Despite the restrictions on using monetary policy as an accommodative tool, dollarization in Ecuador proved to be effective in eradicating inflation for good and promoting long-term economic growth in an economy that, until 1999, had a very low profile in terms of development expectations.
The Central Bank of Ecuador, a monetary entity dedicated only to statistical measurement, confirmed that the GDP at constant prices expanded 99.8% between the first quarter of 2000 and the fourth quarter of 2022, practically doubling after 22 years.
With a predictable structure, Ecuador could adapt to the global economic scenario.
It took advantage of the commodity boom in an efficient manner, unlike what happened in other countries such as Argentina and Venezuela.
Supply-side policies fostered long-term growth in the economy, in contrast to what happened in previous decades.
Even under “competitive devaluations” and “import substitution”, Ecuador’s per capita income grew by only 2.41% between 1980 and 1999, a situation of evident stagnation.
According to the ECB, between 2000 and 2022, per capita income expanded by 39%, and the increase amounts to 47% compared to the peak observed in 2014.
The year-on-year variation of the Consumer Price Index (CPI) had averaged 39.2% between 1980 and 2000, with peaks of up to 63% in August 1983, 99% in March 1989, and almost 108% in September 2000, the prelude to the dollarization process.
With the new monetary scheme and the abrupt elimination of fiscal dominance, the average inflation rate fell to only 5% between 2001 and 2023 and an average of 3% since 2003, ignoring the transition period and statistical drag between 2001 and 2002.
DOLLARIZATION AND COUNTRY RISK
It is often argued that one of the main signs of the alleged “failure” of the dollarization program is precisely the high Country Risk premium (an indicator measured by JP Morgan) that Ecuador has compared to other Latin American economies that adopted free market rules but kept active monetary policy, such as Chile or Peru.
Ecuador maintains a Country Risk index above 1,200 basis points, which implies that it must pay a 12% differential rate over the international interest rate of typically safe assets (such as US Treasury bonds).
Although it is below unstable countries (with full use of their monetary policy) such as Argentina, and Venezuela, it is much higher than that of Chile, Uruguay, Peru, or Colombia.
But this risk associated with the country’s sovereign debt does not come from dollarization per se but from the episodes of fiscal irresponsibility inherited from the Correa administration and the present political instability as a guarantee of institutions and property rights (a fact that today threatens President Guillermo Lasso).
The Country Risk before the dollarization process exceeded 4,500 basis points between October 1999 and March 2000.
The 45% differential over the international rate was mainly due to the risk associated with currency devaluation, which was eliminated with dollarization.
The risk premium fell below 1,300 basis points by the first week of September 2000, dropping more than 3,000 points from the initial situation.
Under a fiat currency regime and sovereign monetary policy, Ecuador’s debt was riskier than ever, even with most of the fiscal imbalances corrected.
This allowed the reactivation of international credit for the domestic economy quickly and is one of the advantages of dollarization over other ways of stabilizing prices.
It has a rapid and strong effect on the risk premium.
With information from La Derecha Diario