Ecuador: 2005 Article IV Consultation—Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Ecuador
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International Monetary Fund
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Publication Date:
10 Mar 2006
eISBN:
9781451811827
Language:
English
Keywords:
ISCR; CR; CPI inflation rate; deficit; minister; government; private sector; exchange rate; banking system; fiscal policy; heavy crude oil; Oil prices; Global
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This 2005 Article IV Consultation highlights that despite a difficult political environment, economic growth in Ecuador is estimated to have exceeded 3 percent in 2005, with the non-oil sector expanding by 3½ percent. The strong growth in the oil sector that followed the completion of the new oil pipeline in 2003 has tapered off, but high oil prices have helped bolster confidence and underpin domestic demand. The external current account deficit is estimated to have remained unchanged at about 1 percent of GDP.

Abstract

This 2005 Article IV Consultation highlights that despite a difficult political environment, economic growth in Ecuador is estimated to have exceeded 3 percent in 2005, with the non-oil sector expanding by 3½ percent. The strong growth in the oil sector that followed the completion of the new oil pipeline in 2003 has tapered off, but high oil prices have helped bolster confidence and underpin domestic demand. The external current account deficit is estimated to have remained unchanged at about 1 percent of GDP.

I. Background

A. Political Context

1. Political conditions have been turbulent in 2005. Congress dismissed President Gutierrez in April. His successor, President Palacio, became Ecuador’s sixth president in the last 8 years.

  • For much of his time in office, President Palacio has been locked in a dispute with Congress over his desire to set up a constituent assembly that would have powers to design and implement wide-ranging political reforms.

  • After initially encouraging expectations for a broad expansion in government spending, the new government has shown a greater concern for fiscal discipline and for advancing much needed structural reforms, while continuing its strong emphasis on addressing the country’s social needs.

  • However, because of the government’s weak political base—it has no party affiliation or representation in Congress—and the population’s increasing focus on the October 2006 presidential and congressional elections, it has had difficulties in withstanding pressures for more public spending and in resisting inappropriate policy initiatives from powerful interest groups and local governments.

B. Recent Economic Developments

2. The economy has been largely resilient to the difficult political environment and, aided by high international oil prices, macroeconomic performance in 2005 was generally positive.

  • Overall GDP growth is estimated to have exceeded 3 percent, with the non-oil sector expanding by 3½ percent (Figure 1). The strong growth in the oil sector that followed the completion of a new oil pipeline in 2003 has tapered off, but high oil prices have helped bolster confidence and underpin domestic demand.

  • Employment growth has remained sluggish, however, and the unemployment rate, which averaged 10.7 percent, was little changed from 2004.

  • Driven mainly by strong growth in bank credit and public spending, 12-month CPI inflation rose from less than 2 percent in June 2005 to 4 percent at the end of the year despite frozen domestic fuel prices (Figure 2).

  • The external current account deficit is estimated to have remained unchanged at about 1 percent of GDP, reflecting rapid import growth which offset strong increases in oil and non-oil exports led by shrimp and metal products (Figure 3). While oil sector FDI inflows increased, non-oil FDI remained low, at less than 1 percent of GDP.

Figure 1.
Figure 1.

Ecuador: Real Sector

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Central Bank of Ecuador; and Fund staff estimates.1/ 2005 observation is for the first half.
Figure 2.
Figure 2.

Ecuador: Prices

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Central Bank of Ecuador; and Fund staff estimates.1/ Staff projection for 2005.2/ Fiscal spending is NFPS current primary spending plus returned social security contributions.
Figure 3.
Figure 3.

Ecuador: External Sector Indicators

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Central Bank of Ecuador; and Fund staff estimates1/ 2005 observation is for the year ending in June.2/ 2005 observation is for the year ending in September.3/ 2005 observation is January-September average.

3. Investor confidence has improved.

  • Banking system credit and deposits grew strongly in 2005, while liquidity remained at comfortable levels and other stability indicators continued to improve (Figure 4). Moreover, there was no evidence of spillover effects on deposits or on interest rates from the political turbulence. However, bank intermediation is still well below pre-crisis levels and deposits are overwhelmingly at short maturities.

  • The authorities successfully regained access to international capital markets with a US$650 million bond issue in December 2005. The 10-year bullet bond, with a yield of 10.75 percent (95 basis points below that of the existing 2012 global bond) was greatly oversubscribed. Nevertheless, the EMBI spread, although having declined substantially in the past year, remains the widest among Latin American countries.

Figure 4.
Figure 4.

Ecuador: Monetary Sector Indicators 1/

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Central Bank of Ecuador; Bank Superintendence and Fund staff estimates.1/ Yearly data for 2005 based on November figures.2/ Short term deposits include sight and term deposits with maturities under 91 days.3/ Ecuador average refers to 84-91 day loans. El Salvador average refers to short-term loans. Ecuador prime is the corporate rate for loans with maturities below 30 days.

4. Although public debt ratios continued to fall and liquidity problems eased in 2005, the underlying fiscal stance has weakened (Figure 5). In recent years, non-financial public sector (NFPS) primary surpluses have been maintained consistently above 4 percent of GDP, reflecting mainly high oil revenues, which have helped reduce public debt from over 90 percent of GDP in 2000 to 43 percent of GDP in 2005. However, the non-oil deficit is projected to have increased to 5 percent of GDP in 2005, driven by the growing cost of fuel subsidies (owing to fixed domestic prices) and the continued rapid expansion of recurrent spending, especially in wages and pensions.

Figure 5.
Figure 5.

Ecuador: Fiscal Indicators 1/

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Ministry of Finance and staff; and Fund staff estimates.1/ Staff projections for 2005 and 2006.
uA01fig01

Current Spending and Non-oil Balance, 2004-05

Cumulative changes since 2003 in percent of oil windfall

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

5. The authorities aim to restrain recurrent spending in their 2006 fiscal program to make room for larger capital and social spending while maintaining an overall primary surplus above 4¾ percent of GDP. Their budget proposal envisages growth in wages and pensions of 4 percent, compared with 15 percent a year during 2002–05. However, capital spending is projected to rise by some 40 percent, in line with the authorities’ priority of addressing the country’s outstanding social and infrastructure needs. Under current WEO oil price projections, the authorities’ program would be consistent with an increase in the NFPS surplus to 4.8 percent of GDP from 4.2 percent in 2005 and a decline in public debt to 40 percent of GDP. However, the non-oil deficit would remain unchanged, reflecting a further substantial increase in the cost of fuel subsidies. The fiscal program for 2006, which also includes significant resources earmarked for liability management operations, appears to be adequately funded, reflecting the recent bond issue and approved disbursements in January 2006 from the Latin American Reserve Fund (FLAR). The authorities also expect to receive US$400 million in budget support financing from the multilaterals, half of which appears to be well in train.

6. There has been little progress in implementing structural reforms to enhance the prospects for long-run growth or address key economic vulnerabilities as discussed in the 2004 Article IV consultation. Rather, many of the measures that have been implemented in the last year weakened the macroeconomic policy framework.

  • Reforms stalled in Congress. The Gutierrez government made three unsuccessful attempts to pass oil sector reforms in Congress, and had two electricity reform proposals rejected. Congress also rejected (without debating) an omnibus bill containing proposals for reforms in the oil and electricity sectors, fiscal area, pension system, labor market, and financial system, many of which were in line with recommendations of the 2004 Article IV consultation. In December 2005, Congress again rejected an electricity reform bill that aimed to settle intra-sector debts and introduce incentives for greater private participation in electricity generation.

  • The overall framework for fiscal policy has weakened. In June, Congress approved a reform to the fiscal responsibility law (FRL)—sponsored by the new government—that eliminated the FEIREP oil fund, removing capital spending from the ceiling on primary expenditure growth, and increasing the earmarking of oil revenues (Box 1).

  • The actuarial deficit of the pension system has increased. Congress approved a bill which returns the accumulated assets of the Social Security Institute’s (IESS) reserve fund to employees every three years.1 In addition to the impact on the actuarial deficit, the reform potentially complicates liquidity management for the central government since about half of the IESS’s portfolio is invested in government paper.

  • The tax base has been eroded. A government-supported law granting generous tax incentives to foster investment in various sectors was approved by Congress.2 The law’s effectiveness to encourage investment is doubtful, but it would weaken the tax base and complicate tax administration.

  • Some headway was achieved in financial sector reforms. The Superintendency of Banks tightened up regulations governing capital and liquidity in line with the 2004 FSAP recommendations. Congress approved new anti-money laundering legislation and passed a law to strengthen the operation of credit bureaus. However, a new banking law recently sent to Congress by opposition parties raises serious concerns (Box 2).

Modifications to the Fiscal Responsibility Law

The authorities’ decision to change the Fiscal Responsibility Law (FRL) was based on a desire to increase resources for capital and social spending. Even though compliance with the original law was far from perfect, the June 2005 reform of the FRL weakened the overall framework for promoting fiscal discipline.

  • The reform removed capital spending from the 3.5 percent cap on annual real increases in central government primary expenditure.

  • It retains the requirement that the non-oil fiscal deficit decline by 0.2 percent of GDP per year, but this provision was violated in both 2004 and 2005.

  • It eliminated the FEIREP oil fund, bringing heavy crude oil revenues into the budget, and reallocating resources formerly earmarked for debt buybacks toward social spending and credits aimed at reactivating the economy.

uA01bx01fig01

Primary Expenditures Real Growth

(Percent change)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

uA01bx01fig02

Fiscal Rule on Non-oil Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

The staff’s main concerns are the following:

  • With more resources being made available to the budget, the reform has given rise to new pressures to increase spending.

  • The funds earmarked for economic reactivation are to be managed by two public development banks beset by management and institutional problems, raising the risk that the resources may be misused.

  • The earmarking of revenues for a host of expenditure categories has increased budget rigidities—a long concern in Ecuador—relative to the original law.

  • The likelihood of any heavy crude oil revenues being used for external debt buybacks, as originally intended, was further reduced.

uA01bx01fig03

Fiscal Rule on Public Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

The Draft Banking Sector Law

The largest party in Congress has sponsored a draft bill that aims to channel more credit to productive activities and reduce the cost of financial intermediation. In particular, the draft legislation seeks to:

  • Cap intermediation spreads. The central bank would be required to set a ceiling on lending rates at 300 basis points above the central bank’s reference rate—the 3-month prime rate for the corporate sector—and a floor on deposit rates at 70 percent of the reference rate. All fees and commissions on loans would be abolished.

  • Direct lending to productive activities. Banks would be required to lend at least 75 percent of their deposits to productive sectors and would have to place remaining deposits in the central bank. The central bank would determine the allocation of credit among productive sectors based on their share of GDP according to the national accounts. Banks would be subject to stiff fines for non-compliance.

The authorities concur with the staff that the current draft legislation, if approved, could result in a sharp reduction in financial intermediation. Moreover, the credit allocation guidelines would likely undermine prudent credit management, thus threatening the soundness and stability of the banking system.

Congress is considering modifications to the draft bill. Amidst opposition from the financial community and warnings from the Superintendency of Banks and the central bank, Congress is reportedly considering eliminating directed lending from the bill and relaxing intermediation caps by setting them according to credit type—commercial, mortgage, consumer, and microcredit.

II. Macroeconomic Outlook and Risks

7. The inherent volatility in international oil prices and the unsteady domestic political situation imply a large degree of uncertainty for short-term macroeconomic projections. On the basis of current oil futures prices, which imply an average WTI oil price of US$61 per barrel in 2006, staff projects real GDP to grow at 2¾ percent, with non-oil GDP expanding at a similar pace. CPI inflation would fall to 3 percent in 2006, reflecting a deceleration in credit and government spending growth, while the external current account deficit would remain at about 1 percent of GDP. The NFPS surplus would rise to 4.9 percent of GDP, slightly higher than in the authorities’ program, reflecting lower capital spending which would more than offset somewhat higher current spending.

Ecuador: Main Economic Indicators, 2003–06

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8. However, the economic outlook is subject to substantial risks.

  • Spending pressures. The authorities will be challenged to keep recurrent spending and capital transfers to subnational governments within tight program limits, given the strong demands for increases from powerful interest groups, and the presence of large cash holdings from recent credit disbursements. However, such spending overruns could be partially offset by a lack of institutional capacity to execute the large capital budget.

  • Oil prices. Given the strong dependence of the budget on oil revenues, a fall in the price would substantially reduce the financing cushion for the fiscal program: every US$1 decline in the price of oil would reduce the central government overall balance by about 0.1 percent of GDP.

  • Inappropriate policy initiatives. The recent legislative changes to the FRL, pension system and tax incentives, and the banking reform bill now in Congress demonstrate that the tendency for damaging legislation is high. A continuation of this pattern could lead to a sudden sharp deterioration in confidence, with possibly serious spillover effects on the banking system.

9. In the absence of policies to address underlying vulnerabilities and advance key growth-enhancing reforms, the medium-term outlook would be characterized by low growth and an increased susceptibility to shocks that could undermine the sustainability of the dollarization system (Table 8 and Figure 6).

Table 1.

Ecuador: Selected Social and Economic Indicators

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Sources: Central Bank of Ecuador; Ministry of Finance; and Fund staff estimates and projections.

Based on percent of population aged 15+.

In 2004–06 includes a broader definition of deposits in all open financial institutions.

November data for 2005.

September data for 2005.

Table 2.

Ecuador: Central Government Operations, Net Accounting

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Sources: Ministry of Finance; Central Bank of Ecuador; and Fund staff estimates and projections.

Transfers from PetroEcuador generated by the domestic sales of oil derivatives net of derivative import costs.

Table 3.

Ecuador: Central Government Financing

(In millions of U.S. dollars)

article image
Sources: Ministry of Finance; Central Bank of Ecuador; and Fund staff estimates and projections.

Includes public financial institutions.

For 2005, includes bilateral financing from Venezuela in the amount of US$200 million.

Includes the refund of contributions to the social security reserve fund (totaling 2.2 percent of GDP) in 2005-06.

For 2005, reflects the value of discount given on the December 2005 bond issue.

Table 4.

Ecuador: Operations of the Nonfinancial Public Sector, Net Accounting

article image
Sources: Ministry of Finance; Central Bank of Ecuador; and Fund staff estimates and projections.

From 2003 onward, includes revenues accruing to the oil stabilization fund (FEIREP).

Includes the refund of contributions to the social security reserve fund (totaling 2.2 percent of GDP) in 2005-06.

Table 5.

Ecuador: Nonfinancial Public Sector Financing

(In millions of U.S. dollars)

article image
Sources: Ministry of Finance; Central Bank of Ecuador; and Fund staff estimates and projections.

Includes public financial institutions.

Includes financial assistance to public banks.

Includes the refund of contributions to the social security reserve fund (totaling 2.2 percent of GDP) in 2005-06.

For 2005, includes bilateral financing from Venezuela in the amount of US$200 million.

Information about the financial position of some agencies within the NFPS is incomplete.

For 2005, reflects the value of discount given on the December 2005 bond issue.

Table 6.

Ecuador: Summary Accounts of the Financial System

article image
Sources: Central Bank of Ecuador, and Fund staff estimates and projections.

The previous methodology included open and closed commercial banks, the new one includes only open commercial banks.

Does not exclude loan provisions starting in 2003 new methodology.

Includes the BNF, CFN, finance companies, cooperatives, savings and loans, and the BEV.

Includes the BCE, open commercial banks, and the other financial institutions.

Table 7.

Ecuador: Balance of Payments

article image
Sources: Central Bank of Ecuador; and Fund staff estimates and projections.

Imports of goods related to new foreign investments in the oil sector.

Includes errors and omissions.

Includes liabilities to the IMF and excludes deposits of the FEIREP oil fund.

For 2005, reflects value of discount given on the December 2005 bond issue.

Table 8.

Ecuador: Passive Medium-Term Scenario

article image
Sources: Ecuadoran authorities; and Fund staff estimates and projections.

September data for 2005.

Gross debt minus central government deposits.

  • Low growth. Based on current economic trends, annual real GDP growth would average about 2¼ percent over the next five years, with oil production trending downward on account of continued low investment by PetroEcuador and a failure to establish an attractive regime for new private investment. Limited progress on structural reforms would likely prevent the non-oil sector from sustaining growth above its long-run average rate of 2.6 percent, resulting in continued high poverty and unemployment rates and possibly increased social pressures.

  • Deteriorating fiscal outlook. In the public sector, the NFPS surplus is projected to decline by 2½ percentage points of GDP over the medium term, large financing gaps would emerge, and public investment would be crowded out, reflecting gradually declining oil revenues, continued recurrent spending pressures, and limited access to credit. Potentially severe cash flow problems would increase the risk of default or a possible disorderly forced exit from dollarization.

  • Banking system fragility. The reluctance of depositors to lengthen the maturity of their deposits indicates that the recent improvement in confidence is not yet deep-rooted. This increases the likelihood that any worsening in the overall macroeconomic environment could produce negative spillover effects in the banking system, which could quickly turn into systemic banking problems because of the effective absence of deposit insurance or any lender of last resort.

  • Increased susceptibility to shocks. Though the debt-to-GDP ratio would continue to decline gradually, the debt sustainability analysis (Appendix I) shows that in the event of below-average overall economic performance or lower (but still high) international oil prices, fiscal and external sustainability problems would likely resurface.

10. The staff has prepared an active policy scenario based on a strong effort at fiscal consolidation and the implementation of key pro-growth structural reforms (Table 9 and Figure 6).

Table 9.

Ecuador: Active Medium-Term Scenario

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Sources: Ecuadoran authorities; and Fund staff estimates and projections.

September data for 2005.

Gross debt minus central government deposits.

Table 10.

Ecuador: Selected Vulnerability Indicators

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Sources: Central Bank of Ecuador; Ministry of Finance; and Fund staff estimates and projections.

November data for 2005.

January-September data for 2005.

Nonfinancial public sector.

Public sector gross debt net of deposits in the banking system.

Includes banking system, which is fully dollarized. November data for 2005.

The ratio of available funds and tradable securities to demand and term deposits.

Table 11.

Ecuador: Millennium Development Goals

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Source: World Development Indicators database. Note: In some cases the data are for earlier or later years than those stated. Goal 1 targets: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger. Goal 2 target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling. Goal 3 target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015. 2,015.00 Goal 4 target: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate. Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio. Goal 6 targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases. Goal 7 targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers. Goal 8 targets: Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address the Special Needs of the Least Developed Countries. Address the Special Needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.
Figure 6.
Figure 6.

Ecuador: Medium-Term Scenario, 2003–10

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Ministry of Finance; Central Bank of Ecuador; and Fund staff estimates and projections.

  • In the fiscal area, the non-oil primary deficit would be reduced by between 2–3 percent of GDP with measures to widen the tax base, lower fuel and pension subsidies, contain the wage bill in part through civil service reform, and reduce revenue earmarking. This would allow for a reallocation of spending toward public investment and social spending while sustaining large primary surpluses which would be boosted by higher oil revenue from increased production. As a result, public debt would fall to about 20 percent of GDP by 2010.

  • Real GDP growth would reach 4½ percent in 2010, reflecting efficiency gains from reforms to public enterprises, better management of the country’s oil resources, strengthening the supervisory and regulatory framework of the banking system, trade liberalization, and other measures to improve the investment climate.

III. Report on the Discussions

11. While recognizing some positive aspects of recent performance, staff emphasized that Ecuador should be doing more to take advantage of the favorable external conditions to strengthen the macroeconomic policy framework and advance structural reforms. The authorities agreed with the need to tighten fiscal discipline in 2006, and to advance reforms that would underpin improved fiscal management and enhance competitiveness and the business environment, while stressing the importance of trying to address Ecuador’s large social needs. Staff recognized the difficult political situation faced by the authorities and urged them to work to build the necessary consensus to facilitate the implementation of these reforms.

A. Fiscal policy

12. While the recent large decline in public debt is an important step toward reducing fiscal vulnerabilities, fiscal management remains subject to fundamental weaknesses that could jeopardize macroeconomic stability and the achievement of growth and poverty reduction goals. Discussions focused on (i) achieving a strong fiscal policy outcome in 2006; (ii) improving the fiscal policy framework; and (iii) reducing vulnerabilities associated with oil dependence and budget inflexibility, while improving expenditure quality.

Strengthening the 2006 fiscal policy stance

13. Recent inflationary pressures and the increased dependence on volatile oil revenues highlight the need for a tighter fiscal stance than contained in the authorities’ fiscal program. The authorities agreed that firm approach to budget execution in 2006 is needed. They reaffirmed their commitment to fiscal discipline and to resisting pressures for spending increases beyond program levels, including the additional spending tacked on by Congress to the government’s budget proposal (amounting to 1 percent of GDP). The authorities intend to fully offset the additional transfers to subnational governments implied by the Congress’s reclassification of oil revenues3 by reducing discretionary capital spending (0.4 percent of GDP). They plan not to act on the other increases voted by Congress, since they can legally reduce (or increase) the approved budget by 5 percent without Congress’s approval. While welcoming the authorities’ intention to increase the primary surplus relative to 2005, the mission urged them to aim for additional savings in order to reduce the non-oil deficit. In particular, the mission emphasized the need to reduce fuel subsidies and to carefully prioritize projects in the capital budget.

Ecuador: Operations of the NFPS

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14. The authorities are aware that their recent success in obtaining external financing could create additional spending pressures. To minimize this risk, they intend to put the proceeds of the recent bond issue in a special-purpose escrow account, to be used for debt management operations only. The mission endorsed the authorities’ plan to use the proceeds from the bond issue and the FLAR loan to retire short-term debt and high interest Global 2012 bonds, which begin amortizing in 2006. These operations would generate cashflow savings, smooth out the debt amortization profile, and reduce rollover risk.

uA01fig02

Possible impact of debt management strategy on scheduled amortizations 1/

(in US million)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

1/ Assumes US$450 million in T-bills and US$600 million in Global bonds are retired.

Improving the fiscal policy framework

15. The mission recommended that the authorities begin work on a new draft fiscal responsibility law for the next government. Despite the frequent non-compliance with the spirit of the original fiscal rules, the mission argued that a strong FRL could serve as an important institutional tool in support of a strong policy commitment to fiscal discipline and sustainability. An enhanced FRL should incorporate greater transparency in the fiscal rules (including in the definitions of target variables such as capital spending or the non-oil balance) and stronger accountability of the Minister of Finance. A new law should also target a debt-to-GDP ratio substantially lower than 40 percent in order to lessen vulnerabilities to oil prices and financing difficulties, and develop a fiscal rule for the non-oil balance that not only reduced dependence on finite oil wealth but is also consistent with utilizing that wealth in an intertemporally efficient and equitable manner. Staff estimations suggest that a central government non-oil primary deficit in the range of 1½–3 percent of GDP (consistent with the staff’s active scenario) would be consistent with keeping the oil wealth constant in real terms and reducing the debt-to-GDP ratio to safe levels.4 The authorities indicated that they are preparing proposals to remove inconsistencies among various rules (apart from the FRL) that affected the budget and agreed to include a review of the FRL in their technical work agenda.

Policies to improve fiscal management

16. A growing dependence on oil revenues in recent years has made the budget increasingly vulnerable to a fall in international oil prices. The mission highlighted the importance of boosting tax revenue through reforms that would simplify and broaden the base of the tax system, and also enhance economic efficiency. In this context, the mission regretted the passage of the recent tax incentives legislation but welcomed the authorities’ plans to push ahead with various reforms in 2006, including some that remained incomplete from the 2003–04 Stand-By Arrangement with the Fund such as (i) strengthening the rules related to transfer pricing; (ii) introducing a simplified turnover tax for small businesses; and (iii) eliminating low-yield, administratively cumbersome, taxes. The authorities indicated that the tax incentives law seeks to increase investment in key, specific sectors, and that their overall tax reform strategy was geared toward broadening the base and simplifying the system.

17. The high degree of budget rigidity in Ecuador has contributed to liquidity problems, made fiscal policy procyclical, and reduced expenditure quality. To reduce budget rigidities, it would be crucial to control the growth of the wage bill, including through a renewed effort at civil service reform.5 A new reform would need to have a more comprehensive coverage of civil servants and outline specific policies to control the growth of the wage bill, including through rationalizing public sector employment. It would also be essential to substantially reduce revenue earmarking, the large subsidies for fuel and electricity, and government contributions to pensions, all of which are highly distortionary and very poorly targeted.

uA01fig03

Budget Rigidity in Selected Latin American Countries 1/

(In percent of primary revenue)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Source: Fund staff estimates1/ Mandatory spending plus discretionary spending with earmarked revenues.2/ Earmarked revenues3/ Mandatory spending
uA01fig04

Gasoline and cooking gas subsidies: implicit transfers

(in US dollars per capita)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Source: World Bank and Fund staff estimates..

18. The authorities agreed on the need to tackle these problems but want to proceed cautiously given their political sensitivity. - The officials acknowledged the need for a gradual reduction of fuel subsidies (which amount to 5¼ percent of GDP) to reduce budgetary pressures and create space for better-targeted social spending and infrastructure investment. Also, the authorities have announced an increase in electricity tariffs beginning in April 2006, the first such increase since 2003. The mission emphasized that even though the current government’s ability to advance politically sensitive reforms is likely to be limited, it was important to begin the groundwork, both in terms of technical work and consensus building, for broader reforms by the government that will take office in 2007.

19. Following the changes made by Congress to the pension system in 2005, and a ruling earlier in the year that portions of the 2001 social security reform were unconstitutional, the authorities have begun preparations for a comprehensive pension reform. They agreed that any pension reform should substantially reduce the pension system’s actuarial deficit and lower the government’s pension contribution, which, at a required 40 percent of the total pension bill, imposes a heavy burden on the budget and benefits mostly middle and upper classes. The mission welcomed the fact that the authorities were in discussions with the Social Security Institute to resolve the government’s outstanding debt to that agency. The authorities have requested Fund technical assistance to design the pension reform.

B. Long-Run Growth and Competitiveness Issues

20. Structural reforms that sustain competitiveness and improve the investment climate are needed to increase long-run economic growth and employment. The authorities agreed with the mission that policies need to be targeted at enhancing the petroleum sector, diversifying the export base, reducing vulnerabilities in the fiscal area and the financial system, increasing the efficiency of public enterprises, trade liberalization, and containing domestic wage and price pressures.

Enhancing the oil sector

21. A coherent policy for the development of the oil sector, including a reform of PetroEcuador, is needed to fulfill the sector’s potential as catalyst for stronger overall long-term growth (Box 3). Management problems and declining crude production by PetroEcuador, inadequate refining capacity, frozen domestic prices, and rising imports of oil products have prevented Ecuador from fully benefiting from the current high international oil prices. Sizable investment is needed to reverse the output decline of PetroEcuador’s fields and improve refining capacity. The authorities indicated that they were planning a comprehensive administrative reform of PetroEcuador (with possible technical assistance from the World Bank), including an external audit as a key first step. The mission encouraged the authorities to define a concrete timetable for the implementation of this reform. The authorities agreed that additional private investment was needed in both extraction and refining and hoped to soon auction new fields for exploration and exploitation in coming months. To attract private investment, the mission highlighted the need to eliminate legal uncertainties and depoliticize the setting of oil derivative prices.

Policy Reforms for More Efficient Oil Resource Management

Issues

  • Total production has increased slowly (except for the large increase in 2004) as rising private output has offset a 40 percent decline at PetroEcuador since 1994, which reflects underinvestment, and administrative and governance problems.

  • Private crude oil production uses only 70 percent of the capacity of the new pipeline but is unlikely to increase significantly because of relatively low investment (compared to what is needed to substantially boost output), reflecting (i) uncertainty about the legal framework, especially given outstanding disputes with government on VAT reimbursement, a charge of contract violation against the largest producer, and the government’s recent announcement that it wants to renegotiate all contracts; and (ii) lack of new exploration licenses since 1998.

  • Total refining capacity has not increased since the late 1980s because of the problems at PetroEcuador and the reluctance of the private sector to invest given the politicized price-setting framework for oil derivatives.

  • Domestic oil derivative prices have been frozen since early 2003. With unchanged refining capacity and increased consumption, in part due to cross-border smuggling to Peru and Colombia (where the retail price is more than four times higher), import volumes of oil derivatives have almost doubled in the last 4 years. The total value of the subsidy1 reached 5¼ percent of GDP this year, severely reducing Ecuador’s net oil windfall gain.

uA01fig05

Ecuador: Crude Oil Production 1/

In million barrels per year

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

1/ 2005 is Fund staff projection.
uA01fig06

Public sector windfall

Changes in the ratio to GDP compared to 2003

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

uA01fig07

Ecuador: Oil Derivatives 1/

In millions of barrels

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: PetroEcuador and staff projections.1/ Staff projection for 2005.

Policy Recommendations

  • Develop a coherent oil sector policy, specifying the role of PetroEcuador, a strategy for restoring production in PetroEcuador’s light crude oil fields,2 and a plan to auction new exploration and production licenses for undeveloped Amazon fields.

  • Implement a comprehensive reform of PetroEcuador to improve administrative efficiency, governance, and transparency. As a first step, undertake a financial audit of the company. Liberalize the domestic fuel market, involving mainly the deregulation of prices, and the curtailment of PetroEcuador’s monopoly in wholesale distribution and storage. This would improve the climate for private sector investment in downstream activities (refining and retail sales).

  • In the planned renegotiation of contracts with oil companies, it will be important to establish clear and transparent rules for private sector participation in the sector, avoiding ad hoc decisions that may lead to governance problems.

1Calculated as the difference between import and domestic prices multiplied by the volume of domestic sales. 2The investment needed to restore output to mid-1994 levels is estimated at US$0.5–1 billion.

Competitiveness issues

22. So far, there is no clear evidence that the dollarization system has been associated with cost-competitiveness problems, but this should be no reason for complacency.6 While non-oil export volumes are estimated to have grown strongly in 2005, and the real exchange rate has declined recently, there are a number of risk factors that could undermine Ecuador’s competitiveness: (i) further strengthening of the U.S. dollar relative to Ecuador’s main trading partner currencies; (ii) the threat of rising inflationary pressures, especially if public spending continues to rise fast; and (iii) with low investment, real wages could rise faster than productivity. Furthermore, Ecuador ranks very low in cross-country competitiveness and business climate assessments,7 and its narrow export base, dominated by commodities with volatile international prices, continues to make the external accounts vulnerable to swings in international market conditions.

uA01fig08

Business Climate Indicators 1/

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

1/ Ranking out of 155 countries. World Bank. Doing Business database, 2005

23. The authorities agreed with the staff on the need for structural reforms to improve the competitiveness of Ecuadoran firms. They indicated that a free trade agreement (FTA) with the United States was key to their efforts in this area and that discussions were well-advanced.8 They expected the FTA to lock-in favorable access to Ecuador’s key export market already provided under a series of preferential arrangements that could otherwise expire, and also act as a catalyst for important institutional reforms (e.g., customs reform and investor rights protection), which would improve the investment climate. The mission agreed that an FTA could bring benefits, but also encouraged the authorities to continue trade liberalization efforts at the multilateral level. The mission emphasized the importance of reducing labor market rigidities, including by eliminating the 15 percent mandatory profit-sharing required from private firms, as crucial for improving economic efficiency and the investment climate, as well, as promoting employment growth.

Electricity and telecommunications

24. Inefficiencies in public enterprises in electricity and telecommunications are a drain on fiscal resources and an obstacle to growth. In the electricity sector, tariff setting is highly politicized and distribution companies are poorly managed and generate losses, putting pressure on the budget and leading to a large accumulation of intra-sector debts. These problems have deterred private investment in electricity generation, resulting in the highest generation costs in South America, which hurts competitiveness. The authorities said that they are taking measures to address these problems, including by putting the telecommunications and electricity distribution companies under private sector management, and raising electricity tariffs to substantially reduce the electricity-consumption subsidy from April 2006. The mission welcomed these initiatives while emphasizing that depoliticizing tariff-setting decisions was key to attract private management and investment into the sector. The authorities also indicated that they were continuing to work with Congress to resolve their differences on the electricity reform bill. While supporting this reform, the mission urged caution in the design and scope of payment guarantees to private generators to minimize the risk of the government accumulating sizable liabilities.

Reducing vulnerabilities and improving efficiency in the financial system

25. The 2004 FSAP noted that the financial system had become more resilient since the 1998–99 financial crisis but stressed the need to reduce remaining vulnerabilities. The FSAP focused on the need to improve supervision and regulation; increase minimum capital requirements; establish a well-financed liquidity fund (to provide lender-of-last-resort protection) and a limited-coverage deposit insurance system; strengthen creditor rights; and improve bankruptcy procedures to facilitate and speed up the recovery of assets by banks. These reforms are crucial to further improve confidence in the system to help reduce interest rates and increase financial intermediation, which is low by international standards.

uA01fig09

Bank credit to the private sector, 2004

In percent of GDP

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Source: country authorities and staff estimates.

26. The authorities have developed a detailed work plan to address some of the FSAP recommendations. Apart from the reforms implemented over the past year mentioned in paragraph 6, the work plan includes plans to (i) submit to Congress a bankruptcy and creditors’ rights bill in the first quarter of 2006; (ii) finalize draft legislation to strengthen the payments system; (iii) continue to implement regulations tightening the definition of liquidity and capital; and (iv) develop better risk management practices. Officials explained that their lack of progress thus far on the FSAP recommendations to set up an adequately-financed liquidity fund, strengthen the deposit guarantee system, resolve the issue of frozen deposits, or liquidate the remaining closed banks was mainly the result of legal obstacles and a difficult political environment.

27. The mission strongly cautioned against the banking system bill currently in Congress. The mission emphasized that instead of administrative regulations to determine interest rates and credit allocation as envisaged in the bill, a durable reduction in interest rates and expansion of banking sector intermediation would depend on the maintenance of macroeconomic stability, the reduction of economic vulnerabilities, and progress on the reform priorities recommended in the FSAP. The authorities also expressed concern about the bill, and indicated that they were working to correct its shortcomings.

IV. Staff Appraisal

28. Aided by high international oil prices, Ecuador’s macroeconomic performance in 2005 was generally positive, exhibiting resilience in the face of a difficult political environment. The strong growth in the oil sector that followed the completion of the new pipeline in 2003 has tapered off, but high oil prices have helped bolster sentiment and underpin growth in the non-oil sector. At the same time, confidence in the financial system continued to improve, with strong expansion in both deposits and credit and further declines in interest rates, and public debt has continued to fall. These factors helped Ecuador regain international market access with the successful placement of a US$650 million bond in December 2005, the first voluntary international issue since 1997.

29. Although the short-run outlook remains positive, significant concerns remain about Ecuador’s policy framework and medium-term outlook. The non-oil deficit has risen, reflecting difficulties in controlling spending and the rising cost of fuel subsidies. Moreover, recent structural reforms—most notably the changes to the fiscal responsibility law, the pension system, and the tax incentives law—have weakened the economic policy framework. The recent increase in inflation is worrisome.

30. Given current favorable external conditions, policymakers should be doing more to address serious underlying vulnerabilities, especially in the fiscal area and the financial system, and to advance on pro-growth structural reforms. Reforms that reduce vulnerabilities, sustain competitiveness, and improve the investment climate would also allow the economy to fully reap the benefits from dollarization, especially low interest rates and a stable investment and trade environment.

31. The staff supports the authorities’ goal to strengthen the fiscal policy stance in 2006 to address recent inflationary pressures and to put the public finances on a more sustainable track. In particular, it would be important to sustain the restraint on recurrent spending envisaged in the draft budget, and moderate the planned growth in capital expenditures. The authorities would need to firmly resist pressures for more spending, including finding offsets to Congress’s changes to the draft budget, which are likely to intensify in the lead up to the October 2006 elections. In this context, it will be key for the authorities to adhere to their commendable plans to use proceeds from the recent bond issue strictly for debt management purposes.

32. To enhance fiscal sustainability over the medium term, it will be important to strengthen the institutional framework for promoting fiscal discipline, reduce dependence on oil revenue, increase budget flexibility, and improve the quality of government spending. The authorities should consider redesigning the FRL to target a debt-to-GDP ratio substantially lower than 40 percent; increase transparency in the fiscal rules; improve accountability; and strengthen compatibility of the fiscal rules with the efficient use of the country’s oil wealth. The staff welcomes the authorities’ plans in the area of tax reform to eliminate exemptions, broaden the tax base, and simplify the tax system. To reduce budget rigidity and improve spending quality, significant reductions in revenue earmarking and in poorly-targeted subsidies are crucial. In this context, the authorities are urged to move quickly to reduce the cooking gas subsidy and prepare for a substantial reduction of all other fuel subsidies while strengthening the social-safety net to protect vulnerable groups. It will also be important to develop a coherent civil service reform to control wage costs, and to move ahead with plans to reform the pension system. As resources are freed up for capital and social spending, it will be necessary to improve procedures for evaluating, prioritizing, and monitoring projects so as to ensure high standards of efficiency.

33. A coherent policy for the development of the oil sector, including a comprehensive reform of PetroEcuador, is long overdue, and will be key to ensure that the oil sector fulfills its potential as a catalyst for stronger overall long-term growth. A first step will be to define a timetable for the administrative reforms at PetroEcuador, including the external financial audit of the company, and the auctioning of oil fields to private investors. The authorities also need to develop and implement an investment plan to reverse the decline in PetroEcuador’s crude production and strengthen refining capacity. To attract greater private investment to the sector, it will be important to eliminate legal uncertainties and strengthen the regulatory framework. In the case of refining, plans to attract private investment would also require liberalization of the domestic oil derivatives market, including depoliticizing price setting, and phasing out PetroEcuador’s monopoly in the wholesale market.

34. The authorities are urged to follow through on the 2004 FSAP recommendations to address banking system vulnerabilities while improving the efficiency of the system and achieving a durable reduction in interest rates. Ongoing efforts to improve supervision and regulation are to be commended, and the staff also welcomes plans to strengthen the payments system and bankruptcy procedures for the quick recovery of assets by banks. However, reforms to create an effective deposit insurance system and to enable the central bank to provide an adequate lender-of-last-resort facility are vital to enhance the stability of the financial system. At the same time, the government should strongly oppose the banking reform bill to introduce administrative controls on interest-rate spreads and credit allocation currently being debated in Congress, including through presidential veto, if necessary.

35. Competitiveness remains a concern in the context of the dollarized economy. While there is no clear evidence that dollarization has been associated with cost-competitiveness problems to date, it is crucial that macroeconomic policy focuses on reducing recent inflationary pressures. Ecuador’s narrow commodity-heavy export base, and low rankings in international competitiveness assessments highlight the need for reforms to raise economic efficiency and improve the investment climate. In this context, the staff endorsed plans to contract private management for public enterprises in electricity distribution and telecommunications, reduce electricity subsidies, and settle electricity intra-sector debts. While these measures will also help attract private investment in lower-cost electricity generation, it will be crucial to depoliticize the setting of electricity tariffs, allowing them to reflect costs. The staff viewed positively the authorities’ efforts to finalize an FTA with the United States, which apart from improving market access could catalyze reforms in governance and legal security, where Ecuador scores very low in business-climate surveys. The staff also stressed the importance of increasing labor market flexibility and improving customs to further raise economic efficiency and improve the investment climate.

36. The lagging reform agenda has become ever more urgent as time has gone by without its implementation. Many of these reforms imply confronting powerful vested interests and changing long-established relations between the government and the private sector, and between the private sector and the rest of the world. These obstacles have been compounded by the lack of a strong political base or congressional representation by successive governments. It will therefore be crucial for the authorities to devise an effective strategy to build the necessary consensus in favor of this reform agenda, and in this context, they should endeavor to place these issues at the forefront of next year’s election campaign discussions.

37. Data provision for surveillance purposes is adequate overall but the statistical base remains uneven. In particular, there are shortcomings in certain areas of the balance of payments statistics, the fiscal accounts, and labor market data. The authorities have requested technical assistance from STA in the area of balance of payments and have expressed interest in having an update of the ROSC in FY2007. Ecuador has subscribed to the SDDS.

38. Ecuador maintains an exchange restriction in the form of blocked deposits in closed banks. Since there exists no formal timetable to resolve the problem, staff does not recommend Board approval of this restriction.

39. It is expected that the next Article IV consultation with Ecuador will be held on the standard 12-month cycle.

APPENDIX I

Table 1.

Ecuador: Public Sector Debt Sustainability Framework, 2000-10

(In percent of GDP, unless otherwise indicated)

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Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(l+g) - g + αε(l+r)]/(l+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; α = real GDP growth rate; ε = share of foreign-currency denominated debt; and ? = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(l+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 1.
Figure 1.

Ecuador: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Central Bank of Ecuador, Ministry of Finance, and Fund staff estimates and projections.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ A permanent decline of the oil prices (WTI) to US$40 and 10 percent of GDP shock to contingent liabilities occur in 2006. The standard scenario assuming 30 percent real depreciation is excluded because Ecuador uses dollar as its legal tender.

APPENDIX II

Table 2.

Ecuador: External Debt Sustainability Framework, 2000–10

(In percent of GDP, unless otherwise indicated)

article image

Derived as [r - g - ρ(l+g) + εα(l+r)]/(l+g+p+gp) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in U.S. dollar terms, g = real GD ε= nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(l+g) + εα(l+r)]/(l+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε> 0) and rising inflat (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Assuming no effect from fall in oil prices on GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their level: of the last projection y ear.

Figure 2.
Figure 2.

Ecuador: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2006, 098; 10.5089/9781451811827.002.A001

Sources: Central Bank of Ecuador, Ministry of Finance, and Fund staff estimates and projections.1/ Shaded areas represent actual data. Individual shocks are permanent 1/2 standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ A permanent decline of the oil prices (WTI) to US$40. The standard scenario assuming 30 percent real depreciation is excluded because Ecuador uses dollar as its legal tender.

APPENDIX III Ecuador: Fund Relations

(As of November 30, 2005)

I. Membership Status:

Joined: 12/28/45 Status: Article VIII

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans

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V. Safeguards Assessments:

An on-site safeguard assessment was conducted in March 2003 and the safeguards assessment report was approved by management on June 23, 2003. The assessment identified a need to strengthen the audit oversight and reporting frameworks at the BCE. In this regard, the BCE committed to the implementation of the safeguards recommendations, including the timely publication of its annual audited financial statements, which are yet to be published.

VI. Latest Financial Arrangements:

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VII. Projected Obligations to the Fund (Expectations Basis):

(SDR million; based on existing use of resources and present holdings of SDRs):

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VIII. Projected Obligations to the Fund (Obligation Basis):

(SDR million; based on existing use of resources and present holdings of SDRs):

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IX. Exchange Rate Arrangement:

On February 12, 1999 the central bank abandoned the exchange rate band and floated the sucre. On March 9, 2000 the economy was dollarized at 25,000 sucres per U.S. dollar.

Ecuador has accepted the obligations of Article VIII, Sections 2, 3, and 4. However, Ecuador maintains an exchange restriction subject to Fund approval under Article VIII, Section 2(a) in the form of a freeze on demand and savings deposits in closed banks. This exchange restriction was approved by the Executive Board on March 21, 2003 until December 31, 2003.

X. Last Article IV Consultation and Recent Contacts:

On July 26, 2004, the Executive Board concluded the 2004 Article IV Consultation. The authorities requested to continue with an intensified surveillance of their policies, and in this context missions visited Quito in December 2004, and May and August 2005.

XI. Technical Assistance:

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XI. Resident Representative:

Mr. Jorge Guzman, stationed in Quito since September 2005, replaced Mr. David Yuravlivker.

APPENDIX IV Ecuador: Relations with the World Bank

(In millions of U.S. dollars)

article image
Source: World Bank.

Net of cancellations.

The Bank engagement in Ecuador remains in the Base Case scenario (US$250 million per year: US$100 million for adjustment and $150 million for investment). In the last two FYs, the Bank has approved three projects, all of which are not yet signed: PRODEPINE II (US$36 million in FY04—and is now cancelled); Institutional Reform (US$30 million in FY04—being redesigned by increasing component by approximately $30 million); and the Fiscal Consolidation Programmatic (US$100 million in FY05—currently on hold due to policy reversals on the program supported by the loan). There are three investment operations and one adjustment operation planned for FY06: Rural Roads (US$20 million—has been in the pipeline for the last three FYs), Education (US$35 million), Bono de Desarrollo Humano (currently being defined), and Human Development Programmatic (US$100 million—slipped from last year).

APPENDIX V Ecuador: Relations with the Inter-American Development Bank

(As of September 30, 2005)

I. IDB Operations

(In million of U.S. dollars)

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Source: Inter-American Development Bank.

The total amount approved is US$4,771.0 million. The difference represents cancellations. The outstanding debt to the Bank is US$1,879.0 million.

II. IDB Loan Transactions

(In million of U.S. dollars)

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Source: Inter-American Development Bank.

The Bank’s pipeline for 2005–06 provides for a lending program of eleven operations totaling U$320 million, and a non-reimbursable technical cooperation program of approximately US$8 million. The IDB supports the Government of Ecuador’s efforts to increase productivity, to improve social programs for the most vulnerable groups and to enhance the quality of public sector administration. The Bank is completing the preparation of a fast-disbursing programmatic loan for US$100 million to improve competitiveness as well as investment loans in areas such as tourism, potable water, the environment, rehabilitation of urban infrastructure, and natural-disaster prevention.

APPENDIX VI Ecuador: Statistical Issues

In spite of shortcomings, macroeconomic data are adequate for surveillance purposes. Ecuador subscribed to the Special Data Dissemination Standard (SDDS) in March 1998, and meets the specifications for coverage, periodicity, and timeliness of the data categories. An advance release calendar and the metadata for Ecuador are posted on the Fund’s Dissemination Standards Bulletin Board. A data ROSC module was completed in March 2003.

Real sector

Two series of national accounts (NA) are being compiled using 1975 and 1993 as base years and following the methodology of the 1968 SNA and 1993 SNA, respectively. Following a data ROSC mission in April 2002, the authorities published, at the end of that year, GDP series for the period 1993–2001 in current and constant 2000 dollars. The authorities have been planning to extend this series to 1965, but this has not been completed. Preliminary quarterly NA is being reported with about a three-month lag. The authorities think that deficiencies remain in the NA, and have asked for technical assistance. Publication of a monthly producer price index (PPI) started in 1998. Labor market data have become more available—monthly surveys are done by a private university while the national statistics bureau does a more comprehensive annual survey. Published survey results include employment, unemployment, participation rates, and some private sector wage data. Reliable data on public sector employment are still unavailable.

Government finance

The compilation and reporting of central government data deteriorated following problems with the introduction of a new information system (SIGEF). Above-the-line data for some nonfinancial public sector entities continue to suffer from long reporting lags and unreliable information. When ownership of public companies was transferred to the Solidarity Fund in 1999, financial information on these companies was no longer recorded. In addition, data on the operations of local governments are only available on an annual basis.

The resumption of reporting annual data on the budgetary central government for publication in the GFS Yearbook is highly recommended. The most recently reported annual GFS data were for 1994.

Monetary accounts

A major effort was undertaken in 2000 by the central bank, with Fund support, to adapt the presentation of its balance sheet to the requirements of official dollarization. Remaining issues were resolved during a monetary and financial statistics mission in March 2004. The 2004 mission concluded that with the introduction of a sectorization matrix (supplementary information to the one obtained through commercial banks’ balance sheets), the quality of the sectorization of financial instruments and the distinction between residents and nonresident accounts is adequate. Furthermore, public sector deposits are properly identified in the sectoral balance sheet of depository corporations, as compiled by the mission in collaboration with the authorities. Finally, data on offshore banks are currently being compiled following the same high quality standards as the onshore banks, but have yet to become available.

External sector

Balance of payment and international investment position (IIP) statistics are compiled and disseminated by the CBE. Ecuador, a SDDS subscriber since March 1998, also reports according to the Data Template on International Reserves and Foreign Currency Liquidity, and began disseminating quarterly data on the SDDS prescribed external debt data category (with a one-quarter lag) in June 2003. In August 2001, a STA mission assisted the authorities in resolving a number of technical issues regarding the international reserves template.

Currently, Ecuador reports to STA quarterly balance of payments statistics as well as annual IIP data for publication in IFS and the Balance of Payments Statistics Yearbook. In October 2002, the authorities reported quarterly balance of payments statistics for the period 1993–2001 as well as annual IIP data for the period 1993–2001. The data are mainly compiled according to the methodology of the fifth edition of the Balance of Payments Manual (BPM5).

The IIP data were prepared with the assistance of a STA mission that visited Quito in July 2002. The mission recommended improvement in the estimates of travel services, introducing surveys of direct investment and portfolio investment, improvement in the recording of external debt transactions, and recording of reserve assets. The mission also made recommendations for further improvements in the compilation of the IIP. While the recording of balance of payments transactions has improved, some deficiencies remain, particularly in the estimation of profit remittances, non-oil direct investment, and private capital flows. The authorities have requested technical assistance to address these issues. STA, with the support of WHD, is considering sending a TA mission on balance of payments statistics in early FY 2007.

APPENDIX VII

Table of Common Indicators Required for Surveillance

(as of December 20, 2005)

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Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.

Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Daily (D); weekly (W); monthly (M); quarterly (Q); annually (A); irregular (I); and not available (NA).

Reflects the assessment provided in the data ROSC or the Substantive Update (published on March 14, 2003, and based on the findings of the mission that took place during April 1l-25, 2002) for the dataset corresponding to the variable in each row. The assessment indicates whether international standards concerning concepts and definitions, scope, classification/sectorization, and basis for recording are fully observed (O); largely observed (LO); largely not observed (LNO); not observed (NO); and not available (NA).

Same as footnote 7, except referring to international standards concerning source data, statistical techniques, assessment and validation of source data, assessment, and revision studies
1

This supplementary fund, with assets of US$780 million (2¼ percent of GDP), was set up to finance severance and pension benefits for employees. This reduction in pension system assets is not matched by a corresponding reduction in pension system obligations to future retirees.

2

The law would provide a 10–12 year tax holiday (on income taxes, custom duties, and municipal taxes) for new companies undertaking a minimum investment of US$2–7 million in strategic sectors, including hydroelectricity generation, oil refining, and production of high technology instruments.

3

By reclassifying oil revenues from capital revenues to current revenues, Congress made oil revenues subject to a 15 percent sharing rule with subnational governments.

4

This calculation is highly sensitive to assumptions about key parameters, e.g., the long run price of oil, and about the rate of return on public investment in human and fixed capital. See the Selected Issues chapter on fiscal sustainability.

5

The 2004 civil service reform sought to bring coherence to wage setting and employment practices. However, it applies only to 25 percent of public servants, while excluding teachers, health workers, and the military.

6

See the Selected Issues chapter on competitiveness.

7

For example, the country was ranked 103rd out of 117 countries in the 2005 growth competitiveness index of the World Economic Forum, reflecting, in particular, the poor ratings in the public institutions and technology subindices.

8

Negotiations between the United States and Ecuador are expected to be concluded in February 2006.

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Cover IMF Staff Country Reports
Ecuador: 2005 Article IV Consultation—Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Ecuador
Author:
International Monetary Fund
Volume/Issue:
Volume 2006: Issue 098
Publisher:
International Monetary Fund
ISBN:
9781451811827
ISSN:
1934-7685
Pages:
64
DOI:
https://doi.org/10.5089/9781451811827.002
Figure 1.

Ecuador: Real Sector
Figure 2.

Ecuador: Prices
Figure 3.

Ecuador: External Sector Indicators
Figure 4.

Ecuador: Monetary Sector Indicators 1/
Figure 5.

Ecuador: Fiscal Indicators 1/

Current Spending and Non-oil Balance, 2004-05

Cumulative changes since 2003 in percent of oil windfall

Primary Expenditures Real Growth

(Percent change)

Fiscal Rule on Non-oil Balance

(In percent of GDP)

Fiscal Rule on Public Debt

(In percent of GDP)
Figure 6.

Ecuador: Medium-Term Scenario, 2003–10

Possible impact of debt management strategy on scheduled amortizations 1/

(in US million)

Budget Rigidity in Selected Latin American Countries 1/

(In percent of primary revenue)

Gasoline and cooking gas subsidies: implicit transfers

(in US dollars per capita)

Ecuador: Crude Oil Production 1/

In million barrels per year

Public sector windfall

Changes in the ratio to GDP compared to 2003

Ecuador: Oil Derivatives 1/

In millions of barrels

Business Climate Indicators 1/

Bank credit to the private sector, 2004

In percent of GDP
Figure 1.

Ecuador: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)
Figure 2.

Ecuador: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)