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DE RUEHQT #0816 2472033
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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
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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