Noboa’s fatallegacy

WHEN GUSTAVO NOBOA took over the presidency from coup leader Lucio Gutierrez at the beginning of 2000, he proved an adept captain of the good ship Ecuador. Despite the ramshackle nature of his vessel, he oversaw a successful transition to dollarization, implemented large primary fiscal surpluses, finally got construction moving on a new heavy oil pipeline and was rewarded with the strongest economic growth in Latin America.

Over the past year, however, and especially the past six months, Noboa seems to have turned almost suicidal. He’s embarked on a massive, irreversible and unaffordable spending spree just as his term as president comes to an end. When Gutierrez – this time democratically elected – takes the helm on January 15 he will find his ship steaming full speed ahead towards the iceberg of default, with no time to slow or turn around before the inevitable crash.

“Ecuador’s road, at least as Mr Noboa has traced it, ends in February 2003,” says José Barrionuevo, director of emerging market strategy at Barclays Capital. “With sharply slowing capital inflows and a sluggish economy, the country cannot afford to draw on reserves to make $175 million in payments in February to avoid a default. A decline in dollar reserves would undoubtedly fatally wound dollarization and trigger a new run on the banking system and the end of stability.”

Many investors simply avoid Ecuador on principle, well aware of its history of default, corruption and chaos. Every time it seems as though the country has found a path to sustainable growth, it inevitably loses its way surprisingly quickly. This time around, investors and analysts are struggling to comprehend the sudden change in the outgoing president’s behaviour.

For the first two years of his term in office Noboa was Dr Jekyll. An unassuming devout Catholic, he just happened to be vice-president when Gutierrez ousted president Jamil Mahuad in a short-lived coup. One day later, with the return of constitutional rule, Noboa became president and took upon himself the task of getting Ecuador’s act together without bowing to any political interests.

Over the past year, however, Noboa seemed to visibly give up the fight, in a move most often explained by new-found political ambition. With a determination to secure a future political career for himself, Noboa’s Mr Hyde side emerged. Fiscal responsibility and the expenditure of political capital was out; caving in to congress and expenditure of non-existent dollars was in. Public-sector wages went up by an astonishing 55%, or $750 million – and not in the form of one-off bonuses either. Gutierrez now faces a monthly payroll that is well beyond what the government can afford and that he is politically incapable of reducing. Cutting wages, after all, is the most difficult thing for any politician to do.

Black hole in the national accounts And in a final act of what can only be considered scorched-earth politics, Noboa raised $245 million in December by selling forward oil contracts – basically pledging more than 20% of 2003’s oil production in order to pay arrears on 2002’s bloated wage bill. This was done after the election of Gutierrez, in the face of Gutierrez’s explicit condemnation, and also in probable violation of domestic law and Ecuador’s international bond documentation.

It also queered the pitch for crucial negotiations between the new government and the IMF, which has had a long-standing non-negotiable opposition to any use of oil money for general fiscal expenditure. Now that Ecuador looks as if it is in technical default on its global bonds, it’s hard to see how a payment default can be put off for more than a few months.

The fault may not wholly be Noboa’s, however. The forward oil sales may turn out to have been his last desperate attempts to fill a black hole in Ecuador’s 2002 accounts – a hole caused by what local consultancy Analytica Securities calls “massive misappropriation and embezzlement performed by former economy minister Carlos Julio Emanuel”. Emanuel is in exile in Panama, along with former president Abdala Bucaram, who’s believed to have absconded with hundreds of millions of dollars himself. The Ecuadorian state auditor reported in the wake of Emanuel’s firing last year that he had diverted $108 million in unbudgeted funds to local authorities, in return for kickbacks. Some estimate far larger sums were involved.

If those estimates are even anywhere near the truth, Gutierrez is going to inherit a much bleaker fiscal situation than the already bleak official accounts suggest. And to make matters worse, his political position is already dire.

For Gutierrez, a bit like Lula in Brazil, has control of the presidency but not control of congress. In fact, he has the certain support of no more than 20 of the 100 members of the house of representatives. He’s going to have difficulty building on his support among the leftists and the indigenous movement, for they are steadfastly opposed to austerity measures – such as the elimination of various fuel subsidies – that he is going to have to try to implement in order to get an IMF deal.

After all, as Alessandra Alecci, Ecuador analyst at Deutsche Bank, says: “Even assuming a nominal surplus of $100 million and arrears to the Paris Club, without an IMF programme it would be impossible for the government to meet its debt payments.”

On the other hand, Gutierrez will face even more difficulty if he attempts to cultivate the right, which has steadfastly opposed him and would want him to become a figurehead, with their own man, former president León Febres Cordero, calling the shots.

And the worst outcome of all would be if Gutierrez ended up trying to cut a deal with the powerful Roldosistas, the party of Bucaram. Gutierrez ran on an anti-corruption platform, and the cost of any deal would certainly be immunity for Bucaram (who remains popular in Ecuador) and a free path for him to return to a position of political power.

The challenges facing Gutierrez are particularly unfortunate for Ecuador because, in Barrionuevo’s words, his election “marks the first time that someone from the people leads the country”. Not since 1534 will native Ecuadorians have been a prominent part of a ruling coalition, and he promised to be the first president ever to govern for the benefit of the country as a whole, rather than for the white elite.

Once he was elected, he behaved extremely impressively, reaching out to all the parts of the electorate who hadn’t voted for him, and publicly embracing the need for a politically unpopular IMF programme. He also started taking a lot of advice from universally admired economist Guillermo Lasso.

Lasso was finance minister under Jamil Mahuad, the president Gutierrez ousted, until just before Ecuador became the first country ever to default on its Brady bonds. Lasso would not stand for default, and resigned rather than go down that road; Mahuad stayed the course, until, not much later, he was overthrown.

Gutierrez certainly needs first-rate economic advice: with no political experience of his own, and little understanding of international finance, he’s out of his depth already. “I don’t think he has the training or expertise to deal with this problem,” says an analyst. “It’s like throwing your mother in to deal with the Enron treasury.”

Crunch time for dollarization But in a sense, the situation is so bad already that Gutierrez’s experience or lack thereof doesn’t really matter. The Gutierrez presidency looks set to follow a similar path to that of Mahuad; it might even happen with the same finance minister. The new president will find himself forced to default early on in his term, probably in the first half of 2003. And, just like all other presidents who default, he will be ousted shortly thereafter. If things get really messy, dollarization could fall apart, with the government paying salaries in some new currency that rapidly hyperinflates.

The only hope is that somehow Gutierrez will be able to keep his government together even after an external debt default – and that the IMF, seeing the necessity of default, will still lend into arrears and give Ecuador its imprimatur, triggering further lending from the World Bank and the Inter-American Development Bank.

Yet again, the logic of the financial markets has failed. The monetary systems of both Argentina (convertibility) and Ecuador (dollarization) were based on the argument that they forced the countries into the kind of fiscal rectitude they would never otherwise adopt. The governments couldn’t keep spending, because that way lay chaos. But the governments kept on spending.