The people of Ecuador are rising up to refound their country as a pluri-national homeland for all. This inspiring movement, with Ecuador's indigenous peoples at its heart, is part of the revolution spreading across the Americas, laying the groundwork for a new, fairer, world. Ecuador Rising aims to bring news and analysis of events unfolding in Ecuador to english speakers.

Saturday, December 20, 2008

Ecuador May Be Forced to Scrap Dollar After Default

By Lester Pimentel and Matthew Walter

Dec. 17 (Bloomberg) -- Ecuador’s default on $3.9 billion of international bonds means it’s only a matter of time before the country drops the U.S. dollar as its currency, Goldman Sachs Group Inc. says.

Ecuador’s use of the dollar gives President Rafael Correa no outlet for providing credit to the economy as access to foreign financing dries up and revenue from sales of oil, the nation’s biggest export, tumbles. Correa, a critic of so-called dollarization, also may use the default as an excuse to abandon the policy, said Alberto Ramos, a Latin America economist with Goldman Sachs in New York.

“Fiscal pressures will increase at the same time that the economy starts to underperform,” Ramos said in an interview. “I would not make a bet that we will have dollarization in three to five years.”

Ecuador joined Panama and El Salvador in adopting the dollar in 2000 to help curb inflation after the sucre tumbled 73 percent against the dollar and the government defaulted on $6.5 billion of foreign debt. While the dollar policy has cut inflation to 9.1 percent from 91 percent in 2000, it provides the government less flexibility as the economy slows, said Albert Bernal, head of fixed-income research at Bulltick Securities Inc.

“Exiting dollarization is not a question of ‘if’ but ‘when,’” said Bernal, a former Bear Stearns Cos. analyst whose Miami-based firm specializes in Latin America. He predicts Correa will reinstitute a local currency within one to two years.

“If you can’t grow credit, you can’t grow your economy,” Bernal said. “This will lead them to exit dollarization.”

‘Anchor of Stability’

Growth in Ecuador’s $44 billion economy will slow to 2.1 percent in 2009 from 5.9 percent this year, according to New York-based Merrill Lynch & Co.

Steven Hanke, the professor of applied economics at Johns Hopkins University in Baltimore who advised Ecuador on its switch to the dollar in 2000, said Correa may have difficulty abandoning a policy that has popular support.

“Dollarization provided an anchor of stability and kept interest rates and inflation low,” Hanke said. “The consequences of abandoning dollarization would be quite negative. He needs to convince the population that he’s right and they’re wrong.”

The last country to give up the dollar as its currency was Liberia in 1985, Hanke said. Many Liberians still prefer to use the dollar, he said.

‘Not a Fan’

Correa, a 45-year-old economist who earned his Ph.D. at the University of Illinois at Urbana-Champaign, called the currency system “a complete failure” in an April 2007 speech in Guayaquil, Ecuador’s largest city.

Even though Ricardo Patino, Correa’s policy minister, said Dec. 15 that the default won’t bring an end to dollarization, Goldman Sachs’ Ramos said the government is unlikely to maintain the policy.

“We know that Correa is not a fan of dollarization,” Ramos said. “I don’t think he’ll go the extra mile to defend dollarization.”

Ecuador will seek to force a “big discount” on holders of its $3.9 billion of foreign bonds in a restructuring, Correa said Dec. 13. The day before, he said the government would skip a $30.6 million interest payment on one of the country’s three bonds because the debt is “illegitimate” and “illegal.”

World War II

An audit commission created by Correa found irregularities in the debt in a November report. All three securities trade at less than 30 cents on the dollar, indicating investors expect Ecuador to offer the smallest payout of any sovereign debt restructuring since World War II, said Arturo Porzecanski, an international finance professor at American University in Washington.

The 2012 bonds trade today at 25.25 cents, down from 31 cents on Dec. 11 and 97.5 cents three months earlier, according to JPMorgan Chase & Co. The $2.7 billion of bonds due 2030 are trading at 23.75 cents while the $650 million of bonds maturing in 2015 are at 23.5 cents.

Correa may impose limits on capital flows and bank deposits to keep money in the country before changing the currency policy because giving up the dollar won’t be easy, said Eduardo Levy- Yeyati, head of emerging-market strategy at Barclays Capital Inc. in New York.

“You have to reintroduce a new currency for which there is no longer demand,” Levy-Yeyati said.

Inflate Oil Proceeds

Such a change would enable Ecuador to weaken its exchange rate and increase revenue in local currency terms from sales of oil, which accounts for 60 percent of the nation’s exports. Oil has tumbled 73 percent from a July record of $147.27 a barrel.

Ecuador needs an oil price of $95 to cover all the spending in its budget, according to Barclays. The government had a surplus of $508 million in the first half of the year, Correa said Sept. 20.

“Correa’s only choice for growing the economy is the public sector,” said Bernal at Bulltick. “The lower the price of oil goes, the more the need for Correa to deliver on the fiscal front. Ecuadoreans will only live with Correa as long as they have expectations of growth.”

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