The resignation of Ecuador’s market-friendly finance minister Fausto Ortiz on Monday battered confidence in Ecuadorian assets this week, deepening fears the nation will default on global bonds this year.
Ortiz resigned in protest over the government’s seizure of 200 businesses, including two private television stations, over unpaid debts from the 1990s’ banking crisis.
Spreads on Ecuador’s 10% 2030s immediately widened by up to 55bp as investors were spooked by the departure of the sole supporter of economic orthodoxy in the leftist administration of president Rafael Correa.
Spreads have since tightened but "market confidence towards the credit is now thin since Ortiz was a respected figure," according to a Latin American debt capital markets banker in New York.
Upon his appointment in January 2007, Correa branded unspecified chunks of foreign debt "illegitimate" and established an external audit commission, comprised of well known anti-debt campaigners, that is due to unveil its final report next month.
The new finance minister Wilma Salgado urged investor caution in the near term upon her appointment on Wednesday, saying no unilateral default was imminent. She said the country’s relationship with external bondholders would be determined by the "results of the audit, which is crucial".
Ortiz was a well known moderating figure in the government, opposing a potential default on global bonds and pushing for a debt swap to assuage political concerns of high debt service costs while remaining in market favour.
The ex-minister was working on a plan to exercise the call option on the 2012 and 2030s global bonds, which carry a 12% and 10% coupon respectively and are worth up to $600m in total, to create a new benchmark. A buyback would be politically controversial since "Correa is ideologically opposed to the idea of giving money to investors to the detriment of social and infrastructure spending," said Felipe Hernandez, research analyst at Deutsche Bank in Colombia.
Hernandez argues Salgado is unlikely to shore up market confidence and drive the government’s commitment to service debt obligations. As a result, the shop recommends investors close all long positions on Ecuadorian assets and re-evaluate relative value trading. He argues that the relative underperformance of the 2030s does not present a buying opportunity and said instead that investors should "lock in the profit at this point and stay out of the credit". He also advises scaling back all exposures on five year CDS on the 2030s. "We believe CDS will likely widen more than cash bonds if the situation further deteriorates."
Nevertheless, all bets are off on whether the government will carry out its threat to default on foreign debt. Correa has in recent months indicated a more pragmatic approach to debt servicing and moderated his rhetoric towards foreign investment.
Furthermore, gushing oil revenues and growing reserves have strengthened the government’s liquid position and its ability to repay debt. One banker concluded: "This is classic Ecuador: the political volatility has increased this week but the risk of default on debt has not materially changed."