News: Ecuador repudiates bonds

The article Emerging-market debt after Ecuador on Reuters July 8th, 2009 discusses the approach of Ecuador to their outstanding debt obligations: unilateral default.

The effect of Ecuador’s default is two sides of the same coin. First, it sets a precedent for other similarly situated debtors, who may follow in Ecuador’s footsteps. Second, it appears to set a precedent for those who may follow in Ecuador’s footsteps, which appearance may be the groundwork for establishing a new category of risk for sovereign debtors.

This act by Ecuador appears to be a calculated risk, albeit a risk in isolation. As Lee Buchheit observed, “Financial markets today tend not to hold grudges the way that predecessor financial markets used to. So the traditional cost of a brutal restructuring is not one that they have to pay any more.”

The risk, of course, is not that Ecuador’s future bondholders retain a memory, but that an swath of sovereign debtors, including Ecuador, be reclassified as higher risk (and therefore subject to higher compound interest rates).