049 – Since 1995, Ecuador had been experiencing galloping inflation and in 1998 and 1999 the situation worsened, and the country was going through one of its worst financial crises.

Thank you for reading this post, don’t forget to subscribe!

The main reason that led to this situation was that the government was issuing inorganic money in order to cover its current expenses and to try to manage inflation, which reached a maximum of 96.1% in 2000. This situation generated an environment of high speculation and macroeconomic imbalances in Ecuador.

Thus, in January 2000, the dollarization of the economy was announced and all debts in the former Ecuadorian currency were to be transformed into debts in U.S. dollars; in addition, in July 2000, Ecuador announced the restructuring of its debt. At first, this restructuring was seen as a success, since, together with the announced dollarization, the government gained greater control over public spending and the monetary base in the economy.

In this sense, the dollarization of the economy allowed Ecuador to implement in its financial system a currency of international use with which it could combat the constant devaluations of the local currency and inflation.

After the dollarization of the economy, there was a clear downward trend in inflation, which was around one digit as of 2003. In addition, prior to dollarization, Ecuador’s GDP growth averaged 1.33%, while after 2000, it averaged 4.42%. One of the key factors in the period between 2000 and 2007 was the increase in the price of WTI oil, which is Ecuador’s main export item, which allowed the Ecuadorian government to opt for an expansionary policy and thus encourage consumption during the transition from the sucre to the dollar.

However, it is important to note that in December 2008, the then President Rafael Correa announced the cessation of payments of its debt and from that moment until June 2014, Ecuador remained excluded from the international capital market; likewise, the proposal to restructure the debt did not take long to arrive.

In April 2009, Ecuador announced an offer to repurchase its bond debt with a 70% discount with respect to its nominal value, i.e., the Ecuadorian government recognized only 30% of the value of the debt. With this strategy, the government headed by Rafael Correa would pay investors only 30% of the total amount they invested, by way of example, an investor who had $100,000 in Ecuadorian bonds received only $30,000 of his investment in 2014. Not only did he receive less money, but he had to wait five years for the government to make a repurchase offer for the defaulted bonds, so clearly the investor is usually harmed in these cases.

It should be noted that in these cases in which the default of a debt is announced, investors decide whether or not to accept the proposed conditions, and if they do not accept them, the issuer of the debt is usually sued in order to be recognized at 100%, which is the duty to be. However, these lawsuits are usually very costly, lengthy in time and there is no guarantee that they will win the lawsuit; there are exceptions that escape this example, such as the case of the “vulture funds” and the Argentine debt.

Now, the restructuring of the Ecuadorian debt was considered a “success” by the Ecuadorian government, due to the fact that it had a 93.22% participation; however, in the eyes of the international community, the announcement of the default will always remain in history as a milestone in the country’s history.

But, how did the dollarization of its economy affect Ecuador? In the first place, the dollarization of the Ecuadorian economy helped the country to have exchange rate stability, otherwise, Ecuador would have followed a fate very similar to what happened in Argentina in the early 00’s. Secondly, Ecuador regained confidence in the international markets, since its debts were reflected in a commonly used currency such as the dollar, and therefore, any debt issuance must be backed by the monetary policy of the United States.

However, at the same time, the dollarization of the economy has brought with it a loss in the country’s autonomy, since its monetary policy is not subject to autonomous decisions, but the last word is in the hands of the U.S. government. This guarantees that the government will not issue inorganic money and the currency will not suffer constant devaluations as it did in the 1990s, but if the Central Bank of Ecuador considers it prudent to take a measure, it is impossible and depends almost 100% on what the United States decides.

Another disadvantage of Ecuador after dollarization was the increase in the cost of products and services, since they are tied to international prices, making them more expensive for the population due to the increase in prices. This also affects international trade policies, since the country is forced to import more and more products and try to optimize the costs of national production.

For these reasons, dollarization in Ecuador has advantages and disadvantages, but it is undoubtedly an example for other South American countries, since the rest of the continent usually has exchange rate and/or foreign debt problems as a consequence of being commodity producing countries. In addition, it is the only country to have taken this measure of dollarizing its economy, which although it “ties its hands” in terms of monetary policy and GDP growth due to the drop in domestic consumption, it benefits in other aspects that in the end end are vital.

Undoubtedly, it is a case that can be seen as a success for some, and a failure for others, as stated by economist Gabriela Calderón, who mentions that “despite having one of the largest economic contractions in the region, we have no inflation, no bank runs, and no capital flight”.