Ecuador: Is the government manipulating the bond market?

Are you still reading the EIU report on Ecuador from last Friday? Silly. Don’t believe for a second that anything in Ecuador can remain germane through a whole weekend. (For what it’s worth, the EIU has Ecuador on a CCC rating with negative outlook, and says that “the Correa government seems determined to forge ahead” with a debt default.)

In any case, the outlook seemed to brighten on Monday, at least according to Felipe Hernandez of Deutsche Bank, who put out a note on the subject of a radio interview given by finance minister Ricard Patiño: apparently he said that “defaulting on external debt is not the policy of the government.”

At the same time, there were rumours in the market that Ecuador had already wired its February 15 coupon payment to Euroclear.

What’s going on? Patiño seems to be in no mood to clarify anything: in the same interview, he said that parts of Ecuador’s external debt is illegitimate and should not be paid. Says Deutsche’s Hernandez:

Minister Patiño reiterated official plans to audit the outstanding external debt to decide which is the illegitimate debt and that the illegitimate debt would not be paid. Plans to audit the external debt are likely to take at least a couple of months. Without the results from this, we do not expect the government making any restructuring proposal or any decision on the debt plans. In line with this, one should expect the government to meet debt payments at least until it has the results from the audit and a clear debt restructuring proposal. This does not necessarily rule out the possibility of some delays in the debt payments. According to Minister Patiño he expects to have a debt restructuring proposal ready some time in H1-07.

This morning, Walter Molano of BCP securities put out his own note, saying, essentially, that if you think you understand why the market in Ecuadorean bonds is moving, you’re probably wrong:

The aggressive statements issued by members of the Correa Administration are an overt attempt to push down Ecuadorian bond prices. At the same time, the close association between Ecuador and Venezuela, and the Chavez Administration’s growing propensity for market manipulation, suggests that the recent statements about the debt instruments were accompanied by surreptitious buyback operations. A game is, definitely, afoot in Ecuador. Government officials are playing a high stakes game of poker, and they are bluffing their way in order to bolster their bargaining positions. Nevertheless, the game is complex, and there are a lot of seasoned players on the table. Therefore, one should be careful. As the old adage goes, “If you can’t spot the patsy at the poker table, then you are the patsy.”

The idea of Ecuadorean shenanigans is hardly new. Two months ago I wrote this:

If I was a devious Ecuadorean finance minister, I might even start buying up credit protection right now – and lots of it. CDS spreads would rise, and eventually arbitrageurs would drive down the price of the bonds, perhaps to levels less than say 80 cents on the dollar, where I could start buying my own debt back cheap without having to go through a formal restructuring.

Not much later, Ecuadorean bonds dropped significantly below 80 cents on the dollar; indeed, at one point, they were even below 70 cents. Did Ecuador buy back any bonds while they were down there? I have no idea. But it would be much easier and cheaper than going through a formal debt restructuring.