Latin Beat November 28, 2006

A Leftist at the Helm in Ecuador

Is Rafael Correa just paying lip-service to defaulting on foreign debt or is he serious? Washington is taking a wait-and-see approach

A leftist economist who has vowed to break off free-trade talks with the U.S. and advocated defaulting on the country's foreign debt has been elected president of Ecuador. But there is no telling whether 43-year-old Rafael Correa will remain in office long enough to carry out the platform that swept him to victory: Ecuador has had seven presidents in the last 10 years, several of them removed by its congress or forced out by violent street protests after just days or months in office.

Correa, running as an independent in a country where traditional political parties are widely discredited, won 57% of the vote to defeat billionaire banana magnate Alvaro Noboa, a populist. But Correa has no political base in Ecuador's congress, and that means he has a tough road ahead: He campaigned on a promise to dissolve the congress and convene a special assembly to completely rewrite Ecuador's constitution, but the congress is likely to block that initiative. "This is a president who will face possible impeachment at every turn," says Patrick Esteruelas, a Latin America analyst for the Eurasia Group, a New York risk consultancy.

Describing himself as a "close friend" of Venezuela's firebrand President Hugo Chávez, Correa is the latest leftist candidate to win at the polls in Latin America, where voters seem increasingly frustrated with the inability of governments to reduce the poverty that afflicts nearly half of the continent's people, in spite of high world prices for oil and other commodities produced in the region. In early November, Nicaraguans elected former Sandinista revolutionary Daniel Ortega, also friendly with Chávez, and with Cuban leader Fidel Castro, as president. By electing Correa, a political outsider, Ecuadorans made it clear that they are frustrated with corruption and incompetence among their country's political class.

Nervous Bond Markets

Correa served as finance minister for just over 100 days last year, but was booted by President Alfredo Palacios after advocating that Ecuador set aside less of the country's oil revenue to pay the foreign debt than it had agreed to. Ecuador's foreign debt is small by Latin American standards—around $10.4 billion, or about 26% of gross domestic product. Yet if Correa were to default on the debt, Ecuador would be financially ostracized and the country would save less than $400 million next year on interest payments. Correa's election roiled emerging bond markets over fears that he might renege on Ecuador's foreign debt. Because of the selloff, Ecuador's bonds have given up half of their total returns for the year.

Ecuador last defaulted on its foreign debt in 1999 in the midst of an economic collapse and only began to emerge from the crisis the following year, when the country ditched its own currency and dollarized the economy. Dollarization and high world oil prices helped stabilize the country, which is growing at a 4.5% clip this year.

Standard & Poor's analyst Lisa Schineller said that Ecuador's sovereign credit rating of CCC+, among the lowest of the 113 countries rated by S&P, reflects the country's political instability and "persistent discussion about lowering the cost of indebtedness in a manner that could be considered default." Yet Eurasia's Esteruelas believes that the lack of a solid political base and the financial consequences of a default may constrain Correa. "The probability of a default is less than 50% but it cannot be entirely discarded," he says.

Moving to Moderation

Correa, who earned a doctorate in economics at the University of Illinois, is well aware of the consequences of default. During the first part of the presidential campaign, his proposals were quite radical, but when he competed in the runoff elections against Noboa, Correa moderated his platform, met with the U.S. ambassador, and struck a more conciliatory tone. "He's well-educated and much more sophisticated than any of his predecessors, but he has very little public policy experience and no support in congress," says Riordan Roett, a longtime Latin America expert at Johns Hopkins University. "So he may have no choice but to moderate his policy promises and find some way to move back toward the political center."

Ecuador had been negotiating a free-trade agreement with the U.S. until earlier this year, when the government abruptly raised taxes on foreign oil companies operating in the country and Washington interrupted the talks, saying the tax hike violated Ecuador's international investment treaties. In May, Ecuador canceled Los Angeles-based Occidental Petroleum's contract to produce oil, kicking the country's largest oil producer out and provoking further protests from the Bush Administration.

Correa's election further complicates Washington's relations with South America. Correa has said he will cancel a lease for a U.S. military air base on Ecuador's Pacific Coast that is used for drug-interdiction flights when the agreement expires in 2009. "Correa's discourse was strongly critical of the private sector and of foreign influence on Ecuador, which isn't very promising," says Peter DeShazo, a former deputy assistant secretary of state for Andean Affairs. DeShazo says Washington is likely to take a wait-and-see approach with Correa, encouraging him to adopt moderate policies and hoping that he doesn't align himself too closely with Chávez, who in a recent U.N. speech referred to President George W. Bush as the "devil."

Correa, perhaps sensing that he has enough strikes against him as it is, was careful to note at his first public appearance after winning that he is a friend, but not a "client" of Chavez. Still, Correa said, "it would be wonderful to move closer to a country like Venezuela, which can help us a lot because it has $53 billion in cash reserves as a result of the oil surplus."

Smith is BusinessWeek's Mexico bureau chief.

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