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/

Coronavirus, oil prices and Ecuador's risk premium

By Luis Fierro Carrion (*)

The World Health Organization has warned that the COVID-19 coronavirus could lead to a worldwide pandemic.

The number of cases of coronavirus has increased exponentially, and according to Harvard University epidemiologist Marc Lipsitch, it could spread to between 40% and 70% of humanity by the end of the year. The incubation period lasts up to 14 days, and many asymptomatic people spread their disease before it is detected.

Despite the quarantine of millions of citizens in China, the epidemic has spread to South Korea, Japan, Iran, Italy, the United States and dozens of other countries (the first cases in South America have already been detected, including 6 in Ecuador by March 2).

If the mortality rate remains as high as in the first cases (1% - 3%), and a pandemic is unleashed, it could reach a death toll not seen since the 1918 "Spanish flu" pandemic (by comparison, annual seasonal influenza has a mortality rate of 0.1%, mainly affecting infants and the elderly with other health problems).

The Chinese economy, which has grown at rates above 6% annually since 1990, is collapsing, and forecasts of the global GDP growth rate have already been lowered; a recession could break out. Foreign trade, international travel and tourism are particularly affected sectors. Stock exchanges fell by 14% at the end of February.

A direct impact of the slowdown in the Chinese economy has been the fall in the price of oil and other commodities (palm oil, corn, soybeans, copper, etc.). The price of WTI crude oil has fallen 23% since the beginning of January, and has fallen below $ 50 per barrel (and below the estimated price for the 2020 Ecuadorian budget, of $ 51.30 per barrel).

The fall in oil has, in turn, influenced the steep increase of the so-called “country risk premium” (the investors' perception of Ecuador's ability to pay the external debt). This is the differential in the yield of Ecuadorian bonds in the secondary market with respect to the rate of the 10 year U.S. Treasury bonds. This index, which reached a level of 5069 basis points (50.69%) in December 2008 (when Correa declared a unilateral moratorium unilaterally not due to an inability to pay), had dropped to 446 in February 2018. After the indigenous strike, it increased to 1418, in January it went back to around 800, and at the end of February it shot up again to 1450.

It did not help that the Moody's rating agency has lowered its credit rating of Ecuador’s external debt to Caa1, considered “a poor position with a very high risk”. In its analysis of the fiscal and economic situation of the country, one of the negative factors mentioned was the inability to generate a social and parliamentary consensus on the economic measures required to deal with the fiscal downturn. Several political sectors are privileging their electoral expectations over the urgent need to recover the fiscal balance.

It should be remembered that the Correa Government did not make an economic adjustment when the price of oil began to fall in 2014, opting for aggressive indebtedness, which left a legacy of public debt of $ 60 billion (including external and internal debt, as well as other obligations). The public debt reached USD 58,560 million in January 2020, equivalent to 53.4% ​​of GDP. Apart from that, according to the Ministry of Economy, there are “Other Obligations of the State”, which total USD 5,941 million.

The Government has cut public investment, aggravating the country's economic stagnation. But it has failed to significantly reduce current spending, which portends a fiscal deficit of 3.1% of GDP. At least USD 6665 million in financing will be required in 2020, including USD 2000 million expected from concessions and sale of public assets.

With the expected disbursements of the IMF and multilateral banks, and other non-orthodox measures (issuance of Treasury Certificates, arrears of payments) the 2020 financing gap is expected to be closed; but Moody’s and other economic agents are concerned that external debt amortizations will increase significantly from 2022, and the economic reforms necessary to achieve an economic recovery are not being adopted; The possible return of economic populism is also worrying.

(*) Translated and updated (to March 2, 2020) version of my column in Diario "El Universo" of Ecuador

https://www.eluniverso.com/opinion/2020/03/02/nota/7762857/coronavirus-petroleo-riesgo-pais