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Ecuador: Default shows need for debt mechanism

NewsNotes, January-February 2009

On December 12, Ecuadoran President Rafael Correa announced a default on Ecuador’s 2012 global bonds worth a total of about $3.8 billion. This momentous decision was based on the recent conclusion of an independent Public Debt Audit Commission that between 1976 and 2006, much of Ecuador’s debt was illegally contracted and that the debt process benefited the financial sector and transnational corporations to the detriment of the citizens of Ecuador.

Next steps in what will undoubtedly be a contentious process are likely to include lawsuits and attachment of assets by angry bondholders, renegotiation of defaulted bonds, a possible drop in foreign and domestic investment, limited multilateral credit and long term difficulties issuing new debt in international markets.

In a briefing paper on Ecuador’s default, the Jubilee USA Network points out that the current global financial crisis and the third world debt crisis share similar roots in reckless and irresponsible lending. Ecuador, like so many other countries in the global South, has been negatively impacted by the so-called “third world” debt crisis for years and is now beginning to feel the consequences of the current financial crisis.

The origins of Ecuador’s debt date to the period between 1976-1982, when, under the dictatorship of the Supreme Government Council, Ecuador contracted $3.4 billion in debt. Of this, nearly two-thirds was used to finance military expenditures. After multiple reschedulings, conversions and further borrowing, Ecuador’s external debt has risen to more than $14 billion despite the fact that Ecuador has more than repaid the principal it borrowed plus significant interest and penalties.  In 2007, Ecuador paid $1.75 billion in debt service, more than the government spent on health care, social well-being, housing and urban development, and the environment combined. As part of its plan to fight poverty, the Ecuadorian government made a public commitment to reverse this situation by 2010, seeking to significantly increase its spending on social services while cutting the amount it pays on debt service.

In this context the government of Ecuador established the independent Public Debt Audit Commission in July 2007 to examine the origins, nature, and impacts of the country’s sovereign debt. The commission completed a report in September 2008 which documents claims of irregularities and illegitimacy in the contraction of Ecuador’s public debt.

The commission was created by Presidential Decree No. 472 in July 2007 to audit the external and internal debt contracted by Ecuador with international banks, multilateral organizations and the bilateral creditors between 1976 and 2006. In fulfilling their mandate, members of the commission confronted enormous difficulties due to the lack of transparency and behind the scenes dealings in the contracting of agreements with the multilateral financial system and the national and foreign private sector. They encountered archives in disarray and stored in inadequate, humid places, as well as incomplete documentation.

Nevertheless, the commission made important findings that confirm allegations of illegitimacy and illegality in relation to Ecuador’s public debt and demonstrate that the debt was used as an instrument by international creditors to extract Ecuador’s economic and environmental resources, damage Ecuador’s sovereignty and contribute to the deinstitutionalization of the State.

Creditors, in collaboration with the government, imposed conditions that had serious economic, social, and environmental impacts.  Since the 1980s, a high percentage of the national budget was used to service the public debt, seriously shortchanging budgets for education, nutrition, health care and social programs. Only 14 percent of all the loans were invested in social projects, such as potable water, electricity, telecommunications and roadways. Eighty six percent of the loans were used to pay debts.

For 30 years, state officials signed whatever agreements creditors offered, in the process violating general principles of law (such as good faith, the free determination of peoples, the prohibition of usury, contractual balance, human rights and environmental rights), international covenants and fundamental norms of domestic law. (See http://www.ecuadorinmediato.com/noticias/88151 and www.jubileosuramericas.org.)

In preparation for the Financing for Development Review Conference, which took place in Doha in late November, debt campaigners around the world tried to persuade governments to include reference to illegitimate debt in the outcome document. Norway took a giant step forward by proposing language referring to the legitimacy of debt. That such language could even be considered by nations of the world makes evident the amazing accomplishments of those, especially in the global South, including Ecuador, who have been working for the cancellation of unjust, overwhelming and illegitimate debt.

As policymakers look for global solutions to the problem of irresponsible lending in the current financial crisis, the case of Ecuador points to an important blind spot: the lack of an international, independent mechanism for countries to question potentially illegitimate and/or illegal debt or to petition in the case of an inability to pay. This vacuum essentially forces a country such as Ecuador, which has found serious issues regarding its debt into a corner with two possible options: restructuring or default. An independent body should be created to address this issue – while Ecuador is the first developing country during the current crisis to consider default -- it is unlikely to be the last given the severity of the global recession.

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