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Telefonica Ecuador CEO Jose Manuel Casas and Ecuador Central Bank President Mateo Villalba. (Photo: Ecuador Central Bank)
Wednesday, August 27, 2014

Ecuador: Instant Money

The risk of Ecuador’s new electronic currency.


Ecuador's new monetary and financial code will likely see the light of day much as it passed congress on July 24. President Correa said that he liked what he saw in the close to 600 articles and rules and bankers expect him to include minor items in his veto, including a reasonable extension for the deadline to implement some tax changes until January (the calendar year equals the tax year in Ecuador). But along with virtual legal impunity for the new regulatory board (Junta Monetaria) that will have broad powers to intervene in private banking, the new electronic money continues to cause worry.


In principle, the concept is simple. A person deposits cash into an account linked to the system and can then make payments through an electronic device, typically a mobile phone, at participating merchants or public offices. This could have numerous benefits, as countries as different as Kenya and Sweden show. In the case of Ecuador, merchants perennially short on coinage and other small change could reduce the need for them, or eliminate cash payments after dark for safety reasons. This would also improve the safety of taking a taxi. Another way transaction costs in the economy would drop is by allowing people to make remote payments, which could benefit people in remote rural areas in particular, if they have a connection to the cellular network. Ecuador's central bank (BCE) also points out that through electronic mobile payments people can avoid handling bills, which particularly in small denominations like individual dollars and five-dollar bills tend to be worryingly scruffy and limp rather than crisp. Also regarding security, reducing the cash transactions in society could help control the problem of money laundering, where Ecuador is facing particular scrutiny from the Financial Action Task Force, an anti-laundering organization. A reduction in cash would help to formalize the economy and make it harder to launder bills. Scandinavian countries already register a decline in demand for cash, through the use of debit and credit cards as well as through mobile payments. BCE president Diego Martínez summarizes its benefits as "clean, cheap, safe, (and) fast."


The major difference from models in other countries consists in that the government and the BCE it controls have insisted on routing this through the central bank and that this implies a kind of new currency. "The electronic money system in other countries is a private mechanism, while in the country it will be a public service," according to finance minister Patricio Rivera. This runs in tune with the discrimination the government has applied to the financial industry (along with media companies). For all its length, regarding specifics, the new monetary code has few of them touching upon the new money. Article 36, numeral 20 gives the BCE the exclusive right to issue "national metallic money, as well as electronic money," which, for the electronic currency, is repeated in article 99. Articles 92 and 96 prohibit any other currencies, such as Bitcoins. All transactions "will be expressed" in US dollars, while electronic money shall be "equivalent and convertible to dollars." BCE regulations issued in June as the controversy grew remain valid under the new law, officials say. This means that the BCE will only provide electronic money in exchange for US dollars, dollar-denominated coins minted by the BCE, or US-dollar deposits "duly credited in favor of the BCE." They also say that the BCE will fully back the electronic cash with liquid reserves matching those of the RILD, booking the cash as a liability. Also, the BCE promises not to accept government or private-sector bonds as collateral for electronic money.


But crucial ambiguities remain. The minted quantity of Ecuadorian coins in circulation is less than $90 million. To replace them with Ecuadorian electronic cash would be a positive step, but the term "convertibility" implies a risk that individuals could therefore see them as separate from actual dollars. Electronic money of course already exists in a sense whenever depositors access their cash through the Internet or via an automatic teller machine. Two other articles in the financial code open loopholes for BCE to press the button on opening the floodgates on electronic currency issuance. Article 55 says that the BCE can't take on government debt ""except to implement contingencies of public companies." Article 93 meanwhile obliges the BCE to provide adequate liquidity for the economy. In the event of a crisis, it's unclear how the BCE will technically respond, making this an apparent exception to the rule that the central bank can't be a lender of last resort because Ecuador doesn't have its own currency. Additionally, the BCE regains the ability to carry out open market operations and provide credit via rediscount lines. This poses a risk of provoking a spike in transaction costs as people and companies could become confused whether they are receiving electronic or real US dollars. The details regarding the rediscount operations give added reason to fear that this will happen. On the one hand, the BCE still says that it will back the electronic issuance with cash. On the other, the monetary code eliminates the BCE's four-account booking system designed in 2000 to provide confidence and transparency regarding the real availability of dollars in Ecuador. A simple regulation issued by the new all-powerful monetary board could easily ease the theoretical legal limits on issuance. Worse still, the law permits the BCE to step in and provide banks with emergency BCE loans, even if only for 30 days.

In practical terms, the government's track record implies that it will test the waters with some caution once the system is up and running (not before October). Critics say that the government will be tempted to inject electronic money through the public sector. Finance minister Patricio Rivera denies this, saying that, "civil servants won't be paid with electronic money because the electronic money system is a voluntary system." In the mess of hierarchies that correista legislation has wrought, where a presidential decree like Decree 16 (regulation of non-governmental organizations) can eliminate basic rights guaranteed in the 2008 constitution, Rivera's comments could be disingenuous. If managed poorly, electronic money could begin to withdraw cash rather than trade it in. Bankers say that this hasn't yet happened, but in a more sophisticated economy, it already would have.

This commentary originally appeared in Ecuador Weekly Report published by Analytica. Republished with permission.

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