GOE Policy for a Vulnerable Economy: Buying Time and

C O N F I D E N T I A L QUITO 000220

SIPDIS

E.O. 12958: DECL: 03/30/2019
TAGS: EFIN ECON ETRD EPET EC
SUBJECT: GOE Policy for a Vulnerable Economy: Buying Time and
Hoping Oil Prices Rise

A) Quito 188, B) Quito 60, C) 08 Quito 1145, D) 08 Quito 1124, E) 08
Quito 1062, F) 08 Quito 831

Classified by Ambassador Heather Hodges. Reason: 1.4 b and d.


1. (C) Summary. The Ecuadorian economy, which is dollarized and
heavily dependent on oil exports, is under considerable stress
because of falling oil prices and the global economic crisis. Oil
prices have risen in March, providing some relief. If oil prices
remain at current levels or rise, the economy might muddle through

2009. However, there is a substantial risk, particularly if oil
prices fall again, that Ecuador could experience a bank, fiscal or
balance of payments crisis. If so, Ecuador might be forced off the
dollar.


2. (C) Summary, continued. Ecuador accentuated the current problems
by overspending in 2007/2008, depleting almost all its income from
the high oil prices and increasing demand for imports. It has
weathered the pressure thus far by drawing on government reserves
(down to $3.5 billion, from $6.5 billion in September) and the banks'
privately held offshore funds (also around $3.5 billion, down from
roughly $4.5 billion in January). The economy is adjusting to a
degree, with government-imposed trade restrictions and moderate
fiscal discipline, while private demand has fallen and banks have
curtailed lending. However, the government, which is facing
elections on April 26, has avoided deep budget cuts and is gambling
on higher oil prices and multilateral financing. The gamble might
pay off, but a failure to take more rigorous actions now might
backfire if oil prices decline or sufficient financing is not
available. End summary.

Signs of Stress
--------------


3. (C) The Ecuadorian economy is clearly under stress as a result of
the global economic crisis, a situation that has been complicated by
existing policies such as dollarization (adopted in 2000) as well as
more recent decisions, particularly high levels of government
spending in 2007 and 2008, when oil prices were high. This high
level of spending sustained economic growth for two years when
private sector investment was low, but also created government
spending patterns and an overall demand for imports that are not
sustainable at current petroleum prices.


4. (C) As noted in reftel d, by November, the government began to
perceive that global economic problems, in the form of falling oil
prices, remittances, and non-petroleum exports, would create problems
for Ecuador. The absence of a floating exchange rate (because of
dollarization) and a meaningful local stock market meant that some of
the early indicators of stress were not functioning in Ecuador for
most of 2008. By December, however, the government had begun to
release a number of indicators that demonstrated that the economy was
under considerable pressure. These indicators included:

-- The average price for Ecuadorian petroleum exports fell from
$119/barrel in June to $26/barrel in December.

-- The monthly trade balance turned negative starting in September;
Ecuador has had five consecutive months with a trade deficit.

-- Remittances fell 9% in 2008 compared to 2007, and 4th quarter 2008
remittances fell 22% compared to the same period in 2007.

-- Central Bank reserves fell from a peak of $6.5 billion in
September to $4.5 billion in December, with a $1.5 billion drop in
December alone. Reserves continued to slip in 2009, dropping to $3.4
billion on March 20.

-- The central government's net petroleum income (subtracting
petroleum investment and subsidies) has dropped sharply; monthly net
petroleum income peaked at $880 million in the third quarter for
2008, dropped to $96 million in December, and was approximately $42
million in January and February.

-- Deposits in private banks fell in mid-December before partially
recovering following December 31st deposits by the government.
Deposits continued to fall through February and were down $694
million between December 31 and February 20.

Eight Key Factors
--------------


5. (SBU) This cable discusses eight intermingled factors that are
key to determining whether the Ecuadorian economy will muddle through

2009 or enter into a crisis: petroleum prices, dollarization,
reserves, public sector budget, balance of payments, the banking
sector, economic production, and external financing.

Petroleum Price
--------------


6. (C) Given the imbalances created by the government's spending
spree in 2007 and 2008, the economy was under severe pressure with a
price for Ecuadorian crude under $30/barrel, as was the case in
December and January. However, in March the international reference
price for petroleum began to climb, with WTI trading slightly over
$50/barrel by March 23. Also important for Ecuador was that the
discount for its lower-grade petroleum began to shrink (the discount
was $15/barrel in December/January, but according to anecdotal
reporting it dropped to $5-8/barrel in March).


7. (C) Prospects/implications: Although it is not a given that
prices will remain at current levels, oil at $40-45/barrel gives the
Ecuadorian economy considerably more breathing room than it had in
December-February. After the high level of government expenditures
and imports in 2008, the economy will still be under pressure at this
price level. However, at $40-45/barrel, the government will have
more time to adjust expenditures, seek financing, and hope that oil
prices will climb further. In the long-run, Ecuador would be wise to
lower its dependence on oil revenues, but it has not shown that it is
prepared to do so. The government is eyeing mining as the next big
revenue earner, and if that sector were to emerge Ecuador would still
remain dependent on natural resource prices.

Dollarization
--------------


8. (SBU) As government officials have noted, dollarization limits
Ecuador's ability to respond to international pressures since it
cannot depreciate its currency. Although not publicly mentioned,
dollarization also prevents the government from engaging in
open-ended borrowing from the Central Bank. Another factor that is
widely acknowledged but rarely emphasized publicly is that there is
no lender of last resort for the banking sector in the case of a
liquidity squeeze or bank run.


9. (SBU) For all its limitations, however, dollarization is highly
popular in Ecuador. The stability brought by dollarization is seen
as the underlying factor in Ecuador's solid economic growth and low
inflation since the dollar was adopted as the national currency in

2000. Some exporters bemoan the reduced competitiveness since the
dollar has appreciated against most other currencies in 2008, but
other business contacts stress the importance of dollarization in
forcing the business sector to focus on costs and efficiency, factors
that were more easily hidden in the past with frequent depreciations.
Dollarization also forces discipline on public sector finances and
private banking operations.


10. (C) One former Minister of Finance says that most Ecuadorians
measure the current economic problem with one question -- will
Ecuador maintain dollarization? -- without questioning the broader
policy environment that supports dollarization. She maintains that
as long as they believe dollarization will continue, most Ecuadorians
will leave their funds in the local banking system, but will
immediately withdraw the funds if they believe that dollarization
will end.


11. (C) While President Correa seems philosophically opposed to
dollarization, he has repeatedly asserted that his government does
not intend to abandon the dollar in the near future (leaving the
question open for further down the road). His government has
justified its adjustment measures -- trade barriers and expenditure
reductions -- as necessary to protect dollarization. Most economic
analysts believe that the Correa Administration will defend
dollarization in the near future, recognizing that ending
dollarization could lead to a bank run and carry heavy economic and
political costs. However, in March Central Bank staff were
reportedly working on a regulation, which was quietly circulated by
the business community, that would allow the operation of a parallel
currency. Also, in March rumors circulated that the government had
printed a new currency called the "Condor," a rumor vehemently denied
by Correa.


12. (C) Prospects/implications: Even if Correa dislikes
dollarization and would prefer the policy flexibility and
"sovereignty" of a new currency, it is very hard to see how the
government could successfully introduce a new currency when the
economy is under considerable strain. The populace would have little

confidence in the new currency, which would likely quickly depreciate
if it were allowed to float. This would reduce the value of wages
and financial assets and lead to popular discontent. We cannot rule
out an effort to replace the dollar voluntarily but consider it
unlikely in the near future. The two more likely scenarios are that
the government is forced to issue a parallel currency because of
insufficient revenues (see fiscal section) or a bank run that leads
to the collapse of the banking sector (see banking section). These
two scenarios, particularly the banking collapse, are severe and
would carry high political and economic costs.

International Reserves
--------------


13. (SBU) The Central Bank's reserves play a rather different role
in a dollarized economy than one with its own currency. Typically,
the reserves are available to provide balance of payments support in
case of a shortfall in the current or capital account. In Ecuador,
however, private sector funds (for trade, investment, or loans) are
channeled through the private banks, which for the most part do not
have recourse to Central Bank reserves. To the extent that there is
a shortfall in liquidity for the private banks, they need to draw
down their individually held offshore liquidity funds, which
reportedly totaled around $3.7 billion in early March and are
separate from the Central Bank's reserves.


14. (SBU) In Ecuador, Central Bank reserves are better seen as the
government's savings account. The main source of funds in the
reserves is public sector deposits, and reserves rise when the public
sector saves and drops when it pulls down its savings. In December,
the $1.5 billion drop in reserves was largely explained by a $2.1
billion withdrawal from Central Government deposits, which was only
partially offset by tax and petroleum deposits.


15. (SBU) While most funding for the reserves is from the public
sector, private banks also deposit a limited portion of their funds
in the Central Bank, either as mandated by the required reserve
provisions or for short-term operational needs (one bank said that
about 5% of its assets are in the Central Bank, more than the
required reserve). In January, the largest contributor to the drop
in Central Bank reserves was the withdrawals by the banking sector,
which in turn was prompted by a fall in deposits in the banking
sector.


16. (C) Prospects/implications: Ecuador entered the last quarter of
2008, when the crisis began to manifest itself in Ecuador, with
decent buffers, particularly if one counts the banks' privately held
liquidity funds in addition to the Central Bank's reserves. The
government has quickly run through much of its reserves, particularly
in December when it not only spent freely on domestic spending but
also allegedly spent several hundred million dollars on repurchasing
international bonds at a large discount. There is still some cushion
left, which allows the government to operate in the first quarter of
2009 even though it is spending more than it earns, and for the banks
to absorb a fall in deposits and remain liquid. However, the
government and banks both need to be careful not to reduce their
cushions to the point that the general public begins to believe that
the institutions and dollarization are at risk. It is worth noting
that the Central Bank's reserves are published weekly and are now
closely watched by the media, but the private banks' offshore
liquidity funds are not published information.

Public Sector Finances
--------------


17. (SBU) Public sector expenditure exploded in 2008 with the high
price of petroleum, plus access to financing from the petroleum
reserves funds, which were dismantled in April 2008, allowing the
government to freely spend those funds. Central Government
expenditures increased 67% in 2008 over 2007, with sharp increases in
both current and capital expenses. Petroleum revenues accounted for
39% of central government revenues in the first three quarters of
2008, but dropped to roughly 8% of government revenues in the first
two months of 2009. Taxes, plus the occasional extraordinary income
such as telephone concession fees, provide the remaining government
income.


18. (C) The government has asserted that it will contain
expenditures to reduce the government deficit to manageable
proportions. It has sent some signals about budget cuts, such as
cutting Petroecuador's budget, and we have heard anecdotal stories
about reduced transfers to local governments and universities.
However, the government has not provided an overall budget estimate
for the year or any clear public statement on how it will manage the

budget and where it will cut spending. (Note: the GOE is operating
on a continuing resolution, and does not need to present a 2009
budget until after the new government takes office following the
April 26 elections.)


19. (C) The government's message on the extent to which it will
pursue fiscal discipline is muddled, which may reflect uncertain
policy direction or a desire not to send strong budget-cutting
signals before the April 26 elections. For example, Minister for
Economic Policy Borja asserted that the poor would not suffer from
the adjustment program, that public sector employees would not be
fired, and the government would not cut subsidies. He added that the
government would continue to implement partially complete
infrastructure projects. On the other hand, the government has
indicated that it will fire employees at Petroecuador, the
state-owned petroleum company, although it evidently has not decided
how many. And in March, media stories reported that overall subsidy
costs would fall in 2009. Some subsidies, particularly for refined
petroleum products, fall automatically with lower petroleum prices,
but other subsidies that are projected to fall, such as for housing,
evidently reflect policy changes.


20. (C) In a March 11 meeting with the Ambassador, Minister Borja
said that the government would cut capital expenses to roughly half
of 2008 levels and constrain current expenditures through a wage
freeze (reftel a). He estimated a government deficit of $2.5 billion
in 2009, based on an average price of $35.5/barrel for Ecuadorian
crude in 2009 (this was an increase over the levels that prevailed in
January/February; the government was assuming that the price of
petroleum would rise in the second half of the year).


21. (U) A few non-government analysts have provided estimates for
public sector finances for 2009. The Observatory for Fiscal Policy
estimated a deficit of $3.8 billion, based on oil at $30/barrel. The
financial publication Latin Source estimated a deficit of $2.8
billion dollars, assuming an oil price of $37/barrel.


22. (C) Prospects/implications: The government is making a moderate
effort to contain spending in the expectation that oil prices will
rise and external financing will be available. This is a risky bet,
but if these assumptions hold, it will have avoided the political and
economic costs of a more rigorous budget cut. If these assumptions
do not hold, it will have depleted much of its reserves by the second
half of 2009. By that time, further budget cuts might not be
sufficient, and it may reach the point that it begins to accrue
arrears to suppliers and employees, and possibly be forced to issue a
parallel "currency" or "promissory notes." If so, diminished
reserves and the appearance of a parallel currency would likely
sharply reduce public confidence in the sustainability of
dollarization, which could provoke a bank run.

Balance of Payments
--------------


23. (C) Like the budget, Ecuador's balance of payments is highly
vulnerable to a decline in oil prices. In addition, Ecuador's two
other principal sources of foreign exchange, remittances and
non-petroleum exports, have declined in the face of the global
economic problems. In recent years, a trade surplus and remittances
offset the other parts of the balance of payments, which are usually
negative (services, rent, and capital account). With a trade
deficit, Ecuador will face a balance of payments gap that will need
to be covered with external financing and reserves.


24. (SBU) In November, Ecuador raised tariffs on a range of consumer
goods to their WTO ceilings. In January, it imposed additional
tariffs and quotas that exceeded WTO ceilings, arguing that such
measures were necessary because of balance of payments pressure and
were consistent with the WTO balance of payments safeguard provisions
(ref b). The government estimated that the January measure would
reduce the trade deficit by $1.5 billion. A number of business
sector contacts and private sector analysts argued that even in the
absence of the trade restrictions, there would be a strong element of
self-adjustment in the balance of trade because imports would be
strongly constrained by weak demand and sharply reduced trade
financing.


25. (C) The Central Bank, in an unpublished balance of payments
projection for 2009, estimates that the current account will have a
$1.5 billion deficit, including a $2.5 billion trade deficit (this
estimate incorporates the trade measures introduced in January). It
estimates a capital account deficit of approximately $750 million.
The combined shortfall is about $2.25 billion, and the Central Bank
assumes this would be covered with $2 billion in financing from

multilateral lenders and a $250 million reduction in reserves. The
business publication Latin Source estimates trade and current account
deficits that are comparable to the Central Bank's estimate, but does
not provide an estimate for the capital account or financing.


26. (C) Prospects/implications: As oil prices fell in 2008, the
initial point of concern for many analysts was the balance of
payments. Those concerns have diminished to an extent because of the
trade measures and the expectation of self-adjustment in the balance
of trade. Even so, the sound performance of the external sector is
critical for smooth functioning of a dollarized economy: the balance
of payments needs to generate the dollars needed to maintain the
monetary system. A balance of payments deficit would withdraw
liquidity from the monetary system, creating problems for banks and
public sector finances.
Banking Sector
--------------


27. (C) The private banking sector in Ecuador is in an awkward
situation, since it is relatively well run but vulnerable to a bank
run and the probable linchpin in a crisis. On the positive side, the
banks are highly liquid (roughly $3.7 billion in liquid off-shore
investments -- over 30% of deposits -- that can be used to cover bank
run or decline in domestic liquidity),are adequately capitalized at
13% of assets, and have a relatively low default rate.


28. (C) Even so, public confidence in the banking system is fragile,
and there have been at least three bank runs in the past two years
based on fears of bank "holidays" (forced closure) or
dedollarization, the most recent in December 2008 when banks lost
roughly $300 million in deposits. The public is highly sensitive to
such rumors because of massive bank failures in 1999, when many
clients lost most or all of their savings.


29. (C) As noted in paragraph 3, bank deposits have fallen since the
beginning of the year. Bank contacts maintain that while there had
been a run in December, the contraction in deposits since December is
transaction based. In other words, with a decline in dollar income,
liquidity in the Ecuadorian system has dropped and so have deposits,
but meanwhile clients have continued to withdraw dollars to fulfill
business obligations. Banks have partially funded this shortfall by
drawing on their offshore liquidity funds (which had been around $4.5
billion at the beginning of the year). Banks have also sharply
curtailed lending in order to preserve their liquidity.


30. (C) The government appears to be aware of the challenges to the
banking sector. After taking a largely antagonistic approach towards
the banks for his first two years in office, in February President
Correa met bank leaders for the first time since becoming president.
The move was partly political, to demonstrate cooperation between the
government and the banks to reinforce public confidence. However, it
also led to several measures to help the banks. One was a promise to
consider increasing interest rates, which the government forced down
in 2008 (reftel f). Another was a decision to lower the required
reserve rate from 4% to 2%; the released 2%, however, was transferred
immediately to a new government-established liquidity fund (in the
absence of such a measure, banks would have had to curtail lending or
dip into their privately-held liquidity funds to make the required
contributions to the new government-run liquidity fund). The
Ecuadorian Social Security Institute will also purchase up to $400
million in newly issued bank mortgages, in an effort to promote
additional lending.


31. (C) Prospects/implications: The banking sector is vulnerable to
a bank run in two ways. One is a general panic about the prospect of
dedollarization, which would likely come as a result of a pronounced
deterioration of public sector finances and/or a sharp drop in
liquidity because of balance of payments pressure. If this were to
happen, the corporate sector and the wealthy would try to transfer
abroad the limited financial resources they still have in Ecuador
(most have steadily reduced their financial exposure in Ecuador over
the years),while those without access to international financial
institutions would withdraw their bank holding in cash (many have
transferred term deposits to sight deposits in preparation for a
rapid withdrawal). A second risk is that a few small banks might
fail. Some are under pressure after the government lowered interest
rates and reduced most banking fees, and most do not have the
sizeable liquidity funds that the large banks have. The banking
system -- and public sector confidence -- might absorb the closure of
1-2 small banks, but if several failed that could undermine
confidence in the entire banking sector.


32. (C) Prospects/implications, continued: Under either scenario, a

major bank run could force the temporary shut-down of the banking
sector. That in turn is the most likely scenario to force Ecuador
off the dollar. A combination of bank closures and dedollarization
would be a major crisis and would likely lead to a sharp economic
contraction. Given the weak economic institutions in Ecuador,
particularly a Central Bank that lacks strong leadership and has lost
some of its qualified staff, it could be difficult for Ecuador to
emerge quickly from a bank holiday/dedollarization.

Real Economy
--------------


33. (C) The Central Bank estimates that the Ecuadorian economy grew
5.3% in 2008 (likely an overestimation based on optimistic
assumptions about the government's spending on infrastructure). Even
allowing for some overestimation, the economy grew at a strong rate
last year, which on first reflection is surprising because of the
poor investment climate and modest private sector investment. Growth
was sustained by heavy government spending, and, to lesser extent,
increased bank lending. This supported strong consumer demand, which
created a good year for companies that catered to domestic demand.


34. (C) Growth in 2009 will be significantly lower. The poor
investment climate remains. In addition, lower government spending,
remittances (an important source of consumer demand),non-petroleum
exports (which are labor intensive),and lending will constrain
economic growth. Some of our business contacts told us that demand
held up fairly well through January (in some instances because of
advance purchases in anticipation of price increases due to trade
restrictions),but that demand sharply contracted in February. Media
reports suggest that construction (an important employer of the urban
poor) may already be contracting. Economic Minister Borja said that
growth would be 2.3%, the lower end of the government's projections.
Some analysts are projecting lower growth than that, or a mild
recession.


35. (C) Prospects/implications. In the absence of a crisis brought
on by a bank run and/or dedollarization, we expect that economic
growth will slow appreciably this year, but there would not be a
sharp contraction. The government appears intent on implementing
only a moderate reduction in spending, in part to avoid the political
costs of a sharper cut. If this gamble works, the economy might grow
or contract by about 1%. If the government determines after the
election that it has to cut spending even further, that would likely
push the economy into a deeper recession, although much of that would
not be felt until the second half of the year. The positive side of
an economic slowdown/contraction is that it will reduce pressure on
the balance of payments because of weaker demand for imports.
However, a slowdown will further increase unemployment, which began
to climb at the end of 2008, and lower tax revenue, which will
increase pressure on the fiscal accounts.

Financing
--------------


36. (C) The GOE expects to finance Ecuador's fiscal and balance of
payments gaps primarily with financing from multilateral lenders,
namely the InterAmerican Development Bank (IDB),Andean Development
Corporation (CAF),and the Latin American Reserve Fund (FLAR).
Economic Minister Borja has said publicly that the GOE expects
roughly $500 million from each institution. He has said privately
that the government also expects to borrow $1 billion from the
Ecuadorian Social Security Institute (IESS).


37. (C) The Central Bank maintains that Ecuador can cover its
balance of payments gap with the $1.5 billion in multilateral lending
mentioned above, plus another $500 million from "ongoing" projects
from the same institutions, and another $250 million from reserves.


38. (C) CAF and IDB representatives in Quito suggest that financing
from their institutions will be less than the GOE asserts. The CAF
representative said that his bank might be able to lend $300-350
million in net new funds to Ecuador, but stressed that CAF funds are
tied to projects and if the GOE curtails investment spending CAF
financing might not reach those levels. He added that the GOE asked
if the CAF could step in to fund projects that the GOE had already
initiated by itself. However, the CAF cannot since it only funds
projects where the implementer has been picked through open tenders,
and all of the GOE's major investment projects had been allocated
through sole-source tenders.


39. (C) The IDB representative said that the GOE has asked for a
$100 million competitiveness project (which essentially would be
budget support) and a $500 million liquidity facility, which would go

to a government development bank, and from there lent to private
banks, which would use the funds to support private sector trade. He
acknowledged that both projects would require an assessment letter
from the IMF, which he thought might be available in April (the GOE
is providing information on its adjustment efforts to the IDB and IMF
through document exchanges and video conferences). He speculated
that the liquidity facility, if it went forward, would be appreciably
less than the GOE was requesting (perhaps $100-200 million),in part
because of constraints on overall IDB financing. He added that if
the GOE worked really hard to implement ongoing health and education
projects, the IDB might be able to disburse $100-150 million under
those projects.


40. (C) The Embassy does not have contact with the FLAR (a regional
IMF-like institution),since it does not have an office in Quito.
The government maintains that it will borrow $480 million from the
FLAR. One former Ministry of Finance official said that FLAR prides
itself on IMF-like criteria to determine economic sustainability, and
while less rigorous than the IMF it was not a given that the FLAR
would extend financing to Ecuador.


41. (C) Several private sector analysts argue that Ecuador is
solvent, and, with government external debt at 19.6% of GDP, in good
position to take on additional debt to get it through the current
crisis and keep dollarization intact. Those same contacts speculated
that the government might approach the IMF for a Stand-by Arrangement
after the April 26 election, arguing that it is the best placed
institution to support Ecuador in the current crisis.


42. (C) Ecuador has defaulted on two of its principal commercial
bond issuances, the Global 2012 and Global 2015, alleging that the
issuances were illegitimate (reftel c and e). President Correa
announced that Ecuador would present a debt restructuring agreement
on the margins of the March 27-31 IDB annual meeting in Medellin,
Colombia. However, the default, which bond holders see as a
political decision, precludes access to commercial lending for the
time being. In addition, the default and the status of negotiations
between the GOE and the bondholders might be a factor for some of the
multilateral lenders, although it does not appear to be an
insurmountable obstacle for the IDB, CAF, or FLAR.


43. (C) Prospects: Some multilateral financing will be available,
but probably not as much as the GOE has indicated, and probably not
as quickly as it has implied. If that is the case, and if
international oil prices do not continue to rise, Ecuador will have
to draw down its international reserves even further. With those
prospects, it would make sense for Ecuador to approach the IMF.
However, that would require Correa to swallow his animosity towards
the IMF, and it is not evident that he would.

Comment
--------------


44. (C) The Ecuadorian economy is highly vulnerable, having spent
most of its oil boom resources and created fiscal and balance of
payments pressures that are hard to unwind. The government's trade
restrictions and budget cutbacks will buy it some time as the
government hopes that oil prices will rise. However, the government
is not approaching the crisis as though it has to deal with a
worst-case, or even bad-case, scenario. Instead, it is maintaining a
relatively high level of expenditure, and most likely spent $200-300
million in badly needed reserves to buy back debt in December. As a
result it has quickly depleted its reserves.


45. (C) As of late March, it is an open question whether Ecuador
will stumble through 2009 without a crisis, or suffer a major crisis
that forces Ecuador off the dollar in late 2009 or early 2010.
However, this 50/50 perspective is an improvement over apparent
prospects in January. At that time most analysts consulted by the
Embassy thought it was a foregone conclusion that Ecuador would
suffer a severe economic crisis, and the question was whether it
would happen in the first or second half of the year. The relatively
less pessimistic perspective prevailing in March reflects that the
government has made some adjustments and could get some outside
financing. This mood shift, which also seems to hold with the
business community and the broader public, is important, as least for
the short term, since it should reduce capital flight and give the
economy more time to adjust. If the pessimistic mood in
December/January had continued, capital flight may have reached
unsustainable levels, provoking a crisis.


46. (C) As of the second half of March, oil prices were recovering,
and it appears there is a chance the government could win its gamble,
provided oil prices remain at current levels or higher, the GOE

obtains a fair portion of its expected external financing, and it
continues to maintain a moderate degree of fiscal restraint.
However, none of those assumptions are guaranteed. And even if
Ecuador makes it through 2009 without a major crisis, it will deplete
much of its reserves and the economy will remain vulnerable in 2010
unless there is a strong recovery in oil prices.

Hodges