from Follow the Money

This kind of thing usually happens in Ecuador when oil is at $20, not $50

April 22, 2005

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Ecuador is not the most stable country in the Western Hemisphere. The best one can say about its political system is that it is disfunctional.

Still, oil is around $50 a barrel and Ecuador exports oil -- perhaps not as much as it could, but still a significant amount. You would think high oil prices would increase the odds an elected President would be able to serve out a full term in office.

But not in Ecuador --

I have not followed the details of events in Ecuador closely enough to have a clear sense of why this particular "constitutional" coup happened, but I would note the following.

Ecuador’s external debt (and external debt service) is high relative to its GDP, and ongoing payments of interest on this external debt generate signficant flows out of the country (particularly now that the coupon on Ecuador’s long bond has almost fully stepped up). Ecuador’s high debt load generally is not the result of recent borrowing: rather it is the consequences of not paying your old debts for extended periods of time and a relatively stagnant economy. No matter. Sustaining the political support needed to make large interest payments on external debt is a real challenge when those payments are large, and they are not offset by consistent external inflows. In my view, "political" risk is not independent of the size of the economic burden associated with payment, and the effective burden is larger for external than domestic debt (there usually is a powerful domestic constituency in favor of continued domestic debt payments too).

Ecuador had a policy of trying to get its debt levels down in the hopes of gaining market access at some point in the future -- but sustaining the political consensus behind that strategy would be hard anywhere, let alone in a country as deeply divided by region and class as Ecuador. And the more political noise along the way, the lower the probability that a country like Ecuador will be rewarded for payment on its old debt with access to new funds.

Ecuador dollarized its economy back in 1999 (it restructured its debt around then too). I suspect that Ecuador will show the world how to dedollarize -- though it probably won’t do that until oil falls substantially. Think how difficult running Ecuador is when oil is high. Think how much harder it will be when oil falls and the mechanism for real exchange rate adjustment in a dollarized economy (particularly one that lacks access to external credit) is domestic deflation ...

Ecuador lacks the systemic importance of the US and China, but it does highlight how many different risks are out there.

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