Fitch: Higher Debt Levels Could Hurt Ecuador's Credit

NEW YORK--(BUSINESS WIRE)-- Ecuadorean President Rafael Correa's recent decree effectively gives the government flexibility to continue to run large deficits, provided there is adequate financing. Over time, a build-up of debt could erode fiscal flexibility and undermine Ecuador's creditworthiness, according to Fitch Ratings.

The decree established that the debt ceiling (40% of GDP) will now be measured against the consolidated public sector debt that nets out intergovernmental debt, including debt held by the central bank and the public pension fund, versus the total public sector debt. This will effectively allow the government to continue to run high fiscal deficits.

The previous calculation, which used the total public sector debt, reached 38.4% of GDP at the end of September. Under the new method, the debt would be 26.7% of GDP in September, which would give the government the space to accumulate significantly more debt before reaching the ceiling.

The economy entered a recession in 2015 resulting from the decline in energy prices; the country's key export is oil. Real GDP will likely contract by 2% this year and will see only a small rise in 2017, although downside risks persist for next year. The drop in oil prices also resulted in a sharp loss of government revenues.

Ecuador's fiscal deficits averaged nearly 5% of GDP in 2013-2015. We expect the fiscal deficit to widen further, possibly exceeding 5.5% on average in 2016-2017. While the government raised taxes and cut spending, particularly capital spending, to adjust to the oil price decline, the recession will make further fiscal consolidation challenging.

Financing higher deficits could also prove challenging going forward. Ecuador has a weak debt repayment history. It has restructured twice since 2000. The government covered its 2016 financing needs from a combination of sources, including multilateral and bilateral sources, and the market.

Fitch believes Ecuador's ratings could be negatively affected by financing constraints or failure to adjust external accounts to low oil prices. Ecuador's high commodity dependence makes its growth, fiscal accounts and external accounts more vulnerable to oil market changes than most.

Petroleum and its derivatives were 52% of Ecuador's total exports and 28% of its public-sector revenue in 2014. These figures fell to 36% and 19%, respectively, in 2015 due to the sharp drop in oil prices. Fitch forecasts average prices for Brent of USD45 per barrel in 2017 and USD55 per barrel in 2018.

Political risk could also add to fiscal challenges in the lead up to and following the general elections in February of next year. If the election results, as we expect, in a more divided Congress, the next president's policymaking abilities could be constrained by political gridlock.

Fitch rates Ecuador 'B' and assigned a Negative Outlook on Aug. 25, 2016, reflecting the country's weak growth performance, high fiscal deficits, increasing debt burden, and potential challenges to timely policy adjustments in the context of subdued growth, the oil price outlook and prospects for a divided congress following the 2017 elections.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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