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Wednesday, September 1, 1999 Published at 16:22 GMT 17:22 UK


Business: The Economy

Ecuador default triggers change

Default has cast a shadow on Ecuador's borrowing horizons

Last week Ecuador won itself a place in economic history books when it became the first country to default on its Brady debt.

The default doesn't just set a first for Ecuador, it is also likely to set a precedent for how government and investors behave when borrowers default.

The question is: whose responsiblity is it when a borrower can't pay the money it owes?

Last year, official lenders, such as the IMF, came under fire for effectively bailing out private investors with public money during and after the Asian crisis.


[ image: Ecuadoreans will be hard hit by the budget]
Ecuadoreans will be hard hit by the budget
The motivation for "bail outs" has long been the fear of what default could mean for stability in the region as a whole, and the impact any default could have on the banks who lent the money in the first place.

But in the wake of the crisis, both the IMF and the US Treasury made it clear that they would like to find a mechanism which "shared the burden" with the private sector when the next economic crisis hit.

In effect, they wanted to force the private sector to renegotiate the terms of any loans before the situation got so bad that the public authorities would be forced to intervene.

Now Ecuador appears to be a test case for that plan, which has been fiercely opposed by private sector interests.

The IMF and the US have publicly backed Ecuador's efforts to restructure its so-called Brady debt, government bonds partly backed by the US goverment.

Unusually, Ecuador is to still get a $400m loan from the IMF to help shore up its economy.

Neither a borrower nor a lender be

In the immediate aftermath of the Asian crisis, US Treasury secretary Robert Rubin made it clear that public institutions should not bail out the private sector.

Rubin also indicated that the IMF should be prepared to agree an aid package even if a country was in default with private creditors.

UK Chancellor Gordon Brown said that before the IMF uses its own resources it should be certain that there will be a contribution from the private sector.

Brady bonds were born an earlier Latin American debt crisis and offered investors collateralised debt, in return for which the investors forgave some of the debt.

They were named after US Treasury Secretary Nicholas Brady.

Ecuador has some $6bn worth of them issued to international lenders.

"The financial institutions are showing the private sector that these are risky debt instruments, they are speculative grade," Lacey Gallagher, analyst at Standard & Poor's said following Ecuador's default.

Upsetting the lenders


[ image: Prime Minsister Jamil Mahuad has to steer Ecuador through the crisis]
Prime Minsister Jamil Mahuad has to steer Ecuador through the crisis
Not everyone agrees this is the way forward. "The whole thing is ludicrous and will backfire and Ecuador will show that," Arturo Porczecanski, Americas analsyt at ING Barings said.

His forecast is that, "Ecuador will become a ward of the G7. No one will lend a cent to them again."

Mr Porczecanski holds beliefs echoed elsewhere in the financial community

. First, if Ecuador believes that by defaulting, it can escape some of it's debts, others will follow. The risk is that in Pakistan, Romania and the Ukraine, he says, the public sector will encourage them not to pay their debts.

Secondly, he says, "After the tens of billions poured down the drain in Asia to support exchange regimes which were fundamentally flawed_it would have been a small price to pay to prevent Ecuador defaulting."

Default will hardly prove an easy option for Ecuador, then, though it will most likely get a reduction in the face value of its debt.

That will be of major help to the economy, which is expected to contract by 7% this year. As it stands the country's total foreign debt is $13bn and the interest payments on this soak up 42% of the budget.



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01 Sep 99 | Americas
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27 Aug 99 | Americas
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