Ecuador | Political setback

Siobhan Morden | February 10, 2023

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.

For holders of Ecuador’s sovereign debt, the latest political setback for the administration of President Guillermo Lasso underscores policy risk and keeps repayment uncertainty high ahead of backloaded bond payments. The headlines coming out of the recent referendum on economic reform were also inopportune with Ecuador already vulnerable to weak market technicals. These weak technicals and uncertain medium-term debt repayment capacity explained my shift to a more cautious view last month the recommendation to reduce a tactical overallocation.

The political referendum was supposed to provide a boost to confidence and a marginal improvement in overall governability.  The results show otherwise.  The resounding “no” across all of referendum questions represent a vote of no confidence for the Lasso administration (Exhibit 1).  But worse is what is says about society and its view of economic reform.  The questions themselves were not enough to encourage broad support for even minor economic reforms across security, the environment and the legislature. There has been no in-depth discussion across the mainstream media or the social media about the implications. This is part of the problem.  There is no forum for discussion about the structural political, security and economic problems and how best to fix them.

Exhibit 1: Initial results from Ecuador’s referendum on political and economic reform

Source: https://equinocciodigital.com/2022/12/17/segun-cedatos-el-si-tiene-ventaja/, https://www.cne.gob.ec/wp-content/uploads/2022/12/RESOLUCION-PLE-CNE-1-6-12-2022.pdf, https://elecciones2023.cne.gob.ec/

The near final 97% results for the referendum are not ideal. The “no” vote has won across all questions.  These results clearly contradict the majority of polls that favored “yes” over “no” on all questions. It also merits an assessment of the implications for policy and political risks during and beyond the Lasso administration.

The referendum itself has limited impact near-term with questions that only targeted marginal reforms across the security, the environment and political institutions.  It’s curious that the protest vote against President Lasso dominated over the popularity of the questions themselves. The voters would rather penalize the Lasso administration on a symbolic protest vote instead of tackling security problems, strengthening political institutions or improving the environment.

This is not a victory for the opposition, with a continuing low 7% approval ratings in the legislature.  This may embolden the opposition into a more obstructionist strategy But the executive still benefits from a powerful veto and a rational judiciary that enforces checks and balances and encourages policy moderation.  The threat of impeachment is still not viable with the unpopular legislature equally facing high-risk scenarios under snap elections of the executive and the legislature. This is why the legislature was unable to rally two-thirds support for this proposal last year.  The recent setback probably doesn’t have much if any tangible near-term impact on political risks but rather only reinforces the current policy paralysis and dependence on high oil prices.

There are minimal near-term liquidity risks for Ecuador with low coupons on its bonds, high oil prices and a market-friendly Lasso administration. However, the solvency risks remain high and maybe now worse with no societal consensus for even minimal reform.  There is no cooperation to fix problems now and high uncertainty on whether there will be consensus to fix problems later. This has been the narrative behind my cautious view of the past few months and the recent recommendation to take profits last month.  This latest political setback only reinforces this pessimism and validates the highly discounted medium-term payments with no clear path to increase trend growth or decrease high structural spending.

There was a knee-jerk 8- to 10-point price drop in the immediate aftermath of the referendum with stale overweight positions vulnerable to weak technicals and surprise negative event risk. These results were a wake-up call to medium-term risks that deeply discount backloaded Eurobond payments.  There may be soon a pause to reassess at lower levels from late last year (price congestion at late Aug/early Sep).  A de-leveraging trade looks unlikely for now.  It’s difficult to commit to a high conviction view on the evolving risks over the next three years and the varying policy options through the political transition after the Lasso administration.  However, a quick recovery looks unlikely with bias to sell into strength and reduce trapped long positions.