Questioning Ecuador's Threat to Default

Sources: Bloomberg News, Ecuador Bondholders Doubt Correa's Default Threat, Prices Show; Latin Business Chronicle, Debt Default: Don’t Try This at Home; Forbes.com, Leftist Assumes Presidency of Ecuador.

In an event that investors have been awaiting anxiously since his election, on January 15, Rafael Correa took office as Ecuador’s President. Given his campaign promises to default on the nation’s $11 billion in foreign debt, the previous months have been full of speculation regarding whether President Correa will actually follow through with his threat. Presently, however, the country’s bonds are trading at more than twice the level they were when the country defaulted in 1999, indicating that many bond holders doubt Correa’s sincerity.

The surge in bond-holder confidence stems, in part, from the recent increase in Ecuador’s oil export revenue. The increase in funds has hastened the nation’s economic growth and created a budget surplus, diminishing the perceived need to default because the country actually has the money to pay the debt. Additionally, investor confidence is supported by history—in the past two decades no country with a budget surplus and strong economic growth has defaulted. In 2006, Ecuador’s economy grew approximately four percent and exports increased over twenty percent.

Even if President Correa has backed away from his threat to default fully, he is still focused on leading the country in an "economic revolution." As he mentioned in his inauguration speech, such a movement would emphasize the renegotiation of the foreign debt, "paying only what we can after attending to the needs of the poor."

See Ecuadorian Presidential Candidate Creates Unease Over Debt; Ecuadorian President Plans to Cut Ties with World Bank and IMF; and, Ecuador’s Post-Election Bond Risk for more information.

Question:

(1) To what extent has foreign-debt default become an act of symbolism as well as an act of financial desperation? Are bond holders warranted in believing that Ecuador will follow the historical trend and refrain from defaulting because it does not need to?