Can Ecuador’s digital currency save its economy?

Ecuador’s government is poised to introduce a state-backed digital currency to reverse its decline, though some claim the name is misleading

Ecuador's President Rafael Correa. Since the 1990s, when Jamil Mahuad took charge, the country's economy has been in tatters. Many hope a new digital currency can reverse the nation's decline
Ecuador's President Rafael Correa. Since the 1990s, when Jamil Mahuad took charge, the country's economy has been in tatters. Many hope a new digital currency can reverse the nation's decline 

Ecuador was already embroiled in a two-year long economic slide when Jamil Mahuad took charge in 1998, and a combination of soaring fiscal deficits, record inflation and slumping oil prices left the newly elected president with a financial crisis to contend with less than a year into his tenure. In only his first full year in charge, the sucre lost 67 percent of its value, inflation tipped 60 percent, and 70 percent of the country’s financial institutions were forced to shut up shop amid widespread discontent and ongoing civil strife.

It took until the first month of the new millennium for Mahuad to declare a state of national emergency, and in the days that followed officials set forth the merits of an Ecuadorian dollarisation plan to avert economic and social collapse. The Central Bank’s President Pablo Better, opted not to play a part in what he called “rushed, crazy measures,” and thousands of the Ecuadorian populace chose to march on Quito, calling for Mahuad’s resignation and an end to the proposed dollar switch.

Successful only in forcing Mahuad to step down, the dollarisation process continued regardless under his successor and, much like it had done in the case of Panama a century previous, succeeded in lifting the national economy from the doldrums.

Starting out with an exchange rate of 25,000:1, in the four years that followed, triple digit inflation fell to three percent, GDP climbed on average 4.5 percent per year, and investors came in their droves. Fast-forward to today, however, and the country is looking to another currency to save it from an all-too-familiar predicament, though this time one of its own making, and one that bears little resemblance to any that have come before it.

Should the electronic money later qualify as a currency in its own right, increased supply could succeed in devaluing the dollar

Digital accompaniment
Assuming the government’s proposal proceeds as planned, the country come December, will be the first to formalise the introduction of a state-backed ‘digital currency’ to accompany its own. “Digital money will stimulate the economy; it will be possible to attract more Ecuadorian citizens, especially those who do not have checking or savings accounts and credit cards alone,” wrote the Ecuadorian National Assembly in a statement.

Digital currencies have been gaining traction among consumers in recent months and years, and Ecuador has – irrespective of its socialist leanings – opted to outlaw all other digital currencies and introduce an alternative of its own to stave off the downturn. “If you let the private sector create money, there is no control over the supply of this money,” says Mark Weisbrot, Co-Director of the Centre for Economic and Policy Research. “This would be, in some ways, a step backward to the days before there was central banking. The central government needs to control the money supply in order to have an effective monetary policy, which affects growth, employment, and inflation.”

Significant shares of the country’s dollars are tied up in either debt or dwindling oil and gold reserves. Ecuador’s currency is under immense pressure and excessive government spending, which has tripled since President Rafael Correa took charge in 2007, and has exasperated an already-desperate situation. What’s more, with an anticipated budgetary shortfall of $4.5bn for this year and national debt in the billions (see Fig. 1), the country has again been forced to seek a radical means of shoring up its finances.

The decision to bring the – as yet unnamed digital currency – in alongside the dollar has been gathering momentum now for months, beginning with the National Assembly’s decision in July to prohibit the use of any digital currency other than its own. “If you speak with members of the local ecosystem, they would say that this has to do with larger historical factors. For example, that Ecuador is part of the ALBA group of nations, which tend to be more socialist and less open to economic freedoms,” says Pete Rizzo, US Editor of the digital currency news site Coindesk.

“Apart from that, any government trying to introduce a new money would have a compelling incentive to outlaw any alternatives, in order to spur the promotion of their new offering.” With a 91 to 22-approval rating, congress passed a bill that same month permitting consumers to make payments using “electronic money” and laid the groundwork for the country’s digital dollar counterpart.

“For one, I’d like to dispel the notion that Ecuador is introducing a ‘digital currency’, a term that denotes payment systems based on bitcoin’s or similar block chain technology. Ecuador is introducing a state-backed digital money, which will operate very differently,” says Rizzo. “More broadly, should the programme be successful, it could have affects like the M-Pesa programme in Kenya, which has been shown to improve money flow, thereby making transactions and business environments easier.”

Backed by the central bank’s assets and designed to benefit the country’s poorest citizens and protect against irresponsible public sector payment, sources at the bank say the parallel currency will enter into circulation in December and boost Ecuador’s outlook. Breaking down the barriers for entry into the country’s formal banking system and curbing its dependency on dollars are two very obvious benefits, though there are also a number of disadvantages to first consider before the digital money comes to be seen as the saviour so many believe it to be.

Benefitting the lowest
The currency, as Rizzo said, shares certain likeness with East Africa’s M-Pesa, which, since its introduction to Kenya in 2007, has drastically improved quality of life and access to financial services for underserved sectors of the population. Today, over 50 percent of Kenya’s adult population uses the mobile money transfer service, which has eliminated the costs and risks associated with the handling and carrying of cash. “As M-Pesa has show, mobile money systems can work to provide economic benefits and increase the ease with which residents of a country can transact with each other,” says Rizzo.

Source: Ministry of Finance, Ecuador
Source: Ministry of Finance, Ecuador

Once the money enters into circulation, the 40 percent of Ecuadorians who are today without access to a bank account will be given the opportunity to swap out any cash they have for digital money. And though the ruling authorities have been quick to ramp up the radicalness of the system, it’s one that in reality shares a great deal in common with existing digital wallets rather than crypto currencies. What differentiates the country’s proposed currency from available crypto currencies is that it is by its very nature centralised, whereas decentralisation and an open-source model are defining factors of more popular digital alternatives.

“The most important thing is to bring some financial services to people who would not otherwise have them, because they do not have access to a bank account or credit cards,” says Weisbrot. Although often-volatile crypto currencies such as bitcoin look an appropriate means for comparison when taken at face value, Ecuador’s new currency actually bears little resemblance to its existing digital counterparts. Without the high degree of community involvement or anonymity, key for so many of its ilk, the currency’s benefits are comparatively limited, and its real significance will only become clear in time.

Starting out as a simple mobile payments system in the short-term, should the electronic money later qualify as a currency in its own right, increased supply could succeed in devaluing the dollar, and so, the $11bn in debt Ecuador owes to foreign parties. However, rampant speculation that the currency marks the first stage of a larger government plan to abandon the dollar has been denied by Correa, who said that the currency is intended to benefit those who fall outside the remit of traditional banking. Before the money is seen as a legitimate currency, however, the government must first demonstrate that that it’s capable of negotiating what obstacles remain.

The digital currency, in principle, should make clear any accounting missteps or counterfeiting issues, though ultimately its transparency depends on the government’s willingness to clamp down on any instances of corruption. Failure to do so would surely compromise the currency’s feasibility, and risk leaving underserved sectors of society with money that is worth little to nothing on the common market. Similarly, the powers that be must also arrest privacy concerns and security lapses by issuing an updated regulatory framework and ensuring an adequate security infrastructure is in place to protect consumers against any damages – personal or financial.

Others believe that a national digital currency carries little to no risk for the country, and that an alternative of this form is only a more efficient way of managing currency. Weisbrot says simply: “I don’t really see any big risks.” The fact remains that the decision to introduce state-backed digital money is still an untested policy, and one that depends chiefly on where the intentions of the government behind it lie. It’s problematic to draw conclusions about what is essentially an unknown entity at this point, though the months that follow its introduction should indicate what benefits a centralised digital currency can bring for an economy teetering on the brink of turmoil.