Fitch downgrades Ecuador

Friday, August 17, 2018

Press release from Fitch (Please note that this is an abridged version. Read the full release).

Fitch Ratings-New York-17 August 2018: Fitch Ratings has downgraded Ecuador's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B-' from 'B'. The Outlook has been revised to Stable from Negative. Additionally, Fitch has assigned the sovereign a 'B-' Long-Term Local-Currency IDR/Stable Outlook and a 'B' Short-Term Local-Currency IDR.

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A full list of rating actions is at the end of this rating action commentary.


The downgrade of Ecuador's Long-Term Foreign-Currency IDR to 'B-' reflects evidence of increased fiscal financing constraints amidst a steady deterioration of Ecuador's key metrics, including rapidly rising government debt and interest burden as well as weaker economic growth performance relative to the 'B' median.

Ecuador's fiscal financing options are narrowing. In 2018, the government's financing needs are estimated USD11.7 billion. The government tapped the international financial markets in January for USD3 billion, and it received approximately USD1.1 billion from bilateral and multilateral sources (including the forward sale of oil to China). On the domestic market, it tapped pockets of liquidity from public-sector entities and other sources for a further USD1.8 billion.

Fitch estimates that Ecuador needs a further USD5.8 billion to close its financing gap this year. While Fitch believes that the sovereign can close the gap through a combination of multilateral and bilateral financing along with the rollover of domestic debt and some accumulation of supplier arrears, the outlook for 2019 and 2020 is more uncertain. Fitch estimates financing needs of USD8.5 billion in 2019 (not including short-term Cetes debt) with some risk to the upside if some contingent liabilities materialize as they have over the past two years. The domestic market is shallow and offers limited additional financing.

Large fiscal deficits and increased reliance on expensive market debt have led to rapidly rising debt and interest burdens. Ecuador's government debt/GDP is estimated to rise to 51.3% in 2018, nearly double the level when Fitch upgraded Ecuador's rating to 'B' in 2013. Furthermore, the interest burden has risen sharply and the government's interest/ revenues are expected to approach 10% in 2020, nearly double the 2016 level.

External liquidity is weak and heavily reliant on the sovereign's external borrowing. Ecuador's international reserve levels have historically been low and volatile. While Ecuador is a fully dollarized economy, and therefore technically international reserves do not serve a balance of payments purpose, the central bank of Ecuador is the country's and the government's payment agent and as such needs a certain threshold of operational reserves, which Fitch estimates at around USD2 billion. Fitch forecasts that Ecuador's international reserves will approach USD2.4 billion by the end of 2018 or just one month of current external payments, little changed from year-end 2017.

Ecuador is expected to enter a recession in 2H18 due to the fiscal retrenchment underway. Public-sector capital spending fell by nearly 2% of GDP in 2017 and is expected to fall by 0.8% of GDP in 2018. Furthermore, public-sector employment adjustments (largely through contract employment) are expected to begin to take effect in 2H18. A sharp slowdown in domestic credit expansion is taking hold as well, which will undermine domestic demand. Fitch expects just 1.1% overall GDP growth in 2018, followed by 0.8% growth in 2019.

The Stable Outlook reflects our expectation that the public sector fiscal deficit will decline to 3.9% of GDP in 2018, down from 5% in 2017 and 7.4% in 2016 on the back of the government's new fiscal consolidation strategy. To date, the adjustment has come largely from a reduction in capital expenditures and a pick-up in revenues due to the higher average oil price and the economic recovery in 2017. The government has also announced cuts in government consultants and mergers between government ministries and public-sector enterprises, which should lower the government's wage and salary bill as well.

Fitch expects only very gradual fiscal deficit reductions in 2019 - 2020, partly due to the slowdown in economic growth and pension-related spending pressures beginning in 2019 (when the government is required to begin contributing to the national social security fund). Although Fitch expects government debt/GDP to continue to rise over the forecast period to 56.4% of GDP by 2020, the ratio will rise at a more gradual pace than in 2013 - 2017.