almost the sole source of funding for $4.5 billion in gross financing needs with critical rollover of domestic obligations in local markets.

Ecuador’s preview for this year shows a recovery in spending and a continuing net fiscal surplus in early 2022 thanks to the oil windfall.  The revised budget deficit for 2022 at $2.3 billion versus $3.6 billion only incorporates part of the windfall at average oil prices of $60 a barrel. The current oil prices at $100a barrel would wipe out the revised fiscal deficit, or conversely, provide a spending buffer to manage the social and political pressures with perhaps even a softening of IMF fiscal targets. These pressures are particularly relevant for the obstructionist opposition and the inflationary demand-side shock of higher fuel prices. The tax revenues are still impressive at an average 15%year-over-year in the first quarter of 2022, but it’s the oil windfall that financed the budget with limited support from either local or external markets.  There hasn’t been an IMF disbursement since December 2021. However, the local press suggests a quick resolution to resolve data discrepancies after recent high-level conversations between President Lasso and IMF MD Georgieva and ahead of the IMF spring meetings.

The impressive fiscal consolidation is only sustainable under potential scenarios that include permanent higher oil revenues funded by higher oil production, higher tax revenues funded by higher trend growth or the structural reduction in expenditures, especially public wages. This fiscal consolidation is critical for not only lower rollover risks of the high gross financing needs but also for medium-term debt sustainability on the backloaded restructured debt payments.  The spending restraint shows the commitment to fiscal discipline of the Lasso administration through 2021. However, the preferrable political path towards fiscal consolidation is through private investment-led growth. There has been no improvement in foreign direct investment with perhaps the political risk a deterrent as long-term investors require broader political support for rationale economic policies.  The political strategy has since shifted to a referendum or popular consultation that will require an extensive socialization process for popular support of the economic agenda including investment and judicial (maybe labor) reforms. The Lasso administration seems committed to push forward economic reform with still latent upside for bondholders at current distressed levels.

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

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