Friday, December 12, 2008

Ecuador maintains bond default threat

(FT) Rafael Correa, Ecuador’s combative leftwing president, is keeping financial markets guessing about whether he will make an interest payment due on Monday on an international bond issue his administration claims is illegitimate.

Regardless of whether Mr Correa makes the payment, many observers say the global financial crisis, a sharp fall in oil prices and remittances from abroad, together with a costly programme of social spending make the odds of Ecuador eventually defaulting greater by the day.

”We feel that the government has entered a slippery slope that will ultimately lead to default, as low oil prices take a toll on revenues and risks over Ecuador’s willingness to pay are compounded by liquidity shortfalls,” said Patrick Esteruelas, Latin America analyst for New York-based Eurasia Group.

Participants in the market for credit default swaps, which provide a form of insurance against non-payments of debt, consider a default highly likely: it costs £4.2m to insure £10m of Ecuador’s bonds against default over the next five years .

But bond prices jumped sharply yesterday after a Quito newspaper reported that the government appeared to have quietly bought back bonds with a face value of $680m in recent months.

A 30-day grace period to pay $30.6m in interest on the 2012 bond issue runs out on Monday, when another $30.9m interest payment falls due on a 2015 bond.

While Ecuador has the funds to make the payments, Mr Correa has denounced these issues and another maturing in 2030 – $3.8bn in total – as ”illegitimate”. Mr Correa claims they were improperly authorised by previous administrations and involved onerous interest rates, commissions and pre-payments.

Mr Correa has engaged US law firm Foley & Hoag to sue bondholders to Manhattan’s district court and flagged up an appeal to a forum such as the International Court of Justice at the Hague. ”We are not going to jump into the void. We’ve got to be responsible. We will seek all mechanisms to repudiate the debt, which is absolutely illegitimate and corrupt,” he said.

Meanwhile the president, a US-trained economist, is likely to find it increasingly difficult to pay, even if he wanted to. The collapse in oil prices has already driven the Opec nation to its first trade deficit in 15 months and remittances, which accounted for 7 per cent of gross domestic product last year, have slumped.

Mr Correa is also hamstrung by a dollarised economy. Ecuador abandoned the sucre for the dollar in 2000, after the collapse of its banking sector, leaving the government unable to run an independent monetary policy.

Mark Weisbrot, co-director of the Center for Economic and Policy Research, a left leaning Washington think tank, said Mr Correa may believe the costs of default are acceptable, given that Ecuador’s access to credit has already been strained by its frosty relations with international bodies such as the World Bank, fractious dealings with foreign investors and a recent suit against Brazil over a loan it says was contracted illegally.

”The consequences [of default] are not always as great as one might think,” he said. ”In Ecuador’s case they can’t really borrow on international markets anyway so they’re in a strong economic position to renegotiate with their creditors.”

But Ramiro Crespo, of Quito-based Analytica Securities, said Ecuador was engaging in dangerous game of brinkmanship that could leave it isolated.

”It is very difficult to try to look for rationality in perhaps an irrational situation,” he said. ”In a sense this is very ideological. They [Mr Correa’s administration] don’t like markets. They don’t like Wall Street. They don’t like most of the international organisations, especially the World Bank and the [International Monetary Fund]. But instead of being pragmatic about it and using them according to their needs they have taken an ideological approach.”

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