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The fall in oil prices makes it impossible to enact expansionary fiscal policies to combat the recession. Here a worker at Petroamazonas, which was downgraded by Fitch. (Photo: Petroamazonas)
Wednesday, March 25, 2020

Ecuador Catastrophe: Oil Shock & Pandemic

Pandemic, fall of oil prices predicted to have catastrophic effects on economy.

Inter-American Dialogue

Ecuadorean President Lenín Moreno said March 10 that he will seek to cut the government’s budget by $1.4 billion and improve the country’s debt payment terms amid the economic fallout of the coronavirus pandemic and the plunge in the price of oil, a key export for the Andean nation.

[Ecuador will use a 30-day grace period on some bonds to delay making around $200 million in interest payments due this week, and will devote those funds toward containing the coronavirus outbreak, Reuters reports. Fitch subsequently downgraded Ecuador’s sovereign rating and that of state oil company Petroamazonas]

How vulnerable is Ecuador to those two threats to its economy? Will Moreno face legislative pushback to his plan? Will social unrest flare up? Is Moreno taking the right actions in light of the developments, and what more should he be doing?

Daniela Chacón Arias, executive director at Fundación TANDEM and former Quito vice mayor and city council member:  Since the announcement, the crisis caused by the coronavirus pandemic has deepened, forcing the government to take extreme measures to prevent its expansion. The country is now under quarantine for 15 days with only basic industries functioning. Amid these measures, the government has assured Ecuadoreans that there will be economic aid to stimulate businesses’ recovery. Nonetheless, the impact of this quarantine on an already-weak economy will be immense. Ecuador is facing a triple menace: low oil prices, appreciation of the dollar and a higher country risk rate, which makes external indebtedness a costly option. Additionally, Ecuador has a high rate of informality in the economy, with only 39 percent of the population formally employed. The backbone of Ecuador’s economy is made up of small and medium businesses (formal and informal), which will suffer the most, making the recovery from this external and internal crisis long and painful. In the midst of all these problems, we are approaching presidential elections, and some of the political actors have not yet expressed their views on the future of the economy. Given the political weakness of Moreno’s government, many of us are expecting maturity from the political class and solidarity from the population, given that the measures to be taken will be hard, will affect everybody and will require support from across the political spectrum. The government will have to present a comprehensive package that takes into consideration the realities of inequality and the country’s informal sector. Otherwise, political and social support could be at risk. 

Vicente Albornoz, dean of business and economics at the Universidad de Las Américas in Quito: In the early years of the 21st century, Ecuador created funds using unexpected income from oil. During Rafael Correa’s short stint as finance minister in 2005, those funds were all but destroyed. Then, during the first eight years of Correa’s presidential term (2007-2014), the country enjoyed a long period of unusually high oil prices that gave the government unexpected additional income. Sadly, the government spent all of that income, and none of it was kept in any stabilization fund for a rainy day. Furthermore, the government, even during the oil boom, acquired substantial new debt. So when the boom ended, the country did not have any savings, and it was highly indebted. As the situation deteriorated, the country only reluctantly began an adjustment program. However, Ecuador’s public finances are grossly unprepared for the situation the country now faces, especially the fall in oil prices. The price per barrel is $30 less than the level set in the government’s budget. This means there is an significant deficit that will not be covered, even by the plans announced earlier this month. Ecuador should be seen as a cautionary tale about the need for savings in countries that depend on volatile prices of primary goods.

César Coronel Jones, founding partner at Coronel & Pérez in Guayaquil, Ecuador: Both the pandemic and the fall of oil prices are predicted to have catastrophic effects on Ecuador’s economy. Ecuador has carried a hefty budget deficit for more than a decade, which combined with the fall in oil prices makes it impossible to enact expansionary fiscal policies to combat the recession. In addition, being a dollarized economy also makes it impossible to use monetary policy. In short, Ecuador’s government is incapable of enacting any significant counter-cyclical policies in the face of the economic downturn. On the contrary, the government is essentially forced to do the opposite: to enact austerity measures in a time of recession. Moreno’s tax increases will likely face legislative pushback. However, the executive branch has the discretion to cut public salaries. As of now, there are no signs of social unrest, but unrest might flare up if more aggressive measures are taken, which will likely be necessary. Moreno’s measures are pointing in the right direction, but they are too shallow. Putting an end to fuel subsidies, substantial public-sector salary reductions or a significant reduction in labor regulations would be more effective at controlling the deficit, but they would be hard to achieve given the current political climate. Another option that Moreno could consider is a declaration of a temporary default on the national debt. Ecuador’s country risk rate is so high that a default would hardly have a real impact. 

Abelardo Pachano, president of Finanview in Ecuador, former CEO of Produbanco and former Ecuadorean central bank president: Within political and social constraints, the government’s decisions are going in the right direction, but they are insufficient. They lessen the situation, but they do not lead to structural changes to the issues that brought us to this complex situation. Since 2007, macroeconomic balances have been neglected, obligations have accumulated, public accounts have been inflated, savings mechanisms have been undervalued and, today, the country is financially suppressed and competitively deteriorated. Ecuador has no financial buffers. Without resources, a recession is imminent. The Ecuadorean Congress is still reluctant to make appropriate adjustment decisions. The government is confined to its political agenda. Correcting the economic policy course has encountered serious difficulties. Indigenous leaders maintain their threats if subsidies are eliminated or taxes are created. Despite all this, there is relative calm. Health measures are accepted as a priority, and businesses are seeking to safeguard what they have. The country requires emergency international resources, and the multilateral lenders are maintaining an open dialogue. The IMF is showing understanding. What is missing is a national political agreement that encompasses the most difficult challenges.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor


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