Sat | Aug 19, 2017

Walter Molano | Ecuador: How bad is bad?

Published:Friday | July 15, 2016 | 7:00 AM
President of Ecuador Rafael Correa.

Ecuador is battling heavy headwinds. A devastating earthquake, a staggering term of trade shock, a sharp appreciation of the dollar, and limited access to the capital markets are the reasons why the Ecuadorean economy is expected to contract by more than four per cent y/y in 2016.

The fiscal deficit will be more than 6.8 per cent of GDP, and the current account surplus has turned into the red.

These factors led to credit rating downgrades and the widening of sovereign spreads. Unlike some of its Andean neighbours, like Bolivia and Chile, Ecuador did not accumulate a large savings pool during the commodity bonanza. This left it wrong-footed when oil prices collapsed.

However, the windfall did not evaporate into a frenzy of consumption, as was the case in Colombia, or a cloud of corruption, as was the case in Venezuela. It was channelled into a flurry of public work projects that radically improved the productivity of the Ecuadorean economy.

The most visible change was the modernisation of the national highway system. An impressive network of new multi-lane roads helped stitch the rugged nation together.

From the volcano-studded highlands to the thick Amazon jungle to the string of coastal ports, the new roads slashed travel time and transportation costs. Investment into ports, hydro-generation plants and a new metro system in Quito has dramatically improved the ability of the country's producers to move products in and out of the nation, while reducing production costs.

The rugged terrain of the small Andean nation helped explain the deep schisms that always complicated its governability.

Communication between the lowlands of Guayaquil and the high sierras of Quito created a sense of factionalism that fostered political divisions. Adding to that, the large indigenous population, where many continued to speak solely in their ancient languages, gave Ecuador a high degree of instability.

Yet, the new advances in infrastructure helped break down the barriers, increasing the sense

of common nationality and improving the country's overall social stability. Therefore, the oil boom was not lost.

Correa's work

Ecuador may have not saved for a rainy day but, at least, it did not convert the boom into a sea of new apartment buildings, millions of foreign-made cars and endless trips to Disney World, as did some of its spendthrift Andean neighbours.

President Rafael Correa is often pilloried for his authoritarian demeanour, his Ch·vezista friends, his radical rhetoric and his disdain for foreign investors. However, he must be credited for converting Ecuador from a highly segmented, dysfunctional state into a more cohesive entity.

We are less than a year from the next presidential elections. It looks like he will stand down and let someone else take his place. The electoral field is not well-defined. The leading figure appears to be Lenin Moreno, Correa's former vice-president. A congenial person, his ideology fits well with his first name. Still, he would be a continuation with the current policies.

Another individual who could throw his hat into the race is Jaime Nebot. He is currently the mayor of Guayaquil and a former presidential candidate.

Guillermo Lasso, the former president of Banco Guayaquil, seems to be another contender. Unfortunately, he is one of the prominent names listed in the infamous Panama Papers.

A loss of competitiveness

Many locals believe that Correa will step aside so he can come back in 2021. The next government will have to wrestle with some difficult issues. One of the most important ones will be future of the country's currency.

Dollarisation has helped stabilise the economy, but the appreciation of the greenback has led to a loss of competitiveness. The accumulated inflation rate has converted Ecuador into an expensive country.

In order to regain competitiveness, it will have to go through a gut-wrenching deflationary process or adopt its own currency so it can devalue.

The vast improvement in infrastructure has given the nation a competitive boost. Furthermore, the current recession is helping to realign relative prices. Property values are falling and workers are being forced to accept lower wages.

The overvaluation of the currency is estimated by the International Monetary Fund to be 25 per cent to 30 per cent. The de-pegging of the currency would probably not be as painful as it was in Argentina. Ecuadorean banks are well-capitalised, and they rely solely on local deposits for their funding needs. Therefore, a devaluation would probably not wipe out the banking sector. Hence, the situation in Ecuador is not great, but it is nowhere near as bad as what many pundits claim.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com