Saturday, 13 December 2008

Ecuador Defaults! So ... What's Next?


Ecuador declared a moratorium on Dec. 12 and it is likely that this obeys to a perception that it would force bondholders to accept a restructuring. This will certainly give other countries with similar political orientation in South America to follow suit (let's remember that in recent days President Chavez of Venezuela urged allies to audit their foreign debt contracts and declare many of them illegal if possible.) 

I believe that the recent news about the Ecuadorean debt buybacks in the secondary market suggest that President Correa is playing hardball to influence a restructuring ``a la Argentina.'' Success of this initiative is, though, limited: investors learned from the lesson that the softer they play, the tougher their suffering will be.

The consequences of this decision will be the impossibility by the Ecuadorean government and companies to obtain more funding and the prospect that even multilateral institutions begin to curtail aid to the so-called Bolivarian bloc of countries, citing their likely unwillingness to pay. The social impact of this is unquestionable. The decision, thus, will have pan-regional consequences in the long run, detrimental to countries that are even in a different political direction that Ecuador. The case of Brazil's BNDES loan to Ecuador is a clear sign that the noise created by President Correa's decision will probably lead the Brazilians to pare investment projects in South American countries funded with Brazilian taxpayers' money. 

One other thing that is important to look into is the damage that the Ecuadorean default will create to Venezuela. For years, the Venezuelans created structured notes pegged to the price of Argentina, Ecuador and Bolivia debt that were purchased by Venezuelan banks. The losses stemming from a default by Ecuador on Venezuela's sovereign wealth fund (Fonden) as well as banks should be enormous. We will need to see the reaction by Caracas.