Featuring: Argentina | ECUADOR | THE IMF

This week we focus on the two active distressed sovereign situations in Latin America and comment on Argentina’s underwhelming initial debt restructuring offer that is unlikely to be accepted by investors and Ecuador’s struggle to avoid a hard default and secure multilateral lifelines after successfully deferring interest payments on its Eurobonds until August. We also highlight the main EM debt relief initiatives that were discussed during the virtual IMF/World Bank spring meetings last week.

Argentina’s initial restructuring offer unlikely to be accepted; blue chip swap under pressure while inflationary forces persist

Market Event: The government released its proposal to bondholders on Friday evening which entails an offer to exchange 2005 and 2016 indenture bonds for a set of new securities to be ruled by the 2016 indenture. The terms entail a 3-year grace period with interest payments beginning in 2023 at a rate of 0.5% with incremental increases and an annual average rate of 2.33%. The bulk of the adjustment stems from interest relief (62% reduction) and little principal relief (5.4%). Estimated recovery rates on USD bonds would range from 30-35 cents assuming a 12% exit yield. The offer is set to close in 20 days. Meanwhile, the gap between the blue chip swap rate and official FX rate reached a multi-year high of 70% this week while March inflation exceeded expectations at 3.3% m/m (vs. consensus of 2.3%).

Gramercy View: Bondholders are unlikely to agree to the authorities’ terms given low recovery rates particularly in the context of little clarity on future policy. Additionally, the proposal suggests that the government intends to obtain majorities utilizing a single-limb voting structure within designated buckets. While typically this approach would be beneficial in reducing holdouts, the more punitive NPV losses to the front end of the curve pose an additional challenge to acceptance of this offer across all buckets. Furthermore, in the backdrop of a wave of impending sovereign defaults, acceptance of such a deal would set a negative and challenging precedent for other restructurings as well as the broader emerging market asset class. We anticipate further negotiations and counterproposals in the near-term, but the nature of the offer implies increased likelihood of a hard default on May 22nd following the 30-day grace period on the roughly $500mm of payments due on April 22nd.  Despite this, we still expect incentives for resolution to the debt crisis to persist and therefore, believe an attractive deal for both bondholders and the Republic can be reached. In the meantime, the macroeconomic situation will remain challenged as the government increases spending amid the health crisis and continues to rely on deficit monetization. This will continue to fuel a weaker parallel rate and higher inflation.

Ecuador secures temporary liquidity relief until August as the authorities scramble to negotiate a successor IMF program and avoid a hard default amid mounting economic and social pressures due to the COVID-19 crisis   

Market Event: Ecuador reached the required thresholds for its consent solicitations to bondholders on delaying around $650mm in Eurobond interest due between March 27th and July 15th to August 15th; meanwhile, the 30-day grace periods the government took on four interest payments (around $200mm) that were due in March start to expire on April 25th.

Gramercy View: The successful conclusion of the consent solicitations launched on April 8th will give Ecuador a few months of breathing room during which the government will attempt to secure funding lifelines from the IMF and other multilateral sources. The authorities hope to conclude negotiations on a successor IMF program by August 10th, but a number of domestic political obstacles can derail these plans and timeline. President Moreno’s Administration lacks political capital and is struggling with containing the massive economic and social shocks that the country is experiencing as a result of the COVID-19 health emergency and multi-year lows in the price of oil, one of the economy’s key sources of FX inflows. The finance ministry is estimating that fiscal revenue loss could be as high as $6-7bn in 2020 (~6-7% of GDP) versus what was budgeted, so it urgently needs to find savings as well as sources of fresh financing to plug the gap. The government expects additional external financing of $3-4bn, including up to $940mm from the IMF’s Rapid Financing Instrument (RFI) that could be disbursed by the end of April. The short-term liquidity relief that Ecuador has secured will help avoid a hard default in the near term that would have jeopardized fresh multilateral financing. However, if a new IMF program and an orderly debt re-profiling are not achieved by August, a hard default appears to be inevitable later this year as Ecuador is unlikely to have the resources and/or political willingness to pay in the current environment. A potential hard default will not only create yet another material shock to the country’s embattled economy, but could have important long-term policy consequences by increasing the probability of a populist outcome in the presidential and general elections in early 2021. The political outlook is a major factor in determining the fair value of Ecuador’s Eurobonds as the economic policy trajectory in 2021 and beyond will be one of the key drivers of how much of its external debt obligations Ecuador will be able to repay.

IMF virtual spring meetings are underway and point to a bleak economic outlook but evidence a coordinated approach to official and bilateral sector support for struggling EM economies

Market Event: The Fund released its updated World Economic Outlook forecasts on Tuesday which include contractions of 3% in global growth, 6.1% in DM growth, and 1% in EM growth. The IMF also announced $500mm in debt relief (in process of being increased to $1.4bn) for 25 countries under its Catastrophe Containment and Relief Trust (CCRT), increased access to emergency financing from $50bn to $100bn, and added a short-term liquidity line (SLL) available for higher credit quality EM sovereigns. Meanwhile, the G20 agreed to temporarily suspend bilateral debt service effective May 1st until year-end with the possibility to be extended into 2021. The debt service will be repaid over three years with a one year grace period.  Eligible countries include those designated under the International Development Association (IDA, https://ida.worldbank.org/about/borrowing-countries) and Least Developed Countries (LDC, https://www.un.org/development/desa/dpad/least-developed-country-category.html) as per UN and WB guidelines. The relief comes with conditionality as countries either have to have access to an IMF financing program or request access, commit to use the fiscal space provided to respond to the crisis, increase fiscal transparency and not raise new non-concessional debt during the suspension period.

Gramercy View: We expect the market to again revise its growth forecasts downward to be closer to the Fund’s estimates and still see risks tilted to the downside, particularly on EM growth, depending on individual country responses to the crisis as well as risks associated with the pace of demand-side recovery. The debt and liquidity relief announcements made this week are, in theory, most beneficial for those countries with large amounts of bilateral debt outstanding (Angola, Pakistan, Zambia etc.) but in some cases the criteria associated with the relief may pose challenges and limit sovereigns’ willingness to participate. Additionally, the relief is temporary and will not solve broader debt sustainability issues. Thus far, the G20 agreement excludes private and other multilateral creditors. We expect some degree of support from the broader set of multilateral lenders as well as case by case efforts for private sector involvement. The latter will be challenging to execute on a collective and coordinated basis although the G20 has called for the Institute of International Finance (IIF) to spearhead these efforts. Regardless of IIF involvement, legal challenges will abound in many cases. Bonded debt of eligible countries for G20 bilateral relief is roughly $65bn but we anticipate private sector involvement to be more selective among IDA and LCA countries as well as others that face significant liquidity or solvency challenges. Among the relatively weaker sovereign issuers, those that have preexisting and strong relationships with the IMF and thus, higher propensity to reform and optimally manage macroeconomic policy, will be the ones that outperform in the aftermath of COVID-19, all else being equal.

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]

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