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10. Ecuador Declares Foreign Debt Illegitimate

Alternet, November 26, 2008
Title: “As Crisis Mounts, Ecuador Declares Foreign Debt Illegitimate and Illegal”
Author: Daniel Denvir

Utube, Fall 2008
Title: “Invalid Loans to Ecuador: Who Owes Who”
Producer: Committee for the Integral Audit of Public Credit

Foreign Policy in Focus, December 15, 2008
Title: “Ecuador’s Debt Default”
Authors: Neil Watkins and Sarah Anders

Student Researcher: Rosemary Scott
Community Evaluator: Tim Ogburn
Sonoma State University

In November 2008, Ecuador became the first country to undertake an examination of the legitimacy and structure of its foreign debt. An independent debt audit commissioned by the government of Ecuador documented hundreds of allegations of irregularity, illegality, and illegitimacy in contracts of debt to predatory international lenders. The loans, according to the report, violated Ecuador’s domestic laws, US Securities and Exchange Commission regulations, and general principles of international law. Ecuador’s use of legitimacy as a legal argument for defaulting set a major precedent; indeed, the formation of a debt auditing commission sets a precedent.

In the 1970s Ecuador fell victim to unscrupulous international lending, which encouraged borrowing at low interest rates. But in over thirty years the country’s debt rose from $1.174 billion in 1970, to over $14.250 billion in 2006, a twelve fold increase, due in large part to interest rates that rose at the discretion of US banks and Federal Reserve from six percent in 1979 to twenty-one percent in 1981.

The commission revealed that Salomon Smith Barney, now part of Citigroup Inc., issued unauthorized restructuring of Ecuador’s debt in 2000 that lead to exorbitant interest rates, which, combined with illegal borrowing by former dictators, has turned the country, along with many of its Southern neighbors, into a major capitol exporter to its Northern “benefactors.” Over the years, the country has made debt payments that far exceed the principal it borrowed.

Of all loans made between 1989 and 2006, fourteen percent was used for social development projects. The remaining 86 percent was used to pay for previously accumulated debt. Continuously from 1982 and 2006, the country paid foreign debt creditors $119.826 billion for capital and interest, while receiving over the same period $106.268 billion in new loans, which amounts to a total negative transfer of $13.558 billion.
The human costs are staggering. Every dollar spent on illegitimate international credit means less is available for fighting poverty. In 2007 the Ecuadorian government paid $1.75 billion in debt service alone, more than it spent on health care, social services, the environment, and housing and urban development combined.

While the risks of default are high, Ecuador had only two options: keep paying a dubious and illegal debt at the risk of social unrest, or default and face the wrath of the international market.

Under the World Bank system, which oversees investment treaties, there is no public accountability, no standard judicial ethics rules, and no appeals process. Ecuador has thus exposed a major problem in the international financial system: the lack of an international, independent mechanism for countries to resolve disputes over potentially illegitimate and/or illegal debt. Ecuador’s findings could set a precedent for the poorest of indebted countries, whose debt burden has long been criticized as predatory and inhumane.

Ecuador has called on Latin America to forge a united response to foreign debt. Venezuela, Bolivia and Paraguay have recently created debt audit commissions. The country has also asked the United Nations to help develop international norms to regulate the foreign debt market.

A bill pending in the US Congress presents an ethical step forward. The Jubilee Act, which passed the House of Representatives in April 2008, would require the Comptroller General to undertake audits of the debt portfolios of previous regimes where there is substantial evidence of odious, onerous, or illegal loans. The legislation also instructs the Secretary of the Treasury to “seek the international adoption of a binding legal framework on new lending that . . . provides for decisions on irresponsible lending to be made by an entity independent from the creditors; and enables fair opportunities for the people of the affected country to be heard.”

Update by Daniel Denvir
In June 2009, Ecuador announced that it had reached an agreement with 91percent of creditors to buy back its debt for 35 cents on the dollar, confirming many analysts’ predictions that the default was a strategic move aimed at getting a “haircut” on their debt. Ecuador’s default drove down the price of their debt, making a buyback far more affordable. Many analysts believe that Ecuador had already started to quietly buy back debt on the secondary market, a claim the government has declined to comment on. Ecuador was expected to pay $1.075 billion for $3.375 billion in debt.

Following the December 2008 default on the Global Bonds 2012, Ecuador defaulted on the Global Bonds 2030 in March. Ecuador continued to pay the Global Bonds 2015, although there is widespread speculation that the successful buyback will lead them to default on that debt, too.  Some analysts disagree, noting that allied Venezuela owns some of the 2015 bonds, while others say that maintaining payment could be a way to stay in the free market’s good graces.

The default and buyback received widespread coverage in the business press, but aside from my article, IRC Americas was the only English-language outlet to dedicate in-depth analysis to the political and economic significance of the debt auditing commission, illegitimate debt and default. The Financial Times, undertaking a sober analysis of the long-term impact of Ecuador’s default, noted “Analysts fear that the government’s deliberate default on two bonds—almost a third of its foreign debt—could prompt other countries to follow suit as they seek to navigate the financial crisis.” Investors are worried about the precedent Ecuador is setting as the first country in decades to default while technically having the ability to pay.

One prominent international investment advisor is quoted as saying that Ecuador’s default was a “brilliantly run and managed process. They nailed the timing.”
To get involved with the movement against illegitimate debt, contact Jubilee USA (

Update by Neil Watkins and Sarah Anderson
After Ecuadorian President Rafael Correa announced the default in December 2008, the financial press smoldered with condemnations and predictions of dire consequences for this small South American nation.
Most articles quoted only the harshest critics.  Ecuador had “lived up to its reputation as a banana republic” (Investor’s Business Daily).  Ecuador was “one of the axis of evil in Latin America” (Financial Times).  A separate article in the Financial Times did quote two sympathetic analysts, but that effort at balanced reporting was an extreme exception.

We found no examples of mainstream press reporting on the long history of Ecuadorian activists calling for action to address illegitimate debts. Indeed, Ecuadorian civil society had long advocated for the creation of a commission to examine the nature of Ecuador’s debt.  That commission was founded in 2007, and its results formed the basis for the Correa government’s decision to default.

The mainstream media gave the overwhelming impression that this default was the result of the personal whim of a political extremist.  Virtually every story labeled Correa as a leftist and emphasized his ties to Venezuelan President Hugo Chavez.  The analysts quoted reinforced this message.  “I think this default is nonsense. The market sees it as politically motivated” (Euromoney).  A former International Monetary Fund official said the default reflected “a ridiculous ideology” (Bloomberg).

Meanwhile, activists associated with the global Jubilee network that has campaigned for the cancellation of illegitimate debts in countries around the world applauded Correa for fulfilling a campaign promise to respect the findings of the debt audit commission. And Paraguayan President Fernando Lugo announced less than a week after Ecuador’s default that his government would also “exhaustively study” its debt.
In late April of this year, Correa was re-elected in a landslide, and as of this writing, his government appears on the brink of successfully negotiating with the holders of defaulted bonds.  Dow Jones is reporting that a very high percentage of bondholders are expected to accept Correa’s offer of 35 cents on the dollar.

As part of the response to the current financial crisis, governments should establish an international mechanism to handle debt disputes in a systematic way that balances the interests of debtors and creditors and considers how debts were accumulated in the first place.  A special United Nations commission on the crisis, chaired by Nobel Prize economist Joseph Stiglitz, came out in March 2009 in support of such a mechanism.  But thus far, the issue is not even on the table within the G20 grouping of the most powerful nations.

With the financial crisis hitting heavily indebted poor countries hard, there will be greater pressures on developing nations to default.  Instead of demonizing leaders who default, it’s time for the international community to develop a fair solution that addresses the real impacts of crushing debt on the poor.

For more information, see:
Jubilee USA Network:
Audit Commission of Ecuador:
Jubilee South / Americas:
Latindadd (Latin America Network on Debt and Development):
Institute for Policy Studies:

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