On May 24, after a brutal general election and a controversial recount, Lenin Moreno was inaugurated as Ecuador’s 44th president. President Moreno already faces several difficult challenges including the Odebrecht scandal and a substantial foreign debt inherited from the Correa administration.

As one of his first acts as President, Moreno eliminated six ministries. Two will be consolidated into existing ministries, and the other four will be eliminated outright. The move signals a shift from the previous government, which some argue had become bloated and overbearing on the Ecuadorian economy.

In his inauguration speech, Moreno laid out the foundation of his administration’s economic plan. There were several takeaways from his speech that should be highlighted, in particular: his support for dollarization and opposition to a parallel currency, his plans to cut the deficit by enacting austerity measures, and his support for increasing the export of high value-added goods.

Dollarization and Parallel Currency

The dollarization refers to the formal adoption of the United States dollar as the official currency of Ecuador. The process was the culmination of years of political and economic instability that began in the mid-1990s.

The political crisis in Ecuador began in earnest in 1996, after President Bucaram was impeached. Under most governments, presidential succession is a relatively straightforward process where the predetermined next-in-line is sworn in and assumes the office. However, a vague constitution meant that Ecuador went through two weeks of political turmoil with the President of the Congress, Fabián Alarcón, becoming the President of Ecuador for three days before Vice-President Arteaga was sworn in as President. Her rule lasted only two days before the Congress and army forced her out and returned Alarcón to the presidency. (After this ordeal Rosalía Arteaga was returned to the Vice Presidency to serve under the Alarcón).

Under these unusual circumstances, Jamil Mahuad was elected President in 1998. Within two years he too would be removed from office by a coup backed by the army. One of the reasons for his ouster was his decision to formally adopt the United States dollar as the official currency of Ecuador. His decision to implement dollarization allowed Ecuador to escape from high inflation and return to a modest rate of growth.

While dollarization proved fatal to Mahuad’s presidency, it saved Ecuador’s economy. One of the most significant issues that faced the economy was high inflation. By the time dollarization was completed in 2001, inflation was rapidly declining from its peak of more than 100%. With the exception of a spike to about 10% during the Great Recession, inflation has generally remained under 5%. For a region that is characterized by high and sometimes uncontrollable inflation, dollarization has provided Ecuador with an uncommon form of economic stability.

Ecuador Inflation Rate

Concern about the end of dollarization in Ecuador is not new. However, fears were once again stoked when former Greek finance minister Yanis Varoufakis visited the country in late April. During his trip, Varoufakis promoted the use of an electronic currency that the Correa administration created two years ago. The digital currency is not being used as a parallel currency to the US dollar.

In an article in El Universo on May 12, Gabriela Calderón de Burgos a research associate at the Cato Institute, a libertarian think tank based in Washington, DC, explains the benefits of dollarization to Ecuador:

It happens that the role of reserves in a dollarized economy is very different from the one they have in an economy with national currency. El Salvador’s former Finance Minister Manuel Hinds explained that “in a dollarized economy … there is only one currency … whose value does not depend on any reserve maintained in the country. The value of the local currency, the dollar, is not defined by the government or the BCE … That value does not change if Ecuador has or does not have reserves. Prices in dollars and contracts in dollars are still the same, here and in China, even though Ecuador has no reservations.”

And precisely because, fortunately, our politicians can not do anything to determine the value of the dollar, it generates much more confidence than any alternative that can occur to our politicians, including and particularly in times of financial crisis.*

In a region where inflation and fluctuating currency prices are a significant issue, dollarization has provided stability to the Ecuadorian economy. Moreno’s commitment to maintain the US dollar as the official currency reinforces economic stability in Ecuador.

Debt and Austerity

During the Correa administration (2007-2017), Ecuador ran large fiscal deficits and accumulated massive levels of debt. The large budget deficits were primarily the product of low oil revenue and large government spending on social programs.

Ecuador Government Budget

Ecuador’s debt ballooned as the price of commodities, especially the price of oil, fell after the global economic meltdown and the industrial slowdown in China. China was also a major purchaser of the government’s debt.

Ecuador Government Debt to GDP

Just a few days after being sworn into office, President Moreno spoke of the necessity to refinance Ecuador’s debt. As Reuters reported on May 29,

“We will go to whatever instances are necessary to be able to refinance this debt,” Moreno told journalists.

“I’ve spoken with (Chinese) President Xi Jinping about the possibility that we could at least establish longer maturities to allow more resources for national projects,” added Moreno, who has promised a swath of social spending.

The overtures towards austerity and fiscal responsibility are a welcome change from the previous administration. In an article for El Comercio, Xavier Bastantes, economics journalist and an editor of El Comercio TV, wrote:

Economic austerity and restructuring are certainly good signals for putting public finances in order. Good health in the economy is also attractive to achieve the purpose of attracting new investments. In the end it all adds up, when you want to strengthen dollarization.*

Lenin Moreno has said that reducing debt and deficit levels are an economic priority for his administration. However, the social programs that he proposed on the campaign trail would increase Ecuador’s deficit. As Arturo Torres, general editor of El Comerico wrote in an article in El Comerico:

During the campaign, the current president-elect Lenin Moreno pulled several aces out of his sleeve. In particular, he shot the electorate nine offers that had great impact and include the construction of 325,000 homes; raising the Human Development Bonus from $ 50 to $ 150 per month; loans for young people; the creation of 40 universities, as well as the start-up of the Pacific Refinery, among others.

A study by the Universidad San Francisco, led by Luis Espinosa, estimated that to meet his campaign promises Moreno would need about USD 9.3 billion annually.

The budget deficit for this year reaches 8 billion, which are covered by 3 billion of debt, according to announced the economic authorities of the outgoing government. It is said that one of the urgent tasks of the incoming administration will be to seek funding for the remaining 5 billion.

In this scenario, it is very unlikely that Moreno will be able to fulfill his campaign promises, at least in the first year of his term, since he must prioritize the management of the fiscal cash register.*

Torres is correct. In his inaugural speech, Moreno included both a call for fiscal responsibility and austerity while also calling for increased social spending. As the budgetary process unfolds, his administration will find that it cannot have it both ways.

Exports

President Moreno also said that he would work to boost exports of high-value added goods. For years, Ecuador has primarily exported primary commodities, especially oil, and imported high-value goods, such as electronics and industrial products. During President Correa’s tenure, Ecuador typically ran a trade deficit.

Products Exported by Ecuador 2015
Source: The Observatory of Economic Complexity; Data from UN COMTRADE
Products Imported by Ecuador 2015
Source: The Observatory of Economic Complexity; Data from UN COMTRADE

Improving exports is a long-standing ambition of Latin American leaders. After World War II, many countries embarked on import substitution industrialization policies with the goal of transforming their economies. However, by closing off their economies with high tariffs and creating monopolies, the countries that followed ISI policies only created highly subsidized, inefficient industries that ultimately set their economies back after the economic collapse decades later.

The Moreno government could promote trade growth through bilateral or multilateral trade agreements. Currently, Ecuador has preferential trade agreements with several Latin American countries and is a member of the Andean Community, a regional trade bloc created in 1969. However, unlike other countries in the region such as Chile, Colombia, and Peru, Ecuador has few trade agreement with major global economic powers, the exception being a free trade agreement with the European Union. Improving trade through liberal policies would also help ensure that domestic manufacturers in Ecuador are globally competitive.

The government’s goal to export higher value goods may prove to be the most difficult. If Moreno’s government is to be successful at improving exports, it must promote a free market approach that encourages domestic industry and takes advantage of domestic supply chains. Improving domestic supply chains by processing the basic commodities that it already produces would be low hanging fruit for the Moreno administration.

Conclusion

President Moreno’s first actions in office appear promising. Although the social programs that Moreno promised on the campaign trail were in line with the 21st-Century Socialism policies of his predecessor, his apparent commitment to austerity and deficit reduction are positive signs for Ecuador. The test of President Moreno’s commitment to the long-term economic health of his country will come with his first budget. Will his priorities be to reduce the deficit and bring fiscal responsibility to the country, or will he continue to run large deficits and increase Ecuador’s already substantial debt levels?

* Author’s translation