Tiny Ecuador in the Spotlight as Government seeks to Renegotiate Debt on its terms

24 May 2007 by Gail Hurley


The small and often overlooked Latin American country of Ecuador has been in the media spotlight over recent months. It has many rich country governments, multilateral institutions and the international capital markets in a state of anxiety about what steps the government will take to honour (or not) regular payments on its external debt burden. This follows the election of Rafael Correa to power in November 2005. Correa’s leftist government was elected after promises not to sign a controversial free-trade agreement with the United States and a commitment to reduce the country’s external debt burden of US$10.97bn.

Can Ecuador Pay?

In some of the world’s major mainstream newspapers such as the Financial Times (Ecuador threatens to become the first debtor with the ability to pay: 16 February 2007), journalists and commentators have suggested that Ecuador in fact “has the ability to repay” its external debt. They argue that the country’s debt ratios are “low by emerging market standards” with an external debt-to-GDP GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
ratio of approximately 38%. Should the Correa Government choose to default it could”set a dangerous precedent”. What these articles have in common - and neglect to mention - is that external debt service Debt service The sum of the interests and the amortization of the capital borrowed. as a percentage of government revenues is extremely high in the country. This coupled with high and worsening social indicators and serious questions in relation to the legitimacy of many of creditor’s claims throw serious doubt as to the robustness of these newspapers’ conclusions.

In 2006, payments on Ecuador’s external debt reached a massive 38% of government revenues (the UN recommends that developing nations spend not more than 10-13% of revenues of external debt repayments). Ecuador owes US$4.38bn to multilateral institutions such as the Inter-American Development Bank and the World Bank World Bank
WB
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

, US$2bn to bilateral lenders and US$4.15bn in government bonds. Spain is the largest bilateral creditor with a total of US$396.8mn in claims on the country (see table below). Ecuador, despite high (and worsening) poverty indicators has to-date been excluded from all bilateral and multilateral debt cancellation initiatives and has been eligible instead for (repeated) debt restructuring deals. Ecuador has visited the Paris Club Paris Club This group of lender States was founded in 1956 and specializes in dealing with non-payment by developing countries.

a total of eight times between 1983 and 2003. According to the Debt Management Department in the Ministry of Finance, only one visit was made to refinance the capital on the country’s loans with Paris Club creditors. The rest rescheduled interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. and interest-on-interest only. Various non-transparent decisions to bail-out the private sector by buying-back its debt via the issuing of government bonds (essentially transforming private debt into public sovereign debt Sovereign debt Government debts or debts guaranteed by the government. ) followed by the restructuring of these same bonds - several times over - at higher interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
has also been mired in controversy, as is explained in a new report by Ecuador’s Special Investigation Commission on External Debt (CEIDEX).

Ecuador’s creditors in Europe: as at 31 March 2007

Source: Ministry of the Economy and Finance. Figures in US$mn.

Selected social indictors: 2003

Source: Jubileo 2000 Red Guayaquíl
It is little wonder then that the government wants (and has committed) to end this absurd cycle of continuously high debt service payments coupled with repeated debt refinancing Debt refinancing Taking out new loans to reimburse current debts. deals of various sorts.

Correa’s Commitments

In April 2007, at an international seminar on the illegitimacy of the country’s external debt, organised by Jubilee 2000 Red Guayaquíl and supported by a range of local and international organisations, Ricardo Patiño, Ecuador’s Minister for the Economy and Finance announced ambitious new budget plans for the period 2006-2010. These include bold measures to reduce the percentage of national revenues dedicated to external debt repayments. The table below shows that between 2007 and 2010, the Correa Government intends to reduce external debt service from a high 38% of the central government budget to 11.8%. In parallel, amounts invested in the social sectors and the development of basic infrastructure will be dramatically increased. How the government intends to secure these ambitious reductions in external debt service has been the subject of intense political speculation by the international community. Some creditors fear the government will choose to default, leaving them in a quandary as to how to react. Others have pointed to the fact that to-date Ecuador is still honouring its external debt service obligations. Meanwhile Minister Patiño has moved to secure fresh debt swap agreements with Spain and Italy over the past couple of weeks. What is clear however is that the government has ruled no option in or out at this stage. Indeed at the seminar, the government announced that it would be fleshing-out its external debt policy over the next few months and has established an advisory group composed of academic and civil society experts to advise and recommend various options as they relate to bilateral, multilateral and commercial debt stocks. Eurodad has been invited to contribute to this group. Ricardo Patiño also announced that he would begin a formal audit process of the country’s debts.



Norway given Public Recognition for Cancelling Illegitimate Debt

As a further indication of the government’s progressive stance on debt, on 26 April the Ministry of Economy and Finance hosted a public event to thank Norwegian Government for cancelling US$20mn owed by Ecuador. The debt was cancelled by Norway in October 2006 following significant public pressure by campaign groups who argued that debts incurred via the controversial ship export credit campaign in the 1970’s and 1980’s were illegitimate and should be cancelled immediately. On 6 October, Norway’s Development Minister, Eric Solheim announced that he would cancel US$80mn owed by five countries and admitted that the campaign had been a failure. He said his country ”shared responsibility” for the debts which resulted from the failed policy. At the press event, which gave the Norwegian Government public recognition of its bold step to acknowledge creditor co-responsibility, Ecuador’s Finance Minister Ricardo Patiño said that Ecuador appreciated the steps taken by Norway to cancel this illegitimate debt. Patiño said that out of an original debt of US$35, US$100mn had already been paid and yet over US$20mn still remained on the books. This was not right, he said. He urged Minister Solheim to be bold and to encourage other creditors to take-on the issue of the illegitimacy of debt, in particular in Europe.

World Bank Representative Expelled from Ecuador

The event was followed by a press conference at which the Finance Minister formally announced that the World Bank’s representative in Ecuador, Eduardo Somensatto, had been expelled. This followed the actions taken by the World Bank in 2005 when now-President Rafael Correa was Finance Minister. In 2005, after careful debate in Parliament, a law to reform the FEIREP Fund (Fondo de Estabilización, Inversión y Reducción del Endeudamiento Público) was agreed. Prior to the reform process, the special fund’s rules stated that 70% of revenues generated via oil exports would go towards the repayment of external debt obligations. According to Minister for Energy and Mines, Alberto Acosta “this left practically nothing for investments in the social sectors”. Changes to the rules stated that 20% of the Fund would now go towards social needs and 10% for national development in science and technology. In response to these reforms, the World Bank stated that it would be freezing a loan - which had already been agreed several months beforehand - for US$100mn. At the press conference, Ricardo Patiño quoted from the letter which his department had received at the time of the decision. In it, the Bank stated that it was “concerned at recent moves to reform the FEIREP Fund” in the country and in particular the potential implications on “macroeconomic stability”. It stressed the need to maintain strict controls on fiscal expenditures. Patiño said that his interpretation of the “need to maintain macroeconomic stability” could really be translated as the “need to remain current on external debt service obligations” and “strict expenditure controls” really meant “limit the amounts given to social expenditures”. This was not acceptable, he said particularly because the changes to the FEIREP Fund’s rules had been agreed through a democratic legislative process. Said Patiño, “we gave the Bank’s country representative 72 hours to explain the actions he took in 2005. We received no response. We therefore told him he was no longer welcome in this country”.

The action comes at the same time as Ecuador pays-off the International Monetary Fund IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
to the tune of US$9mn. Patiño stressed that Ecuador no longer wanted the multilaterals’ conditions for the Ecuadorian people. Instead, Ecuador is participating in negotiations with Argentina, Brazil, Venezuela, Bolivia and Paraguay about the setting-up of an alternative “Banco del Sur”. Over the past four months, four high level meetings have taken place between these countries which aim to reach a consensus on how a new alternative regional financial architecture might be formed. Various proposals are on the table e.g. for how a voting structure may be organised and political negotiations are tough, but there is definitely a sense of optimism in the air. Eurodad will keep listserve subscribers informed of developments as they progress.

The Road Ahead: the Challenge for Creditors

Ecuador is one more of several other Latin American countries which have veered to the left over the last couple of years. Given the abject failure of the policy prescriptions imposed on the continent by the multilateral institutions, the struggle to reassert national (and regional) sovereignty is understandable.

Whereas in 2006, Ecuador paid-out some 38% of government revenues in external debt service, only 22% were directed towards the whole range of social expenditures. The sense of dissatisfaction and desire for change can therefore be easily understood. It will be interesting to monitor how the government chooses to fulfil its stated policy aims of a sharp decline in debt service and dramatic increase in poverty related expenditures. The Ecuadorian government is setting its priorities straight: the people first and wealthy external creditors second. How the creditors will choose to react - whatever course is steered - will also be telling. How far will European Governments be prepared to “take the hit” and write-off what are relatively small amounts of outstanding loans to Ecuador? Or how far will they create a fuss and insist that Ecuador makes the payments? This will be a real test of creditors’ claims that they do indeed support the Millennium Development Goals for all developing countries.

Gail Hurley
Eurodad
(ghurley at eurodad.org)




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