Ecuador: Selected Issues and Statistical Appendix

This Selected Issues paper and Statistical Appendix analyzes Ecuador’s fiscal policy using the concepts of the fiscal stance and fiscal impulse adjusted for movements in the real effective exchange rate. It finds that fiscal policy has been expansionary in 2000 and 2001. The paper shows that the growth of gross fixed investment was relatively strong during the 1970s; thereafter it slowed, particularly in the public sector. The paper also explores the evolution of oil reserves in recent years and the projections for the medium term.

Abstract

This Selected Issues paper and Statistical Appendix analyzes Ecuador’s fiscal policy using the concepts of the fiscal stance and fiscal impulse adjusted for movements in the real effective exchange rate. It finds that fiscal policy has been expansionary in 2000 and 2001. The paper shows that the growth of gross fixed investment was relatively strong during the 1970s; thereafter it slowed, particularly in the public sector. The paper also explores the evolution of oil reserves in recent years and the projections for the medium term.

Ecuador: Basic Data

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Sources: Ecuadoran authorities; and Fund staff estimates.

Corresponds to the 84-91 days average deposit rate.

Includes reschedulings and net change inpayments arrears.

I. Overview1

A. Recent Economic Developments

1. Ecuador went through a difficult period in the 1990s, and per capita income stagnated. The 1998 oil price slump, damage from the El Niño weather phenomenon, and disease in the shrimp industry further complicated the situation and Ecuador experienced severe economic stress, culminating in accelerating inflation and a currency and banking crisis.

2 The adoption of the U.S. dollar in January 2000 stabilized expectations, and economic activity began to turn around. Moreover, demand was given further impetus by the start of the construction of a new (private) oil pipeline (Oleoducto de Crudos Pesados, OCP) and escalating public sector spending in 2001. However, economic growth slowed again in 2002 due to policy slippages and faltering confidence. Consumer price inflation came down from 91 percent at end-2000 to just under 10 percent by end-2002.

3. After a strong improvement in 2000, the fiscal position weakened in 2001 and 2002. The nonfinancial public sector (NFPS) primary surplus fell from 7¾ percent of GDP in 2000 to around 4½ percent of GDP in both 2001 and 2002. Revenues fell from 27½ percent of GDP in 2000 to 26 percent in 2002. Oil revenue declined with a drop in oil prices and inefficiencies in PetroEcuador that are causing a gradual but persistent shortfall in oil output. These losses outweighed the gains from improvements in the central government tax administration, revenues from the sharp jump in domestic demand, some one-time effects,2 and strong social security receipts following the large wage increases and a broadening of the base for social security contributions in the private sector. At the same time, primary expenditures surged from 19 percent of GDP in 2000 to 21¾ percent in 2002. The main drivers were an increase in the wage bill from US$910 million in 2000 to almost US$2 billion in 2002; increases in purchases of goods and services and capital outlays, and a boost in social security benefits with the aim of restoring real pre-crisis (1998) benefit levels. The public debt-to-GDP ratio (including arrears) declined from 102 percent in 1999 to 60 percent in 2002. This result reflects the haircut received after the 1999 default and the growth in nominal GDP

4. Monetary aggregates expanded rapidly during 2001–02, as improved stability led to reintermediation. Private bank deposits and credit to the private sector both increased by around 30 percent over 2001–02, while net credit to the NFPS declined as some government entities accumulated deposits. Average deposit rates have remained around 5 percent, and average lending rates were close to 14 percent at end-2002. The high interest spread reflects bank’s efforts to restore adequate revenue margins, and the continued high EMBI spread on sovereign bonds, which places a floor on lending rates. The private banks raised average return on equity to 17½ percent in 2002, and they have built a large liquidity cushion abroad, with total liquidity now at over 30 percent of deposits.

5. Public banks have fared less well. Filanbanco, owned by the treasury, received a capital injection of US$300 million in May 2001, but had to be closed soon after. Banco del Pacifico, owned by the central bank (BCE), and the only public commercial bank that remains open, received capital injections of US$129 million in 2001 and US$121 million in early 2002. The bank was placed under a recovery plan with private management in late 2001, and its financial position has stabilized as the new managers cut costs and benefited from expanded powers to collect collateral (coactiva). Some eighteen private banks that were taken over by the Deposit Guarantee Agency during the banking crisis remain unresolved. Little progress has been made toward collecting on US$1.6 billion in defaulted loans, and these banks still have blocked deposits.

6. The external current account deficit widened to 5 percent of GDP in 2002. While merchandise exports benefited from higher oil prices and continued growth of non-oil exports, imports grew rapidly on strong domestic demand (in part reflecting materials brought in to build the new pipeline), and an appreciating real effective exchange rate. In the capital account, FDÏ in the oil sector declined to about 4 percent of GDP as the construction of the OCP pipeline approached completion, while private sector capital showed some reflows for the first time since the crisis.

7. The pace of structural reform slowed in 2002. Achievements in 2001 included a social security reform,3 the unification of private sector wages, and increased private sector participation in the water and telecommunications sectors. However, in 2002, the privatization of public enterprises was cancelled, after tariffs were frozen. The main achievement in 2002 was the approval of the Fiscal Responsibility and Transparency Law, which governs medium-term fiscal policies and is key to medium-term debt reduction.

8. In January 2003, the new government started a bold program aimed at strengthening the fiscal balance and help eliminate arrears. The program includes structural reforms to reduce rigidities in fiscal policy, resolve remaining issues in the banking system, and modernize the state enterprises. The successful implementation of this program would help to place Ecuador on a sustainable fiscal path, increase competitiveness, and improve living conditions for all Ecuadorans, but particularly the poor.

B. Selected Issues Covered in this Paper

9. The adoption of the U.S. dollar as national currency and the associated loss of the monetary policy instruments, has increased the importance of fiscal policy in macroeconomic management. Chapter II analyzes Ecuador’s fiscal policy using the concepts of the fiscal stance and fiscal impulse adjusted for movements in the real effective exchange rate. It finds that fiscal policy has been expansionary in 2000 and 2001. This may have delayed the adjustment of Ecuador’s dollar inflation to U.S. levels, putting additional pressure on competitiveness, particularly in the absence of structural reforms. However, the projection of fiscal policy for 2003 and 2004 seems appropriately cautious, and would be supported by the implementation of the recently adopted Fiscal Responsibility and Transparency Law.

10. Chapter III shows that the growth of gross fixed investment was relatively strong during the 1970s (following the discovery of oil in the 1960s); thereafter it slowed, particularly in the public sector. The private sector’s net fixed capital stock (the gross capital stock minus depreciation) increased through 1998, before declining during the economic and banking crisis. The estimates suggest that the nominal U.S. dollar value of the public sector net fixed capital stock increased at an annual average rate of 4 percent in the period 1985-2002.

11 Chapter IV explores the evolution of oil reserves in recent years and the projections for the medium term. It finds that, depending on the assumptions for new oil discovery and extraction rates, oil reserves might be exhausted in about 20-30 years As a counterpart to the oil economy, simulations of the economy without oil—the non-oil economy—show large fiscal and external imbalances. These imbalances are the result of fiscal policies and, intertwined with it, of price misalignments associated with the Dutch disease. The exhaustible resource, oil, has largely been used to finance consumption.

12. The evolution of the public sector’s net worth is introduced in Chapter V as a long-term indicator of fiscal sustainability and the country’s solvency. The chapter presents a preliminary public sector balance sheet for Ecuador. The most important asset is the oil reserves, while the most important liability is the registered debt (the actuarial pension deficit in the social security system also appears large, but the estimates are very uncertain at this time). Leaving the actuarial pension deficit aside for the moment, the figures show that the public sector net worth (valuing oil reserves at a constant 2001 oil price) has dropped significantly since 1970. With oil reserves projected to last for only another two decades or so, this decline in net worth suggests the need to strengthen fiscal position. Ecuador is making efforts to do this, as reflected in the new Fiscal Responsibility and Transparency Law.

13. Ecuador has recently adopted the Fiscal Responsibility and Transparency Law (see Chapter VI). The salient features of this law are: to restrict the growth in central government real noninterest expenditure to a maximum of 3.5 percent a year (consistent with potential real GDP growth); to cut the central government deficit, excluding oil export revenues (the non-oil deficit), by at least 0.2 percentage points of GDP a year; and to use 70 percent of the public sector revenues coming from a new pipeline (the OCP) to repay debt, 20 percent to provide a stabilization cushion for (oil price) contingencies and national emergencies, and 10 percent for social spending. The new law is countercyclical in nature.

14. The financial system has recovered significantly since the 1998–99 crisis, and banks have built large liquidity reserves. Chapter VII suggests that fiscal consolidation, reductions in government debt, and bold actions to deal with the closed banks, would help to reduce further the remaining vulnerabilities. It also recommends that the government and the banks continued their work towards designing and implementing a new liquidity fund.

15. Chapter VIII shows that Ecuador’s trade regime is very complex. It suggests that the country could move towards a more open trade regime to improve efficiency and facilitate the expansion of the non-oil economy. In particular, Ecuador could benefit from a more uniform import tariff structure, and reduced nontariff barriers, which impose a high burden on the poor, and, ultimately, constitute a tax on exports.

16. The macroeconomic difficulties faced by Ecuador during the 1990s increased poverty and affected social conditions. Chapter IX discusses the World Bank’s proposed agenda for reforms in education, health, and social assistance.

1

Prepared by Mayra Zermeño

2

The VAT rate was increased in July 2001, but this increase was reversed by a decision of the constitutional court. Also, VAT refunds to private oil companies were suspended at end-2001.

3

The reform strengthened the pension system by raising contributions and pensionable age, and opened up the possibility for private capitalized pension funds alongside the public pay-as-you-go system. However, regulations to implement this reform have not yet been issued, and there have been legal challenges to establishing private pension plans.