IKN

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Ecuador Bonds: The Eurasia Group’s take on things

Below the XXXs, find the Eurasia Group’s take on the Ecuador bonds saga as written yesterday morning. For those of you unaware, Eurasia is an analyst group that covers the region very well.
FWIW I often find myself disagreeing with Eurasia’s Patrick Esteruela’s take on things, but it’s questions of degrees and not the basic philosophy. He’s very VERY good at his job (and as regular readers might have worked out by now, I’m as cynical as they come on regional coverage but Esteruelas is as good as it gets in the English language). He also had this quote in the London FT tonight…..

Mr Correa was playing “a giant game of chicken” with bondholders, said Patrick Esteruelas, Latin America analyst at Eurasia Group. “Correa clearly feels that this is the right time to extract savings in a potential restructuring negotiation before oil prices continue to decline and before emerging market sentiment recovers. And his only way of doing that is if he credibly threatens default,” he said.

……and i think that nails the scene very well. Certainly a damned sight more perceptive than the annoyingly arrogant Alberto Ramos of Goldman Sachs who is quoted by Bloomie as saying;

“The report is so exaggerated that it weakens their claims,” said Alberto Ramos, an economist with Goldman Sachs Group Inc. in New York. “This is about ideology and dogma and retribution……Their case for restructuring is non-existent,” Ramos said. The country’s “debt load is low.”

RAMOS……….JUST………..DOESN’T…………GET…………..IT.

Back to the Eurasia Group note pasted below: Today I listened to a recording of the Debt Commission Veep Canelos interview on Radio Quito mentioned in the text below and I think Esteruelas is cherrypicking his comments (that’s being diplomatic). Canelos was much more conciliatory than he makes out, and both Canelos and Debt Commission chief Patiño are willing, nay keen, to get the bond holders to the table. My main problem with the whole Eurasia take on things is that Esteruelas thinks Correa has left himself no wiggle room. That’s crap. So far it’s been straight out of the Studmuffin successful playbook, and his deal with Carlos Slim shows he’s perfectly willing to do smoke-filled room type deals and give way in negotiations in order to get to the idyllic win-win.

Finally, this afternoon The Muffin talked about setting up an international tribunal to investigate the illegality of the bonds. You can bet your sweet bippy that if such a body is set up, a prerequisite from the international community (and the IMF won’t be invited to this party) is that the debt servicing continues while the commission sits. And you can bet that Correa will concede this point for the good of….of whatever.

So here’s the Eurasia note. Enjoy. By the way, I think he’s spot on with the Venezuela angle.

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ECUADOR: Debt audit announcement will heighten risks of default
19 November 2008 08:49 AM EST

The government-tasked debt audit commission (CAIC) will present and comment on the full results of a year-long audit of Ecuador’s external debt on Thursday, 20 November – heightening market fears of a potential external debt default. The commission’s report, which has been in President Rafael Correa’s hands since September and which we include a copy of here, identifies multiple irregularities in debt contracted between 1976 and 2006 and recommends the suspension of payments on all three global bonds, at least 45 multilateral loans and the Paris Club debt. The government will likely use these findings to enter into talks with bondholders over restructuring terms, driving a very hard bargain that will hamstring any negotiations and could likely lead the government to default. Contrary to recent market speculation, we believe Venezuela will not play a moderating influence.

The debt audit commission (CAIC) will present the full results of a year-long audit of Ecuador’s external debt on Thursday, 20 November, at 10.30am (EST). President Correa will also be in attendance and will offer comments, according to our local sources. Correa’s government decided not to meet its $30 million coupon payment on Ecuador’s Global 2012 bonds last Friday and to use its 30-day grace period to examine the final audit results and decide the government’s future course of action. The commission’s report, which has been in Correa’s hands since September and which we include a copy of here, identifies multiple irregularities in debt contracted between 1976 and 2006 such as double payments, abusive clauses, false justifications and negligence on the part of high-level government officials and multilateral institutions. The commission’s report recommends the suspension of payments on all three global bonds, at least 45 multilateral loans and the Paris Club debt. It remains unclear how much of this will be made public on Thursday. While legally questionable, the report appears to give Correa ample domestic cover to suspend payments. Ecuador’s public external debt stood at $10 billion in September or 21% of GDP, of which Ecuador’s external bonded debt represents an estimated $3.86 billion.

The government will likely use these findings to enter into talks with bondholders over restructuring terms, entering a slippery slope that could ultimately lead the government to default. Correa’s government, which has always had a questionable willingness to pay, has in our view stepped up its threats to default out of concern with falling oil prices and in a bid to take advantage of depressed market conditions before Ecuador’s fiscal and perceived bargaining position continues to deteriorate (see Eurasia Group Note 14 November 2008). Supporting this view, government officials such as Minister of Economic Policy Pedro Paez and Finance Minister Maria Elsa Viteri have refused to rule out a default in recent days and played down its market implications while at the same indicating that this would be a good time to seek talks with the government to restructure Ecuador’s debt.

However, this strategy will have many pitfalls and will likely end up in failure. On the one hand, the government has proven to be a very aggressive negotiator in its dealings with private companies over the last two years, and will likely look to extract substantial savings. In what could be a sign of things to come, CAIC Vice-President Franklin Canelos indicated in an interview yesterday in Radio Quito that he would like to see the government seek a haircut of 85% from bondholders. On the other hand, bondholders are unlikely to make major concessions to a country that has sufficient funds to pay and whose annual debt servicing obligations on its bonds are under $400 million. Bondholders are for the most part minimally exposed to Ecuador, are in some cases legally barred from voluntarily accepting a lower value and have hedged their positions with credit default swaps (CDS). They will also be reluctant to allow Ecuador to set a poor precedent that could embolden other countries with much heftier external debt burdens to strong arm the market into a restructuring of terms. The government could therefore end up fulfilling its threat to default by the end of the 30-day grace period or at a later stage if, as it seems likely, the government fails to persuade bondholders to accept its terms. The government has not given itself much wiggle room to continue making payments under current terms after making the results of the audit public in such a dramatic fashion, and with strong political backing, a fiscal surplus and ample liquid assets at this point, clearly underestimates the costs of a potential default.

Contrary to recent market speculation, we believe Venezuela will not play a moderating influence. Some investors are betting Correa will pay because a default would hurt his ally, Venezuelan President Hugo Chavez. Venezuela owns structured notes tied to Ecuadorian CDS that would force Chavez’s government to pay if Correa defaults on Ecuador’s global bonds. The Venezuelan government, which had accumulated substantial Ecuadorian CDS positions in excess of $5 billion by early 2007, played a major role in persuading President Correa not to default on Ecuador’s bonds right after he assumed the presidency in February 2007. However, the Venezuelan government has since dramatically pared back its exposure to Ecuadorian CDS. Venezuela’s national development fund (FONDEN) currently has less than $400 million in structured notes after writing off $300 million in notes underwritten by Lehman Brothers. Given that the Venezuelan government has been quick to unload any notes tied to Ecuadorian CDS first after last year’s scare, its real exposure in the event of a default could end up being quite small. Far from holding Correa back, Chavez has been reportedly in talks with Ecuador to provide financing if need be as other sources dry up and would likely support Correa’s quest to question and undermine foreign bondholders and international financial institutions.

Patrick Esteruelas
Analyst, Latin America

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