The Big Idea
Ecuador | Next steps
Siobhan Morden | May 12, 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.
The next few days look critical for the final phase of impeachment in Ecuador. It’s been an almost contradictory cross-current of headlines between the country’s blue bond launch, generating funds for Galapagos conservation, and the impeachment trial. Neither are transformational, the blue bonds offering only minimal debt relief and many expecting status quo under the political continuity of President Lasso. This is why bond prices remain mostly stuck at recovery value levels.
The Lasso administration will likely adopt a high-risk strategy to survive the actual impeachment vote next week. This is a process of negotiation and a tight vote count after the trial run this week. The plenary voted on whether the impeachment trial should proceed after the committee failed to approve the NO impeachment vote report. There were 88 votes in favor, just shy of the necessary 92 for an actual impeachment. The stakes are now higher with both President Lasso and the majority of deputies at risk under either impeachment or snap elections.
The next vote count depends upon the counter leverage between the Correistas and the Lasso administration. The 21 absent deputies (passive abstention) represent the swing voters for the actual impeachment vote. It’s not clear what the Correistas can offer to what has become a weaker coalition after various defections from within the Social Christian Party and the divisions from within Pachakutik. The offer to maintain the status quo on Assembly leadership probably doesn’t strengthen their coalition whereas ruling party CREO could offer their support in Assembly elections as well as discourage impeachment vote with snap elections. There is also the proposal for tax reform that could further splinter the tax-adverse Social Christians. The executive branch typically has more leverage than the largest minority opposition block in the legislature. If we assume that politicians prioritize self-preservation, then the status quo should remain. The negotiations on internal Assembly elections this weekend should provide a preview on whether the ruling party successfully blocks impeachment next week.
This status quo is not ideal for bondholders. The weak Lasso administration may gain some marginal political capital. But this is probably insufficient to regain a stable coalition. Surviving is not thriving. The low approval ratings and fractured legislature will probably favor populist initiatives and avoid any controversial economic reforms. This does not bode well for reducing the structural fiscal deficit either through spending cutbacks or increasing revenues with pro-growth initiatives in strategic sectors. There are marginal if any financing sources when gross financing needs escalate from higher payments for Eurobonds, IMF, and China loans beyond 2025.
This is what traps bond prices at these current lows with backloaded payments heavily discounted by high repayment uncertainty. There have been many headlines about the successful launch of a blue bond. This has only a minimal impact on bondholders because of the unique structure that diverts debt service savings to marine conservation with only a marginal 6% decline in the stock of debt. There are no cash flow savings with ongoing high liquidity risks for the scarce funding options and high structural fiscal deficit. The marine conservation initiative would not likely transform the economy in terms of tourism or foreign direct investment inflows while also adding to the high structural spending and persistent liquidity and rollover risks. There is also no broader support for a medium-term economic development plan on the distraction of the persistent power struggles.
This may trap bond prices at low levels, but the lower event risks under the status quo of the Lasso administration could also establish a near-term floor on bond prices. The worst of the political and social risks could soon subside with the Lasso administration reverting back to a muddling through with priority payment of the low Eurobond debt service. This would benefit the highest current yield of the ECUA’30s ahead of the step-up on coupons in July. There is no rush to add to an already neutral recommendation under the context of only carry returns and ahead of the still important event risk of the impeachment vote next week, especially on the potential volatility and tight odds for the outcome.