Ecuador: Is it nuts to invest here?

You would have to be nuts to invest in Ecuador. Firebrand socialist leader Rafael Correa has just secured another four-year term and vowed to carry on his “citizens’ revolution”. And so far, that revolution has been a painful one for Western investors.

Since coming to power in 2007, Correa has voluntarily defaulted on the country’s debt, rewritten terms for natural resource companies and steadily pushed up taxes for imported goods.

Unsurprisingly, most multinationals have taken the hint and left the country. Foreign direct investment now stands at less than 1% of GDP – the lowest in the region apart from Venezuela.

But today, I want to tell you why I reckon that could be about to change and throw up some exciting – though risky – investment opportunities in the region.

First though, I must confess, I have something of a vested interest in Ecuador. My fiancée is from the country and I’ll be getting married over there in August.

That doesn’t make me automatically bullish on the country. After all, landowners in the coastal region where my other half  is from are no great fans of Correa. Many are wary of his attempts to meddle in agriculture.

Correa: two sides to the man

I have spent a fair bit of  time in the country and I’ve seen first-hand some of the unreported positive aspects of the Correa regime. The most obvious is the road building programme.

Ecuador’s transport system was a mess when Correa came to power and since then he’s built thousands of kilometres of road and constructed massive new bridges. That’s helped to slash journey times and cut costs for the country’s businesses. He’s also spent heavily on schools and welfare payments.

Not all of this money has been well spent, and you could argue that the latter was a calculated bid to buy voters. But either way, it’s helped boost growth in the economy. In the last few years, Ecuador has been one of the fastest-growing economies in the region, with GDP averaging 6.7% since the start of 2011. 

That economic growth, combined with shrewd political nous and generous wealth transfers, helped Correa win last month’s election by a landslide. He picked up 57% of the vote with his nearest rival collecting just 24%.

So why, given Correa’s strong position, do I think that the country has potential for British investors? Well for starters, Correa’s situation is not as comfortable as it looks.

There are plenty of complaints about his meddling, authoritarian style. Many in Ecuador are uneasy about his attempts to control the media, while he often causes annoyance with his penchant for micromanaging society.

For example, last year he produced a strange ruling that governed how pupils at public schools could celebrate their Christmas parties. There are also plenty of corruption scandals, examples of nepotism and a supposed coup in 2010 that many suspect was faked.

Yet, as the elections demonstrated, the majority of the population will overlook these issues as long as Correa continues to spend heavily and deliver economic growth. And that’s why Correa, with an economics PhD, may be nervous.

Over-reliance on oil – where to look now?

So far, he’s rejected the ‘Washington Consensus’ of free trade and liberal economic policies and managed to carve out impressive growth by doing things his own way.

His 2008 default cut Ecuador off from international debt markets but he made up for this by negotiating oil finance deals with China. As a result, he’s been able to almost double government spending and turn Latin America’s lowest spending government into its highest.

As for the general economy, his anti-Western rhetoric and harsh tax regimes scared off most foreign investors, leaving the country increasingly dependent on the state-owned oil company and local agricultural exporters. Fortunately for Correa, record commodity prices have helped both industries and the economy has continued to boom.

The trouble is, neither of these things can carry on indefinitely. His government is dependent on oil, which accounts for 40% of revenues. If oil remains flat or falls, as many analysts expect, then Correa will struggle to maintain his largesse. When faced with this problem in the past, Correa has turned to the Chinese but they won’t be able to help him out forever.

According to leaked reports, it’s estimated that Correa has pledged 80% of Ecuador’s state-controlled production until 2020 to China. In other words, he is running out of stuff to offer the Chinese.

Oil is also very important to the wider economy, making up around 50% of exports. “Ecuador is running a current account deficit despite the fact oil prices, and hence its terms of trade, are close to record highs”, notes Michael Henderson at Capital Economics. “We estimate that if global oil prices were to fall to below US$90/bbl, this would be consistent with the current account deficit widening to over 5% of GDP.”

So if Correa wants to keep the economy growing and remain popular with the voters, he needs to find another source of capital – and that could be you. As unlikely as it sounds, Correa is starting to realise that Western resource companies – owned by shareholders such as yourselves – are his best chance of keeping growth going and staying popular with the voters.

Ecuador is finally opening its arms, especially to miners

Thanks to Correa’s tough treatment, many oil firms have left the country and production is stagnating. Now Ecuador is trying to fix that by auctioning exploration rights in hitherto unexplored parts of the country.

Given the understandable reluctance of international oil companies, officials from the Hydrocarbons Secretariat of Ecuador (SHE) are launching a worldwide charm offensive. They’re halfway through an international roadshow that is stopping off in Colombia, the US, France, Singapore and China.

It’s a remarkable turnaround for a country that has spent the last four years fighting international investors. Indeed, Wilson Pástor, minister of Ecuador’s Nonrenewable Natural Resources, admitted as much when he launched the roadshow.

“We are beginning a new era of exploration in Ecuador. We have not explored enough in the past 15 years, and it is time for Ecuador to attract new foreign investment to move our industry and country forward and to increase our reserves.”

Correa also seems keen to diversify away from an overdependence on oil. Fortunately for him, Ecuador is rich in a wide range of natural resources. One is agriculture. Just look closely at the label the next time you buy a packet of shrimps or bananas from Tesco and odds on they’ll be from Ecuador.

However, encouraging large-scale foreign investment in agriculture would be politically disastrous. So instead, Correa is looking to push investment in the untapped mining sector.

In the last few months, he’s made a number of high profile calls to “make it easier” for mining companies. In February, he told Reuters “I don’t like mining, and open-pit is even worse, but it’s impossible to think of modern life without mining and it would be irresponsible not to use those resources… They can be key to fight poverty.”

Given Correa’s previously hostile approach to miners it’s a massive turnaround. More importantly, he’s backing up his words with actions. Last year, he signed a contract with a Chinese miner for a $1.6bn copper project. While just last month, Chilean state-controlled miner Codelco received permission to start another major copper mine.

Meanwhile, Correa is currently pushing legislation through Congress that will relax terms for miners. His aim is to water down the existing framework – which includes a 70% windfall tax – so that he can finally finalise a much-debated project with Canadian miner Kinross (NYSE: KGC).

The proposed mine – known as Fruta del Norte – is one of the world’s biggest remaining gold and silver deposits. According to Kinross it contains 6.7 million ounces of proven and probable gold reserves and nine million ounces of proven and probable silver reserves. 

Negotiations have been going on for years and I am not going to bet that they’ll be concluded successfully now. But while I can’t be sure if this deal will happen it is clear that Ecuador’s mining sector is hotting up.

Problems Correa will have to overcome

It won’t be easy. William Lee, the Ecuador analyst at the Economist Intelligence Unit, told me that, while Correa may be talking up investment, there still remains plenty of work to be done on the ground. 

Firstly, the regulatory structure has been adjusted so many times that miners are bound to be nervous. Meanwhile the difficult business environment and weak institutions will increase the cost of operations.

Another obstacle is opposition from environmentalists and community groups who are worried that these projects will damage the country.

Given the shocking environmental pollution caused by Western companies in Ecuador in the past – these groups deserve to be listened to. However, I actually think that opposition could work in the favour of listed Western resource firms who – nowadays at least – are often the best equipped and most inclined to take care of environmental issues.

The final thing to remember – as an Ecuadorian trade official pointed out to me in a private conversation – is that “these companies are active all over the world. Ecuador might be risky but many other countries are a lot worse.” It’s not your typical sales pitch but it’s a fair point. Especially when you consider the country’s massive potential for gold, copper and oil projects.

I’ll be keeping a close eye on Ecuador’s resource sector in the coming months and will update you on any exciting developments. Western companies operating there are likely to trade at a discount – for example Kinross’s on-going Ecuador debacle has hammered the share price – which will create opportunities for brave investors.

This article is taken from The New World, MoneyWeek’s FREE regular email of investment ideas and news from Asia and Latin America. Sign up to The New World here.

  • Rajah Brookes

    It’s well worth reading ‘Confessions of an Economic Hitman’ for the lowdown on the West’s shameful engagement with Ecuador in the past. I’d be very surprised if the current president uses air travel! The wealthy loathe the president. I was in Ecuador last year and the inequality is a huge issue. But compared to basket cases like Peru, Ecuador looks positively European…with great infrastructure. If they finally want to make sure that they actually profit from their own natural resources, they deserve that chance…on their own terms.

  • Changing Man

    Nuts? Of course not! It’s the perfect way of reducing your capital gains tax liability!

  • stephen maly

    I spend 70% of my time in Quito and I think in order to judge the changes one has to understand what proceeded this Government. Whilst I would not say I am a fan of every thing that they do, you can see real progression and actually it feels that there is a macro plan at play that should leave the country in a much stronger position. To me, Ecuador is becoming a better place to invest and do business. Its worth pointing out that while the UK high street suffers a drastic downturn a stroll through Quicentro a Quito based shopping mall includes Tiffany’s, Mont Blanc, Chop hard, Rolex etc etc etc. New world is seeing a much better growth than old economies.

  • Trini Quiroz

    I have a simple wish for all YELLOW PRESS passing as Journalism or Media!

    Stay the heck off and out of Ecuador, and the Best President Latin America has ever known (except for Clinton) better that any USA dictator!
    And you James McKeigue…just because you are marrying a relative of “land-owners” who are the very same bourgeoisie oppressive class President Correa most deal with to help “their peons-slaves” to prosper too! …does not make you any better….you too are part of the PROBLEM and unless you are taking your anti-Correa PREJUDICE blinders off your gringo eyes….your “sudden… possible change-of-heart” is not needed over there! Ecuador and its noble people (not the evil bourgeoisie) will do just FINE and will continue to SHINE with the wise, noble and unlike any-other LEADERSHIP of President
    RAFAEL VICENTE CORREA!!!!!

  • James McKeigue

    Hi Trini,

    I’m Irish – no one has ever called me a gringo before :-)

    Seriously though, if you are not keen on more gringos doing business in Ecuador you may want to communicate that with President Correa. As I mentioned above he seems pretty keen to do business with them…

    Take care and thanks for reading,

    James

  • SS

    Go up and down the coast and inland. There is “Gringos” everywhere moving in for a simplier life. They bring with them ideas of growth and investment. I agree with both of you in the fact there needs to be and will be balance either forced or natural in this country. Ask any gringo in Ecuador if you should invest and see what they say. A simple life with friendly people.

  • Matt

    “a supposed coup in 2010 that many suspect was faked” you got to be freaking kidding right? I live in Quito and was here during the coup and you would have to have been blind or stupid if you think it was faked. Trying telling that to the family of the people killed including the policeman shot dead protecting Correa. This is just typical of the blatant lies in the right wing spin against the progressive government under Correa. He is not perfect but has done so much for the country in reducing poverty, enforcing legal employment conditions and social security, improving beauracracy and fighting corruption, and yes the press he has fought against ARE corrupt, a small group of wealthy and privileged Ecuadorians with vested interests who have exercised control for too long.
    Having said that I am not that fond of Ecuador and have spent enough years here, but for other reasons, mostly because of the unreliability of the people andbad cultural habits.

  • Matt

    By the way, any foreigner is called “gringo” in Ecuador, I met an Argentinian who was called gringo. I suggest you get used to it if you spend much time in Ecuador!

  • Lorne S.-Saskatchewan, Canada

    I bought a home in Cotacachi..Love the country, the people,the food, the weather and the president..
    am probably going to buy more property and perhaps start a small business..
    was in Cuenca last week…incredible community…

    This is a great country to live AND invest..I’ll be telling all my Canadian friends and family…

  • Changing Man

    Oh James, what a hornet’s nest you have stirred up! Judging from the above I imagine that the Ecuadorian Toutist Board have got their work cut out? Where will you go for your next article? Investing in the Falklands Oil Industry or the Iranian nuclear programme? :)

  • Michael

    The clear winner if mining moves forward is Dynasty Metals & Mining.

    A Canadian junior miner that already has a fully-functioning gold/silver mine built, is mining and selling both already, and just picked up small miner licenses from the Ecuadorian government.

    Their share price looks completely hammered down, likely due to political risk and the Ecuador taint.

  • Tigre

    By and large, Correa is doing a great job as President. His economic and social policies are a success. Poverty has been greatly reduced, while economic growth has picked up. Public expenditures in the social sectors have been greatly increased, while economic infrastructure has also received the benefits of more spending. He has given the country an era of economic, social and political stability. That’s why he won the last presidential race by a landslide.

  • PJC

    This seems like a very misguided article.

    “Thanks to Correa’s tough treatment, many oil firms have left the country and production is stagnating”

    What exactly are we supposed to say? Perhaps the author would be happy if we responded by saying:

    “Yeah!! We like it better here in the USA where Oil Companies make record profits in the billions while the prices at the pump rise to unbearable levels, all along with the rising numbers of Americans facing HUNGER, chronic unemployment and a shaky economy. …and the numbers of billionaires increase by hundreds each year. “.

    Based on what I’ve seen of Rafael Corea, he’s saying to foreign investors “Play fair or GET OUT”. And that’s not the way some of them are accustomed to doing business in Latin America.

  • Andres

    This article is bad and boring. zzz…

  • Wge

    I have witnessed first hand the progress in Ecuador, the infrastructure is available for better commerce, communication and growth.

    I believe that Ecuador and President Correa need to look at new sources of revenue. The beautiful beaches, mountains and jungle need to be exploited for tourism purpose. The Galapagos Island is a under utilized/promoted tourism opportunity.

    Like Mexico (Cancun and other destinations) have made tourism an integral part of the overall economy.

  • Daniel

    Trini – why are you reading a magazine called MoneyWeek with your agenda? Likewise PJC, this is an investment magazine, right?

    Looking at the way Bolivia, Argentina and Venezuela have treated foreign multinationals in the past (Red Electrica Bolivia, Repsol/YPF, BBVA Banco Frances, Telefonica inability to repatriate Venezuelan cash) I would need a MASSIVE discount to invest in a country with a president that has previous on defaulting on investors.

  • kingwowns

    Daniel -being interested in investing your hard-earned money isn’t always synonymous with “profits before people”.

    On Ecuador – I criss-crossed it for 7 weeks last July and it has amazing infrastructure (roads that shame the UK) and obvious natural wealth – tourism alone could make it a big hitter.

    On Correa – anyone that tells the US they can retain their Ecuadorian bases on a simple condition that Ecuador gets a base outside of Miami gets my respect!

  • hit2013

    Mr McKeigue in order to talk about my country’s situation you should go in deep about its new policies, economy and political history. You didn’t mention the following:1)He applied “sovereign default” after a rigorous debt auditory from European experts. Many other countries in the past have applied such defaults including US 2) He is applying “imports substitution” leveling up import taxes it’s a supporting policy for this3) Regarding the new way of contracting services for mining and oil sector is absolutely legal and good for the Ecuadorians who now enjoy benefits going from social to business. We have clear rules for foreign investment in the new “Code for investment”.
    In my humble opinion this article lacks of proper information and instead of been objective it only communicates the journalist’s biased point of view. Hoping in the future you Mr McKeigue can write more professional articles about my country.
    All the best for you.

  • Daniel

    @ kingwowns – I dont think I did say that. I was just surprised that given Trini’s views (talks of evil bourgeoisie) why she would read this magazine. Can’t be good for her blood pressure. Incidentally regards her comment what Latin country was Clinton president of?

  • Bob

    My wife and I were in Ecuador two years ago looking at property to purchase, we loved the country, the climates, and the people, however Correa had just won his 9 point referendum and some of these points we were afraid of since he, Chavez, and Morales were great friends and we were afraid of nationalization of properties as Chavez had accomplished in Venezuela. We were disappointed, but perhaps there is hope yet that the beautiful country of Ecuador can solve its problems and draw international business.

  • Luis Robles

    Nice article though. I really enjoyed it! What I think it missed to point out is that President Correa aims to the lower class (poor people) hence the big popularity he has. The social bonus (welfare) is planned to be increased to $100 (currently $60).

    I like President’s decisions (I’m ecuadorian) I think our country needed a leader like him, not doblegating or taking biased decisions for the “rich people” on our country, who manage our country. What I don’t like is the excessive taxes to different industries, at the moment, the banks are affected with a new tax (Robin Hood thought, take from the rich and give to the poor) but that means later on, it would not be the banks only, but private industries and similar.

    I love my country, we have everything, from fruits, to paradises, to animals, climate, etc. But we don’t have any real leaders anymore, we don’t have politicians that actually care about our country and only want to rob as much as possible.

  • PJC

    Just noticed this response from Daniel (#16):
    “Likewise PJC, this is an investment magazine, right?”

    Yes, it’s an investment magazine but as I stated, US Companies are not accustomed to playing fair when they go to South America. They are accustomed to EXPLOITATION. Correa deserves credit for putting his foot down and demanding that investors play fair.

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