Dollarization in ecuador

summary The reason why Ecuador was dollarized? When did Ecuador become dollarize? The effect of dollarization in Ecuador Advantages and Disadvantages Long term benefit?

Ecuador’s drive to dollarization

dollarizaiton 1997-2000 President Jamil Mahuad was president of Ecuador. The Mahuad administration propose officially replacing the country’s currency with the US dollar. By January 2000 Ecuador adopted the U.S. dollar as a legal tender. In the spring of 2000 the Ecuadorian government began exchanging sucres for dollars at the rate of S/. 25,000 = $1.

Advantages of dollarization Dollarization helps to limit currency and balance of payments crises. Without a domestic currency there is no possibility of a sharp depreciation, or of sudden capital outflows motivated by fears of devaluation. By rejecting the possibility of inflationary finance through dollarization, countries might also strengthen their financial institutions and create positive sentiment toward investment, both domestic and international.   A closer integration with both the global and U.S. economies would follow from lower transaction costs, assured stability of prices in dollar terms and possibly lower interest rates.

disadvantage A dollarizing country would surrender any possibility of having an independent monetary and exchange rate policy, and will be constrained in the use of central bank credit to provide lender of last resort funding to its banking system in emergencies. From an economic point of view, the right to issue a country’s currency provides its government with seigniorage revenue, which show up as central bank profits and are transferred to the government. They are lost to dollarizing countries and gained by the United States as it has so far not agreed to share them.

DISADVANTAGES No more monetary decisions Competitive disadvantage Unfamiliar with the currency

Residuals of the predicted sucres-dollar exchange rate as predictor of bond prices Brady bonds index (obtained from JP Morgan) for Ecuador from January 1994 to September 2000.

Brady Bond Index Evolution Related to Exchange Residuals Source: www.sela.org

Source: World Bank Migration and Remittances Factbook 2008

Source: World Bank Migration and Remittances Factbook 2008

Ecuador’s 10-year adoption with dollarization The elimination of the sucre, which had lost 300% of its value in the 18 months preceding dollarization, has created a long-needed sense of financial stability. Ecuador’s GDP grew an average of 5% annually from 2000 to 2006, more than double the rate of growth. 2000 to 2006, real family income increase 14% In the last four years (through June 2010), real salaries rose an additional 25%.

2007 – new president Rafael Correa. Decrease in private investment 2007 to 2009, the average growth rate fell to 3% annually. At the same time, the 3% annual inflation rate seen in the last 10 years shows that the control of monetary policy has helped Ecuador become one of the most stable currency regimes in international markets. As of December 2009, the urban poverty rate fell to 25 percent.

The minimum annual wage—now in a reliable currency—rose from $67 in 2000 to $280 in 2010. The job growth today 2.6 million people are either unemployed or underemployed. In order not to endanger the stability and growth brought on by dollarization, Ecuador must get its fiscal house in order.

conclusion Banking System had benefited from the adoption of the dollarization. According to estimations, official dollarization has played a significant role in improving bank liquidity and asset quality in Ecuador. Macroeconomic variables and financial structure indicators show the bank liquidity, loan quality, and bank profitability has responded to variables that are bank specific.

Source: www.sela.org

Remittances after dollarization. Slide 15. Graph shows Remittances after dollarization.  

ECONOMIC INDICATORS 1998 1999 2000 2001 2002 Real GDP 2.1 -6.3 2.8 5.1 3.4 Exchange Rate 6825 20243 Dollarized Exports (millions) 4202 4451 4927 4678 5192 ECONOMIC INDICATORS