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February 21, 2016


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Certainly Ecuador is not Venezuela. But on the point: "This is painful, but it is responsible". Well, yes and no. Given the starting point at end of year 2014 I think the govt has been relatively responsible. But the main issue was the lack of financial savings pre 2014. Said differently -- if you know that your main source of income (oil) is volatile then you should be building up assets that you can draw down from in order to smooth out your consumption. Yes, infrastructure is certainly an asset but you can't really sell it to meet your consumption needs. Correa thought he could borrow if oil prices fell but, well, no. So with the above in mind the main issue with Ecuador's finances is that they were not well prepared for an oil price fall. Being well prepared meant building up liquid assets that are not correlated with oil prices.

In principle, I agree that resource windfalls should be saved. But there are a few mitigating factors here, I think.

(1) The price crash blindsided everyone. The surprise hasn't been that supply outpaced demand; the surprise is how inelastic oil demand has turned out to be. Massive price declines are not leading to significantly more consumption. In that sense, Ecuador hasn't done worse than most of the private sector, which also banked on oil prices remaining high. Demonstration: oil price hikes are making markets happy even in consuming countries!

(2) Ecuador has done a good job of freeing itself from dependence on oil revenues. That's basically what the above post is about. Spending the windfall was therefore less costly than in countries whose fiscal system is more dependent on oil. In addition, so far the government has been able to finance a fiscal deficit on the order of 4% of GDP in 2015, down from 6% in 2014.

(3) The windfall wasn't that big. The cumulative windfall since 2007 has been about $20 billion, nominal. That is around ten months of current government spending or one-fifth of its 2014 nominal GDP. (In October, the IMF estimated that 2015's nominal GDP would clock in around $99 billion.)

This is not to say that Ecuador was right to spend the entire windfall! It is to say that the decision was a calculated risk with a manageable (so far) downside.

To be honest, I'm not sure that we disagree! I'd be curious what Cad thinks.

I don't think we have a meaningful disagreement. Probably the main bone to pick is #1. Absolutely agree that the extent of the price crash blindsided everyone. That being said, I still think it was reasonable to have prepared for the risk of a price crash. The "stress test" concept would have applied here. Maybe two years ago we would have said $60 oil was a stress test, so the other $30 we've gone down is truly unexpected. Here I'm not intending on singling out Ecuador, certainly not relative to companies. Even countries that build up large financial assets like KSA did so in a less than smart way; my understanding is that they had some meaningful EM exposure (i.e., commodity exposure) in their portfolio which is just terrible.

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