The Big Idea
Ecuador | Waiting for IMF program revisions
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The next main event for Ecuador is the release of the International Monetary Fund staff report early next month. This should address the balance between reducing or financing the country’s fiscal deficit after the drop in oil and an upsized IMF loan program. There is also tension around tax reform and overly optimistic assumptions on market-based financing. Ecuador may also have to reassess the balance between US and China diplomatic relations. Risk and reward have become more difficult to nail down. With tighter relative valuations, a challenging IMF program and debt payments next year, Ecuador has moved from strong to fair value.
Ecuador has already made some progress on subsidy cuts, but tax reform remains the next critical structural benchmark. Tax reform is a litmus test for political support and the backbone for the permanent revenues necessary to lower oil dependence. This isn’t going to be easy. Populist culture and broad-based rejection of tax reform among the political establishment stand in the way. The last tax reform was almost a mini miracle. The next tax reform will have to be less controversial, avoiding VAT hikes and targeting corporates over individuals. There is also not the same debate about the quality of the fiscal adjustment, in clear contrast to Argentina, with the primary struggle of achieving bottom-line results under any type of adjustment. There should also be further discussion about the alternative “contingency” measures with maybe more focus on further unwind of subsidies across the corporate sector.
The other debate is the financing breakdown between the official and private sector. This is relevant on several different fronts. The IMF is the preferred lender until a later phase of fiscal adjustment allows for gradual market access. In the meantime, China loans may undermine US support either indirectly with the IMF or directly through collaboration on security and immigration issues. There could be some residual tensions on the IMF program due to either the heavy reliance on market issuance or concerns about US diplomatic support if China has a more dominant project financing role.
The $1 billion upgrade to the IMF program was extremely important. It acknowledges the program was structurally underfunded with unrealistic reliance on market access at an early phase of gradual fiscal adjustment. The timing was also an opportune response to the drop in oil prices. The IMF financial support immunized bond prices against oil price weakness. It funded the temporary shock as opposed to seeking permanent savings from bondholders. There was also the de facto commitment from the IMF and Ecuador alike to honor debt payments under budget stress. However, the staff report needs to detail the breakdown. Do IMF funds partly finance lower oil revenues with a slightly higher fiscal deficit or partly substitute for market funding?
The IMF assumption of $1.5 billion market funding this year could occur on the one-off creative options of guarantees (repos, partial multilateral guarantees). However, it’s still overly optimistic to assume recurrent market funding of $2 billion a year from 2026 on. That was the initial flaw of the IMF program, to assume almost immediate market access after only gradual fiscal adjustment. It’ll be important to assess whether the IMF staff reduces the market funding assumptions with either a lower fiscal deficit above the line or alternative higher multilateral funding below the line. This doesn’t necessarily alter the execution risks for the IMF program since fiscal adjustment and market access are both difficult. However, it will make the program more robust by prioritizing solvency over liquidity risks. These lower solvency risks should be critical to the IMF’s own interest in opening capital markets to repay the exceptional access IMF loan exposure (that reaches maximum 980% quota in 2025).
The next debate shifts to the burden sharing with the bilateral community. The current trip of President Daniel Noboa to China may complicate US diplomatic relations. The US still holds the dominant 17% voting block at the IMF against the 6% share for China. The statement from Foreign Minister Gabriela Sommerfeld is interesting: “Bilateral topics to focus on boosting commerce, investment and good relations with China as a leading shareholder in the International Monetary Fund.” There is a difference between re-negotiating the China loans to seek liquidity relief as opposed to seeking new project-based financing. If Ecuador seeks to deepen engagement with China, then this may weaken US financial and diplomatic support. Ecuador may be aware of these tensions on specifically referencing China’s IMF membership; however, it’s not clear whether this deeper engagement will backfire within the IMF or with the US directly on diplomatic relations. The US diplomatic support is important for the IMF program and unilateral assistance on tackling the security crisis.
As the highest yielding EM credit, Ecuador is now no longer misaligned to peers. The high yield is still attractive on the context of risk-on appetite and few if any other high conviction trades elsewhere. There have been predictably positive headlines on the political capital and momentum of a new Noboa mandate. This is why I liked the country’s relative value into earlier this month. The upsized $1 billion IMF financial support immunizes against continuing low oil prices and provides confidence on a “muddling through” strategy to gradually adjust and avoid default. However, the next phase of returns is probably more based on market beta than country specific events. If the risk rally continues, then Ecuador should continue to benefit from its high beta status. However, the risk-and-reward is now more balanced on less stressed valuations that are also equally sensitive to the execution risks on the IMF program and hence warrant a neutral recommendation.
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