By Walker Simon - Analysis
NEW YORK (Reuters) - Ecuador votes Sunday for the framers of a new constitution, a step which could defuse volatility in the country's bond prices, but could also pave the way for radical 2008 reforms which may hurt the economy's repayment capacity.
The bond market has already priced in a resounding win by leftist President Rafael Correa's party and his allies in the elections for a constitutional assembly, so Ecuador's $3.8 billion in global bonds are unlikely to show any sharp reaction to that outcome, Wall Street analysts said.
Sworn in last January as Ecuador's eighth president in a decade, Correa in the past threatened to default on the country's debt.
Ecuador last defaulted on debt, totaling $6.5 billion, during a popular revolt in 1999 that toppled a president, so for investors in the country political instability is a chronic worry.
However, despite his leftist policy platform, a landslide win on Sunday by Correa may endow him with more authority, and at least in the short term that may reduce political instability and temper volatility in Ecuador's bond prices, analysts said.
"With a Correa win, there will be less political uncertainty in Ecuador, at least this year," said Goldman Sachs analyst Alberto Ramos. "But for next year, the risk dynamics increase with the possibility of an increasing radical agenda."
"We fear that the new assembly will validate greater government intervention, a laxer fiscal policy and this could hurt investment and expose Ecuadorean debt to the vicissitudes of international oil prices," Ramos added.
Ecuador's debt is rated by Wall Street as the least credit-worthy in Latin America. Downgraded deep into junk category, its bonds hover barely above default status.
"21ST CENTURY SOCIALISM"
Correa is an avowed admirer of Venezuelan President Hugo Chavez and both have vowed to build "21sth century socialism."
Applauded by Correa, Chavez this year launched a nationalization drive, targeting over $30 billion in assets in the oil, telecommunications and electricity sectors.
"Correa and Chavez have basically the same agenda," said Moody's economy.com analyst Juan Pablo Flores.
"They both want to increase the power of the state and eliminate the private sector's role in mining and energy."
The key difference is that Venezuela, one of the world's largest oil producers, pumps enough crude to easily repay its debt even in an oil price downturn.
But a price slump could jeopardize Ecuador's capacity to repay its debt, even if it wanted to, Flores said.
In addition, Ecuador's oil production has been declining for a decade, so a big question for Wall Street is whether the new constitutional assembly will adopt policies that would deter private investment seen as key to boosting oil output.
For now, Correa has sought to allay default fears, telling Wall Street investors on Tuesday in New York that Ecuador had ample income to meet debt payments and even launch new bonds.
He softened his hard-line stance in talking to Wall Street investors, said HSBC analyst Marjorie Hernandez.
"He showed signs of flexibility and pragmatism, talking about potential external debt buybacks and expressing satisfaction with Ecuador's 5.5 percent of GDP debt servicing costs for next year," she said.
"The last time he was here he talked about defaults and reducing debt service to 3 percent of GDP," she said, recalling his earlier statement about considering Argentina debt restructuring as a possible model for reducing Ecuador's debt burden.
Argentina in 2002 defaulted on $100 billion debt and restructured in 2005 at a steep loss to bondholders.
The next Ecuador bond payment litmus test comes on November 15, with $30.6 million due on its 2015 bond. Ecuador this year has kept investors on tenterhooks, only announcing days before a coupon is due if it will actually pay it.
RISKS ALSO SEEN IN AN OPPOSITION WIN
Because Sunday's vote falls under a complex proportional representation system, it can take weeks before the definitive makeup of the Assembly is known, analysts said.
An upset opposition win, while unlikely, also entailed the potential to hurt the business climate, said Lisa M. Schineller, Director, Sovereign Ratings at Standard & Poor's.
"A sharply divided Constituent Assembly following a strong opposition showing would complicate any sort of decision-making in the assembly and could impair the investment climate, but so could an assembly dominated by President Correa's supporters," she said.
The first exit polls are expected around 5 p.m. local time (6 p.m. EDT), with an independent quick count due around 8 p.m. local time (9 p.m. EDT).
(With additional reporting by Alonso Soto and Pat Markey in Quito and Saul Hudson in Caraca)
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