By Delfina Cavanagh
& Joydeep Mukherji
Standard & Poor's
On Aug. 12, 2015, Standard & Poor's Ratings Services (S&P) lowered its long-term foreign and local currency sovereign credit ratings on the Republic of Ecuador to 'B' from 'B+'. The outlook is stable. At the same time, we affirmed the 'B' short-term foreign and local currency sovereign credit ratings. In addition, we lowered our transfer and convertibility (T&C) assessment for Ecuador to 'B' from 'B+'.RATIONALE
The downgrade reflects that tensions between Ecuador's government and society have risen following the fall of global oil prices, limiting the government's ability to implement fiscal measures. Oil and oil derivatives represent nearly 15% of economic output, 50% of exports, and 25% of fiscal revenues. Lower revenues from oil have led the government to attempt to raise other revenues in order to sustain expenses and aggregate demand. They have also prompted the government to cut more than $1 billion in planned capital expenditure. Both efforts have met with social protests and have subsequently partly been modified. We now expect the general government fiscal deficit to reach 5%-6% of GDP in 2015. In line with our forecast on oil (see "Standard & Poor's Revises Its Crude Oil And Natural Gas Price & Recovery Assumptions," published March 26, 2015), we expect the 2016 fiscal deficit to fall near 3% of GDP before rising again in the run-up to the 2017 presidential elections. We expect social and political tensions to remain elevated through the election.
Official credit, from China and multilateral lending institutions, and international and domestic bonds will fund the government's 2015 financing requirements, estimated at $10.5 billion, or 10% of GDP, in 2015 (including its $650 million global bond due in December). At the end of June 2015, the government already raised $6.3 billion. The government borrowing requirement is expected to be lower in 2016, around $6 billion, including $2.6 billion in amortizations, down from the $5 billion amortization payments in 2015.
We expect net general government debt to increase to 31% of GDP by the end of 2015 and to increase to about 38% of GDP by the end of 2017.
On the external side in 2015, we expect oil exports to drop about 40% while oil imports decline 18% on lower oil global prices, resulting in a smaller oil trade surplus. Even though we expect the non-oil trade deficit to moderate given lower non-oil imports on economic growth deceleration and import restrictions, we still expect the country's current account deficit to widen to 2% of GDP in 2015 from 0.6% of GDP in 2014. Thereafter, we expect lower current account deficits as oil prices slightly increase. We anticipate that external debt will largely finance these deficits. The government already issued $1.5 billion in global bonds in 2015. After these issuances and other external loans, reserves increased to $4.8 billion as of July 31, 2015, from $3.9 billion as of December 2014, or 143% of short-term public external debt by remaining maturity.
We expect that Ecuador will continue to use the U.S. dollar as its currency, constraining the country's monetary flexibility and the central bank's ability to act as a lender of last resort. Consumer price inflation was 3.9%, on average, over the past five years. Inflation reached 3.6% in 2014 and is expected to increase 4.3%. Higher inflation than the U.S. indicates a steady loss of competitiveness. Ecuador's real effective exchange rate increased 4.6% during the first five months of 2015, mainly as a result of nominal appreciation against its non-dollar trading partners, and 22% since 2008.
We project that Ecuador's narrow net external debt will increase to about 80% of current account receipts (CARs), on average, in 2015-2018. During the same period, we expect that gross external financing needs will remain just over 110% of CARs and usable reserves. About 60% of the public sector's debt is external, almost all in dollars. Official creditors hold 42% of the public-sector debt. External commercial debt is about 17% of total debt, or $5.4 billion.
We expect the completion of major hydroelectric energy projects in 2016 to reduce government spending on subsidies and reduce energy imports, helping to stabilize the recent rise in both the fiscal and external current account deficits. However, a prolonged period of low oil prices could result in persistently large fiscal and current account deficits, absent further adjustments in spending and other policies. Under such a scenario, we expect that the government would postpone some capital projects, control current spending, and take other steps to contain fiscal slippage and rise in its debt burden. We expect that the government will keep the U.S. dollar as the legal tender and avoid steps that could undermine public confidence in foreign exchange policy. Thus, we do not see the Monetary and Financial Code, passed in 2014, as a harbinger of dedollarization.
We estimate that the country's per capita GDP growth may decelerate to 2% annually in the next three years, compared with 3.3% during 2010-2014 on the weaker terms of trade.
The ratings on Ecuador also take into account its centralized political leadership. Political power is consolidated within the executive branch, reducing checks and balances and transparency. However, the government has pursued increasingly pragmatic economic policies in recent years, which improved the country's infrastructure, restored ties with official lenders, and regained access to capital markets.OUTLOOK
The stable outlook is premised on our assumption that Ecuador's fiscal and external metrics will not deteriorate more than we currently forecast. We expect the government will pursue pragmatic economic policies to contain the impact of low oil prices on fiscal revenues and the balance of payments. After many years of good GDP growth and a high level of public-sector investment, the government has the fiscal capacity to reduce or delay its investment plans to contain the recent increase in its debt burden. The resulting negative impact of fiscal austerity on GDP growth could be compensated for, over the medium term, by steps that encourage more private and foreign investment.
If these assumptions do not hold, we could lower the rating. We could also lower the ratings if there are signs of a weakening commitment to dollarization, or if the political environment worsens, leading to potential capital flight or lower prospects for economic growth.
Conversely, we could raise the ratings if the government's fiscal profile and the country's external liquidity improve beyond our forecasts. Over the medium term, the combination of reduced fuel imports, higher oil exports, and greater inflows of foreign direct investment could improve the country's external profile. That, along with steps to reduce the fiscal deficit and reverse the recent increase in the sovereign's debt burden, could lead to an upgrade.