The Big Idea
Ecuador | Election fallout
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Recent elections in Ecuador have raised concerns about sovereign default. President Daniel Noboa may have been the official frontrunner in the first round, but Correismo ran a tight race and dominated the legislature. This is worrisome and creates more downside, less upside and less relative value for bondholders. Correismo is not dead, and governability is now more difficult with higher policy and political risks. The technicals are also not ideal with trapped longs after the surprise of the election results. This may invite “selling into strength” with bond prices more sensitive to negative than positive news.
There is much anticipation for the next round of polls from the reliable Comunicaliza pollster. It’s still my base case that Noboa gets reelected in the April 13 runoff round, but this requires favorable polls of say 55% for Noboa to 45% for Gonzalez to validate some relative value or even a neutral view of the credit.
Noboa should still have the advantage
There has been a lot to process in the election aftermath with definitely some regret on not booking some profits after the impressive run-up in prices, especially with and Ecuador’s track record of negative surprises. The base-case view is still for a second-round win for Noboa. The incumbent should have the advantage, with clear opportunity for a more aggressive campaign in the coastal areas.
Noboa has mentioned election irregularities. It’s not clear whether Correismo strength reflects fraud or protest votes, but it couldn’t hurt to step-up the voter station observers in the less secure coastal provinces. There is also a lengthy 2-month interim period that would allow for a more aggressive campaign contrary to the pair of brief 5-day leave-of-absences that Noboa took during the first-round campaign. This lengthy 2-month interim into the runoff round, that was previously seen as an inconvenience, is now viewed as a benefit for the incumbent. The voter breakdown of the first round should also benefit Noboa under the assumptions of an equal split of the indigenous vote (Correa/Iza frictions) and the concentration of centrist voters for the incumbent. Correismo may benefit from some disgruntled protest voters but it’s still difficult for them to reach mainstream support for their radical ideology and traditional party stigma.
October 2023 runoff preview for April 2025?
The polls will be critical to monitor with the October 2023 runoff round between Noboa and Gonzalez serving as an important reference. First, it’s important to mention that select polls are reliable with Comunicaliza almost tracking the 3% margin of error against the first-round results. This margin of error should actually narrow with logically polls more reliable in a runoff round with two candidates. Second, poll accuracy matters when it’s a tight race. There would be greater comfort if the polls showed a similar 55%-to-45% Noboa advantage similar to the 2023 runoff round. The release of the second-round polls should occur fairly soon and maybe as early as next week based on the last runoff election cycle. Maybe this runoff round mirrors the last runoff round with a consistent 55%-to-45% margin resulting in a 52%-to-48% Noboa win? The first preview to the polls will be critical for market sentiment.
The lower upside and higher downside risks for bondholders
The debate over the upside price target has now shifted to debate of the downside price target and recognition of more binary outcomes. There is now much higher Correista risk. This is true to the upside or downside scenarios. If Noboa wins, there should still be prospects for a governing coalition with the smaller parties and independents. But the obstructionist block from Correismo should weaken governability on their dominant (first) minority position in the legislature. There are clear policy tensions against the obstructionism and radicalism of Correismo and Pachakutik that represent 50% of the legislature. The higher Correista risk translates into higher political and policy risks. This cultural populism is highly relevant on a challenging IMF program to reduce the structural fiscal deficit. This weaker governability should cap the potential price upside for Eurobonds maybe from 75 to 70 on 2035s under a Noboa win and also invite debate about the downside price risk under an alternative Gonzalez win, with a default-probability-adjusted price of 40.
There is much debate on what classifies the downside price risk from Correismo. Is default inevitable or will Correismo shift to the center as per recent comments from Gonzalez about potential “IMF cooperation”? The analysis shifts to weighing the default risks under Correismo at maybe 15% * 70 friendly versus 85% * 35 unfriendly policy management for a weighted ratio of 40 downside price on the 2035s. The default risks under Correismo are a serious threat due to the chronic liquidity risks that would only worsen under a suspension from the IMF program. If there is no access to multilateral credit, then repayment risks worsen ahead of the 2026 sinking fund payments and track record of default. Correismo is untested on their IMF relations; however, their ideology would conflict on good governance, data transparency and fiscal discipline. The US diplomatic relations would also predictably worsen on the contrasting Trump and Correa ideology. The political agenda (overruling Correa judgment) would also serve as a distraction for the economic agenda. This seems reasonable upside-downside risk scenarios that would align to current prices at near 60 for the 2035s at 65% * 70 + 35% * 40 for the 2035s. This reasonable market-based scenarios requires still supportive polls for a some relative value or even a neutral view if it’s a tighter runoff round.
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