The IMF announced last night that Ecuador has expressed its intention to seek emergency financial support through its rapid financing instrument (RFI) and, it seems, a new IMF programme. We think continuing IMF support and the authorities' commitment to sound policies and its responsible approach will be welcomed by investors, although it may raise residual concerns about IMF programme design (any hint of burden sharing?) and the authorities' limited room for manoeuvre (Plan B).
Meanwhile, Bloomberg reports that the authorities have said they will pay the 03/2020 bonds due today (24 March), amounting to US$325mn in principal, although suspend some US$200mn on upcoming interest payments on the 2022, 2025 and 2030 bonds, which are due later this week, too, using their grace periods. Under current circumstances, we would expect bondholders to be sympathetic to a temporary payment delay, which is unexpected but allowable (and better than the alternative), although would probably appreciate stronger market communication about the government's intentions. Another question for bondholders will be, will other countries follow suit?
A request for IMF emergency support may be no real surprise. Ecuador has been been perceived by investors as being among the more vulnerable EM countries to the impact of Covid-19, with the subsequent market dislocation and collapse in oil prices, given its own pre-existing vulnerabilities (eg heavy debt service schedule, low reserves and limited policy space). Indeed, we think the current account hit (fall in export revenues) this year could be cUS$3bn at US$35 per barrel oil, other things unchanged, which could be enough to wipe out their already low foreign reserves (this is a static assessment and, in reality, the impact may be lower given the policy response and adjustment in other variables).
Recall, the Fund announced on 4 March that it had set aside US$50bn for emerging markets and developing countries to help countries deal with the economic impact of Covid-19 through its existing rapid-disbursing emergency facilities, with US$40bn for emerging markets (such as Ecuador) available through its RFI and US$10bn for low income countries through its rapid credit facility (RCF).
A request for support under the IMF's emergency facilities is therefore a sensible step, and Ecuador has become the latest country to do so. It follows Ukraine last week for example. We expect the list to continue to grow in coming days. We'd expect Ecuador's request to be dealt with quickly. There was however no mention of how much financing Ecuador is seeking. 100% of quota, the normal maximum allowable under these facilities, would amount to US$940mn we think.
The suggestion of a new IMF programme is, however, a surprise. The IMF statement noted that staff are engaging with the authorities on a "successor Fund-supported arrangement that builds on the current extended fund facility (EFF)". It is not clear what this means. The existing US$4.2bn EFF (435% of quota) was approved in March 2019. The combined second and third review of the current EFF was approved in December. But even getting that review over the line was challenging and the global situation has deteriorated markedly since then. It might be that the existing programme is now sufficiently far off track, given global events, that it is easier to design a new EFF programme or that the EFF is no longer suitable – perhaps a new stand-by agreement with bigger access and less structural conditionality to deal with more urgent balance of payments needs is better (Ecuador is not poverty reduction and growth trust (PRGT)-eligible, so we do not think it would qualify for a more concessional extended credit facility – ECF).
Consideration of a new IMF programme – and ongoing financial support – is clearly welcome. We think the IMF has to do what it can to help its members in current circumstances, especially a country like Ecuador, where there has been demonstrably strong commitment to its existing programme and where the authorities have been taking tough decisions and trying to do the right thing. However, as we have noted before, if the IMF programme fails, there will be few other viable options left open to the country, which might force it to default. We are sure the IMF would prefer to avoid this right now.
However, IMF involvement does raise important questions for investors and, specifically, over burden sharing. Much may depend on the IMF's assessment of debt sustainability and whether it sees Ecuador's situation as a liquidity or solvency crisis (its current lending rules prevent it lending into an unsustainable situation). Ecuador's public debt, at 50% of GDP on IMF figures, was judged to be sustainable by the Fund in its last review, and – crucially – sustainable even under stress scenarios – but this was predicated in part on the envisaged fiscal consolidation path, while the external environment has deteriorated markedly since then. The IMF need to think an appropriate fiscal path is still feasible and debt sustainable with high probability. If not, might the IMF now decide private sector involvement (PSI) is necessary as part of any new programme? Even so, we think that would still look like cashflow relief and maturity extension rather than nominal haircuts, given the relatively low debt burden but heavy debt service schedule on bonded debt in coming years. And Ecuador is not Argentina (at the moment) and the government's orthodox approach, mature policy response and strong commitment to and ownership of its IMF programme should count for something. That said, there are limits to policy adjustment, as President Moreno's low approval ratings show.
Meanwhile, Bloomberg reports that the authorities will pay the 03/2020 bonds due today (24 March), amounting to US$325mn in principal (and we assume paying interest too), although suspend some US$200mn on upcoming interest payments on the 2022, 2025, and 2030 bonds, which are due later this week too, using their grace periods (we calculate US$245mn). The reports suggest this approach has the support of the IMF. It will allow Ecuador to divert crucial resources to more immediate needs to fight Covid-19 while deferral of interest allows time for the IMF's emergency financing, and other donor support, to come through (Bloomberg reports US$1bn-1.5bn altogether). This strategy will allow it to maintain access to external finance and avoid what could be an otherwise more chaotic and costly default (despite some domestic political opposition to using limited resources to pay foreign bondholders at a time of national emergency, the calculus will be whether the benefit of continuing to pay, even if delayed, in terms of access to capital, outweighs the cost of paying the debt service).
If the IMF and other multilateral and bilateral donor funds come through quickly, and the intention to pay remains (which we think it does), then the payment interruption will just be temporary. Under current circumstances, we would expect bondholders to be sympathetic to a temporary payment delay, which is unexpected but allowable (and better than the alternative), although would probably appreciate stronger market communication about the government's intentions.
However, there might be a question about timing and amount of financial support needed (more interest will be due later this year of course), and how sustainable the financing picture looks, and whether this bond-by-bond approach as payments fall due will ultimately require a more comprehensive approach to bondholders to seek cashflow (liquidity) relief. However, again, while this may have merits, it also has costs and could escalate rapidly beyond the authorities' control, despite best intentions, into a more chaotic default. Of course, if Ecuador fails to pay interest after the grace period and falls into default (intentionally or not), that would have implications for the IMF programme too (the IMF cannot lend into private sector arrears, unless the country concerned can demonstrate it is engaged in good-faith negotiations with its creditors).
The Ecuador curve fell yesterday some 10-15pts on concerns over the principal repayment, with longer bonds indicated at c20 (mid). However, we would expect the bonds may recover some ground in the very near term on news about the payment and the government's debt strategy, along with IMF support, although the near-term outlook will depend on what the IMF programme looks like, better visibility on financing needs and sources, and whether this requires any contribution from bondholders, and, of course, the external environment. In any case, a back-of-the envelope calculation suggests to us that bond prices (in the belly of the curve) are below expected recovery values in the event of default under plausible assumptions (especially if compared with Argentina – see our note yesterday on this), although we will have to return to this in more detail in future research.
Another question for bondholders is, will other countries follow suit, and seek to delay interest payments?