Congress last month approved legislation to start a digital currency for use alongside the U.S. dollar, the official tender in Ecuador. Once signed into law, the country will begin using the as-yet-unnamed currency as soon as October. A monetary authority will be established to regulate the money, which will be backed by “liquid assets.”
Less than six years after repudiating $3.2 billion of its dollar-denominated debt, Ecuador has dwindling oil reserves, with current-account deficits that are draining dollars from the economy and financing needs at a record. While using virtual money to pay government workers and contractors would help conserve hard cash, the currency may prompt Correa to boost spending even more and undermine the nation’s ability to repay long-term bonds, according to Landesbank Berlin Investments.
“This is usually the start of debasement, inflation and depreciation,” Lutz Roehmeyer, who helps manage about $1.1 billion of emerging-market assets at Landesbank Berlin, including Ecuadorean debt, said in an interview.
Roehmeyer, who’s been investing in Ecuador for more than 15 years and correctly predicted its last two defaults, plans to reduce his holdings of the nation’s debt. The firm holds some of the $2 billion of bonds that Ecuador sold in June.
The Economic Policy Ministry declined to comment on the new currency and referred questions to the central bank. The bank’s press office also declined to comment and referred to a June resolution signed by the bank’s general manager, Mateo Villalba. The resolution says electronic dollars will be backed by liquid assets and can’t be swapped for government bonds.
Ecuador is developing its own electronic tender as digital currencies led by bitcoin have gained acceptance as a means of payment that have been promoted as a replacement for traditional money. Unlike Ecuador’s plan, most virtual currencies were developed as an alternative to government-backed tender.
Ecuador has posted current-account deficits for each of the past four years, draining dollars from an economy that adopted the greenback as its sole currency in 2000. The government expects a $4.5 billion budget gap this year after public spending more than tripled since Correa took power in 2007.
To prevent a dollar shortage crimping public spending, the government used more than half its gold reserves as collateral to obtain a $400 million loan from Goldman Sachs Group Inc. in May. The same month, it reached an accord with China to borrow $2 billion in return for future oil output.
Correa still sought help from the Latin American Reserve Fund, known as Flar, a month later to prop up the country’s balance of payments with a record $618 million loan.
With Correa boosting spending on public-works projects and social programs to reduce poverty, the Finance Ministry forecast in November that Ecuador would need to borrow about $35 billion through 2017.
The temptation to use the new currency to pay bills will increase as the government exhausts its current sources of dollars, according to Jose Mieles, an economist at Quito-based research institute Cordes. Members of Correa’s party in congress defeated efforts by industry groups to include a guarantee to back up the new currency with an equal amount of dollars in the new law, saying it was unnecessary.
“The problem would be if they began to pay local creditors” with the new currency, he said in an interview. “They could use these resources to get immediate liquidity.”
Yields on Ecuador’s benchmark bonds due in 2024 have fallen 0.24 percentage point since trading began on June 20 to 7.35 percent as of 10:50 a.m. in New York. That compares with an average 0.13 percentage point increase for developing nations.
Analysts are waiting to see how the government will implement the new system, said Juan Lorenzo Maldonado, a Latin America economist at Credit Suisse Group AG.
“If they find a way to make an efficient use of the electronic currency to manage just certain types of payments and make some procedures easier and faster, and they hold themselves on doing it responsibly, it may be a good thing,” he said.
Ecuadoreans may try to get their savings out of the country to avoid being paid with virtual money, according to Steffen Reichold, an economist at Stone Harbor Investment Partners LP, which oversees $65.3 billion of fixed-income.
“I wouldn’t want to be converted into a new currency managed by an untested central bank,” Reichold said. Creating a currency “isn’t straightforward even when you’re in a country with a perfect track record of successful economic management, and I don’t think Ecuador is in that category.”
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