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Ecuador: Hopeless

Ecuador is heading towards debt default, an end to dollarization, soaring inflation and economic decline.


Despite seven years of economic stability, Ecuador is on a crash course with disaster. President Rafael Correa is on a reckless mission to consolidate all political power in his hands, even if it means bringing the country to its knees.

Once known for its political instability, Ecuador went through six presidents in a period of 10 years. The deep division between the sierra and the coast, constant indigenous unrest and highly independent political institutions ensured that no president would last more than two years. This is why many Ecuadorians brushed aside the election of Rafael Correa in 2007, an outsider with no major political clout. They thought that he would soon join the list of former chief executives.


However, with the resources of Hugo Chavez and a bent to consolidate all political power within his hands, the PhD in economics became the most powerful caudillo to govern the Andean nation since León Febres Cordero. Like his Bolivarian brothers, Correa is only interested in one thing—remaining in office for ever. He also has messianic visions of social revolution. However, Correa’s revolt is more of a Maoist type of transformation that seeks to isolate the country, purge external influences and undo five hundred years of European colonization and influence. Like Mao, Correa is willing to burn the Ecuadorian economy to the ground and transform it into a backwater of self-sufficient poverty. An estimated 80 percent of Ecuadorians live at or below the poverty line. Therefore, the change would affect a small minority.

A third-rate producer of oil and bananas, Ecuador surfed the commodity wave of the past few years. The external accounts improved, and the central bank accumulated more than $6.2 billion in international reserves. This was in sharp contrast to the $800 million in reserves that it had at the turn of the decade. Moreover, dollarization was a fortuitous monetary experiment
because it occurred at a moment when the greenback went into decline, giving the country enormous competitive advantage against its traditional trading partners, Colombia, Peru and Brazil.

Unfortunately, the recent appreciation of the dollar coincided with the collapse in commodity prices, and Ecuador could soon be in dire straits. The relatively huge $2.2 billion current account surplus that was recorded this year will become a gapping $1.4 billion shortfall in 2009. The shortfall will be worse if remittances continue to decline. This is one of the reasons why the government is taking a second look at dollarization. A move to a new currency would allow the  government to devalue and take more control of the external accounts. Moreover, the end of dollarization would give it more control over the fiscal accounts.


The recent constitutional reforms will allow President Correa to run for office in April. Hence, the government embarked on a wild spending spree. The decline in commodity prices and the limits of dollarization will reduce the government’s ability to control fiscal policy, which is another reason why the Ecuadorian leader is building a case for the end of dollarization.

Unfortunately, a default will facilitate the transformation. International banks and financial institutions will cut  credit lines. There will be a run on the banks as households try to preserve their savings, and the government will eventually be forced to introduce a new currency. The consumer binge will come to a sudden end, inflation will soar and the economy will tank. Nevertheless, President Correa believes that this is the recipe for remaining indefinitely in power.

It is unclear whether Ecuador will default now or later, but a moratorium is on the horizon. Ecuador’s debt loads are not the problem. Total foreign debt is $10 billion, with $3.8 billion in bonds. Given that the debentures are trading at 25 cents on the dollar, the country could erase its market obligations without having much of an impact on its stock of international reserves. However, Correa is after something else. He is looking to isolate the country, just like Mao and Castro. This is the reason why he is also refuting Brazil’s bilateral debt and the $2 billion it owes to CAF.

As most caudillos know very well, the political power of an economically isolated leader is infinite. This is the reason why the decision to impose embargoes on countries such as Cuba, North Korea and Iran, were futile because they only increased the power of the leadership to arbitrarily decide the allocation of economic resources. Moreover, all Caudillos need a visible enemy. There is no opposition party in Ecuador. Therefore, Correa is transforming foreign creditors into the villains. Ecuador is on a crash course to disaster, and there is nothing much any one can do except, watch it implode.

Walter Molano is head of research at BCP Securities. 



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