Dollarization and fiscal reforms set the tone for continued economic growth
Ministry of Finance and Economy proposes trifold plan to enhance efficiency

“Ecuador recently welcomed a new Minister of Finance and Economy, Carlos Julio Emanuel, who took over the Ministry from Jorge Gallardo, who had been accused of allegedly mishandling proposals pertaining to his tenure as Director of Banco del Pacifico before becoming Minister. (The Attorney General of Ecuador had filed an order for his arrest.) Before resigning his position as Minister, Mr. Gallardo had proposed integral fiscal reform, designed to create a strong and firm financial structure that would benefit future generations. It consisted of three law proposals — the Fiscal Discipline and Transparency Law; the Stabilization and Savings Petroleum Fund to guarantee that funds received from the new petroleum pipeline not be misused; and the elimination of pre-assigned items in the state budget, allowing state policies to adapt to the new economic model based on the dollar.

Mr. Emanuel plans to follow through with these proposals as well as with proposed tributary reform. He indicates that these reforms are necessary not only to enhance Ecuador’s productivity and efficiency, but also to comply with multilateral agreements the country holds with the Inter-American Development Bank (IDB) and the International Monetary Fund (IMF).

The new Minister also plans to restructure the debt of bank depositors in the country’s productive sectors, who have non-performance loans still lingering from Ecuador’s banking crisis of 1999. According to Antonio Acosta, General Manager of Banco del Pichincha, the effects of that crisis are still being felt today. He believes, however, that restructuring the debt may have adversary effects on private banking, fearing that special conditions given to debtors could promote the state as “rescuer.”

He also says that “there are two elements that have impeded that we overcome this crisis: one is that the situation with Filanbanco has not been resolved and the second is Banco del Pacifico, for which the government has found an administrating company.” Before the end of this year, the Superintendence of Banks expects to resolve both situations.

Filanbanco, which was the largest bank in Ecuador at the time of the crisis, had at that time 700,000 depositors and $1.3 billion equity. “We have decided that we are going to liquidate the bank,” says Miguel Davila, Superintendent of Banks. His first step is to transfer 20% of deposits — representing 90% of Filanbanco’s depositors — to private banking. The transfer is to include credit card accounts and state bonds. Mr. Davila explains that Filanbanco’s problems are complicated by deficiencies in information available in the bank’s records, lack of support from employees and political fallout from the crisis. Nevertheless, he does plan to liquidate Filanbanco within the next four years. On the other hand, Banco del Pacifico is focused on strengthening its structure according to international standards established in its agreement with the international consulting firm Interdim & Ahead Advisory Group to manage the bank.

Abelardo Pachano, President of Produbanco, which emerged as one of Ecuador’s largest private banks after the crisis, says that “we have managed to consolidate the private financial sector, although it will probably consolidate more.” He believes that one of the sector’s greatest challenges is regaining the public’s full trust in its nation’s financial system. In its plan to regain that trust, the Superintendence of Banks is now strengthening its supervision of financial institutions and implementing stronger sanctions to guarantee that such a crisis never happens again.

The crisis of 1999 cost Ecuador nearly 25% of its GDP and a caused a decrease in GDP earnings of 7%. In addition, the country’s currency devaluated from 5,000 sucres per dollar to 25,000 sucres per dollar in the year 2000. “Given this macro-economic collapse, Ecuador had no other choice but to dollarize the economy,” explains Mauricio Yepez, President of the Board of Directors of the Central Bank of Ecuador. “This was the first factor that helped stabilize the economy. The second was attaining an agreement with the IMF for a stand-by loan. The third was the renegotiation of the external debt. The fourth was the government’s fiscal management, where they increased earnings and decreased expenses. And last was that Ecuador was able to finalize the negotiations for the Heavy Crude Oil Pipeline. All these were fundamental factors for changing the country’s economic structure in the year 2000, where we managed a 2.3% growth rate.”

He emphasized that one of the advantages of dollarization is that it temporarily disconnects political events from the economy, and stressed that Ecuador can no longer be competitive based on devaluations but must now do so based on productivity. In light of dollarization, the role of the Central Bank is to develop structural reforms that prepare Ecuador for globalization and institute productivity as an essential element for economic growth.

According to Mr. Davila, who was General Manager of the Central Bank when dollarization was instituted, “dollarization was easily implemented because nearly 70% of transactions were already done in US dollars, however preparing the norms and regulations was much more complex…yet the hardest aspect was teaching the population how to use the dollar.” The conversion process was confusing — dollarization was established at a fixed rate of 25,000 sucres per dollar, and Ecuadorians were not used to pennies, nickels, dimes and quarters. With the assistance of Coca Cola, the Central Bank was able to reach all the communities where Coca Cola distributes its products to explain to the general public how to convert Ecuador’s currency.

One of the effects of dollarization was the significant and immediate increase in costs. Frederick Brown, Chairman of Deloitte & Touche in Ecuador, says that costs of company operations, primarily labor costs, doubled owing to hyper-inflation resulting from the devaluated rate of the sucre. In his opinion, labor laws must be adapted to the new economic model that requires increased efficiency and competitiveness.

But according to Minister Emanuel, “dollarization produced what needed to be produced given the circumstances. Inflation, being a monetary phenomenon, where there is too much money after fewer goods, came out in 2000 in spite of dollarization.” He explained that the 90% inflation that Ecuador confronted in 2000 was bound to happen sooner or later as a consequence of the political upheavals of the time. Inflation rates have since been dramatically decreasing and are expected to reach one digit by 2002.