Ecuador: Displaying Incredible Resilience

As most of the developed world struggles to deal with a complex combination of high inflation, low money supplies and soaring commodity prices, one small country on the Pacific coast of South America shows incredible economic resilience.

Not only is Ecuador on track to post economic growth close to the global average for the year, but it also appears to have tamed the most feared beast of 2022: inflation.

According to International Monetary Fund (IMF) forecasts, the country should grow 2.9% in the year, just below the forecasted 3.2% global average. September’s inflation was only 4.1% year on year, well below the euro area’s 10% and even the 8.2% for the US.

There are many secrets behind this performance, such as currency security on the back of a dollarized economy, an improving business climate that includes significant tax reforms, and a low 4% unemployment rate.

Yet, as Daniel Godoy, chief economist at Produbanco, explains, the most fundamental ingredient is a round of successful funding and debt renegotiations with the IMF and other foreign entities.

“Ecuador signed a macroeconomic funding program with the IMF and other multilateral organizations, such as the World Bank, the Inter-American Development Bank and the Development Bank of Latin America. In addition, the country renegotiated its external debt in 2020, alleviating financial burdens for 2020 to 2026,” he says.

“All these events that started before the pandemic have helped the macro indicators to stand in good shape amid the challenging year for the global economy,” Godoy adds.

Dollarization and FDI

Many multinational behemoths, such as Nestlé, Coca-Cola, Philip Morris and General Motors, operate facilities in the country, benefiting from Ecuador’s location, lower foreign exchange costs and currency security. Since declaring the US dollar its official currency in 2000, Ecuador managed to counter once-spiraling inflation and attract new foreign investment.

Interest rates on the dollar in Ecuador have stayed permanently above the US Federal Reserve’s benchmark, drawing buyers to the country’s sovereign bonds and helping maintain a stable 61% debt-to-GDP ratio just under 50% in 2022, according to the World Bank. Currently, Ecuador’s base interest rate is 8.45%—compared to 3.25% in the US.

“Everybody, even on Wall Street, agrees that Ecuador has no risk of default,” says Augusto de la Torre, a former World Bank chief economist for Latin America who now teaches at Columbia University.

Under President Guillermo Lasso’s administration, the country enacted broad-based tax reform, adjusting some foreign tax credits and hiring incentives. The move seems to have produced immediate reactions, drawing Argentine-based MercadoLibre and Sweden-headquartered H&M Group into the country in 2022.

The Other Side of the Story

Yet, social unrest has been erupting all over Ecuador since late 2021, and had broken out several times before that. The population protests social-spending cuts, citing a growing disparity between the cost of living and base salaries. CARE Ecuador calculates that nearly 35% of the country’s population lives in poverty (on less than $2 per day), with as much as 40% of households facing food insecurity.

Coordinated strikes in June prompted an 18-day complete shutdown in many of the country’s primary industries, directly impacting the economy and its investment appeal. “These protests dramatically hindered the economic recovery,” says de la Torre. “They left a pessimistic sense among investors, which has delayed foreign investment in the country.”

Ecuador’s homicide rate has doubled in the first eight months of 2022—and that’s after it nearly doubled in 2021 as well, according to data from the Ecuadorian police. Fighting between drug gangs is held responsible. The pressure has reached such high levels that President Lasso recently declared a state of emergency in its largest city, Guayaquil, and other neighboring regions.

The disruptions have affected the country’s economy. Demand for crude oil has been unusually high—mainly from the EU and the US. However, the country has not been able to meet those demands due to 15 active oil-backed loan agreements with China. Those accords, which the country is renegotiating, forced Ecuador to sell the better part of its production to the Asian country at fixed rates to pay for loans taken by former President Rafael Correa.

The oil industry took a particularly hefty hit, with the closing of 779 oil wells dampening state-owned Petroecuador’s plans for a record year in terms of profitability, as oil production scaled back to its lowest level since 2007. With that, export-related oil profitability is down 11% year on year, according to the country’s export ministry.

Produbanco’s Godoy explains that the current political pressure has also made it difficult for the country to implement a much-needed budget reform. “Macroeconomic efforts to consolidate fiscal accounts have translated into an ongoing political debate due to the expenditure cuts that the government has had to implement,” he notes.

Commodity Supercycle

The current commodity supercycle has positively impacted Ecuador’s main non-oil export of metals, bananas, fish and crustaceans, pushing the country to unseen profitability levels in those industries.

In the first half of 2022, the country’s total non-oil exports grew 24% year over year, mainly driven by increased demand from China, the EU and the US. Among the sectors, crustaceans saw the most significant year-on-year growth, jumping as much as 71%.

In a move that received compliments from the country’s economists, President   Guillermo Lasso embarked on a round of renegotiations to disconnect his country’s debt from its oil production. So far, the president has had significant success, reaching agreements with the China Development Bank and the Export-Import Bank of China for extending loan maturities and reducing amortizations until 2027 and 2032, respectively.

“It’s a good sign that China agreed to renegotiate with Ecuador. But it is still a sensitive issue, as both countries have a very broad agenda,” says de la Torre. “China is the leading buyer of Ecuadorian exports and has substantial infrastructure investments in the country,” he explains. “We need to rethink and reconfigure our relationship with China, and the debt renegotiation is the first step in that direction.”

Opportunities and Expectations

In the face of current challenges, Godoy notes that Ecuador is on the right track to keep up its promising economic performance for the near future. “The risks are mainly political. Yet, the government is working actively to diminish tensions with some sectors to ensure minimum governability agreements; and some economic reforms concerning investment attraction are currently under revision between the executive and the legislative,” he says.

As de la Torre points out, behavioral factors have also been central to the country’s recovery: “Ecuador has been showing great entrepreneurial resilience in the face of current issues with the global economy and the difficulties in domestic politics,” he says. “These entrepreneurs are mainly among the nontraditional exporters, namely in the shrimp and tuna sector, where technology has been positively deployed.”

Tourism is also booming, de la Torre adds. “I see the oil and mining industry with great potential as the country periodically allows more private participation.”

All these factors indicate that, despite the political risk, the country remains well positioned to keep growing. “Ecuador controlled inflation due to the dollarization and does not have exchange rate risks. Furthermore, it has the support of the IMF and other multilaterals and a robust financial system,” concludes Godoy.