The Big Idea

Ecuador | Conflicting objectives

Siobhan Morden | July 8, 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. This material does not constitute research.

The back-to-back shocks that have weakened Ecuador’s Lasso administration have forced a reassessment of popular long positions. The higher volatility and protracted weakness has also probably weakened investor sentiment as Ecuador shifts from the best performing credit so far this year to the worst. Current prices now seem to reflect worst-case scenarios including a sudden regime change or a shift toward policy heterodoxy. But current low bond valuations offer a buffer to a healthy part of the risk.

The worse of the opposition attacks have been averted near-term. The challenge now for the Lasso administration shifts to CONAIE negotiations to avoid a political crisis and maintain economic stability. It will remain difficult to balance policy objectives. The current low bond valuations should offer a buffer while oil prices still remain above budget, IMF relations remain strong and the Lasso administration rebuilds his mandate and negotiates with CONAIE over the next three months.

There have been several opposition efforts to oust President Lasso from office. None of these constitutional venues now look realistic. The primary concern is whether the political and social pressures undermine the economic agenda and fiscal discipline. It will require some serious and skilled political negotiations over the next few months with CONAIE.

There are three constitutional threats to remove President Lasso from office but none of them are (yet) viable.

The legislature has already tried to invoke snap elections under Article 130. There were three successive rounds that were unsuccessful in reaching the 2/3 necessary votes. This is no surprise with many deputies unwilling to threaten their own re-election under the context of snap elections for both the legislature and the executive.
The opposition has also attempted to request a recall referendum of President Lasso under Articles 105-106. The CNE promptly rejected the request for insufficient proof that President Lasso failed to perform his duties. This looks like a hard no. The other hurdle is reaching the 15% necessary signatures required to launch a recall referendum. President Lasso’s popularity may have breached below 30%; however, the latest polls show a renewed appreciation for democracy and for stronger institutions.
The other alternative of impeachment under Article 129 seems technically the least likely as it requires a serious legal breach such as genocide, torture, embezzlement, etc.

Whether or not President Lasso is forced into an early exit depends on how he manages the social pressures in subsequent months. The Lasso administration is still trying to reinvent itself after the indigenous protests and breakdown on legislative relations. The recent cabinet reshuffle doesn’t necessarily bridge any political alliances or much alter public perception. The incoming Finance Minister Arosemena should pivot towards a dual social and economic agenda. There is not much flexibility under the IMF adjustment program. If offering only minor budgetary concessions, then it will require some political finesse through the current CONAIE negotiations to manage the social and political pressures.

The pressing concern for President Lasso is how to manage these fiscal concessions, especially without the anchor of an IMF program next year. The public debate is long overdue on how to fund spending entitlements under the constraints of dollarization, saturation of local markets and restricted access to external markets. The next few months of CONAIE discussions will hopefully allow for a rational debate about budget and financing rigidity. This is the first hurdle – that allows for a political compromise with minimal fiscal slippage. The next hurdle is funding this permanent spending with higher economic growth in strategic sectors. The suspension of decree 95 and amendment of decree 151 complicates the plans to expand oil and mining production. The Lasso administration will have to manage these political constraints to still

If the Lasso administration doesn’t consolidate the fiscal accounts or attract foreign direct investment into strategic sectors for higher trend growth, then how will the country meet the restructured debt beyond 2025 once bond payments accelerate? This remains the overhanging concern for bondholders. The current prices should soon find a floor of support at below 2020 recovery value levels and at recent worst levels of early 2021 when UNES candidate Arauz was leading the polls. The near 9% current yield is also reaching attractive levels for carry returns so long as prices stabilize near current levels. The high oil prices and the IMF anchor are all supportive so long as President Lasso manages the social pressures and avoids a forced resignation. It is also important to recognize the low rollover and repayment risk of deferred amortizations and near zero coupon payments. The upside gains remain dependent upon a successful growth agenda necessary for restructured bond payments once they accelerate in 2025-2026.

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

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

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