Ecuador’s president Rafael Correa has taken a step closer towards scrapping the country’s long-standing dollar policy, following a series of recent government moves which could derail the Andean economy, analysts have warned.
Magdalena Barreiros, a former economy minister who has met privately in recent months with top finance ministry officials, said there are hidden plans to create a body to issue a new currency. Barreiros, who previously served as undersecretary to Correa during the latter’s stint as economy minister, also warned that current policies are incompatible with a dollarized system.
“Correa’s economic policy is so expansive, yet he is closing external sources of financing all the time, so at some point he will need to issue a new currency system so he has the money,” she told Emerging Markets.
Alberto Bernal, Latin America fixed-income analyst at Bear Stearns in New York, agreed that the present currency system is hindering the president’s desire to implement an aggressive populist agenda, since dollarization places a natural limit on liquidity.
“Correa is radical and aggressive enough to move ahead with a dedollarization process because he cannot easily increase the salaries of low-waged workers like his counterpart in Venezuela as there is no independent monetary policy. It is just a matter of time as the country’s expansionary plans clearly disregard the limits of dollarization,” Bernal told Emerging Markets.
Correa, who took office in January 2007, said at the time he would abide by an earlier promise to keep the dollar as the country's currency during his four-year term. Yet, in a speech in April, he said: “the dollar has been a complete failure because we don’t have monetary policy.”
The firebrand leader in the past week has proposed constitutional changes that would erode the market economy, and there have also been threats this week against the largest foreign player in the country’s vital hydrocarbons industry.
The country defaulted on $6.5 billion of debt in 1999 and switched to the dollar as its official currency a year later. The switch revived the insolvent banking system, and dramatically slashed inflation from 108% in 2000 to just 2.9% last year.
However, Correa plans to boost social spending to 38% of the budget by the time he leaves office in 2010, up from 22% at present, as well as reducing VAT. His determination to pursue populist policies may be intensifying, after Congress this week pushed through a financial sector reform bill Correa had earlier vetoed, and opened an investigation into current Economy Minister Ricardo Patino, for allegedly helping Venezuelan banks to profit from the price manipulation of Ecuadorean sovereign bonds.
Ecuador’s oil sector – which represents around 60% of exports - has also come under threat, following a flare-up in tensions this week with Brazilian oil producer Petrobras. Attorney-general, Xavier Garaicoa, claimed the firm, which is central to Ecuador’s national oil output, has broken the terms of its contract.
Barreiros, in her interview with Emerging Markets, urged the energy minister to veto any legal ruling that would close down the company’s operations in the country, although she was not optimistic these pleas would be answered.
“I am immensely surprised by this decisison, throwing out Occidental Petroleum [a US oil company whose operations were closed down last year on a similar charge] was almost inevitable because it was a US company, but a Brazilian company is a different proposition altogether. This will bring no political benefits,” Barreiros told Emerging Markets.
Any loss of hard currency oil revenues could increase the incentive to ditch the dollar. This could lead to a renewed spike in inflation and undermine the viability of the banking sector, thereby making probable a default on Ecuador’s $10 billion in foreign debt branded by Correa as “illegitimate”. This would render Ecuador almost fully dependent on financing from Venezuela’s president Hugo Chavez, and the newly-established Banco del Sur (Bank of the South), Barreiros concluded.