Ecuador | Difficult politics

Siobhan Morden | September 9, 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.

Political and social pressures still hang over Ecuador’s credit, limiting economic reform. The Lasso administration and the legislature remain paralyzed. But market pricing has created a cushion against the risk. Bond prices stand in the 30s and the current yield on the 5.5% ECUA’30 is attractive around 10%. This should provide some protection against adverse headlines, although it’s difficult to identify what domestic catalyst would push bond prices higher.

The weak Lasso administration has not been able to cooperate with an obstructionist opposition in the legislature while also facing populist demands from radical indigenous factions. There have been many distractions and no headway on economic reform with bond prices likely still trapped at low levels until when/if there is a breakthrough on political coordination or a successful unilateral effort to reform the economy via higher oil and mining production.

The Lasso administration is managing the political tensions; however, it’s not clear what’s the plan to move forward on the economic reform agenda.  The prior attempts to push forward reform via the legislature have been mostly thwarted while the single success on tax reform is now under attack from the opposition. The powerful veto should block the attempts to repeal tax reform with the opposition yet to garner the 2/3 majority to overturn an executive veto.  The fragmentation of the opposition offers a check against policy radicalism and instead just translates into policy paralysis. It’s surprising that there has been recent collaboration on an investment reform bill in an Assembly committee; however, tense relations do not bode well on reaching majority support. The challenge for the Lasso administration is whether they can unilaterally push forward as reform agenda under executive decrees while simultaneously managing the social tensions with the indigenous community.

The negotiations between the Lasso administration and CONAIE should continue through October 13 on a 10-point plan that addresses the indigenous demands following the disruptive protests last June.  The below trend budget allows flexibility for spending concessions; however, the highly politicized leadership and Marxist ideology of CONAIE suggest still unstable relations and latent social pressures. The latest headlines may also complicate 5Y plans to double oil production on a moratorium on the exploration phase of 16 oil blocks and societal pressures to extend the moratorium on mining, oil and hydroelectric activities. If the weak Lasso administration cannot either cut high structural spending or attract investment-led growth, then it’s difficult to assess a realistic medium-term economic plan for debt sustainability.

The strong IMF relations and above-budgeted oil prices should offer a near-term buffer that reassures low rollover/liquidity risks of low coupon payments. However, there isn’t a specific catalyst that could strengthen the governability or broaden social and political support for a pro-growth reform agenda. The new economic team under Minister Arosemena suggests that he’ll fully execute the under-budgeted social spending. There hasn’t yet been a boost on President Lasso’s approval ratings with the latest polls suggesting sub 20% against 30% in June. The renewed discussion about a political referendum next year seems more intended to discredit the opposition than strengthen the Lasso administration. It’s unclear whether this proves a successful political strategy to encourage collaboration from the opposition and yet no definition on the specific questions.  The optionality of higher bond prices requires a medium-term plan that reduces the structural fiscal imbalance either through a reduction in spending (unlikely under weak mandate) or an increase in revenues (unclear the catalyst for higher trend growth).

The near-term bond payments benefit from low rollover risk of 1.) restructured low debt payments through 2025, 2.) high oil prices, 3.) strong IMF relations and 4.) the commitment from the investor friendly Lasso administration. This translates into decent current yield of the highest coupon 5.5% ECUA’2030 at near 10%. The low bond prices should also offer technical support at worse levels from when the Correistas were leading the polls in early 2021. This translates into a significant amount of policy risk premium and a buffer against headline risks.  However, the optionality for medium-term payments requires stronger governability and broader political support for economic reform.

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

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