Event

On 16 April, a devastating 7.8-magnitude earthquake struck Ecuador's north-west. Large human losses have been recorded, with over 650 confirmed dead and tens of thousands injured. In response to the crisis, the government of President Correa declared a state of emergency and announced a tax reform to help finance reconstruction efforts. Total damages caused by the earthquake are estimated at some USD 3 billion, or about 3% of GDP.

Impact on country risk

Already under severe economic strain due to the sharp drop in oil prices since mid-2014, the natural disaster hit Ecuador at the worst possible time. IMF forecasts released just days before the quake suggest that GDP will shrink by more than 4% in both 2016 and 2017. This is explained to a large extent by the fact that economic growth had in recent years been primarily public-sector driven, but that the oil price shock has imposed fiscal restraint. Indeed, public finances sharply deteriorated between 2011 and 2015, with the overall government balance moving from virtual break even to minus 5.3% of GDP and public debt booming from 19% to 35% of GDP. Though that level is still considered relatively low, conditions specific to Ecuador have made it difficult to finance the budget shortfalls: full dollarisation of the economy implies that deficits cannot be monetised and access to international capital markets remains fragile (as state intervention in the economy continues to undermine confidence and the 2008 sovereign default signals that Ecuadoran willingness to pay is not unconditional). Facing up to this reality, the Correa administration started to implement austerity measures in 2015. However, with a general election coming up in 2017 and given the urgent need for post-earthquake reconstruction efforts, the outlook on fiscal consolidation is unclear (even if the proposed tax reform is very likely to be implemented and Ecuador has activated a USD 600 million standby agreement with the IMF). Such uncertainty further adds to both short-term and medium- to long-term political risk. Further downgrades are not in the cards however, as both classifications were prudently downgraded to category 6 earlier this year already (to reflect that low investor confidence could result in smaller than expected capital inflows, implying a liquidity crunch, which could in turn inspire the government to impose import or capital controls). Meanwhile, it is evident that the expected severe recession implies that the commercial risk classification in category C remains relevant as well.

Analyst: Sebastian Vanderlinden, s.vanderlinden@credendogroup.be