Ecuador’s bonds pummeled ahead of election

New York — Six months after a swift and smooth restructuring, Ecuador’s sovereign bonds are being pummeled by fears that Sunday’s election outcome could derail ties with the International Monetary Fund (IMF) and trigger another debt crisis.

Suffering one of the region’s worst outbreaks of the coronavirus last spring, the oil-dependent Andean country secured a $17.4bn debt restructuring and a $6.5bn IMF loan in August.

Opinion polls point to a lead in the presidential run for left-leaning economist Andrés Arauz, who has pledged to tear down the IMF agreement and increase social spending if elected. Bond prices tumbled, deepening a slump stemming from the economic collapse during the pandemic.

Arauz promised to give $1,000 each to a million families within a week of taking power, nearly 20% of forex reserves that stood at $5.2bn at the end of December.

Indigenous activist Yaku Pérez and conservative banker Guillermo Lasso, who is making his third presidential bid, are Arauz’s closest rivals in the polls. Undecided voters, who poll in the double digits, will be key for picking the winner and also defining whether an April runoff will be needed.

A candidate will win outright with more than 50% of the vote or more than 40% and a minimum 10-point lead over the nearest rival. The next president will have at hand more than $4bn already disbursed by the IMF while enjoying a schedule of payments that will not make a big dent on the $17.4bn restructured with private creditors.

“The country’s ability to pay in the medium to long term is actually substantially better than before Covid-19, which is a bit counter-intuitive,” 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 really helped improve the debt sustainability of Ecuador.”

Principal repayments on the country’s dollar bonds will kick in from 2026. But with bonds yielding more than 15%, Ecuador is currently shut out 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 dollarisation regime.”

The IMF declined to comment.

Ecuador’s foreign currency bonds were the worst performers in the JPMorgan emerging-market bond index global (EMBIG) diversified index in January, 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.

Dollarisation on the ballot?

Many of Sunday’s voters have never used local currency as Ecuador has been dollarised for more than 20 years. The move brought stability to the economy, which had been weighed by hyperinflation, but at the same time destroyed a lot of local wealth.

After more than two decades, dollarisation remains popular among Ecuadoreans, but it also makes for a toothless central bank, just when they have become the first line of defence against the economic toll of the pandemic.

Still, monetising 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 dollarisation regime.”

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”.

If de-dollarisation is out and the market remains prohibitively expensive, the relationship with the IMF takes sharper focus.

“The IMF support matters a great deal for funding from other international financial institutions, which are important for the budget and infrastructure projects,” said Gustavo Medeiros, deputy head of research at investment manager Ashmore, which specialises in emerging markets.

“Without the IMF, the fiscal anchor would be removed and it would be harder for Ecuador to have market access, which means the bonds would keep trading at a larger discount than merited, given its current favourable debt repayment profile,” Medeiros said.

Reuters