Ecuador and the IMF -- Address by Stanley Fischer

IMF News, May 19, 2000

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Published: May 19, 2000

Background and lead-up to dollarization

Ecuador's decision to dollarize was taken in January 2000 by then President Jamil Mahuad.
Historical context and political fragmentation:
- Deep split between highlands (Quito) and coast (Guayaquil) hampered coherent economic policy.
- El Niño in 1997 caused severe crop damage and destroyed infrastructure in the coastal region at a total cost of about 13 percent of GDP.
Key macroeconomic indicators and events leading into the crisis:
- Mid-1990s: GDP was about $20bn; exports amounted to 20 percent of GDP; half these exports were oil.
- By 1998 GDP had fallen to less than $18.5bn.
- By 2000 GDP had fallen to $13 billion—for a population of 12.5 million.
- 2001 GDP will probably rise to more than $17 billion.
- Ecuador's last good year economically was in 1994: GDP grew by 4 percent and inflation was 27 percent.
- Public sector deficit rose from 2.6 percent of GDP in 1997 to 6.2 percent in 1998.
- External debt was more than $16bn.
Policy and political disruptions:
- Recurrent banking-sector problems addressed through ad hoc actions (including a deposit freeze in March 1999).
- Political instability: frequent changes in leadership (Bucaram ousted, interim president Fabian Alarcón, later Jamil Mahuad).
- Policy reversals such as replacement of the income tax with a financial transactions tax in November 1998 and rollback of energy price increases under political pressure.
- Devaluation of the exchange rate band by 15 percent; $250m in intervention failed to save the band.

Economic deterioration and social impact

Financial and output deterioration:
- The sucre lost almost 80 percent of its dollar value in the 16 months since Mr. Mahuad had taken office.
- Ecuador entered a recession that saw output decline by more than 7 percent in 1999.
Social outcomes:
- The proportion of the population in poverty reached almost 45 percent in 1999, up by a third since 1995.
- Unemployment had doubled to 17 percent since the beginning of 1998.
Banking-sector crises and micro events:
- Run on Banco Progreso (the second largest bank in Ecuador in terms of assets) led to a five-day bank holiday and freezing of all deposits and loans in the bank for a year.

IMF engagement and programs

Timeline of IMF interactions:
- President Mahuad visited the IMF in September 1998 preferring to manage without an IMF program initially.
- IMF Article IV discussions began in late September 1998; protracted negotiations followed with missions in Quito frequently between November 1998 and March 2000.
- Agreement on a program reached in August 1999 conditional on congressional approval and banking reforms; Letter of Intent delivered on September 29, 1999, coinciding with deferment of some Brady bond interest payments.
IMF support after dollarization:
- Following dollarization, IMF worked closely with Ecuadorian authorities and supported the program.
- IMF Executive Board approved a 12-month standby credit of $304m on April 19.
- With additional multilateral support, Ecuador had around $900m available over the next 12 months, with up to $2bn possibly available from official lenders over the next three years.
IMF stance on lending while in arrears:
- Willing to lend to Ecuador while it was in arrears to its private creditors on the basis of an agreed program and good faith negotiations with creditors.

Debt restructuring and creditor negotiations

Private-sector debt exchange:
- Ecuador offered to exchange all of its Brady and Eurobonds with a combined face value of $6.5 billion for new 30-year and 12-year bonds.
- Some 97 percent of all bondholders accepted the exchange offer.
- The exchange produced substantial debt reduction by about 40 percent of the face value of the bond debt and significant cash flow relief in the initial years.
Official creditor support:
- In September, Paris Club creditors agreed to grant Ecuador a rescheduling/deferral of about $800 million in arrears and maturities due in 2000.
IMF comments on creditor coordination:
- IMF did not advise Ecuador to default on specific payments; private sector involvement was necessary but decisions on specific payments remained the authorities’ responsibility.
- A flexible approach to coordinating private creditors is necessary in cases of large short-term financing needs or unsustainable medium-term debt profiles.

Early outcomes of dollarization and immediate effects

Financial stability indicators:
- Early success of dollarization helped restore confidence in the banking system, promoting a rise in bank deposits and an increase in bank reserves with the central bank.
Political ramifications:
- President Mahuad announced dollarization on January 9; he was ousted on January 21.
- Gustavo Noboa, the successor, opted to stick with dollarization.
- Demonstrations and occupation of Congress by indigenous groups (with some army support) underscored the need for national cohesion.
Legislative and programmatic developments:
- The Noboa administration managed to muster support for a broad-based program of economic reform, symbolized by passage of the so-called "trolleybus law" through Congress.

Remaining challenges and policy recommendations

Key structural needs identified:
- Build a strong banking system; comprehensive revamping of the financial sector.
- Put in place other monetary and fiscal institutions compatible with dollarization.
- Assemble a durably stable legislative coalition to sustain reforms and political stability.
Specific fiscal and tax priorities:
- Implement a sensible tax reform to replace highly distortionary taxes (the financial transactions tax and an import tariff surcharge).
- Avoid excessive reliance on oil revenues.
Debt and corporate restructuring:
- Implement corporate debt restructuring that does not bail out large borrowers at taxpayers' expense.
Social policy and growth:
- Policies should invest in critical social sectors to support sustainable growth and political stability.

Conclusion and caution

The decision to dollarize was taken in desperation and without many of the traditionally cited preconditions (unhealthy banking system, weak fiscal position).
Early success has been largely unexpected but fragile: much work remains to consolidate banking, fiscal and political institutions.
Final caution: it is less than a year since the dollarization decision and sustained success requires building institutional strength and political consensus.

Stanley Fischer, First Deputy Managing Director, International Monetary Fund — Hoovers Institution Conference on Currency Unions, Palo Alto, California; May 19, 2000 (edited version).