Summary

Despite economic benefits from adopting the U.S. dollar in 2000, Ecuador could soon find itself with the same problems Argentina is facing. A dispute over how revenues from a new oil pipeline should be spent also could block $240 million in funds from the International Monetary Fund.

Analysis

Ecuador is enjoying the front-end benefits of adopting the U.S. dollar as its national currency in January 2000. The country has one of the fastest-growing economies in Latin America today, interest rates and inflation have dropped dramatically and demand is soaring for new mortgage and automobile loans.

According to Ecuador's Central Bank projections, a consumption boom is under way and even better times lie ahead, with the country's yearly economic growth expected to average at least 7 percent from 2003 to 2006 as a new $1.1 billion pipeline roughly doubles the country's oil exports. However, Ecuador's recent robust economic recovery rests on shaky foundations that likely will not be strengthened in the coming months as the country's political leaders and organizations focus on the October 2002 national elections.

When it adopted the U.S. dollar as its national currency, Ecuador lost the power and flexibility to fuel the economy by printing more currency or making exports more competitive by devaluing the currency. In fact, despite the economy's rosy outlook, the country easily could follow Argentina's path to default, devaluation and political turmoil in two or three years if its political leaders don't expedite critical reforms. These are needed to control public spending and boost Ecuador's competitiveness and productivity in key export industries like textiles, bananas, shrimp, flowers and petroleum.

The International Monetary Fund has deep concerns about Ecuador's overall fiscal outlook over the medium term, IMF spokesman Thomas Dawson said June 6 in Washington, D.C. These concerns likely are justified, given the track record of Ecuador's political leadership over the past decade of blocking or delaying key structural reforms that the country needs to reduce under-development and poverty.

In fact, Ecuador's adoption of the U.S. dollar in early 2000 was a desperate attempt by then-President Jamil Mahuad to avoid economic collapse and hyperinflation caused by years of poor government and bitter congressional resistance to reforms. However, his decision to do so triggered a short-lived military- and indigenous-led coup that toppled him and brought current President Gustavo Noboa to power.

The IMF, which is negotiating a $240 million aid program with Noboa's government, wants all of the future fiscal revenues from the new oil pipeline to be used in paying down the government's $14 billion foreign debt, which is equivalent to about 68 percent of Ecuador's projected gross domestic product in 2002. Of this total, about 52 percent is owed to private banks, 30 percent to multilateral lending entities and 18 percent to wealthy countries in the Paris Club group of creditor nations.

Specifically, the fund wants the government to commit 80 percent of its fiscal revenues from the pipeline to paying down its foreign debt, and put the remaining 20 percent in a rainy day fund that would be used to stay current on debt payments when oil prices fall in the future.

However, the Fiscal Responsibility, Stabilization and Transparency Law approved May 22 by Ecuador's Congress did not satisfy the IMF's preconditions for a new aid program, since it earmarked 70 percent of the pipeline's fiscal revenues to paying down the public sector debt and put 10 percent aside for social spending programs. Fund officials have indicated that if Congress does not reform this new law to eliminate the social spending category, the IMF likely will not approve the $240 million bridge loan the Noboa government is seeking to narrow its fiscal deficit this year.

With the price of Ecuador's oil exports averaging $25 a barrel compared to the fiscal 2002 budget's estimate of $19 a barrel, and with tax revenues running 20 percent higher than was originally budgeted for this year, it's possible that Noboa's government may follow the politically easier course of borrowing against future oil revenues to paper over the fiscal hole before a new president takes power in early 2003.