The debt restructuring deal provisionally agreed between Ecuador’s government and a group of its creditors would, if implemented, ease near-term pressures on the public finances. But we are more pessimistic on its potential to help Ecuador achieve debt sustainability.
- The debt restructuring deal provisionally agreed between Ecuador’s government and a group of its creditors would, if implemented, ease near-term pressures on the public finances. But we are more pessimistic on its potential to help Ecuador achieve debt sustainability.
- In April, the Ecuadorian government agreed a debt moratorium with private bondholders which expires next month. Last week, a provisional restructuring deal on $17.4bn worth of sovereign dollar bonds was reached with a group of major creditors. The government’s investor-friendly approach in negotiations, positive words from the IMF, and the continued rally in oil prices has helped to narrow the spread of Ecuadorian sovereign dollar bonds over US Treasuries over the course of the last few weeks. (See Chart 1.)
- There appears to have been a hiccup in the process over the weekend as two smaller groups of bondholders issued a statement saying that terms “need to be improved for the equal treatment of all investors”. But whether or not the current deal is eventually accepted, the key point is that we don’t think that the deal currently on the table would be enough for Ecuador to achieve debt sustainability over the long-run.
- The current deal involves swapping ten existing bonds maturing between 2022 and 2030 for three bonds due in 2030, 2035, and 2040, with a nominal 9.2% haircut on the face value of the bonds, knocking around $1.7bn off the principal due. The average coupon on the new bonds would be 5.3%, compared to 9.2% on the old bonds. Overall, estimates suggest that the net present value of the new debt would be around 50% lower than the old debt.
- Admittedly, this would all make the government’s debt repayment schedule over the coming years much more manageable. Indeed, it would no longer need to pay any principal on this debt until 2026. But we’re sceptical that it would be enough to prevent Ecuador’s public debt-GDP ratio from rising further out.
- Preventing this from happening would require a number of things. First, the government would need to tighten fiscal policy dramatically in the coming years and maintain an austere stance. Second, it requires interest rates on the government’s debt to remain low. (See Chart 2.)
- We are sceptical on both counts. Appetite for fiscal austerity may fade before long, especially in the face of an economy that is reeling from the effects of the pandemic. It’s also worth highlighting the risk posed by next year’s presidential election, which could either cause fiscal slippage or trigger a shift back to a more left-wing government that may at the least water down the current agenda for austerity.
- Against this backdrop, it is difficult to see fiscal austerity continuing and the bond market staying onside – which is key to lowering the government’s borrowing costs. Under more realistic assumptions, we think that the public debt ratio would continue to rise in the coming years even if a restructuring deal is reached. (See the dotted line on Chart 2.) Accordingly, while Ecuador may soon exit its near-term fiscal crisis, there is a major risk that further restructurings would be required later this decade.
Chart 1: Ecuador JP Morgan EMBI Spread
Chart 2: General Govt. Debt (% GDP, IMF Definition)
Sources: Refinitiv, Capital Economics
Quinn Markwith, Latin America Economist, firstname.lastname@example.org