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Cablegate: Ecuador's Central Bank to Use International Reserves To

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DE RUEHQT #0816 2472033
ZNR UUUUU ZZH
R 042032Z SEP 09
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC0000
INFO RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHBO/AMEMBASSY BOGOTA
RUEHCV/AMEMBASSY CARACAS
RUEHGL/AMCONSUL GUAYAQUIL
RUEHLP/AMEMBASSY LA PAZ
RUEHPE/AMEMBASSY LIMA
RUEHQT/AMEMBASSY QUITO

UNCLAS QUITO 000816

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON EC
SUBJECT: ECUADOR'S CENTRAL BANK TO USE INTERNATIONAL RESERVES TO
SUPPORT DOMESTIC INVESTMENT

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SUMMARY

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1. (SBU) In an attempt to boost internal demand, President Correa
announced August 27 a plan to repatriate US$1.6 billion in
international reserves to fund domestic investments. During a
September 1 meeting with EconOffs, the General Manager of Ecuador's
Central Bank (BCE), Karina Saenz, confirmed that the BCE will
channel the reserves via the GoE's National Finance Corporation
(CFN). The CFN will then use the funds to issue medium-term loans
to the private and public sectors. Saenz subsequently told local
press that the BCE plans to complete the repatriation of reserves
by year's end. However, the plan may require changes to the BCE's
legal framework. This sharp reduction in international reserves
could increase concerns about the soundness of Ecuador's financial
system and overall economy. End Summary.

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BCE to repatriate US$1.6 billion international reserves

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2. (SBU) On August 7, 2009, the BCE announced it was issuing a
regulation that would require $300 million of the country's
international reserves to be invested domestically through the CFN,
a second-tier, government-owned financial institution that provides
loans to state-owned and private commercial entities via banks (and
also administers several public trusts created to finance
microcredit programs). However, during an August 27 televised
broadcast, President Correa super-sized the initiative, announcing
the GOE's intention to repatriate a total of $1.6 billion in
international reserves to fund domestic investments.

3. (SBU) One existing obstacle to this initiative is that current
Ecuadorian law requires that international reserves be invested
abroad. Local law also prohibits the BCE from granting credits to
other entities, such as the CFN. Following the August 7
announcement, BCE President, Carlos Vallejo, suggested to the press
that the BCE could get around this impediment by having the
Ecuadorian Social Security Institute (IESS) use its deposits at the
BCE to purchase BCE securities. This action would reduce IESS
deposits and the corresponding international reserves on the assets
side of the BCE's balance sheet. The BCE would then use the
proceeds of the sale to capitalize the CFN. It appears that the
BCE has not yet finalized this mechanism and it is still possible
that changes to the BCE's legal framework may be required.

4. (SBU) During a September 1 meeting with EconOffs, BCE General
Manager Karina Saenz said that the BCE's financial holdings abroad
currently total around US$ 5 billion (this includes approximately
US$ 4 billion in gross international reserves and US$ 1 billion of
Central Bank foreign assets.) She confirmed that the BCE will
invest the US$ 1.6 billion of reserves - which she referred to as
"excess liquidity" -- in domestic investments in infrastructure and
other projects, via the CFN and as defined by the Secretary of
National Planning (SENPLADES).

5. (SBU) Saenz explained that the CFN will use these funds to
disburse five to eight-year loans to private and public sector
entities (via mostly private sector banks operating in Ecuador).
She also confirmed that this US$1.6 billion includes the US$ 300
million initially announced by the BCE's President in early August.
During a subsequent press interview, Saenz stated that the BCE will
repatriate the US$ 1.6 billion by December 31. Saenz told Econoffs
that she is confident the BCE will find a mechanism to repatriate
the funds and invest them in CFN that is legal. One option the BCE
is exploring is to sell BCE securities to the market (essentially
to the IESS and banks), using the proceeds to buy CFN securities.
(Comment: However, this option anticipates market demand for BCE
financial instruments that may not exist.)

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Concerns about Inadequate Reserve Levels

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6. (SBU) It is not clear that the BCE currently has sufficient
reserves to cover its liabilities, as spelled out in its Charter:
currency in circulation, banks' legal reserves (deposited at the
BCE), and public sector deposits at the BCE. The repatriation of
$1.6 billion in reserves would require a dramatic drawdown of the
Central Bank's public sector deposits. However, as of August 21
(the latest data available), GoE deposits comprised only $1.2
billion of the total $4.1 billion in international reserves. A
further $1.5 billion in reserves represented the deposits of other
public entities (including the IESS) and local governments.

7. (SBU) Should the GoE remove $1.6 billion from all available
public sector deposits, the remaining level of international
reserves would without a doubt be insufficient to cover the BCE's
total liabilities. Therefore, the BCE may decide to use some
percentage of its own cash holdings of over $1 billion (including
the BCE employees' pension fund), which are not counted as
international reserves and are not subject to the legal constraint
on investing domestically.

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Comment: Increased Vulnerability to Financial Instability

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8. (SBU) Comment: BCE General Manager Saenz confirms private
analyst's speculation that the plan to invest international
reserves domestically reflects Ecuadoran authorities' belief that
the country's lack of financing is constraining internal demand
and, therefore, economic growth. However, there are numerous
hurdles, and the private sector is right to criticize the
initiative on several fronts.

-- First, it is not clear that the BCE will be able to raise
financing in a way (such as through the sale of BCE securities)
that allows it to skirt existing prohibitions on the investment of
reserves domestically. Private sector banks are already upset at
GoE and BCE over-regulation, interest rate controls, and recent
decrees requiring them to repatriate a percentage of their own
overseas holdings, and are reluctant to buy additional GoE or BCE
bonds of their own volition. Furthermore, the IESS's President,
Carlos Gonzalez, has commented publicly that the IESS does not have
the capability to provide much additional financing, given that it
bought $1.2 billion in GoE bonds in December 2008 and has already
invested $400 million in CFN.

-- Second, the dramatic reduction in international reserves could
increase concerns about the GoE's financial stability. Not only
would the BCE's investment in CFN be much less liquid than are
their current investments in international assets (i.e., U.S.
Treasuries), but they also bring a much higher credit risk.

-- If the BCE goes through with this initiative, we expect the
general perception will be that the BCE is less capable of
responding adequately to a run on the banks, leaving the economy
more vulnerable to external shocks.
HODGES

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