The persistent fall in oil prices and the appreciation of the U.S. dollar have left the dollarized economy of Ecuador in an increasingly difficult position. The Ecuadorean government rejects assertions that the economy is headed toward a severe recession, despite the collapse in oil price and continued concern over the sustainability of dollarization. While the government positively received the production freeze agreement announced by Saudi Arabia and Russia, the likelihood of a rise in oil prices remains dim.

FSG is projecting a prolonged recession in Ecuador, with the economy likely to contract further through this year and 2017. The Ecuadorean government, already pursuing significant cuts to its investment budget in 2016, will need to further curtail spending and weaken domestic demand for imports. The government will almost certainly need to cut energy subsidies in the months ahead, and further delays in payment to public sector providers is likely. Fears over fiscal sustainability are leading to a prolonged outflow of dollars from the economy, further imperiling dollarization. The government appears committed to eliminating the import safeguards it implemented last year, but demand for imports must continue to fall for the elimination of safeguards to be sustainable.

The IMF is coming, sooner or later

The Correa administration is leveraging financing from a variety of financiers, but at rates that government critics say are extremely high, largely due to heightened country risk. Ecuador has received a credit line of US$970 million from the Industrial and Commercial Bank of China, approximately 15% of the external credit it is going to need this year. While the government hopes to receive further support from regional development banks and other creditors, it is clear that President Rafael Correa’s leftist populist government may be forced to go back to the IMF for financial support. With the likely imposition of significant austerity measures and conditionalities, President Rafael Correa is highly politically averse to doing so.

Ecuador will need to pivot toward an investor-friendly growth model

Unless oil prices recover significantly and the U.S. dollar weakens significantly, the era of public spending driving Ecuador’s economic growth is over. If Ecuador is going to remain a dollarized economy, the government, in conjunction with significant external financing, will need to pursue an internal devaluation that will likely curb public spending and weaken consumer demand over the medium term. This will be very difficult politically given presidential and legislative elections are set for February 2017.

The only medium-term avenue for growth is through a private sector-led investment model, with either the current government or the next attracting significant foreign investment. Among the measures the government is considering would be to increase flexibility in the labor market. This and other pro-investment measures would difficult for the current Ecuadorean government, but the alternative is either de-dollarization (with severe political, economic, and social costs) or prolonged economic stagnation.

Once a surprising market darling, now a danger for multinationals

Multinationals will need to carefully monitor the Ecuadorean market and develop appropriate contingency plans to counteract potentially adverse market scenarios over the coming year. FSG clients can leverage the Global Contingency Planning Process to ensure that their local teams are prepared to react to a quickly deteriorating economic environment in Ecuador.

Photo Credit: Mark Hesketh