The Big Idea

Ecuador | Testing fiscal discipline

| June 14, 2024

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.

The unwind of fuel subsidies in Ecuador is making progress. Economy and Finance Minister Juan Carlos Vega has started discussing details of liberalizing gasoline prices and compensating those affected. Unwinding fuel subsidies would mark an important step toward meeting Ecuador’s ambitious fiscal targets and, more importantly, would show further commitment to fiscal discipline from the Noboa administration. The country’s distressed Eurobond prices should be sensitive to reductions in fuel subsidies, especially considering the recent underperformance. This positive event risk seems to be shifting closer.

There are natural comparisons between Argentina and Ecuador as two distressed credits embarking on an economic stabilization program. Argentina’s Milei shock therapy is not the recipe for Ecuador. There are different political realities that constrain Ecuador’s economic policy management. There is no political or societal cooperation to resolve economic problems, with pushback from the political establishment and social sectors. President Noboa understands these political realities and is in the middle of a balancing act between maintaining popular support and adjusting the fiscal accounts. This is even more pronounced with the need to implement International Monetary Fund austerity measures and maintain support for re-election next year. The unwind of fuel subsidies then represents an important litmus test on commitment to fiscal discipline and the execution risk of the IMF program.

There are not many politically palatable options to shift the fiscal deficit to surplus. Bloated public payrolls and low private sector employment allows limited flexibility for lower spending.  The burden shifts to higher revenues. The successful approval of tax reform was almost a miracle with temporary political support under the solidarity of the security crisis. The other alternative is to reduce the burden of fuel subsidies that ranges from 3% to 4% of GDP. The IMF targets “other revenues” of 0.7% of GDP in 2024 and 0.8% of GDP in 2026.  This seems reasonable for a targeted reduction of select subsidies. There have been many attempts to unwind fuel subsidies but most of them were reinstated under social unrest and even destabilizing street protests.

The social pressures have already started with plans for demonstrations from various unions and student federations over the next few weeks. Can the fuel subsidies survive the social backlash? There has been much trial-and-error on what works and what doesn’t work. This is why the Noboa administration has already calculated the social costs with a careful targeted strategy. First, the subsidies only target gasoline and not diesel and not LPG. According to Minister Vega, this would increase Extra from $2.47 to $2.72 and Ecopais from $2.47 to $2.77. Diesel represents the bulk of the subsidy burden. There is also reference to a monthly trading band that will reduce the volatility to market prices. Secondly, there are direct subsidies to the most vulnerable population of taxi and truck drivers. These direct cash transfers should lower the economic stress and maybe discourage social unrest. Thirdly, the socialization process intends to raise awareness about the pros and cons of the distortive subsidies. The timing is not ideal in the context of security concerns and electricity blackouts; however, President Noboa still benefits from the high 60% approval ratings. There is also an adversarial approach towards the radical factions (like CONAIE) with less tolerance for disruptive street protests and more activist security forces. The Quito protests yesterday were low scale without much disruption.

The unwind of fuel subsidies represents an important test of governability for the Noboa administration and an important contribution to fiscal consolidation.  Every success matters on what remains difficult execution risk on stabilizing the fiscal accounts. The Noboa administration has to survive two challenges: immediate social pressures and the threat to approval ratings necessary for a re-election win. The austerity measures are not idea ahead of an election cycle. It’s a calculated risk. There is still a cushion with high 60% support and, equally important, the popularity should be measured in net terms against the weakness of the opposition.  There are no serious contenders. If President Noboa maintains popular support, then this should reinforce his political commitment to the IMF program with a win/win on political capital and a successful IMF program.

This is what should anchor bond prices. The Noboa administration is building a track record on structurally reducing the fiscal deficit under the adverse political realities. The successful reduction in fuel subsidies would reaffirm the political capital and commitment to lower the execution risks of the IMF program. There is no quick transformation. But the consecutive steps forward should reaffirm optimism on Noboa policy management that allows bond prices to at least recover to recent highs. There has already been a small bounce since our tactical recommendation last week with potential for more follow-through gains on the actual launch over the next few weeks.

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

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles