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Andean Integration and
dollarization:
Some reflections about Ecuador’s
case
Presentation by the Chairman of
the Board of Directors of the
Central Bank of Ecuador, José Luis
Ycaza, at the seminar "Ecuador’s
dollarization and its effects on
Andean subregional trade," held at
the CAN General Secretariat
headquarters
Lima, August 25, 2000
Objectives and Interest
This
presentation brings together some
ideas and reflections about:
The
impact of dollarization on Andean
trade from Ecuador’s viewpoint;
and
The
future goals of the Andean
Community of Nations, particularly
with regard to the viability of
the projected Andean Common Market
planned for the year 2005.
The
interest in this subject can be
traced to the sweeping changes
made by Ecuador in its monetary
and foreign exchange systems in
January 2000 because of the
worsening of a series of fiscal,
monetary, and exchange imbalances.
Ecuador’s Central Bank has given
direct support to the start-up of
the economic dollarization scheme,
which is designed to strengthen
the economy in the short term.
The
new exchange system seeks to work
a favorable change in the
expectations of economic agents,
boost investments, and encourage
more foreign capital inflows,
amidst radical social reforms.
Integration continues to occupy an
important position within this
context. To Ecuador, however, it
is even more significant than a
few short years ago, for the
country embarks upon that
integration in the midst of
sweeping structural changes.
It
is my intention here to show you
that dollarization works as a
stimulus to continue conquering
the subregional market on the
basis of increased productivity
and competitiveness, which would
in no way require longer periods
or protectionist attitudes.
In
my opinion, dollarization does not,
as could be assumed, constitute an
obstacle to the attainment of the
Andean Common Market targeted for
the year 2005.
What
are really important in this
approach are the common strategy
that the subregion will define to
move toward its attainment,
together with the political will
for doing so.
In
this presentation, I will analyze:
I.
Ecuador’s trade experience with
the CAN: the trade liberalization
program, II. Ecuador’s
dollarization, III The objectives
of the new model, IV. The new
model and Ecuador’s trade with the
CAN, and V. Some reflections about
dollarization and the Andean
Common Market, and VI. Conclusions.
I. Ecuador’s trade experience with
the CAN: the Liberalization
Program
The
country’s trade relations with the
CAN have been strengthened since
the beginning of the 1990s due to
agreements that were reached in a
series of meetings held in the
area, among them, those of
Cartagena (1989), Galápagos
(1989), and Macchu Picchu (1990),
which made it possible to move
ahead more rapidly with trade
opening and liberalization.
Complementary to the reduction of
tariff levels, provisions for
streamlining export formalities
were issued at the level of the
Andean market and a series of
trade and integration agreements
were signed.
Ecuador’s exports to the CAN as a
percentage of its total exports
rose from 6.54% in 1990 to 13.0%
in 1998 and 10.8% in 1999, while
its imports from the CAN surged
from 9.7% of its total imports in
1990 to 17.5% in 1998 and on up to
20.3% in 1999.
Ecuador’s exports to the Andean
area in 1990 represented 63.3% of
its total exports to the LAIA.
That level held in 1998 (62.4%)
and dropped slightly in 1999
(58.2%)
On
the other hand, Ecuador’s imports
from countries in the Andean area
accounted for 43.8% of its total
LAIA purchases in 1990, 57.4% in
1998, and 60.1% in 1999.
The
country’s exports to Colombia
amounted to 1.2% of the total in
1990, 6.7% in 1998, and 5.1% in
1999. In the case of Peru, the
5.2% share in 1990 rose to 4.7% in
1998, and declined to 4.0% in
1999. Even so, there are
encouraging signs that the trade
flows with the latter country
could increase.
In
the case of its imports, the
importance of the Andean market as
a supplier to Ecuador has
increased sharply, from a very
poor 5% at the close of the 1980s
to 20.3% in 1999.
In
1999, trade with the area declined
heavily because of Ecuador’s and
Colombia’s troubled economic
situations. Total exports to the
CAN in 1999 amounted to US$ 482.5
million.
Imports from Colombia, the
country’s main trading partner,
rose from 3.1% in 1990 to 10.6% in
1998 and on up to 12.0% in 1999,
while in Venezuela’s case those
percentages declined slightly from
5.1% in 1990 to 4.8% in 1998 and
then increased to 6.4% in 1999.
The
intra-Community balance of trade
has been negative for Ecuador over
almost the entire 1990s, reaching
a negative figure of US$ 428.2
million in 1998.
The
cited evolution of Ecuador’s
balance of trade reveals that its
imports have generally outweighed
its exports within the CAN,
showing it to be a country with a
strong demand.
In
short:
Despite Ecuador’s recurring
deficits, the CAN has proven to be
a very important trade area for
that country in recent years.
The
free trade area with Bolivia,
Colombia, and Venezuela, in
particular, has made the rapid
growth of trade possible, as a
result, above all, of a
significant increase in the
competitiveness of national
producers.
The
rate of exchange was not revealed
as the most important element for
boosting that growth.
II . Ecuador’s dollarization: some
background elements
A.
Deterioration of macroeconomic
aggregates
Ecuador’s economy deteriorated
heavily starting in 1998 and
worsened in 1999 due to a series
of internal and external elements:
the presence of El Nino, the drop
in oil prices, the domestic and
international financial crises,
and the growing fiscal deficit.
In
1999, the real GDP slumped about
8% and the nominal GDP shrank by
almost 30%, reflecting the
conspicuous decline in investment
and private consumption.
Unemployment virtually doubled in
only twelve months, reaching 16%
in December 1999.
The
annual inflation in consumer
prices picked up from 43% at the
end of 1998 to 91% in February of
2000, and producer prices
snowballed from 35% to 301%. The
sucre was devalued almost 200% in
1999 and a further 25% in the
first week of January 2000.
The
total public debt increased
substantially, from 64% of GDP in
1997 to 118% in 1999. The heavy
fall in GDP was responsible for
the drastic rise in this ratio. By
the end of the year, the deficit
of the non-financial public sector
had reached a level of almost 7%
of GDP.
In
August 1999, the Government
temporarily suspended the payment
of debt service on Brady bonds and
Eurobonds.
It
also rolled over roughly US$500
million in short-term domestic
bonds in order to extend their
maturities and lower interest
rates.
B.
Deepening of the banking crisis
The
deterioration of the economic
situation accentuated the problems
of the banking system, produced,
on the one hand, by the
macroeconomic deterioration and,
on the other, by the practice of
certain banking institutions to
grant loans to bank-associated
borrowers.
Also
contributing to the situation was
the failure to supervise with
strictness, particularly
extra-territorial operations.
In
December 1998, the Government
created the Deposit Guarantee
Agency (AGD), with the mandate to
reorganize the banking system and
announced that it would guarantee
all domestic and overseas deposits
and foreign trade operations of
the banking system.
On
January 1, 1999, a 1% tax on
financial transactions was
introduced, adding to the problems
of the banks by triggering
substantial financial
disintermediation.
A
bank run resulted in the decreeing
of a bank holiday from March 8 to
12, 1999 and a freeze of six
months on savings and demand
deposits and of one year on term
deposits. Bank portfolios were
rolled over.
In
August 1999, the Government began
to unblock a large part of the
demand and savings deposits,
completing the process by January
2000. It would appear, however,
that a substantial number of these
deposits, made in United States
dollars, have flown overseas.
In
October 1999, considering the
deterioration of their operations,
the AGD stepped in and merged or
put three of the four banks that
had been recapitalized under
administrators.
By
January 2000, the overdue
portfolio amounted to 43% of the
total loan holdings, in comparison
with 9% at the end of 1998, and
the banks’ foreign credit lines
had been reduced by half.
The
banking crisis affected the
country’s monetary policy in
1998-99. The Government had issued
US$1.4 billion in bonds to enable
the AGD to recapitalize the
troubled banks, pay the deposit
guarantees of the banks that were
shut down, and cover the
withdrawals of the balances owed
to foreign creditors.
Close to US$1.2 billion in bonds
were discounted by the Central
Bank. Inasmuch as the bank of
issue was unable to freeze the
entire increase in liquidity that
resulted from this action, the
annual growth of the base money
accelerated heavily from 41% at
the end of 1998 to about 136% by
the end of 1999.
Faced by sustained pressure on the
foreign exchange rate and
dwindling international reserves,
the BCE in February 1999 left the
sucre to float freely.
The
pressure on foreign exchange rates
intensified in November 1999;
interbank interest rates shot up
from roughly 60% to around 150%;
and the Central Bank increased the
minimum cash ratio on deposits in
sucres. Even so, these pressures
did not let up and on January 9,
2000, the intention to dollarize
the economy was announced.
To
date, the Banking Board, the body
headed by the Banking
Superintendent, and the AGD, have
taken over the administration of
14 financial institutions (among
them, the country’s largest banks),
which account for approximately
65% of the system’s domestic
assets. The owners lost their
capital.
To
sum up:
Ecuador had had no comprehensive
economic program to offer a
scenario favorable to private
investors since 1995.
This
played a large role in building up
the negative expectations of
economic agents, for whom the
public administration lost
credibility, and this was
expressed in extreme foreign
exchange volatility.
The
country had shown absolute
inconsistency in the application
of public policies for
macroeconomic regulation, leaving
the application of a more rigid
model –dollarization— as the only
possible alternative.
III. Objectives of the new model
The
objectives of the new model are:
To
reduce inflation to more moderate
levels by progressively bringing
prices into line with
international levels.
To
reach a higher rate of growth by
cutting down the inflationary and
exchange risks. This would
encourage more saving, reduce
interest rates, and boost foreign
investment.
To
strive for more discipline in
economic management, for the
Central Bank can no longer finance
public spending by issuing more
currency.
To
bring down interest rates,
inasmuch as dollarizing would
reduce the inflationary premium in
interest rates, moving them closer
to international levels and
eliminating the exchange risk.
To
conclude this section:
The
new exchange system would involve
changing the logic behind economic
management, for it would do away
almost completely with the
capacity to make monetary policy
and would make economic growth
dependent upon the capacity to
generate foreign exchange.
It
accordingly calls for making an
effort to be more competitive and,
therefore, giving continuous
support to processes that
contribute to increased
integration and trade
liberalization. In practice, the
tendency of the economic cycle
will depend hereafter on the
balance of payments position.
On
being dependent on foreign
exchange earnings to underpin its
economic growth, Ecuador must
strengthen its position in the
international market and thereby
ensure an increase in its foreign
trade. In this connection, it will
give its support to economic
opening and the efforts to make
the region’s trade flows more
dynamic.
It
should be pointed out that
empirical studies made on
Ecuador’s foreign trade (the
determining elements of its
exports and imports) have found
that policies of economic opening
and the level of the cycle of
activity are essential. Variations
in the rate of exchange would be
only one of the less important
variables.
IV. The new model and Ecuador’s
trade with the CAN
The
dollarization scheme would be
advantageous to trade within the
Andean subregion for the following
reasons:
i)
Dollarization allows economic
agents to define planning horizons
for their mid-term investments and
incentivates their participation
in export projects because foreign
exchange rate volatility is
eliminated.
ii)
The need to ensure a continuing
flow of foreign currency into the
economy, which calls for a greater
willingness on Ecuador’s part to
accept a trade opening, would be
favorable to its trade with the
subregion.
iii)
With the elimination of
restrictions in the new model, it
encourages adjustment from the
import side during economic
upswings.
iv)
The economic growth that would be
attained as part of the
dollarization system would fuel
the growth of trade with the CAN,
inasmuch as the level of economic
trade is directly tied in with the
level of growth, as already
explained.
v)
Greater economic discipline would
have a favorable impact on the
expectations of economic agents,
reinforcing savings and investment
activities and thereby promoting
the domestic demand, with
consequent benefits for the growth
of trade.
In
short:
Dollarization would have positive
effects for Ecuador in its trade
relations with the CAN.
There are also three aspects of
the lessons to be learned from
successful experiences with
international trade that Ecuador
is heeding at the moment:
i)
The importance of having a stable
macroeconomic environment,
including real rates of exchange
that are stable, predictable
inflation, and sustainable balance
of payments deficits. The
macroeconomic environment must be
fully predictable. Governments
must therefore adopt macroeconomic
management policies that enable
exporters to forecast the courses
to be taken by the key variables
and, on that basis, to sign
contracts, open letters of credit,
and make assumptions with regard
to their future costs.
ii)
The need to apply complementary
policies that are consistent.
iii)
The importance of implementing
export promotion programs based on
market mechanisms and systematic
striving for competitiveness that
will allow exporters to react
calmly to changes in the external
demand.
V. Dollarization and the Andean
Common Market: some reflections
A.
Andean Common Market and monetary
area
It
is common knowledge that one of
the most ambitious challenges
facing the CAN in the next few
years is to establish an Andean
common market by the year 2005, a
target set by the Andean
Presidents at the Ministerial
Meeting held in Cartagena,
Colombia in May 1999.
In
the present economic circumstances,
Ecuador attributes unmistakable
priority to integration, for it
considers that the risks of
globalization and the increased
interrelationship and
interdependency of economies
worldwide may be cushioned by more
cooperation and concerted policies
for moving macroeconomic
regulation in the right direction.
Several events contribute to the
conclusion that the other Andean
countries may share this priority.
The intention to move together
toward a one-digit inflationary
target and the desire to encourage
macro-fiscal harmonization are
examples of this.
Attempts at policy harmonization,
however, have been very limited
within the integration movement,
affecting trade and finance and
the monetary and exchange spheres.
Efforts are now focusing on
reaching agreed options within a
pre-defined process of approaches,
if the final aim is to create the
Andean Common Market and monetary
area.
From
Ecuador’s viewpoint, the change in
its monetary model is not, as
could be assumed, an obstacle to
the formation of the Common Market.
On
the contrary, it will contribute
to that aim because it is
conducive to the harmonizing of
economic policies more easily and
lays a sound groundwork for
monetary management and total
integration, as we will see
further ahead.
In
today’s international economy,
there are a series of
circumstances that must be
carefully evaluated before
reaching the conclusion that local
currencies must be kept always.
In a
world of large international banks
and mammoth international
corporations, there is, perhaps,
little room for monetary
independence, except in a few
large countries. It is also
impossible to conclude that
stabilization depends inevitably
on the existence of flexible
exchange rates vis-à-vis fixed
exchange rates, for example.
This
complicates the vision of the
Common Market, in terms of how,
ideally, it should function in the
subregion, inasmuch as the
implicit problems involved in
forming it (stability conditions,
transaction costs, transportation
costs, welfare implications, and
factor and capital mobility) must
be evaluated under assumptions
that in the present situation
differ from those on which
classical literature on the
subject are based.
What
is true, considering that the
subregion’s key final objective is
to arrive at a single currency, is
that the countries must be
convinced that they:
i)
wish to align themselves with the
rate of inflation existing in the
monetary area; ii) want to reduce
transaction costs in their trade
with the most important trading
partner; iii) hope to eliminate
the cost of printing and
maintaining separate currencies;
iv) agree to participate in the "purchasing
power parity area" that can be
sustained by fixed exchange rates,
and even more so in the monetary
area; v) seek to establish a
policy anchor –that is to say, a
fixed point around which the
expectations of economic agents
can be formulated and economic
policies can be organized; vi) aim
to eliminate the discretionary
power of monetary and fiscal
authorities; vii) want to keep the
exchange rate outside the sphere
of politics and of vested
interests wishing to devalue the
currency to increase their gains
or pay off their debts; viii)
intend to set up an automatic
mechanism to reinforce monetary
and fiscal discipline; ix) seek to
have a kind of multinational "cushion"
to absorb shocks; x) want to share
the political decision of deciding
on a rate of inflation inside the
monetary area; in short, xi) that
they will allow the improvement of
internal monetary and fiscal
discipline to be delegated to an
external mechanism; and xii) seek
to strengthen or establish an
economic power bloc that will have
a larger specific weight in
international economic discussions
and in that way will lead to an
improvement in their terms of
trade, among other things.
In
light of the foregoing, some
elements may arise for which the
countries would not necessarily be
willing to lose their monetary
sovereignty. Mundell summarizes
them, pointing out that that
decision would be influenced by
the fact that the potential
partners:
i).
may wish to maintain their own
rates of inflation, different from
that of the area;
ii)
may seek to use the exchange rate
like an economic policy instrument
in order to raise or lower wages
and also to attract jobs away from
the other countries;
ii)
may not want to share the
potential benefits of the union or
to face macroeconomic imbalances
that could be worsened by those
participating in the area;
iv )
may not agree to stop benefiting
from seniority;
v)
may not want to eliminate the
possibility of financing the tax
office;
vi)
may not wish to eliminate areas of
general sovereignty, among other
things.
Thus,
from the theoretical viewpoint, no
major doubts remain regarding the
advantages of forming a common
monetary area, a situation
inherent to the Common Market.
Nonetheless, we should not forget
that behind all of this lies the
fact that the objective calls for
a large degree of coordination,
particularly on tax matters, which
brings to mind a further
reflection.
In
effect, in the world of optimum
monetary areas, as well as in
several reports on the role played
by public finance in European
integration, for example "a large
degree of centralization [of
coordinación]... of national
fiscal policies is advocated so
that [the] budget…can act as a
mechanism for reestablishing the
macroeconomic balance in the event
of possible biased disruptions,
thus making it possible to reduce
the social costs inherent to a
recession."
Fiscal policy becomes a highly
attractive instrument in the
degree to which a country’s
adherence to a monetary area
involves abandoning monetary and
exchange policies for purposes of
stabilization.
Nonetheless, the margins for
maneuver of fiscal policy-makers
may, above all in countries like
the Andean, be subject to several
influences: experience has clearly
revealed the negative effects
produced by fiscal laxity on
interest rates, public and private
investment, and general
macroeconomic performance,
revealing the full importance of
defining objective criteria for
policy coordination.
The
foregoing underscores the need for
a prior rapprochement, in which,
more important than the subject of
foreign exchange, is, face-to-face
with the common objective,
defining the preconditions for
making the operation of the Common
Market and of the monetary area
viable.
In
practice, I agree with the Central
Bank of the Argentine Republic
when, on referring to the subject,
it points out that "the creation
of a [subregional] currency would
involve at least a prior process
of macroeconomic rapprochement
through criteria that are probably
stricter than those of Maastrich,
largely because our countries are
more vulnerable to crises, suffer
from more institutional weaknesses,
and have capital markets that are
little developed."
The
question that arises, then, is
what would that single currency,
the currency of the Andean Common
Market, be?
Alternatives could be explored
that in no way would commit the
countries at this point. For
Ecuador, for example, that role
could be played by the United
States dollar, which is
effectively the currency that is
already most used in the region
and which enjoys the necessary
credibility.
Perhaps the subject could even go
beyond the subregional sphere at
the proper moment to take in the
entire region: it is a well-known
fact that the negotiations for the
formation of the Free Trade Area
of the Americas, FTAA, are moving
ahead as scheduled.
Nonetheless, it should be clear
that what is essential at this
stage of discussion is the
political determination and will
to begin the process of
macroeconomic rapprochement and
dovetailing and to define the
possible ways of alleviating the
biases that a process of this kind
generates.
The
crux of the matter is not
indicating as of this moment that
the common currency should be the
U.S. dollar or that the countries
should create their own currency;
a decision will have to be made
about the matter later, in light
of the elements projected by the
existing international monetary
configuration and the future of
today’s strong currencies, the
dollar and the euro, among others.
Perhaps the greatest benefit to be
obtained from moving toward a
single currency based on a
scheduled rapprochement, is the
elimination of uncertainty. This
benefit, which has been obtained
by Ecuador thanks to the adoption
of its new monetary and exchange
model, should be extended to the
entire region, for it is perhaps
its most important advantage is
anticipating the creation of a
monetary area and of a subregional
currency.
It
is now time to redirect our
efforts in accordance with that
goal. Perhaps we have spent too
much on developing models and
procedures for prediction,
obtaining predictions, and
discussing alternative policy
lines of action and too little on
political and institutional design
and working out rules to cut down
on uncertainty.
B.
Some reflections
I
will start off by pointing out,
lastly, that mistakes in economy
policy are very costly for
countries. Ecuador has certainly
experienced this fact at first
hand in recent years, but today is
looking toward the future with
optimism.
Over
the past decade, the international
economy consolidated the trend
toward the growing interdependence
of national economies through a
variety of vehicles: a significant
increase in the international
trade in goods and services;
growing capital flows; stronger
links and more dependency among
financial systems; a growing
interrelationship between economic
growth and technological
development; and the pulling down
of trade barriers, to name only
the most important.
This
has been borne out, despite the
periods of turbulence faced by the
international economy in the
course of these years, one of
which –perhaps the most serious—
was the recent Asian crisis.
As
the case may be, what is true is
that experience has shown that a
stronger positioning and opening
to the world is positive for the
countries, above all because it
makes it possible to increase the
competitiveness of national
products and to allocate resources
more effectively, thus producing
positive pressures on economic
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