April 21 (Bloomberg) -- Ecuador's President Alfredo Palacio replaced about half the cabinet amid concern his day-old government may boost spending and put at risk the nation's ability to pay debts. Bonds tumbled for a second day.

Rafael Correa Delgado, an economist who today criticized the nation's decision in 2000 to adopt the U.S. dollar, was named finance minister. Correa Delgado also has spoken out against the nation's commitment to a fiscal responsibility law and terms of a government oil fund, most of which is earmarked to pay debts, said Lisa Schineller, a Standard and Poor's analyst in New York.

``There is uncertainty, given the difficult political climate, that there may be pressures for increased spending,'' Schineller said in an interview after S&P said it may lower Ecuador's credit rating. ``We are also uncertain about the new president's commitment on the spending side. In the past, he has signaled changes that would imply higher spending.''

Ecuador's bond due in 2012 slumped after Correa Delgado was named today in a televised ceremony at the presidential palace in Quito. The bond dropped 2.25 cents on the dollar to 94.25 cents, the lowest level since August, according to JPMorgan Chase & Co. at 5:46 p.m. in New York. That lifted the yield to 13.2 percent.

The extra yield investors demand to hold the bond instead of a similar maturity U.S. Treasury climbed to 9 percentage points, up from 8.7 percentage points yesterday.

S&P said it may lower Ecuador's B- credit rating after yesterday's ouster of President Lucio Gutierrez. The government could have difficulty making a $75 million interest payment in May and rolling over domestic debt, S&P said.

`Not Responsible'

``Palacio is not the type of politically and fiscally responsible guy that Gutierrez was,'' said Jaime Valdivia, who manages $230 million of emerging market assets at Emerging Sovereign Group in New York and has been selling Ecuador bonds in recent weeks. ``We are afraid of the forthcoming pressures he will face to stay in power.''

Ecuador, which defaulted on some of its debts in 1999, has a Caa1 rating from Moody's Investors Service, the same level as Argentina. Ecuador, South America's fifth-largest oil producer, has about $16.6 billion of debt.

Correa Delgado, a U.S.-trained economics professor who teaches at Universidad San Francisco de Quito, said today the government would maintain the U.S. dollar as the nation's currency and may concern ``in the long term'' a plan to scrap it to create a new local currency, Efe newswire reported.

Correa Delgado said at a press conference in Quito that setting up the currency system in 2000 was ``the biggest error'' in the country's economic policy, though he's reluctant to change it, Efe said.

`Suicidal'

``Nobody is suicidal,'' he said, according to Efe. Ecuador's central bank President Angel Cordova called on the government in an interview today to respect the bank's autonomy.

``We hope that the independence of the central bank will be respected,'' Cordova said in an interview from Quito.

Palacio may not last and any new government faces pressure to increase spending and sacrifice Gutierrez's budget restraints, S&P said in a statement. The New York-based credit rating agency said it took its decision because of the country's ``highly volatile social and political environment.''

Ecuador's Congress yesterday ousted Gutierrez, who during two years in office helped spur the fastest economic growth in a decade and restrain spending. Palacio, Gutierrez's vice president, said in an interview with CNN en Espanol last night he would keep paying the nation's debts while investing more in education, health and the oil industry.

Palacio also said he would favor renegotiating terms of how to spend money in an oil stabilization fund, 70 percent of which is set aside to make debt payments.

Bonds

``Prices of bonds are going to keep falling,'' said Boris Segura, who helps manage $400 million of emerging market bonds at Standish Mellon Asset Management in Boston, adding he has reduced his Ecuador holdings in recent weeks. ``The uncertainty over who will be the next president and what type of policies he will implement are enormous. Today it's the vice president, but nobody knows who will be in power the day after.''

Segura said he is also concerned Ecuadoreans will pull money from the banking system, which could cause the economy to ``melt'' because of the government's adoption of the U.S. dollar as its currency. S&P's Schineller said a run on bank deposits ``is a risk, it's important to watch.''

Social Security

Palacio yesterday pledged to overhaul the country's social security system and settle wage demands by state doctors, in remarks from a press conference in Quito broadcast live on Canal Uno. He promised to call new elections as soon as possible, which U.S. Secretary of State Condoleezza Rice endorsed in comments today in an interview with Fox News in Vilnius, Lithuania.

Gutierrez, 48, was replaced amid allegations he stacked the Supreme Court with allies and helped clear an ex-president of corruption charges. Gutierrez, who won election with the backing of indigenous groups and unions, failed to secure congressional support for bills needed to renew an International Monetary Fund loan agreement and came under attack for abandoning campaign promises, such as a pledge to reduce unemployment.

``It's not like anybody was expecting any progress on economic reforms with Gutierrez in office, so it's hard to say whether the impact is going to be very significant,'' said George Estes, who helps manage about $3.5 billion in emerging-market bonds at Grantham Mayo Van Otterloo Co. in Boston.

Palacio, a 66-year-old cardiologist and former health minister, on April 19 criticized Gutierrez's economic policy.

Palacio said that day it is ``immoral'' that the country uses about 40 percent of its budget to service its debt and asked Gutierrez for a change in managing the economy.

`Profound Changes'

``I demand profound changes and the fulfillment of the promises we made in the electoral campaign,'' Palacio told journalists in Quito.

The economy grew 6.6 percent last year, the fastest since at least 1993, while the government posted a budget surplus excluding debt payments of 2 percent of gross domestic product, compared with 1.7 percent of GDP in 2003, according to government data.

Oil is the Andean country's largest export and second- largest source of government revenue after taxes. Gutierrez resisted pressure by former allies to increase spending in Ecuador's non-oil economy, said economists such as Bear Stearns & Co.'s economist Jose Cerritelli.

As growth accelerated, the president failed to draw more support from Indians and other residents who say his budget deficit-cutting programs have done little to ease poverty in the country of about 12 million people, said analysts such as Eduardo Gamarra, a political science professor at Florida International University in Miami. Gutierrez also failed to garner support to open the oil industry to foreign investment.

Palacio ``will tend to say what Ecuadoreans want to hear more than anything markets would love to hear, so I don't expect any reassurance of economic policies,'' said Javier Kulesz, director of Latin American debt research at UBS Securities LLC in Stamford, Connecticut. ``We wonder whether Palacio will continue the path of sound economic policies of his predecessor.''

To contact the reporter on this story: Guillermo Parra-Bernal in Sao Paulo at at gparra@bloomberg.net

Last Updated: April 21, 2005 17:48 EDT