Having already faced down one attempt to remove him last year, President Lasso, who took office in May 2021, is coming under renewed pressure as the opposition seeks to take advantage of a weakened President following the government's defeat in a referendum on 5 February to impeach him.
Ecuador bonds have fallen on concerns that Lasso may not be able to finish his term (and what comes next would be less market friendly) or, even if he does finish his term (due to end in 2025), this all weakens governability, with negative implications for policy making.
We maintain our Hold on Ecuador (Caa3/B-/B-), rather than Sell, given the extent of the price falls so far, with a price US$53.0 (yield of 22.9%) for the ECUA 5.5% 2030s as of cob 9 March on Bloomberg (mid-price basis). Still, the bonds are close to their post-issuance lows (not far off their low of US$44 in October 2022, when fear over the global rate cycle was at its peak) and already discount a lot of bad news, and we see little risk of a re-restructuring under Lasso.
Indeed, the ‘30s have edged up 6pts over the last week, and were up 1.5pts yesterday to US$53 amid market chatter that the impeachment process has stalled. However, we think that might only provide temporary respite as, even if impeachment fails, political confrontation with the opposition looks set to continue.
Impeachment
The opposition has seized the opportunity presented by the government's overwhelming defeat in the constitutional referendum held on 5 February, and defeat in a number of local elections, to try to oust the President. The referendum itself – consisting of eight questions ranging from environmental issues, political representation and the extradition of criminals – was the result of the mediated talks between the government and opposition groups to ease last year's social tensions. The government failed to achieved a 50% or more Yes vote on any of the eight questions (see here for results).
Following the referendum defeat, on 4 March, the opposition-dominated National Assembly, led by a leftist coalition, Unity for Hope (UNES), linked to former President Correa, voted in favour of a partisan report which recommended opening an impeachment process against President Lasso. He is accused of corruption over dealings in public companies. The non-binding report was approved by 104 of Ecuador's 137 lawmakers, according to various media reports. The government dismisses the report.
The opposition now has to decide whether to launch impeachment proceedings in the Assembly (under Article 129 of the constitution). However, the removal of the President is not inevitable at this stage.
Despite the opposition seemingly having enough support to start impeachment proceedings against the President (which requires a third of the assembly – 46 legislators, and the UNES has 47 seats, and can rely on other parties too), and – if it came to it – to win an impeachment vote in the Assembly (which requires two thirds – that is 92 votes), it may not get that far. Importantly, the constitutional court could block the impeachment drive as before it can go to a vote in the Assembly, the constitutional court has to decide whether to accept or reject the charge. The constitutional court is regarded as being more independent than Congress and has supported the government on some issues. It may decide that the allegations against the President are insufficient to proceed.
The impeachment process follows the failed effort to remove the President last year. Following nationwide protests, led by indigenous groups, the opposition sought to remove the President (we understand under Article 130 of the constitution) on the grounds of "severe political crisis or internal unrest". In a parliamentary vote in June, the opposition fell short of the required two-thirds majority by just 12 votes. Developments since then might suggest the opposition would have more support now, however, this power can only be used once during the legislative period.
Of course, if the President survives a vote, or the impeachment process fails, he would be emboldened. That said, the opposition has already said if the impeachment process fails, they will pursue other avenues to remove him. Hence pressure could remain and that could leave a weakened president. Meanwhile, the indigenous organisation CONAIE has repeated its calls for Lasso to resign.
If impeached, Lasso would be replaced by Vice President Alfredo Borrero, who would act as caretaker until early presidential and legislative elections are organised.
In addition, the President could avoid being removed by dissolving Congress, triggering early elections, although this would allow him to govern through executive decree in the meantime.
And it was all going so well
After last June's nationwide unrest, and the President having survived a no confidence vote to remove him, Ecuador finished the year in better shape. First, the government reached an agreement with CONAIE on 14 October to end the protests (although it only bought a temporary peace as part of the agreement was the commitment to the referendum). Second, it concluded a debt restructuring agreement with China in September. This provided some up-front debt service relief, over 2022-2025, on payments due to China Development Bank and China Exim Bank, terming out US$3.2bn of debt (78% of debt to China) and lowering interest costs. Third, Ecuador finished its IMF programme with the sixth and final review completed in December.
In addition, last year's fiscal outturn was better than expected. Ecuador ended 2022 with a fiscal deficit (general state level) of 1.7% of GDP, according to the ministry of finance, nearly half as much as expected in the government's proforma budget estimate (-3.2%), and down from 7.7% in 2020. Higher oil prices and the yield from the 2021 tax reform, as well as improved tax collection efficiency, helped to boost revenues, despite some additional spending pressure from higher fuel subsidies and increased social spending following last year's protests.
The government projects a fiscal deficit (general state level) of 2.2% of GDP this year in its 2023 proforma budget estimate.
Meanwhile, the consolidated public sector (NFPS) was in balance last year, according to central bank figures, compared to a deficit of 1.7% of GDP in 2021 and 7.1% in 2020. However, despite the improvement, it fell short of the IMF’s projection of a 1% surplus. The IMF projected the NFPS surplus rising to 1.6% of GDP this year and stabilising at c2% over 2024-2027.
Public debt also fell to 58.3% of GDP in 2022, according to IMF projections, down from 62.3% in 2021. Public debt is projected to ease further this year to 55.6%. Based on its primary surplus projections, the IMF expects public debt to fall to below 50% by 2025 and to 42% by 2027.
An improving fiscal balance, lower public debt, and a favourable debt service profile on restructured bonds (no bond maturities over the next few years), may support investor sentiment. Amortisation on the Global 2030 bonds, the first of the new series to mature, doesn't commence until 2026 (after the next election), and given it amortises in the last five years, that smooths out the redemption profile somewhat (although the coupon steps up again, from 5.5% currently to 6% from July). However, given the size of the issue, that is still US$740mn annually due over 2026-2030, while interest on the new series of bonds is still quite high (despite low coupons), rising to US$610mn in 2024, US$904mn in 2025 and US$1bn in 2026.
Financing challenges remain
However, even with this fiscal improvement, financing needs are large amid limited financing options and liquidity challenges remain. The IMF projected Gross Financing Needs (consolidated NFPS basis) at 3.4% of GDP this year and 3.2% next year, down from 4.4% in 2022, before rising to 4.3% in 2025 (although the lower-than-expected fiscal surplus last year would, other things equal, have increased last year's GFN by the same amount, ie c1ppts to 5.4%). If we scale down the IMF's 2023 projected fiscal surplus by the same amount, that would leave a GFN of 4.2% of GDP (about US$5.2bn).
GFN comprises amortisation and arrears estimated at 5.0% of GDP on IMF figures in 2023 (cUS$6bn), albeit down from 5.4% (US$6.3bn) in 2022. This rises to 5.2% (US$6.5bn) in 2024.
Meanwhile, Moody’s estimate central government financing needs of 6.5% of GDP this year, little changed from 6.6% in 2022, but rising to 7.2% in 2024 and 8.4% in 2025, and Fitch estimate a GFN this year of US$10.6bn (c8.8% of GDP) with identified financing estimated at US$9.4bn and a financing gap of US$1.2bn.
Double digit yields, which seems unlikely to change soon, would seem to rule out borrowing on the international capital market, forcing the government to remain reliant on domestic financing and multilaterals (although MDBs' lending appetite is unclear).
We think an IMF programme would be a positive catalyst for the bonds, but we're not sure a programme is likely at this stage. It is not clear to us that a new IMF programme, as some might hope, would be possible in the current political context, either because of the difficulty in getting broader political support for it, or because of subsequent implementation risks, not to mention the IMF's existing exposure (despite of course, the government exiting the last programme, which it inherited, successfully). The recent programme, if it is any guide, was for an amount of US$6.5bn (661% of quota) and involved an immediate disbursement of US$2bn – that would go a long way to covering this year's financing needs! Moreover, the recent IMF approval of more generous access limits, albeit on a temporary basis (increasing by 40% the annual limit to 200% of quota and the cumulative limit to 600% of quota), would make it easier for the Fund – if it wanted to – to provide a bigger programme without requiring the additional oversight needed under exceptional access criteria.
Investment conclusion
We maintain our Hold on Ecuador (Caa3/B-/B-), rather than Sell, given the extent of the price falls so far, with a price US$53.0 (yield of 22.9%) for the ECUA 5.5% 2030s as of cob 9 March on Bloomberg (mid-price basis). We downgraded to Hold from Buy in June 2022, at a price of US$70.2, as the protests hit the country, although the bonds subsequently fell in H2 in the wider market sell-off (falling to a low of US$44.2 in October), before recovering in the year-end rally (rising back to the low 70s in January). However, the bonds fell 15pts after the referendum and drifted lower, to US$47, but have stabilised in the low 50s over the last few days.
The ‘30s have seen a total return of -19% since our downgrade to Hold on 27 June 2022 compared to +2.3% on the Bloomberg EM Sovereign USD index (through to 9 March 2023); although by the time of the referendum, the bonds had matched the index. The bonds have underperformed by some 20ppts since then.
Ecuador bonds have fallen on concerns that President Lasso may not be able to finish his term (and what comes next would be less market friendly) or, even if he does finish his term (due to end in 2025), governability will become more challenging with negative implications for policy making, particularly for the maintenance of fiscal discipline and financing prospects.
That said, bond prices (for the '30s) in the low 50s are close to their post-issuance lows (hitting US$47 on 1 March, not far off their low of US$44 in October 2022, when the state of the world economy seemed much worse and fears over the global rate cycle was at its peak) and already discount a lot of the bad news, while we see little risk of a re-restructuring under Lasso. Assuming 40 in default (the magic recovery level), there therefore seems limited downside from current levels (and currently with debt/GDP<60%, one might think recovery prospects should be a bit better than that).
To that end, the bonds may offer an attractive running yield of 10% on the 2030s, with a coupon of 5.5% (and shortly due to step up again) and at a price of US$53, although El Salvador ‘29s and ‘32s with a running yield of 16% may be more appealing in that regard.
Indeed, the ‘30s have edged up 6pts over the last week, and were up 1.5pts yesterday to US$53 amid market chatter that the impeachment process has stalled.
But even if Lasso is able to survive current moves to impeach him (and, if the opposition go ahead with it, it is dependent on the constitutional court rejecting a vote, as we think he is likely to lose a vote if it is held, although when push comes to shove, the political wind could change) – and if he does survive, that could open up the possibility of an IMF programme later on – it may only provide temporary respite for the bonds as we think opposition pressure and political confrontation will continue, probably for the remainder of his term. This may mean the best hope for the bonds will be a wider market rally, and EM inflows leading to indiscriminate ETF buying.