Publish in Perspectives - Wednesday, January 30, 2019
Dollarization has helped Ecuador deal with political crises and populist policies, experts say. Here business and trade hub Guayaquil. (Photo: Guayaquil)
Nearly two decades of dollarization have helped Ecuador, experts say.
BY LATIN AMERICA ADVISOR
Nearly 20 years have passed since Ecuador’s decision to dollarize its economy in January 2000. What have been the advantages and disadvantages of dollarization for the South American country? What consequences does having a dollarized economy have on Ecuador’s economic situation today, and will it ever go back to floating its own currency? How likely is it that President Lenín Moreno’s government will resort to the International Monetary Fund to help resolve its latest economic problems?
Mauricio Pozo, former Minister of Finance of Ecuador and academic advisor at Universidad Internacional SEK: Ecuador underwent dollarization 19 years ago. It has been clearly positive, allowing the country to adequately deal with political crises such as those that occurred at the beginning of the 2000s, with the overthrow of two then-presidents. Without dollarization, such incidents would have meant deep macroeconomic imbalances such as the accelerated depreciation of Ecuador’s currency, rapid inflation growth and disproportionate hikes to interest rates, precisely as occurred in 1999 before dollarization. Likewise, under the sucre, the fiscal disorder as seen in the last few years, which translated into high fiscal deficits, would have led to the depreciation of our currency in order to cover fiscal imbalances. Or, simply, the budget deficit would have been covered by printing money without backing, thus producing serious macroeconomic imbalances similar to the problems that Venezuela currently faces. Dollarization requires a flexible and modern labor market, the free flow of capital and sound public finances with savings in order to avoid adverse impacts of shocks, especially external shocks. These requirements, among others, have not been met. This has weakened the exchange regime of dollarization. However, dollarization has the confidence and the support of a large majority of Ecuadoreans, which makes the return to a national currency almost impossible. Exports, investment, remittances and external financing are the sources that drive dollarization, and it is where the government must focus its efforts.
Pablo Zambrano, executive president of the Industry and Production Chamber (CIP) in Ecuador: Although the U.S. dollar was already widely used for financial transactions in the late 1990s, in January 2000 the authorities took the dollar as legal tender and abandoned the Ecuadorean sucre as a last resort amid a serious economic and financial crisis. This decision was inevitable, given the risks of hyperinflation and further capital flight. The legacy of dollarization has been lower exchange-rate risk, the stabilization of salary purchasing power and increased private investment, undoubtedly driven by decreased price and policy uncertainty. Indeed, dollarization is a national asset, and it has more support than any politician or soccer team. The decreased policy uncertainty has a flip side, however. Dollarization means that domestic monetary policy, a tool in most small countries to counterbalance negative shocks, is impotent. Further, without a currency of its own, Ecuador remains at the mercy of U.S. economic developments and the resulting effects of these on the relative value of the dollar. Adjustments to currency value misalignments are necessarily absorbed through domestic activity and employment, as without the option of currency depreciation, competitiveness can only be restored through productivity improvements and the resulting price falls. However, while dollarization has its costs, it remains a bedrock of economic and political stability in Ecuador. As an unyielding restriction on monetary manipulation, dollarization shields citizens from populist politicians and their abuse of the public purse to promote short-term political goals over long-run system sustainability. Currently, Ecuador is facing the consequences of Correa’s fiscal policy mismanagement. The nation is now in the process of renewing the social pact necessary to sustain a robust dollarized economy. It is highly unlikely that President Moreno or any other politician will try to adopt a national currency. Moreover, de-dollarization is a move that would not only further weaken national institutions, but also make the current debt situation worse. The reality is that Ecuador needs dollars to finance its adjustment. Given international conditions, an agreement with the IMF is imperative. The expected arrangement with the IMF will boost investor confidence in the country, stimulating capital flows, and lay the foundations for progress toward stable economic growth.
Marco Naranjo Chiriboga, professor at Escuela Politécnica Nacional and Pontificia Universidad Católica del Ecuador: There has certainly been enough time to evaluate Ecuador’s dollarized monetary system. The advantages have definitely been clear, especially in relation to monetary stability. Ecuador, thanks to dollarization, has had single-digit annual inflation—less than 1 percent in the last two years, 0.2 percent in 2017 and 0.27 percent in 2018—and has eliminated exchange-rate risk. This contrasts with the previous 20 years. Between 1980 and 1999, cumulative inflation reached 44,000 percent, and cumulative devaluation of the sucre surpassed 73,000 percent. Monetary stability has allowed for economic recovery, which, except in 2016, has shown positive growth rates. Per capita income went from $1,300 in 2000 to a little more than $6,400 in 2018. Although Ecuador is currently undergoing an economic stalemate, the average economic growth rate for the 2015-19 period is 0.76 percent, and GDP rose from $99.29 billion in 2015 to $109.45 billion in 2018, according to the Central Bank. Per capita income in that period increased from $6,099 to $6,430. Dollarization has definitely contributed to the fact that the slowdown has not become a recession, and especially, to upkeeping monetary stability, which would have been impossible without the system—the government would have had to recur to inorganic emissions of money and devaluation to cover the fiscal deficit in the face of falling oil prices. Since 1972, the Ecuadorean economy depends on oil exports, which make up one-fourth of our fiscal income. When hydrocarbons prices increase, public spending tends to increase considerably. When prices fall, public spending is financed by increasing public debt and new taxes, which have a recessive multiplier effect on the economy. However, the public debt acquired in recent years is expensive, with interest rates at almost 10 percent, which makes payments highly onerous (almost 10 percent of GDP, 50 percent of exports and more than one-third of the general budget). Ecuador needs a program that sets spending priorities and restructures public debt. For this, a deal with the IMF is imminent.
Vicente Albornoz, dean of business and economics at Universidad de Las Américas in Quito: On balance, Ecuador’s dollarization experience has been positive, not just because of what has been achieved, but also because of what has been prevented. Dollarization gave society confidence in the currency, and this had many positive consequences. The first was a fall in inflation, which dropped from 108 percent in September 2000 to less than 4 percent in January 2004. Such a sharp drop in inflation tends to require an economic contraction, but thanks to dollarization, this was not necessary, and the Ecuadorean economy’s growth was not interrupted. A consequence of the decrease in inflation was that savings and credit were able to grow. Credit’s increase occurred especially in the long term, which has allowed for increased investment in the country. With the exception of two quarters in 2009, Ecuador’s GDP grew every quarter since the second quarter of 2000 until the first quarter of 2015—an unusually long period of growth in Ecuadorean history. But the biggest advantage of dollarization has been preventing Ecuador from becoming Venezuela. The inexistence of a national currency impeded a populist government that was willing to maintain high public spending even at high fiscal costs—such as Rafael Correa’s government—from issuing inorganic money, thus unbalancing the economy completely. After so many years of stability, it is unthinkable for Ecuadoreans to return to a national currency, and an ‘organized de-dollarization’ is technically impossible.