By Enrique Ramos
Ecuador stands at a crossroads ahead of the February 7 national election. It can continue a path of orthodox economic policies and balance its accounts by electing a conservative centrist or adopt the dangerous policies of a young leftist who supports heterodox economics, populist handouts and possible default on the country’s financial obligations.
After the restructuring of the last three-and-a-half years under President Lenin Moreno, Ecuador’s sovereign bonds are being pummeled by fears that Sunday’s possible election of the leftwing candidate, 35-year-old Andres Arauz, could derail ties with the International Monetary Fund and trigger another debt crisis.
Suffering severely from the coronavirus pandemic, the oil-dependent Andean country secured in August a $17.4 billion debt restructuring agreement and $6.5 billion in new loans from the International Monetary Fund with promises of more to come.
With opinion polls showing Arauz with a lead ranging from two to 12 percent, fund and bond managers are understandably spooked, since the candidate has pledged to ignore the IMF agreement and increase capital and social spending if elected. Bond prices tumbled on the concerns, deepening a slump stemming from the economic collapse during the pandemic.
Arauz is the option presented by ex-populist president Rafael Correa, who has been barred from running on alleged corruption charges. Living in Brussels with his Belgian wife, the ex-president will be imprisoned if he returns to his homeland. But things could change dramatically if his chosen successor manages to win outright on Sunday or make it to the April 11 runoff with a substantial lead.
Among other things, Arauz has promised to give $1,000 each to a million poor families within a week of taking power, an amount that represents nearly 20% of Ecuador’s national reserve.
International financial concerns are pinning their hopes on conservative banker Guillermo Lasso, who is making his third presidential bid and who is running second in the polls to Arauz. Indigenous activist Yaku Perez, who runs to the left of Arauz, is third in most polls. Analysts believe that if Lasso runs a strong second in the election he will stand a better than even chance of defeating Arauz in the April runoff.
Under Ecuador election rules, a candidate will win outright with over 50% of the vote or with over 40% and a 10-point lead over the nearest rival.
The next president will have at hand over $4 billion already disbursed by the IMF while enjoying a schedule of payments that will not make a big dent on the US$ 17.4 billion restructured with private creditors. “The country’s ability to pay in the medium to long term is actually substantially better than before Covid, which is a bit counterintuitive,” said Carlos de Sousa, a manager of emerging market debt portfolios at Vontobel Asset Management. “The debt servicing costs over the next five years are much lower than they were before, so the restructuring did a very good thing to improve the debt sustainability of Ecuador.”
Principal repayments on the country’s dollar bonds will kick in from 2026 onwards. But with bonds yielding over 15%, Ecuador is currently shut out of most of the market. That need not be a problem, but it could be under a government that spends its way out of the crisis.
“The way to fund the country’s deficit is through multilaterals, which come with significant conditions, or through the market, which is effectively closed, or through monetary financing,” said Patrick Esteruelas, head of research at Emso Asset Management in New York. “If they resort to monetary financing that’s the beginning of the end of the dollarization regime. On the hand, if Lasso wins, financing remains open.”
Ecuador’s foreign currency bonds were the worst performers among the JPMorgan EMBI Global Diversified index last month, with a -15% total return. On a 12-month basis the return is -55%, the second-worst globally behind Lebanon. Ecuador joined Sri Lanka, Zambia, Venezuela, Lebanon, Belize and Argentina as countries with EMBIG spreads above 1,000 basis points.
Many of Sunday’s voters have never used the former local currency, the Sucre, since the country converted to the U.S. dollar 20 years ago following a banking crisis. The move to the dollar brought stability to the economy, which had been weighed by hyperinflation, but at the same time destroyed a great deal of local wealth.
Monetizing the debt is a risk investors need to be aware of, according to Goldman Sachs analysts, who noted that “the implementation of a populist and heterodox policy agenda by an Arauz administration could undermine confidence in the dollarization regime.” Publicly, Arauz says he will stay with the dollar.
The effect of that confidence loss, the Goldman analysts said, could show up “potentially triggering a run on bank deposits and a full-blown financial crisis and eventually forcing the authorities to suspend debt service.”
Enrique Ramos is a former fund manager and Latin American accounts analyst for Goldman Sachs, currently a bank president in Lima, Peru.