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Fitch Ratings: Ecuador's Elections Pose Risks Following Progress Made in 2020

· 02/05/2021 11:14
Fitch Ratings: Ecuador's Elections Pose Risks Following Progress Made in 2020

(The following statement was released by the rating agency)

Fitch Ratings-New York/London-05 February 2021: Ecuador's economic recovery and progress under its IMF program face considerable uncertainty from Sunday's elections, with risks in any outcome, Fitch Ratings says. Further improvement may depend on whether the elections deliver a popular mandate and legislative support for reforms and fiscal adjustment as these become much more challenging. Presidential and legislative elections come five months after Ecuador completed a sovereign debt restructuring and the IMF approved a US6.5 billion, 27-month Extended Fund Facility (EFF). Ecuador had a particularly large shock in 2020 from the oil price slump coupled with the rupture of a major pipeline, an early and severe coronavirus outbreak, and a government liquidity squeeze. Yet the economic contraction was less extreme than we expected mid-year, partly due to a 10% rise in non-oil exports led by mining, and banks' ability to offer some relief to households, which the government could not provide. We now estimate that real GDP fell 7.5% last year, in line with the regional median. The outgoing government of Lenin Moreno made some important progress, improving labor-market flexibility, rationalizing fuel subsidies, and signing phase one of a trade deal with the US. The restructuring cleared most bond debt service through 2026. Wide ideological differences between the candidates to succeed Moreno make the election critical to the adjustment envisaged under the IMF program. Front-runners include Andres Arauz of the left-leaning Union for Hope coalition, Guillermo Lasso of the centre-right Creating Opportunities (CREO), and Yaku Perez of the indigenous Pachakutik Party. Lasso broadly supports the EFF and pledges to liberalize the economy, while Arauz and Perez vocally oppose the EFF, austerity, and liberalization. Fitch expects large political challenges to reforms and fiscal consolidation to remain in any outcome. Whoever wins the presidency may face a fragmented legislature or social resistance to unpopular measures, both of which hampered reform under President Moreno. Furthermore, EFF conditionality will become much tougher as disbursements tail off, which could reduce incentives for compliance. USD4 billion was disbursed in 2020 and USD400 million could follow in April before the new government takes office, leaving it with just USD2.1 billion in late-2021-2022. The 5.5pp-of-GDP fiscal adjustment required under the EFF by 2025, around half from spending cuts and half from tax reform, will be particularly challenging. Even under Lasso, fiscal adjustment prospects could be unclear. He has long championed tax cuts and has ruled out increasing VAT, clouding prospects for tax reform required under the EFF. His plan to cut the deficit by boosting oil production and economic activity could take time and is less certain to succeed. He has promised labor reforms to create jobs but recently pledged to raise the minimum wage to USD500/month, which runs counter to the EFF aim of improving competitiveness. Such pledges could be an inauspicious sign regarding Lasso's mandate to enact the unpopular measures the EFF requires, if he is elected. Should a leftist candidate win, financing constraints and dollarization might not restrain fiscal populism. Arauz has proposed "creative monetary policy" to allow the central bank to finance the government. While money creation is possible even under dollarization, it implies growth in the local stock of dollars without growth in international reserves needed to ensure these can be used abroad, undermining financial stability and dollarization itself. To counter such risks, Arauz proposes raising the capital outflow tax to 27% from 7%, but this could undermine prospects for FDI and the economic growth essential for debt sustainability. Fitch upgraded Ecuador to 'B-'/Stable from 'RD' in September following the sovereign bond restructuring, balancing an improved repayment schedule and policy progress with persisting liquidity and debt sustainability challenges and acute political risk posed by the elections. Contact: Todd Martinez Director, Sovereigns +1 212 908 0897 Fitch Ratings, Inc. Hearst Tower 300 West 57th Street New York, NY 10014 Mark Brown Senior Director, Fitch Wire +44 20 3530 1588

Media Relations: Jaqueline Carvalho, Rio de Janeiro, Tel: +55 21 4503 2623, Email: jaqueline.carvalho@thefitchgroup.com
Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@thefitchgroup.com

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.


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