Ecuador | Oil dependence

Siobhan Morden | March 17, 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.

After some delay, Ecuador’s legislature is moving forward with impeachment of President Guillermo Lasso. Next the legislative CAL committee reviews the motion and then likely next week the most important test—review from the constitutional court. This is where many constitutional lawyers believe the criminal allegations will fall short. Even if the constitutional court admits the impeachment, the threat of snap elections would likely deter a two-thirds impeachment vote in the Assembly. But even no impeachment could weaken Lasso and lower the trading range for Ecuador’s Eurobonds.

Our base case scenario is no impeachment, but a weak Lasso administration will still face many challenges. The recent shock of lower oil prices would only aggravate latent social and political tensions. There is no margin for flexibility on the 2023 budget. This would not jeopardize the low near-term Eurobond coupon payments, especially for their priority status under the market friendly Lasso administration. However, it does reinforce the high political and social tensions under a scenario of pro-cyclical fiscal austerity and a lower trading range for Eurobond prices.

There has been back and forth and much indecision among the opposition on the impeachment process. This is not just a political process but rather a technical process that requires a favorable ruling under Article 129 from the constitutional court on the criminal allegations. President Lasso issued a statement rejecting the impeachment and claims that there is no legal basis but rather just an attempt to destabilize the government.

If the legislative CAL committee signs off on the impeachment documents, then the next step is review from the constitutional court next week. It would require six of nine justices to either approve or archive the impeachment. The strong institutions and independent judiciary suggest a rational outcome that would archive the impeachment. The alternative scenario is that the threat of snap elections would discourage a two-thirds impeachment vote from the legislature. It would require 92 versus the latest vote of 59 deputies and versus 80 deputies on the last impeachment attempt in June 2022. The same roadblocks remain on either rejection from the constitutional court or failure to achieve two-thirds majority vote under threat of snap elections.  This was always our base case scenario.

The impeachment threat may soon be averted; however, the weak governability should continue.  The political and social pressures remain unresolved and now weaker oil prices provide even less policy flexibility.  There is no room for fiscal stimulus under weak oil prices and less borrowing capacity under the assumption of no IMF successor program (Exhibit 1).  This should perpetuate a pseudo limbo of weak governability for the Lasso administration and persistent political risk premium for Eurobonds.

Exhibit 1: Ecuador’s funding

Source: https://www.finanzas.gob.ecf *budget excludes oil/derivative  accounts

The current oil prices are now near budgeted levels of $65 a barrel for the Ecuador mix. This now exposes some weak assumptions within the budget including $1 billion sale of non-financial assets (Soplaverde Hydro plant and Monteverde Terminal), $637 million external financing, and 4.5% higher oil production. There has been no progress on asset monetization under either the Lasso or the Moreno administration, no progress on reversing the decline in oil production since 2016 peak levels and no access to external capital markets at distressed bond prices. The volatility of oil prices and high oil dependence reaffirms the need to expand oil production beyond 500K/bpd. The budgeted fiscal deficit of 2.1% of GDP could passively revert back to the trend levels of 4% to 5% of GDP. The limited financing alternatives should force lower spending since you cannot spend what you cannot borrow under the constraints of dollarization. There is marginal borrowing flexibility from the multilaterals as well as the typical reliance on arrears (stock that varies from $2 billion to $4 billion). This should force the Lasso administration to actively adjust the fiscal deficit closer to 3% of GDP. This fiscal austerity should not impact priority Eurobond coupon payments, especially for the small payments of less than 0.5% of GDP.

The low coupon bonds shouldn’t have such a high sensitivity to the near-term volatility of oil prices with low Eurobond payments inferring low liquidity/rollover risks for their small burden within the 2023 budget.  The backloaded payments depend on a gradual process to either structurally decrease the non-oil deficit or increase oil revenues (volume and/or prices).  The volatility of oil prices could also provide some temporary budget relief either now or later.  The bottom line is that backloaded coupons should be less vulnerable to near-term macro trends and much more dependent upon medium-term political and policy risk beyond 2025. The ECUA’35 and ECUA’40 bonds are now at critical support levels of historic low 30 recovery value that already discount worst-case medium-term scenarios. This may provide a near-term floor for bond prices but bond prices may still be trapped at a lower trading range under the constraints of policy paralysis of a weak political mandate.