Dollarization in Ecuador

The problems that Ecuador faced in 2000 were an accumulation of many years of struggling economies and governments. The blunders of the government began to have a crippling effect on the nation in the 1980's when there was a "debt crisis" that led to many macroeconomic changes that led to exchange rate instability. Along with an external debt that had been growing since the 1960's, "the surging interest rates on floating-rate commercial bank debt and declining commodity-export prices thrust Ecuador into crisis" (Beckerman, p. 6). In order to keep up with high inflation rates and the need to repay the debt, in the 1980's Ecuador instilled a series of devaluations of the Sucre, Ecuador's currency at the time. The 1990's Ecuador brought along many of the same problems. Inflation was growing at uncontrollable rates and the Sucre was devaluating accordingly. Slowly people began to lose confidence in the Ecuadorian currency and the population began to semi-dollarize. People withdrew their monies from the banks and sought the stability of the dollar for their savings. The stage was set for dramatic reform as the economy seemed weaker than ever and the people were rapidly losing confidence. The final blow came with the presidency of Jamil Mahuad and the external disasters he faced before dollarization.

Jamil Mahuad took presidency in 1998 and by 1999 "the economy plunged into its worst recession ever" (Arteta, p. 1). GDP decreased by 7.3%, inflation rose to 61%, employment reached 17% and the Sucre depreciated by 195%. These were the effects left over by a political corruption in the presidency of Abdala Bucaram, an "El Niño" crisis in 1997, plunging crude oil prices and various effects of the East Asian, Russian and Brazilian financial crisis. Never had the country's dependence on agriculture and outside economies hurt it so much as it did during this crisis. In March of 1999, Ecuador's currency was unable to resist devaluation in the wake of the Asian and Brazilian economic crisis resulting in the closing of 8 Ecuadorian banks. Several days later the government freezes deposits in order to prevent a bank run. In the next few months leading to dollarization, the economy goes into deep recession and the country defaults on $6.5 billion in Brady and Eurobond debt.

Mahuad's approval plummeted to a miniscule 5% as he faced a violent country and constant pressure. In an apparent act of desperation, Mahuad announces that Ecuador will fully dollarize its economy in order to regain stability, but this is too little too late for Mahuad. On January 21, 2000 Jamil Mahuad is removed from the presidency by an indigenous uprising and a military coupe. After much discussion and unrest, the presidency changes to the hands of Gustavo Noboa, but the plan to dollarize is not weakened - instead it reaches its full execution.

Gustavo Noboa comes into office with the main objective of making dollarization work. He succeeds in convincing Congress to pass all the legislation necessary to implement dollarization as soon as possible in February of 2000. The IMF approves Ecuador for aid and adds changes to the dollarization bill known as the Economic Transformation Law. Noboa signs dollarization into law on March 9, 2000 as the country sets out to eliminate the Sucre. The exchange rate was set at 25,000 Sucres per US dollar, which was what the government could afford to pay and what the currency had been fluctuating around (Jara, p. 9-10). Once the process started it was critical that the Central Bank of Ecuador allocate its funds properly. It estimated its inadequacy of reserves and covered them with bonds from the National Currency and increasing reserves, which was all possible because of a very timely increase in oil exports and money from a program sponsored by the IMF. Dollarization was finally complete after a year from its implementation when nearly 98% of all sucres had been exchanged. The process went relatively well amongst the people who were reluctant at first, but easily adjusted because of heavy use of dollars and Sucres before.

Dollarization in Ecuador basically consisted of exchanging all the Sucres for dollars except for the coinage that was government issued but still tied to the dollar for its value. This system is different from the system put in Panama, which has been dollarized since early in the 20th century. Mainly the government in Ecuador still has a central bank. Although this bank is not as powerful as a nation with its own currency it still has its share of influence. The Central Bank has limited control on the money supply, as most of it is determined within the market. Ecuador produces its own coinage in order to maintain national pride and to add to some seignorage. There are reserves for the coinage issued, which allows for the banks to still have some monetary policy, but the administration is low and limited.

The advantages of dollarization seem to be perfect for a nation like Ecuador that has had so much economic instability. Inflation was one of the major problems that Ecuador has faced in the past twenty years. The Sucre was depreciating at high rates and the people were rapidly losing confidence. Dollarization fixed the problem of having an unstable currency by simply replacing it. The dollar works well in this economy because of its stability and ubiquity throughout the world. As a result of dollarization, inflation has been significantly reduced because the market, and not inept politicians, naturally determines the amount of money in the economy.