Default and oil expropriations have cost Ecuador billions of dollars in lost foreign direct investments the past few years.
BY ALBERTO BERNAL
We have not written about Ecuador in a while, following the sovereign decision taken by the Correa administration to detach itself from international markets on ideological grounds. That said, we think that some comments are warranted following the quasi “market-friendly overtures” that came out of Quito at a Bloomberg-organized event a few days ago. Basically, President Correa conceded that his country needed to boost the level of domestic and foreign investment in case it wanted to grow faster. The president made the caveat of arguing that the country wanted to see “responsible investments” from capitalists. The president argued that under his tenure his country had achieved “stability.”
The president, being who he is, still continued to deliver blows to the markets, reminding investors about “obligated debt buybacks, high interest and coupon rates, long neo-liberal nightmares, etc, etc, etc”. Still, we think that the acceptance of President Correa to speak at a Bloomberg event hints that his administration may be opening the window to issue a new external bond, and perhaps even become more amicable with markets.
The legal capacity to follow such strategy may not be that straightforward, however, because investor endorsement of the 2009 bond-buyback was not unanimous (some 10 percent of holders decided to hold-on to the defaulted paper). In other words, attachment risks will probably remain an important question mark in the investment decision of future investors. In any case, based on relative value calculations, if a new bond does in the end make it to the markets, an 11-11.5 percent guidance for an eventual new Ecuador 10-year sounds more or less logical. Now, would we buy this bond, in case it were to be issued at some point in the future? Not really. Despite material supply risk, we think that a PDVSA 2017,
Clearly, we consider that the economic policies that this government and the prior one implemented have been extremely inefficient ones. The figures are very clear. Foreign investment has collapsed since the prior government decided to take over an Occidental Petroleum oil field (Bloque 15) and after this government decided to renege on external debt payments arguing “illegality” of the debt. As we have argued in prior research pieces, we think that the decision by the Ecuadorian government to treat investors with disdain has cost this country a great deal (in terms of foregone growth). According to the official data published by the CEPAL, foreign direct investment in Ecuador collapsed ex-post 2006, following the expropriation of the famous “Bloque 15” and the subsequent decision to default on the debt following artful judicial arguments trying to support a supposed illegality of the existing debt. Keep in mind that the judicial review used to default on the debt was never presented in international courts, most likely because the case had absolutely no judicial merit.
In any case, how much did the decision to take over Occidental’s oil field and not pay the debt cost Ecuador as a nation? Here is our estimation: according to the official data included in the CEPAL website (www.cepal.org), Ecuador’s annual average foreign direct investment flow went from $1,2 billion per year from 2000-2005 (2.9 percent of GDP), to an average of $363 million from 2006-2011, or 0.6 percent of GDP (2010 and 2011, our forecasts). In other words, following the anti-market rhetoric of the Correa administration and the Palacio administration, the flow of foreign direct investment fell by a nominal 67 percent per year. In comparison, a peer mining country like Peru saw foreign direct investment go from an average of $1.58 billion (2 percent of GDP) between 2000-2005 to an average of $5.52 billion (4.7 percent of GDP) between 2006-2011 (2010 and 2011 FDI numbers, our forecast). In the Peruvian case, FDI increased by 249 percent between the two time intervals in question, thanks to the global commodity boom and the existence of market friendly policies.
As investors know, collapsing FDI is a major problem for a dollarized country, because the Central Bank of Ecuador cannot print US dollars. In other words, without foreign direct investment or the existence of a very high trade balance (which Ecuador lacks because of its aggressive anti-business rhetoric and stagnant oil production following very low investment in exploration), Ecuador’s monetary base simply cannot grow. And lack of growth in base money implies
In any case, we do think that it is positive news that the Correa administration seems to be looking for ways to mend its relationship with investors. Ideology (defaulting on the debt by choice) allowed Ecuador to save $290 million per year in external debt payments --about 0.5 percent of GDP. That said, saving those $290 million in interest payments generated an annual reduction of at least $850 million in annual FDI flows to Ecuador (assumes that without default and nationalization FDI would have remained stable in the 2006-2011 period). Now, if Ecuador had more or less emulated the performance of Peru or Panama (see graph in prior page), the foregone FDI would have amounted to an amazing $2.63 billion per year, more or less 10 times the savings delivered from reneging on the public debt. The lack of sufficient investment condemned Ecuador to grow only an average of +3.5 percent year-over-year between 2006 and 2011, compared to the Latin American average of 4.3 percent year-over-year, Panama’s +7.7 percent year-over-year, and Peru’s +7.1 percent year-over-year average.
Alberto J. Bernal-León is Head of Research at Bulltick Capital Markets. This column is an excerpt of a research paper for Bulltick clients. Excerpted with permission from Bulltick.