By Luis
Fierro Carrión (*)
In August 2018,
the government of Ecuador carried out a credit operation with Goldman Sachs
International, for $ 500 million dollars; the operation was guaranteed with
bonds with a nominal value of $ 1,201 million dollars.
In October,
Minister Martínez made another "repurchase agreement" or
"repo" for the same amount, with Credit Suisse, likewise with a
guarantee of bonds with a nominal value of about $ 1.2 billion.
María de la Paz
Vela published back in August 2018 in Revista Gestion an article titled
"High risk in the new financing of Ecuador with Goldman Sachs for $ 500
million" (https://bit.ly/3coGHte), in which she highlighted that “It is an extremely
high risk for the country in the present and future situation of scarcity of
resources, with the high level of indebtedness it faces - of 60% of GDP or more
- extending a collateral of 2.4 times the value of the credit, having high
maturities of capital expected for bonds contracted in previous years.”
A collateral of
2.4 times the amount loaned was undoubtedly exaggerated, and very risky.
But even so, back
then it could not be foreseen that the value of the bonds in the secondary
market could drop below 40% of the nominal value, which would trigger a “margin
call” to maintain the real value of the guarantees.
But that was
exactly what happened after the October 2019 Indigenous Uprising, when the 2022,
2023 and 2026 bonds fell below 40%, and later, as a result of the COVID-19
pandemic and the collapse of the oil price in the international market, they
would drop to less than 30% of the nominal value.
This led to the
government having to pay a total of $ 762.9 million to compensate for the drop
in collateral value between November and March, with the bulk of $ 506 million
paid in March, in the midst of the pandemic. Additionally, $ 220 million had
been amortized (it is not clear when); therefore, to close the two “repo”
operations in April 2020, the government indicated that it had to pay an additional
$ 35.9 million.
In the Ministry's
bulletin, an amortization of debt with banks for $ 865 million appears in
April, plus $71.2 million paid in "interest and commissions".
According to the Ministry's explanation, only $35.9 million was paid in cash,
and the rest corresponded to previous payments for “margin calls” of $762.9
million. It is unclear whether other bank debts were amortized in the month.
The justification
for the 2018 operations was to achieve an annual interest rate of 6.5%, lower
than that prevailing in the financial market at the time for Ecuador, close to
10%. However, it is not clear how much the country ended up paying in interest,
commissions, and penalties for the “margin calls” and the advance payment of
the operations. It is likely that it resulted in more than 6% per year in the
less than two years that they were in force.
The underlying
problem is the lack of transparency that persists in the Ministry of
Economy and Finance regarding foreign debt and these other financial
operations, which is a legacy of the Correa government, but has continued in
the current government. The payment of the two operations was first reported by
the "Dollarization Observatory" and then picked up by "Bloomberg",
before the Ministry reported what had happened.
A potential risk
is that the payment of the total capital of these two operations could have an
adverse effect on the renegotiation of the outstanding bonds (by inferring
unequal treatment of different private creditors).
In April, the
consent of the bondholders was requested and obtained, to suspend the payment
of interest for four months, in order to renegotiate in that period the terms
of the bonds: amount (possible reduction of part of the principal), interest
rate, term, grace period etc. A grace period would be sought (without paying
principal or interest); possibly an extension of the term (especially those
that expire in 2022, 2023 and 2026); and if possible a reduction in interest
rates (which average nearly 9 % per year). The renegotiation of Argentina's
debt with private creditors could be taken as the basis, although an agreement
has not yet been reached.
In a conference on
May 29, Minister Martinez mentioned that another financial transaction with
Goldman Sachs for $ 500 million is also planned to be canceled in September;
this operation was guaranteed with gold from the reserve (according to the
"Dollarization Observatory" the amount would be $ 515 million).
The truth is that
the government carried out two very risky operations, with the aggravating
circumstance that they had to advance the payment precisely in the most
precarious moments due to the pandemic and quarantine; unlike other
contingent bonds based, for example, on GDP growth or on natural disasters,
this one was designed to be paid just in the moment when Ecuador's country risk
skyrocketed.
Relationship
with the IMF: emergency loan and suspension of the EFF
On May 28,
documents related to the approval of the "Rapid Financing Instrument"
for $ 643 million by the International Monetary Fund (IMF) were published. The
curious thing is that the approval of this emergency loan occurred on May 2,
but the documents were only released on May 28.
This was perhaps
because the report mentioned, precisely, the payment of the "margin
calls" for the two "repo" operations with Goldman Sachs and
Credit Suisse, and the government preferred not to disclose it at that time. It
is noted that the international reserve fell by about $ 1.5 billion until the
end of March, "the decline was driven by the payment of margin calls on
transactions with some private banks ... and public sector external debt service".
Net international reserves ended at a negative amount of - $ 3.1 billion at the
end of March.
The report also projects
a contraction of 6.7% in GDP in 2020, and a financing gap of 8.4% of GDP
in 2020 and 7.6% in 2021. In 2019 there was growth of 0.1%, higher than the
expected contraction of 0.5%. Total GDP is not expected to return to the 2019
GDP level until 2023.
The report also
mentions a reduction of $ 1 billion (2.3% of the total) in deposits from the
private financial system at the end of March. However, it indicates that the
financial system is well capitalized and has adequate reserves for bad debt.
While noting that systemic banks are relatively more resilient, smaller banks
and credit unions are "comparatively weaker, especially in terms of asset
quality and profitability, and exposed to the shock through a loan portfolio concentrated
in consumers loans and microfinance”.
The IMF estimates
an increase in the fiscal deficit by 6% of GDP, with a drop in oil revenues and
tax revenues, as well as additional expenses for health, social protection and
social security.
Public debt would
increase to 69% of GDP in 2022 and would remain at that percentage until at
least 2024 (a possible reduction in the amount as a result of the renegotiation
is not taken into account).
The document also
cancels the existing Extended Financing Facility (EFF) program, which was
approved in March 2019, in anticipation of another long-term loan being
negotiated (also, theoretically, before August, according to the terms of the
consent request to bondholders to defer payment of interest).
Among the risks at
the international level mentioned in the IMF report:
• Lower-than-projected oil prices.
• A more severe
and/or protracted COVID-19 pandemic.
• Weaker-than-expected
global growth, which would affect the demand for export products.
• Increased
protectionism in international trade
• A reduction in
international financial flows (which would not affect Ecuador as much, since in
practice it does not have access to the private markets).
Regarding domestic
risks, apart from the continuation or worsening of the pandemic, the following
are mentioned:
• A shortfall in
fiscal revenues
• Health expenses
higher than expected.
• "social discontent
that causes economic disruptions and policy missteps"
• “lack of
political cohesion in pursuing much-needed structural reforms and policies to
support the population in crisis and to restore macroeconomic stability”
• “intensification
of financial sector vulnerabilities”.
The IMF adds that
"failure to reach an agreement consistent with debt sustainability with
creditors by mid-August (when the standstill on debt service to external private
sector creditors expires)" as well as the lack of an adequate funding by
bilateral creditors would leave the country in very vulnerable conditions for a
long period of time "including through the forthcoming presidential
election period".
A
"substantial debt operation" is required to address large and
persistent financing gaps in the medium term; but, the Fund adds, a substantial
fiscal consolidation (of at least 6% of GDP) will also be required.
(*) This is an
English translation of the article published by “Revista Gestión” on June 4, 2020.
The author is an
economist graduated from the Pontifical Catholic University of Ecuador (PUCE), with
graduate degrees from the University of Oregon and the University of Texas at
Austin. He was a staff member of the IDB from 1997 to 2013, and Representative
of Ecuador to the IMF in 2006. Advisor on climate finance and development
issues. These are his personal opinions.
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