## 1. Pre-Pandemic Bottlenecks and Vulnerabilities

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### Introduction and growth outlook
- Ecuador’s potential growth:
  - About 4 percent during 2001-2014.
  - A meagre 1 percent over 2015-2019.
- Without structural reforms, the pandemic could cause permanent scarring and sluggish potential growth of around 1.5 percent.
- Structural reforms in labor market, financial sector, external finance, and trade can boost growth up to 4 percent.

### Pre-pandemic growth performance and drivers of slowdown
- Methods to estimate potential GDP growth:
  - Hodrick–Prescott (HP) filter on annual real GDP.
  - Production function (PF) approach using Cobb-Douglas: Y = A * K^∝ * (L * H)^(1−∝), where A is TFP.
- Key supply-side and demand-side drivers (2015-2019):
  - TFP decline was the main supply-side driver.
  - Capital contribution declined modestly; labor contribution fell gradually.
  - Positive correlation between growth/TFP and oil prices: high oil prices financed greater public and infrastructure investment with positive spillovers to TFP.
  - Permanently lower fiscal spending (notably public investment) after the oil price shock reduced aggregate demand.
  - Structural barriers limited private demand and net exports: overvalued real exchange rate, rigid labor markets, difficult business climate, and low competitiveness.

### Macroeconomic and sectoral impact of COVID-19
- GDP and activity:
  - Actual GDP collapsed by record 7.8 percent in 2020.
  - Economic activity fell by 12.8 percent (y-o-y) in 2020:Q2.
- Sectoral effects:
  - High-contact service sectors accounted for about 43 percent of gross value added pre-pandemic.
  - High-contact sectors fell by about 12 ½ percent in 2020:Q2 (q-o-q), driven by transportation, accommodation and restaurant services.
  - As of end-2020, most high-contact sectors failed to recover about 10 percent of their 2019 output.
- Labor market and scarring mechanisms:
  - Elevated unemployment driven by job losses in high-contact sectors; job quality below adequate levels.
  - Permanent scarring channels:
    - Prolonged unemployment reducing human capital.
    - Permanent loss of jobs, firms, and activities → permanent unemployment and stranded capital.
    - Shift toward working from home in services → stranded physical capital and lower investment.
  - Historical evidence:
    - Average long-term per capita output loss around 7 percent; in severest cases up to 10 percent (IMF, 2021).
    - Past pandemics imply capital and TFP losses around 4 ½ and 2 percentage points, respectively.

### Long-term output loss scenarios for Ecuador
- Optimistic scenario:
  - Permanent loss of 2½ percent by 2030 (assumes no change in TFP, average fall in labor, lowest fall in capital from past pandemics).
- Realistic scenario:
  - Permanent loss of about 6½ percent of pre-pandemic output (assumes TFP permanently lower by 1 percentage points, capital and labor loss at the average of past pandemics).
- Pessimistic scenario:
  - Permanent loss of about 9 percent over the long term (larger declines in TFP and labor contributions).

### Reform options to boost long-term growth
- Evidence on growth dividends:
  - Comprehensive structural reforms in Emerging Market economies (EMs) yield overall growth dividends ranging from 1 to 2 percent.
  - Largest contributions from financial sector reforms, external finance reforms, labor market reforms, trade liberalization, and governance reforms.
- Reforms already undertaken:
  - Fuel subsidy reform.
  - Amendments to the fiscal responsibility law to anchor medium-term fiscal sustainability.
  - Amendments to the anti-corruption framework to criminalize corruption.
  - Amendments to the central bank law (COMYF) to restore central bank autonomy and strengthen dollarization.
- Remaining constraints and priorities:
  - Dollarized regime increases need for structural reforms to raise labor productivity and private investment.
  - Significant room to:
    - Enhance labor market flexibility.
    - Increase access to finance and reduce domestic real interest rates.
    - Streamline regulations and licenses.
    - Integrate into US-linked global value chains.
    - Reallocate fiscal resources toward infrastructure for the digital economy.
- Projected impact of successful reforms:
  - Long-term potential growth can reach 4 percent if most suggested reforms are implemented successfully.
  - This would be 1.5 percentage points higher relative to pre-Covid potential growth estimates.
  - Higher potential growth would be driven by significantly higher TFP and labor accumulation; contributions of physical and human capital would be comparable to 2015-2019.
- Risk of inaction:
  - Without these reforms, Ecuador risks remaining in mediocre growth rates amid projected lower oil prices and pandemic scarring.

### Policy recommendations (growth and structural)
- Implement comprehensive structural reforms across financial sector, external finance, labor markets, trade, and governance to raise potential growth toward 4 percent.
- Reallocate fiscal resources to productivity-enhancing infrastructure, especially for the digital economy.
- Continue reforms that strengthen central bank autonomy and fiscal discipline.

---

### The Ecuadorian labor market going into COVID-19 and pandemic effects

### Pre-pandemic labor market features and minimum wage
- Macroeconomic distortions included a mostly discretionary setting of the minimum wage and rigid labor arrangements.
- "The minimum wage has outpaced productivity growth in recent years and is now double the level in Colombia and 75 percent higher than in Peru."

### Impact on poverty, inequality, and regional disparities
- As of December 2020:
  - Pandemic pushed an additional 1.5 million Ecuadorians into poverty (compared to December 2019).
  - About [one] million persons fell into extreme poverty.
- Microdata indicate the pandemic wiped out many years of progress in reducing labor income inequality.
- Regional disparity: poverty rate in rural areas is double that of urban areas.

### Microdata approach and employment dynamics
- Data and scope:
  - Quarterly micro labor survey data from December 2019 to June 2021.
  - Tracks pandemic trough (Spring 2020) and recovery into mid-2021; examines school closure impacts using regression analysis.
- Employment shocks and recovery:
  - Spring 2020: employment dropped by about 30 percent; exits from the labor force by about 20 percent.
  - Aggregate employment and labor force participation gradually recovered to pre-pandemic levels.
  - Number of hours worked per employee plateaued after the rapid yet partial recovery in 2023:Q3, in line with GDP dynamics.
  - Increased reliance on part-time work; la Ley Humanitaria provided flexibility.
- Distributional impacts:
  - High-skilled (college education) employment recovered close to pre-pandemic levels.
  - Less educated persons (basic education or less) and minority groups saw only partial recovery.
  - Wholesale & retail trade and accommodation & food services accounted for about 30 percent of women employment prior to the pandemic, increasing exposure to job loss.
  - Touristic areas like Galapagos were more exposed going into the pandemic.

### School closures and gender/skill differentials
- Schools remained closed through Summer 2021.
- Presence of children below age 12 ("children" dummy) used to identify parental effects.
- Workers with young children reduced market work amid school closure; unskilled mothers disproportionately carried childcare burdens.
- Stronger adjustment among the unskilled may reflect lower opportunity cost of employment.

### Informality, job quality, and social assistance
- Household coping mechanisms cushioned the shock but contributed to persistent informality and weak job quality.
- Cash transfers supplemented income but were insufficient to fully cushion impacts.
- Share of adequate employment (full-time job earning at least the minimum wage) remains well-below pre-pandemic levels; recovery in formal employment has been very timid.
- Social assistance response:
  - Expansion in coverage and payouts supplemented household income, especially in Spring 2020 and December 2020.
  - Scope to improve regional coverage of social assistance programs.
  - Relaxation of eligibility for unemployment benefits complemented cash transfers; survey data lack details on those benefits.

### Policy implications (labor market and social protection)
- Make the labor market more flexible to foster creation of formal jobs and reduce persistent informality.
- Limit informality via:
  - Lowering barriers to formalization.
  - Income tax policy that does not unduly discourage creation of formal jobs.
  - Schemes to improve employee-employer matching, including specialized training.
- Adopt the recently adopted mechanism for setting the minimum wage tying changes to macro parameters (inflation and productivity).
- Continue expansion of social assistance coverage to reach low-income families and address a rising class of "working poor."
- Expand education and training for unskilled and minority groups.
- Promote flexible work arrangements and better childcare options:
  - Support la Ley Humanitaria flexible arrangements.
  - Promote father leave policies.
  - Improve access to market-based childcare when the pandemic wanes.
  - Complement employer-side flexible arrangements with continued government income support while the pandemic lasts.
- Continue tracking labor market developments and conduct impact evaluations of measures adopted under la Ley Humanitaria.

---

### Determinants of deposit rates in dollarized Ecuador and financial sector dynamics

### Cross-country and Ecuador-specific empirical approach
- Objective: Identify determinants of interest rates in dollarized economies (Ecuador, El Salvador, Panama), focusing on Ecuador.
- Empirical model (from extended Monti-Klein):
  - r_it^D = β0 + β1 r_it + β2 r_it^F + β3 θ_it + X_it + μ_i + σ_it
  - X: control variables; μ_i: country fixed effects; σ_it: idiosyncratic error.
- Estimation:
  - Pooled OLS regressions.
  - Two-tier: cross-country panel (ECU, ELS, PAN, US) and Ecuador-specific time-series analysis.
- Data:
  - Term-deposit rates from BCE (weighted average of private banks, cooperatives, mutuals).
  - Monthly frequency, 2001-2020; some Ecuador data gaps handled by dropping Nov 2011-Apr 2014.

### Key regression findings
- EMBI yield:
  - Pooled regression with country fixed effects: a percentage point rise in EMBI yield → about 0.2-0.3 percentage points increase in domestic deposit rates on average.
  - Ecuador-specific pooled result: about 0.1 percentage points.
  - Ecuador time-series regression: impact around 0.4 percent.
- Capital outflow tax (Ecuador-specific):
  - A one percentage point increase has similar magnitude impact on deposit rates as EMBI yield in pooled regression.
- Other significant determinants:
  - Federal funds rate, inflation, and bank reserves to deposits affect deposit rates as theory predicts.
- Ecuador dummy:
  - Large coefficient indicates substantial domestic idiosyncratic factors explaining high deposit rates.
- Policy implication:
  - Tightening the EMBI spread through fiscal consolidation and gradual removal of the capital outflow tax would help reduce bank funding costs.
  - Recommendation: remove the capital outflow tax gradually while monitoring capital flows and fiscal revenues.
- Selected regression table notes:
  - Observations: 726.000 (panel); 48.000 (Ecuador time series).
  - Adjusted R^2: 0.830, 0.884, 0.889 for panel specifications; 0.647, 0.680, 0.710 for time-series specifications.
  - Capital outflow tax exists in Ecuador since January 2008; for other years and countries the value is zero.
  - p-values in parentheses; significance markers: * p < 0.10, ** p < 0.05, *** p < 0.01.

### Financial sector competition and cooperatives
- Market structure (deposits, July 2021):
  - Banks: about 72 percent of the financial system.
  - Cooperatives and mutuals: about 28 percent.
- Deposit rate dynamics (Jan 2016-Feb 2021):
  - Cooperatives paid an average of about 2.6 percentage points higher deposit rates than banks.
  - Difference widened in 2017-18 and since late 2020, coinciding with increases in market liquidity.
- Market share (new deposits):
  - Cooperatives increased from about 24 percent in January 2016 to about 34 percent in February 2021.
  - Average increase of about 1.6 percent of market share per year.
- Drivers and risks:
  - Competition for funds between banks and cooperatives may drive up deposit rates.
  - Possible causes: different business models, not-for-profit status of cooperatives, and different regulatory frameworks (SEPS vs SB).
  - Recommendation: close regulatory gaps for all deposit takers; monitor cooperatives closely as they gain systemic importance.

### Policy conclusions on deposit rates
- Reduce government bond interest rates and the tax on transfers abroad to lower deposit interest rates.
- Strengthen fiscal position to reduce government funding costs.
- Gradual reduction in the tax on transfers abroad recommended, monitoring effects on capital flows and fiscal revenues.
- Undertake a comprehensive market assessment to understand causes of high deposit rates and competition effects.
- Close regulatory gaps to ensure resilience and a level playing field as cooperatives gain systemic importance.

---

### Central Bank of Ecuador balance sheet expansion, stress tests, and reforms

### Origin and mechanism of balance-sheet expansion
- Despite dollarization, legislation in 2009-2014 allowed BCE balance-sheet expansion to finance fiscal deficits.
- Timeline and mechanisms:
  - March 2000: ban on BCE credit to public/private sector; "system of four balances" to cover BCE obligations.
  - December 2009: BCE Board resolution allowed acquisition of government bonds from public banks ("Domestic Investment").
  - 2012: transactions triangulated to the Ministry of Economy and Finance (MEF).
  - September 2014: COMYF legalized mechanism enabling direct credit operations between BCE and MEF.
- Examples and quantitative outcomes:
  - By 2014, BCE credits to public banks peaked at about 3 percent of GDP.
  - Oct 2015–May 2017: mechanism grew to close to US$7 billion, over 7 percent of GDP.
  - As of March 2021, outstanding public banks' debt to the BCE is US$1.3 billion.
  - Currently, the MEF owes the BCE approximately US$6 billion.
  - On June 30, 2021, MEF and BCE signed an agreement whereby the MEF bought-back outstanding debt of public banks at the BCE, clearing legacy assets and increasing BCE liquidity.

### Economic and financial effects
- Expansion acted as a multiplicator, raising deposits and affecting the balance of payments through capital outflows.
- Reserves at the BCE created opportunity costs for financial institutions (no remuneration), prompting increased credit supply by banks and cooperatives.
- After the 2015 contraction, credit to the private sector rebounded to growth rates between 12%-18% between mid-2017 and mid-2019.
- Risk: reduced reserve coverage increases probability of foreign default and creates liquidity imbalances for the central bank.

### Stress test methodology and results
- Stress test objective:
  - Gauge each month what the reserve coverage would have been without future external public debt disbursements, assuming no new public financing is obtained but external payments continue.
  - Determine the number of months international reserve can cover without inflow of new resources from public external debt.
- Illustration:
  - January 2014: without new public external disbursements:
    - Seven months for reserves to reach US$2 billion.
    - Eight months to reach US$500 million.
    - Reserves exhausted after nine months.
  - Exercise replicated for 84 months (January 2014–December 2020).
- Key stress-test findings:
  - Values vary between 2 and 8 months.
  - Very high-risk levels (below 2 months coverage) recorded in 4 of the 84 months.
  - In 14 months, international reserves could only withstand three months without new financing.
  - 21 percent ((14+4)/84) of instances between 2014 and 2020, the BCE’s liquidity horizon was less than three months.
  - 2018 recorded 7 of the 18 high-liquidity stress episodes.

### Conclusions and institutional reforms
- Balance-sheet expansion:
  - Put the financial sector and the dollarization system at risk.
  - Put significant stress on the public sector’s cash position.
  - Generated a need for external resources due to increased liabilities.
- Government response relied on external debt (sovereign bonds, bilateral loans, multilateral organizations), leaving large outstanding obligations of MEF to BCE.
- Institutional, legal, and accounting reforms:
  - Ecuador reversed the 2014 COMYF amendments in 2021.
  - Amendments (published May 3, 2021) aim to:
    - Prohibit future quasi-fiscal activities of the BCE and direct/indirect lending to the government or public sector.
    - Strengthen central bank autonomy, governance, and financial stability oversight.
    - Achieve full coverage of liabilities with international reserves by 2035 (return to "four balances").
  - IMF technical staff working with BCE to align financial balances with IFRS.
  - Application of international accounting standards would have made risks more apparent and potentially reduced motivation to undertake the earlier operations.

---

### Climate change, savings-investment balance, and spatial vulnerability

### Physical risks: exposure, channels, and uncertainty
- Physical risks: damage to capital from more frequent natural disasters and gradual global warming impacts.
- Theoretical effects on the current account (CA) ambiguous:
  - Destruction of wealth can reduce consumption and deter investment.
  - Post-disaster reconstruction may spur investment.
  - Financial account openness affects smoothing: higher openness enables consumption smoothing and rebuilding.
- Empirical citations:
  - Rasmusen (2004) and Laframboise and Loko (2012): CAs worsened after natural disasters.
  - Prati et al. (2011): natural disasters raise CA in low financial openness countries and reduce it in high openness countries.
- Precautionary savings:
  - EBA-Lite CA includes a dummy based on historical disaster damages; sign depends on financial openness.
  - Climate change may require higher precautionary savings if disasters become more recurrent/severe.
- Vulnerability indicators for Ecuador:
  - ND-GAIN Index: Ecuador vulnerability score 0.44 vs LA6 average 0.41.
  - Geospatial analysis (McKinsey, 2020) highlights high risk for share of capital stock vulnerable to flooding and share of outdoor working hours affected by extreme heat.
  - Topography and climatic heterogeneity increase projection challenges.

### Transitional risks: fossil-fuel exposure and sensitivity
- Oil exports:
  - Accounted for 34 percent of Ecuador’s export base on average over 2016-20.
- EBA-Lite consumption-based module assumption:
  - Ecuador can use its entire proven reserve base (around 8.3 billion barrels or 45 years of production).
- Transition scenario sensitivity:
  - A 10 percent reduction in the reserve base (around 4 years of production), holding prices and production constant, would increase the current account norm by 0.1 percentage points of GDP.
- Mitigants:
  - Financial diversification (invest surpluses in low-carbon assets, e.g., a sovereign wealth fund).
  - Real diversification: develop non-oil sectors and boost competitiveness.

### Investment needs, productivity, and CA implications
- Climate-related investment needs could increase investment; direction for CA norm depends on productivity of such investments.
- EBA-Lite vs Investment Needs model:
  - Consumption-based model does not consider allocating resource wealth to finance productive investment.
  - Investment Needs model allows that capital scarcity raises marginal product of capital and justifies using resource windfalls for investment.
- Application with assumptions preserved:
  - Using baseline oil reserve and production and public investment efficiency assumptions of 50 percent or 75 percent, medium-term current account norms generated:
    - -0.6 percent of GDP (50 percent public investment efficiency)
    - -2.1 percent of GDP (75 percent public investment efficiency)
  - Efficiency assumption: 50 or 75 percent of public investment spending translates into productive capital.
- Caveats:
  - Adaptive investments may protect existing capital without raising output.
  - Adaptive investment could lower output growth if resources shift away from productive capital or reduce capital efficiency.
  - Micro evidence mixed: some resource-efficiency or low-carbon investments improve firm profitability; others may be less productive.

### Conclusions and policy implications (climate)
- Climate change may impact Ecuador’s savings and investment balance, but direction is uncertain:
  - More frequent disasters or an early transition could warrant higher precautionary savings.
  - Climate mitigation and adaptation may require higher investment depending on productivity of those investments.
- Priorities and open questions:
  - Better quantify Ecuador’s specific climate investment needs and potential returns given relatively high capital stock.
  - Assess how climate change will affect export sectors and commodity prices via supply shocks.
  - Determine financing: debt financing vs built-up precautionary savings or financial innovations (e.g., debt for climate swaps).
  - Consider multilateral context: CA and REER are relative; varied climate impacts across countries will affect relative prices and trade flows.
- Policy management implication:
  - Public investment efficiency and public investment management quality are critical determinants of macroeconomic implications of climate-related investment.

### Distributional considerations and greening the recovery
- COVID-19 exacerbated poverty and inequality; social assistance aims to reach 80 percent of families in the three lowest income deciles by end-2021.
- Fiscal savings from phasing out regressive fuel subsidies are redirected to targeted cash transfers and critical public spending.
- Greening the recovery will have heterogeneous local effects:
  - Some green policies are labor intensive (short-term jobs); others are capital intensive and require specific skills.
  - Green policies can be welfare-enhancing overall but create distributional trade-offs needing careful design to avoid backlash.

---

### Spatial assessment of climate, employment, and social protection vulnerabilities

### Methodology and indices (province-level z-scores)
- Indices normalized as z-scores (mean zero, standard deviation one) at province level.
- Climate vulnerability:
  - Average z-score of vulnerability to extreme temperatures, droughts & fires and vulnerability to extreme rains, floods & mass movement (World Bank 2021).
  - Most vulnerable provinces: Carchi, Loja, Napo, Pastaza, Zamora Chinchipe; followed by El Oro, Imbabura, Orellana, Sucumbios.
  - Amazonia and Sierra border provinces historically more vulnerable.
- Employment vulnerability:
  - Computed as z-score of [(1 – employed/labor_force) + employed x (1 – adequate_employment)] using INEC labor survey, reference period December 2019.
  - Highest employment vulnerability: Cotopaxi, Chimborazo, Napo, Zamora Chinchipe; followed by Bolivar, Carchi, Morona Santiago, Pastaza, Tungurahua.
- Social vulnerability:
  - Z-score of share of poor population not covered by social protection.
  - Proxy: [1 – (0.78 x BDH + 0.95 x BVA)/(population x poverty_rate)] using MIES data.
  - Highest social vulnerability: Chimborazo, Pichincha, Pastaza, Sucumbios; followed by Carchi, Esmeraldas, Morona Santiago, Santa Elena, Zamora Chinchipe.
- Galapagos omitted due to low population and idiosyncratic climate and employment features.

### Spatial patterns, compound vulnerability, and correlations
- Overlap and hotspots:
  - Climate vulnerability, labor fragility, and weak social protection partly overlap geographically.
  - Compound "heat map": unweighted sum of ranks of climate, employment, and social vulnerability indices.
  - "Triple down" provinces (high on all three): Carchi, Pastaza, Zamora Chinchipe.
- Indicative policy target:
  - Proposed location-specific floor for social protection coverage: no less than 80 percent coverage by province.
- Cross-correlations (by province):
  - Climate vulnerability vs. Employment vulnerability: 0.39**
  - Climate vulnerability vs. Social vulnerability: 0.34*
  - Employment vulnerability vs. Social vulnerability: 0.22

### Recommendations and avenues for further analysis
- Potential extensions:
  - Employment transition matrices for greening the economy by provinces and cantons with fiscal compensation schemes (e.g., social assistance, training, carbon taxes, abatement tech, clean energy subsidies).
  - Dynamic economic assessment with high spatial resolution to determine temperature-change impacts on productivity and amenities.
  - Use IMF’s Carbon Pricing Assessment Tool (CPAT) to estimate impacts of carbon pricing and other policies on distributional outcomes.
- Data gaps noted:
  - Better spatially disaggregated costing of climate adaptation and mitigation measures is needed.

*Source: 1ecuea2021002*

### 1. Pre-Pandemic Bottlenecks and Vulnerabilities _______________________________________ 6

### 1. Pre-Pandemic Bottlenecks and Vulnerabilities

### Introduction
- Ecuador’s potential growth:
  - About 4 percent during 2001-2014.
  - A meagre 1 percent over 2015-2019.
- Without structural reforms, the pandemic could cause permanent scarring and sluggish potential growth of around 1.5 percent.
- Structural reforms in labor market, financial sector, external finance, and trade can boost growth up to 4 percent.

### Pre-pandemic Growth Performance
- Methods used to estimate potential GDP growth:
  - Hodrick–Prescott (HP) filter applied to annual real GDP.
  - Production function (PF) approach using a Cobb-Douglas production function, Y = A * K^∝ * (L * H)^(1−∝), with A as total factor productivity (TFP).
- Key drivers of the slowdown (2015-2019):
  - TFP decline was the main supply-side driver.
  - Capital contribution declined modestly.
  - Labor contribution fell gradually.
  - Positive correlation between growth/TFP and oil prices (high oil prices financed greater public and infrastructure investment with positive spillovers to TFP).
- Demand-side channel:
  - Permanently lower fiscal spending (notably public investment) following the oil price shock reduced aggregate demand.
  - Structural barriers—overvalued real exchange rate, rigid labor markets, difficult business climate, and low competitiveness—limited private demand and net exports from filling the public spending void.

### The Impact of the COVID-19 Pandemic
- Macroeconomic impact:
  - Actual GDP collapsed by record 7.8 percent in 2020.
  - Economic activity fell by 12.8 percent (y-o-y) in 2020:Q2.
- Sectoral impact:
  - High-contact service sectors accounted for about 43 percent of gross value added pre-pandemic.
  - High-contact sectors fell by about 12 ½ percent in 2020:Q2 (q-o-q), driven by transportation, accommodation and restaurant services.
  - As of end-2020, most high-contact sectors failed to recover about 10 percent of their 2019 output.
- Labor market and scarring risks:
  - Elevated unemployment driven by job losses in high-contact sectors; quality of jobs below adequate levels.
  - Mechanisms for permanent scarring include:
    - Prolonged unemployment reducing human capital.
    - Permanent loss of jobs, firms, and activities → permanent unemployment and stranded capital.
    - Shift toward working from home in services → stranded physical capital and lower investment.
  - Historical pandemic evidence cited:
    - Average long-term per capita output loss around 7 percent; in severest cases up to 10 percent (IMF, 2021).
    - Past pandemics imply capital and TFP losses around 4 ½ and 2 percentage points, respectively.
- Long-term output loss scenarios for Ecuador:
  - Optimistic scenario: permanent loss of 2½ percent by 2030 (assumes no change in TFP, average fall in labor, lowest fall in capital from past pandemics).
  - Realistic scenario: permanent loss of about 6½ percent of pre-pandemic output (assumes TFP permanently lower by 1 percentage points, capital and labor loss at the average of past pandemics).
  - Pessimistic scenario: permanent loss of about 9 percent over the long term (larger declines in TFP and labor contributions).

### Reform Options to Boost Long-term Growth
- Evidence on growth dividends:
  - Comprehensive structural reforms in Emerging Market economies (EMs) yield overall growth dividends ranging from 1 to 2 percent (Table 1 summary; IMF, 2015; IMF, 2019; Biljanovska & Sandri, 2018; David et al., 2020).
  - Largest contributions come from:
    - Financial sector reforms (enhancing financial inclusion, reducing cost of intermediation).
    - External finance reforms (opening to foreign direct and portfolio investments).
    - Labor market reforms (increasing labor market flexibility).
    - Trade liberalization (reducing trade barriers, deeper trade integration).
    - Governance reforms (improving institutions and policy frameworks).
- Reforms already undertaken:
  - Fuel subsidy reform.
  - Amendments to the fiscal responsibility law to anchor medium-term fiscal sustainability.
  - Amendments to the anti-corruption framework to criminalize corruption.
  - Amendments to the central bank law (COMYF) to restore central bank autonomy and strengthen dollarization.
- Remaining constraints and reform priorities:
  - Dollarized regime increases the need for structural reforms to raise labor productivity and private investment.
  - Significant room to:
    - Enhance labor market flexibility.
    - Increase access to finance and reduce domestic real interest rates.
    - Streamline regulations and licenses.
    - Integrate into US-linked global value chains.
    - Reallocate fiscal resources toward infrastructure for the digital economy.
- Projected impact of successful reforms:
  - Long-term potential growth can reach 4 percent if most suggested reforms are implemented successfully.
  - This would be 1.5 percentage points higher relative to pre-Covid potential growth estimates.
  - Higher potential growth would be driven by significantly higher TFP and labor accumulation; contributions of physical and human capital would be comparable to 2015-2019.
- Risk of inaction:
  - Without these reforms, Ecuador risks remaining in mediocre growth rates amid projected lower oil prices and pandemic scarring.

*Prepared by Botir Baltabaev (WHD); content based on the IMF country report chapter "Pre-Pandemic Bottlenecks and Vulnerabilities."*

### 1.      The Ecuadorian labor market was characterized by high rigidity going into the COVID-

### The Ecuadorian labor market was characterized by high rigidity going into the COVID-19 pandemic

### Pre-pandemic labor market features and minimum wage
- Macroeconomic distortions included a mostly discretionary setting of the minimum wage and the rigid labor arrangements.
- "The minimum wage has outpaced productivity growth in recent years and is now double the level in Colombia and 75 percent higher than in Peru."

### Impact of COVID-19 on poverty, inequality, and regional disparities
- As of December 2020, the pandemic had pushed an additional 1.5 million Ecuadorians into poverty (compared to December 2019), with about [one] million persons falling into extreme poverty.
- Microdata suggests the pandemic has wiped out many years of progress in reducing labor income inequality in Ecuador.
- Wide regional disparity: the poverty rate in rural areas is double that of urban areas, compounding pre-existing spatial employment vulnerabilities.

### Microdata analysis approach and scope
- Uses quarterly vintages of micro labor survey data from December 2019 to June 2021.
- Documents disparities not only at the pandemic trough (Spring 2020) but also during the subsequent recovery into mid-2021.
- Examines the effect of school closure on parents with young children and implements regression analysis to assess systematic patterns, including controlling for endogenous selection into employment.

### Employment dynamics and adjustment mechanisms
- COVID-19-related supply disruptions led to a massive drop in employment and exits from the labor force in Spring 2020 (by about 30 and 20 percent respectively).
- Aggregate employment and labor force participation gradually recovered to pre-pandemic levels, but:
  - The number of hours worked per employee plateaued after the rapid yet partial recovery in 2023:Q3, in line with GDP dynamics.
  - Increased reliance on part-time work as an adjustment mechanism, possibly leveraging flexibility in work arrangements provided by la Ley Humanitaria.
- Unskilled and minority groups were hit hardest, with negative impacts persisting through the recovery:
  - Recovery for persons with college education ("high-skilled") returned close to pre-pandemic levels; less educated persons (basic education or less) and minority groups saw only partial recovery.
  - Wholesale & retail trade and accommodation & food services accounted for about 30 percent of women employment prior to the pandemic, increasing exposure to job loss.
  - Touristic areas like Galapagos were more exposed going into the pandemic.

### School closures and gender/skill differentials
- Schools remained closed in Ecuador through Summer 2021.
- Presence of children below age 12 (dummy variable "children") used to identify effects on parents.
- Workers with young children reduced market work amid school closure, with unskilled mothers continuing to carry a heavier burden of home-based childcare.
- The stronger adjustment among the unskilled may reflect lower opportunity cost of employment (they earn less from labor).
- Women were disproportionately affected by the presence of children mainly when they were unskilled.

### Pandemic scars: informality and job quality
- Household endogenous mechanisms cushioned the shock but are resulting in persistent informality and weak job quality.
- Cash transfers supplemented household income but were not enough to entirely cushion the impact.
- The share of adequate employment (full-time job earning at least the minimum wage) remains well-below pre-pandemic levels; recovery in formal employment has been very timid.
- The slow recovery in formal employment is seen across Latin America but is more acute in Ecuador.
- Rising informality as a coping mechanism may have underscored virus spread due to work-related mobility, especially among vulnerable groups.

### Social assistance response and limitations
- Expansion in coverage and payouts of social assistance programs (extensive and intensive margins) supplemented household income, especially in Spring 2020 and December 2020.
- There is scope to improve the regional coverage of social assistance programs.
- Relaxation of eligibility criteria for unemployment benefits complemented cash transfers, but information on those benefits is not available from the labor force surveys used.

### Policy implications and recommendations (labor market and social protection)
- Make the labor market more flexible to foster creation of formal jobs and reduce persistent informality.
- Options to limit informality include:
  - Lowering barriers to formalization.
  - An income tax policy that does not unduly discourage the creation of formal jobs.
  - Establishing schemes to improve employees-employers matching, including through specialized training.
- Government should adhere to the recently adopted mechanism for setting the minimum wage that ties changes to macroeconomic parameters such as inflation and productivity to support competitiveness and policy predictability.
- Continue expansion of coverage of social assistance programs to reach low-income families to address a rising class of "working poor."
- Expand education and training for unskilled and minority groups to limit pandemic scars on human and social capital.
- Promote flexible work arrangements and better childcare options to improve employment outcomes of parents, especially mothers:
  - Support flexible work arrangements as adopted in la Ley Humanitaria.
  - Promote father leave policies to level the playing field between married mothers and fathers.
  - Improve access to market-based childcare when the pandemic wanes.
  - Complement employer-side promotion of flexible arrangements with continued government income support while the pandemic lasts.
- Continue tracking labor market developments and conduct an impact evaluation of labor market measures adopted under la Ley Humanitaria to inform reform.

---

### Determinants of deposit rates in fully dollarized economies: the case of Ecuador
- Aim: shed light on determinants of interest rates in dollarized economies (Ecuador, El Salvador, Panama), with a focus on Ecuador.
- Despite adoption of the US dollar, there is significant dispersion in observed deposit rates among these economies.
- In 2020, average deposit rates were:
  - Ecuador: 6.3 percent
  - El Salvador: 3.8 percent
  - Panama: 1.9 percent
- Regression-based results identify:
  - The EMBI yield and capital outflow tax explain the high deposit rates in Ecuador.
  - Key factors from theory and previous literature—federal funds rate, bank reserves, and inflation—also affect deposit rates.
  - Additional country-specific structural factors may contribute to high deposit rates in Ecuador.

### Financial sector competition and cooperatives
- Market competition for funds between lower segments of banks and upper segments of cooperatives seems to drive high deposit rates in Ecuador.
- Since 2016, cooperatives have paid an average deposit rate of about 2.6 percentage points higher than private banks.
- Cooperatives have gained market share in deposits from about 24 percent of the market in January 2016 to about 34 percent of market in February 2021.
- Possible reasons for cooperatives' higher rates include different business models, not-for-profit status, and different regulatory frameworks.
- Main competition in the financial sector is between small- and medium-sized banks and larger cooperatives; cooperatives' ability to pay higher rates could put pressure on banks to increase deposit rates to protect funding.

*Prepared by Constant Lonkeng (WHD); sections on deposit rates prepared by Pablo Druck (MCM), Botir Baltabaev, Juan Pablo Erraez, and Ivan Burgara (all WHD).*

### 4.      The rest of the paper is organized as

### 4.      The rest of the paper is organized as follows

### B. Fundamentals of Deposit Rates — Empirical Strategy and Data
- The empirical model is derived from the extended Monti-Klein model of a monopolistic banking system (Dermine, 1986) and is presented as equation (1):
  - r_it^D = β0 + β1 r_it + β2 r_it^F + β3 θ_it + X_it + μ_i + σ_it
  - X is a vector of control variables; μ_i are country fixed effects; σ_it is the idiosyncratic error.
- Estimation approach:
  - Equation (1) estimated using pooled OLS regressions.
  - Two-tier approach:
    - Cross-country panel regression comparing Ecuador, El Salvador, and Panama to the United States.
    - Ecuador-specific time-series analysis.
- Data:
  - Panel regression uses term-deposit rate data published by the Central Bank of Ecuador (BCE): weighted average term-deposit rate of private banks, cooperatives, and mutuals.
  - For El Salvador, Panama, and the United States a simple average across term-deposits is used due to data limitations.
  - Monthly frequency, range 2001-2020, except Ecuador term-deposit rates from November 2011-April 2014 were dropped because deposit rates remained fixed; BCE did not publish the reference rate during this period.
  - Additional database built (monthly data starting in 2016) for deposit rates on new deposits by private banks, cooperatives, and mutuals; from these a weighted average deposit rate was calculated for private banks, cooperatives, mutuals, and the total financial system (TFS).

### B. Fundamentals of Deposit Rates — Results of Regression
- Key regression findings (summary):
  - EMBI yield:
    - In pooled regression with country fixed effects: a percentage point rise in EMBI yield leads to about 0.2-0.3 percentage points increase in domestic deposit rates on average.
    - Ecuador-specific pooled result: about 0.1 percentage points.
    - Ecuador time-series regression: impact around 0.4 percent.
  - Capital outflow tax (only relevant for Ecuador):
    - A one percentage point increase has similar magnitude impact on deposits as EMBI yield from pooled regression.
  - Other significant determinants:
    - Federal funds rate, inflation, and bank reserves to deposits show statistically significant impacts in line with the theoretical model.
  - Ecuador dummy:
    - Relatively large coefficient indicates substantial domestic idiosyncratic factors explaining high deposit rates.
- Policy implication drawn from regression:
  - Tightening the EMBI spread through fiscal consolidation and gradual removal of the capital outflow tax would help reduce bank funding costs in Ecuador.
  - Recommendation to remove the capital outflow tax gradually while monitoring impacts on capital flows and fiscal revenues.

- Selected regression table notes:
  - Observations: 726.000 (panel); 48.000 (Ecuador time series).
  - Adjusted R^2: 0.830, 0.884, 0.889 for panel specifications; 0.647, 0.680, 0.710 for time-series specifications.
  - Dollarized panel: (ECU, ELS, PAN, US, 2001-2020).
  - Ecuador time series: (2016-2019).
  - Capital outflow tax exists in Ecuador since January 2008; for other years and countries the value is zero.
  - p-values in parentheses; significance markers: * p < 0.10, ** p < 0.05, *** p < 0.01.

### C. Deposit Interest Rates and Market Share
- Structure of the financial sector (as of July 2021, measured by deposits):
  - Banks: about 72 percent of the financial system.
  - Cooperatives and mutuals: about 28 percent of the financial system.
- Regulatory oversight:
  - Superintendency of Banks (SB) oversees private and public banks.
  - Superintendency of Popular and Solidarity Economy (SEPS) oversees cooperatives and mutuals.
  - In this section SB and SEPS refer to these two sectors.
- Deposit rate dynamics (Jan 2016-Feb 2021 data):
  - Cooperatives paid higher deposit rates than banks: an average of about 2.6 percent higher during the period.
  - Difference widened during 2017-18 and again since late 2020; these episodes coincide with increases in market liquidity.
  - Most institutions overseen by SEPS have been paying consistently higher interest rates than banks.
- Market share (new deposits, month-by-month basis):
  - Cooperative market share increased to about 34 percent in February 2021, up from about 24 percent in January 2016.
  - This represents an average increase of about 1.6 percent of market share per year.
- Loan composition:
  - Banks serve all customer types; cooperatives and mutuals serve mostly microcredit and consumer loans.
- Regulatory framework:
  - Regulatory frameworks differ between SB and SEPS; SEPS framework described as more lenient than SB.
  - Closing regulatory gaps for all deposit takers recommended to ensure resilience and a level playing field.
- Hypotheses regarding high deposit rates and cooperative behavior:
  - Potential factors explaining high deposit rates include:
    - Different regulatory frameworks set by SB and SEPS.
    - Cooperative not-for-profit status possibly allowing higher deposit payments.
  - Cooperative sector has gained substantial market share and rapid growth, attributed by some market participants to higher deposit rates offered by cooperatives.
- Risk monitoring recommendation:
  - As cooperatives gain systemic importance, authorities should closely monitor these institutions’ risk management practices; closing regulatory gaps for all deposit takers is necessary.

### D. Conclusion
- Main policy conclusions:
  - Reducing the interest rate for Ecuador government bonds and reducing the tax on transfers abroad were found to be determinant factors for deposit interest rates.
  - Strengthening the fiscal position to reduce government funding costs could help reduce deposit rates.
  - Gradual reduction in the tax on transfers abroad recommended, considering effects on capital flows and fiscal revenues.
  - Competition for funds between cooperatives and banks may be pushing up deposit rates; a comprehensive market assessment is needed to understand underlying causes.
  - Closing regulatory gaps for all deposit takers would ensure resilience and a level playing field as cooperatives gain systemic importance.

### Origin, Functioning and Consequences of Central Bank Balance Sheet Expansion in Ecuador — Key points
- Context:
  - In a fully dollarized economy such as Ecuador, money creation is in principle impossible, but legislation approved in 2009-2014 allowed expansion of the BCE balance sheet in the 2010s to finance the fiscal deficit.
- Mechanism and history:
  - BCE had a ban on granting credit to public or private sector since March 2000; a “system of four balances” was established to ensure full coverage of BCE obligations.
  - December 2009: BCE Board resolution allowed acquisition of government bonds from public banks ("Domestic Investment").
  - 2012: mechanism reconfigured; transactions triangulated directly to the Ministry of Economy and Finance (MEF).
  - September 2014: new Monetary and Financial Code (COMYF) legalized the mechanism and enabled direct credit operations between the BCE and the MEF.
- Illustration of balance sheet expansion:
  - Initial state example: reserve coverage ratio illustration given as 75 / (20+10+40) = 107 percent.
  - Domestic Investment example: BCE invests 20 in public banks; liabilities rise making reserve coverage 75 / (20+30+40) = 83 percent.
- Quantitative outcomes and liabilities:
  - By 2014, BCE credits to public banks peaked at about 3 percent of GDP.
  - Given fiscal difficulties from late 2014, the mechanism grew from October 2015 to May 2017 to reach close to US$7 billion, over 7 percent of GDP.
  - As of March 2021, outstanding public banks' debt to the BCE is US$1.3 billion.
  - Currently, the MEF owes the BCE approximately US$6 billion.
  - On June 30, 2021, MEF and BCE signed an agreement whereby the MEF bought-back outstanding debt of public banks at the BCE, clearing legacy assets and increasing BCE liquidity.
- Economic and financial effects:
  - The expansion acted as a multiplicator, raising deposits and affecting the balance of payments through capital outflows.
  - Reserves at the BCE created opportunity costs for financial institutions (no remuneration), prompting increased credit supply by banks and cooperatives.
  - After the 2015 contraction, credit to the private sector rebounded to growth rates between 12%-18% between mid-2017 and mid-2019.
  - Risk: reduced reserve coverage increases probability of foreign default and creates liquidity imbalances for the central bank, putting the financial system at risk.
- Recommendation:
  - The note performs a stress test analysis (section B) to evaluate liquidity impacts of these policies (section B details follow in the source).

*Italic: Content summarized from the IMF chapter provided in the supplied PDF content.*

### 6.      A stress test method consists of

### 6.      A stress test method consists of

### Stress test methodology
- Gauge each month what the reserve coverage would have been without future external public debt disbursements, assuming no new public financing is obtained but external payments, both public and private, continue.
- Objective: determine the number of months that international reserve can cover without inflow of new resources from public external debt.
- Nature: both a liquidity and a financing stress test — the longer reserves can cover liabilities without external debt, the more liquid the central bank and the less dependent the government on external financing.
- Benchmark analogy: international reserves to months of imports.
- Illustration: In January 2014, assuming no new public external disbursements onward:
  - It would have taken seven months for the international reserves to reach US$2 billion.
  - Eight months to reach US$500 million.
  - Reserves would have been exhausted after nine months.
- Exercise replicated for each of the 84 months between January 2014 and December 2020.

### Results of the stress test
- Liquidity shortages emerged starting end-2015 and worsened in 2018, when Ecuadorian authorities started negotiating a program with the IMF.
- Heat map presentation:
  - Columns: months from January 2014 through December 2020 (84 months).
  - Rows: continuous thresholds from zero to US$2 billion.
  - Cells: number of months international reserve will take to reach the defined threshold (values vary between 2 and 8 months).
  - Color scale: greenest corresponds to values above 8 months; reddest corresponds to values below 2 months.
- Key statistics:
  - Values found vary between 2 and 8 months.
  - Very high-risk levels (below 2 months on coverage) recorded in 4 of the 84 months of analysis.
  - In 14 months, international reserves can only withstand three months without new financing.
  - In 21 percent ((14+4)/84) of instances between 2014 and 2020, the BCE was in a situation where its liquidity horizon was less than three months.
  - 2018 recorded 7 of the 18 high-liquidity stress episodes.

### Conclusion on balance-sheet expansion and financing
- Expansion of the Central Bank of Ecuador's (BCE) balance sheet:
  - Put the financial sector and the dollarization system at risk.
  - Put significant stress on the cash position of the public sector.
  - Generated a need for external resources due to increased liabilities that could be demanded for foreign payments or cash needs.
- Government response:
  - Relied on obtaining external debt through sovereign bonds, bilateral loans, and more recently multilateral organizations.
  - This left the Ministry of Economy and Finance (MEF) with large outstanding obligations towards the BCE that remain a significant legacy, especially during difficult times.

### Institutional, legal, and accounting reforms
- Legal reform:
  - Ecuador reversed the 2014 amendments to the COMYF in 2021.
  - Amendments to the COMYF were approved by the National Assembly and published in the Official Gazette on May 3, 2021.
  - Main objectives of the amendments:
    - Prohibit all future quasi-fiscal activities of the BCE as well as direct and indirect lending to the government or public sector (including loans, advances, guarantees or transactions that indirectly support lending operations of the public sector).
    - Strengthen the central bank’s autonomy and governance arrangements.
    - Strengthen the central bank’s financial stability oversight function.
    - Achieve full coverage of liabilities with international reserves by 2035, a return to the so-called “four balances”.
- Accounting and valuation:
  - IMF technical staff are working with BCE to align financial balances with international financial standards (IFRS).
  - Unmarketable and unfunded securities (IOU’s) received from public banks and Central Government would likely have been significantly lower in value upon origination in fair-value terms.
  - This reduction in value on origination would have either:
    - (i) reduced the BCE’s ability to invest as much in the public banks or Central Government; or
    - (ii) required the BCE to record a loss on origination, eroding BCE equity.
  - Application of internationally recognized accounting standards would have made the risks more apparent, potentially reducing the motivation to undertake those operations.

*Italic: Source — 1ecuea2021002 - 6.      A stress test method consists of*

### 1.      Climate change may impact Ecuador’s sustainable savings and investment balance.

### 1.      Climate change may impact Ecuador’s sustainable savings and investment balance.

### Physical risks: exposure, channels, and uncertainty
- Physical risks include damage to capital from more frequent natural disasters and more gradual impacts of global warming.
- Theoretical impact on the current account (CA) is ambiguous:
  - Destruction of wealth can negatively affect consumption and deter investment.
  - Damage to physical capital may spur post-disaster increases in investment.
  - Degree of financial account openness affects smoothing: higher openness can enable consumption smoothing and rebuilding.
- Empirical findings cited:
  - Rasmusen (2004) and Laframboise and Loko (2012) find CAs worsened after natural disasters.
  - Prati et al. (2011) find natural disasters raise the CA in countries with low financial openness and reduce it in countries with high financial openness.
- Precautionary savings:
  - The EBA-Lite CA includes a dummy based on historical economic damages from natural disasters; the sign of the effect depends on financial account openness.
  - Climate change may require additional precautionary savings if disasters become more recurrent or severe.
- Vulnerability indicators for Ecuador:
  - ND-GAIN Index: Ecuador registered a vulnerability score of 0.44 compared with the LA6 average of 0.41.
  - Geospatial analysis (McKinsey, 2020) identifies high risks for Ecuador in share of capital stock vulnerable to flooding and share of outdoor working hours affected by extreme heat.
  - Topography and climatic heterogeneity increase projection challenges (Chimborazo and Vuille, 2021); some regions could face more droughts or more flooding (Campozano et al., 2020).
- Mitigation via resilient capital: investments in disaster-resilient capital could reduce precautionary savings needs.

### Transitional risks: fossil-fuel exposure and sensitivity
- Oil exports accounted for 34 percent of Ecuador’s export base on average over 2016-20.
- EBA-Lite consumption-based module assumption:
  - Ecuador can use its entire proven reserve base (around 8.3 billion barrels or 45 years of production).
- Transition scenario sensitivity:
  - A 10 percent reduction in the reserve base (around 4 years of production), holding prices and production constant, would increase the current account norm by 0.1 percentage points of GDP.
- Complexity in estimating transition effects:
  - Global supply and price responses to a transition are ambiguous: producers may accelerate output or reduced investment could raise prices.
- Mitigants:
  - Financial diversification: invest oil export surpluses in low-carbon assets (e.g., via a well-governed sovereign wealth fund).
  - Real diversification: develop non-oil sectors and boost competitiveness.

### Investment needs: adaptation, mitigation, and productivity uncertainty
- Climate-related investment needs could require higher investment; the direction for the CA norm depends on productivity of such investments.
- EBA-Lite frameworks:
  - Consumption-based model does not consider allocating resource wealth to finance productive investment.
  - Investment Needs model accounts for possibility that capital scarcity raises the marginal product of capital and could justify using resource windfalls for investment.
- Ecuador’s preexisting capital and competitiveness context:
  - IMF Public Capital Stock Database and WEF indicators suggest Ecuador has relatively high public capital stock and infrastructure competitiveness compared with peers.
- Specific mitigation commitment:
  - Ecuador’s Paris Agreement commitment: reduce emissions by 9 percent (or 21 percent conditional on support of the international community).
- Investment Needs model application (assumptions preserved):
  - Using baseline oil reserve and production assumptions and public investment efficiency assumptions of 50 percent or 75 percent, the model generates medium-term current account norms of:
    - -0.6 percent of GDP (50 percent public investment efficiency)
    - -2.1 percent of GDP (75 percent public investment efficiency)
  - Note on efficiency assumption: 50 or 75 percent of public investment spending translates into productive capital.
- Caveats on adaptive vs. productive capital:
  - Adaptive investments may primarily protect or repair existing capital and may not raise output.
  - Arguments exist that adaptive investment could lower output growth if resources shift away from productive capital or if continual adjustments reduce capital efficiency (Batten, 2018; Fankhauser et al., 1999; Pindyck, 2013).
  - Other models (e.g., IMF’s DIG-ND) attempt to model resilient capital that reduces depreciation and simulate natural disaster shocks; applications have focused on small economies with very large shocks.
- Microeconomic evidence on mitigation investments:
  - Some studies find resource-efficiency or low-carbon investments improve firm profitability (e.g., Rexhäuser and Rammer, 2014), but low-carbon investments can also be less productive than carbon-intensive alternatives.

### Conclusions and policy implications
- Main conclusion:
  - Illustrative EBA-Lite model applications show climate change may impact Ecuador’s savings and investment balance, but the overall direction is uncertain.
    - More frequent natural disasters or an early transition away from fossil fuels may warrant higher precautionary savings.
    - Climate mitigation and adaptation needs may warrant higher investment depending on investment productivity.
- Open questions and priorities for decisive assessment:
  - Better quantification of Ecuador’s specific climate investment needs and potential returns, given relatively high capital stock.
  - How climate change will affect different exporting sectors and commodity prices via supply shocks.
  - How climate responses will be financed:
    - Investment Needs model typically assumes debt financing.
    - Alternatives include using built-up precautionary savings or financial innovations (e.g., debt for climate swaps).
  - Multilateral context:
    - CA and REER are relative; impacts depend on both domestic and foreign country characteristics.
    - Varying climate impacts across countries could redistribute incomes and alter relative prices and trade flows.
- Data and costing gaps:
  - Costing of climate adaptation and mitigation measures for Ecuador and globally is limited.
  - Institute for Global Environmental Strategies Nationally Determined Contributions Database lacks financial needs estimates for around 60 percent of the 197 countries (including Ecuador).
- Policy management implication:
  - Public investment efficiency and public investment management quality are critical in determining the productivity and macroeconomic implications of climate-related investment.

### Distributional considerations: climate, employment, and social vulnerabilities (summary)
- COVID-19 impacts:
  - Pandemic and economic crisis disproportionately affected low-income families, increased poverty headcount, and exacerbated income inequality in Ecuador.
  - Social assistance expansion aims to reach 80 percent of families in the three lowest income deciles by end-2021.
  - Fiscal savings from phasing out regressive fuel subsidies are being redirected to targeted cash transfers and other critical public spending.
- Greening the recovery: heterogeneous local effects
  - Green policies (renewables, building retrofits, reforestation, moving away from carbon-intensive processes) may disproportionately affect localities concentrated in high-GHG activities.
  - Some green investments are labor intensive short-term; others (e.g., windmills) are capital intensive and require specific skills.
  - Green policies may be welfare-enhancing at the aggregate level but can create distributional trade-offs across constituencies and income groups, requiring careful design to avoid backlash.

*Source: 1ecuea2021002 - 1.      Climate change may impact Ecuador’s sustainable savings and investment balance.*

### 4.      This study assesses the configuration of climate change, employment, and social

### 4.      This study assesses the configuration of climate change, employment, and social protection in Ecuador across geographical districts

### Methodology and indices
- Indices constructed at the province-level and normalized as z-scores (the observed value minus the mean, divided by the standard deviation). The normalized variables have a mean of zero and a standard deviation of one.
- The indices are as follow:
  - Climate vulnerability:
    - Computed as the average of the z-score of vulnerability to extreme temperatures, droughts, and fires and the z-score of vulnerability to extreme rains, floods, and mass movement from the World Bank’s (2021) report.
    - Provinces identified as most vulnerable: Carchi, Loja, Napo, Pastaza, and Zamora Chinchipe; followed by El Oro, Imbabura, Orellana, and Sucumbios.
    - General pattern: Amazonia region provinces and border provinces in the Sierra region are historically more vulnerable to extreme climate events.
  - Employment vulnerability:
    - Computed as the z-score of the sum of the unemployment and inadequate employment rates:
      [(1 – employed/labor_force) + employed x (1 – adequate_employment)]
    - Employment data source: labor survey at the household level conducted quarterly by the Instituto Nacional de Estadística y Censos (INEC).
    - Reference period: December 2019 as representing the pre-pandemic period.
    - Provinces with highest employment vulnerability: Cotopaxi, Chimborazo, Napo, and Zamora Chinchipe; followed by Bolivar, Carchi, Morona Santiago, Pastaza, and Tungurahua.
  - Social vulnerability:
    - Computed as the z-score of the share of the poor population not covered by social protection.
    - Proxy used due to lack of geographical data on the distribution of social protection for the bottom three deciles:
      [1 – (0.78 x BDH + 0.95 x BVA)/(population x poverty_rate)]
    - BDH = “Bono de Desarrollo Humano”; BVA = “Bono de Desarrollo Humano con Componente Variable”.
    - Data on BDH, BVA, and their weights: Ministry of Economic and Social Inclusion (MIES).
    - Provinces with highest social vulnerability: Chimborazo, Pichincha, Pastaza, and Sucumbios; followed by Carchi, Esmeraldas, Morona Santiago, Santa Elena, and Zamora Chinchipe.
- Note: The Galapagos province was omitted from the analysis, as it is not densely populated and faces its idiosyncratic climate and employment (mainly in tourism) challenges.

### Spatial patterns and compound vulnerability
- Overlap and hotspots:
  - Vulnerability to climate events, labor market fragility, and weak social protection are significant and partly overlap across locations.
  - Compound “heat map” constructed as the unweighted sum of the ranks of climate, employment, and social vulnerability indices.
  - Provinces identified as "triple down" (susceptible to extreme climate events, fragile employment, and weak social protection coverage): Carchi, Pastaza, and Zamora Chinchipe.
- Indicative policy target:
  - A proposed location-specific floor for social protection coverage: no less than 80 percent coverage by province.

### Cross-correlations (by province)
- Climate vulnerability vs. Employment vulnerability: 0.39**
- Climate vulnerability vs. Social vulnerability: 0.34*
- Employment vulnerability vs. Social vulnerability: 0.22

### Recommendations and avenues for future analysis
- Potential extensions and methodological improvements:
  - Employment transition matrixes of greening the economy by provinces and cantons (i.e., simulated employment shifts by industrial codes and geographical location) accompanied by fiscal schemes for compensating the losing constituencies (e.g., social assistance, training, carbon taxes, abatement technologies, and clean energy subsidies; see: Schaffitzel, Jakob, Soria, Vogt-Schilb, and Ward 2020).
  - A dynamic economic assessment model of the world economy with a high spatial 1×1-degree resolution to determine the impact of temperature changes in productivity and amenities depending on local temperatures (cf. Alvarez and Rossi-Hansberg 2021) in Ecuador, and Colombia and Peru for comparison and range validation.
  - Use of the IMF’s Carbon Pricing Assessment Tool (CPAT) to estimate impacts of policies to accelerate green transitions, notably carbon pricing, on various metrics, including distributional impacts (see upcoming WHD REO for application to selected Latin American countries).

*Source: World Bank, INEC, MIES and authors’ calculation; authors’ calculations and discussion as presented in the chapter.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1ecuea2021002.pdf_