Rafael Correa, Ecuador’s new president, has been playing a game of chicken with the international capital markets.  Earlier this week the government announced that it would utilise a 30 day grace period to repay interest on its bonds – in effect, defaulting.  Yesterday, however, the government surprised the markets by making the payment on time. Predictably, the response in the bond markets has been volatility: first a massive selling off of Ecuadorian debt, then a rally.  All of this follows on a campaign promise by Correa to restructure the country’s debt.

There are two surprising things about this situation: the first is the on again off again behaviour of the government and the second is the fact that Ecuador has no reason to default – it is awash with liquidity from its commodity sales and has a low debt to GDP ratio (30% of GDP).   Default is expensive: it reduces credibility, can lead to expensive litigation and makes borrowing impossible for some time.  Government don’t usually do it lightly (though the timing of default is often affected by underlying political reasons – as was the case with the Argentine crisis of 2001).

Nor is it generally national policy to confuse the markets and generate volatility by threatening to default and then not following through.  But this behaviour is consistent with the eclectic campaign that Correa ran – mixing leftist / populist rhetoric and neo-classical economics – as recently explained in a post by Penelope Anthias.  This seems to indicate that Correa is playing a complicated game domestically as well as internationally – trying to please a highly diverse electorate that supported him because of this mix of ideologies and policies.  Correa has to appeal to all parts of the political spectrum – which could explain how threatening to default and then repaying in the end makes political sense.   Such behaviour is a potentially ruinous however: a similar pattern developed at the outset of the presidency of Fernando Collor de Melo, who governed Brazil as the first democratically elected president after the end of military rule from 1990 until he was impeached in 1992.  Collor drove the international capital markets to distraction by applying a highly inconsistent and unpredictable economic policy (one day heterodox, one day orthodox) which ultimately resulted in the necessity of another massive economic programme (the Real plan) to bring Brazilian inflation under control and restore credibility to the currency.

Framed in this light, it become more understandable why Ecuador is threatening to default when it is suffering from neither a liquidity nor solvency crisis: Correa is buying support at home from both sides of his constituency for a minimal short-term cost.    The question, as the Collor de Melo example illustrates, is how long the new president can keep up such a policy without doing more lasting damage.