Is the Obama administration condoning Ecuador’s default?

By Felix Salmon
May 18, 2009

One of the great things about working for Reuters is that if an important story appears on the wire, I can agitate to have it put online as well. So go and read this, by Alexandra Valecia and Alonso Soto: the astonishing yet seemingly all-but-missed news that Ecuador’s audacious and dangerous decision to bite its thumb at the entire international financial community has seemingly been ratified by not only its Andean neighbors, the owners of the Andean Development Corporation, but also by the international community more generally, in the shape of the Inter-American Development Bank.

The Andean Development Corporation’s representative in Quito, Luis Palau-Rivas, said the lender sees the OPEC-member nation’s defaulted debt restructuring “positively.”

“We see the process positively because it’s a voluntary process,” Palau-Rivas told reporters. “It’s helping to solve a difficult situation … and will benefit everyone.”

Palau-Rivas said the CAF was planning to disburse up to $700 million in loans to Ecuador in 2009. From those credits about $450 million will go to the public sector.

The IADB also said it was seeing progress in Ecuador’s talks with bondholders.

“The good results obtained (in the restructuring) will benefit all Ecuadoreans during difficult times,” the lender’s representative, Carlos Melo, said in a statement. “The IADB reiterates its predisposition to work alongside Ecuadoreans to promote economic development.”

This is absolutely astonishing stuff. Historically, private lenders have looked to the multilaterals having what’s known as a “lending-into-arrears” policy, whereby countries which needlessly and gratuitously default on their debts get cut off from international funding.

In this case, Ecuador had more than enough money to pay all of its debts, but defaulted for nakedly political reasons, and is now in the process of buying back its defaulted debt for little more than 30 cents on the dollar.

The idea that this is “a voluntary process”, as Palau-Rivas says, is utterly ridiculous: the bondholders have had no say whatsoever in what has happened, and their only choice is whether to accept Ecuador’s risible offer or to hold onto defaulted Ecuadorean paper indefinitely.

And it’s far from clear that even if the restructuring does generate “good results”, the consequences “will benefit all Ecuadoreans”. Indeed, it’s quite likely that the opposite will be the case — that Ecuadoreans, cut off from private-sector funding and investment, will find themselves shunned for the foreseeable future.

But never mind Ecuador — what message does this send to the rest of Latin America, not to mention Africa and the rest of the world? The multilaterals seem to be saying that they will embrace any default, no matter how egregious, and that the best strategy for any indebted nation is to simply force its lenders to write off the vast majority of their loans. This is likely to backfire massively not only on the multilaterals themselves — which of course have billions of dollars in debts outstanding to the likes of Ecuador — but also on the countries in question, most of whom who want to be taken seriously but all of whom must now be considered highly suspect credits, given the incentives being put in their way by CAF and the IDB.

I can’t imagine that these statements from CAF and the IDB were made without the foreknowledge, if not the outright approval, of the Obama administration, and that worries me a lot. Somebody should ask Lael Brainard, the nominee to be undersecretary for international affairs, what she thinks of all this. For that matter, somebody should ask Larry Summers and Tim Geithner, both of whom held that job in the past, what they think. In the midst of a major domestic financial crisis, I fear some nasty precedents are being set internationally with nobody noticing.

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