Best Emerging Market Debt Lifted by Oil as Correa Tightens Grip on Ecuador
Ecuador is benefiting from the highest oil prices in two years as the surge in export revenue helps fund President Rafael Correa’s $4.69 billion infrastructure program and rewards bondholders with the highest returns in emerging markets.
Yields on Ecuador’s only international bond have declined to the lowest level since Correa’s $3.2 billion debt default two years ago as the rally in crude, the nation’s biggest export, eases concern that a doubling in public outlays in the past four years is unsustainable. Ecuador’s 9.375 percent bonds due in 2015 gained 7.1 percent this year to 98.5 cents on the dollar, reducing the yield by 1.77 percentage point to 9.77 percent.
Correa is forecasting growth of as much as 5.1 percent this year after the South American economy expanded 4.3 percent in the third quarter, the fastest pace since 2008. While demand for the country’s debt is growing, the rally is dependent on oil holding near $100 a barrel, said Lutz Roehmeyer, who helps manage about $14 billion at Landesbank Berlin Investments.
“Ecuador’s a troubled country, but with oil above $100 a barrel it’s worth the risk,” said Roehmeyer, who also holds half a million dollars of Ecuador’s 2015 bonds. “We are still very hesitant to invest more in the country though given Correa’s turbulent political ways.”
Ecuador’s dollar debt returned 8.7 percent this year through March 1, the best performer among developing nations tracked in JPMorgan Chase & Co.’s EMBI - Global Diversified index. Emerging-market bonds on average slumped 0.3 percent.
The extra yield investors demand to hold Ecuadorean dollar bonds instead of U.S. Treasuries has fallen 152 basis points this year to 761, according to JPMorgan. The government’s credit rating was raised one level to Caa2 on Feb. 1 by Moody’s Investors Service, which cited prospects that the government will close its budget deficit and increase output of crude oil. The rating, which is eight steps above default, is the lowest among all country rankings tracked by Moody’s.
Ecuadorean oil, which usually trades at a discount to benchmark West Texas Crude, provides the government with 24 percent of its revenue. WTI is forecast to reach $95.40 in the fourth quarter of 2011, according to the weighted average of 28 analysts surveyed by Bloomberg.
Correa, a 47-year-old former economics professor and ally of Venezuelan President Hugo Chavez, took office in 2007 promising to reduce poverty in a nation where the United Nations estimates about 40 percent of people can’t meet basic needs. As part of that effort, he halted payments on bonds that he called “illegitimate,” renegotiated oil contracts with oil companies, including Spain’s Respol YPF SA and Italy’s Eni SpA (ENI), to give the government better terms and halted mining exploration for almost two years.
The default reduced Ecuador’s debt burden to 20 percent of gross domestic product in 2009 from 26 percent a year earlier, according to data compiled by Bloomberg. The debt-to-GDP ratio will reach 28 percent this year, according to a December report by the Quito-based Fiscal Policy Observatory. That compares with Brazil’s net debt of 40 percent.
Ecuador’s 2011 budget deficit, estimated at $3.7 billion in this year’s budget, will narrow to $1.2 billion by the end of the year, Alejandro Arreaza, an economist at Barclays Capital in New York, said in a phone interview. Ecuador’s 2010 deficit was probably $1.5 billion, he said.
A 121 percent rise in government spending to 39 percent of GDP since 2006, or about double that of neighboring Peru, is also tempering investments in Ecuador, said John Ditieri, who helps manage emerging-market equities at Arlington, Virginia- based Emerging Markets Management.
“I’m not convinced the spending is good. What happens if peace settles in the Middle East and oil goes back down to $70 a barrel,” Ditieri said.
Correa’s push for control of the economy since taking office is hurting business confidence and hindering investment that could help boost economic growth, said Mauricio Yepez, a former economy minister who’s now the regional vice president for the northern region at Banco de Guayaquil SA.
“There have been too many changes in the regulatory framework, and that has hurt confidence,” Yepez said in a telephone interview. “There’s a lack of private investment.”
In a constitutional referendum scheduled for May 7, Correa’s third, he proposes stripping the judiciary of its independence for 18 months to improve crime fighting while banning financial and media companies from owning companies outside their industry to limit potential conflicts of interest.
The gains in oil, brought on by unrest in the Middle East, position Ecuador, OPEC’s smallest member, to shore up finances and provide funds to invest in the nation’s infrastructure, Barclay’s Arreaza said. Ecuador pumps about 486,000 barrels a day, about 60 percent of neighboring Colombia’s output.
“It’s an oil price story,” Arreaza said. “We’re seeing oil prices above $100 a barrel, and that’s basically what’s going to change the country.”
Correa said in an Oct. 21 interview with Bloomberg Television he’s considering a debt sale in international markets, in what would be its first since 2005, to finance infrastructure projects. Those statements signaled to investors that the government is unlikely to default again, helping spark gains in the bonds due in 2015, said Diego Lavalle, chief executive officer of brokerage Mercapital Casa de Valores SA.
“The government will honor its debts internally and externally because they have now learned how painful it can be to be out of international markets,” Lavalle said in an interview from his offices Quito.
Investors would demand yields of as high as 15 percent interest, said Roehmeyer. There may be demand for a five-year bond backed by an asset such as oil revenue, he said.
Ecuador, which has received $3 billion in loans from China since 2009, is also relying on regional multilateral lenders Corp. Andina de Fomento, known as CAF, and the Inter-American Development Bank to help cover the budget deficit, Barclay’s Arreaza said.
PetroChina Co., China’s largest oil producer, renewed a contract to provide Ecuador with a $1 billion, 7.1 percent loan in exchange for future crude sales, Finance Minister Patricio Rivera said Feb. 22 in a statement. Caracas-based CAF will lend the nation $2.2 billion over the next three years, bank President Enrique Garcia said Feb. 23.
‘Winds of Change’
Correa has boosted infrastructure spending on highways, airports, and the nation’s energy grids to 8.7 percent of GDP from 3.2 percent in 2006 in an attempt to spur productivity, according to a government statement. Ecuador will invest $4.7 billion in public works this year on items including the construction of a $1.68 billion, 1,500-megawatt dam in the country’s Amazon region, according to the Finance Ministry.
“There have been winds of change and that always brings fear at the beginning," Santiago Peralta, founder of Pacari Chocolates, said today when asked about the changes brought by Correa. "Socialism was the bogeyman and now he’s gone. But there’s still a lot to be done.”
A reduction in corporate tax rates and the passage of new mining regulations may also boost investment in the Andean country and diversify revenue, Thierry Benoit, a managing partner at Humboldt Management, said in a Feb. 24 interview in his offices in Quito. After a crackdown on tax evasion, Correa raised tax revenue 72 percent since 2006, easing pressure on state finances and allowing the government to boost salaries for public workers and increasing assistance to the poor, he said.
Investors are waiting on signs from the government before deciding to increase their risk, Ditieri said.
“It’s an interesting story and has potential if things are managed right,” said Ditieri. “It could go one way, like Colombia, or another, like Venezuela. Who knows, the jury is still out.”
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