Ecuador: Effects of Global Recession and Future Prospects

In recent postings, I have commented on the difference between the growth prospects of developed and emerging market economies. I have also noted the remarkable recovery in Latin American stock markets relative to the rest of the world.

I have just completed a series of articles co-authored with my students at the Business School at the University of Palermo in Buenos Aires. These included articles on Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. The articles assess the impact of the global recession on these countries and their future growth prospects.

The following study on Ecuador was written by Diego Gauna, a professor in the economics depeartment and business school at the University of Palermo. Professor Gauna and I will shortly publish a summary article on the effects of the global recession on Latin America. This article and all the country studies will be published as a special issue of the Palermo Business Review.

Professor Gauna’s article on Ecuador is presented below.

Ecuador: Effects of Global Recession and Future Prospects

by Diego Gauna

Introduction

Ecuador is one of the poorest countries in Latin America. Excluding Bolivia and Paraguay, it has the lowest GDP per capita in South America.

The performance of Ecuadorian economy had been disappointing. It entered the new Century with the same per capita income it had in 1980, reflecting a long period of stagnation and economic downturn. During the local financial crisis in 2000, the local currency was eliminated and the US dollar was made the official currency.

Historically, the economy was based on commodity production, especially crude oil and bananas. In 2008, agriculture and mining’s share of GDP was 30.4% and the primary export share of total exports was 76%. Clearly, the Ecuadorian economy has a high degree of vulnerability to commodity price fluctuations. Periods of high growth in Ecuador coincide with periods of high commodities prices (1973-1978; 2001-2008).

Ecuador has the highest percentage of remittance inflows in Latin America. In 2007, remittances as a percent of GDP were 6.9%. The main sources of remittances are the US (47%) and Spain (41%) followed by Italy (7.5%).

In trade, Ecuador is highly dependent on US. In value terms, 45% of Ecuador exports went to the US and 20% of its imports came from there in 2008.

Ecuador has one of the most underdeveloped stock markets in Latin America. The stock markets of Quito and Guayaquil are extremely narrow, with few firms and low levels of liquidity. Excluding Paraguay, Uruguay and Venezuela for no data, Ecuador has the lowest ratio of stock market capitalization to GDP in Latin America. In 2008, this ratio was only 9% (World Development Indicators, 2009).

Ecuador has one of the worst investment climates in Latin America. Ecuador ranks 133rd in the Doing Business Index (World Bank) with only Bolivia and Venezuela lower. It interest spread is higher than any other Latam country.

The most notorious characteristic of Ecuadorian economy is the dollarization regime. Because of the dramatic financial crisis by the end of 1999 and the los of confidence in the local currency, Ecuador adopted the US dollar as the official currency. This policy reduced the inflation rate and stimulated economic growth after the year 2000, but at the same time, the government lost control of fiscal and monetary policy to stabilize the economy. It could reduce aggregate demand by increasing taxes or reducing expenditures, but its ability to stimulate the economy is limited by its holdings of US dollars.

Ecuador has experienced large and volatile rates of inflation. During the nineties, the inflation rate was above 20% every year, reaching almost a 100% in 2001. With the dollarization regime, the inflation rate fell steadily. In 2004-2007 period, the average rate of inflation was less than 3%. Inflation pressures emerged during 2008, mainly because of the rise in international commodities prices.

Crisis Effects

The global recession impacted Ecuador via the following channels:

  1. Sharp drop in commodities prices, especially oil prices.
  2. The lower demand for exports resulting from the US credit crisis.
  3. Lower remittances resulting from higher unemployment in Spain and USA.

Commodity prices fell sharply. The Ecuadorian crude oil price, which had hit almost US$120 per barrel in June 2008, dropped to US$27 per barrel in December. That means the primary export commodity of Ecuador lost more than of 75% of its value in only six months.

The oil price drop caused a marked fall in export values. 2009 exports were 25.6% less than in 2008. The average price fell 23.8% while volume was down by 2.5%. Oil export prices fell 40.3% and volume was down 7.6%. The average price of non-oil exports did not change while they increased in volume by 10%, primarily as a result of an increase in banana exports.

This has led to a downturn in Ecuador. Demand has fallen almost 7% between the third quarter of 2009 and the same period of 2008, mainly because of the drop in value of oil exports. The effects of global crisis started in the second quarter of 2009 and, since the first quarter of 2009, government policy has been to increase its expenditures.

Table 1 shows that public consumption was 5.35% higher in the second quarter of 2009 than it was in the same quarter in 2008 and 2.45% higher in the third quarter.

Table 1. – Ecuador: 2008- 2009 Changes in Expenditures (%)

2008-09

Internal

Consumption

 

 

 

Total

Change

Demand

Private

Public

Investment

Exports

Demand

1st Qtr.

2.60%

2.14%

0.02%

4.77%

-6.64%

0.04%

2nd Qtr.

-3.60%

-1.34%

5.35%

-4.02%

-9.17%

-5.13%

3rd Qtr.

-7.57%

-3.04%

2.45%

-8.06%

-4.91%

-6.88%

Source: Central Bank of Ecuador

Table 2 shows that with the exception of one quarter, public consumption has grown quarter to quarter starting in the third quarter of 2008.

Table 2. – Ecuador: Quarterly Changes in Expenditures (%)

Percent

Internal

Consumption

 

 

Total

Change

Demand

Private

Public

Investment

Exports

Demand

2008: II-III

5.38%

2.25%

2.97%

5.43%

-4.07%

2.78%

2008: III-IV

-0.11%

0.85%

2.75%

0.98%

-0.91%

-0.31%

2008-09:IV-I

-5.70%

-2.48%

-0.57%

-7.58%

-3.86%

-5.23%

2009: I-II

-2.89%

-1.91%

0.14%

-2.46%

-0.60%

-2.30%

2009: II-III

1.04%

0.48%

0.14%

1.00%

0.43%

0.88%

Source: Central Bank of Ecuador

The dollarization regime in Ecuador has impeded the use of exchange rate as policy instrument. The current account deficit moved from a surplus of US$1.6 billion in 2007 (3.6 % of GDP) to a deficit of US$427 million in 2009 (up to September). To correct this disequilibrium, Ecuador could not depreciate their currency to reduce the outflow and increase domestic expenditures.

Urban unemployment has increased from 7.1% in September of 2007 to 9.1% in September of 2009 (“Evolución de la Economía Ecuatoriana”, Enero de 2010, Banco Central de Ecuador).

Ecuador’s government depends on oil revenues: the oil revenue share in total revenues was 25% in 2000-2008. For this reason, the sharp fall in oil prices during global crisis contributed to the growing government deficit. The Central Bank of Ecuador estimates the government deficit at 3.5% of GDP in 2009, which is higher than the 1.5% deficit in 2008. It important to understand that unlike countries that have their own currencies, Ecuador is limited in what it can do to stimulate its economy to its US$ reserves. CEPAL estimated Ecuador’s international reserves at US$2.7 billion at the end of June, 2009. For all of 2009, LatinFocus estimates the government deficit at 4% of GDP, or approximately US$2 billion, leaving it with only US$700 million for stimulus in 2010 and following.

The Ecuadorian banking system was not significantly threatened by the Western banking collapse.

The stock market index of Ecuador fell 26% between December of 2007 and December of 2009. Ecuador’ stock market is not recovering to levels attained prior to the crisis. This contrasts with most Latin American countries where stock prices have recovered. (excluding Venezuela). It is important to keep in mind that Ecuador’s stock market is precarious and index movements have little economic significance.

Policy Responses

As indicated above, the dollarization regime in Ecuador limits what the government can do to mitigate the consequences of the global recession. The only way the government can run a deficit to stimulate the economy is to draw down its international holdings of dollars, and these holdings are limited.

It is important to note that maintaining a fiscal and external equilibrium is the key factor to sustain the dollarization regime.

As table 2 shows, Ecuador chose to increase public spending in 2008, but then held them steady because of the sharp deterioration in government revenues. In 2008, President Correa got a new article enacted into law that eliminated the independence of the Central Bank.

Ecuador introduced restrictions on imports to restore the equilibrium in the current account. These policies included an increase in the import tariff rate (December ’08), quantitative restrictions (January ‘09) and tariff barriers (July ’09).

Prospects

Table 3 provides World Bank growth estimates for Latin American countries. Ecuador is expected to recover as oil exports increase.

Table 3. – World Bank Latin American GDP Growth Estimates

Country

95-05

2006

2007

2008

2009

2010 est.

2011 est.

Argentina

2.3

8.5

8.7

6.8

-1.5

1.9

2.1

Brazil

2.4

3.7

5.7

5.1

-1.1

2.5

4.1

Chile

4.2

4.3

4.7

3.2

-0.4

2.7

3.6

Colombia

2.1

6.8

7.5

2.5

-0.7

1.8

4.0

Ecuador

3.2

3.9

2.5

6.5

-2.6

1.8

3.1

Mexico

3.6

4.8

3.3

1.4

-5.8

1.7

3.0

Peru

3.3

7.6

9.0

9.8

3.0

4.3

6.0

Venezuela

1.6

10.3

8.4

4.8

-2.2

-1.4

1.2

But serious problems remain. LatinFocus estimates that the countries unemployment rate will increase to 10% and stay there, at least through 2011.

Ecuador has difficult choices in the short run. If Ecuador continues with the dollarization regime, the recovery will be slow and painful for their economy and their workers. The radicalization of Correa polices the bad investment climate and the volatility in oil markets lead to pessimism about the country’s future. Ending dollarization would allow the government to again exercise monetary and fiscal policy. But introducing a new currency will not be easy and could generate panic and instability in local financial markets.

The content above was saved on the old Morss Global Finance website, just in case anyone was looking for it (with the help of archive.org):
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