Ecuador Turning to Virtual Currency After Oil Loans

After mortgaging most of Ecuador’s oil and gold to finance spending, President Rafael Correa is planning to create a virtual currency that financial professionals say his government could use to pay bills.

Congress last month approved legislation to start a digital currency for use alongside the U.S. dollar, the official tender in Ecuador. Once signed into law, the country will begin using the as-yet-unnamed currency as soon as October. A monetary authority will be established to regulate the money, which will be backed by “liquid assets.”

Less than six years after repudiating $3.2 billion of its dollar-denominated debt, Ecuador has dwindling oil reserves, with current-account deficits that are draining dollars from the economy and financing needs at a record. While Ecuador hasn’t said it plans to use the currency to fund spending and the legislation states that people can refuse to accept it as payment, Landesbank Berlin Investments says Correa may seek to use it to compensate workers and contractors and conserve hard cash.

“This is usually the start of debasement, inflation and depreciation,” Lutz Roehmeyer, who helps manage about $1.1 billion of emerging-market assets at Landesbank Berlin, including Ecuadorean debt, said in an interview.

Roehmeyer, who’s been investing in Ecuador for more than 15 years and correctly predicted its last two defaults, plans to reduce his holdings of the nation’s debt. The firm holds some of the $2 billion of bonds that Ecuador sold in June.

Digital Currency

The Economic Policy Ministry declined to comment on the new currency and referred questions to the central bank. The bank’s press office also declined to comment and referred to a June resolution signed by the bank’s general manager, Mateo Villalba. The resolution says electronic dollars will be backed by liquid assets and can’t be swapped for government bonds.

The virtual currency will increase access to the banking system among the country’s poorest residents while being easier and more hygienic to use than dollar bills, central bank President Diego Martinez said in congressional testimony, according to a statement published in the official gazette on June 4. Globally, digital currencies led by bitcoin have gained acceptance as a means of payment that have been promoted as a replacement for traditional money. Unlike Ecuador’s plan, most virtual currencies were developed as an alternative to government-backed tender.

Gold Loan

Ecuador has posted current-account deficits for each of the past four years, draining dollars from an economy that adopted the greenback as its sole currency in 2000. The government expects a $4.5 billion budget gap this year after public spending more than tripled since Correa took power in 2007.

To prevent a dollar shortage crimping public spending, the government used more than half its gold reserves as collateral to obtain a $400 million loan from Goldman Sachs Group Inc. in May. The same month, it reached an accord with China to borrow $2 billion in return for future oil output.

Then in June, the government sold $2 billion in debt, in part by offering the second-highest interest on a similarly rated dollar bond sold this year, data compiled by Bloomberg show.

The Temptation

Correa still sought help from the Latin American Reserve Fund, known as Flar, a month later to prop up the country’s balance of payments with a record $618 million loan.

With Correa boosting spending on public-works projects and social programs to reduce poverty, the Finance Ministry forecast in November that Ecuador would need to borrow about $35 billion through 2017.

The temptation to use the new currency to pay bills will increase as the government exhausts its current sources of dollars, according to Jose Mieles, an economist at Quito-based research institute Cordes. Members of Correa’s party in congress defeated efforts by industry groups to include a guarantee to back up the new currency with an equal amount of dollars in the new law, saying it was unnecessary.

“The problem would be if they began to pay local creditors” with the new currency, he said in an interview. “They could use these resources to get immediate liquidity.”

Yields on Ecuador’s benchmark bonds due in 2024 have fallen 0.26 percentage point since trading began on June 20 to 7.33 percent as of 3:37 p.m. in New York. That compares with an average 0.13 percentage point increase for developing nations.

Getting Out

Analysts are waiting to see how the government will implement the new system, said Juan Lorenzo Maldonado, a Latin America economist at Credit Suisse Group AG.

“If they find a way to make an efficient use of the electronic currency to manage just certain types of payments and make some procedures easier and faster, and they hold themselves on doing it responsibly, it may be a good thing,” he said.

Ecuadoreans may try to get their savings out of the country to avoid being paid with virtual money, according to Steffen Reichold, an economist at Stone Harbor Investment Partners LP, which oversees $65.3 billion of fixed income.

“I wouldn’t want to be converted into a new currency managed by an untested central bank,” Reichold said. Creating a currency “isn’t straightforward even when you’re in a country with a perfect track record of successful economic management, and I don’t think Ecuador is in that category.”

(Corrects headline to remove reference to dollar saving in story originally published Aug. 5. Attributes speculation that government would use the new currency to pay bills in first paragraph. Clarifies in third paragraph that people can reject government payments in the new currency and adds government’s explanation of its advantages in seventh paragraph.)
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