Ecuador’s 10-year experiment with dollarization is at a crossroads. Unless public spending can be reined in and the government can come up with a sound budget, the experiment could collapse in the medium term.
That would be a severe setback. A January 2009 survey by the Market polling firm suggests that 80 percent of Ecuadorans approve of dollarization—with good reason.
The elimination of the sucre, which had lost 300 percent of its value in the 18 months preceding dollarization, has created a long-needed sense of financial stability. Ecuador’s GDP grew an average of 5 percent annually from 2000 to 2006, more than double the rate of growth during the 1990s. However, from 2007 to 2009, the average growth rate fell to 3 percent annually. At the same time, the 3 percent annual inflation rate seen in the last 10 years shows that the suppression of monetary policy has helped Ecuador become one of the most stable currency regimes in international markets.
In contrast to the inflation and devaluation of the 1990s, dollarization has introduced a sense of stability that has directly benefited Ecuadorans. From 2000 to 2006, real family income increased 14 percent. In the last four years (through June 2010), real salaries rose an additional 25 percent.
The urban poor in particular have reaped clear gains from the policy. At the time when the government introduced dollarization in December 2000, 54 of every 100 Ecuadorans were living below the poverty level. Six years later, the Instituto Nacional de Estadísticas y Censos de Ecuador reports this figure dropped to 26 percent. As of December 2009, the urban poverty rate fell to 25 percent.
At the same time, the minimum annual wage—now in a reliable currency—rose from $67 in 2000 to $280 in 2010. And as a result, Ecuador is experiencing an influx of workers from countries such as Colombia and Peru.
But fiscal policies have shifted since President Rafael Correa came into office in January 2007.
The President has stepped up government intervention in the economy, boosting public spending to deliver on his campaign promises of increasing social outlays and expanding government efforts to reduce poverty and inequality. During the first six years of dollarization, expenditure in the non-financial public sector (NFPS) amounted to 25 percent of GDP. This figure has escalated to 39 percent of GDP, on average, during the last four years—a trend that threatens the strict fiscal discipline necessary to survive a fixed exchange rate model.
Correa’s subsidy policies are also threatening the long-term survival of dollarization.
In 2010, a general fuel subsidy, electricity subsidies, a monthly stipend for more than a million poor Ecuadorans, and a subsidy for the poor to afford housing and agricultural products totaled approximately 7 percent of GDP. These expansionary fiscal policies are simply unsustainable with a monetary policy constrained by the rigors of a dollarized economy.
On top of that, government intervention since 2007 has led to a decrease in private investment—a prime driver of employment. It is not surprising that the creation of 91,000 new government jobs has been accompanied by the loss of 100,000 formal jobs over the same period. The lack of private investors has become a drag on Ecuador’s economy and job growth: today 2.6 million people are either unemployed or underemployed.
Today, even government proponents like Alberto Acosta, the former president of the constituent assembly, have recognized that employment is the government’s Achilles’ heel.
Sustaining dollarization is Correa’s top priority in the fourth year of his administration. Economic stability will depend to a large extent on the price of oil—though both production and exports have fallen. But the government will also need to put the brakes on public spending, find new and much-needed sources of income, and develop a sound, viable budget.
The alarm has already sounded. This year’s annual budget calls for a 6 percent deficit in NFPS spending as a percentage of GDP. On top of that, since 2008, the Correa administration has sold $3 billion in domestic bonds to the Instituto Ecuatoriano de Seguridad Social (IESS) to finance current expenditures.
The Central Bank has also used $500 million of its liquidity to finance the public budget. Last year, the government had to borrow $1 billion from China—under less than favorable conditions—to keep it afloat and another $1 billion was being negotiated when this magazine went to press. Additionally, its credit line is maxed out with the Corporación Andina de Fomento and the Inter-American Development Bank.
Against this background, it is questionable whether the Correa administration can continue to sustain its ambitious, multiple campaign pledges.
Ecuador would do well to learn from the recent chaos in Greece—another country with a strong currency but out-of-control public spending. While the circumstances of the two countries are quite different—Ecuador, for example, does not have an excessive national debt—the risk of a currency collapse is a possibility without better policy management.
In order not to endanger the stability and growth brought on by dollarization, Ecuador must get its fiscal house in order.