Ecuador and the IMF |
Country's Policy Intentions Documents
of Intent, Memorandum of Economic and Financial Policies, and Technical
Memorandum of Understanding
Mr. Horst Köhler
International Monetary Fund
Washington, D.C. 20431
Dear Mr. Köhler:
The attached policy memorandum and annexes describe the economic policies and objectives of the government of Ecuador for the period March 2003-March 2004, in support of which the government requests a 13-month Stand-By Arrangement from the Fund in the amount of SDR 151 million (46 percent of quota on an annual basis). The government is convinced that these policies will promote sustainable growth while addressing priority social needs, controlling inflation, strengthening public sector solvency, and bolstering external viability.
During the period of the arrangement, the government will maintain close relations with the Fund, including regarding the adoption of any measures that may be needed to achieve the program's objectives, in accordance with the Fund's practices. In particular, it will take additional measures during the arrangement, including on the fiscal side, if the expected decline in the rate of inflation does not materialize, the external current account deficit rises above that envisaged in the program (unless it reflects additional FDI), or the fiscal program appears to be moving off-track. The government will not incur any new domestic or external arrears at any time during the arrangement, nor impose new international trade restrictions, and it will maintain prudent borrowing practices to reduce the debt to GDP ratio.
The government is returning gradually the blocked deposits in closed banks managed by the Deposit Guarantee Agency. This is an exchange restriction subject to Article VIII of the Fund's Articles of Agreement, for which the government requests approval until end-2003. The Government also requests that the repurchase expectations arising during the arrangement period be moved to an obligations basis, equivalent to SDR 14 million (4.7 percent of quota).
Four reviews are envisaged, no later than end-June, September, December 2003, and March 2004. The first review will assess progress under the program, including with respect to the government's efforts to focus subsidies more equitably and restarting the structural reforms.
The government is committed to maintain prudent macroeconomic policies and building further on its reform program in 2004. While at this time, the government does not envisage a need for additional financing from the Fund beyond the present arrangement, we will maintain close relations with the Fund, and for this purpose we plan to request a precautionary arrangement with the Fund for 2004.
Ecuador—Memorandum of Economic Policies
1. In early 2000, after a severe economic and political crisis, Ecuador formally replaced the Sucre with the U.S. dollar. With this strong exchange rate anchor, the economy quickly stabilized and started to recover, led by domestic demand. The recovery was also helped by rising oil prices and by debt relief through the restructuring of Brady bonds and a rescheduling of Paris Club obligations. However, after a promising start, fiscal policies in 2001-02 were not strengthened in step with the requirements of dollarization, as public sector wages ballooned, imposing significant fiscal rigidities for the subsequent years, and the primary surplus declined. Moreover, while the banking system recovered rapidly after the economic crisis, there was little progress in cleaning up closed banks, and the privatization program of public enterprises and other important structural reforms were halted. As a result of these slippages, by end-2002, the central government was again facing domestic and external payments arrears, the treasury was running out of cash with few options to obtain new financing, and economic activity was slowing.
II. The Economic Program for 2003
2. The government of President Gutierrez was inaugurated on January 15, 2003, and it already has adopted specific economic measures to correct the situation described above. The main objective of the government is to improve the living conditions of all Ecuadorans, particularly the poor, through sustained growth with low inflation, improvements in the social safety net, and the provision of better public services. Ecuador remains committed to dollarization, and sustained growth under dollarization requires achieving a strong fiscal position, fully restoring credit worthiness, and structural reforms to improve the economy's competitiveness. The economic program for 2003 reflects these policy objectives.
A. The Macroeconomic Framework
3. The macroeconomic framework for 2003 projects moderate output growth, with continued progress in lowering inflation. Output growth in 2003 is projected to be around 3½ percent, led by an expansion of oil exports, although there will be some slowing of investment after the completion of the new oil pipeline (OCP). Consumption is expected to expand at a more moderate pace from previous years following a period of catch-up spending on consumer durables. The widening in the external current account deficit is expected to moderate in 2003, while consumer price inflation is projected to decline to around 6 percent by end-2003, notwithstanding an increase in some administered prices.
4. Sustained prudent fiscal policies and continued structural reforms are essential to achieving strong output growth and other medium-term goals. The fiscal primary surplus will need to be maintained at a high level in 2004 and beyond, while revenues from extra oil exports will be used in large part to reduce the public debt. The government is confident that a diligent implementation of this strategy will boost confidence in fiscal and debt sustainability and bring down the current account deficit, consistent with dollarization, thus contributing to reducing significantly the very high interest rates and EMBI risk spread still faced by Ecuador. Bringing down risk spreads will enhance private sector growth.
B. Fiscal Policies
5. The government's fiscal policies are geared towards the following main objectives: (i) resolving immediate liquidity pressures and regularizing arrears left by the previous administration; (ii) tightening the fiscal stance to recover from the slippages of 2001 and 2002; (iii) protecting the poor by stabilizing their income levels and strengthening social programs; and (iv) improving the flexibility of fiscal policy and prioritizing expenditures.
6. The public sector needs a strong primary balance to bring down inflation, to narrow the large external current account deficit, and to meet debt servicing obligations. Within one week of taking office, the government implemented a set of corrective measures, described below, consistent with strengthening the primary balance of the nonfinancial public sector (NFPS) from 4.5 percent of GDP in 2002 to 5.2 percent in 2003. The overall NFPS balance in 2003 is targeted to be US$509 million, or 1.9 percent of GDP, resulting in a drop of the public sector debt ratio from 59 percent of GDP at end-2002 to 52 percent by end-2003.
7. Revenues of the NFPS are programmed to increase by 0.9 percentage points to 26.9 percent of GDP in 2003. As a cornerstone of the adjustment effort, on January 19, the prices for fuels were increased by an average of 25 percent, yielding close to US$400 million (1.5 percent of GDP) in 2003. This step was complemented by resolutions issued by COMEXI reversing selective and highly distortionary import tariff cuts (for US$30 million; see prior actions, item 6) that were implemented in the last few weeks of the outgoing administration. The government is also committed to reducing subsidies on government services, including in utility prices. By August, the government is also seeking approval of legislation to unify the public sector wage structure (see paragraph 13), which is projected to yield US$20 million in 2003 in additional social security revenues.
8. Primary expenditures of the NFPS are projected to stabilize at 21.7 percent of GDP in 2003.
9. Efforts to strengthen the social security system will continue. With technical assistance from international institutions, the government will assess the operating procedures and actuarial balances of the three social security funds (IESS, ISFA, ISPOL) by end-September 2003. This assessment is intended to result in a reform strategy aimed at ensuring a reasonable and reliable income for retirees on a sustainable basis, including by eliminating the actuarial deficits and minimizing transfers from the central government.
10. The government wants to target the cooking gas subsidy more equitably. The current large subsidy is an important distortion in the economy, gives rise to smuggling and corruption, and benefits disproportionately the higher income groups in society. In the first semester, the government will undertake a project, with help from the IDB, to improve the data base of the bono solidario to focus better the cash assistance on the truly poor, and remove the subsidy in the cooking gas price. These steps are programmed to yield US$40 million (net) in 2003.
11. The financing requirements of the non-financial public sector in 2003 are projected to amount to nearly US$2.0 billion. The main component is debt amortization, which is projected to amount to US$1.2 billion (including a US$29 million debt reduction in the last quarter of the year from the new oil stabilization fund (FEIREP)). Also included are nonreschedulable external arrears (amounting to some US$100 million), which will be cleared as a prior action under the program, and domestic arrears, estimated at US$0.4 billion that are also being cleared. The financing needs are programmed to be met from the fiscal surplus of US$0.5 billion; rolling over some US$0.4 billion of domestic debt falling due in the year; US$0.3 billion in project financing; and with exceptional program financing of just over US$0.6 billion (US$130 million from the World Bank, US$100 million from the IDB and the CAF each, US$160 million from the Fund, and the government is seeking cooperation of Paris Club and other official creditors to resolve intrayear cash flow pressures through US$150 million in external debt rescheduling). With these amounts, the 2003 program would be fully financed. Ecuador will not seek an oil-backed loan.
12. The budget for 2003, which is expected to be approved in congress before end-February, is consistent with the program. The budget includes a freeze on wages (see prior actions, item 9) and is based on an oil price assumption of US$18 per barrel for Ecuador mix. If realized petroleum revenues fall below the programmed level, the government would fully compensate the shortfall with expenditure cuts. If petroleum revenues turn out higher than programmed, they will be used in full to build up central government deposits in the central bank (in the Fondo de Estabilizacion Petrolero por Liquidar) or to lower the public debt. Any higher than programmed revenues for the social security system will also be saved, and used to increase its asset base. Finally, to protect budgetary revenue, the government has issued regulations to the new tourism law that prevent the opening of new tax loopholes.
13. While these policies address immediate fiscal needs, the government will also send several bills to congress this year to bolster the fiscal and structural outlook for 2004 and the medium term.
14. The reforms described above will provide the basis to achieve an overall budget surplus on an enduring basis, with the objective of reducing the public sector debt. The new private sector oil pipeline (the OCP) has the capacity to more than double oil exports, which significantly boosts the medium-term prospects for exports and growth. However, this increase could also intensify the dependence on oil and Dutch disease problems in the economy, if the new oil revenues are not managed prudently. Therefore, in January 2003, and as a prior action for the program, the government issued regulations to put in place the Fiscal Responsibility and Transparency Law that was adopted by congress in September 2002. A key aspect of the legislation and its regulation is that the bulk of the public sector revenues accruing from the new pipeline will not be used to augment current spending but rather be placed in an oil stabilization fund (the FEIREP). Ten percent of the resources in the FEIREP are dedicated to social spending; 20 percent will be saved to help deal with contingencies, such as a natural disaster or a sharp decline in oil prices; and 70 percent would be dedicated to debt buybacks (not for regularly scheduled budgetary amortizations). The new pipeline is expected to come on stream in the last quarter of 2003. The government's medium-term policy of fiscal surpluses, combined with the debt buyback capacity from the FEIREP, are projected to reduce the debt to GDP ratio from 59 percent at end 2002 to below 40 percent by end-2006, as stipulated in the Fiscal Responsibility and Transparency Law.
C. Financial System Policies
15. The government will make a strong and immediate effort to liquidate Filanbanco and at least eight of the closed banks in the AGD to end the painful experience of the 1999 banking crisis. This has priority because the unpaid debts in the moribund banks tolerate the damaging culture of nonpayment of debts, while some deposits still remain blocked. Moreover, with technical assistance from the Fund and others, the government will also continue to develop more comprehensive policies to maintain a sound financial system. These include the reinforcement of banking supervision, reforming the liquidity support system, and improving mechanisms for the recovery of nonperforming loans.
16. Filanbanco. By end-February 2003, and as a prior action under the program, the authorities will sign contracts with independent firms that will manage the trust fund containing the fixed assets of Filanbanco, and to recover/sell the loan portfolio of the bank. The proceeds from the portfolio recovery will be distributed to claimants via a second trust fund that also already has been constituted to facilitate the liquidation of the bank. The return of deposits and other liabilities from the trust funds will begin in March and be completed by end-December 2003.
17. The liquidation of the closed banks held in the deposit guarantee agency (AGD) will be done in two steps. First, the legally required independent audits of at least 8 banks will be conducted by end-April 2003. The contracts for these audits will be signed as a prior action under the program. Once audited, the banks will be placed into formal liquidation before end-May 2003. Then, the remaining assets and liabilities of these banks will be placed into trust funds, managed by independent managers, as with Filanbanco, in accordance with the contracts to be signed by end-June 2003 (see structural performance benchmark, item 8). These managers are to conduct the sale of assets and return the blocked deposits and other liabilities before end-December 2003. For the other 10 banks in the AGD, the government will move expeditiously to remove the legal obstacles to their liquidation.
18. Parallel with the efforts to liquidate the AGD banks, the private sector debt portfolios of these banks that were already restructured will be auctioned off by end-March 2003. Any cash proceeds produced by the auctions will be used to pay off the blocked deposits first, before settling any other liabilities.
19. The privatization of Banco del Pacífico will be conducted in two-steps. First, before end-March 2003, the bank itself will hire an international investment firm. This firm will then conduct an analysis of the bank, so that Pacífico is brought to the point of sale by end-July 2003.
D. Other Structural Policies
20. Strengthening competitiveness is essential for sustaining growth and preserving dollarization in Ecuador. Fiscal expenditures have driven up costs in the economy, and these outlays need to be controlled as described above. At the same time, productivity growth needs to be accelerated with structural reforms. In this area, the government is implementing several measures in 2003:
Ecuador—Technical Memorandum of Understanding
1. This Technical Memorandum of Understanding (TMU) defines the quantitative performance criteria under the program as presented in Tables 1 and 2 attached to the Letter of Intent (LOI) of February 10, 2003, and the Memorandum of Economic Policies (MEP).
2. Ceiling on the NFPS overall balance. The NFPS comprises the central government, the municipal and provincial governments, the public sector enterprises, the social security institute (IESS), the Development Bank of Ecuador (BEDE), port authorities, universities, and NFPS autonomous agencies and funds. The NFPS overall balance is measured from below the line, defined as the change in the NFPS gross debt, minus the change in public sector deposits in the Central Bank of Ecuador (BCE) and in the commercial banks (defined in point 4). NFPS gross debt comprises total registered NFPS gross debt (defined in point 6), and external and domestic arrears and accounts payable (as defined in point 7). For purposes of measuring the NFPS overall balance, the debt outstanding at end-December of the previous year is valued during the present year at the constant U.S. dollar-third currency exchange rate of end-December of the previous year. New debt flows incurred during the program period are valued at the exchange rate of the day the debt is issued. Privatization receipts and other forms of below-the-line debt reduction are excluded for purposes of measuring compliance with the NFPS overall balance. For purposes of measuring the NFPS overall balance under the program, the amount of any forward sale of oil will be added to the registered debt; this debt will be considered amortized at the moment the oil is delivered (i.e., any nonspot oil sales are treated as asset-backed debt financing).
As indicated in paragraph 12 of the MEP, the NFPS overall balance will be adjusted upward by the amount of petroleum revenues accrued to the budget that are in excess of those assumed in the program (shortfalls of petroleum revenues must be compensated by expenditure cuts). The cumulative amount of petroleum revenues accruing to the budget, as assumed in the program, is US$429 million for the period January-March 2003; US$803 million for the period January-June; US$1,209 million or the period January-September; and US$1,595 million for the period January-December 2003.
3. Ceiling on the NFPS noninterest expenditure. NFPS noninterest expenditure comprises all current and capital spending (including net lending) of the public sector as reflected in the table on Public Sector Operations in the staff report.
4. Floor on the stock of public sector deposits in the BCE and in the commercial banks. Public sector deposits are defined as all deposits held by the NFPS in the BCE and the commercial banks as reflected in the table on The Public Sector Balance Sheet (preliminary), in the staff report. The floor applies to the average of end-of-month deposits during the relevant calendar quarter.
5. Floor on the central government deposits in the cuenta única in the BCE. This stock of deposits is defined as those deposits owned by the central government and held in the cuenta única in the BCE. The floor applies to the average of end-of-month deposits during the relevant calendar quarter, as reported in line 231105 (cuenta corriente única) of the central bank Fund reporting Table 10-R.
6. Ceiling on the stock of registered public sector gross debt, recorded on a disbursement basis. The public sector comprises the NFPS (as defined in point 2) and the financial public sector (comprising the Central Bank of Ecuador (BCE), the National Development Corporation (CFN), The National Development Bank (BNF), and The Housing Bank of Ecuador (BEV)). The stock of registered public sector gross debt (defined as all current debt and principal in arrears on external debt; it excludes domestic debt servicing arrears and external interest in arrears) is defined as the total domestic and foreign debt of the nonfinancial and financial public sector, and government guaranteed debt, as reflected in the below-the-line fiscal accounts and in the table on The Public Sector Balance Sheet (preliminary), in the staff report. The term debt will be understood to mean a current, i.e. not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:
(i) loans, i.e., advances of money to the obligator by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully-collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);
(ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and
(iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lesser retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.
7. Under the definition of debt set out above, arrears, penalties, and judicially awarded damages arising from the failure to make repayment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt. For purposes of this ceiling, the debt includes any amount of oil sold forward; this debt will be considered amortized at the moment the oil is delivered (i.e., any nonspot oil sales are treated as asset-backed debt financing).
8. External and Domestic Arrears and Arrears Clearance. The attached Table 2 on the arrears clearance program for 2003 presents the stocks, at end-of-period, of identified external and domestic arrears, and a schedule of the clearance for these arrears. Domestic arrears are those identified by the treasury of the central government only. The public sector (as defined in point 6) will not accumulate at any time during the arrangement period any new arrears, domestic or external.