Dollarization in Ecuador Miguel F Ricaurte University of Minnesota Fall 2007 My name is Miguel F Ricaurte and I am from ECUADOR and COSTA RICA And I studied in Ecuador Chile and Kalamazoo MI Content of the Presentation Ecuador some facts Exchange rates and dollarization Ecuador s crisis Costs and benefits real vs nominal economy Concluding comments Ecuador some facts GDP PPP 2006 est Population Jul 2006 GDP Per Capita PPP 2006 est Ecuador USA 61 52 billion 13 060 Billion 13 755 680 301 139 947 4 500 43 800 283 560 Size sq km incl Galapagos Is Minnesota 206 000 9 631 420 Before 2000 Sucre Currency US Dollar After 2000 US Dollar Source CIA World Fact Book https www cia gov library publications the world factbook Ecuador some facts Ecuador USA Main Exports Crude Oil Bananas Shrimp Coffee Flowers Fish Capital goods Automobiles Industrial supplies Consumer goods Agricultural products Main Imports Machinery Equipment Fuels Consumer goods Main trade partners US 51 2 Peru 8 1 Colombia 4 4 Chile 4 1 Crude oil Refined petroleum Machinery Automobiles Consumer goods Canada 22 2 Mexico 12 9 Japan 5 8 China 5 8 UK 4 4 Source CIA World Fact Book https www cia gov library publications the world factbook Ecuador some facts Ecuador is among the poorest countries in S America GDP per capita PPP US 2006 Argentina 15 200 Chile 12 600 Uruguay 10 900 Brazil 8 800 Colombia 8 600 Venezuela 7 200 Ecuador 4 500 Bolivia 3 100 It has experienced slow growth in the last two decades GDP per capita constant 2000 US 1 500 1 400 1 300 1 200 1 100 1 000 900 800 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 and it has been lagging compared to the US GDP per capita constant 2000 US 40 000 35 000 30 000 USA 25 000 20 000 15 000 10 000 5 000 Ecuador 0 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 Exchange Rates and dollarization Exchange rates and dollarization Flexible Inflexible Floating No intervention US Dirty flotation Some intervention Costa Rica Fixed Pegged to another currency Venezuela China EU Dollarized No local currency Ecuador El Salvador Exchange rates and dollarization Unofficial Dollarization or de facto dollarization refers to the case when a large number of agents in a country keep a significant fraction of their financial wealth in foreign currency although this currency is not the legal tender Official Dollarization refers to the case in which a country s monetary authority renounces to its own currency and adopts a foreign currency in particular the dollar to use it as legal tender The Crisis The Crisis Ecuador suffered a severe shock in 1998 1999 El Ni o weather phenomenon affected agricultural sector The Crisis Ecuador suffered a severe shock in 1998 1999 El Ni o weather phenomenon affected agricultural sector Oil price historically low affected government s budget In 1998 the government s budget forecasted oil price to be at 14 per barrel but Historically low oil prices were observed in 1998 effective prices for Ecuador 70 41 01 60 50 26 49 20 29 40 19 16 30 9 20 20 10 0 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 total government revenues dipped in 98 99 as well as oil revenues as a of total revenues 40 10 000 35 9 000 8 000 30 7 000 25 6 000 Oil revenue Tot Rev 20 5 000 4 000 15 3 000 10 2 000 Total Revenues mill US 5 1 000 0 0 1989 1991 1993 1995 1997 1999 2001 2003 2005 and the budget deficit was the largest in a decade government budget as a of GDP 4 2 0 2 4 6 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 The Crisis Ecuador suffered a severe shock in 1998 1999 El Ni o weather phenomenon affected agricultural sector Oil price historically low affected government s budget Financial crisis in Latin America triggered in SE Asia decreased loanable funds available to the government and private banks The Crisis More than 20 half of the banks went bankrupt The government took over them making its situation even harder The result The worst economic crisis in Ecuador s history Real consequences Real GDP per capita fell 7 65 between 1998 and 1999 from 1384 to 1279 in 1999 in 2000 US Dollars and Real GDP fell by 6 3 Real GDP Growth Minimum reached in 1998 8 7 9 increase 6 4 2 0 2 4 6 6 3 drop 8 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Employment The magnitude of the crisis resulted in an increase unemployment rate 16 14 12 10 8 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Nominal consequences People didn t trust the Sucre and this caused depreciation Sucres per US 30000 25000 20000 Between Jan 99 Jan 00 274 depreciation of the sucre 15000 10000 5000 0 Jan 97 Jul 97 Jan 98 Jul 98 Jan 99 Jul 99 Jan 00 Jul 00 The resulting financial crisis caused affected foreign reserves International Foreign Reserves Mill US 2500 2000 1500 1000 500 Sep 97 Mar 00 Loss more than 50 of reserves 0 Jan 95 Jul 95 Jan 96 Jul 96 Jan 97 Jul 97 Jan 98 Jul 98 Jan 99 Jul 99 Jan 00 with increasing import prices inflation jumped 12 month change in the CPI 120 Maximum Inflation 107 9 100 80 60 40 20 0 1993 1994 1995 1996 1997 1998 1999 2000 so the Central Bank increased nominal interest rates Nominal Interest Rate 80 70 60 50 40 30 20 10 0 Jan 97 Jul 97 Jan 98 Jul 98 Jan 99 Jul 99 An Unofficially Dollarized Economy By the year 2000 Ecuador was unofficially dollarized Most transactions of durable goods e g cars housing as well as rental payments and loans were denominated in US Dollars 40 of broad money savings and checking deposits as well as other liquid assets were held in US Dollars The Official Dollarization January 11 2000 official dollarization implemented by President Jamil Mahuad The exchange rate was fixed at 25 000 Sucres per Dollar January 21 2000 Mahuad deposed acting President Gustavo Noboa ratified his predecessor s decision The Central Bank began to exchange Dollars for Sucres March May 2000 savings and checking deposits were converted to dollars September 2000 transactions were conducted in dollars The defunct Sucre The defunct Sucre Gave way to the dollar Why dollarize Decrease inflation which in turn causes Reduction of nominal inom ireal expected inflation No possibility of currency a crisis no depreciation which in turn causes decrease of local nominal rate iECU iUS country risk expected depreciation Promotes fiscal discipline since printing money cannot be used to finance deficit anymore Why not dollarize Loss of monetary independence not a cost when monetary authorities are not responsible Loss