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Ecuador’s bonds fell sharply after the decision to default on $3.86bn of foreign debt on Friday, with its main benchmark bond yield jumping more than 100 basis points since Friday to trade at about 60 per cent.
The decision of Rafael Correa, Ecuador’s radical leftist president, could return to haunt the country and others in the region as investors subsequently demand higher yields to buy their bonds.
Although Ecuador attracts only investors willing to take big risks in exchange for high yields, even the most risk-hungry funds may think twice now. The country’s credit default swap prices, a form of insurance against debt defaults, are trading at more than 4,000 basis points, one of the highest sovereign prices in the world.
The failure to pay a $30.6 million interest payment on its 2012 global bonds, despite the fact that it has $5.65 billion in cash reserves and debt service accounts for less than 1% of Ecuador’s GDP, will cause great harm to the nation’s economy pundits speculate. From Bloomberg, Correa’s decision “comes as a deepening global economic slump throttles demand for oil, the country’s biggest export. Ecuador, which defaulted in 1999, owes about $10 billion to bondholders, multilateral lenders and other countries.”
Per The Economist, “Correa has said that Ecuador will default only if it concludes that it could win subsequent lawsuits against bondholders. [Because] that looks unlikely, one theory is that the whole exercise is aimed at driving down the value of the questioned bonds—they now trade at less than a third of face value—so the government can either buy them back or force a debt renegotiation. Ricardo Patiño, a former finance minister who took part in the audit, suggested that investors should accept a write-down of more than 60% in the bonds’ value.”
Of note, Hugo Chavez’s government owns structured notes tied to Ecuador’s bonds that would force Venezuela to pay $800 million if Correa doesn’t make the payment, according to estimates by Barclays Capital Inc.