Ecuador tapped international debt markets with a $1billion bond issue. The money comes at a vital time for the earthquake-hit economy that is trapped between low oil prices and the high dollar.
The 10.75% coupon on the five-year bonds is the highest that Ecuador has had to offer in what is now its fourth issue since its post-default return to the markets in 2014. But despite that, the bond was another canny piece of financial engineering from President Rafael Correa, who has had previous successes with a selective default and subsequent well-timed return to the market. Cash-strapped Ecuador has been looking to raise money for several months but, with yields hovering at 17.5% in March, decided to hold off. A further hiccup came with the surprise Brexit vote in June, which sent markets into a tailspin. Yet an uptick in international appetite for emerging market debt helped to drive LatAm sovereign yields down (see page 10) and Correa was quick to take advantage of the 50% drop in Ecuador’s yields.
There’s no doubt that this bond issue relieves some pressure on the Ecuadorian economy but the fact is the remaining challenges are severe. The largest structural pressure on Ecuador is that the price of its main export, oil, has more than halved in the last two years. This has caused the fiscal and current account deficits to rocket. Similar pressures have been observed around Latin America but Ecuador’s added problem is that it is a dollarized economy. This means it has no floating exchange rate to absorb the shock of the falling oil price.
"the remaining challenges are severe…"
Indeed the dollar has strengthened, making Ecuadorian exports less competitive than that of its peers. The other role of a depreciating currency is to help make imports more expensive and thus close the current account deficit. Correa has tried to simulate the same effect through a series of import taxes, though it is an inherently less flexible and nuanced measure than having a currency traded on global FX markets against those of multiple trading partners. As if things weren’t serious enough, on April the 16th Ecuador was rocked by its most severe earthquake in a generation, which killed hundreds of people and caused $3billion worth of damage.
The $1billion will help but constitutional restrictions mean that loans raised on the international debt markets can only be used for infrastructure works. However, that could stretch to repaying debts to government contractors, who are owed around $2bilion. Paying those contractors would help provide liquidity and give a much-needed boost to an economy that is expected to contract by 3.3% this year. Either way, Ecuador will still be left with a shortfall. It has other financing options and over the years it has raised significant sums from China, natural resource companies and multilateral lenders. However, with its official debt-to-GDP ratio standing at just 35% Ecuador could well become a familiar face at the market.