Rebuilding Ecuador

Despite the rising death toll, and humanitarian crisis, Ecuador’s earthquake, which struck on 16th April, seems to have barely registered in the public conscience.

The quake hit with a magnitude of 7.8 on the Richter Scale. Tremors and subsequent quakes were registered continuously over next few days and the country remains on a state of high alert.

As of last week, official figures account for 650 fatalities with another 58 missing and 16,600 wounded. These are, however, conservative estimates. Upwards of 22,000 people have been displaced from their homes. Provinces most affected are without access to basic necessities. The country is facing a drastic humanitarian crisis, and now more than ever it needs strong and effective leadership.

The process of rebuilding Ecuador will be long and hard, and it is made more challenging by the country’s dire financial straits. The costs will likely be crippling for an economy that is forecast by the IMF to shrink by 4.5% in 2016 and a similar figure in 2017. Ecuador will continue to suffer as long as oil prices are depressed and the Dollar remains strong. The country’s President, Rafael Correa, has suggested that the devastation caused may cost in the region of $3bn, other sources believe the figure to be closer to $5bn.

One might assume, in a nation prone to natural disasters, that some financial provision is made for just such an occasion (see Chile). You would be wrong. Correa’s government failed to save any of the excess revenues made during the oil boom. Instead, the government banned all savings funds, arguing that they benefitted international interests. What is more, Quito, the Capital city of around 3 million people, lives in the shadow of Cotopaxi, an active Volcano that has shown concerning levels of activity in recent months. It has been estimated that as many as 325,000 people could be at risk in the event of an eruption. Ecuadorians should be asking themselves what provision has been made for such an event, and should they have any confidence in their government in light of last month’s catastrophe?

While this seems criminally short sighted, an argument could be made in favour of this policy. Mr Correa would suggest that cleaning up your debt profile and relying on emergency lines of credit is a more cost effective means of responding to these crises. It’s a question of what you do with your cash. Building up any kind of cash reserve for disasters would mean generating interest income and paying the going rate on credit spreads to the bond market on outstanding debt. But disaster relief funds won’t be investing in equities or debt with significant yield, they’re looking for risk-free instruments which won’t generate significant returns. So you might rationalise that you are better off using the cash to service and pay off your outstanding debt, and improve the country’s credit profile, rather than sinking it into deposits which are potentially paying negative rates anyway. At least, that might be what Mr. Correa would argue.

While cash may not make it to disaster relief, Rafael Correa has emphasized expenditure on a broad gamut of pet projects. One example has been reforming higher education. In principle the initiative, enshrined in the 2008 constitution, is commendable. The government abolished fees for private universities and closed down poorly performing institutions. According to official sources, enrollment is outpacing population growth, but the government universities budget has increased five fold ($335m 2008 – $1.7bn 2013). What is more these institutions have very little autonomy and all subjects offered must be in line with the “national development plan.” In an egregious example of over expenditure, an article in the Economist notes, that some deans at Mr. Correa’s new universities were being paid $16,300 a month, or 32x the GNI per capita wage in Ecuador! While it is important to produce a qualified workforce, and free tertiary education is a laudable ambition, questions have been raised as to the quality of these new institutions and whether they are in fact little more than a vanity project for Mr. Correa.

So, if the government has made little provision for natural disasters, how is it going to finance rebuilding the country? In seeking to monetize his nation’s abundant natural resources, Correa’s regime has racked up an enormous amount of foreign debt, the full extent of which is murky at best.  The country now faces a chasm-like fiscal deficit. In order to stopgap the nation’s finances, the government has announced a raft of new taxes, which include a levy on millionaires, this is expected to raise about $1bn. This follows on the heels of the government’s proposed “Organic Law”, which targets higher tariffs on tobacco, liquor and sugary drinks. As ever, it is the Ecuadorian people that are forced to pay for their government’s mismanagement. This economic recklessness is unforgiveable, particularly for a man who has made much of his fiscal credentials as a US trained economist.

Well there is always the Chinese. The Chinese government and her proxy lenders are the biggest creditors in Latin America, and nowhere is that more true than Ecuador. In January, the Chinese government agreed to a series of credit lines amounting to $7.5bn, $5.3bn of which coming from their Exim Bank. Last month, the China Development Bank signed over a $2bn loan, designated towards the government “investment plan”, with no mention of Earthquake reconstruction. While her “generosity” is warming, there can be little doubt that China is unlikely to be an accommodating creditor. This is particularly true in light of the country’s massive exposure to developing world debt. For the moment, Beijing seems to be a viable credit line, but it is not one that Ecuador should rely on. The opacity, questionable market terms and murkiness surrounding dealings with Chinese lenders should prompt Ecuador to look elsewhere to fund its rebuilding project.

Any prospect of tapping the capital markets seems slim, and certainly not favourable. Although Mr. Correa has said that the country is looking at issuing bonds, coupon payments would likely be prohibitively expensive.In an effort to instil confidence in the nation’s finances, Mr. Correa’s government made history last December, when it repaid $650m of international bonds on time, a first in the nation’s history. However, According to Bloomberg analysis, Ecuador would have to pay the highest overseas borrowing costs on record for a “B” rated country. Creditors will also surely remember Ecuador’s default on $3.2bn of international bonds in 2008.

Which begs the question, what recourse is left to Mr. Correa? Concern had already been rife about the Ecuador’s ability to balance the books, but in light of the disaster in April, there can be little doubt that the country will not be able to go it alone. In the past, Rafael Correa has vaunted against the IMF as a neo-liberal, crony-capitalist institution, and blamed it for Ecuador’s previous economic woes. However, the President was forced to swallow his pride, and last Wednesday (27th April), he appealed to the Fund for assistance. News of talks with the IMF saw Ecuador’s bonds jump to their highest levels since July 2015, at 86.1 cents on the Dollar.

But Mr. Correa’s resistance to the Fund lies beyond purely ideological grounds. Like any creditor, the IMF will want to understand Ecuador’s finances. This involves exposing the country’s accounts to international scrutiny, a prospect at which Mr. Correa balks. Turning the keys over to the IMF will entail the full disclosure of Ecuador’s massive international debt obligations, including the amounts and interest payments. It seems ironic for the Ecuadorian people that in surrendering a portion of their sovereignty to the Fund, they will finally enforce a degree of accountability upon their government.

Let us not lose sight of the profound human tragedy that has occurred. Thousands of people have lost their homes, their schools, their livelihoods and their loved ones. It would be crass to make political capital out of such a human disaster, but there can be little doubt, that the inefficiencies and insufficiencies of Ecuador’s leadership have worsened the country’s prospects of rebuilding.

This entry was posted in Earthquake, Ecuador, Oil, Politics. Bookmark the permalink.

One Response to Rebuilding Ecuador

  1. Beak says:

    Re: volcanoes and natural disasters, is it reasonable to expect the president to have that under control? Which nation actually plans for that, apart from maybe the very organised Japan? Here in Europe, for example, Italy is prone to earthquakes; yet L’Aquila is in ruins since 2008 – and I strongly doubt the Italian government is putting money aside for unexpected Vesuvio activity!

    Like

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