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Featuring: COVID-19 | ecuador | Ukraine

In addition to the international policy response to the coronavirus pandemic the global economy is grappling with, we are discussing Ecuador’s multitude of crises as the country moves toward a complex election season and the next chapter in the legal saga around Ukraine’s Privatbank that could impact cooperation with the IMF.

COVID-19 shock combined with an oil price war will continue to cause extreme market volatility and dislocations

Market Event: EM fixed income faced significant pressure this week with particular underperformance of oil dependent credits, as fears over the oil price war between Saudi Arabia and Russia, as well as the impact of the increasingly prevalent coronavirus, grew. As a proxy, the EMBIG Diversified Sovereign spread now exceeds the wide witnessed during the 2015-16 oil price rout and China growth scare but remains comfortably below levels witnessed during the global financial crisis (GFC). Governments and central banks continued to react with the European Central Bank announcing 120 billion euro of additional quantitative easing through year-end and the UK and Italy presenting targeted fiscal packages. Markets expect another 50bps rate cut from the Fed next week while Trump pushes for additional fiscal stimulus.

Gramercy View:  The evolving economic shocks emanating from the virus as well as the collapse in oil will now almost certainly result in global recession. While perhaps not as bad as the GFC, spreads have the ability to continue to widen towards those levels given the high degree of uncertainty and unique and multifaceted nature of the crisis. The duration and depth of the virus shock will depend on the medical response and effectiveness of containment, while the robustness of recovery will be linked to the ultimate policy response.  On the former, there is a possibility that the psychological panic and cases begin to peak in 2Q, but challenges and consequences from the stress to the system will likely linger. Limitations of monetary policy will be tested and fiscal stimulus is likely to be substantially less, at least initially, than efforts employed in response to the GFC due to political constraints and lack of hard data on the extent of the impact. Given impending outflows and disorderly market reactions, we anticipate several dislocations in the emerging markets space to occur in the coming months.

A “perfect storm” for Ecuador and further dark clouds on the horizon  

Market Event: The collapse of global oil prices and postponement of the 4th IMF Review on Ecuador (originally scheduled for March 15th) due to delays in president Moreno’s reform agenda came in the midst of acute market risk-off sentiment due to the coronavirus pandemic.  This created a “perfect storm” for Ecuadorian assets, which were one of the hardest hit globally this week and now trade deep in distressed territory. In addition, former President, Rafael Correa, or a candidate supported by him, appear to be competitive in the 2021 elections, which creates a material cloud of political uncertainty on the horizon.

Gramercy View: The potential return of Rafael Correa to mainstream Ecuadorian politics, either directly (as a vice presidential candidate or in congress, should he not get disqualified from running before October 2020 by the ongoing legal proceedings against him) or indirectly (by throwing the substantial political support he enjoys in the country behind another candidate, most likely his sister, Pierina Correa) is our main medium-term concern. A return to “Correismo” economic policies would be seen as detrimental from a market perspective and will likely completely undo the market-friendly shift in policy direction since 2017 under President Lenin Moreno, a former political ally and current arch nemesis of Correa. In a scenario where a Correista candidate wins the presidency in 2021, it is almost a certainty that cooperation with the IMF will be terminated. Given the precarious situation of Ecuador’s dollarized economy, as government market borrowing is prohibitively expensive, and a strong USD further impairing external competitiveness, we see a high probability that a hard currency liquidity squeeze will necessitate a restructuring of sovereign debt in the not so distant future. However, we see a materially different outcome for investors depending on the political scenario that will play out next year.

Ukraine’s Supreme Court hearing on March 16th on one of the key cases related to Privatbank 

Market Event: On Monday, March 16th, Ukraine’s Supreme Court will hear one of the multitude of cases filed by the former owners of Privatbank and/or their associates against the government and the Central Bank (NBU) related to the 2016 nationalization of Ukraine’s largest bank at the cost of $5.5bn of taxpayers’ funds. Although associated to a non-systemic issue (i.e. the bail-in of $250 million from a large private depositor), Monday’s decision will pave the way for the Supreme Court to move on to the most critical hearing on the actual constitutionality of Privatbank’s nationalization.

Gramercy View: If the court’s decision next week goes against the government, it will not directly impact the ongoing negotiations between the authorities and the IMF over a new program, but it will serve as warning shot that a similar decision could be taken in the much more important hearing on the constitutionality of Privatbank’s nationalization. As such, an unequivocal reaction by President Zelensky’s Administration and a strong political signal that the government will not allow compensation to be paid to Privatbank’s previous owners under any circumstances will be necessary to reassure the IMF. The Fund has been abundantly clear that although the government cannot meddle in the work of the courts, the authorities should make a clear political commitment that the taxpayers’ interest will be protected in the Privatbank legal saga. Passing banking system legislation in Ukraine’s parliament designed to prevent reversals of earlier bank resolutions, and specifically Privatbank’s nationalization, is one of the two remaining prior actions required for a new IMF program, the other being approval of land reform.

Please contact our Co-Heads of Sovereign Research with any questions:

Kathryn Exum, Senior Vice President, Sovereign Research Analyst
[email protected]

Petar Atanasov, Senior Vice President, Sovereign Research Analyst
[email protected]

This document is for informational purposes only. The information presented is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Gramercy may have current investment positions in the securities or sovereigns mentioned above. The information and opinions contained in this paper are as of the date of initial publication, derived from proprietary and nonproprietary sources deemed by Gramercy to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. This paper may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader. You should not rely on this presentation as the basis upon which to make an investment decision. Investment involves risk. There can be no assurance that investment objectives will be achieved. Investors must be prepared to bear the risk of a total loss of their investment. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. The information provided herein is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation.