Ecuador’s Budget Cuts and China Loans Mitigate Oil Risks

On January 7, Ecuador signed five loan deals with China worth USD7.5bn, including a USD5.3bn credit line with the Export-Import Bank of China. Earlier in the week, the government said it would cut the 2015 budget by USD1.4bn, or 1.4% of GDP.

Last week’s announcements are important policy steps to preserve fiscal and financing sustainability amid the sharp decline in international energy prices. If effectively implemented, the budget cuts could enable the government to maintain its 2015 deficit target of 5% of GDP, which is in line with our projections. The credit lines ease concerns about possible financing constraints from lower oil-derived revenue and potentially tighter external funding conditions in 2015. However, they also highlight the sovereign’s increasing dependence on external borrowing.

China Exim Bank’s credit line is a 2%, 30-year facility. Ecuador increased its financing flexibility last year by re-entering the international bond market and expanding its pool of multilateral and official creditors. In December, the Inter-American Development Bank approved a contingency line of credit for up to USD300m to maintain social spending.

The budget cuts consist of reductions to capital (USD840m) and current expenditure (USD580m). The authorities also introduced new levies on telecom companies and measures to reduce exemptions and tax fraud to boost revenues. The fiscal adjustment presents a downside risk to growth, which has been dependent on public spending.

GDP growth in 3Q14 decelerated to 3.4% yoy, suggesting the figure for the year may be lower than our 4% forecast and well below the ’B’ median of 5.3%. Recently imposed import restrictions and tariff hikes to neighbouring trade partners intended to safeguard US dollar liquidity could weigh on business confidence and economic performance.

Existing public infrastructure investment plans meant we had forecast public debt to grow by around 7pp to 35% of GDP by 2018, still below Ecuador’s 40% legal ceiling and the 45% median of the ’B’ category. The impact of the new credit lines on debt metrics will depend on the pace of execution of infrastructure projects. The authorities intend to use USD4bn (4% of GDP) of the approved USD7.5bn credit facilities with China this year for public-works projects. Their financing plan also incorporates the issuance of USD2bn in international bonds. Maintaining market access will be important to service the USD650m global bond repayment coming due in December 2015.

Reducing vulnerability to oil shocks and changes in global financing conditions would support Ecuador’s debt tolerance, which is constrained by these factors as well as a weak repayment record. We affirmed Ecuador’s ’B’ sovereign rating with Stable Outlook in October 2014.