Download Avantages and Disadvantages of Dollarization in

COMMENTS ABOUT
THE MACROECONOMIC SITUATION IN ECUADOR
Enrique Lasprilla R.
Quito, February 22nd 2000
ADVANTAGES AND DISADVANTAGES OF
DOLLARIZATION IN ECUADOR
Assuming that the conditions required for the dollarization process are fulfilled in the
Ecuadorian case, which has not been proven so far, it has some advantages and
disadvantages that are important to analyze in this specific case. The main advantages
foreseeable are: control of inflation in the medium and long run, control of the loose of
purchasing power of salaries, reduction of interests rates, control of capital leakage,
elimination of money exchange risks , improvement of country-risk position, economy
planned in the medium and long run directed toward productive activities, elimination
of indexation of prices, salaries and contracts, credibility of the system if it works fine,
and decreasing financial costs; an small international monetary reserve is required.
It is expected that in the medium and long run inflation will decrease sharply,
nevertheless in the short run inflation has been growing in a very important magnitude
and has not stopped so far, because there is a gap between the trend of devaluation and
the trend of inflation. Additional price increases are expected in items such as gasoline
because they have been approved to finance the state budget; in public services
(electricity ,gas, telephone and water supply) that now are subsidized; these subsidies
have to be cut out so the public companies can be sold in the international markets in
order to get resources to guarantee the regular functioning of the economy. Along with
these price increases would come other price increases as public transportation and
general prices of goods and services derived of the increases mentioned.
The loose of purchasing power of salaries would also come to a halt in the medium and
long run because of low levels of inflation and because there are no more devaluation of
the currency; the problem now is that salaries levels are too low due to the huge rates of
devaluation and inflation that Ecuador has experienced during the last two years. It will
not be possible to restore the former salary levels for employees in the public sector
since government will be tied by the need to maintain the fiscal equilibrium. In the
private sector of the economy raises in salaries will depend upon the conditions of
factories and companies. Great companies will be able to increase salaries as their
businesses improve, but small businesses are unlikely that could go on with significant
salary increases.
Another expected effect of dollarization process is that the interests rates will fall slowly
through time because there will not be the exchange risk anymore, and because if the
scheme works well the risk-country will diminish. So far, the government decreed a
conversion of interests rates of credits given in Sucres to its equivalent in dollars.
Nowadays, the interests rates in dollars have not fallen and its level for the transactions
renewed are about 20-25 % yearly. New credit operations have not been opened lately.
On the contrary, the interest’s rates in dollars for the frozen resources in the financial
system are fixed at the 7% level. In case the interests rates in dollars decline the
financial costs of the economic agents looking for credit would go down.
There would be some confidence that the leakage of capital resources from the country
would cease and resources that went out the country would return; nevertheless the
mechanism that is being used to defrost the money deposits in the financial system
frozen in March 1999, do not deserve trust from the public due to the fact that all
deposits higher than 4000 US$ will continue to be frozen at least for 3 or 5 years more;
this mechanism reveals that the financial system is not strong enough to face the
dollarization process. On the other side, the International financing institutions and the
international community has not given a strong support to the dollarization process of
Ecuador; they seem to be waiting for the results of the experiment. Anyway, it will take
some time for the confidence in the financial system and in the economy as a whole to
be restored..
There is no doubt that the money exchange will disappear at least while the exchange
rate is kept fixed. Another important issue is that if the dollarization prevails the
economy would have to be directed to productive and not to speculative activities. The
problem is that the productive activities have to be directed toward the foreign sector
since the domestic sector is completely depressed. Under such situation arises the issue
of efficiency and productivity. Too much would have to be done for reaching the
requirement mentioned. As an example, it is possible to say that only 9 factories in the
country are applying the ISO 9001 standard , which serves as accreditation certificate
to inter in foreign markets.
Among the disadvantages of the dollarization process it has to be point out that the
country would be dependant of changes in the political economy of the United States of
America; we have to be aware that their economic policy will never be taken
considering the requirements or the economic conditions of Ecuadorian economy.
Besides it is necessary to take into account that the export goods and services of
Ecuador, like, oil, bananas, shrimps, coffee, cocoa and flowers are very fragile and the
country do not have capacity to answer to sudden and important price fall downs of the
prices of these goods.
Another weakness, in the case of Ecuador’s economy is the exposure to the financial
instability of the foreign financial markets, or economic crisis in the world, which may
occur anytime.
With the dollarization process there will be a loose of the revenues due to seigniorage,
that is to say the benefits for issuing the local currency; Ecuador will not issue more
Sucres, so it will not receive revenues for this concept; the seigniorage will be received
by the United States Government. In order to reduce the loss of seigniorage the
Ecuadorian Government could request to the US government the share of seigniorage
once the country become officially dollarized.
It is expected that the dollarization process will cause serious problems to medium and
small industries and companies; it is very likely that they do not have the capability to
face the narrowness of the domestic markets, and will not be able to reach the efficiency
required to compete in the international markets; such situation may be leading to the
bankruptcy of small companies and to increase the level of unemployment at the
national level; it is known that the level of unemployment now, without the
dollarization process being implemented is around 18%.
Right now, the low level of salaries and the high rates of exchange in relation to other
currencies are comparative advantages that facilitate exports to other countries specially
to the neighbors (Colombia and Peru) But as time passes these comparative advantages
will progressively be lost, because the economy will be tighten by the dollar. In the
medium and the long run, it will be more advantageous to import than to export goods.
Under the circumstances described people who will benefit from dollarization will be
very few and the income distribution will be more inequitable than it is now. The gap
between the reach and the poor will broaden.
There is a law project in order to establish the dollarization in the ecuadorian economy
and it seems to be that it will be approved by the national Congress; so Ecuador is next
to start a trip without return.