The Republic of Ecuador moved closer to defaulting on its global bonds due 2012, 2030 and 2015 this week after the country’s debt audit commission said it uncovered “illegality and illegitimacy” in the obligations. The commission said that bonds were issued without proper government authorization, lacked transparency and had inflicted “incalculable damage to the economy”.
The bonds issued amount to $3.9bn- around 40% of the sovereign’s foreign debt obligations. After yesterday’s (Thursday) announcement, the price on the $510 million bonds due 2012 fell as much as 2.5 cents to 24 cents on the dollar, sending yields over 70%. The market is now pricing in a default while Standard & Poor’s has cut its sovereign rating to CCC and Moody’s to Caa1.
The foreign debt issuance “occurred for the benefit of the financial sector and transnational companies and clearly went against the interests of the country,” the commission said in the report. Paying the debt “hurt the fundamental rights of people and communities, deepening poverty and adding to migration.” It did not recommend what course of action should be taken but the report does provide Correa with the legal basis to default.
President Rafael Correa says he will seek to prosecute bankers at JP Morgan and Salomon Smith Barney, now part Citigroup, and ex-government officials involved in the debt sale. He said the bankers “compulsively induced, threatened, bribed and pressured with all their might to push their loans and make their juicy commissions”. But Correa stopped short of announcing a complete default. Last week, he withheld $30m interest payment on the 2012 bond, saying the government would use a 30-day grace period to digest the commission’s findings.
Ricardo Patino, head of the debt commission, has reportedly said that any restructuring would have to cut more than 60% in the debt principals. In the event of a 50% haircut, Barclays says holders could find exit values representing yields of $27-$30 or $28-$65 if it renegotiates coupons at 50% of the original amount.
Correa won a landslide election in 2006 vowing to default on foreign debt to help fund pro-poor programs. In recent months, he has argued that in any trade off between lower social spending and debt servicing costs in the event of lower oil receipts, a default would be necessary in the interests of poverty reduction. However, analysts argue the country has ample resources to service its debt with $6.5bn in foreign currency reserves. Fernando Pozo, general manager of the country’s largest private bank Banco Pichincha and outgoing head of the Federation of Latin American banks (Felaban), said: “This is just politics but it is utterly disgraceful, the government has absolutely no reason not to pay and it [a default] would undermine our economy.”
Jorge Suárez-Vélez, investor for high-net worth individuals in Latin America at Global Plus Investments in New York, said: “I think these moves are disgusting, tremendously near sighted and sets a bad precedent.” The country’s total foreign debt hit $10.03 billion in August, down 29% since 2006 and now stands at 21% of GDP. By contrast, Argentina's debt burden amounted to 150% of GDP when it defaulted in 2001. Ecuador’s 2012 and 2030 are restructured bonds from when the country defaulted in 1999.
A default would also damage the country’s relationship with Venezuela as well as investor sentiment. Venezuela holds around $230 million in Ecuadorean debt in a national development fund- only 1% of its $39bn foreign currency reserves. However, it is thought to own a sizeable amount of credit default swaps in Ecuadorian debt.
The spectre of a contagion effect for other emerging market assets in the event of an Ecuadorian default was raised in a Barclays research note this week. “A "successful" default by Ecuador may cause countries in similar situations to reassess the costs of default - or investors to fear that, leading to a repricing of these credits.”