Ecuador - iuj.ac.jp€¦ · Ecuador August 2000 The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom At a glance: 2000-01 OVERVIEW The EIU’s forecast assumes

COUNTRY REPORT

Ecuador

August 2000

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

At a glance: 2000-01OVERVIEWThe EIU’s forecast assumes that the government will overcome recenttension between political parties to pass the second part of the Ley deTransformacion Económica, which is necessary for privatisation to takeplace. There is a continuing risk of social protest, which will endanger thesuccess of dollarisation. A stable currency will increase business confidence,and the economy will manage to grow in 2000, accelerating in 2001.

Key changes from last monthPolitical forecast• The co-operation seen in Congress between the two main political parties

during the first half has broken down, after a split in the largest party,Democracia Popular (DP), and a row over the choice of speaker in theChamber of Representatives. This could delay the passage of the secondpart of the Ley de Transformación Económica, which was submitted toCongress in July.

Economic policy outlook• The exchange of sucres for dollars is proceeding relatively smoothly. A

proposal to restructure defaulted Brady bonds, reducing the country’sexternal debt, has been presented to private creditors.

Economic forecast• Stabilisation of the currency has produced some improvement in con-

fidence. A small rise in the Central Bank’s index of economic activityindicates that the economy is picking up modestly. Consumer pricesmoderated in July but the upturn in producer prices is an indication of thecontinued backlog of price pressures in the system. The expansion of theexisting oil pipeline and a forthcoming tender for the construction of anew pipeline for heavy crude promise an increase in Ecuador’s main export.

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Ecuador 1

EIU Country Report August 2000 © The Economist Intelligence Unit Limited 2000

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2000-017 Political forecast8 Economic policy outlook9 Economic forecast

13 The political scene

16 Economic policy

20 The domestic economy20 Economic trends24 Oil and gas25 Financial and other services

28 Foreign trade and payments

List of tables

9 International assumptions summary10 Forecast summary17 Money supply under dollarisation19 Tax revenue21 Gross domestic product growth by sector21 Components of gross domestic product24 Oil production and exports26 Financial services26 Bank deposits and loans27 Tourism28 Merchandise exports, Jan-May29 Merchandise imports, Jan-May29 Balance of payments

List of figures

12 Gross domestic product12 Sucre real exchange rates

2 Ecuador


22 Index of Monthly Economic Activity (IDEAC)22 Inflation23 Real minimum wage index23 Total underemployment and unemployment

Ecuador 3


Summary

August 2000

Fragile relations between the two largest parties in Congress will complicate themost important task facing the Noboa government, namely to hold together areform-minded coalition in Congress. Without this, the government will notbe able to continue with the reforms necessary for dollarisation to work. Pop-ular support for the government’s programme will also be at a premium, givencontinued high inflation. The EIU assumes that the momentum of reform willbe maintained and that the privatisation programme will get under way at theend of 2000, but the probability of slippage in this timetable has increased. Thedownside risks to our global forecasts—notably the risk of a hard landing in theUS—represent serious threats to Ecuador’s commodity-dependent export base.

A breakdown in relations between the two largest parties in Congress, occasionedby a split in the leading party of government, has put at risk the passage of thesecond part of the economic transformation bill, which was to have beenapproved in mid-August. Although popular protest has been contained so far,the indigenous peoples’ movement, Conaie, and most of the public-sectorunions still strongly oppose dollarisation and the sell-off of majority stakes instate-owned firms to foreign investors.

The exchange of sucres for dollars is proceeding smoothly. The governmentpassed an IMF review of its economic policies in June. A promised, politicallysensitive, cut in subsidies on domestic cooking gas has been postponed, whileprice rises on other fuels have been phased in earlier than agreed. The taxauthorities have improved their performance. The IMF is urging the governmentto remove the cap on the maximum lending rate and allow interest rates toreturn to market levels. The new debt renegotiation committee has presented abond-restructuring proposal to private creditors.

GDP grew modestly quarter on quarter in the first quarter, led by higher oiloutput. Key agricultural export sectors, especially shrimp, are depressed. Privateconsumption and investment have continued to fall amid the uncertaintysurrounding dollarisation. In the second quarter the stability of the exchangerate improved business confidence and unemployment began to come down.

A sharp increase in oil revenue helped the current-account surplus to widen inthe first quarter, despite a poor performance by most non-oil exports and anincrease in debt-related outflows.

Editor: Charles SevilleEditorial closing date: August 9th 2000

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

August 9th 2000

The domestic economy

The political scene

Economic policy

Outlook for 2000-01

Foreign trade andpayments

4 Ecuador


Political structure

Republic of Ecuador

Presidential

The president, elected for a period of four years, is head of state; he appoints the cabinetand provincial governors. Gustavo Noboa’s term of office expires in 2003

Unicameral Chamber of Representatives (Congress). 20 members are elected nationallyby proportional representation for a period of four years, and 101 members are directlyelected on a provincial basis for two years. Voting is compulsory over the age of 18.

Congress selected a new Supreme Court with life tenure in October 1997 fromnomination lists presented by electoral colleges and civic groups

May 1998 (congressional and first-round presidential); July 1998 (second-roundpresidential); next elections due by 2002 (congressional and presidential)

President Noboa and cabinet, predominantly independents

Partido Social Cristiano (PSC); Izquierda Democrática (ID); Frente Radical Alfarista (FRA);Democracia Popular (DP); DP-Frente Nacional; Acción Popular RevolucionariaEcuatoriana (APRE); Movimiento Popular Democrático (MPD); Movimiento Pachakutik(MP); Partido Conservador (PC); Partido Roldosista Ecuatoriano (PRE); LiberaciónProvincial (LP); Concentración de Fuerzas Populares (CFP).Outside Congress: Confederación de Nacionalidades Indígenas del Ecuador (Conaie);Movimiento Independiente para una República Independiente

President Gustavo NoboaVice-president Pedro Pinto

Administration secretary Marcelo SantosAgriculture & livestock Mauricio DávalosCulture & education Roberto HanzeEnergy & mines Pablo TeránEconomy & finance Luis YturraldeForeign relations Heinz MoellerHousing Nelson MurgutioInterior Antonio AndrettaLabour Martín InsuaNational defence Hugo UndaPublic health Fernando BustamantePublic works José MacchiavelloSocial welfare Raúl PatiñoTourism Rocío VasquezTrade & industry Roberto Peña-Durini

Banco Central del Ecuador, Superintendencia de Bancos, Agencia de Garantía deDepósitos (AGD)

Luis Ycara

Juan Falconí Puig

Form of government

The executive

National legislature

Legal system

National elections

National government

Main political organisations

President of Central Bank board

Key ministers

Monetary institutions

Superintendent of banks &president of AGD

Official name

Ecuador 5


Economic structure

Annual indicators

1995 1996 1997 1998 1999

GDP at market prices (Su bn) 46.0 60.7 79.0 107.4 162.2

GDP (US$ bn) 17.9 19.0 19.7 13.8 12.6

Real GDP growth (%) 2.3 2.0 3.4 0.4 –7.3

Consumer price inflation (av; %) 23.1 24.2 30.7 36.0 52.5

Population (m) 11.5 11.7 11.9 12.2 12.4

Exports of goods fob (US$ m) 4,381.0 4,873.0 5,264.0 4,203.0 4,451.0

Imports of goods fob (US$ m) –4,057.0 –3,680.0 –4,666.0 –5,198.0 –2,786.0

Current-account balance (US$ m) –765.0 84.0 –714.0 –2,169.0 955.0a

Foreign-exchange reserves excl gold (US$ m) 1,627.6 1,858.5 2,092.8 1,619.7 1,642.4

Total external debt (US$ bn) 14.0 14.5 14.9 15.1 14.9a

Debt-service ratio, paid (%) 26.6 21.4 28.5 28.8 19.4a

Exchange rate (av; Su:US$) 2,564.49 3,189.47 3,998.27 5,446.57 11,786.80

Exchange rate fixed at Su25,000:US$1 pending full dollarisation, due to be completed by end-2000.

Origins of gross domestic product 1999 % of total Components of gross domestic product 1999 % of total

Agriculture 12.4 Private consumption 65.0

Industry 37.4 Government consumption 10.1

Petroleum & mining 11.3 Fixed investment 14.0

Construction 4.5 Stockbuilding –1.7

Electricity, gas & water supply 0.3 Exports of goods & services 37.3

Manufacturing 21.3 Imports of goods & services –24.7

Services 44.2 GDP at market prices 100.0

GDP at factor cost incl others 100.0

Principal exports fob 1999 US$ m Principal imports fob 1999b US$ m

Oil & oil products 1,480 Raw materials 1,191

Bananas 954 Capital goods 772

Shrimp 607 Consumer goods 572

Canned fish 263 Fuel & lubricants 200

Flowers 180 Total 2,737

Total incl others 4,451

Main destinations of exports fob 1999 % of total Main origins of imports cif 1999 % of total

US 36.9 US 29.7

Colombia 5.2 Colombia 12.6

Italy 4.9 Venezuela 6.2

Chile 4.6 Japan 4.6

Peru 3.9 Germany 4.1

a EIU estimate. b Customs basis.

6 Ecuador


Quarterly indicators

1998 1999 20002 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

Non-financial public sector (Su m)Revenue 5,235 5,695 6,718 7,116 8,825 10,716 14,233 19,796Expenditure 7,051 7,395 7,889 9,958 9,675 12,341 16,474 18,246Balance –1,815 –1,700 –1,171 –2,842 –851 –1,626 –2,240 1,551

OutputGDP at constant 1975 prices (Su m) 56,699 57,125 57,201 53,568 52,544 52,576 52,442 52,883 % change, year on year 0.2 0.1 –0.1 –5.4 –7.3 –8.0 –8.3 –1.3

Employment, wages and pricesUnemployment Quito, Guayaquil, Cuenca (% of the labour force) 8.7 10.5 11.4 13.0 15.6 16.5 15.5 16.6Underemployment (% of the labour force) 42.8 47.7 48.2 52.7 51.9 53.5 51.0 46.5Real minimum wage index (1990=100) 111.4 117.0 118.2 114.8 99.7 107.3 95.9 80.3Consumer prices Quito (1995=100) 212.8 225.5 253.1 281.2 328.9 347.2 389.4 515.2 % change, year on year 34.5 35.4 44.1 45.5 54.6 54.0 53.9 83.2Producer prices (1995=100) 217.3 227.2 258.1 303.0 396.7 466.5 664.2 1,078.6 % change, year on year n/a n/a n/a 51.4 82.6 105.3 157.3 256.0

Financial indicatorsExchange rate Su:US$ (av) 5,117 5,544 6,560 8,565 9,774 11,679 17,129 24,954 Su:US$ (end-period) 5,275 6,255 6,825 10,067 11,236 13,801 20,243 25,000Interest rates (av; %) Deposit 37.3 41.7 47.2 53.2 49.4 46.5 46.7 n/a Lending 45.5 52.4 58.9 64.1 65.1 63.4 63.5 n/aM1 (end-period; Su bn) 6,540 6,711 9,082 8,927 11,178 13,876 19,129 n/a % change, year on year 15.9 9.1 30.6 50.0 70.9 106.8 110.6 n/aM2 (end-period; Su bn) 28,467 30,652 35,386 43,323 48,562 56,749 70,498 n/a % change, year on year 23.2 25.0 31.1 61.0 70.6 85.1 99.2 n/a

Sectoral trendsCrude oil Production (m barrels/day) 0.38 0.37 0.38 0.38 0.37 0.38 0.39 0.39 Exports (US$ m) 197 184 174 167 268 393 485 525 Spot prices (Oriente-29; US$/barrel)a 11.1 11.6 9.9 10.4 14.6 19.5 23.0 27.2

Foreign trade (US$ m)Exports fob 1,097 965 982 1,001 1,117 1,147 1,186 1,230Imports cif –1,435 –1,519 –1,308 –952 –611 –695 –759 –698Trade balance –338 –554 –326 49 506 452 427 531

Foreign payments (US$ m)Merchandise trade balance 242 –438 -231 125 553 511 475 591Services & income balance –472 –538 –451 –520 –406 –466 –418 –477Current-account balance –539 –786 –468 –128 383 318 384 415Reserves excl gold (end-period) 1,829 1,568 1,620 1,482 1,580 1,824 1,642 1,426

a Gulf, composite assessment.Sources: IEA, Monthly Oil Market Report; IMF, International Financial Statistics; Banco Central del Ecuador, Información Estadística Mensual; Oil Market Intelligence.

Ecuador 7


Outlook for 2000-01

Political forecast

Having achieved unprecedented momentum in economic reform since he tookoffice in January, President Gustavo Noboa’s main challenge in the next fewmonths will be rebuilding the alliance between the Quito-based DemocraciaPopular (DP) and the Guayaquil-based Partido Social Cristiano (PSC). Thecohesion of the alliance remains crucial to the momentum of reform, withanother major package of legislation due to be voted on in August (see below).Mr Noboa must also manage popular discontent with continuing rapid pricerises and try to increase support, both inside and outside Congress, for thereforms that are necessary if dollarisation is to be a success. Tangible progresson combating corruption and managing growing pressures for regionalautonomy will also be needed to reduce the risk of further political instability.

A split between Guayaquil- and Quito-based factions within the DP and aquarrel between the DP and the PSC over the election for the congressionalpresidency threaten to slow down or derail the reform timetable.

The adoption in May of a gradual pace of subsidy adjustment, the announce-ment of compensatory salary rises and advances in negotiations in June withthe Confederación de Nacionalidades Indígenas del Ecuador (Conaie), theindigenous umbrella organisation that co-led the January coup attempt, haveall contributed to a calmer social environment. However, Conaie is stillideologically opposed to most of the reform programme, including dollar-isation. It has recently organised marches against the government in collabor-ation with public-sector workers and has also collected some 1m signatures in apetition calling for a referendum on dollarisation, the US presence at theManta airbase and the sell-off of majority stakes in state companies. Thelegality of the petition has to be decided by the Supreme Court, but if thereferendum were held, it would again delay the passage of reforms. Underlyingsocial tensions will remain high as an already impoverished population suffersfurther economic hardship.

The DP’s loss of the Quito mayorship in the May polls and the substantial gainsin the highlands achieved by Izquierda Democrática (ID) and the MovimientoPachakutik (MP), the two major left-wing movements sympathetic to the Januarycoup attempt, have highlighted a significant streak of resentment of andalienation from political institutions. Moreover, although the approval in May ofan amnesty for the military officers who participated in the January coup attempthas eased tensions within the military, the root causes of disenchantment withpoliticians and political institutions, including the impunity of politicians,remain. Given the deficiencies of the court system, it is unlikely that any of thoseaccused in the Filanbanco case will be brought to trial.

Growing concerns about security along the Colombian border and politicalsensitivities over the US military presence at the Manta airbase are the mainchallenges facing the Ecuadorean foreign ministry in coming years. The huge

Domestic politics

International relations

8 Ecuador


expansion in recent years of—mostly illegal—Ecuadorean migration abroad(mainly as a result of economic deterioration) is also presenting difficulties.Host countries—of which the US and Spain are the largest—want theEcuadorean authorities to do more to prevent illegal immigration, while inEcuador the pressure is for action to be taken in response to the reportedmistreatment of emigrant nationals abroad.

A rise in banditry along the Colombian border area in recent months hasfuelled fears over the potential for an overspill of the Colombian civil conflict.Many fear that the US presence at the Manta airbase—while theoreticallyconfined to the surveillance of drug-trafficking in the region—may also be usedto support more direct US involvement in Colombia’s civil conflict in thefuture. Retaliation by the Colombian guerrillas could see Ecuador’s territory orcitizens become embroiled in the civil conflict. Political sensitivities overManta have been fuelled in recent weeks by local media reports that US aircraftbased at Manta are being deployed in international waters to track vesselssuspected of carrying illegal immigrants. Many regard this as a violation of theterms governing the US presence in Manta.

Economic policy outlook

Having clinched the long-awaited IMF deal in April, the government’s nextchallenge is to get the privatisation programme under way in order to attractthe inflows of foreign direct investment (FDI) on which the growth rate willdepend under dollarisation. This requires a further reform package (part two ofthe Ley de Transformación Económica), which was submitted in July andawaits approval. However, the recent conflicts in Congress represent a majorthreat to the bill, and unless the reforms are passed by September, the prospectof privatisations getting under way before the end of the year is bleak.

Because of Ecuador’s poor track record, the transparent sale of at least one majorpublic company or major infrastructure concession is badly needed to increasethe country’s attractiveness to foreign investors. Attracting interest also dependson the government’s success in convincing investors that it has finally embarkedon a sustainable programme of reform. Mending relations with external creditorswill be as important for credibility as for the fiscal accounts (see below). JoséGallardo, who was appointed the government’s new chief debt negotiator inMay following the resignation of Jorge Guzmán, is regarded as a capableeconomist, and the proposal that he presented looks likely to be accepted by thenecessary 85% of bondholders by the mid-August cut-off point. Subsequentnegotiations are expected in the next meeting with the Paris Club in September.

The first bi-monthly evaluation in late June by the IMF of the government’sadherence to the promises made in its letter of intent went well, with the IMFpronouncing itself satisfied with the government’s progress on achieving itsfiscal targets. However, concerns about interest rate policy remain, and unlessthe burden on the fiscal accounts of the public debt can be alleviated, fiscaladjustment measures will be insufficient to put government finances on asound enough footing to make dollarisation work in the longer term. The

Policy trends

Fiscal policy

Ecuador 9


government implemented some of the subsidy reductions planned for June-July ahead of the schedule agreed with the IMF, while it postponed others inorder to avert potentially destabilising social unrest.

A slower pace of subsidy removal will, however, be reflected in higher inflationfor a longer time span and will absorb fiscal resources to the detriment ofinvestment. In the medium term, the effective abolition of monetary policyunder dollarisation leaves the government with fiscal policy as its only means ofprotecting the economy from sharp swings in years of falling dollar inflows (forexample if oil prices fall). To provide for a countercyclical fiscal policy duringsuch times, the government would need to establish and build up a macro-economic stabilisation fund. Assuming such a fund could be capitalised, admin-istering it would require a level of fiscal discipline that Ecuador has never beforeachieved. Given neglected social programmes, high unemployment and lowreal wages, ringfencing such a fund would be politically challenging.

The Banco Central del Ecuador (the Central Bank) is charged with settingmaximum interest rates each month, in theory through a formula involvingLibor, a premium for country risk plus a maximum of 4 percentage points.Besides creating market distortions—with the banks unwilling to lend at suchrates and depositors subsidising borrowers—the mechanism has already beensubject to interference, as political pressure for lower rates forced a reduction inthe cap from 24% to 20% in May. Given high inflation, this places real interestrates deep into negative territory. The IMF has questioned such discretionarymanagement of interest rates and the government has included an amendmentin the reform bill that would establish a maximum legal rate of 1.5 times themarket average, thus freeing interest rates to more realistically match inflation.

Economic forecast

International assumptions summary(% unless otherwise indicated)

1998 1999 2000 2001

GDP growthUS 4.3 4.2 4.9 2.9OECD 2.4 2.9 3.9 3.0EU 2.6 2.2 3.4 3.0

Exchange rates (av)US$ effective (1990=100) 119.3 116.4 117.3 112.9¥:US$ 130.9 113.9 106.0 104.0US$:€a 1.12 1.07 0.97 1.04

Financial indicatorsUS$ 3-month commercial paper rate 5.34 5.18 6.52 6.55¥ 2-month private bill rate 0.72 0.27 0.13 0.38

Commodity pricesOil (Brent; US$/b) 12.8 17.9 27.1 22.0Food, feedstuffs & beverages

(% change in US$ terms) –13.9 –18.6 –2.8 5.3

Industrial raw materials (% change in US$ terms) –19.6 –4.3 15.4 6.8

a Ecu before 1999.

Monetary policy

10 Ecuador


The EIU’s forecasts for firm oil prices, which represent a major improvement inthe external environment for Ecuador on the previous two years, rest onassumptions of continued growth in the world economy and, in particular, asoft landing for the US economy. Banana prices are expected to pick up in 2001as global demand strengthens, but those for shrimp are expected to remaindepressed, compounding the problems of the beleaguered export industry.

If dollarisation were to fail, Ecuador would be plunged into renewed economicchaos, with profound financial, social and political consequences. The economywould probably become locked into a spiral of stagnant growth and acceleratinginflation. This does not form part of our central forecast, however, as we assumethat the recent threats to democracy and a widespread belief that the alternativesto dollarisation have been exhausted will maintain the momentum of reform inCongress. Assuming dollarisation continues to be adequately implemented, theeconomy should emerge from recession in the second half of 2000, providing abase for a stronger recovery in 2001 and over the medium term.

Forecast summary(% unless otherwise indicated)

1998a 1999a 2000b 2001b

Real GDP growth 0.4 –7.3 0.8 3.7

Oil production growth –3.3 –0.6 7.0 2.5

Agricultural production growth –1.4 1.8 0.2 2.5

Gross fixed investment growth 6.3 –35.4 8.0 25.0

Unemployment rate (av) 11.5 15.1 13.0 11.0

Consumer price inflation Average 36.0 52.5 96.0 29.1 Year-end 43.6 61.0 88.5 16.1

Lending rate 49.6 64.0 19.0 19.0

NFPS balance (% of GDP) –5.6 –4.6 –1.2 0.0

Exports of goods fob (US$ bn) 4.2 4.5 5.6 5.5

Imports of goods fob (US$ bn) –5.2 –2.8 –3.4 –4.6

Current-account balance (US$ bn) –2.2 1.0 c 0.6 –0.9 % of GDP –11.0 6.9c 4.9 –5.6

Total foreign debt (year-end; US$ bn) 15.1 14.9c 15.8 17.3

Exchange rates (av) Su:US$ 5,446.6 11,786.8 25,000.0 25,000.0 Su:€d 6,100.2 12,557.5 24,228.8 26,000.0

a Actual. b EIU forecasts. c EIU estimate. d Ecu before 1999.

The recession, which saw the economy contract by 7.3% in 1999, appearsfinally to be bottoming out, according to data for the first quarter. But therecovery will be slow, with real aggregate demand not expected to return to1997 levels before the end of the forecast period. The serious problems facingshrimp producers will hold back the recovery of agriculture, and all sectors willbe hampered by credit scarcity stemming from the fragility of the banks andthe interest rate cap. Real wages will take a long time to recover and—evenassuming the remaining reforms are achieved on schedule—the privatisationprocess is unlikely to attract investment inflows before the fourth quarter of

Economic growth

International assumptions

Ecuador 11


2000. Furthermore, any recovery in private consumption is likely to bereflected in higher imports as pent-up demand for consumer goods is satisfied.

If the government is successful in adhering to the dollarisation programmeprices will stabilise from 2001. But the decision to adopt a more gradual pro-gramme of subsidy removal will prevent a more abrupt decline in inflation nextyear. Average inflation will rise in 2000 as inflationary pressures already in thesystem—stemming mainly from the rapid rise in producer prices and the hugemonetary expansion of 1999—are worked out. Monthly inflation has moderatedin the past few months, but in year-on-year terms inflation remains high.

The 5.3% month-on-month increase in consumer price inflation in June, whichtook accumulated inflation for 2000 to 65%, reflects the initial impact of thesubsidy reductions and electricity price adjustments carried out in May. But a fallin the monthly inflation rate to 2.4% in July marks a possible slowdown ininflation. Some lagged effects will be felt as higher freight costs feed through tofood prices. Further price adjustments will also be needed, in particular to publictransport fares (to reflect higher fuel prices) and utility charges to bring themcloser to international levels. Another major inflationary pressure in the systemstems from the huge disparity between the producer price index (PPI) andconsumer price index (CPI). Year-on-year growth of the PPI stood at 205% at theend of June, compared with growth in the CPI of 104%. Our forecasts assumethat subdued demand—amid depressed real wages—will set a ceiling on con-sumer price increases by limiting the extent to which producers will be able torecover lost margins. But higher producer prices (which will be compounded bywage increases) are likely to begin feeding through to the CPI when the economypicks up, militating against a more abrupt fall in inflation in 2001.

The exchange of sucres for dollars has been proceeding more quickly than hadbeen expected. Sucre notes are scheduled to be phased out entirely by the endof September, although there is a possibility that an extension could be decreedif necessary. Automatic teller machines now dispense dollars, and mostbusinesses and utilities have converted sucre prices to dollars. Cash trans-actions continue to be carried out in a mixture of dollar and sucre notes, sucrecoins and, increasingly, US coins. As most Ecuadoreans are unfamiliar withdollars, the authorities are having to undertake a large-scale programme toeducate the population, not least to help them identify counterfeit notes. Evenwith a year of high inflation in 2000, the exchange rate will remain signif-icantly undervalued in real trade-weighted terms in 2001-02 because of thelarge overshooting that occurred in 1998-99.

With imports relatively slow to recover and firm oil prices supporting exports,the trade and current accounts will remain in surplus in 2000. However, in2001, as imports recover and the trade surplus narrows, the current-accountwill fall into deficit again as a result of the large debt-service burden. Interestpayments due represented some 8% of GDP in 1999. In the interests of clarity,we have not built debt rescheduling into our forecasts and assume that interestarrears will accumulate until a deal is reached. Successful debt restructuringwould bring interest payments down markedly, narrowing the 2001-04current-account deficits to below currently forecast levels.

Inflation

External sector

Exchange rates

12 Ecuador


A recovery in investment should promote growth of non-traditional exports in2001, although it is clear that shrimp will take longer to recover than hoped,following the recent discovery of a new virus, yellowhead. On balance, weexpect Ecuadorean exports to remain competitive under dollarisation, at leastin the medium term. In 1999 Ecuador ranked the cheapest location in theregion in the EIU’s Worldwide Cost of Living Survey. Although prices of tradeablesare likely to adjust towards international prices relatively quickly, those of non-tradeables and wages are likely to adjust far more slowly, and local costs willremain competitive. Moreover, the elimination of the sucre will reduce sometransaction costs and exchange-rate stability will ease financing conditions.

Ecuador 13


The political scene

Co-operation between the Quito-based Democracia Popular (DP) and theGuayaquil-based Partido Social Cristiano (PSC), which enabled PresidentGustavo Noboa’s government to push through reforms in March, continuedinto the second quarter. Despite the DP’s high-profile losses in and around thecapital at the local elections (in particular the loss of the Quito mayorship) inMay, the party performed relatively well on a national level, as did the PSC. Byconfirming the two parties as important national players within a highlyfragmented political spectrum, these results originally bolstered the alliance. TheDP worked implicitly as the party of government under the leadership ofprominent Guayaquil members, including the president of Congress, Juan JoséPons, and the DP bloc leader, Alex Aguayo. However, this legislativehoneymoon came to an end as the election of the authorities that were to leadCongress in the last two years of its term approached. The first sign of problemscame when party delegates at the DP’s national convention criticised the role ofthe leadership in the failures of the Mahuad administration and ousted MrAguayo from the leadership of the DP congressional bloc. This led to the formalsplit of the bloc into a Guayaquil-based faction led by Mr Pons and a Quito-based group led by the party’s president and new bloc leader, Raúl Hurtado, thebrother of Oswaldo Hurtado, the former president (1980-83) and founder of theDP. The result was a 12-member dissident bloc under Mr Pons friendly to thePSC and a 23-member “official” DP bloc headed by Mr Hurtado. Initially thesplit did not seem significant in terms of PSC-DP co-operation in the legislature.However, statements made by the PSC questioning the legitimacy of MrHurtado’s leadership soon sparked chaos in Congress over the election of thenew congressional authorities.

The constitution calls for the presidency and first vice-presidency of Congressto rotate between the first and second largest parties in the chamber. WithMr Pons having occupied the presidency since August 1998, it is now the turnof the second largest party in Congress, the PSC, to occupy the post. However,the PSC nominee for the post, Xavier Neira, who had to be approved by acongressional vote, was staunchly opposed by the centre-left and left-wingparties. Mr Neira was initially promised the support of the DP, which wouldhave been enough to guarantee his election, but in the week before theelection Mr Hurtado, the new head of the DP congressional bloc, announcedthat the DP had withdrawn its support as a result of public comments from thePSC president, who had attempted to pressure the party into making a decisionand questioned the legitimacy of the DP bloc’s new congressional leadership.

Despite these difficulties, the PSC was unyielding. The other PSC legislatorssigned a letter stating that they would not accept the presidency of Congressand would only support Mr Neira, on pain of expulsion from the party.However, Mr Neira could only count on 46 votes, short of the 62 he needed togain the presidency, after failing in a controversial bid to secure the support ofthe Partido Roldosista Ecuatoriano (PRE).

When Congress met on August 1st to select its new president, a chaotic sessionled to the election of Susana González, a former PSC member who had left the

The DP-PSC allianceruptures

14 Ecuador


party just ten days before, with José Cordero of the DP elected first vice-presidentand Antonio Posso of the Movimiento Pachakutik (MP) elected second vice-president. Congress split into two rival camps and the PSC issued a legal chal-lenge against the elections, forcing Mr Noboa to try to mediate in the dispute.

This political squabble threatens a return to the political stalemate that hasstymied successive government efforts at reform. The Noboa governmentneeds the support of the PSC and a united DP to approve the second part ofthe Ley de Transformación Económica (see Economic policy). Submitted as“economically urgent”, the bill was to have passed automatically in mid-August unless it was explicitly voted down. However, following the DP-PSCsplit the government announced that it would no longer insist on this in orderto make sure that such an important bill did not become law without havingbeen properly debated in the chamber.

The government enjoys a modest level of popular support, with Mr Noboa’sapproval rating at around 40%. Allegations of financial misconduct against theowners of Filanbanco, the largest private bank in the country before its collapsein December 1998, have increased popular mistrust of politicians. However, thestrength of public opposition to dollarisation reforms has so far been limited.The adoption in May of a gradual pace of subsidy adjustment, complementedby compensatory salary increases, wrested support from the protests organisedby the Confederación de Nacionalidades Indígenas del Ecuador (Conaie),which co-led the January coup attempt. Two attempted national strikes led bypublic-sector unions to protest against dollarisation, privatisation and fiscalausterity have also had little impact, but the potential for renewed unrestremains. Conaie remains ideologically opposed to dollarisation andprivatisation and has called for a national referendum on these issues, with thebacking of social security and oil workers’ unions. By the beginning of August ithad gathered the required 1m signatures from registered voters to propose thereferendum to the supreme electoral board. This body must decide whether toallow the referendum to be held. In the most likely scenario, the board willdelay its decision for as long as possible before disallowing the plan. If thereferendum were to be held, it would stand a good chance of being approvedby the population, throwing the entire reform process into reverse. However, arejection of the referendum proposal on legal grounds could result in anotherround of destabilising street protests.

An instrumental factor in reducing social tensions has been the amnestygranted to all civilians and military personnel involved in the January coupattempt against the former president, Jamil Mahuad. In May Congress approved(by 90 votes to 24) the amnesty proposed by Mr Noboa in a vote timed tocoincide with the economic reform measures. Among those covered by theamnesty were the recently elected mayor of Quito, Mr Moncayo, the Conaieleader, Antonio Vargas, and the former Supreme Court head, Carlos Solorzano.

The subsidy adjustment policies adopted by Mr Noboa provoked theresignation of the finance minister, Jorge Guzmán, after less than five monthsin his post. Mr Guzmán, who was a strong supporter of shock therapy for theeconomy, disagreed with Mr Noboa’s gradualist approach (see Economic

Economic team causesconcern

Social tensions have calmedfor now

Ecuador 15


policy). Mr Guzmán’s resignation was a disappointment, as he had built acredible reputation abroad and his departure delayed the presentation of thedebt-restructuring plan by about one month, until the end of July. Afterreportedly struggling to find a replacement for Mr Guzmán, Mr Noboa namedLuis Yturralde the new minister of economy and finance. Mr Yturralde, a formeraccountant and tax specialist, is well known in Guayaquil, and was formerly amember of the Board of Directors of the Guayaquil Chamber of Commerce.Critics point out that he does not have an economics background and say hisextensive business links could influence his decision-making. Mr Yturralde hasin fact gone on record in the past to oppose government policies and elementsof the IMF programme. Since then, however, he has toned down his commentsand has increasingly followed the government’s line.

The lack of a truly qualified economics team to back Mr Noboa extends to thepoliticised Banco Central del Ecuador (the Central Bank), which has failed toprovide sufficient technical advice to the government. Not a single member ofthe five-member board is a trained economist, and members have sometimesappeared to lack a sound grasp of economic issues when questioned in public.In addition, powerful interest groups wield undue influence over policydecisions. For example, the Ley de Restructuración Económica established thatthe maximum legal interest rate was to be determined by applying Libor pluscountry risk plus a maximum of 4 percentage points. This left the maximumpermissible interest rate far short of the nominal levels needed to compensatefor very high inflation. In June, under pressure from a small group oflegislators, the Central Bank further reduced the maximum rate from 24% to20%, reportedly to favour existing debtors. Following lengthy discussions withthe IMF, which opposes this discretionary management of interest rates, theCentral Bank and the government agreed to amend the legislation, establishinga new mechanism to set the maximum rate. The new proposal would fix themaximum rate at 1.5 times the average lending rate in the banking system.

Mr Noboa’s decision to establish a debt-negotiating committee separate from theMinistry of Finance is designed to reduce the risks of political disruption. In thepast, negotiations with creditors have been derailed as a succession of financeministers have fallen victim to the rough and tumble of domestic politics. Thecommittee will be headed by Jorge Gallardo, who previously served as financeminister in the Rodrigo Borja government in 1988-90. At the time of his appoint-ment he was acting as head of the government-owned Banco Continental.

In recent weeks public concern about the presence of US military personneland surveillance aircraft at the Manta airbase has grown. The revival of con-cerns followed the announcement of the approval by the US Congress offinancing for the Plan Colombia programme, designed to fight and controldrug-trafficking, as well as an attack on a military depot in the city ofEsmeraldas in which some 500 rifles and ammunition were stolen. The armsare suspected to have been diverted to Colombian guerrillas.

The government and the military have been trying to decide how best tosecure the northern border with Colombia. A reported rise in the number ofguerrillas from the Fuerzas Armadas Revolucionarias de Colombia (FARC)

US airbase prompts unease

16 Ecuador


crossing into the isolated border region to resupply and escape their pursuershas brought fears that the Colombian conflict could spill over into Ecuadoreanterritory. Some believe that by permitting the US presence at the militaryairbase in Manta, Ecuador has broken with its 40-year record of neutrality inthe Colombian conflict, despite repeated claims by both the government andUS embassy officials that US operations at the base will be directed solelytowards combating drug-trafficking.

Economic policy

A wide-ranging successor bill to the Ley de Transformación Económica (May2000, page 15), a major package of reforms needed to implement dollarisation,was submitted to Congress in July. The passage of this package is crucial togetting the privatisation programme under way. While a great deal of progresswas achieved by the first package, several details remain to be finalised,especially with regard to regulation, before the country can start to attract newinvestment. The new package contains a complex assortment of reforms toregulations governing telecommunications, energy, mining, petroleum, naturalgas, public utilities and the labour market. It also changes the formula fordetermining the maximum legal lending rate and eliminates the capitaltransactions tax (ICC), currently levied at 0.8%.

The privatisation reforms have generated considerable debate. The bill opensthe way for just about any conceivable version of privatisation, includingpublic enterprise capitalisation according to the Bolivian model (involving thesale of 50% stakes with management control in return for investment pledges).The bill also updates mining sector regulations dating back 30 years, whichhave held back the development of the industry. There is significant potentialin gold, copper, natural gas and many other minerals, and a more business-friendly legal environment should stimulate renewed investor interest.

The proposed labour reforms, which build on those approved in March, aredesigned to increase the flexibility of labour markets. Among the most importantof these is a reform of the mandatory employee profit-sharing requirement, underwhich 15% of a firm’s profits must be distributed to its employees. This regulationhas acted as a non-tax cost to businesses, deterring foreign investment. It has alsoled to the use of accounting methods that avoid reporting profits and hasdiscouraged public offerings on the local stockmarket. The profit-sharingrequirement is being capped at US$4,000 per employee and the amount formerlypayable above this limit is earmarked for the public education and health budgets.

The proposal to eliminate the ICC has been controversial, as the law does notenvisage an alternative that makes up for the revenue to be lost, which at thecurrent rate of 0.8% amounts to US$250-300m (about 2% of GDP). There isalso a concern that the efficiency of the Servicio de Rentas Internas (SRI,internal revenue service) in raising compliance with other taxes will beimpaired by the loss of information gleaned through the collection of the ICC.The IMF is seeking to maintain the tax, albeit at a lower rate, until 2001 tomitigate the impact on revenue.

The second major reformpackage is submitted

Ecuador 17


The IMF programme contemplates US$310m of financing, of which US$114mhas been disbursed. The government has also secured commitments from theInter-American Development Bank (IDB), World Bank and the CorporaciónAndina de Fomento (CAF, Andean Development Corporation) of US$3.1bn forthe next three years. These institutions have already approved various policy-and project-based loans for over US$300m. The World Bank has approved aUS$150m structural adjustment loan to finance fiscal reforms and an overhaulof the inefficient and corrupt customs system.

According to the IMF, the exchange of sucres for dollars has proceeded moresmoothly than expected. By the end of July the Banco Central del Ecuador(BCE, the Central Bank) had retired 78% of sucre notes and coins incirculation. Of the US$102m remaining, authorities expected to withdrawanother US$30-40m in notes before September 13th, the deadline for com-pletion of the exchange process. The remainder (about US$60-70m) will bereplaced by sucre coins with equivalent denominations to US coins (50, 25, 10,5, and 1 cent). About US$10m in US coins has already been put in circulation,but this is proving insufficient to meet transactions demand. The populationappears to have accepted the new currency, although there are bound to besome practical problems as only a small minority has experience as yet ofhandling dollars. By June all financial transactions and records were fullydollarised as cheques in sucres dated after June 13th ceased to be accepted andbanks converted their accounting systems to US dollars. The policy hasintroduced interest rate stability and a slow but steady return of businessconfidence to levels not seen in the past 18 months. However, the Achilles heelof the entire process has been rapid inflation (see The domestic economy).

Money supply under dollarisation(US$ m unless otherwise indicated)

Notes and coins in circulation Monetary base Liquid reserves

US$ m % change US$ m % change US$ m % change

1999Dec 577.9 – 770.2 – 872.1 –

2000Jan 457.3 –20.9 615.9 –20.0 852.0 –2.3Feb 442.7 –3.2 567.3 –7.9 909.2 6.7Mar 425.0 –4.0 631.2 11.3 778.4 –14.4Apr 339.0 –20.2 562.9 –10.8 938.2 20.5May 237.4 –30.0 439.3 –22.0 890.4 –5.1Jun 152.8 –35.6 364.9 –16.9 890.9 0.1Jul 102.4 –16.7 312.1 –10.2 889.9 –7.7

Source: Banco Central del Ecuador, Información Estadística Mensual.

The government took important steps in the stabilisation process in late May.The IMF programme included a group of measures to reduce the fiscal deficitby increasing the prices of subsidised fuels in June, and the government, understrong social and fiscal pressure, applied them one month early. The measuresincluded an average 60% increase in gasoline and diesel prices, in line with thepledges made in Ecuador’s letter of intent to the IMF. Regular gasoline rose to80 US cents per gallon from 48 US cents, diesel to 60 US cents and high octane

The first IMF reviewgoes well

18 Ecuador


fuel to US$1.20 per gallon. Jet fuel, bunker fuel, fuel oil and other industrialfuels were raised in price by between 170% to 300%. The latter were over andabove what the IMF programme called for and allowed the government topostpone an unpopular 40% increase in the price of cooking gas.

In an effort to alleviate the impact of the fuel price increases, the governmentestablished a series of compensation measures. The monthly minimum wagewas raised from US$51 to US$116, the bonos de solidaridad (solidarity bonds)were hiked to US$10 from US$5 per month, and social security benefits tothe elderly were increased. The government also increased public-sectorsalaries by between 51% and 70%, with lower-income earners obtaining thebiggest pay rises.

The fiscal result of the price increases and compensation measures was roughlyneutral. Expenditure grew to US$20m more than the expected revenue gains.However, the IMF let this pass, considering the continued strong performanceof world oil prices, which have averaged US$3/barrel above projected levels in2000, and strong tax collection results achieved by the SRI. Both of thesefactors point to a fiscal deficit of 3.9% of GDP or better, which meets theFund’s target. As such, after its first review in June, the IMF approved therelease of another US$34m.

Tax collection improved in the first half of 2000, mostly as a result of theongoing impact of the tax reforms and administrative changes carried out in1999 (1st quarter 2000, page 17). The reinstatement of income tax in April1999 was accompanied by efforts to reduce loopholes and abolish exemptionsto income tax and value-added tax (VAT). Perhaps more importantly, thereform significantly strengthened the tax authority’s powers of collection bygiving it the right to audit sales receipts and invoices. It also specified thatindividuals that did not pay or transfer retained taxes could be jailed. A furtherreform in September raised the VAT rate from 10% to 12% and similarlyeliminated exemptions and loopholes.

The SRI has improved the quality of its information systems, allowing it tomonitor a large number of previously unregistered businesses. The informationcollected from the capital transactions tax, the ICC, has helped to raise thenumber of registered value-added taxpayers from 150,000 at the start of 1999to 250,000 by July. The average number of applications for new taxpayerreference numbers, known as RUCs (registro unico de contribuyentes) increasedfrom 4,000 in 1999 to 13,500 in 2000. Similarly, the number of renewals forJanuary-May increased from 10,000 in 1999 to 27,000 in 2000.

Raised standards of administration are translating into higher collections.Despite the economic downturn in 1999, tax revenue increased by 6.6% in realsucres and 8.1% in terms of GDP. In the first half of 2000 total collections grewby 24% year on year when measured in US dollars and by 30% in real terms.However, this is not only the result of the higher VAT rate.

Tax collection improves

Ecuador 19


Tax revenue(US$ m unless otherwise indicated)

Jan-Jun Jan-Jun1998a 1999a 1998b 1999b 1999b 2000

Income tax 1.8 0.8 351.3 106.7 102 119

Indirect tax 13.8 15.9 2,722.4 2,188.9 467 588 VAT 4.2 4.2 825.3 571.6 299 379 Consumption excise tax 0.6 0.5 123.4 68.3 25 34 Capital transactions tax 0.0 2.3 0.0 320.8 120 146 Import tariffs 3.0 2.2 588.0 305.0 – – Social security contributions 2.3 1.6 447.9 225.8 – – Other 3.7 5.1 737.8 697.5 23 29

Total 15.6 16.7 3,073.7 2,295.6 569 707

a As a percentage of GDP. b Converted to US dollars using the average selling intervention ratepublished by the Banco Central del Ecuador.Source: Servicio de Rentas Internas.

This performance has surpassed the expectations of the IMF and thegovernment’s original revenue projections and was an important factor in theFund’s flexible stance on the May decision to postpone the reduction ofsubsidies on cooking gas. If the trend continues, along with high oil prices, it ispossible that the fiscal deficit target of 3.9% of GDP will be bettered.

An indispensable component of the government’s efforts to place the fiscalaccounts on a firmer footing is the restructuring of the public debt burden,which has reached unsustainable levels over the past two years. With thesupport of the IMF secured, the head of the debt negotiating committee, JorgeGallardo, unveiled the government’s debt restructuring proposal in late July.The centrepiece of the plan is a bond swap that would reduce the debt stockand arrears by around 40%. It would replace US$6.6bn of outstanding PAR,PDI, Discount, IE, and Eurobonds (plus debt service arrears) with two classes ofglobal bond: Global A (US$2.7bn) and Global B (US$1.25bn).

The plan establishes sanctions in the event that Ecuador does not fulfil itsliabilities during the first ten years. If arrears accrue during the first three years,Ecuador will have to issue new bonds for an amount equal to 1.3 times theirvalue. The factor will be 1.2 times after the fourth year and 1.1 after theseventh.

The IMF pledged its support at the end of July for the plan, which needs atleast 85% participation of current bondholders in order to be implemented.To win approval, Ecuador will have to overcome a problem of credibility, as ithas failed to meet the terms of past restructurings. The initial reactionssuggest that after some negotiations, a large number of creditors will be readyto accept the proposal, which calls for a smaller reduction in the debt stockthan the market expected.

Debt restructuring

20 Ecuador


Summary of bond restructuring proposal

Under the proposal, Ecuador has committed to pay up front US$140m of the US$183min arrears accumulated since August 1999 and the remainder once the Brady bonds’collateral is liquidated. Global A bonds have the following features:

• 30-year maturity and bullet amortisation in 2030.

• Bi-annual interest coupons of 4% per year during the first year, increasing by1 percentage point a year, starting in year two, until the interest rate reaches 10% in2007. The coupon remains fixed at that rate until maturity.

• A special clause allows Ecuador to buy back 3% of the bonds issued (aroundUS$81m) each year at market prices beginning in 2013. This would provide furtherreduction of the debt burden proportional to the market discount rate of the papers.

The proposed Global B bonds differ in the following ways:

• Maturity in 2012 and a bi-annual interest coupon of 12% per year.

• Repurchase clause allowing Ecuador to repurchase up to 10% of the original stockbeginning in year six.

• The bondholders that acquire Global A bonds may swap these for B bonds but suffera 35% discount.

A programme to restructure private bank loans greater than US$50,000 expiredin July having achieved little success. The programme, established with WorldBank and IMF backing, rescheduled debts over 5-7 years with a two-year graceperiod of lower interest rates, but many commercial debtors objected to theconditions attached. Participating firms were not allowed to make new capitalinvestments for the duration of the restructuring, were compelled to pay debt-service arrears up front in cash and had to produce a notarised sworn depos-ition stating that they did not have funds deposited or invested abroad.Debtors have asked for a new programme, the details of which the bankingsuperintendent will negotiate in Washington. Meanwhile, banks and debtorsare slowly carrying out voluntary restructurings.

The domestic economy

Economic trends

The economy performed better than expected in the first quarter of 2000,growing by 0.8%, seasonally adjusted, quarter on quarter, but GDP was downyear on year and output in constant sucres was the lowest for the first quartersince 1994. The quarter-on-quarter improvement resulted mostly from the

Loan restructuring

Output grew in the firstquarter

Ecuador 21


petroleum and mining sector, which expanded by 8% on the fourth quarter of1999 as soaring world oil prices stimulated higher output. Agriculture and retailgrew modestly. The two largest components of total output, manufacturing(accounting for 15% of GDP) and other non-government services (18% of GDP)contracted slightly. This slowdown is partly explained by severe negative realinterest rates, which delayed the resumption of lending to agriculture andconstruction, which are consequently lagging in the reactivation process.Agriculture will remain depressed because of the problems affecting shrimp andbananas (see below). Although national accounts data are not available for thesecond quarter, indications are that sectors such as manufacturing and retail arerebounding and should post positive growth.

Gross domestic product growth by sector(% change, quarter on quarter) 1999 2000

1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

Agriculture & fishing 1.4 –1.3 –4.0 –7.4 2.1

Mining & petroleum 1.6 0.8 –2.6 –2.5 8.0

Manufacturing –5.3 –2.4 2.6 2.9 –2.3

Electricity, gas & water 6.1 1.1 –4.8 5.7 1.5

Construction –10.5 –8.0 2.5 –5.1 –8.9

Retail –8.6 –5.3 0.7 0.3 2.0

Transport –12.2 1.2 –0.9 5.4 –2.5

Financial services –12.3 –7.6 4.5 7.3 3.6

Other non-government services –8.7 1.0 0.6 0.9 –2.0

Government services –16.5 –5.5 3.3 6.7 3.9

GDP –6.4 –1.9 0.1 –0.3 0.8

Source: Banco Central del Ecuador, Cuentas Trimestrales.

On the expenditure side, there were signs that the crisis was bottoming out,with quarter-on-quarter expansion led by higher government consumptionand positive real export growth. However, both private consumption and grossdomestic investment fell slightly, the latter contracting for the sixthconsecutive quarter. The fall in consumption can be partly explained by the25% devaluation of the sucre ahead of the announcement of dollarisation inmid-January and the uncertainty provoked by the change in government(1st quarter 2000, page 14). On a year-on-year basis, all expenditure itemsposted negative growth rates except government consumption.

Components of gross domestic product(% change, quarter on quarter) 1999 2000

1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

Private consumption –9.7 –2.1 0.9 2.3 –1.7

Government consumption –15.7 –4.1 3.5 6.2 3.7

Gross fixed investment –25.0 –17.4 –1.6 –3.3 –0.4

Exports –3.7 4.0 1.4 –9.3 2.4

Imports –31.0 –18.8 8.7 5.1 2.7

GDP –6.4 –1.9 0.1 –0.3 0.8

Source: Banco Central del Ecuador, Cuentas Trimestrales.

Government consumptionand exports lead growth

22 Ecuador


The economy showed signs in the second quarter of benefiting from thestabilisation imposed by the fixing of the exchange rate and a gradual return inconfidence. Although no official GDP figures have been released, the index ofeconomic activity (IDEAC) showed a 2% rise in economic activity betweenJanuary and April. Other indicators showed this positive trend continuing intoJuly, with a rise in demand deposits demonstrating greater confidence in thebanking system and urban unemployment in decline (see below).

Relative prices, which were misaligned by a 129-percentage-point gap at thebeginning of 2000 between consumer and producer price inflation, have begunto move towards equilibrium. At the end of June the consumer price index(CPI) showed annual inflation of 103.7% and accumulated inflation of 65%.Producer price inflation grew by 75% in the first six months of 2000 and wasup by 204.5% year on year. The gap between producer and consumer priceinflation therefore narrowed considerably in January-June. However, thereremains a backlog of inflationary pressures in the system. The fuel priceincreases implemented in May underpinned an 11% increase in the producerprice index (PPI) in June as the cost of transported goods (which have a 30%weighting in the index) rose by 33.8%.

A stable exchange rateimproves confidence

Consumer prices catch upwith producer prices

Ecuador 23


High inflation has eroded real wages, with the value of the monthly minimumwage tumbling from US$101 in March 1999 to US$49 in March 2000. Thegovernment was forced to increase the minimum wage twice in the first half of2000. In March nominal wages were increased by US$20 (41%), and followingprotests by teachers and health workers the government raised the minimumsalary by another 68%, to US$116 per month. Demands for further increasesare likely as inflation continues for the remainder of the year.

An increase in urban employment in the second quarter provides furtherevidence that an economic recovery is under way. In Ecuador’s three largestcities (Quito, Guayaquil, and Cuenca) the unemployment rate fell by3.1 percentage points, from its peak of 17% in February 2000. The chambersof commerce and industry have reported increases in sales of about 50%since February 2000, reflecting the rise in employment and a fall inunderemployment.

Lower unemploymentprovides sign of recovery

24 Ecuador


Agriculture

In the first quarter of 2000 agriculture grew by about 2.1% year on year. Outputof certain basic foodstuffs, including sugar, rice and potatoes, recovered despitecontinued financing constraints. Currency depreciation made agriculturalproducts very competitive relative to neighbouring Colombia and Peru.Farmers were able to exploit price differentials at the Peruvian border of up to300% for some products, exporting (mostly by smuggling) cattle, chicken, milkand vegetables.

Higher tuna production boosted fishing and overall sector output in thesecond quarter, but shrimp cultivation continued to be seriously blighted bydisease. This problem will not be fully overcome unless a majority of shrimpfarmers can obtain financing to restock their pools with disease-free, laboratoryspecimens. The Cámara Nacional de Acuacultura (CNA, National AquacultureChamber) is pessimistic about the sector’s prospects for recovery in the secondhalf of the year.

Overall, the agriculture and fishing sector is expected to continue to recoverslowly as the good performance of some subsectors is offset by setbacks to keyareas such as flowers, shrimp, bananas and coffee. These continue to beaffected by external factors and the financial system’s lack of readiness to fundnew projects and refinance existing debts.

Oil and gas

Oil production grew by 5.8% year on year in January-May. Work to expand theSistema de Oleoducto Trans-Ecuatoriano (SOTE, the cross-country oil pipeline)has increased its output capacity. In line with this expansion, the averagevolume transported per day increased by 6.8% year on year in the same period.The value of oil exports has also increased, by 300% year on year in the firstquarter of 2000, thanks mainly to the continued rise in world prices, whichsent the average price for Ecuador’s crude from US$7/barrel in January 1999 tomore than US$24/b in March 2000.

Oil production and exports

Jan-May Jan-May1999 1999 2000 % change

Exports (’000 barrels) Crude 84,653 32,570 36,302 11.5% Derivatives 13,646 6,857 6,998 2.1%

Production (b/d) Crude 373,405 371,331 392,913 5.8%

Memorandum items: Average crude price (US$/b) 15.12 10.50 23.65 125.2% Volume transported (b/d) 354,214 351,317 375,162 6.8%

Source: Petroecuador.

Output of domestic cropsrises

Pipeline expansion raisestransport capacity

Ecuador 25


The expansion of SOTE was finally completed in early July, allowing an in-crease in the volume transported from an average of 330,000 barrels/day to390,000 b/d. The expansion began to take effect with a 30,000 b/d rise in April,with transport capacity increasing every month until the last new pumps wereinstalled in July. In July President Gustavo Noboa also announced an executivedecree to establish the framework and rules for the presentation and selectionof bids from private investors interested in constructing the second pipeline forheavy crude, known as the Oleoducto de Crudo Pesado (OCP). The decreedetermined that the offers must be submitted within 30 days (mid-August) andthat the government would have 90 days to select the winner of theconcession. If all goes according to schedule, the contract should be signedduring the fourth quarter. After a construction phase expected to take about 18months, the OCP will begin to operate at the end of 2002. It will doubleproduction and export capacity, although there will be a lag before productioncan be stepped up to take full advantage of this. The project is expected tobring US$500m in foreign investment.

The project also provides the opportunity to engage in some form of oil-backedfiscal financing in the near future. The government has been negotiating withvarious parties, and such an agreement could be struck once construction ofthe OCP is seen to be under way.

Also in July, the Consejo de Comercio Exterior e Inversiones (Comexi) resolvedto eliminate all import tariffs and surcharges on the import of fuels. As part of ageneral strategy to liberalise local gasoline and diesel markets, the energyminister is expected to approve the resolution, the first step in a process whichalso includes plans to give concessions for the construction of new refineries.The government still needs to resolve the elimination of the subsidies currentlyin place and the introduction of a gasoline tax. However, the timing of thesechanges is still being determined.

Financial and other services

The financial system underwent a deep restructuring in the first part of 2000.The stabilisation of the currency under dollarisation has helped in that debtorsare beginning to be able to afford repayments. However, by eliminating thesucre-dollar foreign-exchange market it has removed the principal source ofprofit for many banks, many of which are ill-prepared to make a living fromtraditional lending activities. Profits from currency trading sustained manybanks through 1999 when otherwise they might have failed. During the firstquarter of this year value added in the sector (as reported in the nationalaccounts) grew by 7.4% year on year and by 3.6% quarter on quarter,representing the third straight period of positive quarter-on-quarter growth.The stability brought by the new monetary system has allowed banks to beginto recover.

Energy minister expectedto scrap fuel import tariffs

Stabilisation eases debtorrepayments

26 Ecuador


Financial services(% change in output)

1999 20001 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

Quarter on quarter –12.3 –7.6 4.5 7.3 3.6

Year on year –13.6 –18.8 –14.0 –9.1 7.4

Source: Banco Central del Ecuador

In the first five months of 2000 demand deposits increased by US$328m, or47%. This increase in liquidity was in part due to the release of frozen funds,but also to a return of confidence in the banking system. Term deposits alsoincreased, but at a more modest 5%. The difference can be explained by thepreference of depositors for higher liquidity instruments and a propensity toconsume in the presence of high negative real interest rates. Negative real ratesare also limiting credit growth, as banks are unwilling to lend at nominal ratesfar below inflation.

Bank deposits and loans(US$ m unless otherwise indicated)

Term and Demand deposits saving deposits Credit

US$ m % change US$ m % change US$ m % change

1999Dec 696.6 – 2,306.5 – 4,881.4 –

2000Jan 649.2 –6.8 2,093.5 –9.2 4,558.2 –6.6Feb 726.5 11.9 2,102.4 0.4 4,519.9 –0.8Mar 835.4 15.0 2,091.5 –0.5 4,339.0 –4.0Apr 851.4 1.9 2,262.9 8.2 4,375.5 0.8May 968.1 13.7 2,384.5 5.4 4,452.9 1.8Jun 968.8 0.1 2,419.4 1.5 – –Jul 15th 1,024.4 5.7 2,432.9 0.6 – –

Increase Dec-Jul 327.8 47.0 126.4 5.0 –428.5 –9.0


During the first five months of 2000, for the system as a whole, the ratio ofperforming loans to total loans rose steadily and the bad loan ratio stabilised.However, there were marked differences between private banks, public banks stillin operation and those banks that have been closed down. For the bankingsector as a whole the bad loan/total loan ratio was 50% in May, a figure inflatedby the public banks, which account for the majority of defaulted loans: whileprivate banks had bad loan ratios averaging 14% in January-May, public bankshad a 71% ratio. Operating results for the first five months show that state-owned banks accounted for most of the US$32m losses of the banking system,while private banks as a whole recorded profits of US$3.7m. During the secondquarter the health of the financial sector improved as deposits rose andexchange-rate stability made it easier for borrowers to service their debts.

The government is using a variety of methods to clean up the banking system.Closed banks are being liquidated and the Agencia de Garantía de Depositos(AGD, the Deposit Insurance Agency) is trying to recover funds by selling off

Demand deposits rise

Public banks suffer from ahigh bad loan ratio

Ecuador 27


their physical assets. By June the AGD had paid out US$275m of the US$1.1bnit owed to depositors in the banking system, reimbursing 650,000 depositors.The remaining US$825m to be returned belonged to about 12% of depositors.The government has made significant efforts to make good on the unlimitedinsurance, but faces a difficult task. One mechanism being used to compensatethe remaining savers is to allow certificados de depositos reprogramados (CDRs,reprogrammed certificates of deposit, which froze the deposits for 5-7 years) inclosed banks to be used to pay off debts, purchase fixed assets of the banks,make limited capital provisions to businesses, and pay up to 50% of incometaxes. The mechanism is allowing large depositors that stand little chance ofgetting their deposits back to use these funds. By accepting the CDRs for taxobligations, the government in effect cancels the debt with current assets.

To recover more of the money tied up by the banking crisis, the government isalso preparing the sale of some of the functioning public banks, after mergingsome of the institutions to make them more attractive to foreign investors. Thetwo “megabanks” to be sold are the result of the Filanbanco-Previsora andBanco Continental-Pacífico mergers. The Filanbanco-Previsora merger createdthe largest bank in the system, representing 25% of the market and holdingUS$1.1bn in assets. The merger of Continental and Pacífico would groupUS$570m in assets and would rank as Ecuador’s third largest banking insti-tution, with 12.9% of market share. Although the authorities will try to sell thebanks as soon as possible, any sales are unlikely to occur before the end of 2000and will have to wait until after Ecuador renegotiates its foreign debt. There areworries that the capital inadequacies and bad debt problems of these banks,when combined, risk creating a bigger headache for potential purchasers.

Tourism is the fourth largest export earner behind oil, bananas and shrimp. In1999, direct receipts from tourism totalled US$343m, despite the bad publicitygenerated by political turmoil and the re-awakening of the Pichincha volcano,situated just 8 km from Quito. The country has great untapped tourismpotential, offering a wide range of attractions: the Galapagos Islands, beaches,the Amazon Basin and a unique biodiversity. The recent peace treaty with Peruhas led to the establishment of new direct flight routes between the twocountries, enabling tour operators to offer combined tourism packages thatinclude both countries.

The government recognises that the importance of the sector is greater thanthe foreign exchange earned. The Ministry of Tourism argues that for everydirect job created from tourism, more than a dozen people receive benefitsfrom tourist expenditure.

Tourism

1996 1997 1998 1999

Tourism receipts (US$ m) 281 290 291 343

Total visitor arrivals 493,727 529,492 510,600 n/a

Visitors from US (% of total) 25 29 22 n/a

Visitors from Colombia (% of total) 39 37 32 n/a

Source: Banco Central del Ecuador.

Tourism revenue buoyantdespite negative publicity

28 Ecuador


Foreign trade and payments

Oil earnings grew by 138% year on year in the first five months of 2000 on theback of higher world prices. However, the dismal performance of most non-oilexports continued during the second quarter. After declining by 9% in 1999,they fell by 32% in January-May. Shrimp exports contracted by nearly two-thirds as the white spot virus continued to afflict production. Proceeds frombananas, the second largest export, also fell in comparison with the year-earlierperiod. Some non-traditional exports, however, began to recover as adepreciated real exchange rate made them more competitive in the regionalmarket. Vehicle exports grew by more than 175% in the first five months of theyear and are expected to increase further following the announcement byGeneral Motors of Ecuador of ambitious plans to export to neighbouringcountries. Textiles and leather and plastic goods exports also rose considerably.Overall however, non-traditional exports fell slightly, as the performance of thetwo largest components, fresh flowers and canned fish, was disappointing inthe first half.

Merchandise exports, Jan-May(US$ m; fob)

1999 2000 % change

Traditional exports 1287.7 1578.4 22.6 Oil 413.1 983.2 138.0 Crude 348.0 857.6 146.4 Products 65.1 125.6 92.9 Non-oil 874.6 595.2 –31.9 Bananas 459.9 402.3 –12.5 Shrimp 311.7 119.8 –61.6 Cocoa beans & products 48.8 29.5 –39.5 Coffee beans & products 18.0 13.2 –26.7 Tuna & other fish 36.2 30.4 –16.0

Non-traditional exports 466.0 451.6 –3.1 Canned fish 113.8 98.0 –13.9 Vehicles 6.5 18.0 176.9 Metal manufactures 29.1 24.8 –14.8 Flowers 84.1 65.6 –22.0 Textiles 5.7 6.9 21.1 Chemicals 22.5 22.3 –0.9 Leather, plastic & rubber manufactures 24.2 28.1 16.1 Fruits juices & conserves 30.2 27.6 –8.6 Fishmeal 5.4 5.7 5.6 Others 144.5 154.7 7.1

Total exports 1,753.7 2,029.9 15.7


The reactivation of much of the export sector remains severely constrained bythe financial crisis and weak prices for soft commodities. The credit crunch isexpected to diminish gradually towards the end of the year as the return ofmarginally positive medium-term real interest rates encourages banks to beginlending again.

Oil earnings soar but non-oil exports disappoint

Ecuador 29


Merchandise imports , Jan-May(US$ m; fob)

1999 2000 % change

Consumer goods 227 187 –17.6 Non-durables 159 133 –16.4 Durables 68 54 –20.6

Raw materials 527 488 –7.4 Agriculture 86 70 –18.6 Industrial 400 390 –2.5 Construction 40 28 –30.0

Capital goods 406 251 –38.2 Agriculture 12 5 –58.3 Industrial 272 168 –38.2 Transport equipment 122 78 –36.1

Fuel & lubricants 74 114 54.1

Total imports 1,233 1,041 –15.6


The effects of the 1999 economic crisis were still evident in the low demand forimports observed in the first half of the year. Imports fell by 15.6% in January-May year on year. Imports have remained fairly stable in 2000, at an average ofUS$208m per month, or about half the 1998 level. They should recover in theremainder of the year as the real exchange rate continues to appreciate. Thepace of this recovery will also be dependent on the easing of credit lines fromdomestic banks.

Balance of payments(US$ m)

1999 20001 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

Trade balance 125 553 511 476 591 Merchandise exports 1,001 1,117 1,147 1,186 1,230 Merchandise imports 876 564 636 710 639

Service and income balance –520 –405 –466 –417 –476 Credits 214 213 210 224 227 Debits 734 618 676 641 703 of which: interest payments 324 234 294 253 314

Net transfers 267 235 273 326 301

Current-account balance –128 383 318 385 416

Net foreign direct investment 176 180 134 146 200

Net public debt 124 147 129 111 –11

Net private debt –227 –159 –12 –223 –84

Other short-term capital –465 –433 –591 –417 –728

Capital account balance –392 –265 –340 –383 –623

Change in reserves (– denotes increase) 520 –118 22 –2 207


In the first quarter of 2000 the current account posted a US$416m surplus, upslightly on the fourth quarter of 1999 despite a US$61m increase in interestpayments. Export growth, mostly as a result of high world oil prices, and a

Imports fall in the firsthalf of the year

Current-account surpluswidens

30 Ecuador


decline in imports led to an increased trade surplus. The non-oil trade balanceposted a US$90m surplus in January-May. However, because imports remainedroughly constant while non-oil exports fell steadily, the non-oil trade surplusdeclined.

The current-account surplus continued to be supported in the first quarter by ahigh level of net current transfers. Although a breakdown that separates privatefrom official transfers is not available, from the annual balance of payments wecan deduce that most of the increase corresponds to private unrequitedtransfers. It appears that the large-scale emigration that has taken place overthe past couple of years has produced a corresponding increase in remittances.

The capital account showed a US$54m increase in net foreign investmentcompared with the fourth quarter of 1999, a marked slowdown in private debtoutflows and a US$207m decline in reserves caused by the dollarisationprocess, through which US notes and coins were substituted for sucres. Othershort-term flows included an estimated US$300m in capital flight.

Documents

Ecuador - iuj.ac.jp€¦ · Ecuador August 2000 The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom At a glance: 2000-01 OVERVIEW The EIU’s forecast assumes