Ecuador: Keeping Up With Hugo

Not to be left behind by his Venezuelan ally, Ecuador’s President Rafael Correa is moving ahead with a new constitution. In September, President Correa and his Alianza Pais (AP) party secured a majority in the new constitutional assembly. Having cobbled together a grassroots movement to combat the traditional political parties and entrenched interest groups, President Correa is plowing ahead with changes that promise to overhaul the nation’s institutions. The president is vowing to implement reasonable reforms, such as the separation of powers and an independent judicial system, but he is also pushing for measures that will give him more control over the economy. Like President Chavez, President Correa is pushing the so-called Socialism XXI agenda by advocating direct control of the energy sector, better distribution of wealth and the ability to nationalize private property. As was the case in Venezuela, the new initiatives are scaring the private sector and producing a decline in fixed investment. Although the new measures will allow the Ecuadorian president to consolidate his powerbase, it could also lead to a deterioration of the country’s capital stock.

Unlike Venezuela, Ecuador is not booming. The Ecuadorian Central Bank recently revised its 2007 GDP growth forecast to 3.4% y/y from 4.1% y/y, and some local economists believe that final number could be closer to 2% y/y. Fixed investment fell 2.3% y/y during the second quarter, marking the second largest decline since the 1999 default. The nationalization of the oil sector is increasing government revenues, allowing the public sector to expand expenditures. Government revenues improved 28% y/y to $8.69 billion in 2007, or 20% of GDP, and outlays rose by 30% y/y to $8.88 billion. However, total oil production is declining as investment evaporates. The increases in government spending and social assistance programs boosted consumption, thus offsetting the decline in investment. This allowed Ecuador to post a modest expansion. Nevertheless, the lack of investment will make Ecuador one of the slowest growing countries in Latin America. Fortunately, soaring oil prices left the central bank with $2.5 billion in international reserves, a massive windfall for a such a small country. The government hopes to use the resources to improve investment and social programs. However, the increase in consumption will push up the import bill, and it may leave Ecuador with a current account shortfall. Likewise, the increases in public expenditures will leave the government with a gap of 0.4% of GDP in 2007.

The improvement in external conditions allowed Fitch to revise Ecuador’s sovereign debt outlook to neutral from negative, but the overall rating remained the same. President Correa also softened his rhetoric, saying that Ecuador would continue to service its debt as long as it had the resources to do so, which is the case for every country on the planet. In sum, President Correa’s initiatives are strengthening his powerbase and ensuring that he will remain in office for the foreseeable future. As was the case with President Chavez’s Bolivarian revolution, President Correa’s initiatives are boosting consumption. However, the measures are disincentives for investment, resulting in a gradual depletion of the country’s capital stock. The erosion of the capital stock forces a country to rely more on imports and weakens the external accounts. Given the huge size of Venezuela’s oil sector, it can sustain a simultaneous erosion of the capital stock and an increase in imports for a moderate amount of time. However, Ecuador’s oil production is much smaller and in worse shape. Therefore, Ecuador could get into trouble relatively quick. Although President Correa may be trying to keep up with Venezuela, it may not have the resources to implement a similar program.