Ecuador’s Likely Debt Default Gets Yawns in Region

Ecuador’s looming default on $6 billion in foreign debt has so far been shrugged off by neighboring Latin American markets.

Unlike the faraway crises in Asia and Russia that caused havoc in Latin America, the placid reaction to Ecuador’s likely default shows that investors have become more sophisticated about emerging markets, said Lacey Gallagher, Latin American ratings director at Standard & Poor’s.

“In and of itself, Ecuador’s crisis is not a watershed of any kind,” Gallagher said. “This is a catalyst for investors to face head-on the risks of emerging markets. But they are falling back on the credit-worthiness of individual countries.”

A general sentiment of bearishness about Latin America has prevailed for several months, Gallagher noted, but that has more to do with political uncertainty in Brazil, Argentina and Venezuela than with the financial dilemmas of tiny Ecuador, whose gross national product is a mere $15 billion.

Though the Ecuadorean Brady bonds at risk have a face value of $6 billion, their market value is less than $1.5 billion. So the money that Ecuador bondholders would lose is “close to negligible”--a minuscule fraction of overall emerging-market bonds, said Michael Gavin, an economist with Warburg Dillon Read in Stamford, Conn.

Brady bonds, named for former U.S. Treasury Secretary Nicholas Brady, are repackaged bad loans that were made to emerging nations by banks in the 1980s. They became tradable after the U.S. government guaranteed a portion of their principal and interest.

Ecuador has had a low credit standing for years and on a half-dozen occasions has renegotiated the $3.5 billion it owes to major industrial countries.

“It’s no Thailand, where the crisis was unexpected and international investors were more exposed. Nobody significant is in Ecuador in amounts large enough to create a systemic problem,” Gavin said.

Ecuador’s Brady bonds due in 2015 traded Friday at 22 cents on the dollar of face value, down from 45 cents May 10. They are yielding 35%, which is “default pricing,” said Greg Heywood, senior analyst with Montgomery Asset Management in San Francisco.

Unlike the currency crisis that befell Thailand in 1997, which quickly spread throughout Asia and into other emerging markets, the debt crisis in Ecuador is a surprise to nobody, said Montgomery’s Heywood.

Ecuadorean President Jamil Mahuad said this week that the country will not pay the $95 million in Brady bond interest payments due Aug. 31.

Mahuad announced Friday the broad outline of a debt restructuring plan involving about $400 million in new loans from the International Monetary Fund. The deal would involve a swap of existing debt for new bonds, with investors taking a bath.

Mahuad also announced that Finance Minister Ana Lucia Armijos will step down Tuesday. She will be replaced temporarily by Economy Minister Guillermo Lasso. Mahuad didn’t say why Armijos is quitting.

But surrounding markets have been tranquil. Brazil’s most popular 20-year bonds are unchanged since mid-July and Mexico’s bonds on Friday closed slightly higher in value than on Aug. 10, before Ecuador’s problems came to a head.

Brazil’s Bovespa stock market, the nation’s largest, has gained 3% this month, while Mexico’s Bolsa is up about 2.5%. Argentina’s volatile main stock index has risen 8%.

But some are less sanguine about the impact of Ecuador’s woes. A debt restructuring by Ecuador could undermine the market for Brady bonds generally if the safe-haven image of U.S. Treasury-backed Brady bonds is undercut, said Jaime Valdivia, research director at Morgan Stanley Dean Witter in New York.

The debt swap as envisioned by the IMF would introduce a new kind of bond but would in fact be a reversion to loan arrangements of the 1970s and 1980s, when countries were “under the tutelage” of multinational lenders such as the IMF or of big foreign banks and a step away from free markets, Valdivia said.

Valdivia also said markets fear that Ecuador’s restructuring of its Brady bond debt--a de facto default--could set a precedent that could be followed by other debtor nations such as Venezuela, which also is experiencing severe economic problems.

But that danger is discounted by S&P;’s Gallagher.

“That’s misguided. If Ecuador defaults, it will be in a severe recession, will have a harder time getting credit, and that’s a huge negative. I don’t think Ecuador will motivate Venezuela or anyone else to default, “ Gallagher said.