Can Ecuador Escape Its Cycle of Economic Instability?

(SEZER OZGER via Getty Images)

Ecuador's flag waves behind rows of coins.

While it may help Ecuador avoid a greater crisis in the years ahead, another International Monetary Fund (IMF) program is unlikely to ensure the country's long-term economic and financial stability, as the government will continue to struggle to maintain macroeconomic discipline amid significant political constraints. Ecuador has a long history of political and financial instability. A combination of economic challenges, socio-economic discontent and, at the institutional level, legislative-executive deadlock have prevented successive Ecuadorian governments from pursuing forward-looking economic policies, which, in turn, has contributed to the South American country's recurring financial problems. Since its independence in 1822, Ecuador has defaulted on its debt almost a dozen times. And in just the past 30 years, five Ecuadorian presidents have either been ousted, deposed or impeached, with the most recent being former President Guillermo Lasso (2021-2023), whose term was cut short after he dissolved the National Assembly and triggered early elections.

Ecuador is a serial defaulter. Most recently, the government was in default on its international bonds in 1997-2000 and in 2008-09. It restructured its international bonds in 2020, which economically translated into a default due to a reduction in the net present value of the bonds. In 2020-22, Ecuador also restructured its debt with Chinese banks and agreed to modify an oil-based credit agreement with PetroChina to allow for debt relief.
Former President Rafael Correa stands as a unique exception to Ecuador's history of fragile, short-lived presidents. Correa, who held the presidency from 2007 to 2017, benefited from a favorable global economic environment and rising oil revenues that enabled his administration to significantly increase social spending.

Ecuador's dollarized economy and commodity dependence make it vulnerable to exogenous shocks, which its perennially fragile governments have been poorly positioned to address with forward-looking economic policies. Ecuador adopted the U.S. dollar as its official currency in 2000 following a financial crisis in the late 1990s. In doing so, Ecuador hoped to reduce inflation and foster economic growth by replacing its currency with the U.S. dollar. But while this helped stabilize the country's economy and inflation, it came at the cost of an independent monetary policy. This is because full dollarization severely curtails (or completely eliminates) the central bank's ability to both function as a lender-of-last-resort and stimulate the economy through currency depreciation or lower interest rates. Full dollarization also takes away the government's ability to generate revenue through currency issuance (so-called seigniorage). This has forced Ecuadorian policymakers to rely even more on fiscal policy to stabilize their country's economy in the face of shocks, including commodity-related terms-of-trade or international interest rates shocks. It has also left Ecuador more susceptible to greater economic and financial volatility, as well as fiscal and debt crises, because a fully dollarized economy has fewer tools to counteract adverse shocks due to a more limited policy toolkit. This vulnerability to exogenous shocks is further exacerbated by Ecuador's dependence on oil, mining and agricultural exports — all commodities with highly volatile prices — as a source of revenue. During the oil price boom (2007-14), Ecuador's government failed to save oil-related windfalls, which would have required pursuing prudent, forward-looking fiscal policies. As a result, the country has experienced protracted low economic growth as Ecuador was forced into fiscal adjustment in the face of external shocks (including the 2015 drop in global oil prices and the global economic fallout from the COVID-19 pandemic in 2020). This has, in turn, raised the risk of government instability (as evidenced by Ecuador's recent political crises) and socio-economic instability (as evidenced by the sharp uptick in homicides in the country in recent years).

Full dollarization means that the official legal tender is the dollar and there is no national currency.
According to the World Trade Organization, fuels and mining products account for almost 40% of Ecuador's total exports, while agricultural products account for over 50%.
Under the Correa administration, Ecuador's political stability and economic progress were relatively high as Ecuador benefited from oil-related revenue windfalls. But instead of saving those oil-related windfalls to avoid being forced into pro-cyclical austerity during the next downturn, the Correa government significantly increased social expenditures, which doubled between 2007 and 2016 from 4.3% to 8.6% of GDP. This social spending spree temporarily reduced inequality and poverty rates in Ecuador. But once oil prices fell in 2015, political, social and economic instability in the country again increased as a result of the government's overspending and overborrowing during the oil price boom.

Despite a recent debt restructuring, Ecuador continues to face significant external financing challenges, which will give it little choice but to sign up for another IMF program if it wants to avoid another broader external default. Fully dollarized Ecuador faces weak economic growth and high interest rates due to high U.S. interest rates. Meanwhile, the country's fiscal deficit has declined since the COVID-19 pandemic, mostly due to increasing oil prices (and only partly because of an IMF-supervised macroeconomic adjustment), which means the government has not implemented any structural fiscal adjustment. This casts doubt on the outlook for Ecuador's debt sustainability. The government remains in domestic arrears and locked out of international capital markets, forcing it to rely on multilateral borrowing, despite the 2020-22 debt restructuring. Against this backdrop, external debt service is set to increase significantly in 2025 and 2026, including IMF loans.

As Ecuador was already granted exceptional access under its previous IMF program, net new financing will be limited, but will be helpful to effectively roll over IMF loans. Ecuador owes the IMF almost $8 billion, which will be coming due in the next few years. Another IMF program would help to refinance maturing IMF loans. Rolling IMF loans and unlocking additional multilateral borrowing would therefore help support Ecuador's external financing outlook. But this does not mean that Ecuador will avoid another debt restructuring, as its external liquidity position remains very weak and the bonds that were restructured in 2022 will be coming due starting in 2025 (along with IMF loans from its previous programs). However, another debt restructuring in the context of an IMF program would still prove less disruptive than a ''hard'' default.
The IMF understands that macroeconomic adjustment in a fully dollarized economy is financially and politically difficult. The older staff members will remember how quickly the Argentina program went off track in the late 1990s and 2000s and how the fund's reputation was tainted, which highlighted the risk of supporting adjustment programs in macroeconomically constrained, dollarized, commodity exporters. To mitigate such risks, the IMF will thus demand significant assurances from the Ecuadorian government before agreeing to another bailout. But it will also be keen to secure a new program in order to reduce the possibility of Ecuador defaulting on its IMF obligations.

A new IMF program would ensure that the government continues to implement macroeconomic adjustment, helping unlock additional, multilateral and possibly bilateral funding with the aim of avoiding broader medium-term economic and financial destabilization. Ecuador will need to reach an agreement with the IMF if it wants to avoid a default on its IMF and private external debt. Negotiations with the IMF will prove challenging, and it remains to be seen whether the IMF's insistence on financing assurances will lead to yet another restructuring of Ecuador's international market debt. The IMF has already granted Ecuador exceptional access under its Extended Fund Facility (EFF), meaning the fund will not be willing to run financial risks in the context of the government's uncertain ability to stick with implementation and the commitments of the next president. At the same time, the IMF will be interested in securing a new program for Ecuador, if only to avoid broader destabilization, including a potential default on the country's IMF debt. A new IMF program would help Ecuador with the necessary macroeconomic adjustment, while it would benefit from improved access to multilateral and likely bilateral financing. It remains to be seen whether this would help unlock sufficient financing to help the Ecuadorian government get over the bunching of international bond maturities, particularly as Ecuador's IMF loans will help refinance its maturing IMF loans, rather than provide additional financial resources.

After an initial IMF program was terminated prematurely (March 2019-May 2020), Ecuador signed up for a new EFF arrangement in December 2020, after also receiving COVID-related IMF financial support in the guise of the Rapid Financing Instrument (RFI). The IMF completed the final review of the 27-month EFF program in December 2022. Although the program helped improve Ecuadorian fiscal and debt dynamics and shore up the dollarization regime by reversing much of the institutional erosion in terms of the government weakening the central bank, Ecuador remains shut out of international bond markets given its increasing external debt service in 2025-2027. All major international credit rating agencies — including Fitch, Moody's and S&P — rate Ecuador close to default.

While a new IMF program will help stabilize the economy in the short term, Ecuador is unlikely to enter a sustainable economic and financial path in the longer term due to significant political constraints. Since taking office in November 2023, Ecuadorian President Daniel Noboa has sought multilateral loans and, in March, officially requested a new IMF program. But Noboa's National Democratic Action alliance holds only 10% of the seats in Ecuador's legislature, which will make it difficult to push through necessary reform, especially fiscal austerity. The upcoming 2025 presidential elections will also increase the political costs of implementing reforms, particularly as Noboa may decide to run for a second term. Indeed, both Noboa and lawmakers in the National Assembly will be wary of significant fiscal retrenchment, which could politically backfire by weighing on Ecuador's economic growth and employment outlook. Because of these political constraints, rather than adopt structural measures aimed at putting Ecuador on a sustainable economic and financial path, the Noboa government will be more inclined to implement one-off measures, such as the recent one-off tax on bank deposits, to address the financial challenges the country faces. The challenging political economy of macroeconomic adjustment means that the economic and political outlook will remain fraught with financial, economic and political instability — thus possibly resulting in international bonded debt restructuring and/or a default, low economic growth, high unemployment and reduced social spending, which would ultimately generate yet more political instability and social unrest.

Ecuador's government debt peaked at more than 60% of GDP in 2021, but medium-term debt dynamics remain vulnerable, not least due to a strong dollar and high U.S. interest rates. The Noboa government has relied on one-off measures rather than structural adjustment (e.g., reprofiling public debt held at the central bank), while deposits continue to fall and domestic arrears continue to increase, pointing to very considerable domestic and external financing challenges.