Ecuador’s Economic Crisis from 1999 to 2000

Students:
Marcela Andrade B.
Nathaly Hernández B.
Camilo Simmonds
Andrés Chaves
Julio Rodríguez
Oscar Romero

Professor:
Andrés Mora

Master of Business Administration

Administration School
EAFIT University
2023
 1. Abstract

The financial crisis of Ecuador in 1999, is a situation that makes us reflect in depth as

MBA students. No economy in the world has the guarantee to avoid crisis at some point; today

Venezuela and Argentina face a fairly complex financial situation, the curious thing and in

particular with the two countries is that Venezuela could have become the most solid economy in

Latin America thanks to its large oil reserves. Argentina was positioned among the best

economies in the world years ago, but today the country is one of the weakest in the region. For

these reasons we believe it is important to know the development and lessons learned from the

different financial crises experienced throughout history.

In the following paper we present a consolidation of the Ecuadorian crisis at the end of

the 90’s, we mention how political decisions influenced the functioning of the financial system,

the impact of the crises in Southeast Asia with the fall in the price of oil, and the impact of the

“Fenomeno del niño” on national production, and what finally ended up with a social crisis

which produced a migratory exodus of Ecuadorians to other countries. As a result of

unemployment and poverty, there was a decrease of foreign investment, inflation raise, the

devaluation of the Ecuadorian sucre and the dollarization process in 2000.

 2. Key Words

Crisis dollarization, inflation, employment, GDP, monetary policy, fiscal policy, financial

regulation, information risk, macroeconomic analysis, financial and banking system, foreign

investment, exchange rate, banking holiday.

3. Introduction

This paper discusses the main aspects of Ecuador's financial crisis in 2000, which led to

the dollarization of the Ecuadorian economy. The aim of the dollarization was to stabilize the

economy, control high inflation rates and reactivate employment and foreign investment.

The main significance of this crisis lies in the fact that it was created little by little over

time, as a result of a series of bad political decisions, an economic environment of uncertainty

and even climate conditions, which came together and, in the end, deteriorated the country's

economy, leading to the final decision to opt for dollarization.

In order to understand and analyze this crisis, it is necessary to identify its causes,

background, evolution, consequences, and the main lessons learned. It is important to mention

that this paper serves as a reference for the rest of the MBA Bogotá students, to deepen this type

of general knowledge and contribute to the recognition and understanding of these crises and

how to face them from a managerial perspective, and to contribute from the knowledge of each

one of them and their own positioning within their own company, so that they can take each

situation presented as a reference and apply the solutions or lessons learnt. In the context of the
Ecuadorian crisis of 2000, this paper has been prepared through the research of historical and

economic data available with open access to the public, which have led to the conclusions

presented.

4. The background

Ecuador begins its economic life after the separation of Gran Colombia where inherited

21% of its foreign debt, coinciding worldwide with the time of recession (1825-1826) where

creditor countries were aggressive in their respective collections (Sánchez-Parga et al., 1998)

which brought an important challenge to the economy incurring on failure for approximately 65

years and making it impossible to access new credits. This would be their first approach to a

series of different economic crises that would characterize the country in a coming and going of

different growth opportunities, followed by different setbacks partly due to corruption and

marked political instability. It is not a typical situation of the Ecuadorian country, but a reflection

of what happened in the region by not having a defined path or a remarkable leadership, as

happened in Colombia with the so-called "Patria Boba" and that later would be replicated in the

period between 1995 and 2000 with political instability by having 4 presidents in 4 years.

Among the milestones in favor of Ecuador and its economy, in 1911 it begins with

exploratory drilling as the main source of economic growth. Although initially it did not directly

benefit the state (Waranda, 2005), it would become the main source of economic financing of the

country over time, creating a high dependence on international hydrocarbon prices. In the same

way, a great agricultural opportunity benefited from the privileged geographical location as well
as the stability of its climate, giving way in 1956 to the boom of banana exports, positioning

itself as the most outstanding country of the activity throughout the world (Macaroff & Herrera,

2022). These banana exports generated a remarkable source of additional income to the already

consolidated oil business and that over time. If it had not been affected by external factors such

as the weather, it would have been consolidated as a strong contributor to GDP.

The growth of the demand for food worldwide during the postwar period represented an

opportunity for growth and development to the Ecuadorian countryside. This marked a trend to

development leveraged by foreign investment and likewise lived a period of relative economic

and political stability. However, during the decades of 1960 to 1980 there were short periods of

military repression, and a marked social discontent led some political sectors to establish populist

discourses on protectionist reforms that later triggered the beginning of a political decline and

would mark the bases for economic destabilization (Soria, 2011). However, the decade of the

80's is accompanied by political and economic reforms as part of a widespread democratic social

movement in Latin America, resulting in the first constitutional presidential term from 1992

(Muñoz López, 2006).

By 1990 the increase in the unemployment rate that went from 6.1% to 14% in 1999

(Osvaldo Bardomiano, 2014) worsens, being a clear x-ray of the galloping crisis that plunged the

country. In addition, there was an unfortunate decline in the projection of public policies, fact

that results in having 4 presidents in a period of 4 years, which coincides with different external

aspects that led to the greatest economic crisis in its recent history (Ecuavisa, 2021).
 5. Causes of the economic crisis in Ecuador

The biggest economic crisis in Ecuador was in 1999. Several factors contributed to the

crisis, starting with the modifications in the internal policies regarding the management of the

Ecuadorian financial system. Additionally, the “Fenomeno del niño” greatly affected national

production. Here is a brief description of the main causes:

Policy changes: The roots of the crisis can be traced back to 1994 during the presidential

terms of Sixto Duran Ballén and Alberto Dahik. They promoted the Financial Institutions Law,

which granted more autonomy and less control to financial entities. The law liberalized interest

rates, allowed free movement of capital, and led to significant increases in credit. This quickly

resulted in speculation, capital flight, and the collapse of some private banks. In 1998, during

President Jamil Mahuad's term, bank rescue policies were implemented. These policies involved

providing loans to private banks through public institutions, and the creation of the Deposit

Guarantee Agency (AGD) to assume the debts of private banks. These measures eventually led to

the so-called "Feriado Bancario" (TLD, 2022)

Asian Crisis: On the other side of the world, alongside the crisis in Ecuador, a financial

crisis was unfolding in the emerging economies of Thailand, Malaysia, Indonesia, the

Philippines, and South Korea, commonly known as the Asian Crisis. This crisis led to a

significant reduction in global oil prices (Larrea, 2009) which is a key export product and an

important component of the GDP for Ecuador and other nations, specifically the OPEC

(Organización de países exportadores de petróleo). The crisis also had a negative impact on

foreign investment confidence, affecting the emerging economies in Latin America.

 Fenómeno del niño: In 1998, the coast of Ecuador experienced a series of floods as a

result of the “fenomeno del niño”, which mainly affected the agricultural industry, representing a

significant portion of the country's exports. It is estimated that these losses reached nearly 14.5%

of the GDP (Larrea, 2009), including productive infrastructure and transportation routes. This

climatic event exacerbated the economic uncertainty that Ecuador was already facing due to the

financial crisis, leading to an increase in the outflow of foreign capital, fiscal deficit, and

inflation. As a result, they were unable to fulfill the credits of national producers.

6. Crisis Development

As mentioned, the development of the 2000s crisis in Ecuador was preceded by several

causes. According to (García, 2013), in 1999 the crisis broke out and a GDP decline rate of

4.74% was registered, which caused a decrease in the country's demand and production.

Bardomiano (2014, p. 8) proposes the following diagram to illustrate GDP:

Graph 1. Ecuador’s GDP and inflation

 During the crisis, one of the indicators most closely monitored was the exchange rate.

The economic subjects sought to protect their purchasing power by buying stronger currencies

such as the dollar, which went from a level of S/10.754 at the beginning of 1999 to S/25.000 in

January 2000. However, after several attempts by the Central Bank such as the sale of foreign

currency and the change of the reaction scheme to the foreign currency float, the underlying

tensions in the economy continued to deepen: the currency was further devalued, GDP continued

to fall and public debt continued to reach its highest level (García, 2013, p.9).

In the middle of the crisis, the government then decided to delay the servicing of the

public debt. Subsequently, there was a decrease in imports because of the depreciation of the

Sucre. Unemployment reached more than 14% and the Superintendence of Banks decided to

freeze deposits to avoid a massive withdrawal of resources; this further affected the country's

productivity and exacerbated the problem of insolvency of the financial system.

In January 2000, the dollarization of the Ecuadorian economy was decreed as an

alternative to stop the recession of the economy and to restore the purchasing power through a

strong currency such as the US dollar, since the Sucre had a depreciation of 245% and that

created an environment of even more accelerating inflation. With the dollarization of Ecuador, it

was intended to: eliminate the exchange risk for the financial system and commerce in general,

eliminate pressures when seeking competitiveness abroad (giving way to improvements in

production chains and cost reduction), search for affinity between U.S. inflation and Ecuadorian

inflation, stop capital flight and make the economy transparent with the informal dollarization,

since by that time several prices were quoted in dollars: rents, appliances, cars and even

merchandise sold in shopping malls.

 The law established a new monetary regime that obliged the Central Bank of Ecuador to

exchange the Sucres in circulation for dollars at a fixed exchange rate and to withdraw from

circulation the sucres received. The law also prohibited the issuance of national currency and in

little more than three months the Central Bank of Ecuador exchanged and withdrew from

circulation about three quarters of the Sucres.

During the crisis, this decision benefited some sectors such as the financial system,

importers (who no longer had to negotiate with an unpredictable currency), the construction

sector and the government sector, which would collect more money from the citizens. Some

affected sectors were producers and exporters who no longer had the benefit of the devaluation,

and some companies, given the lack of support in financing, had to close their businesses during

the crisis (Garcia, 2013, pp. 9-12).

As mentioned by Bardomiano (2014), this political decision had an impact on the

behavior of inflation in 2000 with a downward trend and contributed to improve economic

activity since dollarization opened new markets and the country's interaction with the world (pp.

102-106).

7. Post-Crisis

After the crisis presented in Ecuador generated by low oil prices, the unviability of the

private financial sector, corruption in the central government, the increased of public spending

and the failure of monetary policy, among others, the exchange of the Ecuadorian Sucre for the

dollar, generated important changes within the country's economy. These effects on the main
macroeconomic indicators of the country have been the subject of different studies and

investigations.

Next, we will briefly review the following indicators: Economic growth (GDP), Inflation,

public debt and unemployment, which presented significant changes after dollarization. When

talking about economic growth, it is necessary to be able to make an analysis of a timeline of

more than 15 years and observe the main variations as seen in (graph 2).

Graph 2. Gross Domestic Product Annual Rate of Change

Source: Own elaboration according to World Bank (2023a)

It can be evidenced that there is a sustained growth between 2000 and 2019, with a single

negative growth in 2016 of (1.2%). However, the growth in that period was above 3%, with

some great cycles between 2004 and 2008 and 2010 and 2014 where it exceeded 5% in both

cases.

This good performance responds to the judicious application of a decalogue of

requirements proposed by (Edwards in 2001) which includes productive diversification, salary

flexibility, and increase in merchandise trade, among others. Adding these factors shows the

favorable effect on Ecuador's GDP, which went from 16,282 USD MM in 2000 to almost

108,000 USD MM in 2018 (Toscanini et al., 2020b). Regarding inflation, figure 2 shows a
sustained decrease that can be seen in timeline from 2000 to 2019, going from 91.01% to 0.04%

respectively.

Graph 3. Ecuador's annual inflation rate

Source: Own elaboration according to World Bank (2023b) .

However, if this is compared with the inflation of other countries in the region such as

Colombia, Peru, Chile and Panama, there are no significant changes in real terms (Graphic 3).

Graph 4. Annual inflation rate by Country

Source: Own elaboration according to Toscanini (2020b, p. 134) data.

It does not sound very encouraging if we think that foreign countries are better or the

same as Colombia. However, the question is: what would have happened to Ecuador if

dollarization had not been implemented?

 Graph 5. National Ecuador Budget

Source: Own elaboration according to Toscanini (2020b, p. 134) data.

The behavior of the need for indebtedness shows a clear trend towards a lower debt

requirement in the first years from 2000 to 2008, mainly marked out by higher income derived

from the better international price of crude oil and higher tax collection. However, in 2009 the

drop in the price of oil is evident and that, added to the higher public spending, begins to

generate an imbalance in the budget. Then the financing needs of the state increase, reaching

almost USD 6,200 billion in 2017. Finally, this graph clearly shows that we must make a

judicious exercise from the mining and Economy and Finance portfolios to be able to control

public spending and have greater control over the changes that must be made to prevent good

times from becoming times of crisis due to not having a well-thought-out state in maximizing the

resource and being more efficient in spending.

Graph 6. Unemployment rate

Source: Own elaboration according to Bardomiano (2014, p. 103) data.

 According to Bardomiano (2014) data about regarding unemployment, we can note

(Graph 5) that starting in 1990 an increase is noted from 6% this year to its ceiling of almost

14% in 1999 associated with problems with its internal economy. Starting in 2000 and with the

application of dollarization, its effect was seen immediately lowering the rate to historical levels.

Coincidentally with the fall in international oil prices between 2008 and 2009, an upward trend is

noted. Finally, the trend after this structural issue of hydrocarbons continues its downward trend,

reaching 5% unemployment in 2012.

8. Learnings

The first thing to remember is that a complex event such as this cannot be satisfactorily

explained by looking at just one piece of the puzzle. According to Martinez (2006) identifies four

types of explanations for financial crises (macro-policy weakness, financial liberalization, moral

hazard, and euphoria). Some of these are easy to quantify, while others are not.

As we have already pointed out, the crisis in Ecuador in 1999-2000 was partly due to an

excessive increase in the lack of credibility and trust of citizens in both financial and political

systems (Velasteguí López, 2017).

One of the lessons that we can highlight is therefore the responsibility of the government,

or rather the State of any country, to care for and strengthen the confidence of its citizens in the

system. This is only possible by implementing responsible and well-planned strategies that are

not the result of urgency and that always seek to enhance their economy in general, and not just

the finances of certain groups that condense power.

 Another important lesson for Ecuador and countries with emerging economies is the

urgency of not being dependent on a single source of income based on exhaustible and non-

renewable products such as oil. Today, more than ever, it is imperative that the governments of

these economies seek new sources of energy and join the crusade that developed economies have

been leading for several years. Likewise, it is of paramount importance to encourage national

industry in the generation of employment, but without forgetting the growing globalization that

is being generated and from which we can take advantage, encouraging foreign investment and

taking competitive advantage of the products and/or services that each economy can provide.

Lastly, another lesson we can draw is that a crisis of this type goes beyond the financial

aspect. As evidenced in the document "Dollarization in Ecuador: A review of macroeconomic

results in the last two decades", the common denominator of the crises in several Latin American

countries is basically the fact that the crisis is not only a financial one, for example:

1. Bad policy decisions create information asymmetries and lead them to adopt more

tolerant and risk-averse attitudes.

2. High uncertainty economic environment.

3. Exploitation of the system by key players (financial corruption).

4. General regulatory forbearance. (Toscanini et al., 2020a)

This is an invitation to the regulators of each country to bear in mind that, in order to

avoid a crisis, they must cover the entire universe of public policies and be particularly vigilant

with regard to the behavior of those they are in charge of, without neglecting the general public,

in order to maintain its confidence in the system and thus avoid a situation of general panic,

which would have greater and more serious consequences for the country concerned as a result

of the crisis in question.

 9. Conclusions

1. Developing countries should seek to diversify their economies away from a single product,

especially if it is finite and non-renewable. They should strive for diversification of their

income, with a view to improving investment in their industries and employment levels.

2. The consequences of a generalized crisis and moments of financial panic in the economy can

be prevented or mitigated if the state ensures a high level of credibility and public confidence

in the system.

3. It is important to identify and learn how the different economies are affected by political and

social decisions. Now that we are studying an MBA, this gives us the opportunity to see the

general perspective of the governments, to think globally, to understand our companies and

strategies we make without losing the world’s perspective and the impact of working on an

international environment.

4. The state must guarantee the economic stability of the nation, and for this it must create

financial policies that allow the control of both public and private financial institutions.

5. Crises can be prevented or mitigated by the stability and precision of monetary and fiscal

policy and by effective supervision of the financial system.

10. References

Banco Mundial. (2023a). Crecimiento del PIB (% anual) - Ecuador | Data. Crecimiento PIB Ecuador.

https://datos.bancomundial.org/indicator/NY.GDP.MKTP.KD.ZG?locations=EC
Banco Mundial. (2023b). Inflación, precios al consumidor (% anual) - Ecuador | Data. Inflación

Ecuador. https://datos.bancomundial.org/indicator/FP.CPI.TOTL.ZG?

end=2018&locations=EC&start=1960&view=chart

Ecuavisa. (2021). Presidentes 1996-2000 | 4 Décadas de Presidentes | Ecuavisa.

https://www.ecuavisa.com/4decadasdepresidentes/presidentes-1996-2000

García, N. (2013). La crisis financiera del Ecuador 1998 2000. Universidad Tecnológica Equinoccial.

Larrea, C. (2009). Crisis, dolarización y pobreza en el Ecuador. Retos Para La Integración Social de

Los Pobres En América Latina, 1.

Macaroff, A., & Herrera, S. (2022). Estado del banano en Ecuador.

Martinez, G. X. (2006). The political economy of the Ecuadorian financial crisis. Cambridge Journal

of Economics, 30(4), 567–585. https://doi.org/10.1093/cje/bei097

Muñoz López, P. (2006). ECUADOR: REFORMA DEL ESTADO Y CRISIS POLÍTICA. 11, 101–110.

Osvaldo Bardomiano, M. (2014). Ecuador: panorama y evolución económica reciente. Economía

Informa, 385, 100–108. https://doi.org/10.1016/s0185-0849(14)70424-4

Sánchez-Parga, J., Acosta, A., Ribadeneira, L., Espinosa, S., Menacho, D. C., Chiriboga, M., Rivera,

F., Borja, J., Marco, T., Director, R., Rhon, F., Director, D., & Caap, E. (1998). La deuda externa

de América Latina: Origen, evolución y alternativas de solución. www.flacsoandes.edu.ec

Soria, A. B. (2011). Ecuador - estado del país.

TLD. (2022). Feriado Bancario en Ecuador | Historia, Resumen, Causas y Consecuencias - YouTube.

https://www.youtube.com/watch?v=ly4M3r6wyMg
Toscanini, M., Lapo-Maza, M., & Bustamante, M. A. (2020a). Dollarization in Ecuador: A review of

macroeconomic results in the last two decades. Informacion Tecnologica, 21(5), 129–138.

https://doi.org/10.4067/S0718-07642020000500129

Toscanini, M., Lapo-Maza, M., & Bustamante, M. A. (2020b). La dolarización en Ecuador: resultados

macroeconómicos en las dos últimas décadas. Información Tecnológica, 31, 129–138.

Velasteguí López, E. (2017). La crisis económica del Ecuador 1999-2000. Visionario Digital, 1(4), 5–

20. https://doi.org/10.33262/visionariodigital.v1i4.254

Waranda, W. (2005). boletin_petroleo_apuntes. Fundación INRED.