Fernando Santos, Ecuador’s ex-minister of energy and mines, shook his head several times while speaking recently in his Quito law office adorned with antique maps of his country. “At the height of his greatest glory, when he signed the peace treaty with Peru, the very next day his worst nightmare began, the crisis. . . .”
He wasn’t speaking about some forgotten leader out of Ecuador’s past. He was referring to Jamil Mahuad, Ecuador’s current president, and the dire situation that confronts him. An astute man known for attacking problems calmly and rationally, Mahuad achieved within his first months in office what his predecessors couldn’t do in years-a peaceful solution to the last unresolved border dispute in South America, that between Peru and Ecuador. Yet the 49-year-old Harvard graduate may have met his match in trying to placate strife within his own country.
Today, as many as 20% of Ecuadorians are unemployed while 50% are underemployed.
Inflation is expected to run at 48% this year and government debt likely will exceed the country’s GDP. The banking system is practically imploding while the 82-seat Congress is so bitterly divided that it can barely legislate. On top of that, Guayaquil community leaders abhor the idea of any new taxes the Quito-born president proposes.
Political, economic and banking problems abound.
And they are taking a toll. The nation’s taxistas took to the streets in March to protest the enormous hike in gasoline prices that the president decreed under a state of economic emergency, after Congress failed to consider his initial tax increases. One driver said the price of gas rose overnight from 9,000 sucres per liter to 24,000 sucres. “The president doesn’t know what it is to support a wife and family, because he is a rich, single man,” said the driver. The price increase coincided with the partial freezing of checking and savings accounts throughout the country.
Although the government later rescinded the gasoline hike and altered the length of the account freeze, the moves did little to assuage the generalized discontent manifested by an economy that just isn’t working well. In mid-April, when the Marriott Hotel opened in Quito, more than 7,000 people applied for 380 jobs. Local press reports tell of the endless lines of Ecuadorians seeking passports to flee the country, and those who can’t make it out legally are trying illegal methods. The port city of Guayaquil has become a sieve for illegal immigration, thanks to an understaffed and ill-prepared customs authority. Three young men lost their lives recently after they illegally boarded a refrigerated cargo ship in Guayaquil, which they thought would take them directly to the United States. They were later discovered frozen to death after the ship stopped in Tokyo.
The IMF Calvary
President Mahuad is sounding the bugle and hopes the IMF will come running. He has pinned all hopes of financial sanitation and fiscal recovery on a $400 million IMF rescue package that as of mid-April was still nowhere in sight. The IMF’s assistance is contingent on the government’s slashing deficit spending to no more than 3.5% of GDP this year, implementing a strategy to alleviate the fiscal crisis, and ending support of failed financial institutions such Filanbanco, the nation’s largest commercial bank.
If the package is successfully negotiated, the World Bank, the IDB and CAF would kick in an additional $500 million. With $900 million Mahuad’s government can clean up the banking system and get its fiscal house in order.
Yet Congress, incredibly, may be threatening the completion of the IMF standby agreement.
Legislators had been debating most of the month of April over reform of public finances, and in the third full week of the month, managed to approve a watered-down version of the reform, which by early accounts missed the target on the reduction of deficit spending.
Reports indicate the reduction by Congress reaches only 4.1% of GDP and that the government will have to reduce other planned expenditures or raise other taxes.
When Mahuad strolled into office, he had the support of the Social Christian Party (abbreviated PSC in Spanish), which represents the largest bloc in Congress. But in what some say is pure political positioning, the party’s leader, two-time presidential candidate Jaime Nebot, irretrievably broke with the Mahuad government and passionately refused to support any hike in taxes. Hence, the slow progress.
Michael Henry, Andean Pact analyst for ING Barings, sees a bleak future if the nation does not secure the IMF package. Without IMF funding, Ecuador might fail to make debt payments this year, making next year a disaster, he says. The country’s total foreign debt is $16 billion, of which 45% is held in Brady bonds.
“The central issue is essentially a political one,” said Enrique Garcia, president of the Andean Development Corporation, CAF, whose organization is willing to help but cannot until the IMF agreement is reached. “My impression is that the political forces there understand that the only way out of this is to work together for the good of the country. We encourage very strongly that Ecuador come to an agreement with the IMF.”
Apart from the politics, some oppose the IMF’s guidelines for other reasons including the severity of the measures on the nation’s poor.
Jerry Harr, senior research associate at the University of Miami’s North-South Center, is one. “To me, the IMF solution is the equivalent of giving an enema to someone suffering from severe diarrhea. It will only serve to make the situation worse and postpone recovery. I think there are ways that Ecuador can recover without swallowing the IMF pill.”
Ex-minister Santos, who is a director of the Ecuadorian-American Chamber of Commerce, believes the IMF package and higher taxes alone are not enough to solve the fiscal problems in the long run. The only way to do so, he said, is to also privatize state monopolies in energy, electric power and telecommunications, which the president hasn’t been pushing recently.
Who Cares?
While no one likes to hear of the human suffering going on there, the question arises: Why should the global financial community be concerned about Ecuador? After all, when this small nation of 12 million tucked between Colombia and Peru experiences difficulties, it doesn’t generate as much global attention as when its colossal neighbor to the east has similar difficulties. In all likelihood, investors yawn when a bank closes in Ecuador, but they break out in a sweat if one even shakes in Brazil.
Some observers insist that unconcerned investors should remember that reverberations will take place elsewhere. According to one foreign investor familiar with the Andean region, those reverberations have already been felt in both Colombia and Peru. “Peru’s export balance, its current account, has been injured and the banking system in Colombia has been affected by the weakness of Ecuador’s banks, due to all the cross-holdings,” he said.
Michael Henry says the crisis should not only worry the financial community, but the US State Department as well. Considering the guerrilla warfare in Colombia, the economic vulnerability of Venezuela, and the on-again, off-again privatization program in Peru, the Andean region is far from truly stable. When you add in today’s Ecuador, the region starts to smoke.
Friends and foes alike have criticized Mahuad for not reacting faster to the problems when he first took office, but he can’t be blamed for the crisis itself. “There’s no way the president can be blamed for all of this,” said Charles Intriago, a Miami lawyer, publisher and native Ecuadorian. “This just didn’t happen overnight. He inherited a terrible situation.” Harr agreed. “The seeds of this crises were planted long ago,” he said.
From There to Here
In the early 1970s when Fernando Santos was minister, Ecuador discovered oil. Before long, the price of oil on the world market quadrupled, greasing the government’s coffers.
That fattened the state’s bureaucracy – for it was a time when people looked to the state to provide – and many citizens did not pay their taxes since the country was swimming in oil money. As long as there was money, authorities didn’t really care about things like inefficient tax collection or deficit spending. Meanwhile, fraud and kickbacks were running rampant.
Twenty-five years later, as Jamil Mahuad was elected president, the price of oil plummeted.
Suddenly the country was broke. Ecuador never had a crisis like the present one because oil prices had never crashed to such an extent-and the country’s budget was never so compromised by deficit spending and foreign debt.
The crash in oil prices revealed many weaknesses in Ecuador’s economy, the greatest of which is a shoddy banking system with inadequate government supervision. Another was the extent of corruption in the economy. When asked about the health and quality of the country’s banking system, the foreign investor quoted above said: “On a scale of 1 to 10, with 10 being the best, I’d say the system rates about a negative 42.”
Observers say bad laws, poor government and a culture tolerant of abuse created the banking problems. “Ecuador is a class example of crony capitalism,” said Haar. Others say Ecuador’s traditional ways are worse than cronyism. Both Intriago and Nicolas Aguirre, president of the Florida Exporters and Importers Association and another Ecuadorian, say that corruption within both the banking system and the government is a big part of the problem. “It’s cronyism with corruption,” said Intriago.
Before 1994, Ecuador had about 15 banks operating in the country. Then a law was passed that made the requirements to open a bank, including initial capital required, much easier. The traditional, hard-working, honest bankers were subsumed by a class of untrained entrepreneurs seeking wealth and looking to take advantage of the system. So by mid-1998, there were 40 banks operating in a country of 12 million people.
Not only did the 1994 law make it easier to open a bank, it also allowed for the majority shareholders of banks to dip into their bank’s deposits and loan themselves money for other businesses through vehicles known as creditos vinculados. In Colombia, for example, a bank president could loan himself up to 20% of the total deposits in the bank through such vehicles. But until recently in Ecuador, a bank president could loan himself up to 60% of the bank’s total deposits.
Some suggest the law was passed to keep oil money from going into a few hands and to spread out the wealth more evenly. But it didn’t really work. While many bankers remained honest to their profession, others didn’t. Vistazo, a local newsmagazine, this year reported that bankers had misused loans to delve into currency speculation for their own personal gain, to channel money into their own offshore accounts, to acquire expensive real estate and other luxurious properties outside of Ecuador. Henry says government regulators failed to install adequate safeguards against such activities and failed to crack down on corruption within the banking sector.
The Mahuad government has attempted to solve the problem by creating the Deposit Guarantee Agency, which is similar to the FDIC, to protect depositors. It has also tackled the problem of the creditos vinculados. But as the president has done on other reforms and decrees, at first he came down hard, eliminating the ability of bankers to take out loans against deposits. Later, the government reinstated the practice and set a limit of 20% of deposits. While the new guarantee agency offers some help to consumers, there is no limit to the amount of coverage on each account, contrary to what the FDIC does. That means, observers agree, that corrupt bankers can still enrich themselves and that the public will ultimately pay the bill, rather than be protected.
In retrospect, says Aguirre, in Ecuador a poor man will go to jail for stealing a chicken, but a rich man who steals millions of dollars will get away clean.
A Millennium Plan
After months of stalling to address the nation’s difficulties, and after weeks of mounting criticism, President Jamil Mahuad in mid-April finally came forward with a plan to generate thousands of jobs for the unemployed and reduce the size of the state bureaucracy.
Called Plan 2000, it calls for boosted spending in the areas of health care and education, more incentives to improve agricultural and industrial production, major payroll cuts in certain areas of the government, and privatization of state monopolies.
Of course, as soon as Mahuad had finished presenting his program, which reportedly took almost two hours using 81 different Power Point presentations, critics were already calling it utopic and a band-aid solution to the country’s problems. Part of the plan calls for the creation of 142,000 jobs this year alone in re-constructing devastated roads from last year’s El Niño phenomenon and further rehabilitating the coastal areas and boundary areas with Peru, among other measures. It also calls for the creation of a special committee to micro-manage the country’s foreign debt.
Whether or not it solves the chronic fiscal imbalances, it does show the government is willing to go through with needed reforms that could generate foreign investor interest in Ecuador. Foreign direct investment in the banking sector, for example, would do a lot to solve some problems. Yet, without an IMF agreement, Plan 2000 may not get off the ground. That’s because all of the country’s resources would have to go into cleaning the banking system and correcting the current fiscal imbalances, which is what the $400 million IMF standby agreement would do.
The president wants to eliminate 40,000 government positions over the next four years, which would save the state some $240 million annually. Additionally, in the way of privatizations, the plan calls for ending the state monopolies in telecommunications, electric power, transportation and energy. In Mahuad’s own words, the plan “is an emergency plan to bring the country out of crisis.”