The Big Idea
Ecuador | Crux of the problem
Siobhan Morden | March 3, 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.
Prices on Argentina’s and Ecuador’s bonds have nearly converged in the 30s and again discount a high probability of default so soon after the last debt restructuring in 2020. But Ecuador is clearly at a different stage with relative near-term economic stability after impressive fiscal consolidation, higher foreign exchange reserves and strong multilateral support. However, the repetitive political setbacks and populist policy bias undermine Ecuador’s future debt repayment capacity. The backloaded Eurobond payments should remain heavily discounted until there is political commitment to a medium-term economic plan.
Ecuador fundamentals are stronger than Argentina’s but there is no societal or political consensus to fix problems. Argentina has no other choice but to face its problems at an acute phase of liquidity stress and stagflation with memory of repetitive crisis. The referendum results and policy paralysis show reluctance in Ecuador to even recognize structural economic problems under the crutch of high oil prices and dollarization and the distraction of power struggles among the fractured political parties. This leaves for high uncertainty on ability and willingness to pay beyond 2025 – when higher Eurobond payments only worsen budget stress against uncertain oil prices and multilateral relations. There has been much focus on the improving fundamentals in 2022 but the more important question for bondholders is the ability and willingness to pay beyond 2025.
It’s all about managing the liquidity risk for a country that has high dependence on oil prices and minimal access to funding. Ecuador has difficulty on financing even low 6% of GDP gross financing needs. This is why the IMF recommends that the central government fiscal deficit shifts to surplus. This recipe is quite difficult for a weak government that faces pushback to tax hikes, subsidy cutbacks and restrictions to develop strategic sectors of oil and mining. This is the crux of the problem. There is no widespread debate about the budget constraints among the media, the political establishment, and the social sectors. There is overwhelming support for the stability of dollarization but no understanding about the financing restrictions and budget management.
The Marxist ideology of the CONAIE indigenous organization seeks huge subsidies and entrenched entitlements and pushes back against oil development while the majority of the legislature oppose tax hikes, labor reform and investment reform. There is no obvious cooperation or recognition that the country requires fiscal discipline or broader economic reform. The Lasso administration has been successful on halving the fiscal deficit from $4-$5bn to $2bn in 2022; however, these efforts mostly reflect the high oil prices and cutbacks to capex. This strategy does not allow for a structural shift towards a central government fiscal surplus. There is no obvious path under the weak Lasso administration for either a pro-growth strategy (higher oil exports) or for a fiscal consolidation strategy (cutbacks in public payrolls).
The Eurobond debt burden appears manageable with a restructured smooth debt service profile that doesn’t exceed 2% of GDP. However, it’s a question of spending priorities amongst scare funding options. Are oil prices higher or lower for the next administration? Will the next administration choose policy moderation and maintain IMF relations or policy heterodoxy with inward isolation? The next administration will most likely face the same structural cashflow deficit and similar political and social constraints of the Lasso administration. It would take an enormous boost to political capital to build broad consensus. Meanwhile, the strength of Correismo in the local elections further worsens this tradeoff if there is a shift back towards public consumption growth model financed with domestic repression.
The high political tensions should not threaten the near-term, low debt payments, especially under the market friendly Lasso administration. This is why current low bond prices should be at (or near) a floor. However, it’s difficult if not impossible to commit to a bullish medium-term view under the many uncertainties on policy and political risks. These many uncertainties should continue to heavily discount backloaded Eurobond payments until when/if there is clarity on a medium-term economic plan.