Should multinationals be worried about Ecuador?

The steep decline in oil prices over the past few months has forced oil exporters in Latin America to dramatically cut government spending to offset the effects of falling oil revenues. Ecuador is no different, and the government has announced significant budget cuts along with additional financing from the Chinese in order to confront its growing budget shortfall. Though this should ensure short-term stability for the Ecuadorean economy, a shift toward austerity will be particularly dire for Ecuador, especially if oil prices remain low over the next few years.

A surprisingly attractive market for multinationals

Ecuador, despite President Rafael Correa’s populist rhetoric, has been a surprisingly strong market for multinationals, many of which have latched onto the government’s public investment push since President Correa came to power. While import controls and other populist measures have rankled many companies importing into the market, the benefits of strong growth over the last decade have largely outweighed the challenges.

Indeed, Ecuador has experienced average growth rates in excess of 4 percent over President Correa’s presidency, with government spending being by far and away the biggest driver of the country’s performance. Meanwhile the country’s status as a dollarized economy has also attracted multinationals who do not have to worry about foreign exchange (FX) risk or the macroeconomic instability seen in other Latin America markets led by populist presidents.

The challenge is that Ecuador’s growth model is almost entirely based on public investment in infrastructure and public spending, which accounted for over 44 percent of GDP last year, will have to be significantly cut in order for the government to meet to its deficit target of 5 percent of GDP.

Should this be a cause for multinationals to start worrying?

In the near term, Ecuador should be able to avoid a crisis by leveraging financing from China, implementing investment cuts, issuing further debt. However, if oil prices remain low, Correa’s government will have limited policy options to confront its long-term budget problems. The government cannot deploy monetary or exchange rate policy to lessen the pain of adjustment measures going forward given the country’s dollarization (which President Correa has always opposed).

As such, President Correa needs to find a new growth model for Ecuador, and given his populist leanings, the government will either have to find a way to de-dollarize its economy (a very perilous approach) or move toward a more business-friendly stance. More import controls and other populist measures will do little to build a sustainable growth model in a context of low oil prices.

Want to know more about how FSG can help you outperform in Ecuador? Contact us today.

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