Did The Imf Drop The Ball In Ecuador?

By refusing a bailout, it may have made things far worse

Ecuadorans are used to hard times. But hardly anyone in this small Andean nation of 11 million can recall times as hard as these. The economy shrank by 7.3% last year--the largest decline since the central bank began keeping records in 1927. The banking system is in a shambles, and deposits have been frozen since March. Its currency, the sucre, has shed more than two-thirds of its value since it was floated last February, and hyperinflation looms. "The country is on its knees," says Santiago Rodriguez, a 32-year-old taxi driver in Quito, who supports a family of four on $12 a day.

Ecuador was a way for the International Monetary Fund to show through a small country that it could get tough with creditors. Instead, it's shaping up as an IMF failure. Back in October, the IMF stood by as Ecuador defaulted on $5.9 billion in so-called Brady bonds. It was the first time any country had defaulted on the bonds, which are repackaged debt from the 1980s. The IMF's message: No more bailouts for private creditors who take risky bets on economic basket cases. By holding back, the IMF hoped to compel bondholders and the Ecuadoran government to hammer out a restructuring deal.

But three months later, there's still no deal, and Ecuador's economy worsens by the day. The irony is the IMF may still have to step in--only a rescue now will be far harder than it would have been in October. So thanks to the experiment, everyone--international lenders, Ecuador's government, and most of all, Ecuador's people--have suffered one blow after another.

Faced with a deepening crisis, Ecuador's President, Jamil Ma-huad, has been desperately trying to land a $250 million standby loan from the IMF. This would automatically unlock an additional $850 million in credit from the World Bank and others to revive the banking sector.

After 14 months of talks, the government and the IMF had come close to finalizing an agreement in early January. Then Mahuad, in a panic over the plunging sucre, resorted to extreme measures. On Jan. 10, he unveiled plans to pull the local currency from circulation by exchanging all sucres for the U.S. dollar, at a rate of 25,000 to 1. The government hopes that swapping the sucre for the greenback will restore confidence, reduce interest rates of more than 150%, and tame inflation, now running at 60.7%.

Dollarization is no magic bullet, though. "Congress has to approve crucial and important reforms to make the dollarization proposal viable," says Gustavo Arteta, a local economist. What's more, Ecuador may not have enough reserves to cover all sucres in circulation and on deposit in banks.

SURPRISE MOVE. The decision to dollarize also took the IMF completely by surprise. According to one fund official, the move renders earlier negotiations "completely invalid." Adds the official: "We need a new letter of intent, with new economic targets." The IMF is dispatching a team to Quito to help the government sort out technical issues. Some analysts believe an IMF deal would not only shore up the crumbling economy but may prove crucial to Mahuad's survival as well. The IMF "must make a decision whether it comes to the rescue of Mahuad or it leaves him twisting in the wind until someone cuts his string," says Arturo Porzecanski, an analyst at ING Barings in New York.

Did the IMF Drop the Ball in Ecuador? (int'l edition)

Indeed, Mahuad's popularity has depreciated faster than the sucre. Since taking office in August 1998, his approval rating has sunk to 7%--though it has risen to 26% since the dollarization proposal. Demonstrations have become commonplace and are expected to build up to a national strike by mid-January. The opposition-dominated Congress has threatened to impeach Mahuad, as it did with former president Abdala Bucaram in 1997.

To clinch a deal with the IMF, both Mahuad and Ecuador's Congress will have to demonstrate a firm commitment to reining in the fiscal deficit and curbing the state's role in the economy--something they've failed to do in the past. Mahuad can take comfort from the fact that he has friends in Washington. U.S. President Bill Clinton and Treasury Secretary Laurence H. Summers recently telephoned him to convey their support. No doubt it was welcome. But a fat check from the IMF would put Mahuad's mind more at ease.

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