Ecuador did a pretty bold thing this week, to put it mildly.
April 20 (Bloomberg) — President Rafael Correa offered to repay holders of Ecuador’s defaulted bonds as little as 30 cents on the dollar as the country’s foreign reserves plunge amid slumping oil prices.
Those are the 2012 and 2030 bonds the Latin American country defaulted on in late 2008, hence why they’re trading so cheaply now.
There appears to have been little actual need for Ecuador to default. The country’s economy was still growing in 2008, it was current on all its other debt and the bonds in question amounted to no more than a few billion dollars.
Instead the default had more to do with Ecuadorian President Rafael Correa’s unorthodox view of debt in general — a mixture of philosophical hubris (see for instance, the reference to Suma Kwasay, or a “life in harmony with nature”, contained in the circular sent to bondholders) and claims that the debt was illegal.
In fact Correa was voted into office on an outspoken anti-debt platform and, as president, set up an audit commission to study the legitimacy of the country’s debt. The not very surprising result of that study (in Spanish) is here.
Investors are now left with significant losses on the “illegal” bonds. Interesting then, that one of the few recourses open to them is a formal legal challenge, Argentina-style. This from RBS Securities’ Latin American debt strategist Siobhan Morden:
What are the options for the current bondholders?
1.) Opt for litigation for upside price risk for those select hedge funds that have the option for legal recourse, 2.) Await for another offer which could imply significant downside price risk for the rapid deterioration in the fiscal and external accounts that suggest a worsening inability to pay, or 3.) Assume that the secondary market bid will still exist at the minimum clearing price that will allow bondholders to exit at a later date to wait and assess the options.
So the results would either reflect around a 30% participation rate to recognize those bonds already bought back or the results could be much higher above 90% to reflect the exodus of current bondholders to cash out of their long positions (litigation too long and expensive process while the current offer could reflect the best option under the growing inability to pay). Whether or not the government dedicates the scarce resources towards the exchange could either reflect the political ambitions of trying to redefine the financial infrastructure of debt legitimacy or the economic ambitions of trying to access multilateral funds (IMF credit facility) on the attempt to cure the event of default. This latter objective does not seem realistic, therefore failing to reverse the current erosion in local investor sentiment and deterioration in the fiscal and external accounts. Even on the best case scenario of a high participation rate above 90%, this would not likely provide a positive shock to investor sentiment to either encourage access to more official financing or reverse the capital flight but rather only deplete already scarce reserves and fiscal funds that would worsen the near-term ability to pay on the “legitimate” outstanding 2015 bonds. This bond invitation is only an extension of the current strategy, which doesn’t imply an exit from the distressed conditions but rather only exasperates [sic] the future inability to pay.
Of course exacerbating “the future inability to pay” is only a concern if you are actually planning to pay.
Given Correa’s rather libertarian views on the nature of debt, we’re not sure he recognises that as a problem.
Related links:
Ecuador’s chutzpah-filled exchange offer - Felix Salmon
Ecuador has funds for debt-buyback, president says - Reuters
Margaret Atwood discusses her new book ‘Payback’ - YouTube
