President Rafael Correa’s new government likes to keep people guessing. In two months in office, the administration has confused Ecuadorians and analysts at home and abroad with conflicting statements and decisions concerning a host of issues, including a constituent assembly to rewrite the country’s constitution, its debt policy and trade relations. There is even speculation, created by President Correa himself, about his own future in government. Correa announced in mid-February that he might have to go home if the opposition wins control of the constituent assembly. In the meantime, the government has been working at a frenetic pace, announcing new spending initiatives on an almost daily basis.
President Correa and his ministers appear to be in a race with each other to see who can visit the most cities and towns and promise the most in the shortest period of time. “This government has one priority – the Ecuadorian people. All our decisions are aimed at meeting this priority. We have done more in one month than all the governments in the previous 10 years,” foreign affairs, trade and integration minister Maria Espinosa tells Emerging Markets in an exclusive interview. The first battle won by Correa, who ran for the presidency on a coalition that included candidates to the unicameral Congress, was the February 13 decision by lawmakers to approve a constituent assembly.
The election of delegates is now scheduled for April 15. The delegates chosen will be charged with writing a constitution to replace the existing one, which was drafted by a similar assembly in 1998. The assembly is a tool that has been used by two of Correa’s chief allies in the region: Bolivian president Evo Morales and Venezuelan president Hugo Chavez.
The Venezuelan assembly rewrote the constitution, allowing Chavez to remain in power. Bolivia’s assembly was seated last August and is still working, bogged down for months on the percentage of votes needed to pass laws. The debate is now about what Ecuador’s assembly will do once it is seated. Correa maintains that it is sovereign and members will decide if they substitute the Congress. “The fight has just begun ... to crush the political mafias at the ballot box,” he stated through a palace communique. The representatives of political parties in Congress who approved the measure have a different idea, seeing the assembly as operating parallel to Congress as it did in the 1990s version and as is currently underway in Bolivia.
Bond babble
The decision on the assembly was overshadowed by the Correa government’s confusing stance on its debt and, in particular, a $135 million coupon payment on its 2030 global bonds that came due on February 15. As Congress was debating the referendum on the assembly, the finance minister Ricardo Patino announced that the country would miss the debt payment. The initial suggestion was that a default was imminent. That position was replaced by a plan to pay, but pay late, using the 30-day grace period.
Yet despite all the rhetoric, the government paid on time. “President Correa has defined the issue as life before debt. This means that we have to prioritize the responsibilities the Ecuadorian state has to guarantee the fundamental rights of the population, food, security, healthcare and education before we service the debt,” says Minister Espinosa. Correa thinks Ecuador’s debt is partly “illegitimate” and therefore lacks a whole-hearted commitment to repayment on time and in full.
“In the end, there was enough money in the treasury, so Ecuador complied with its commitments and paid,” adds Espinosa. “This is how it is going to work. We are going to analyze each situation, and if the conditions permit, we will pay. When the situation is complicated, there will have to be negotiations, and the creditors will have to understand this.” In a February 21 briefing, Patino had a more mundane explanation for the near default. He said the central bank only had $83 million on hand on February 13, which is why his office announced that it would not pay on time. Deposits in the bank’s coffers jumped to $139.1 million the following day, so the payment was made.
The other, more cynical interpretation is that double-speak by the Correa administration is part of an overt attempt to push down Ecuadorian bond prices. The risk premium on Ecuador’s bonds has risen sharply since Correa’s victory in the presidential election in November. After the coupon payment, it fell to its lowest level of the year. The seesawing in price also gave bond speculators the chance to make a large profit if they knew what the ministry had ultimately planned to do. According to BCP Securities’ Walter Molano, Quito’s rhetoric was accompanied by “surreptitious buyback operations” from Venezuela. “Government officials are playing a high stakes game of poker, and they are bluffing their way in order to bolster their bargaining positions,” he says.
It’s a suggestion that’s being taken seriously in some quarters – even in the Ecuadorian Congress, which was asked at the end of February to investigate the finance ministry’s tactics. Luis Almeida, the president of a congressional oversight commission, believed that the manner of the payment raised “strong suspicions of corruption” on the part of the finance ministry, referring to market rumours that some Venezuelan banks had been involved. Whatever the case, Ecuador’s eleventh-hour decision to pay at least partially reflects advice from many quarters, not all of them obvious.
A team of officials from Argentina, which defaulted on $81 billion of bonds in 2001, flew to Quito to make the case that, for Ecuador, default was not the best option. Ironically, some analysts suggest that Hugo Chavez’s Venezuela may also have urged the government not to default: Venezuela holds at least $300 million in Ecuadorian bonds. As John Welch, senior vice-president at Lehman Brothers, points out: “Venezuela sold protection in Ecuador through a credit-linked note. If Correa defaults, there will be a huge capital loss to Venezuela. The market has in effect put a bind on the relationship between Correa and Chavez. The idea that there could be a friendly restructuring is absurd.”
Finance minister Patino travelled to Venezuela on February 15 for a meeting with his Venezuelan counterpart, Rodrigo Cabezas. Patino came away with an offer of $500 million in financial assistance over the next two years that could include buying Ecuadorian bonds, a practice Venezuela has already used in Argentina. “Ecuador does not have a short-term problem paying its debt, but we are offering to help anyway,” Cabezas told reporters at the time. If it happens, the purchase of Ecuadorian bonds by the Venezuelan government will more than likely end up in the hands of local banks and other institutions eager to get dollars on their books.
A market unnerved
The market is quick to condemn the Correa government’s approach as erratic and arbitrary. “The government’s policy is not driven by incapacity to pay, but by unwillingness to pay. This is something new for everyone. Ecuador is moving toward a pre-emptive default. They want to default without needing to default, because they believe that the debt burden is too high and that they have to pay the social debt. This is purely political,” says Alberto Ramos, senior Latin America economist at Goldman Sachs. Ramin Toloui, senior vice-president for emerging markets at Pimco, agrees, saying the government’s mixed signals and apparent willingness to default, despite having met the February 15 payment, does not bode well for long-term stability.
“Many investors are waiting for what the government will propose. I think that there is a lack of clarity in the market about what the government’s plans are with respect to a debt restructuring,” says Toloui. “You may see some bonds trade up on daily spot news, but the market is essentially waiting for more clarity on the government’s objectives.” Pimco began eliminating its Ecuador exposure even before Correa was elected in a run-off election, concerned by his rhetoric during the campaign. The same is true for other emerging market investment firms and international ratings agencies. Standard & Poor’s downgraded Ecuador’s credit rating to CCC in late January, because of Correa’s post-election comments that the debt was “illegitimate”. Moody’s Investors Service followed suit, downgrading the country’s bond rating to Caa2 with a negative outlook. T
he country’s foreign debt is $16.8 billion. Adam Lerrick, professor of economics at Carnegie Mellon University puts it thus: “Ecuador wants to send a message to the world: the poor take precedence. Governments have the right to prioritize spending. Lenders have a reciprocal right to know their rank in the payments chain before their dollars are handed over.” In an interesting twist, Ecuadorian Congress was asked by a senior congressman to investigate the finance ministry’s antics on its $135 million coupon.
Power struggle
The double discourse on the debt is also playing out in the context of the country’s commercial policy, particularly with respect to Venezuela and the United States, the two countries defining relationships in the region. Ecuadorian leaders are pressing hard for the US government to maintain preferential tariffs for more than 6,000 products it ships tariff free to the United States under the Andean Trade Promotion and Drug Eradication Act (ATPDEA), which also applies to Bolivia, Colombia and Peru. ATPDEA was set to expire on December 31, 2006, but the US Congress extended it another six months.
The extension largely had to do with the fact that separate free trade agreements between the United States and Peru and Colombia had not been passed by the US lawmakers as had been expected. The extension to Bolivia and Ecuador was something of an afterthought. The trade agreement is essential to most of Ecuador’s major export commodities, such as shrimp, tuna, fresh cut flowers and bananas. The United States accounts for half of Ecuador’s $12.5 billion in exports.
The Ecuadorians, like the Bolivians, are arguing that the preferences should remain indefinitely, even if they do not have free trade agreements with the United States and are critical of the Bush administration. Before winning the elections, Correa publicly backed Chavez’s remarks at the UN General Assembly referring to US president George W Bush as the devil. The Ecuadorian idea is that it deserves the preferences for its successful efforts in combating drugs, the US government’s principal interest in the Andes. “The issue of ATPDEA is the minimum recognition of our efforts in fighting drugs, so for us the preferences need to exist as long as we are involved in these efforts,” says Minister Espinosa. At the same time, she says that she was enticed by Chavez’s proposal for Ecuador to join the Bolivarian Alternative for the Americas (Alba), the alternative to the US-promoted Free Trade Area of the Americas.
Bolivia, Cuba and Nicaragua are members of Alba. “This is a very interesting proposal from Venezuela. For us, Alba is an interesting framework of analysis. A decision, however, has not been made about joining,” she says. In this context, Venezuela’s recent offer of financial assistance makes sense. Ecuador exported $186 million in products to Venezuela and imported $415 million from it in 2006, according to statistics compiled by the Andean Community of Nations. On the internal front, local analysts are concerned that the government’s plans to increase spending and limit income with lower taxes could disrupt the economy, which has been performing well in recent years. GDP expanded by 4.5%, and inflation was 3.4% in 2006. Correa’s budget projects the same GDP growth for 2007. The amount could be higher if the price of oil, Ecuador’s principal export, rises.
In just his first month in office, Correa announced new major outlays, including doubling the “solidarity bond” to $30 and increasing a housing bond by six-fold for poor urban families. The solidarity bond is the Ecuadorian government’s conditioned cash transfer programme for poor families. It reaches 1.2 million families. The housing bond helps poor families build or repair homes. The government estimates a housing deficit of more than one million homes. Wage increases have also been decreed for teachers and other low-paid public employees. The government has also created a new plan, known as the 555 Programme, which will make $5,000 loans, for five years at 5% interest to small businesses.
At the same time, the government has announced a plan to reduce the value added tax (VAT) from 12% to 10%, creating what critics say will be a $400 million hole that cannot be filled quickly by increasing the tax base or increasing the selective tax on products such as energy, drinks, beer and cigarettes. Taxes as a percentage of GDP are 11.9%. Tax collected in 2006 rose by 15% compared to the previous year. Total tax collection was $4.5 billion, with VAT representing $1.5 billion. Jaime Carrera, coordinator of the UN-sponsored Fiscal Policy Observatory, says the government could be setting itself up for major problems, by promising to spend more than it has while simultaneously adopting policies that will curb money coming into the state coffers. He said the VAT reduction is fiscally irresponsible. “It is impossible to recuperate this by taxing sports drinks. This plan make no fiscal sense and is going to lead to major problems,” says Carrera.