Event

The spectacular drop in oil prices witnessed in the second half of 2014 – a barrel of WTI crude cost more than USD 100 at the end of June, but only slightly more than USD 50 now – has impacted Latin American economies in contrasting ways. Where net oil importers such as Argentina, Brazil and Chile have seen inflation dynamics and external balances improve, net oil exporters have on the whole suffered. Fiscal pressures have arisen in Mexico and Colombia, but negative effects are limited in both countries thanks to prudent macroeconomic policies. Not so in Venezuela, where mismanagement of the all-important oil wealth pushed the economy into crisis long before prices started falling, and in Ecuador, where the price drop is exposing long-standing fiscal and external weaknesses. Indeed, because Ecuadoran policy makers failed to save windfall revenues during the oil bonanza, they now lack the fiscal space to counteract the negative effects of lower prices. The fiscal deficit envisaged in the 2015 budget is a considerable 5% of GDP, and this is a very optimistic figure that is based on a crude oil price of USD 80 per barrel. As for the monetary policy, note that the full dollarization of the Ecuadoran economy compounds the adjustment challenge. It implies that unlike in countries like Peru and Colombia, exchange rate depreciation cannot serve as a first buffer to worsening terms of trade. Rather to the contrary, the strengthening USD is undermining Ecuadoran competitiveness and efforts to diversify the economy.

Impact on country risk

With oil making up more than 30% of total government revenues, sustained lower prices would have a detrimental effect on Ecuadoran public finances. In such a scenario, given that financing sources are in short supply – domestic liquidity has already been effectively tapped, investor confidence remains subdued (largely due to a history of sovereign defaults), overall international risk appetite is declining and Chinese credit conditions may be becoming more restrictive – the policy response would most likely consist of ad hoc interventionist measures as well as some fiscal retrenchment. A good example of the former is the recent decision by President Correa to increase import tariffs on Peruvian and Colombian goods to compensate for the depreciation of those countries' currencies. The latter would possibly hurt economic growth – which in recent years has been predominantly public sector driven – and fuel popular discontent with the government, thereby emboldening the opposition.

Analyst: Sebastian Vanderlinden, s.vanderlinden@credendogroup.com