Why doesn't the Ecuador country risk go down?

By Luis Fierro Carrion (*)

Twitter: @Luis_Fierro_C

In recent weeks, the so-called "country risk" of Ecuador, instead of going down, has continued to rise, reaching 1,945 basis points (that is, 19.45% above the US Treasury bond rate). .

The "country risk" essentially reflects the probability that a country declares a default on servicing its foreign debt. It is true that Ecuador has a negative trajectory in this regard, having declared a moratorium on 11 occasions, tying with Venezuela and Argentina in the moratorium record (the last in 2020, at the beginning of the pandemic). (Spain has more defaults, but over 5 centuries).

However, Ecuador's macroeconomic indicators should rather have induced a reduction in said risk differential.

A few weeks ago, an agreement was announced to restructure the external debt with Chinese entities, reducing the interest rate between 0.2 and 1%; extending deadlines; and reducing debt service by $870 million in 2022-23.

The fiscal deficit has fallen from $7.1 billion in 2020 to $2.3 billion in 2022. The public debt/GDP ratio will drop from 62.2% of GDP in 2020 to 57% of GDP in 2023. International reserves have exceeded $8.4 billion (having fallen to less than $2 billion in March 2020). The average price of oil has exceeded IMF projections (by $24.20 per barrel in 2022, and by $13.50 per barrel in the medium term). The projected GDP growth rate in 2022 (2.9% according to the IMF) is one of the highest in the region, while inflation is one of the lowest (4.1%).

All these objective macroeconomic factors should have lowered the country risk to around 500-600 points, but instead it has shot up to almost 2,000 points.

The explanation, therefore, is not that the default risk has increased in the short term (I would say that this risk is zero, given that the main payments to the IMF and China have been postponed from 2025, and of sovereign bonds to 2026).

The concern is fundamentally political:

• It is considered that the government of President Lasso will not be able to approve structural reforms in the Assembly, for example, in the labor or investment legislation.
• The commitment to double oil production does not seem viable (mining production will continue to increase, but gradually).
• There is a risk that the Assembly will dismiss the President, or that he will invoke the "simultaneous death" (closing the Assembly and calling for new elections).
• Although the leader of the indigenous confederation, Leonidas Iza, has weakened his support within the indigenous movement, a new “national insurrection” is still possible, affecting oil, mining, and rural production (agriculture, livestock, flowers, etc.).
• It is feared that the next government (either a product of the “crossed death”, or regular elections in 2025) will not be “market friendly” and will invoke a new debt moratorium.

The "Iza effect" then becomes in reality an Iza-Correa-PSC-Pachakutik effect. Some PSC spokespersons (among them Mayor Cynthia Viteri) have questioned the servicing of the external debt, and apparently they have a close alliance with Correísmo and the “anti-capitalist” sectors of the Pachakutik movement.

There are also technical factors that affect Ecuador's country risk, such as low liquidity and high transaction costs, given that the country is not a recurring issuer.

In the long term, the only way to overcome this perception of high risk is by achieving a fiscal agreement between the main political forces, assuming as an objective to lower the cost of the country's external financing; and tax reforms that raise the level of fiscal pressure in the country to levels close to the average for Latin America. Currently, it is 19.1% of GDP, while the average for Latin America is 21.9%, and for OECD countries 33.5%.

(*) Translated version of the column published in "El Universo" newspaper on October 20, 2022

https://www.eluniverso.com/opinion/columnistas/por-que-no-baja-el-riesgo-pais-nota/

Elections in Ecuador: Two opposite options

By Luis Fierro Carrión (*)

Twitter: @Luis_Fierro_Eco

On Sunday, April 11, Ecuador will go to the polls to choose between Andrés Arauz, candidate of Correísmo; and Guillermo Lasso, candidate of the CREO-PSC alliance (with the support of other political forces).

These are two diametrically opposed alternatives, in almost all aspects.

While Arauz said in his proposal on "good de-dollarization" that he will raise the Tax on Currency Outflow (ISD) to 27%, and that the Central Bank would grant a "fixed quota" for importers (creating a market distortion, as he himself recognized in his 2009 Master's Thesis); Lasso proposes to eliminate the ISD. Apart from this exchange control (unique in a dollarized economy), Arauz would probably increase tariffs or collect safeguards on imports again.

The correista bloc in the Assembly also proposed to deliver a “universal basic income” in “electronic currency”; candidate Arauz later rejected that proposal and said, instead, that a $ 1,000 bond would be delivered to 1 million families by taking resources from the reserve of the Central Bank of Ecuador. It should be mentioned that these correspond to the reserve of private bank deposits held in the Central Bank; that is, ultimately, it is the depositors' money. Currently, the international reserve does not cover all commercial bank deposits, which is why there is a gap of nearly $ 7 billion between the assets and liabilities of the Central Bank (the Moreno government began to reduce this gap inherited from Correa, but with the pandemic it has increased again).

In more general terms, Lasso's proposal focuses on the generation of productive employment, and he even proposed increasing the monthly minimum wage to $ 500 (from the current $400); while Arauz focuses on the delivery of cash transfers, even at the risk of further reducing the net international reserve, and therefore putting dollarization at risk.

Arauz's pre-announcement that he will increase the ISD to 27% could possibly lead to an outflow of currency in anticipation of this measure.

Lasso has proposed to lower five taxes, while Arauz proposes to increase the income tax and create a wealth tax. Arauz would bet on strengthening a State-centered model, including increasing public spending; while Lasso would seek to strengthen the private sector.

Lasso proposes reducing income tax for companies that create at least 10 jobs.

While Lasso has said that he would strengthen dollarization, Arauz talks about the emission of "electronic currency" and using the resources of the international reserve. By refusing to lower public spending and investment, Arauz will maintain a high deficit and continue with the aggressive public indebtedness process that began in 2014 under Correa; it is likely that his fiscal policy, his proposal to raise the ISD, the potential use of the BCE reserves and the issuance of electronic money would lead to Arauz not receiving the outstanding disbursements from the IMF for $ 2.5 billion. Lasso has said that he would seek to reduce the deficit.

On issues that interest the young and progressive voters of Hervas and Yaku Pérez, such as mining, oil exploitation and the protection of water sources, Lasso's position is closer to the voters of Pérez and Hervas than the practice of Correísmo, which expanded oil and mining extraction, even in places of great biodiversity and environmental vulnerability such as the Yasuní National Park (manipulating the Electoral body under its control for the purpose of thwarting a plebiscite against oil exploration in the Yasuni). Lasso proposes to maximize environmental prevention in mining and oil production, including prior consultation of affected communities.

This extreme extractivism during the Correa decade even led to the murder of several indigenous activists who were opposed to the oil and mineral exploitation, such as Bosco Wisuma, Freddy Taish, José Tendentza, three of the 35 unsolved murders of the Correa government (others include 15 journalists and people who denounced corruption , such as General Jorge Gabela, Quinto Pazmiño and his wife, journalist Fausto Valdivieso, among others).

Correísmo also faces accusations and sentences of corruption, including Rafael Correa, Jorge Glas, ministers Carlos Pareja Yanuzelli, María de los Ángeles Duarte, Ricardo Patiño, Walter Solís, Vinicio Alvarado, Fernando Alvarado, Alecksey Mosquera, María Duarte, Raúl Carrión , Ramiro González and Viviana Bonilla, the Legal Secretary Alexis Mera, the Comptroller Carlos Polit, the assembly members Cristian Viteri and Esperanza Galván, the president of the Central Bank Pedro Delgado, the directors of the IESS María Sol Larrea and Iván Espinel (as well as former IESS President Ramiro González), the director of Petroecuador, Álex Bravo, the Secretary of Intelligence, Pablo Romero, the Secretary of Communication Carlos Ochoa, and the Presidential advisor Pamela Martínez, among others. Of these, 8 were imprisoned, and the rest are at large. It is estimated that the amount of resources lost to corruption reached $ 35 billion.

Arauz has mentioned that he will seek to have the sentences against Correa and other members of his government annulled.

Lasso has never been criminally charged, and, despite the fact that the Correa government investigated his alleged participation in the banking crisis of 1999, he was never accused. Eduardo Valencia, who led the investigation, found presumptions of guilt of Juan Falconí Puig and Pedro Delgado in the embezzlement of the CFN that occurred in 1999-2000, but they were never charged or separated from their positions in the Correa government; Delgado fled to his “son's wedding” in Miami in 2012 and never returned.

Arauz affirms that virtual platforms are natural monopolies, and that is why they must be considered public utility goods, as happened when they turned the right to communication into a public service. This proposal would be aimed at controlling virtual platforms and their users.

The two government plans could be strengthened in terms of environmental issues, sexual and reproductive rights, identity issues, the prevention of animal abuse, and gender and diversity approaches, among other topics of interests of the Millennial and Gen Z voters.

(*) This is a translated and expanded version of the column published in Diario “El Universo” on March 5^th, 2021.

https://www.eluniverso.com/opinion/columnistas/dos-opciones-opuestas-nota/

The image shows the original version of the article by Andrés Arauz on "good dedollarization".

Mis artículos de blog más leídos en el 2020 / Top 10 blog posts of 2020

Mis artículos de blog más leídos en el 2020 / My top 10 blog posts in 2020

#10 A risky and unsuccessful bet that sacrificed Ecuador's liquidity

https://economicsandinvestment.blogspot.com/2020/06/a-risky-and-unsuccessful-bet.html

#9 Comentarios a las propuestas de académicos holandeses sobre escenarios post pandemia y modelos de decrecimiento

https://economicsandinvestment.blogspot.com/2020/04/comentarios-las-propuestas-de.html

#8 A successful bond restructuring in Ecuador

https://economicsandinvestment.blogspot.com/2020/08/a-successful-bond-restructuring-in.html

#7 La deuda eterna 

https://economicsandinvestment.blogspot.com/2020/07/la-deuda-eterna.html

#6 Políticas de Reactivación frente a la Crisis y la Pandemia; apoyo a MIPYMES

https://economicsandinvestment.blogspot.com/2020/09/politicas-de-reactivacion-frente-la.html

#5 Sobre el ingreso básico universal (es mejor un ingreso mínimo garantizado)

https://economicsandinvestment.blogspot.com/2020/07/sobre-el-ingreso-basico-universal-es.html

#4 Coronavirus, oil prices and Ecuador's risk premium

https://economicsandinvestment.blogspot.com/2020/03/coronavirus-oil-prices-and-ecuadors.html

#3 Propuestas ante la Emergencia Sanitaria y Crisis Económica en el Ecuador

https://economicsandinvestment.blogspot.com/2020/03/propuestas-ante-la-emergencia-sanitaria.html

#2 No, Sr. Arauz, no hay una “desdolarización buena” (respuesta a un artículo del Econ. Andrés Arauz)

https://economicsandinvestment.blogspot.com/2020/11/no-sr-arauz-no-hay-una-desdolarizacion.html

Y el número 1 / the top blog post:

#1  Iniciativas de ayuda durante emergencia COVID-19 en el Ecuador 

(compilación de sitios para donaciones, preparada con  con Gabriela Vivero).

https://economicsandinvestment.blogspot.com/2020/04/iniciativas-de-ayuda-durante-emergencia.html

Diría que la mitad son versiones mas extensas de mis columnas publicadas en el Diario El Universo (o traducciones al inglés).  Aqui todas las columnas:

https://www.eluniverso.com/columnista/luis-fierro-carrion

Happy New Year!   Feliz Año Nuevo!  (and let's hope that 2021 is better than 2020!).

A successful bond restructuring in Ecuador

By Luis Fierro  (*)

The government of Ecuador announced on August 3^rd that it had obtained the consent (favorable “votes”) of 97.85% of the holders of external debt bonds in favor of a bond swap, much higher than the required 66 % (95.42% in the case of the 2024 bonds, which required 75%). The term was extended until August 7^th to allow those who had not given their consent to join the exchange.

This is undoubtedly excellent news for Ecuador, and the team of Minister Richard Martínez, as well as the country's financial and legal advisers, should be congratulated.

Through the agreement, the series of 10 bonds (originally maturing between 2022 and 2030) will be exchanged for three new bonds, which mature in 2030, 2035 and 2040 (the repayments of capital are distributed in five years, in each case).

There will be an immediate reduction in the amount of principal owed by $ 1.54 billion (a 9% decrease from the original amount of $ 17,375 million), but it is estimated that the arrangement will allow a reduction in net present value (NPV) of 41,7% (based on a discount rate of 10 % per year).

This saving is produced mainly by the reduction of interest rates from an average of 9.2% per year to 5.3% per year, to which is added the aforementioned 9 % reduction of the principal; and the extension of the terms (from an average of 6.1 years to 12.7 years). It also reflects the postponement of the payment of the suspended interest payments in the March-August period ($ 818 million), which will be paid with interest-free bonds between 2026 and 2030.

The discount rate is the opportunity cost of money: you are indifferent to receiving 90 now or 100 a year from now. It is related to the average return on capital in an economy. Some analysts prefer to use a higher rate (12%), although the World Bank uses a discount rate of 5% for the cost-benefit analysis of its projects (currently there are few legal activities that guarantee an annual return greater than 5%).

Two investment funds, GMO and Contrarian Capital, filed a lawsuit in a court in the Southern District of New York, arguing that the government's proposal was coercive. The two funds were part of a "Steering Committee" of holders who claimed to represent about 25% of the bonds, which presented a proposal that was less advantageous to Ecuador. But after Judge Caproni dismissed their arguments and did not give way to a "temporary restraining order" to stop the vote, even the two plaintiff funds accepted Ecuador's initial offer.

All this occurred, in addition, in the midst of the confrontation between the government of Argentina and its bondholders. The Argentine government offered a 47% reduction in net present value, and the bondholders counter-offered a 44% reduction. On August 4 (one day after Ecuador) an agreement was announced for a 45.2% reduction in VPN (using the same 10% discount rate).

The lower discount in the case of Ecuador could be attributed to the fact that the IMF had not considered the country's external debt unsustainable, unlike Argentina.

It is important to clarify is that the restructuring of the bonds will not imply the inflow of new funds to the country. It does reduce the debt service burden, by $ 1,361 million in 2020, and a total of $ 10 billion through 2025 (kicking forward the bulk of amortizations).

But it does not contribute in any other way to reducing the fiscal deficit or closing the financing gap, estimated at $ 4 billion. For this, a new program is being negotiated with the IMF, the same one that will take into account the reduction of the debt in bonds, as well as the fiscal consolidation efforts already made; but will likely seek a greater deficit reduction and structural reforms.

New $ 2.4 billion loans from Chinese banks have also been announced; as well as postponing the payment of the principal of $417 million that was due in 2020-21. In the case of the bilateral debt with China, a reduction in the principal and the interest rate of the current loans is not expected, although the interest rate of new loans is expected to be lower. The G-7 has urged China to join the debt relief efforts associated to the global pandemic under the Paris Club (China does not belong to this creditor forum).

It would be unfortunate if the next government returned to increasing the debt, as the Correa and Moreno governments did. Correa quadrupled the public debt (going from $ 10,234 million in December 2009 to $ 41,894 million in May 2017). Part of the blame also falls to the investors, who until last year lent money to Ecuador given the high expected rate of return, despite the risk of being a country that competes with Argentina and Venezuela for the world record of debt defaults.

(*) A shorter version of this note was published in Spanish in “Diario El Universo” on August 7^th.

https://www.eluniverso.com/opinion/2020/08/07/nota/7932633/reestructuracion-bonos

 

The Eternal Debt

By Luis Fierro Carrión (*)

Ecuador was born in debt. When the Republic of Ecuador became independent, an agreement was reached whereby the nascent State would assume 21.5% of the debt of the "Gran Colombia", equivalent to £ 1,424,579.

The distribution of this debt was made at a meeting called in Bogotá, which was not attended by the Ecuadorian delegate. The division was made based on population but did not consider where the assets acquired with that debt were (mainly weapons). "Except for the old frigate Colombia, which happened to be in Ecuadorian waters, and 16 thousand pesos, Ecuador did not receive any other material good as a balance of the purchases made with the loans obtained for the struggles for independence (Alberto Acosta Espinosa, “The Eternal Debt”, 1990, p. 64).

The Republic began to walk with the difficulties of a child who carried "a sack of lead on his back," as Agustín Moreno said (quoted by Acosta).

Beginning in 1830, there were moratoriums on the payment of the external debt, renegotiations, proposed arrangements, etc. Ecuador ties with Spain, Venezuela and Argentina as the countries that have had the most defaults in history (a dozen in each case).

Acosta's book tells the story of the Ecuadorian foreign debt until 1990, with its sequence of defaults, negotiations, proposals. On some occasions it offered to pay the debt with "empty lands" in the Amazon or Esmeraldas (in fact there were Native Americans living there), with the Galapagos Islands, with shares in customs revenues, mine rents and other taxes. The effort to deliver "empty lands" in the Amazon even led to military conflicts with Peru, which claimed sovereignty over those territories. Thus, for example, in 1859 the Treaty of Mapasingue was signed, under occupation, which annulled the delivery of territories to bondholders.

As early as 1855, there was speculation with the purchase of the bonds in the secondary market: they could be bought at 4 percent of the nominal value, and, after some payment arrangements were announced, the price would rise to 16%. After the Liberal Revolution, the bonds of the "English debt" were exchanged for new bonds to finance the construction of the railway from Guayaquil to Quito. As the "repurchase" of the independence bonds progressed, their price increased, reaching 45%.

The "English debt" of independence would only be canceled in 1976, in the midst of the oil boom. The oil boom of the 1970s was the first opportunity to eliminate the country's external debt. For example, Norway, which developed the oil fields of the North Sea, not only did not get into debt, but rather accumulated a sovereign investment fund starting in 1990 that by 2020 had reached a value of 1,186,000 million dollars in assets (more than a trillion dollars).

But Ecuador, whose external debt had been reduced to just $ 241 million in 1970 (15% of GDP), began to borrow aggressively, partly to finance infrastructure works such as hydroelectric dams, and partly for military spending, reaching $ 10,283 million. in 1987 (109% of GDP).

The second opportunity to eliminate the debt occurred during the Correa government, in the years 2007-2016, when oil prices rose, generating $ 95,581 million in revenue for the treasury. In fact, in 2007, the (small) balance of the debt with the IMF was canceled.

But, instead of canceling foreign debt and accumulating savings and investment funds; the Correa government carried out a moratorium, not due to inability to pay, but to manipulate the market (so much so that more funds were used to buy back the discounted bonds than would have been the entire debt service expected that year). 

As oil prices fell from 2014, instead of reducing bulky public spending (44% of GDP in 2014), the Correa government began to issue debt aggressively. Thus, public external debt went from $ 8 billion in 2009 (13.2% of GDP) to $ 32 billion in 2017 (32% of GDP) and $ 40 billion in April 2020 (37% of GDP). Of this total, $ 18,7 billion corresponds to the bonds.

In the face of the COVID-19 pandemic, and the collapse of exports and tax revenues, the government asked bondholders to suspend payments until August, with a view to restructuring. It is clear that the Ecuadorian State will not be able to continue servicing the debt in the terms initially foreseen. A grace period is expected to be approved (no principal or interest payments, perhaps until December); a reduction of interest; an extension of the terms (could be extended between 5 and 7 years); and possibly a reduction in the principal amount (a 15 % reduction of the principal).

The Barclays investment bank, in an analysis of the issue, indicated that a 46% reduction in the net present value of the bonds could be obtained, combining a capital reduction, a grace period, lower interest rates (which it estimates could rise from 0% in 2020 to 6% after 2023), and longer terms. The International Monetary Fund itself has indicated that developing countries will require debt relief because of the severe economic recession caused by the pandemic.

But even if an adequate restructuring occurs, the external debt is likely to continue to affect the life and economy of the country for generations to come (unless steps are taken to create a savings and investment fund in a future oil or mining boom).

(*) This is an extended version of an opinion column published in Spanish in Diario El Universo of Ecuador, on July 3, 2020.

https://www.eluniverso.com/opinion/2020/07/03/nota/7892709/deuda-eterna

 

 

A risky and unsuccessful bet that sacrificed Ecuador's liquidity

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.

https://revistagestion.ec/index.php/economia-y-finanzas-analisis/una-apuesta-arriesgada-y-fallida-sacrifico-la-liquidez-nacional

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.

Source: IMF  

The lost savings Funds would have cushioned the crisis in Ecuador

By Luis Fierro Carrión (*)

On May 11, Norway's sovereign wealth fund decided to liquidate 3% of the fund's value, to support the government's efforts to combat the COVID-19 pandemic and boost economic recovery.

That withdrawal of 3% of the value was equivalent to 37 billion dollars. This is so because the fund has accumulated a value of 1.18 trillion dollars. It is the largest sovereign wealth fund in the world; it is followed by SWFs from China (China Investment Corporation), Abu Dhabi, Kuwait, and Saudi Arabia, all with more than $ 500 billion in assets at the end of 2019.

In Latin America, some countries have stabilization and savings funds, but with much smaller amounts. For example, Chile has an economic and social stabilization fund ($ 14.7 billion) and a Pension Reserve Fund ($ 9.4 billion). Other countries with smaller funds include Peru, Brazil, Mexico, Trinidad and Tobago, Colombia, and Bolivia (all linked to the export of natural resources). Venezuela had a substantive fund, but with its protracted crisis it has vanished.

In the case of Norway, the fund has the official name of “Global Government Pension Fund”, and was created in 1990 to save the oil income that the Nordic country was receiving; The objective was to reduce the volatility of tax revenues due to the fluctuation of oil prices in the international market. A secondary objective was to reduce the macroeconomic impact of oil revenues, which in other countries (including Ecuador) has generated the so-called “Dutch disease”, in which the productivity of other economic sectors was affected.

The "Tiny Funds" in Ecuador

In Ecuador, apart from the international reserves, there were some attempts to create a stabilization or savings fund:

• In 1998, the Petroleum Stabilization Fund (FEP) was created to accumulate the surpluses of oil revenues above the budget.

• In 2002, the “Fund for Stabilization, Social and Productive Investment, and Reduction of Public Debt” (FEIREP), a trust managed by the Central Bank, was created.

• Later, in 2005, at the initiative of then Minister Correa, the FEIREP was transformed into the “Account of Productive and Social Reactivation” (CEREPS); 20% of its income went into a “Savings and Contingency Fund” (FAC), apart from the unused CEREPS balances at the end of the fiscal year. The FAC had among its specific objectives to be able to attend natural disasters and other emergencies.

• In 2006, the “Ecuadorian Investment Fund in the Energy and Hydrocarbon Sectors” (FEISEH) was created, fed with the income of Block 15 (after the declaration of expiration of the Occidental oil contract), as well as the Eden-Yuturi fields and Limoncocha.

Between these “tiny funds”, as then President Rafael Correa derogatively called them, savings equivalent to 12.1% of GDP were accumulated (https://flacsoandes.edu.ec/web/imagesFTP/9431.WP_018_CGiraldo_01.pdf ). Apart from this, the balance of public debt was reduced.

During the Constituent Assembly, an Organic Law was approved in 2008 for the “Recovery of the Use of State Petroleum Resources and Administrative Rationalization of Debt Processes”. In practice, it meant the elimination of these funds and facilitating the contracting of additional debt.

Oil revenues and fuel subsidies

During the decade of Correa's government, the country had oil revenues for a total of $95,581 million (35% of all oil revenues in the history of the country, in real terms, according to a study by Alberto Acosta and John Cajas, “A Wasted Decade”). Between 2007 and 2016, the non-financial public sector had total revenues of $ 283 billion. 

Notwithstanding this massive level of income, not only were the savings and contingency funds eliminated, but the net international reserve was left in negative terms; and Correa bequeathed a total public debt of about $ 60 billion.

Of the total oil revenue, about $ 23 billion (a quarter) was used for fossil fuel subsidies. This subsidy is very regressive, as more than 50 % benefits the two quintiles with the highest incomes: apart from which a significant part of the subsidy escapes by contraband. The subsidy also encouraged fossil fuel consumption, with adverse effects on climate change, health, pollution, etc.

After a failed attempt in October 2019 to eliminate subsidies for extra gasoline and diesel (the subsidy for super gasoline had previously been eliminated), on May 19 the President issued Decree 1054, which establishes a new market price system for extra gasoline, extra gasoline with ethanol and diesel. A “price band” system was established, taking into account the cost of fuels, the marketing margin, plus a monthly variation limit of +/- 5%.

In the initial period of application of this new price system, the result was that the price decreased, given the significant drop in the international price of crude oil and derivatives in international markets. Thus, the retail price of extra gasoline (including the commercial margin) decreased to $ 1.75 per gallon, and the price of diesel decreased slightly to $ 1 per gallon.

The Ministry of Economy and Finance will design the “necessary compensation instruments as a consequence of the application of the price band system”. Minister Martínez indicated that the government is analyzing social protection mechanisms in the event of sustained growth in the prices of gasoline and diesel. There is a preliminary proposal to increase the Human Development Bonus cash transfer program by $ 10 and compensate the most vulnerable in the event of an increase in public transport tickets. Another alternative is to subsidize public transport (either to users or carriers). 

Laws approved by the Assembly

In the laws approved by the Assembly, the Solidarity Law or COVID-19 and the Law on Public Finances, there are two aspects to highlight regarding the issue of oil revenues.

On the one hand, the possibility of contracting insurance to hedge the risk of lower oil prices is introduced, as the Mexican government has regularly done (Minister Martínez argued that previously he did not have the legal backing to do so, which will now be made possible by a provision of the Public Finance Regulation Law).

On the other hand, a Fiscal Stabilization Fund is created again, from income from the exploitation and commercialization of non-renewable natural resources (oil, gas, mining) that exceed what is contemplated in the annual public budget.

Obviously, with current prices, it will not be possible in the short term to accumulate resources in the fund, nor to contract a price insurance, but the reform is designed for the future, so that, if another pandemic, natural disaster or abrupt fall in the prices of exports occurs, Ecuador has a financial “cushion” – a cushion that the Correa government took away from us.

(*) This is an English translation of the article published by “Revista Gestión” on May 23, 2020.

https://revistagestion.ec/economia-y-finanzas-analisis/los-desaparecidos-ahorros-nacionales-hubieran-amortiguado-la-crisis

The author is an economist from the 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. Personal opinions.

Quarantine, Death and Reactivation

By Luis Fierro Carrión (*)

There is an etymological similarity between the Spanish (or Italian) words "quarantine" and "lent" (cuaresma).

For Christians, Lent is a 40-day period of penance, reflection, fasting, and abstinence, between Ash Wednesday and Holy Thursday.

Jews commemorate Passover, which was the liberation from slavery in Egypt and the survival of the 10 plagues, including the death of the firstborn, from which the Jews were saved by placing lamb blood on their doorsteps, to indicate their faith (the “Angel of Death” passed over those homes). Christians believe in the death and resurrection of Jesus.

These ceremonies are linked to pagan practices on death and rebirth of life, reflecting the passage from winter to spring in the Northern Hemisphere (Easter eggs and chocolate bunnies reflect this emphasis on fertility).

Quarantine refers to the 40-day isolation of people and property suspected of carrying the bubonic plague in Venice, during the 14th century pandemic (the worst pandemic in recorded history, in terms of percentage of the population that died).

In 2020, a forced quarantine of the population has been put into effect in many countries of the world, starting with China. In the case of Ecuador, these measures were taken as of March 12, with the suspension of classes, mass events and flight restrictions; and a curfew from March 17. We have already had more than 40 days of these restrictions (as of May 4, a system of "traffic lights" was established by municipalities, but as of May 7^th all remained in "red", or full lockdown and curfew).

Despite the restrictions, there were a large number of excess deaths, most of which can be attributed to COVID-19 (perhaps a fraction correspond to people with other illnesses or accidents who did not have access to hospitals, especially in the provinces of Guayas and Santa Elena).

Between January and April, in the province of Guayas there were 10,655 deaths above the average in the same period of 2018-19. The following was Santa Elena, with 613 excess deaths; Manabi 385; Pichincha 308; and El Oro 146; in Santo Domingo de los Tsachilas, Pastaza and Galapagos there were 2-4 excess deaths. In the other provinces, the number of deaths decreased, probably due to fewer deaths from accidents and homicides (for which reason it is also possible that the figure attributable to COVID-19 exceeds 12 thousand).

Considering a case fatality rate between 1 and 2%, this would mean that there have already been more than 600,000 cases of COVID-19 in Ecuador (even with a high case fatality rate of 3%, taking into account the poor health infrastructure , we would have more than 400,000 cases). Considering that until May 6 only 81 thousand tests had been taken, the official figures for COVID-19 cases and deaths have scant meaning.

The economic impact of the quarantine will be devastating. According to Econ. María de la Paz Vela in a seminar organized by the consulting firm Multiplica and Revista Gestión, Ecuador's GDP could fall by 7% (I estimate between 11 and 15%, based on a prolonged recession that would also continue to impact the price of oil and other exports). Adequate employment will fall from 38.8% to 35.4%, while open unemployment would increase to 3.8% to 9%. The poverty rate, which had already risen from 22% in 2017 to 25% in December, would now rise to 35% (reversing a decade of progress).

Tax revenue would drop by $ 7 billion; the fiscal deficit would triple to $ 8,652 million; financing requirements would reach $ 17 billion. This makes unavoidable a process to renegotiate the external debt (with private and bilateral creditors), and rollover the internal public debt. The government has proposed a “Humanitarian Law” to raise funds from people with the higher incomes, and from companies with profits of more than $ 1 million, but the fate of the law in the National Assembly seems uncertain.

Exports would fall by 26%, but imports would only decrease by 13%. Remittances from emigrants would drop by 9%. A reduction of the international reserves is estimated at $ 1 billion.

The IMF approved a quick financing loan for $ 663 million; The IDB has approved $ 700 million, and $ 500 million is expected from the World Bank [plus a $ 6 million grant] and $ 300 million from CAF [later increased to $400 million]. An announced Chinese loan (of up to $2 billion) has not yet crystallized.

Resources will be required for economic reactivation. The creation of a guarantee fund for bank loans to SMEs has been proposed, with resources from IDB Invest, IFC, CAF, EIB and other entities.

A gradual reactivation requires making way for Internet sales, home delivery or pick up at the door of stores, and home delivery of food and prepared food.

(*) This is the English translation of an opinion column published on May 11th in Diario El Universo of Ecuador:  

https://www.eluniverso.com/opinion/2020/05/11/nota/7837575/cuarentena-muerte-reactivacion

A prosperous 2020?

Luis Fierro Carrión (*)
@Luis_Fierro_Eco

Ecuador's per capita income fell by 2% in 2019, and will fall again by 1.3% in 2020, according to the projections of the International Monetary Fund (IMF). GDP per capita has been contracting in real terms since 2014, with a cumulative fall of 7.3%.
As a result, the poverty rate, which had dropped from 36.7% in 2007 to 21.5% in 2017, has begun to rise again, reaching 23.2% in 2018. Unemployment is rising, from 3.8% in 2014 to a projected 4.8% in 2020. Most worrying is that the adequate employment rate has been reduced from 45.5% in 2014 to 38.5% in 2019.
This economic contraction and social deterioration is generating frustration and political instability, as evidenced in the October protests against the elimination of gasoline subsidies.
The main reason for this economic contraction is the fall in international oil prices. The average price of Ecuadorian crude fell from $ 84 per barrel in 2014 to $ 35 per barrel in 2016, and projected values ​​of $54- $56 in 2019-2020.
However, the need for economic adjustment was exacerbated by its delay. Instead of immediately reducing public spending (which had reached 44% of GDP in 2014), the Correa government began to incur massive public deficits, reaching 8.2% of GDP in 2016. Public debt (internal and external), which stood at 27.1% of GDP in 2014, quickly doubled, reaching 44.6% of GDP in 2017, and a projected level of 50.1% of GDP in 2020.
The indebtedness included the issuance of international bonds, at high interest rates (compared to our neighbors, Colombia and Peru); indebtedness with China, also with onerous rates, and sometimes tied to projects of Chinese companies; oil presale, with Asian companies; “pawning” part of the gold reserve; use of the reserves of the Central Bank of Ecuador (BCE), through the issuance of internal bonds and the delivery of 'assets' to the BCE; use of IESS reserves, through the issuance of internal bonds; taking of the pensions of some institutions; and the suspension of the 40% contribution of the State to the social security pensions. Several of these forms of indebtedness were unconstitutional or illegal.
By the time Correa handed Lenin Moreno the supposed 'served table', the BCE’s net international reserves (NIR) were negative at -3,293 million dollars (that is, there was a gap in the reserves, which could affect financial stability).
The calamitous fiscal and financial situation in the country led the Government to seek an adjustment program with the IMF. In exchange for financing in soft terms of the IMF for $ 4200 million, and multilateral banks for $ 6000 million, Ecuador promised to reduce its fiscal deficit, recover the NIR, and adopt structural reforms.
The initial goal was to improve the fiscal situation by 5% of GDP (improvement of about $ 5400 million), and a recovery of the NIR (to positive levels). More recently, the Fund reduced the fiscal consolidation target to 3.9% of GDP. Fiscal goals have been achieved, but only thanks to a severe contraction of public investment. The public wage bill has not been reduced, although a reduction of 0.3% of GDP is anticipated in 2020. It will be essential to reduce fuel subsidies, which will be attempted through better targeting.
An economic recovery could be achieved by:
-An increase in the price or volume of oil exports.
-Expansion of mining production (gold began to be exported from a concession).
-Increase in the prices of raw materials (which seems unlikely, given the recessive trends in some countries).
-Increased private investment (which is hindered by high labor costs in Ecuador, compared to Colombia and Peru; legal uncertainty; and bureaucratic obstacles for entrepreneurship in Ecuador). A labor reform that creates incentives to generate employment would be welcome, as well as reforms that facilitate the creation of companies.
-Expansion of energy efficiency, greater generation of renewable energy, greater use of public transport (for which there is international concessional financing).
-Increase in productivity, as well as greater value added of exports.

(*) Translation of opinion column published on January 6, 2020 in Diario “El Universo” of Ecuador

https://www.eluniverso.com/opinion/2020/01/06/nota/7677411/prospero-2020