Newsroom: Article

Omni News May 2007 - Ecuador

Never was Latin America’s sharp nationalist trend clearer than on January 15, 2007 at the inauguration of the Ecuadorian president Rafael Correa. Many of the befriended nationalist leaders from within and outside Latin America were present at the ceremony, such as Hugo Chávez of Venezuela, Evo Morales of Bolivia, Daniel Ortega of Nicaragua and even Mahmoud Ahmadinejad, the controversial Iranian president, who flew in from Teheran for the ceremony. The gathering in Ecuador for the ceremony sent shivers to investors worldwide. Investors realised that they could be facing another round of nationalisation in Latin America, this time in Ecuador.

Ecuador rewrites constitution.
In the past ten years, Ecuador has seen eight different presidents and as a result of that much political turmoil. To create a more stable political environment, Correa has been announcing that the constitution should be rewritten (by a constitutional assembly) as to limit the powers of the Congress, which is primarily controlled by Correa’s opposition. This plan severely threatens the powers of the opposition and led to chaos within the Congress. As a result, the president ordered the dismissal of 57 members of Congress (from a total of 100 members) alleging that they were destabilising “a government that is seeking the common good”. In March, new Congress members were sworn in and the obstructions for further far-reaching economic and social reforms were thereby removed. Subsequently on April 15, 2007, the people of Ecuador were consulted and they approved Correa’s proposal to rewrite the constitution by a constitutional assembly with an overwhelming majority of more than 80%. In Venezuela, the popular president Chávez has already rewritten the constitutions to pave the path for a more leftward-leaning society. Morales is trying to do the same in Bolivia.

Already during his campaign, Correa unveiled a four-year economic plan, which will give economic relief to the poor, increase social investments and includes the suspension of ‘illegitimate’ foreign debt. Correa has insisted that Ecuador cannot afford its debt service and confirmed during his inauguration speech that an ‘economic revolution’ is on its way that will entail foreign debt renegotiation. Debt service will decrease from 28% of the government budget as scheduled for 2007 to 12% in 2010.

The intention of Correa to strategically default on external debts is quite worrisome. Ecuador last defaulted in 1999, which led to the dollarisation of the economy in the following year. The dollarisation solved Equador’s short-term rampant hyperinflation at that time, but also caused the political crisis that eventually led to the downfall of then-President Jamil Mahuad. Just weeks after Correa took office, Ecuador announced a 30-day grace period on a scheduled bond payment because of cash shortage. These plans rekindled fears of an Argentinean-style default, which amounted to Buenos Aires managing to pay fewer than 30 cents on the dollar after reneging on roughly US$100 billion of bonds. However, contrary to all announcements made by Correa, Ecuador still paid out the scheduled interest payments on the bonds saying that debt restructuring could be postponed by first realising Correa’s plans to rewrite the constitution. This reasoning leaves investments bankers, hedge funds and other investors in Ecuador (especially since Correa’s success with the referendum of April 15, 2007) still very much on the alert for future debt default.

Correa also denied review of the country’s economy by the World Bank and the International Monetary Fund (IMF). Boosted by the outcome of the referendum - which clearly gave his reform agenda a new impulse - Correa accused the World Bank of fraud and threatened to expel World Bank representatives from Ecuador. Furthermore, he announced that his government has paid off all its debts to the International Monetary Fund and stated that he does not want “to have anything to do with this international bureaucracy”. Correa stated that unfair IMF conditions have severely harmed Ecuador’s economy. Since Venezuela is providing for an alternative source of credit to countries in the region such as Ecuador and Nicaragua, the credit cartel of the IMF does no longer exists. Ecuador is now able to openly disagree with IMF’s “unfair” policy and credit conditions, without being afraid to be denied any credit from IMF or institutions such as the World Bank, Inter-American Development Bank, and so on.

Venezuela leads the pack.
In the elections, Correa commented on Ecuadorian-Venezuelan relations. He claimed that he does not wish to become part of the Venezuelan Bolivarian movement, but that he considers Chávez as a friend and is determined to follow Venezuela in some of the economic reforms which have been initiated by Chávez.

Chávez was first elected Venezuelan president in 1998. In late 2002, the country faced a general strike that led ground oil production to a halt and initiated a capital flight. If anything, Chávez, a former army paratrooper and loyal ally of ailing Cuban leader Fidel Castro, is forging ahead with his plans to transform Venezuela into a socialist society.

Since Chávez was re-elected last December, he has decided to nationalise the country’s largest telecommunication and electricity companies. Venezuela forced, for example, US firm Verizon as shareholder of Compañía Nacional Anónima Teléfonos de Venezuela to sell its 28.5% stake to the government. Also AES Corporation's 82% share in Compañía Anónima Electricidad de Caracas is now being purchased by the government.

Chávez further forced international energy groups like BP, Exxon Mobil and Total of France to sell part of their stakes and surrender control of projects in the Orinoco Belt in western Venezuela, giving state-owned oil company PDVSA at least a 60% stake in each venture.

Despite high oil prices, PDVSA recently divulged a 26% fall in profits for 2006, which is blamed largely on the company’s budget being spent mostly on social programmes by the Chávez administration.

Following developments in Venezuela, Correa announced during his campaign further reforms and nationalisations in Ecuador as well. Before Correa’s government took office some nationalisation in the oil industry had already taken place.  Ecuador took control over US$1 billion of assets owned by the US-based Occidental Petroleum Corporation, the largest foreign investor in Ecuador. Occidental is seeking compensation at ICSID. New attempts to revise and renegotiate contracts with other oil companies in Ecuador have not started yet, but are to be expected to happen sooner or later.  Reforms in other areas are expected as well.

Roughly at the same time as the peak of the Venezuelan nationalisations, Chávez announced the creation of a new national currency, the bolivar fuerte, or strong bolivar. However, the naming could not have been less appropriate for the sickly currency. While by the official exchange rate to one dollar equalled2,150 bolivares, the dollar was widely sold for over 4,500 bolivares in street trading earlier this year. Although Chávez believes this new action will help address surging consumer prices and the battered local currency, inflation hit 17% in 2006, higher than that of any other country in Latin America. Equador is still dollarised, with inflation therefore under control, but also causing Correa to have no influence on interest rate policy and money supply and creating a strong dependency on the US treasury. Correa has always critised the system of dollarisation. Correa vowed to keep the US dollar as the country's currency, but said a new constitution should enable Ecuador to introduce a dual-currency system. With regard to foreign policy Correa is also supporting Chávez’s attitude towards the US. In response to Chávez's comparison of President Bush with Satan, Correa said it was unfair to the devil.

Uncertainty in Bolivia.
The outlook is not too different in Bolivia, whose president Evo Morales has introduced its reform plan which includes the plans to rewrite the constitution, further nationalise natural recourses, redistribute land, and so on.

In March 2006, the Bolivian IMF-agreement expired without any intention from the side of Bolivia in renewal. Bolivia has long been operating within the corset of the IMF and did not seem to profit from it. The IMF conditions imposed on Bolivia restricted economic policy choices and forced Bolivia to complete numerous reforms without actually reducing poverty in Bolivia. The expiration of the IMF agreement gave the Bolivian government the freedom to pursue different economic and development policies. Of course the expiration of the IMF-agreement was only possible for Morales since Venezuela has broken with IMF’s creditor cartel by providing for an alternative source of credit for countries in the region.

One of the first reforms that were introduced by Morales’ government was to increase the government’s control over its energy industry. Morales ordered the army to seize the assets of energy companies Petrobras, Repsol YPF and others last year, shortly after being sworn in. Morales’ move to have the army storm the assets of international oil and gas companies in 2006 set off six months of negotiations that forced foreign energy companies to give up the majority control of their operations and to lose substantial parts of their revenues to the Bolivian government.

The significance of the government’s energy reform can hardly be over-emphasized. According to the IMF, royalties from for example hydrocarbons have increased by 6.7 % of GDP over the last two years. This is huge already and the Bolivian government is even expecting these revenues to triple over the next four years.

It is justified to state that the Bolivian economy has done well in the first year of Morales’ presidency. There where improvements from an economical point of view, together with some new initiatives from the government to fulfil its promises to the impoverished 65% of Bolivia’s population that still lives below the poverty line. The country’s increased revenue will allow Morales to pursue his plans to improve access to education and health care, develop a strategy that allows productivity and economic growth to accelerate, and boost incomes among the poor majority. For foreign investors in Bolivia however it created uncertainty.

Nicaragua – back to left.
Nicaragua is a somewhat different story up until now. After 16 years of right-wing governments Daniel Ortega again leads the country since the beginning of this year. Ortega was the leader of the Sandinista revolution that threw over the former dictatorship of Somoza García in 1979. After the first democratic elections in Nicaragua in 1985 he became president until 1990, when his government was suddenly voted out of power. Back then the Nicaraguan population, tired of the continuous internal war against the Contra’s (the organised, armed opponents of the Sandinista regime, supported by the US) and the severe social and economic crises, voted against his government.

For the outside world Ortega has been out of picture since then, but while playing it low key in a country that officially became right-wing by heading an opposition party, Ortega managed to maintain and practice his Sandinista influence on the government. This has resulted in a new reign of the two-faced Ortega, who is now even cooperating with his former enemies, the Contra’s, by appointing their former leader Jaime Morales, a banker, as vice-president.

Ortega says he has changed and is no longer the revolutionary of the past, expropriating the property of the oligarchy. His main concern is now attracting foreign investors, he says. Nevertheless, on the one hand he has appointed former activists as ministers while on the other he is pursuing an active dialogue with the IMF and various multinationals, guaranteeing economic stability and safety of investments.

Ortega is clearly balancing between the demands of the rich right-wing upper class, which he desperately needs to stabilise the economy, and the cry for help of the extremely poor masse, where his socialist heart has always been.

Nicaragua’s recent decision to join the ALBA (Alternativa Bolivariana para las Américas), the Bolivarian Alternative for Latin America and the Caribbean, which is an alternative for the U.S.-backed Free Trade of the Americas (FTAA) treaty, does not come as a surprise therefore. Ortega complies with the left-wing social demands and at the same time obtains financial relief because of the investments the other members like Venezuela and Bolivia are making in Nicaragua in return. Venezuela for example has forgiven Nicaragua a debt of US$31,3 million, is assisting Ortega with the prospecting of an oil refinery, to “free Nicaragua from the IMF” and donates money and oil in enormous quantities to socialise (and eventually nationalise?) the energy market.

Just as they welcomed Correa recently, Castro, Chávez and Morales have loudly welcomed Ortega’s comeback. The country is unmistakably heading to the political left again, but although export results in US$600 million a year, Nicaragua is very much depending on the US$500 million of foreign aid it receives every year as well. Time will tell how Ortega will deal with his country’s need to grow independent and -following predecessors Castro, Chávez and Morales- the temptation of becoming another Latin-American Robin Hood.

Argentina’s cancellation route.
Correa tries to take advantage of the developments in Argentina as well. Like the Argentine President Néstor Kirchner, Correa has called for a renegotiation of Ecuador's US$11 billion external debt. Ecuador with its much smaller economy claims that it would be reasonable and fair to receive a similar debt cancellation as Argentina.

In a bid to keep inflation in check in Argentina under Kirchner utility prices have hardly been allowed to increase and limiting exports of soft commodities such as corn, soybeans and wheat has caused an oversupply in the internal market. And although Kirchner has managed an average of 9% gross domestic product growth yearly since 2003, his measures have left international investors discouraged to commit further investments.

Another discouraging fact for foreign investors is that Argentina still did not overcome the international investments claims brought against it since the banking crises of late 1990s and early 2000s. Only with ICSID Argentina has 34 investment disputes pending.

Conclusion.
At Correa’s inauguration ceremony it was once more made clear that Latin America’s new leaders are strongly connected and supporting each other in making a sharp turn to the left.  With Venezuela and Bolivia as big brothers, the path to the left has been smoothened for countries like Ecuador (and probably also Nicaragua). It was therefore to no ones surprise, that Correa has announced to nationalise natural resourses and industries connected with these resourses. And since Argentina’s experiment of debt cancellation has been called a success, it is no surprise that Correa says he wants to try the same for Ecuador.

If Correa actually follows the footsteps of Argentina and his befriended nationalist leaders in the region, then indeed more discouraging developments for foreign investors in Ecuador can be expected. How the investors will deal with these developments is not to be foreseen. After having already endured severe nationalisations in combination with compulsory suspension and/or cancellation of external debt in Latin America, would foreign investors be able and prepared to endure another round of such measures, this time in Ecuador? Would the ICSID arbitration between Ecuador and Occidental only be one in a long list of international investment disputes or would foreign investors in Ecuador simply swallow nationalisations and forced debt cancellations just as the majority of them did previously in Venezuela and Bolivia?

For companies and organisations facing difficulties in Ecuador and in other Latin American countries due to nationalisations and/or debt suspension/cancellation, please contact Omni Bridgeway at info@omnibridgeway.com.
Omni Bridgeway is specialised in the recovery of outstanding debt in political risk countries. Omni Bridgeway has a worldwide range of clients consisting of multinationals, banks, insurance companies and Export Credit Agencies (ECA’s).