A challenging financial outlook and significant governability challenges make for a difficult economic and political outlook in Ecuador, leaving the government with little choice to agree to a another IMF program if it wants to avoid a destabilizing economic and financial crisis by 2026. Ecuador has a history of governability challenges and financial stability. The presidency of Rafael Correa (2007-2017) proved an exception, which can be largely attributed to a favorable international economic environment. A significant increase in oil revenues allowed for a significant expansion of social spending, which supported political stability. More typically, however, a combination of economic challenges, socio-economic discontent and, at the institutional level, legislative-executive deadlock circumscribe the ability of Ecuadorian governments to pursue a forward-looking economic policies and contributes to recurring financial problems. Most recently, President Guillermo Lasso was effectively forced out of office in the context of a stand-off between the executive and the legislature. Ecuador is also a serial defaulter and mostly recently restructured its international bonds as well as its debt owed to China in 2020-22.
> In the past 30 years, many Ecuadorian presidents were ousted, deposed or impeached (e.g. Bucaram in 1997, Arteaga in 1997, Mahuad in 2000, Gutiérrez in 2005, Lasso in 2023).
> Ecuador has defaulted almost a dozen times since its independence. Most recently, the government was in default on its international bonds in 1997-2000 and in 2008-09, and it restructured its international bonds in 2020, which economically translated into a default due to a reduction in the net present value of the bonds.
> In 2020-22, Ecuador also restructured its debt with Chinese banks, while an oil-based credit agreement with PetroChina was modified to allow for debt relief. In May 2023, Ecuador’s creditors also agreed to a debt-for-nature debt swap.
Governability challenges are compounded by a dollarized economy and commodity dependence, which makes the Ecuadorian economy more susceptible to exogenous shocks, while it limits its to pursue forward-looking economic policies consistent with the macroeconomic constraints imposed by dollarization. Full dollarization is constraining in macroeconomic terms because it effectively removes monetary and exchange rate policy from the government’s toolkit to stabilize the economy in the face of shocks, including commodity-related terms-of-trade or interest rates shocks. Dollarization also eliminates seigniorage. This forces policymakers to rely even more on fiscal policy to stabilize the economy and the financial situation. By severely curtailing the central bank’s lender-of-last-resort function and removing the ability to stimulate the economy through currency depreciation or lower interest rates, fully dollarized economies are more susceptible to greater economic and financial volatility as well as fiscal and debt crises. A fully dollarized economy that is subject to large terms-of-trade or inflation shocks will experience greater interest rate, price and inflation volatility, which can undermine the government’s financial position. Governments need to save oil-related windfalls so as not to be forced into pro-cyclical austerity during the next downturn. This requires a government that is able to pursue prudent, forward-looking fiscal policies. Failing to build up fiscal buffers when economic growth is high or keeping inflation under control when experiencing favorable commodity price shocks, governments in dollarized monetary regimes are then often forced into protracted low economic growth and fiscal restraint, which raises the risk of socio-economic and political instability. In face of increasing financial instability, governability challenges, such as the executive’s limited control of the legislature, tends to undermine market confidence further, as policymakers prove unstable to implement the measures necessary to counteract instability. This captures Ecuador’s experience under dollarization fairly well. Political stability and economic progress was relatively high when Ecuador benefitted from oil-related revenue windfalls under Correa, but instability increased after oil prices declined and the government had overspent and over-borrowed.
> Ecuador’s export revenues are highly dependent on volatile commodity prices. According to the World Trade Organization, fuels and mining products account for almost 40% and agricultural products for more than 50% of total exports. Meanwhile, dollarized export markets, the United States and Panama, account for 40% of all Ecuadorian exports.
> Social spending doubled between 2007 and 2016 from 4.3% to 8.6% of GDP, the Gini coefficient declined, and both inequality and poverty fell. A fair share of the improvement has reversed in the past few years, while homicides increased sharply, as Ecuador was forced into fiscal adjustment in the face of external shocks (oil after 2015, COVID-19 in 2020).
> Government debt did initially decline when oil prices increased, but the government failed to save enough revenues when the times were good and failed to resist increasing difficult-to-reverse social spending. After the end of the oil price related boom in 2015, successive governments have failed to stabilize the economy.
Despite the recent debt restructuring in during 2020-22, Ecuador continues to face significant external financing challenges, which will give it little choice but to sign up for another IMF program if it wants to avoid broader economic instability, even if it will not necessarily help it avoid another restructuring of international bonds. Ecuador faces high interest rates due to high U.S. interest rates and weak economic growth. Although the fiscal deficit has declined following the COVID-19 pandemic and IMF-supervised macroeconomic adjustment, increasing oil prices explain a fair share of improved budgetary outcomes. Unable to implement a structural fiscal adjustment, the government often resorts to one-off measures. This casts doubt on the long-term sustainability of the fiscal adjustment. The government remains in domestic arrears and its remains locked out of international capital markets, forcing to rely on multilateral borrowing, despite the 2020-22 debt restructuring. External debt service is set to increase significantly in 2025 and 2026, including IMF loans. (e.g. drawing down deposits, tapping the central bank.
> As Ecuador was already granted exceptional access under its previous program, net new financing will be limited, but it will be helpful to effectively roll over IMF loans. Ecuador owes IMF almost $ 8 billion, which will be coming due in the next few years. IMF roll-over. But effectively rolling IMF loans and unlocking additional multilateral borrowing will help support Ecuador’s external financing outlook. But this does not mean that Ecuador will avoid another debt restructuring. But another debt restructuring in the context of an IMF program would prove less disruptive than “hard” default.
> The IMF understands that macroeconomic adjustment in a fully dollarized economy is financially and politically difficult. The older staff members will remember how quickly the Argentina program went off trach in the late 1990s and 2000s and how the Fund’s reputation was tainted, suggesting the risk of supporting adjustment programs in macroeconomically constrained, dollarized, commodity exporters. While the Fund will therefore demand significant assurances from the government, it will also be keen to agree to a new program in order to reduce the possibility of Ecuador defaulting on its IMF obligations.
A new IMF program would ensure that the government continues to implement macroeconomic adjustment, help unlock additional, multilateral and possibly bilateral funding with the aim of avoiding broader medium-term economic and financial destabilization. If it is to avoid a default on its IMF and private external debt, it will need to reach an agreement with the IMF. Negotiations with the IMF will prove challenging, and it remains to be seen whether the IMF’s insistence on financing assurances will lead to yet another restructuring of Ecuador’s international market debt. The IMF has already granted Ecuador exceptional access under its EFF, meaning the Fund will not be willing to run financial risks in the context of uncertain ability of the current government to stick with implementation and commitment of next president. At the same time, the IMF will have an interest in a new agreement if only to avoid broader destabilization, including potential default of Ecuador on its IMF debt.
> After an initial IMF program was terminated prematurely (March 2019 – May 2020), Ecuador signed up to a new Extended Fund Facility (EFF) arrangement in December 2020, after also receiving COVID-19-related IMF financial support in the guise of the Rapid Financing Instrument (RFI). The IMF completed the final review of an 27-month EFF program in December 2022. Although the program helped improve Ecuadorian fiscal and debt dynamics and help put shore up the dollarization regime by reversing much of the institutional erosion in terms of the government weakening the central bank, Ecuador remains shut out of international bond markets in view of the increasing external debt service in 2025-27. All major international credit rating agencies rate Ecuador close to default (CCC+/ Fitch, Caa3/ Moody’s, CCC+/ S&P).
> The 2019 and 2020 IMF program helped strengthen the central bank after years of weakening of central bank and foundation of dollarization (e.g. central bank lending to state-owned banks, direct government financing), which had led to weakening of central bank balance sheet (e.g. reserve coverage of banks’ deposit) and help put the dollarized regime on a sounder footing. While fiscal targets were met, this was primarily due to increased oil-related revenues and higher growth. Some of the structural fiscal measures fell short, largely due to domestic political opposition and the president’s inability to get the relevant measures approved by congress.
President Daniel Noboa will not be able to reestablish access to international markets before his term expires in May 2025, unless his government agrees to a new IMF program, and even then regaining access to international markets will remain highly uncertain in the near term (> 12-15 months). Since taking office in November 2023, President Noboa has sought multilateral loans and in March official requested a new IMF program. But Noboa’s National Democratic Action alliance holds only 10% of all seats, which will make it difficult to push through necessary reform and especially fiscal austerity. The upcoming 2025 presidential elections will also make it politically costly (CAN RUN AGAIN?). Continued socio-economic pressures combined with congressional fragmentation will make it difficult to implement the necessary reform, not least because the next presidential elections will take place in 2025. Rather than adopt structural measures that promise putting Ecuador on a sustainable economic and financial path, the Noboa government will be more inclined to implement one-off measures to address the financial challenges. Significant fiscal retrenchment would weigh on economic growth and employment outlook and will fund at best limited political support from the executive and the legislature. Negotiating an IMF program in view of Ecuador’s economic challenges and political situation will prove challenging, and if a program is agreed, it remains to see to what extent Ecuador will live up to its reform commitment.
> Government debt peaked at more than 60% of GDP in 2021, but medium-term debt dynamics remain vulnerable, not least due to a strong dollar and high U.S. interest rates. The Noboa government has relied on one-off measures rather than structural adjustment (e.g. reprofiling public debt held at the central bank), while deposits continue to fall and domestic arrears continue to increase, pointing to very considerable domestic and external financing challenges.