Ecuador: Staff Report for the 2019 Article IV Consultation and Request for an Extended Arrangement under the Extended Fund Facility—Press Release; Staff Report; and Statement by the Executive Director for Ecuador
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
20 Mar 2019
eISBN:
9781498303583
Language:
English
Keywords:
ISCR; CR; authority; building crisis-preparedness capability; oil price decline; deficit; U.S. dollar; outstanding balance; debt service; emergency liquidity support; governance arrangement; Fiscal stance
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Staff Report for the 2019 Article IV Consultation and Request for an Extended Arrangement Under the Extended Fund Facility-Press Release; Staff Report; and Statement by the Executive Director for Ecuador

Abstract

Staff Report for the 2019 Article IV Consultation and Request for an Extended Arrangement Under the Extended Fund Facility-Press Release; Staff Report; and Statement by the Executive Director for Ecuador

Backdrop

1. The fall in oil prices and rise in the U.S. dollar in 2014–15 caused an abrupt downturn in Ecuador’s fully dollarized economy in 2015–16. After five consecutive quarters of contraction measured on a year-on-year basis, in the midst of which there was a major earthquake, the economy returned to growth at the end of 2016, with a rebound of 2.4 percent in 2017.

2. The IMF provided balance of payments support following the April 2016 earthquake. On July 8, 2016 the Executive Board approved a disbursement of SDR 261.63 million (about US$364 million) under the Rapid Financing Instrument. This disbursement helped the country meet an urgent balance-of-payments need due to the 7.8-magnitude earthquake that caused significant damages to infrastructure, housing, and agriculture, and killed 671 people. Reconstruction of the affected areas is still ongoing (Box 1).

3. The current administration took office in May 2017. Over the past 21 months, President Moreno has fashioned a pragmatic path, showing openness to engage with the private sector and the opposition. The Moreno administration has also been active in building stronger relationships with IFIs in support of their policy efforts. In particular, Fund staff have been working closely with the authorities on a range of technical assistance areas (e.g. in statistics, the fiscal responsibility framework, debt management, and financial policies). In February 2018, President Moreno obtained approval in an important national referendum for a range of institutional changes including restoring term limits for the presidency, strengthening the fight against corruption, reinstating the independence of the judiciary and control bodies, broadening environmental protections for certain areas, and eliminating the controversial real estate capital gains tax.

4. Over the past year, growth has decelerated. Year-on-year growth in 2018Q3 was 1.4 percent and growth is estimated to have been 1.1 percent for the year as a whole. An expansion in domestic demand has been met through a rise in imports, particularly following the removal of tariff safeguards. Despite the economic deceleration in 2018, private investment has been relatively strong. The unemployment rate fell to 3.7 percent in December although the share of the so-called “inadequate employment” (official definition includes, among others, those who are earning below the minimum wage) has increased. Cumulative inflation was negative for much of 2018 reflecting slow growth, the overvaluation of the real exchange rate, and broader imbalances in the economy.

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Ecuador: Contributions to Growth, 2015–2018

(In percent, q-o-q, annualized)

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Haver, BCE, and IMF staff calculations.
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Ecuador: Labor Market

(In percent of labor force)

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Haver, INEC, and IMF staff calculations. Note: Inadequate employment refers to workers earning less than the minimum wage, or working less than full time while willing and able to work more hours.

5. Over the past year, the government has made progress in implementing reforms in a range of areas including:

  • Reaching consensus in the National Assembly to pass the “Productive Development Law”1 in August 2018 which contained:

    • A prohibition for (i) the BCE to purchase new public securities and bonds and (ii) for public financial institutions to hold domestic investment funds from the BCE as an indirect means to invest in securities issued by other public-sector entities;

    • A new fiscal framework that combines a formal debt anchor with a rule capping the growth of public spending (at Ecuador’s long-term growth rate), supported by escape clauses and automatic correction mechanisms;

    • An oil stabilization fund that would eventually serve to smooth spending over the commodity cycle.

  • Lowering the non-oil primary deficit (including fuel subsidies) from 7.6 percent of GDP in 2016 to 5.3 percent of GDP deficit in 2018. The deficit reduction that took place in 2018 was largely a product of a reduction in capital spending (of 2.3 percent of GDP). The fiscal position also benefited from the temporary effects of a tax amnesty during the course of the year (adding 1 percent of GDP to nonoil revenues).

  • Beginning the process of reducing fuel subsidies by eliminating the subsidy on high octane gasoline (super gasoline) and reducing subsidies on regular gasoline and for the industrial use of diesel.

  • Bringing transparency to the compilation of public debt statistics including by publishing a report by the auditor general that revealed the public debt was significantly higher than previously stated. The government has been working with Fund technical assistance to bring the reporting of public debt into line with international best practice. This work allowed reconciling above- and below-the-line fiscal data as well as stocks and flows in the fiscal accounts for 2018 with minimal discrepancy, which provides reassurances on the quality of public debt statistics.2

  • Completely removing import surcharges that were imposed in 2015 to address the country’s deteriorating balance of payments situation following the decline in world oil prices.

  • Strengthening the governance of public operations including by undertaking corruption investigations into bribes allegedly paid to government officials by a foreign construction company.

6. Throughout the tenure of the current administration Ecuador has maintained its access to external financing. In January 2018, Ecuador issued US$3 billion in 10-year bonds on international markets at a yield of 7.875 percent. Subsequently, as global financial conditions tightened and spreads on emerging market debt rose, Ecuador chose to issue collateral-like debt and undertake repurchase operations with international banks. In January of this year, the government placed US$1 billion in 10-year bonds at a yield of 10.75 percent.

Earthquake Reconstruction

On April 2016 Ecuador was hit by a 7.8 magnitude earthquake mainly affecting the coastal provinces of Manabí and Esmeraldas. The earthquake killed 671 people and affected some 68,000 households. The authorities’ joint assessment with the UN’s Economic Commission for Latin America and the Caribbean estimated reconstruction costs of US$3.3 billion. More than 32,000 houses need to be rebuilt or repaired. Public infrastructure suffered considerable damage: 875 schools were affected (of which 325 suffered medium to severe damage), 48 health facilities (e.g., clinics and hospitals), 83 km of roads, more than 7,000 km of power lines, and damage to telecommunications and water facilities.

The emergency and initial response of the government involved dispatching more than 1,500 emergency personnel to the affected areas. Within the first two weeks of the disaster the government restored water and electricity access to most of the affected areas, set up 30 shelters, and provided medical care to over 31,000 people. The government gave cash transfers for food, and for families to find shelter (supporting about 43,000 households).

Earthquake Financing Sources

(In millions)

article image
Source: Reconstruction Technical Secretariat.

Temporary taxes introduced to finance the reconstruction.

The IMF’s RFI loan was for balance of payments support due to the earthquake, but was not necessarily used directly in the emergency or reconstruction effort.

The government raised revenues to finance the emergency response and reconstruction. The “Solidarity Law” included a temporary increase in the VAT rate of 2 percent (raising about 1.6 percent of GDP). The government also received grants, and loans to finance the post-earthquake efforts. Almost ¾ of the funds went towards reconstruction of housing, roads, health and education facilities with the remainder used to help businesses recover and provide employment opportunities. The reconstruction work and the restart of economic activity has created more than 50,000 direct jobs, and about 126,000 indirect employment opportunities.

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Earthquake Spending

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Source: Re construction Technical Secretariat.

Diagnosis

7. At the core of Ecuador’s imbalances has been the pursuit of an unsustainable fiscal path. The 2014 oil price decline exposed the underlying structural imbalances of Ecuador’s economy, including the very high non-oil primary fiscal deficit and rising public debt. The overall fiscal deficit peaked at 8.2 percent of GDP in 2016 (the non-oil primary balance including fuel subsidies was 7.6 percent of GDP in the same year). This deficit was financed largely by short-term domestic debt, a draw-down of central bank reserves, and the placement of debt in international markets at a high cost. By 2017, a rebound in oil prices, cuts to capital spending, a public sector hiring freeze, and the introduction of temporary tax measures after the April 2016 earthquake led to a reduction in the fiscal deficit to a still-high 4.5 percent of GDP. In 2018, cuts to capital spending and a better oil balance (mostly from higher oil prices earlier in the year) lowered the deficit to 0.9 percent of GDP. However, investor confidence has been eroded by lower oil prices and uncertainties surrounding the accurate measurement of the level of the public debt.3

8. Expenditure on wages and salaries and on fuel subsidies is relatively high compared with regional peers. The large expenditure increases of the past decade on wages and salaries have proven difficult to reverse, while poorly-targeted fuel subsidies remain a significant component of government expenditure.

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Fiscal Imbalances

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

9. The foundations of the dollarized system have been undermined by a fiscal policy that is inconsistent with the constraints imposed by dollarization and, in parallel, by an erosion of domestic institutions. The decision to dollarize the economy continues to receive significant public support. However, under the previous administration, policies steadily undermined the viability of the dollarization framework, mainly through central bank financing of fiscal spending. This, in turn, has resulted in an increase in balance of payments vulnerabilities, a high public debt-to-GDP ratio, inadequate reserve coverage, and an overvalued real exchange rate.

10. Ecuador’s external position is now judged to be weaker than the level that is consistent with medium-term fundamentals and desirable policies. Wage growth has outpaced productivity growth over the past decade and, since 2014, the terms of trade have moved against Ecuador. The strong cyclical position of the U.S. economy and the appreciation of the U.S. dollar continue to add to Ecuador’s external imbalances. The current account has been adjusting to the 2014–15 oil price shock, largely through a compression of imports, but the 2018 cyclically-adjusted current account remains at 3.7 percent of GDP below the estimated current account norm. The REER is judged to be overvalued by around 31 percent (Annex IV).

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Ecuador: Real and Nominal Effective Exchange Rates

(Jan-10=100)

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: INS and IMF staff calculations.Note: The effective exchange rates exclude Venezuela.
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Ecuador: Real Labor Productivity and Real Minimum Wage

(2003=100)

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: INEC, BCE, ILO and IMF staff calculations.

11. These external imbalances imply a significant gross external financing need (US$7.3 billion over the next 12 months). About one half of the US$7.3 billion arises from upcoming budgetary amortization payments to international creditors.

12. Ecuador’s external imbalances are exacerbated by a very low level of international reserves, leaving the dollarized system highly vulnerable to a sudden shift in capital flows and terms-of-trade shocks. The stock of gross international reserves (GIR)4 at end-2018 was US$2.2 billion (representing 12 percent of the Fund’s ARA metric or about 1¼ months of imports). Ecuador’s gross reserve coverage is the lowest of any emerging market economy. Net international reserves5 are estimated to have ended 2018 at negative US$1.7 billion.6

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Reserve coverage and current account balance

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Source: VEE.

The Government’s Policy Objectives

13. To counter these vulnerabilities, restore growth, and improve social outcomes, the authorities have designed a comprehensive policy plan. This plan aims to put debt on a firmly downward path, build reserve buffers and restore international competitiveness, while also making substantive improvements to the social assistance system. The plan further envisages measures to restore central bank autonomy, tackle corruption, and increase transparency.

Rebuild and Strengthen the Institutional Foundation for Dollarization

14. The authorities have adopted a credible and ambitious medium-term fiscal plan that will put the debt-to-GDP ratio on a firmly downward path. The goal of the government’s plan is to increase the non-oil primary balance (including fuel subsidies) by 5 percent of GDP from 2019‒21, with a substantial share of this taking place in the first year of the program. The improvement in the non-oil primary balance will be achieved by reductions in public employment and lower government wages; a gradual elimination of untargeted fuel subsidies; an overhaul of the tax system; and efforts to better prioritize spending on both capital outlays and goods and services. The authorities also intend to improve the medium-term framework for fiscal policymaking, upgrading both the fiscal responsibility framework (to provide meaningful medium-term constraints on fiscal policies) and debt management processes.

15. There is a strong commitment to restore autonomy to the central bank. The authorities have taken legislative and other steps to put an end to new central bank financing of the government and the quasi-fiscal activities of the central bank. The authorities intend to go further in the coming months to strengthen the central bank’s autonomy and governance arrangements and to strengthen the central bank’s financial stability oversight function.

Generate Employment and Growth Through Competitiveness

16. Supply-side constraints are also being addressed to restore international competitiveness. The authorities believe that a comprehensive tax reform, reform of fiscal institutions, labor market reform, and steps to increase financial sector resilience and ease capital market regulations will all contribute to improving the investment environment. These policies will provide a strong foundation to improve productivity and foster private investment, support the middle class, and further strengthen the foundations for dollarization. These reforms, together with the measures to restore fiscal sustainability are expected to realign the current account and the real effective exchange rate with their medium term fundamentals.

Promote Equality of Opportunity and Protect the Poor and Vulnerable

17. The authorities intend to replace untargeted energy subsidies with up-front improvements to the existing social assistance system. The authorities’ plan will extend the coverage of, and increase the nominal level of benefits under, the existing conditional cash transfer program. Work is also underway to improve the targeting of social programs. The government will strengthen the non-contributory pension (an important safety net for the elderly) and expand existing programs to support the disabled. Finally, the government is examining options to increase the efficiency of education and health spending, particularly to improve outcomes for lower income households.

Ensure Full Transparency and Good Governance

18. A multi-pronged effort is underway to increase transparency and tackle corruption. Policy measures include improving fiscal transparency and procurement practices, including in the oil sector and for public infrastructure; adopting international standards for reporting of the public debt; preparing legislation to prevent and penalize corruption; publishing the financial accounts of the central bank and of public oil companies; and strengthening the framework for AML/CFT.

Outlook and Risks

19. The authorities’ plan to reduce the non-oil primary deficit by 5 percentage points of GDP over the next three years will put debt on a downward path starting in 2020, falling below 40 percent of GDP by 2023. The forecasts incorporate some near-term costs to growth from the planned fiscal consolidation, but supply-side reforms are expected to improve growth prospects over the medium term. There was agreement that growth in 2019 would likely be in the -0.5 to +0.5 percent range (although forecasts under the program are based on the weaker end of this range). The current account is expected to move from a deficit of 0.7 percent of GDP in 2018 to a surplus of around 0.4 percent of GDP this year. Inflation is likely to remain subdued throughout the next few years which, alongside nominal wage restraint and improving productivity, should steadily erode the overvaluation of the real effective exchange rate. Under the program baseline, it is assumed that the improvement in the fiscal position is sufficient to leave the sovereign completely financed. Gross reserves are expected to increase to about US$11.4 billion (63 percent of the ARA metric) by the end of the program.

20. There was broad agreement on the downside risks to this outlook (see Risk Assessment Matrix—Annex III).

  • External risks are predominantly associated with a significant further fall in oil prices that could necessitate an even larger and perhaps more accelerated economic adjustment than is currently being planned, weighing on incomes and job creation. Such a scenario is likely to be associated with a much less hospitable environment in global capital markets at a time when fiscal financing needs will increase (because of the effect of the lower oil price on the nonfinancial public sector oil balance).

  • A further upward move in the U.S. dollar would increase the overvaluation in the real exchange rate, worsen competitiveness and weigh on the external accounts. This would likely cause a more prolonged (and perhaps painful) period of disinflation, creating a headwind to growth, and putting downward pressure on the current account. As such, a stronger U.S. dollar would complicate the government’s efforts to reduce external vulnerabilities.

  • Domestic political and social opposition could create challenges for the implementation of the government’s policy plans (particularly changes to fuel subsidies, the public-sector wage bill, and the tax system). It will be important that these policy changes are carefully calibrated and well-communicated to garner societal consensus.

Ecuador: Active Scenario

(Selected Indicators, Percent of GDP Unless Otherwise Specified)

article image
Sources: Central Bank of Ecuador, Ministry of Finance, IMF staff calculations.

Excludes non-liquid and encumbered items included in the authorities’ definition of GIR.

GIR less outstanding debt to the IMF (excl. liabilities of the treasury), short-term foreign liabilities of the BCE, and bank reserves of ODIs.

GIR less outstanding debt to the IMF (incl. liabilities of the treasury), short-term foreign liabilities of the BCE, and bank reserves of ODIs.

The Government’s policy Plan

A. Putting Public Debt on a Firmly Downward Path

21. Putting the public debt on a downward path will require a sustained reduction in the fiscal deficit. The authorities are planning to lower the non-oil primary deficit, including fuel subsidies, from 5.3 percent of GDP in 2018 to 0.3 percent of GDP by 2021. Around 2 percent of GDP of that effort would be accomplished in 2019. The overall fiscal balance is expected to move from a deficit of 0.9 percent of GDP in 2018 to a surplus of 2.9 percent of GDP by 2021. The public debt is forecast to peak at 49 percent of GDP in 2019 and fall below 40 percent of GDP and towards more prudent levels after 2023.7

22. The authorities intend to achieve this fiscal realignment through both revenue and spending measures

  • Adopting a comprehensive tax reform. The authorities intend to develop a tax reform in the first half of 2019 (with the changes legislated by November and implemented in 2020–21) that will target an increase in revenue of 1½ to 2 percent of GDP. The goals of the reform will be to simplify the tax system and make it more growth-friendly and more equitable; to improve the business environment and encourage investment; to broaden the tax base and eliminate unwarranted tax exemptions, special regimes and preferences; to rebalance the system from direct to indirect taxation; and to phase out distortionary turnover taxes and levies on capital flows. The design of the reform will build on the recommendations of a recent IMF technical assistance mission; a Poverty and Social Impact Analysis (PSIA) by the World Bank could help ensure that the tax reform is equitable.

  • The tax policy reform would be complemented with tax administration improvements including strengthening tax and customs operations and conducting a diagnosis of tax and customs operations (e.g. to raise compliance levels and to assess the potential risks and benefits of integrating the tax and customs administrations).8

  • Phasing out the tax on transfers abroad. At the end of 2007, Ecuador introduced a tax on transfers abroad (impuesto a la salida de divisas) to minimize short-term capital flow volatility. The tax rate was increased from 0.5 percent in 2008 to 5 percent in 2012. The tax is imposed on current account transactions and constitutes an exchange restriction (subject to Fund approval under Article VIII). It also applies to capital account transactions and as such constitutes a capital flow management measure (CFM) according to the Fund’s Institutional View on capital flows. The authorities intend to phase this tax out once macroeconomic stability is restored and the reserve position is strengthened and as a means to encourage inflows that will be used to finance new private investment.

Calibrating Ecuador’s Debt Ceiling1

The appropriate range for Ecuador’s debt ceiling is established as a level that ensures, with high probability, that the maximum debt limit (i.e., the level of the debt-GDP that creates debt distress with high probability) will not be breached. This involves a sequential approach of:

(1) estimating a “maximum debt limit” from cross country data that keeps the probability of debt distress below a specific level. A probit model was used, based on a sample of oil-exporting emerging markets, to estimate the probability of debt distress (i.e. when the EMBI spread exceeds 1000 bps) at different levels of public debt-GDP. The model controls for global factors (the degree of global risk aversion, level of oil prices) as well as Ecuador-specific inputs (e.g. the quality of institutions, the history of default, the level of the fiscal deficit). For Ecuador, the model suggests that keeping the probability of debt distress below 10 (15) percent would require keeping debt below 47 (57) percent of GDP.

(2) simulating a distribution for future debt outcomes based on the past distribution of key macroeconomic variables. This distribution embeds a fiscal reaction function estimated from past outcomes for Ecuador that yields an estimate of the primary balance, conditional on the macroeconomic outcomes for each stochastic simulation.

(3) deriving a debt ceiling that ensures the probability of exceeding the maximum debt limit over the next six years is kept below 15 percent. This would imply a debt ceiling of about 30 percent of GDP. A sensitivity exercise was also undertaken for different parameters for the maximum debt limit and for the likelihood of exceeding that ceiling.

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Ecuador: Public debt to GDP ratio; 6-year forecast from Debt Ceiling per quintile of the public debt empirical distribution

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Debt Ceiling -Estimated Past Behaviour

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Note: Debt ceiling obtained on the basis of estimated fiscal reaction function for a sample of commodity-exporting emerging markets.

Debt Ceiling – Market-led Fiscal Consolidation

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Note: Debt ceiling obtained on the basis of primary balance forecast path necessary to implement a fiscal adjustment capable of closing market

A separate exercise was conducted using the same methodology but assuming Ecuador’s fiscal reaction function is more prudent than that which prevailed historically. Such analysis shows that a 40 percent of GDP debt ceiling could be appropriate but only at risk tolerance levels and debt distress probabilities above 10 percent. In the longer term it would be desirable to reduce the debt ceiling to at least 30 percent.

1 See Lledo, Sasson and Acevedo, “Enhancing Ecuador’s Fiscal Framework: Lessons from Second-Generation Rule-based Systems” IMF Working Paper, forthcoming, and “Calibrating Ecuador’s Debt Ceiling” in Selected Issues and Analytical Notes.

Ecuador: Fiscal Consolidation Measures

(In percent of GDP – Non-financial public sector)

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Sources: Ministry of Finance and IMF staff calculations.

For 2019, 1 percent of GDP is a one-off effect from tax amnesty collection in 2018, while 0.2 percent of GDP is the effect of other tax changes introduced in 2018.

Refers to revenues from leasing of government assets to private sub-contractors for temporary use and maintenance. For 2019, this includes the proceeds from the concession of the Sopladora hydro power plant. For 2020, it includes the proceeds from the concession of electric lines,

For 2019, the increase in capital spending following the implementation of the housing program “casa para todos” is broadly matched with capital cuts of similar amount in other areas.

This includes: (i] increase in the price of retail, domestic and industrial gasoline, (ii) increase in the price of diesel for certain fishing categories, [iii] removal of the subsidies in industrial gas, and [iv] increase in the price of electricity.

  • Realigning public sector wage bill. Public sector wages have risen 78 percent since 2007 and are now on average twice as high as private sector wages. In addition, public employment grew by 23 percent from 2005–15. The authorities intend to contain wage growth and reduce the workforce in various government entities, drawing on IMF technical assistance recommendations. To this end, the government has already announced a 10 percent reduction in the number of state enterprise workers, will renew only one of every two expiring contracts in the non-social sectors of the government, and will bring the wages of newly hired public employees into line with those prevailing in the private sector. These measures are expected to generate a cumulative reduction in the public wage bill of 1 percent of GDP by 2021, helping to restore competitiveness by also influencing private sector wage increases.

  • Increasing social assistance spending. The phase-out in fuel subsidies and the projected slowdown in the economy will add to the need to support the poor and vulnerable through well-targeted social programs, including through the government’s “Plan Toda Una Vida”. To accommodate this need, the fiscal plan builds in an additional 0.4 percent of GDP of social assistance spending by the end of the program, phased in a front-loaded way to cushion the impact of reduction of fuel subsidies.

  • Optimizing fuel subsidies. Untargeted fuel subsidies are currently around 3 percent of GDP. The authorities have already announced a reduction in subsidies on gasoline and industrial diesel. Also, since subsidies are ad valorem, the subsidy bill is being reduced in 2019 by the decline in global oil prices. Further subsidy reductions are planned for 2021. To ensure the phase-out of subsidies does not negatively impact the poor, the government is working with the World Bank to enhance the targeting and resources of the social safety net prior to any further reduction in subsidies for household consumption of fuel products. Subsidy reform will be carefully calibrated to promote social equity and efficiency and is not expected to have a major impact on retail consumer price levels.

  • Greater efficiencies in goods and services spending. Improved procurement practices, in particular, in the health sector, and strengthening of controls on expenditure commitments will help support efforts to identify reductions in goods and services spending. At the same time, it will be important to ensure that service quality in the health care sector is not compromised. In addition, there will be small savings from reduction on travel expenses.

  • Reductions in capital spending. Ecuador has very high levels of public capital spending relative to others in the region. However, there is evidence that part of the expenditure recorded under the capital spending—possibly as much as 20 percent—is misclassified current spending. The government intends to reduce capital spending by about 1 percent of GDP by 2021, largely through a better prioritization of projects and improvements in procurement practices.

23. The authorities also intend to take steps to improve public debt management. These include developing a domestic debt market by (i) phasing out direct placements; (ii) issuing benchmark securities through auction mechanisms, and (iii) accepting market interest rates for those issuances. The authorities intend to take steps to enhance communication with market participants, to improve debt statistics, and to formulate and publish a medium-term debt management strategy.

B. Promoting Shared Prosperity and Protecting the Poor and Vulnerable

24. Over the past decades, Ecuador has made important gains in social outcomes. The percentage of the population living below the national poverty line has fallen from 36.7 percent in 2007 to 21.5 percent in 2017 and the share of the population living below US$1.90 a day fell from 10 percent in 2007 to 3.6 percent in 2016. Nonetheless, poverty rates among the rural and indigenous populations remain high. Ecuador’s public health and education spending, literacy and school enrollment, and life expectancy are broadly in line with the Latin American average (although infant mortality and malnutrition rates are high). Social assistance spending is high by regional standards and there is good coverage of those in the bottom 20 percent of the income distribution.

25. The authorities, however, see scope to do more by:

  • Extending coverage, and increasing the level of benefits, under the existing “Bono de Desarrollo Humano” conditional cash transfer program (the current coverage is limited to about 40 percent of those households that are living in poverty).

  • Increasing spending to support the disabled poor (such as “Bono Joaquín Gallegos Lara”).

  • In consultation with the World Bank, developing a plan to improve the targeting of social programs to ensure that the bulk of expenditures goes to the bottom 20 percent of the income distribution. This will include the development of social registry to improve targeting of social programs.

  • Extending the coverage, maintaining the nominal level of benefits, and improving the targeting of the non-contributory pension (in consultation with World Bank technical support).

  • Increasing the efficiency and quality of primary education and health spending to improve outcomes and enhance the quality of the labor force and external competitiveness of the economy (with technical support from other IFIs). A plan to achieve this objective would be published by end-September 2019.

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Selected EM: Poverty Headcount Ratio, 2007 and 2016

(percent of population living under 1.9 constant 2011 PPP dollars) 1/ 2/

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Source: World Development Indicators.1/ Green dots correspond to LAC countries.2/ 2015 numbers used in Poverty Headcount Ratio for Chile, Brazil, and Kazakhstan.
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Selected EM: Gini Coefficient, 2003 and 2016 1/

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Source: World Development Indicators.1/ Green dots correspond to LAC countries.

C. A Better Medium-Term Fiscal Framework

26. Passage of the Productive Development Law and its regulations was an important step forward and further measures are being planned to make the new fiscal framework more effective (drawing on technical assistance recommendations outlined in Box 3). Future changes would include steps to complement the expenditure growth rule with binding annual targets for the non-oil primary balance, to ensure the institutional coverage of the debt and expenditure rule apply to the consolidated nonfinancial public sector (measured in line with international standards), and to strengthen the consistency and the enforceability of the framework. Such changes would be critical to contain Ecuador’s historical overspending during oil price booms thus allowing for countercyclical policies during oil price busts and preserving fiscal sustainability over the entire cycle. The government also intends to introduce legislative reforms to modernize budget processes, strengthen internal and external controls, and improve fiscal transparency, bringing such areas into line with international best practice. These efforts will be guided by a public financial management action plan that will be developed with technical assistance providers.

Priority Changes to the Fiscal Framework

Fiscal Rules. The following legal changes should strengthen rule design and implementation:

  • Establish the necessary mechanism to ensure the effective operation of the expenditure rule underpinning the fiscal framework and its consistency with the Constitutional “golden rule” provision.

  • Modify definitions to ensure that the expenditure rule and debt anchor applies to the nonfinancial public sector.

  • Establish binding annual targets for the non-oil primary balance consistent with the debt anchor within a fully articulated medium-term fiscal framework

  • Specify explicit escape clauses, automatic correction mechanisms (for deviations from the rules), and in-year fiscal reporting to strengthen enforcement.

  • Ensure rules dictating the accumulation of assets for the stabilization fund do not jeopardize compliance with fiscal rules and the fiscal plan.

  • Over the medium-term, consider lowering the debt ceiling below 40 percent to build additional fiscal buffers following oil price booms.

Budget Preparation, Execution and Control. The following changes in legislation and procedures should strengthen budget processes:

  • Limit the Executive discretion to amend the budget and introduce a robust framework for allocating budget contingencies so as to give appropriate flexibility in budget execution.

  • Prepare the annual budget through a top-down, medium-term, and transparent process including by changing procedures that fragment budget formulation and approval of capital and current expenditures.

  • Impose on all central government entities hard annual budget and medium-term expenditure ceilings that are consistent with the overall fiscal framework.

  • Develop, implement, and disseminate a mandatory methodology for cash projections

  • Prepare a plan for the reduction in the current stock of Treasury Certificates (possibly with some of the stock swapped for government bonds) and restrict new issuance to facilitate cash management only. For fiscal policy purposes such instruments should be considered as part of the existing stock of public debt.

  • Strengthen budget controls, including by ensuring central government entities enter their expenditure commitments into Ecuador’s information management system (E-SIGEF).

  • Enhance budget execution by eliminating the Cuenta de Financiamento de Derivados Deficitarios from the central government budget and recording it instead as current transfers.

  • Improve legislation, information collection systems, and procedures and perform a survey to identify, prevent, and clear domestic arrears, including by strengthening the system for commitment controls.

Fiscal Transparency. More transparent practices should include the publication of:

  • A summary of the fiscal measures underpinning the budget with a full quantification and a statement of fiscal risks in the draft budget submitted to Parliament.

  • Quarterly fiscal reports that monitor budget execution and the government’s compliance with fiscal rules.

Undertaking a Fiscal Transparency assessment may provide useful guidance.

Over the medium to long-term, reforms should turn the fiscal framework more appropriate for resource-dependent economies that would build liquid financial assets (managed through a sovereign wealth fund); adopt net (financial) wealth as the fiscal anchor; and undertake a broad societal debate on how, or whether, net wealth should be transferred between generations.

27. Efforts are underway to increase fiscal transparency and adopt consistent international standards for the reporting of the public debt. The recent publication of public debt data in a manner that more closely matches international standards is an important step forward. The government is committed to quickly bringing all of its fiscal reporting in line with international standards (including by providing a detailed list of debt instruments by creditor and compiling public sector debt on a consolidated basis). Later this year, the government will begin publishing quarterly fiscal reports on budget execution of the nonfinancial public sector that will include an assessment of the government’s compliance with the fiscal rules.

28. The central bank has recently published its financial statements. In line with recommendations from the Fund’s safeguards mission, the authorities intend to change legislation to allow the publication of the auditors’ opinion and notes on the financial accounts of the central bank (to bring such reporting into line with international best practice). The authorities are committed to implementing the International Financial Reporting Standards for the central bank’s accounts in a phased way in the coming years.

29. The government intends to increase the transparency of the oil sector. This will include publishing audited financial statements of the state-owned oil companies, increasing the transparency of employment policies in oil companies, and reviewing the governance structure of these oil companies. Ecuador is also working to gain membership of Extractive Industries Transparency Initiative.

30. The Moreno administration is taking steps to improve governance and tackle corruption. A transitional Citizens’ Participation and Social Control Council was appointed to oversee government operations and a Presidential corruption task force has been established. The latter has highlighted the need to (i) enhance the independence and powers of law enforcement agencies and the judiciary; (ii) strengthen domestic and international coordination on anti-corruption among different agencies; (iii) improve access to information about government operations (so as to facilitate civil society oversight) and (iv) strengthen procurement processes (including by statutorily requiring that all procurements contracts, and the winning bids/companies are published). To implement these changes the government will soon submit comprehensive anti-corruption legislation to the National Assembly. Finally, work is underway to improve the asset declaration regime for senior government officials.

31. The government is planning to strengthen the effectiveness of the AML/CFT framework to support anti-corruption efforts. In line with the FATF recommendations, an AML/CFT national risk assessment that gives proper consideration to corruption-related threats is being developed. The government will aim to ensure that banks and other relevant entities monitor their business relationships with senior officials. Additionally, they will ensure that proceeds of acts of corruption (as defined by the UN Convention Against Corruption) can be frozen, seized and confiscated.

D. A Stronger and More Independent Central Bank

32. The government intends to fully prohibit all direct and indirect central bank financing of the government and nonfinancial public sector. This prohibition will cover all types of direct and indirect financing, including the purchase of bonds issued by publicly owned enterprises and temporary advances, lending, the provision of guarantees to the government, its agencies, and state-owned entities. In 2016–17, the government drew around US$4.5 billion in central bank financing for the budget and has been using central bank resources to fund state banks and support quasi-fiscal operations. The 2018 Law on Productive Development has already introduced a number of welcome changes including a prohibition (i) on the purchase of new public securities by the central bank and (ii) of new central bank funding to public banks that is subsequently invested in securities issued by public sector entities9. This will allow the stock of these nonfinancial public sector obligations to the central bank to be reduced as they mature. The Monetary Board has recently adopted an additional measure to prohibit any increase in the central bank’s domestic investment operations. Central bank emergency liquidity support to public banks would be preserved, however, consistent with prudential norms. The intention is that these prohibitions will be formalized later this year in amendments to the Monetary and Financial Organic Code.

33. A new legal framework will be introduced requiring the central bank, over time, to cover all its liabilities vis-à-vis banks with international reserves. This would be consistent with the need in dollarized economies for a backing rule that backs specific central bank liabilities (i.e. private and public bank reserves at the central bank and domestic currency (coins) in circulation) with international reserve assets. A transition period is needed, however, before sufficient reserves can be accumulated to fully meet this requirement.

34. Drawing on Fund technical assistance, further steps are intended to strengthen the central bank’s institutional framework. The central bank’s current legal framework contains multiple and unwieldy objectives and functions; the government intends to streamline these in line with best practice for dollarized economies. There are plans also to improve the central bank’s governance arrangement and institutional autonomy including through the introduction of an independent central bank Board that has fiduciary responsibilities toward the central bank (the Board would take over responsibilities of the existing Monetary Board composed of ministerial representatives and a delegate representing the President). The central bank’s financial autonomy and personal autonomy (i.e. the criteria and procedures for the appointment and dismissal of Board members) will also be strengthened and strong internal mechanisms will be introduced to ensure proper audit and accountability. In this respect, an Audit Committee, which is currently lacking, will be introduced and the central bank’s Internal Audit function will be reformed in line with best practice. In the medium term, the authorities intend to strengthen the BCE’s balance sheet, including by dealing with contingent liabilities linked to the legacy of the liquidated banks from the crisis in the 90s.

E. A More Resilient Financial System

35. The financial system remains stable although liquidity conditions are tightening. Deposits and credit contracted in 2015 but those pressures eased in 2016 as oil prices recovered and new regulations required commercial banks to repatriate overseas assets. Capital to risk-weighted assets is 13.4 percent, 3 percent of bank loans are nonperforming, and liquid assets are 28 percent of short-term liabilities. Nonetheless, private credit is growing at 15 percent y-o-y (largely financing household consumption) while deposits have been flat over the past year. This has eaten into bank liquidity and could raise the prospects for nonperforming loans in the future. Liquidity risks could also materialize if oil prices decline further. There have been some reports of rapid growth and increasing stress in cooperatives—which account for 16 percent of total system assets and 23 percent of total deposits. While the expansion of cooperatives is unlikely to create systemic strains, tighter financial supervision of these entities is warranted, in part to prevent regulatory arbitrage.10,11

36. Impediments to effective financial intermediation and sovereign-financial linkages need to be addressed. The total exposure of the commercial banking system to the central government and public banks represents about 38 percent of banks’ net worth (mostly in central government paper). This partly is a result of various liquidity requirements (e.g. at least 60 percent of liquid assets have to be domestic assets and about 17 percent of deposits have to either be deposited at the central bank or held in other liquid instruments). To move toward a more competitive financial system, ceilings on interest rates should be eliminated (so as to allow financial resources to be allocated according to relative risk and term) and the complex system of bank liquidity regulations should be replaced with minimum liquidity requirements that are aligned with international best practices. The authorities intend to work in this direction and will articulate a clear plan of action for such reforms during the course of the arrangement, drawing on planned Fund technical assistance.

37. The government intends to improve financial oversight and crisis preparedness by:

  • Enhancing the banking resolution and crisis preparedness framework, including by reviewing the adequacy of the financial safety net (i.e. the deposit insurance scheme and the Liquidity Fund) coverage parameters and more clearly defining the deposit insurance fund’s role in bank resolution. This may encompass changes to institutional arrangements and the legal powers of the regulatory agencies (the authorities have requested technical assistance in these areas).

  • Enhancing the effectiveness of financial oversight by monitoring household indebtedness, collecting information on housing prices, and possibly imposing prudential limits on loan-to-value and debt-to-income ratios; and examining the need for cyclical factors in certain regulatory requirements.

  • Supporting the recently-started diversification of the deposit insurance fund’s assets away from Ecuadorian sovereign risks.

F. Reducing Labor Market Rigidities and Improving Competitiveness

38. The government intends to support the needed strengthening of the external position through a combination of supply side measures:

  • Allowing for less-rigid labor contracts that can particularly support an increase in female labor force participation and youth employment opportunities. Policies supporting families with young children and ensuring provision of childcare programs will be continued.

  • Increasing the probation period prior to an open-ended contract (after the probation period the employee becomes entitled to significant protections including severance payments). This would make hiring more attractive and support job creation.

  • Reducing hiring and firing costs by eliminating severance payments for workers that voluntarily resign.

uA01fig11

Ecuador: Contributions to Growth, 1960–2016

(In percent)

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Central Bank of Ecuador, Penn World Table v9.0, and IMF staff calculations.

39. There is also scope for public policy to foster higher private sector productivity. Total factor productivity growth in Ecuador has been negative for much of the past decade.12 Future increases in productivity will necessarily need to be sourced in private sector investments but there is a role for the government to support these private efforts by:

  • Building a framework for public private partnerships to attract private capital into a range of infrastructure investments (which would both support a rise in productivity and lessen fiscal needs).

  • Allowing private sector companies to take over the operations of certain public functions as concessions (potentially including airlines, utilities and other publicly owned enterprises) while retaining the ownership of these entities in public hands. The expected efficiency gains will help lower production costs, increase economy-wide productivity, and support diversification.

  • Continuing the process of trade liberalization by seeking trade agreements with both regional and international partners. For example, Ecuador is committed to join the Pacific Alliance in the near future. Such an increase in international economic integration will facilitate private sector led-growth and ultimately raise living standards.

Program Modalities

40. Balance of payments need. Ecuador faces high gross external financing needs in an environment of tightening global financing conditions and, more recently, deteriorating terms-of-trade. International reserves are low, the country faces significant BOP vulnerabilities (which give rise to a clear BOP need), and the real effective exchange rate is overvalued. In this context, Fund resources, in the form of direct budget support, would provide the needed near-term balance of payments financing on favorable terms as the country improves its fiscal position. With the better fiscal outturn, gross international reserves are expected to increase to 63 percent of the ARA metric by the end of the arrangement.

41. Access and phasing. Access for the 3-year Extended Arrangement is proposed at US$4.209 billion (435 percent of quota, SDR 3.035 billion, or about 4 percent of GDP). Access will be made available upon completion of quarterly reviews of the program with the first review to be considered by the Board in June 2019, based on end-March performance criteria.

42. Budget support. It is proposed that the full amount of Fund access under the arrangement would be used for direct budget support. Fund resources would be deposited in the Treasury’s account at the Central Bank of Ecuador and drawn down, as needed, to finance the budget. A memorandum of understanding will be established between the central bank and the government on their respective roles and obligations.

43. Conditionality and monitoring. Program performance would be monitored by quarterly reviews (see Table 1 of Attachment I) with:

  • A floor on the non-oil primary balance, inclusive of spending on fuel subsidies, of the nonfinancial public sector (quantitative performance criterion, QPC).

  • Non-accumulation of external payment arrears by the nonfinancial public sector (continuous performance criterion (PC)).

  • A floor on the change in the stock of central bank’s net international reserves (NIR), excluding bank deposits held at the Central Bank (QPC). While the program assumes no new market issuance by the government during the course of the arrangement, if there were to be new market financing then an adjustor to the NIR floor would automatically require that those resources be held in the nonfinancial public sector’s deposits at the central bank (so boosting net international reserves).

  • Zero new gross central bank financing of the non-financial public sector, either directly or indirectly through publicly owned banks (continuous PC).

  • A floor on social assistance spending of the central government (QPC).

  • A floor on the overall balance of the nonfinancial public sector (indicative target (IT)).

44. Ecuador has entered into certain sovereign repurchase agreements and other borrowing arrangements with collateral-like features (Box 4). The authorities have committed not to enter into new sovereign repurchase agreements or borrowing that encumbers international reserves during the period of the arrangement. They have also committed to providing full information on past and future borrowing with collateral-like features.

Selected Borrowing Arrangements

Ecuador does not have any borrowing arrangements that, legally, would be considered collateralized. However, it has other types of non-standard borrowing arrangements.

Repurchase Agreements and Derivatives Agreements (current debt stock less than US$1.5 billion). Sovereign derivatives and repo agreements using gold reserves and government bonds. The Ministry of Economy and Finance of Ecuador and the Central Bank of Ecuador have collectively entered into two sovereign repurchase agreement operations and one derivatives agreement with international banks. The derivatives transaction involved the delivery of a combination of gold and bonds issued by the Republic of Ecuador to the international bank with gold being replaced on the central bank’s balance sheet with derivatives. This gold is excluded from the measurement of gross and net international reserves for purposes of program conditionality. On the date of the derivatives transaction, the government received a loan of US$500 million from the international bank. Both the derivatives transaction and the loan have a term of 35-months, expiring in September 2020. The two repurchase agreements included delivery only of bonds of the Republic of Ecuador to the international banks. The government has received a total of US$1 billion in the course of the two transactions.

Borrowing with restricted funds (current stock of approximately US$3.5 billion) from certain Chinese banks. Ecuador sells a significant share of its oil revenues through off-take agreements with a range of global oil and petrochemical companies. Some of these off-take contracts were entered into in connection with multiparty agreements relating to loans provided by Chinese banks to the government of Ecuador. Some of these contracts also have ‘tie ins’ (contratos atados) involving tranches that are borrowed and paid in renminbi for specific projects selected by the Ecuadorian government and approved by the lender.

45. As prior actions, the government has already:

  • Prohibited quasi-fiscal operations of the Central Bank, as well as any direct or indirect lending to the non-financial public sector, including that via public banks, through a decision of the Monetary Board (Junta de Política y Regulación Monetaria y Financiera).

  • Published the Central Bank’s financial statements.

  • Provided detailed information on external non-financial public-sector debt, including information on all collateralized debt and debt with similar arrangements. This has allowed staff to compile accurate data on the consolidated non-financial public debt stock based on the GFSM2014 manual.

A range of structural benchmarks has also been established (see Table 2 of Attachment I).

46. Financing Assurances. The program is fully financed, given firm commitments for financing in the first 12 months of the arrangement as well as good prospects for full financing thereafter. The remainder of the gross external financing need in 2019 is expected to be met from IFI disbursements, including Fund budget support. This assessment is based on a comprehensive evaluation of the gross external and fiscal financing needs for the course of the arrangement. The current lending plans of the World Bank, Interamerican Development Bank, CAF, and FLAR have been verified with the various lenders and built into the current framework.

47. Capacity to Repay. Under the program scenario, Ecuador’s capacity to repay is adequate. If all purchases are made as scheduled, Ecuador’s projected payments obligations to the Fund would peak in 2026 at SDR 0.586 billion, placing a premium on safeguarding Fund resources well beyond the program period. Obligations relative to exports and reserves are at the high end compared with other program cases (since Ecuador is fully dollarized, it does not have the option of exchange rate depreciation to preserve international reserves and ensure its capacity to service debt). The existing stock of collateralized borrowing is assessed not to have a significant impact on Ecuador’s capacity to repay. Assuming steadfast program implementation, public debt is expected to be sustainable and a successful IMF-supported program is expected to reduce perceived sovereign and balance of payments risks, lower spreads on sovereign debt (Box 5), and facilitate improved financing terms for both the private and public sector. This will serve to mitigate the risks to repayment to the Fund.

48. Lending into arrears. Ecuador maintains a residual amount of arrears to international private bond holders arising from outstanding claims on those international bonds that the authorities repudiated in 2008/2009. At that time, the majority of government obligations were repurchased by the government. However, US$52 million (including accrued interests) remain outstanding in the hands of individual creditors and the authorities have been unable to identify these creditors in order to settle the claims. The authorities have, however, contracted the services of an international advisor to search for, identify, contact, and negotiate with these outstanding bondholders. Staff’s judges that good faith efforts have been made to reach a collaborative agreement with the remaining creditors and will continue to monitor evolving relations with these creditors, confirming, at each review, that the requirements under the policy on lending into arrears have been met. The authorities have indicated they have no outstanding arrears to bilateral or multilateral creditors.

49. Safeguards Assessment. The safeguards assessment of the BCE will be updated before the first program review. The most recent assessment, finalized in June 2017, raised serious concerns regarding the BCE’s institutional framework. The BCE’s subordination to the government and lack of autonomous objectives did not provide a sound system for the management of the bank’s resources, including IMF disbursements. The program includes structural reforms to restore BCE’s autonomy, and to strengthen its governance and accountability.

50. Statistical Issues. The authorities have received, and will continue to receive, technical assistance on government finance statistics, national accounts, balance of payments, and monetary and financial sector statistics.

Determinants of Ecuador’s Spreads1

Using the method proposed by Jorda (2005), the relationship between Ecuador’s EMBI spreads and various determinants is estimated based on an unbalanced panel of 60 emerging market (EM) economies over the period 1990–2017. The estimated model suggests that:

  • The EMBI spread in Ecuador is negatively correlated with oil prices and positively correlated with global risk-aversion. Movements in global risk aversion have a bigger effect on borrowing costs for countries that have had past credit events.

  • An improvement in the cyclically adjusted primary balance of 1 percent of GDP can reduce the EMBI spread by about 34bps. In addition, a 1 percent of GDP reduction in public debt reduces the EMBI spread by 7bps. This would suggest that the fiscal consolidation and reduction in the debt-to-GDP ratio under the authorities’ policy plan could lower Ecuador’s sovereign spread by 175 basis points.

uA01fig12

Ecuador: 1 2-month Rolling Correlation between EMBI Spread and Oil Price

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Bloomberg arid IMF staff calculations.
uA01fig13

Ecuador: EMBI Spread and VIX

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Source: Bloomberg.
uA01fig14

Impact on EMBI Spread of a 1 Percent Reduction in CAPB

(In basis points) 1/ 2/

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Bloomberg, WEO, lCRG, and IMF Staff calculations.1/ CAPB refers to the Cyclically-Adjusted Primary Balance.2/ Estimated on a sample of oil-exporting emerging market economies.
uA01fig15

Impact on EMBI Spread of a 1 Percent Reduction in Debt-to-GDP

(In basis points) 1/

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Bloomberg, WEO, ICRG, and IMF Staff calculations.1/ Estimated on a sample of oil-exporting emerging market economies.
1 See “EMBI Spreads: External Factors, and the Impact of Fiscal Consolidation” in Selected Issues and Analytical Notes.

Staff Appraisal

51. Ecuador is making important efforts to modernize its economy and strengthen the foundations for dynamic, sustainable, and inclusive growth. These planned actions—to strengthen the fiscal position and increase competitiveness—will help reduce vulnerabilities, put dollarization on a stronger footing, and, over time, support growth and job creation. This will help protect Ecuador from a range of risks including those associated with a tightening of global financial conditions, global trade uncertainties, lower international oil prices, or the potential for a stronger U.S. dollar.

52. Restoring prudence to fiscal policy will help achieve fiscal sustainability and improve competitiveness. Government plans to reduce non-oil primary deficit including fuel subsidies by 5 percent of GDP over the next three years would reverse the upward trend in public debt and bring it to more prudent levels in the medium term. A broad-based fiscal reform, which addresses both excessive public spending and inefficiencies in the tax system, would go a long way in fulfilling this objective. Realignment of the public sector wage bill, an optimization of the system of fuel subsidies, and reduction in public spending on capital and goods and services are important components of expenditure reform. The tax reform should aim to make the tax system more equitable, growth-friendly, and simpler. While these fiscal efforts might in the near-term generate headwinds to growth they will lay the foundation for a more sustainable and equitable growth in the future.

53. The efforts being taken to lower the debt-to-GDP ratio and to complement the existing expenditure growth rule with annual targets for the non-oil primary balance will strengthen confidence in the government’s fiscal plans. The intention to increase transparency and accountability through the publication of timely and periodic in-year fiscal reports to assess compliance with fiscal rules will further strengthen the credibility of the fiscal responsibility framework. Over time, better public financial management systems, improved budget procedures, improved procurement practices, and more rigorous fiscal controls will increase the effectiveness and efficiency of fiscal operations.

54. It is essential to maintain the government’s strong commitment to protecting the poor. To prevent a deterioration of social conditions and maintain societal support for their economic plan, the government should move as quickly as possible to expand eligibility for social assistance, improve targeting, and increase the generosity of social assistance programs. This will also be an important prerequisite for further steps in phasing out the existing system of untargeted fuel subsidies. Over time, greater access to high quality primary education and health care will help build human capital and offer a path of opportunity and upward social mobility to all of Ecuador’s citizens.

55. Increasing competitiveness and productivity needs to be at the core of supply-side efforts. Reforms to create a more efficient tax system, maintain restraint in public wages, eliminate rigidities in wages and prices, improve the reliability and efficiency of the energy sector and capital markets, and tackle corruption will all contribute to a more vibrant, private sector-led growth model. There is also scope to remove trade barriers, improve the business climate, and create opportunities for greater private sector involvement both in infrastructure provision and in a range of services that are currently being provided by public entities.

56. Building financial resilience, removing impediments to effective financial intermediation, and strengthening the governance framework of the central bank will support the dollarized system. The planned efforts to further strengthen oversight for banks and cooperatives and to build up crisis-preparedness and contingency-planning capabilities will help Ecuador both anticipate and adapt to potential shocks. Going forward, it will be important to redesign the complex system of bank liquidity regulations and interest rate ceilings so as to simplify the system and support greater access to financial intermediation. The proposed steps to make the central bank more operationally independent, to strengthen its governance, and to prohibit it from providing fiscal financing will have an important impact in bolstering dollarization.

57. Staff fully supports the authorities’ request for a 36-month Extended Fund Facility. The government’s economic plans are well-designed to reduce Ecuador’s vulnerability to downside risks, protect society’s most vulnerable, and support growth and job creation. The efforts of the Ecuadorian government merit the support of the international community.

58. Staff also supports Board approval for the retention for a one-year period of the exchange restriction arising from the foreign exchange outflow tax given that it is maintained for BOP reasons, is temporary and non-discriminatory.

59. It is recommended that the next Article IV consultation takes place on a 24-month cycle.

Figure 1.
Figure 1.

Ecuador: Recent Economic Developments

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Central Bank of Ecuador; National Statistical Institute of Ecuador (IN EC); World Economic Outlook Database; and IMF staff calculations.
Figure 2.
Figure 2.

Ecuador: Fiscal Developments

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Central Bank of Ecuador, Ministry of Finance, Haver, and IMF staff calculations.
Figure 3.
Figure 3.

Ecuador: A Vulnerable External Position

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Figure 4.
Figure 4.

Ecuador: The Financial System has Recovered

Citation: IMF Staff Country Reports 2019, 079; 10.5089/9781498303583.002.A001

Sources: Central Bank of Ecuador; Superintendency of Banks; IMF Monetary and Financial Statistics; and IMF staff calculations and estimates.1/ Data corresponds to Other Depository Institutions, which include private banks, Banecuador, Banco del Pacifico, private financial companies, mutualists, cooperatives, and credit card companies.2/ Data corresponds to the private banks aggregate, which includes Banco del Pacifico.
Table 1.

Ecuador: Selected Economic and Financial Indicators

article image
Sources: Ministry of Finance; Central Bank of Ecuador; Haver; World Bank Development Indicators; and Fund staff calculations and estimates.

Gross debt consolidated at the level of the NFPS. Includes the outstanding balance for advance oil sales, treasury certificates, central bank loans, other liabilities and the stock of domestic floating debt. The 40 percent of GDP debt threshold applies to the official debt definition. The public debt estimates are preliminary and subject to revisions in accordance with the IMF’s Government Financial Statistics Manual.

Includes inventories

GIR excludes non-liquid and encumbered items included in the authorities' measure of GIR.

Program NIR is equal to gross international reserves less outstanding credit to the IMF (excl. budget support) and deposits of other depository institutions at the central bank.

Underlying reserves refers to program NIR less outstanding obligations of the treasury to the IMF.

Includes both crude and derivatives

Table 2a.

Ecuador: Operations of the Nonfinancial Public Sector (Net Accounting)

(Millions of U.S. dollars, unless otherwise indicated)

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

Net of operational cost.

From 2011 on, includes additional public pension sytems which previously had not been consolidated into the NFPS accounts.

Reflects service contract payments to private oil companies beginning in 2011.

The primary balance less oil balance.

Oil revenue plus profits of state-owned oil companies, which is retained for investment in the oil sector, less oil-related expenditure (the costs of imports of oil derivatives, service payments to private oil companies, and investment in oil).

Gross debt consolidated at the level of the NFPS. Includes the outstanding balance for advance oil sales, treasury certificates, central bank loans, other liabilities and the stock of domestic floating debt. The 40 percent of GDP debt threshold applies to the official debt definition. The public debt estimates are preliminary and subject to revisions in accordance with the IMF’s Government Financial Statistics Manual.

Table 2b.

Ecuador: Operations of the Nonfinancial Public Sector (Net Accounting)

(Percent of GDP, unless otherwise indicated)

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

Net of operational cost.

From 2011 on, includes additional public pension sytems which previously had not been consolidated into the NFPS accounts.

Reflects service contract payments to private oil companies beginning in 2011.

The primary balance less oil balance.

Oil revenue plus profits of state-owned oil companies, which is retained for investment in the oil sector, less oil-related expenditure (the costs of imports of oil derivatives, service payments to private oil companies, and investment in oil).

Gross debt consolidated at the level of the NFPS. Includes the outstanding balance for advance oil sales, treasury certificates, central bank loans, other liabilities and the stock of domestic floating debt. The 40 percent of GDP debt threshold applies to the official debt definition. The public debt estimates are preliminary and subject to revisions in accordance with the IMF’s Government Financial Statistics Manual.