Credit improvement in Latin America to slow, says Fitch

By Reshmi Basu

New York, Jan. 18 - Fitch Ratings said it expected to see credit improvement across Latin America to slow down, as the region has clearly shifted to the left following last year's heavy election calendar.

The region faces a multitude of risks, noted Theresa Paiz-Fredel, a senior director in Fitch's Sovereign Group, during a teleconference held on Thursday to discuss the region.

Among the risks are a spike in U.S. interest rates and widening spreads; a sharper global slowdown than originally anticipated; a hard landing in China, and political shocks - such as the emergence of the leftist front, which could lead to a loosening of orthodox fiscal polices.

Nonetheless, the region is in better shape to absorb such shocks, given the substantial improvement in external financial ratios and macro policies.

"Though softening, external conditions remain generally favorable for the region, as commodity prices remain high by historical standards, global growth is still relatively robust and emerging market bond spreads have reached new historic lows," she said.

"However, electoral outcomes over the past 20 months suggest that gradualism on key structural reforms that would ensure the sustainability of healthy medium-term growth prospects is likely to prevail.

"With this as a backdrop, Fitch expects credit improvement to slow in 2007."

In terms of upgrades for the region, Fitch provided insight into what was needed for higher rated speculative-grade Latin American countries, which include Brazil (BB), Colombia (BB), Costa Rica (BB), El Salvador (BB+), Panama (BB+) and Peru (BB+), to move up to investment-grade status in the near future.

However, the ratings agency said that investment-grade status for these sovereigns is unlikely to be achieved over the next 12 months but "faster-than-expected growth and improvement in key external and fiscal solvency ratios could engender greater dynamism in the ratings."

The breakdown of constraints is as follows:

• Brazil, Colombia, and Panama suffer from heavy debt burdens;

• Costa Rica needs to improve policy framework (i.e. recapitalize the central bank);

• El Salvador needs to see improvement in growth and fiscal performances;

• Peru is constrained by heavy dependence on commodities and high external debt.

Ecuador outlook

Turning to Ecuador, Fitch maintains a B- on its long term foreign currency rating and a negative outlook on the credit.

Prior to his inauguration, the question was whether president Rafael Correa would default on the country's external debt. But now the question has become whether the Andean nation would make its Feb. 15 coupon payments.

"He has been very consistent in saying that he will restructure debt... and the country will choose life over debt," noted Morgan Harting, senior director.

As a signal of his commitment to social change; Correa doubled welfare benefits on his first day in office. Additionally, he plans to reduce the VAT and impose a new tax on assets.

"These sorts of commitments lead to less room for debt service," Harting added.

Furthermore, the country said it would pay off the coupon payment due in February if there is cash on hand, which makes Correa's "willingness" a key factor.

Ecuador macro view improves

Paradoxically, Ecuador's macro picture has improved substantially in recent years, noted Harting.

Ecuador's debt to GDP ratio is now down to 35% from 67% in 2001, a noteworthy number given that to cross into investment-grade territory, a country needs a ratio of less than 40%.

Public external debt has also been declining since 2003 and the central government is running a surplus. Additionally, financing needs are low at around 5% of GDP. High oil prices have created a windfall, although much of that cash is kept in trust funds, which creates tight liquidity conditions.

"Their ability to pay their debt is clear. It's all about willingness.

"That is our main credit concern," remarked Harting.

"For us the question is really whether or not we will call it a default?"

Harting explained that distressed debt exchanges are defaults. For instance, he noted that it would be considered a default to extend maturities without raising coupons. But it is not considered a default for Ecuador to get a bridge loan from Venezuela to buy back the bonds.

"It does seem difficult to envision what sort of option the government will come up with to dramatically reduce debt service without doing so by prejudicing bondholders," he said.

"This is a poker game at this point. It's in the government's interest to talk down the bonds in order to buy them back as cheaply as possible.

"If the government misses the Feb. 15 coupon and goes into a grace payment, we will likely downgrade the issuer default rating. The bonds will probably move down as well but more perhaps slowly," observed Harting in the report.

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