Tuesday, December 16, 2008

Ecuador defaults on bonds despite sufficient reserves

By Naomi Mapstone in Lima and David Oakley in London Published: December 16 2008 02:00 Last updated: December 16 2008 02:00 Ecuador has become the second country to default on its bonds since the credit crisis in spite of having sufficient funds to meet its interest payments. The decision of Rafael Correa, Ecuador's radical leftist president, could return to haunt the country and others in the region as investors subsequently demand higher yields to buy their bonds. Ecuador's bonds fell sharply after the decision to default on $3.86bn of foreign debt on Friday, with its main benchmark bond yield jumping more than 100 basis points since Friday to trade at about 60 per cent. However, neighbouring countries saw their debt prices hold up relatively well, with Argentine and Venezuelan debt yields rising only slightly. Analysts believe Mr Correa is taking a gamble on refusing to pay the $30.6m coupon payment on the country's Global 2012 bond in spite of having reserves of $6bn available to meet the bill. He joined Seychelles to be the only countries to default on their bonds since August last year, when the credit crisis blew up, because he said the country's bonds were "illegal", saying the debt was contracted illegally by a previous administration. He wants to restructure the bonds, reducing their value and the country's debt payments. However, analysts warn that this could prove problematic as it could frighten off investors. Although Ecuador attracts only investors willing to take big risks in exchange for high yields, even the most risk-hungry funds may think twice now. The country's credit default swap prices, a form of insurance against debt defaults, are trading at more than 4,000 basis points, one of the highest sovereign prices in the world. Fears have also mounted in recent months that Argentina will struggle to meet its 2009 debt servicing payments of $21bn, but economists believe it will avoid defaulting, especially given that the state went so far as to nationalise private pension funds to meet its obligations. "I'm less concerned about contagion and more concerned about the overall impact on the asset class," said one bondholder. "Ecuador has probably cost all Latin American countries tens of millions of dollars in borrowing costs. Not everybody has the ability to distinguish between these countries in real detail." Patrick Esteruelas, Latin America analyst for Eurasia Group, said the chances of contagion were limited, and would increase only if Ecuador got away with a wilful default and restructuring. Ecuador has defaulted on its debt three times in the past 14 years, and Mr Esteruelas said many of its bonds were now likely in the hands of vulture funds or specialists in distressed debt who favoured a protracted court battle over any proposal for a bond swap at lower interest rates or with a longer grace period. To entice investors to restructure, Ecuador would likely have to offer a significant cash sweetener - as much as $1bn to restructure 70 per cent of its debt - it could ill afford at a time of falling oil prices, he said. "Given Ecuador's poor economic direction and the extremely questionable willingness to pay . . very few investors, if any, are going to be willing to hold any bonds right now," he said.

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