Ecuador's Correa May Burn Ally Hugo Chavez

11/17/2008 6:55 PM

11/17/2008 6:57 PM

Ecuador President Rafael Correa's looming default on $510 million of bonds may hurt his biggest ally, Venezuela President Hugo Chavez, more than anyone else.

Ecuador, hamstrung by a tumble in oil, its biggest export, said last week it will use a 30-day grace period to decide whether to make a $30 million interest payment that came due Nov. 15. Chavez's government owns structured notes tied to Ecuador's bonds that would force Venezuela to pay $400 million if Correa doesn't make the payment, according to estimates by Barclays Capital Inc.

Venezuela's potential losses may strain relations between two presidents who meet every three months and espouse the same socialist themes. During an Ecuador-Colombia border dispute in March, Chavez, 54, mobilized tank battalions in a show of support for Correa, 45.

``Chavez will have something to say'' about the debt payment, said Alejandro Grisanti, a fixed-income analyst at Barclays in New York. He ``will encourage Correa not to default.''

Grisanti said he revised his estimate to $400 million from an initial $800 million after meeting with Finance Ministry officials today. Venezuela has pared its holdings of the notes over the past year, he said. A spokesman at the Venezuelan Finance Ministry declined to comment on the government's holdings of the notes.

`Truly Horrifying'

The price on Ecuador's 12 percent bonds maturing in 2012 plunged to 14 cents on the dollar on Nov. 14, sending yields over 100 percent, as investors braced for the first sovereign default since the global financial crisis deepened in September. The bonds rebounded today to 24 cents at 6 p.m., according to JPMorgan Chase & Co.

Standard & Poor's cut Ecuador's rating to CCC-, three levels above default, on Nov. 14, hours after Finance Minister Maria Elsa Viteri announced the government's plan to withhold the interest payment. Fitch Ratings put Ecuador's issuer default rating of CCC on ``negative'' watch today, saying there was a ``reasonable probability of near term downgrades.''

Correa, an economist who earned his Ph.D. at the University of Illinois at Urbana-Champaign, has been threatening since the 2006 campaign to halt payments on debt he calls ``illegitimate.''

In his weekly radio address on Nov. 15, Correa called a debt auditing committee's preliminary report ``truly horrifying,'' echoing previous statements he's made that some of the obligations were fraudulent. He said he expects to receive a full report on the debt on Nov. 20.

Largest Creditor

``If there's a sufficient basis to say we can't pay this illegitimate debt, that's what we'll do,'' Correa said in his radio address, according to a statement posted on the government's Web site. ``That the bonds fall and the country risk rises doesn't hold the least interest for us. Here we'll act for the country and the common good.''

Ecuador's finances have come under strain as oil, which accounts for 60 percent of the country's exports, has plunged 62 percent from a record high in July to $55.59 a barrel.

Ecuador needs an oil price of $95 to cover all the spending in its budget and a price of $76 to avoid depleting its $6.3 billion of foreign reserves, according to Barclays. The South American country last defaulted less than a decade ago, halting payments on $6.5 billion of bonds in 1999.

Argentine Default Concern

The structured notes, so-called first-to-default baskets that are also tied to Argentine and Venezuelan debt, work like credit-default swaps, Grisanti said. Swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should an issuer fail to adhere to its debt agreements.

Venezuela would be forced to pay $400 million to investors who would hand over defaulted Ecuadorean bonds in return, according to Barclays.

``In the event of default, Chavez will be Correa's largest creditor,'' Grisanti wrote in a Nov. 14 report. Venezuela's position as a creditor would likely bolster the payout Ecuador would offer in a debt restructuring, he said.

Investor concern has also mounted that Argentina will default for a second time this decade amid the global economic slump and rout in commodities. Argentina's benchmark 8.28 percent dollar bonds due in 2033 trade at 26.25 cents on the dollar, down from 75 cents three months ago, according to JPMorgan Chase & Co.

Correa won a landslide victory in November 2006 after promising to rewrite the constitution and boost spending on the poor. He said in September that he'd suspend debt payments before trimming spending on education and health care.

`Collapsing' Prices

Ecuador's foreign debt totaled $10 billion as of September, according to Goldman Sachs Group Inc. That equals less than 25 percent of its $44 billion annual gross domestic product.

While the drop in oil has crimped revenue, Viteri said on Nov. 14 that Ecuador has the cash to make the $30 million payment on time.

The price on the 2012 bonds, which were issued as part of a restructuring in 2000, sank 28 cents over two days last week from 42 cents on Nov. 12, according to JPMorgan. The bonds traded at 99.5 cents on Sept. 8, a week before the failure of Lehman Brothers Holdings Inc. deepened the decline in oil.

``Bond prices are collapsing,'' said Igor Arsenin, an emerging-market strategist at Credit Suisse Group in New York. ``They are seriously considering defaulting.''

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