Correa cries wolf once too often

Ecuador’s voluntary default sees the wily gambler lose

If public opinion is anything to go by, Rafael Correa is either incredibly brave or incredibly stupid. Ecuador’s president recently announced his country would default on interest payments on its foreign debt. Not because Ecuador couldn’t afford the 30,6 million dollars due to holders of the Global 2012 bonds.


The reason Correa isn’t coughing up is because at least some of that debt is illegitimate, according to a government committee tasked with investigating Ecuador’s 10 billion dollar foreign debt.

“The contracts (outlining part of the debt) do not comply with legal norms of our country, nor do they live up to the norms and rules of international law. As a result that debt that is now denominated in Global bonds basically amounts to an illegal debt,” claimed Ricardo Patiño, who heads up the auditing committee that spent the last year sifting through three decades of public debt. He insists 3,6 billion dollars worth of that debt is questionable and so for now Ecuador refuses to pay.

Defaulting on foreign debt has far reaching consequences – Argentina is still a long way from recovering credibility after its spectacular default 7 years ago, as a particularly active New York judge will tell you. Ecuador is no stranger to harsh reprisals, either. In fact it’s still recovering from a default of its own in 1999.

So why force another default in less than a decade? Especially when you don’t have to. Ecuador has 5,700 million dollars in foreign reserves and the total foreign debt amounts to only 20 percent of GDP compared to 80 percent in 1999.

Correa claims – and has been for the past two years - that his country is up against “monsters” both foreign and domestic who have plundered Ecuador’s coffers in the past. Previous governments had begotten debt illegally, the investigating committee writes. Now there are even calls for ex-presidents to be prosecuted.

Critics say the default is politically motivated, but there may be some truth to the claims of illegal dealings. In his 2004 best-seller Confessions of an Economic Hitman, John Perkins writes that as a consultant for a US firm he was involved in misleading the Ecuadorian government into contracting huge debts from the World Bank to finance white elephant infrastructure projects meant for US contractors. In this case though, it’s bondholders and not the multilateral lenders who are getting targeted.

According to president Correa a similar pattern lays at the heart the current stand-off with neighbouring Brazil. Last month Ecuador disputed the legitimacy of 286 million dollar loan from a Brazilian development bank (BNDES). That money was used to pay for a hydroelectric plant constructed by the Brazilian firm Odebrecht, which was also sent packing last month. The plant was inaugurated in mid 2007 but stopped working in June of this year due to structural errors. Brazil recalled its ambassador to Quito over the dispute.

So after Brazil, Correa now seeks to defy all international holders of Ecuador’s debt over the legitimacy of those loans, never mind the consequences.

At a time when oil prices are below 35 dollars, scaring off foreign investors and making Ecuador even more dependent on oil revenues hardly seems like a good idea. Meanwhile remittances, Ecuador’s other source of foreign currency, are dwindling as the world crisis worsens.

The first to be hit by this default will be the credit-needy exporters of the country’s three other main currency earners; bananas, shrimps and flowers.

The fact that Ecuador has no currency of its own, but instead uses the US dollar makes the situation even more difficult. Interest rates will soar even further, as the dollar becomes increasingly scarce.

All in all, a scary scenario that threatens to plunge Ecuador deeper into economic turmoil.

Would all that be worth it on the off chance that at some point an international court will find a part of Ecuador’s foreign debt to be illegitimate?

There are suggestions that Correa may have an ace up his sleeve. His promise to default may be an attempt to push down the market value of the Global 2012 bonds in the hope of snapping them up at bargain prices.

As a major holder of it’s own debt the Ecuadorian government would be in a better to position to force the kind of easy-going debt restructuring that it seeks. So instead of brave or stupid, perhaps Correa is really a sly gambler.

But even if that where the case and wily reasoning is behind the threats to default, why go all the way and actually announce a default. The economic fall-out from a default looks certain surpass any money saved on a benign debt restructuring.

My guess is Correa has overplayed his hand. After threatening to default on several occasions, he finally found himself with no alternative.

If he hadn’t refused to pay, two things would have happened. First of all his claim and Patiño’s that Ecuador’s foreign debt was largely illegitimate would have lost all credibility, damaging his bid for the upcoming presidential elections in April.

Secondly, had he not defaulted, the international legal system may well have turned against his government, punishing it for putting out rumours that seriously damaged bondholders and investigating claims that it was buying back those bonds.

In the fable, the boy who cried wolf was finally ignored and left to fend for himself. In the hands of Rafael Correa, Ecuador awaits a similar fate.