The Big Idea
Ecuador | Equal binary risks
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.
With no reliable polls on Ecuador’s presidential race available yet, a weak consensus expects a win for incumbent Daniel Noboa in the upcoming runoff round. But most investors probably prefer the sidelines. The outcome looks binary, with plenty of uncertainty. If Correismo wins, there is downside with a high probability of default. This translates into a neutral recommendation on the sovereign at current levels with bond prices reflecting equal odds of the binary risks of a tight race.
The only reliable pollster, based on the first-round results, is Comunicaliza. It has yet to publish a preview for the second round, which is unusual after roughly three weeks since the first-round. Comunicaliza was the only pollster for the first round to gauge Correismo support with a reasonable 3% to 4% margin of error. This margin of error should be tighter in a runoff round with two candidates instead of 16 candidates.
The questions become whether President Noboa still has the lead and whether it is beyond the pollster margin of error. The bond prices would still be sensitive to any disappointment considering the downside risks under Correismo. The polls were unable to capture the momentum of Correismo during the 10-day blackout period. This is what keeps the market sidelined until we have a first preview. There haven’t yet been any major events to differentiate much between the candidates ahead of the second round on April 13.
President Noboa logically has focused on security issues. He has discussed inviting international assistance from allied forces, possibly putting that to a referendum. The Correismo campaign has proposed legislation to strengthen dollarization with subsequent criticism that their efforts are disingenuous. If President Noboa retains his lead, then this could allow him build some incumbent momentum for a tight win. If Gonzalez overtakes the lead, then it could be too close to call. The Assembly breakdown should predict the tight race with an equal split Correismo and ADN and probably close to an equal fracturing of the PSC, PK and other independents. The markets should be sensitive to either scenario with equal bias to reset longs on upside risks—and consensus Noboa win—but maybe still trapped longs sensitive to any negative surprise on a Gonzalez lead.
The previous debate was mostly about upside risks of a first-round Noboa win, but analysis has now shifted to the downside risks of a Gonzalez win. The default risks should be high under this scenario if only for the logical assumption that chronic liquidity stress will require strong commitment to pay. The liquidity stress would arguably be worse under the more restricted financing options and the radical ideology that favors a public consumption growth model. There may be a compromise agreement with the International Monetary Fund on a weaker program; however, that compromise may also include forced private sector funding. If the IMF doesn’t want to commit more balance sheet and Correismo doesn’t want to commit to cut domestic liabilities, then the burden logically shifts to bondholders. This should imply a high probability of default under Correismo that weighs downside risks to 40 for the ECUA’2035s (35 * 85% + 70 * 15%). The prospect for a centrist economic agenda under Correismo would also be further constrained for the priority (populist) political agenda to reverse the legal judgments against President Correa for his return back to Ecuador.
These downside risks reinforce the binary swings that reaffirm a neutral recommendation. There has been debate about whether to buy into weakness, say 3 to 4 points lower on the ECUA’2035s. However, this debate sort of defies logic. If bond prices weaken on Correismo strength in the polls, then this adjusts the balance of risk and reward and undermines the view of a Noboa win. It all depends on the election odds. The tight race probably isn’t going to change much if we assume split support of 44% for Noboa and Gonzalez and a tight margin between splitting the remaining voters and quantifying the residual between voter fraud, hidden voters and protest voters.
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