Fitch Affirms Ecuador at ‘B’; Outlook Revised to Negative from Stable

Fitch Affirms Ecuador at ‘B’; Outlook Revised to Negative

Fitch Ratings-New York-25 August 2016: Fitch Ratings has affirmed Ecuador’s Long-Term Foreign Currency Issuer Default Rating (IDR) at ‘B’ and revised the Rating Outlook to Negative from Stable. The issue ratings on Ecuador’s senior unsecured Foreign Currency bonds are also affirmed at ‘B’. The Country Ceiling is affirmed at ‘B’ and the Short-Term Foreign Currency IDR at ‘B’.

KEY RATING DRIVERS
The revision of the Outlook to Negative reflects the following key factors:

The growth and fiscal outlook in Ecuador has deteriorated since the last review in October 2015 due to lower oil prices and higher financing needs. The economy has entered into recession in 2016 with an expected contraction of 2%, followed by only a modest uptick in growth in 2017. Fiscal and external adjustment demonstrate commitment to maintaining official dollarization, but have hit demand. Although deposits in the financial system fell 12% in 2015, they have stabilized in 2016. Furthermore, although banking sector profitability and credit quality has deteriorated somewhat, the capitalization ratios and provisioning remain adequate.

In spite of expenditure containment and cuts (especially capital expenditures) and new tax revenue measures, the sharp drop in revenues (both oil and non-oil), rising interest payments and current expenditure rigidity will result in continued high non-financial public sector (NFPS) deficits of 5.7% of GDP in 2016, up from 5.2% in 2015. The deficit could remain high at over 5% in the forecast period, although much depends on the government’s ability to obtain financing. The government has covered its 2016 financing needs from a combination of multilateral, bilateral and market sources. Financing continued large deficits could prove challenging.

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The high deficits and the recession have negatively impacted debt metrics, as NFPS debt is expected to rise to an estimated 38% of GDP in 2016 from 33% in 2015. Fitch projects debt to continue to rise over the forecast period given the gradual pace of fiscal consolidation and sluggish growth, surpassing the 40% of GDP legal debt ceiling limit in 2017. This is lower than the ‘B’ median 58% of GDP. While Ecuador repaid its 2015 bond issuance last year and most recently tapped the international bond market in July 2016, Ecuador’s debt tolerance is comparatively weaker due to its high commodity dependence, constrained external financial flexibility and a weak historical repayment record.

Presidential and legislative elections are scheduled for February 2017 with the new government taking office in May 2017. Governance challenges that prevent a timely policy response in a weak economic environment could increase given that the next president will likely have to manoeuvre legislation through a more divided Congress.

Ecuador’s external solvency and liquidity indicators are weakening. Ecuador became a moderate net external debtor in 2015, driven by sovereign borrowing and a reduction in the bank’s net foreign asset position. Net external debt is expected to rise further over the next two years to 8.8% of GDP in 2018. The economic recession and the continuing import restrictions are partially containing the current account deterioration from the plunge in oil exports and loss of export competitiveness from the strengthened U.S. dollar and currency depreciation of major regional trading partners.

International reserves fell to USD2.5 billion in 2015 from USD4 billion in 2014. They are expected to end the year at USD2.9 billion from year-end 2015, covering just 1.3 months of current account payments, consistent with recent years.

Ecuador’s ratings reflect its high commodity dependence (oil exports now account for 30% of exports and oil revenues account for 20% of the government’s revenues), weak external liquidity, high fiscal deficits and a poor historical debt repayment record. These factors are counterbalanced by its higher per capita income, improved governance and social indicators, and dollarization that support macroeconomic stability and low inflation.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Ecuador a score equivalent to a rating of ‘BB-‘ on the Long-Term FC IDR scale.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term FC IDR by applying its QO, relative to rated peers, as follows:

Macroeconomic: -1 notch, to reflect Ecuador’s lower growth prospects than rating peers.
External: -1 notch, to reflect Ecuador’s external vulnerabilities to shocks because of its high commodity dependence and restrained external financing flexibility in the context of official dollarization.

Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES
The main factors that could lead to a downgrade are:

Negative:
–Financing constraints or failure to adjust external accounts in an environment of subdued oil prices;

–Governability challenges that hamper a policy response to a weaker growth environment and limits space for further fiscal adjustment.

–Weaker than expected growth that leads to higher fiscal deficits, greater financing needs and a growing debt burden.

–Policies that undermine the sustainability of the dollarization regime.

The Rating Outlook is Negative. Consequently, Fitch’s sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a positive rating change. Future developments that could individually, or collectively, result in a stabilization of the Outlook include:

–Renewed growth momentum, for example driven by higher levels of investment in the oil sector, productivity-enhancing reforms and improvements in the business environment;

–Implementation of policy adjustments that improves the trajectory of its fiscal accounts and/or further easing of financing constraints;

–Improvements in the economy’s external liquidity position that provides a more ample buffer to external shocks.

KEY ASSUMPTIONS
The ratings and outlook are sensitive to a number of assumptions:

–The growth, fiscal and external forecasts assume that oil production could fall 5% from its present levels (548,000bpd) in 2016-2017 due to investment cutbacks by state oil enterprises. Fitch’s latest projections point to a recovery in oil Brent prices to USD42/b in 2016, USD45/b in 2017 and USD55/b in 2018.

Contact:

Primary Analyst
Richard Francis
Director
+1-212-908-0858
Fitch Ratings Inc.
33 Whitehall Street
New York, NY 10004

Secondary Analyst
Kelli Bissett-Tom
Associate Director
+1-212-908-0564

Committee Chairperson
Charles Seville
Senior Director
+1-212-908-0277

Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: elizabeth.fogerty@fitchratings.com.

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