I rarely get emotional when looking out of an airplane window. Ecuador was an exception. I opened my eyes on landing in Quito after a four hour overnight flight from Mexico in an extremely uncomfortable Aeromexico seat. The first sight of Ecuador took my breath away. How can a country of such beauty have so many debt problems?
Quito from my airplane window
Only 100 years ago Ecuador, Venezuela and Colombia were part of the republic of Gran Colombia. Today these countries have only a few things in common: natural resources, the Spanish language and their national flags. The colours on the flags could be symbolic of the paths these countries have taken. While Ecuador would have liked to have the economic strength of Colombia, its left-wing government at times more closely resembled Venezuela. However, the next few weeks could be critical to the path of Ecuador’s economic development, as President Lenin Moreno announces his new economic plan. After our trip to Ecuador, I would be willing to give the president the benefit of the doubt on announcing market-friendly policy decisions. This is despite his party affiliation, his predecessor’s track record and his first name.
With a yield close to 8%, Ecuador is the fourth highest yielding sovereign debt in the JP Morgan Emerging Market Bond index. The country is best known for two things: the Galapagos Islands and serial defaults.
Over the last 183 years, Ecuador has only re-paid one bond maturity in 2015. We are tactically overweight the credit despite its chequered default history, recent aggressive debt issuance and strong performance over the last twelve months. We believe investors could see further spread compression if President Moreno delivers on his promises over the next few weeks.
Ecuador’s list of challenges is long. An uncompetitive labour market and unstable regulatory regime has led to a continuous decline in private investment (45% of total compared to 80% in 2006) and FDI (less than 1% of GDP). The large fiscal deficit (6% of GDP), given the historically low appetite for social pain, combined with a limited central bank toolbox, given a dollarised nature of the economy, has left the country reliant on Chinese and bondholders’ funding.
The latter has doubled in the last year from USD7.5 billion to USD14.5 billion. With debt/GDP close to 40% (or more) the pace of debt increase is unsustainable without a change in economic policy.
Ecuador needs a fiscal adjustment in our view, as well as a meaningful improvement in its business climate. The good news is that the current administration recognises this and is willing to listen and act. The president promises to announce new policy decisions in the first week of March and tighten the fiscal belt to compensate for mismanagement during 11 years of Correa’s administration. We have heard that the deficit target might be reduced from 6% to 3% by 2020, including spending cuts in particular on fuel subsidies.
President Lenin Moreno’s (seated) election last year was supported by his predecessor Rafael Correa (right)
The two stars of the government show, the Minister of Energy Carlos Perez, and the Minister of Trade Pablo Campana, are driving the improvement in business climate and private investments. The energy minister is focused on facilitating energy investments through the introduction of production sharing agreements and opening up the oil sector. Chinese, Russian and UK-based partners are evaluating a number of projects amounting to over USD10 billion (or 10% of GDP) in total investments.
He is also working on merging and re-organising the state-owned energy companies to create a commercial state oil and gas operation that could attract both debt and equity capital, using a Colombian state-owned petroleum company as a model. This could further ease the state debt burden. The trade minister Campana has been focusing on facilitating trade relationships by reviewing commercial agreements with the US in the spirit of the free trade agreement with EU signed last year.
Meeting the Central Bank of Ecuador (CBE) governess was also a positive surprise. Given the dollarised nature of the economy, CBE cannot act as a lender of last resort to the banking sector. In the past the BCE has been rightly criticised for compromising its independence by increasing its lending to the Ministry of Finance. This resulted in a drop in the FX reserve-to-asset ratio at the central bank from 70% to 50% and raised an issue of trust between commercial banks and the CBE. The financial sector vulnerability is further increased by weakly regulated cooperatives in Ecuador – a form of shadow banking. The CBE 34 year-old governess Veronica Artola Jarrin struck the right note in our conversations by being realistic about the need to adopt market-friendly policies, stop lending to the government and put further pressure on restraining expenditures on the fiscal side.
CBE Governess Veronica Artola Jarrin (centre) with the BlueBay team
Ecuador’s structural challenges will be difficult to resolve overnight. It is a country that is exposed to external vulnerabilities from the oil price to US dollar funding costs. Ecuador also has a patchy track record of governments being able to complete their terms (prior to previous President Correa, three out of four presidents were ousted in public protests). Yet we are hopeful that the new president might be able to address investors’ well-deserved scepticism. The Colombian path is a lot more desirable for Ecuador than the form of Chavismo adopted by ex-president Rafael Correa.
Reflecting on my two-day visit, Ecuador’s extraordinary natural beauty and the overwhelming warmth of its people have disarmed me. I hope the policy making follows suit.
Ecuador’s capital Quito is one of the most beautiful cities I have visited