## _cr0698 ## Source details **Canonical URL:** [_cr0698](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0698.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0698.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0698.pdf.json) --- ### Executive Summary — Background and Key Developments - Macroeconomic performance in 2005 was generally positive, aided by high international oil prices. - Output growth expected to exceed 3 percent; staff projects Real GDP growth of 2¾ percent in 2006. - Inflation: 12-month CPI inflation rose from less than 2 percent in June 2005 to 4 percent at end-2005 (statement records 4.4 percent in December 2005). - External sector: external current account deficit estimated at about 1 percent of GDP in 2005; projected about 1 percent in 2006. - Financial markets: - Ecuador issued a US$650 million 10-year bullet bond in December 2005 with a yield of 10.75 percent. - EMBI spread remains the widest among Latin American countries despite declines; EMBI Ecuador (bps, end of period) reported as 642/669/642/669 in various tables (see detailed tables). - Public finances: - NFPS primary surpluses consistently above 4 percent of GDP; NFPS Primary balance: 2003 = 4.7; 2004 = 5.0; 2005 = 4.2; 2006 = 4.9 (staff projection). - Public debt fell from over 90 percent of GDP in 2000 to 43 percent of GDP in 2005; NFPS Public debt (percent of GDP): 2003 = 52.6; 2004 = 46.5; 2005 = 43.2; 2006 = 40.0 (projection). - Non-oil deficit projected to have increased to 5 percent of GDP in 2005. - Political context: turbulent 2005; Congress dismissed President Gutierrez in April; President Palacio in office; weak political base and pressures for more public spending ahead of October 2006 elections. ### Key Recent Developments and Risks — Real Sector, Prices, External Flows - Real sector: - Non-oil sector expanded by 3½ percent in 2005. - Employment: unemployment averaged 10.7 percent in 2005 (little changed from 2004); separate table shows Unemployment (November 2005) = 9.7. - Oil-sector growth following the 2003 pipeline completion tapered off; high oil prices bolstered domestic demand. - Prices and wages: - Inflation picked up in second half of 2005; CPI inflation projections for 2006 = 3 percent (Box 1 macro outlook). - Real minimum wage growth increased (figures given in source). - External flows: - Non-oil FDI remained low, at less than 1 percent of GDP; oil sector FDI inflows increased. - Real exchange rate has depreciated recently (Real effective exchange rate depreciation entries: 2002 = 11.3; 2003 = -1.3; 2004 = -4.6; 2005 = -3.3 / -2.9 in other tables). - Monetary and financial sector: - Banking system credit and deposits grew strongly in 2005; liquidity comfortable. - Bank intermediation below pre-crisis levels; deposits overwhelmingly at short maturities. - Stability indicators improved: declining NPL ratios (NPLs percent of total loans: 34.7; 13.4; 8.4; 8.4; 7.9; 6.4; 5.7) and higher capital-to-risk-weighted-assets (Capital percent of risk-adjusted assets: 13.1; 13.5; 14.4; 14.9; 14.5; 14.8). - Bank lending rates declined; EMBI Ecuador remains high (EMBI Ecuador: 1,801; 799; 690; 642; 669 reported across tables). ### Structural Reform Progress, FRL Modifications, and Associated Risks - Little progress on structural reforms recommended in 2004 Article IV; several measures implemented in 2005 weakened macro policy framework. - June 2005 reform of the Fiscal Responsibility Law (FRL): - Removed capital spending from the 3.5 percent cap on annual real increases in central government primary expenditure. - Eliminated the FEIREP oil fund, bringing heavy crude oil revenues into the budget and reallocating resources formerly earmarked for debt buybacks toward social spending and credits for economic reactivation. - Retained the requirement that the non-oil fiscal deficit decline by 0.2 percent of GDP per year; this provision was violated in both 2004 and 2005. - Staff concerns on FRL modifications: - Increased budgetary pressures from additional on-budget resources. - Increased earmarking and rigidities; reduced likelihood of using heavy crude oil revenues for external debt buybacks. - Funds for reactivation to be managed by two public development banks "beset by management and institutional problems." - Tax incentive law granting 10–12 year tax holidays for new companies investing US$2–7 million in strategic sectors judged to weaken tax base and complicate tax administration. - Box 2 — Draft Banking Sector Law (summary of concerns): - Provisions include cap on intermediation spreads (ceiling on lending rates at 300 basis points above reference rate; floor on deposit rates at 70 percent of reference rate), abolition of fees/commissions, and directed lending requiring banks to lend at least 75 percent of deposits to productive sectors. - Staff warns draft could sharply reduce financial intermediation and threaten banking system soundness. - Congress reportedly considering eliminating directed lending and relaxing intermediation caps by credit type. ### Pension Reform and Fiscal Implications - Congressional 2005 decision to return IESS reserve fund assets to employees every three years reduced supplementary fund assets from US$780 million (2¼ percent of GDP); reduction not matched by a corresponding reduction in pension obligations. - Agreed objectives for pension reform: - Substantially reduce pension system’s actuarial deficit. - Lower government’s pension contribution required to be 40 percent of the total pension bill. - Authorities engaged with Social Security Institute to resolve government’s outstanding debt; requested Fund technical assistance to design pension reform. ### Oil Sector Findings, Investment Needs, and Recommendations - Key findings: - Management problems and declining crude production at PetroEcuador; inadequate refining capacity; frozen domestic oil derivative prices; rising imports of oil products. - Subsidy cost substantial: gasoline and cooking gas subsidies amount to 5¼ percent of GDP; total subsidy reached 5¼ percent of GDP in one table. - Private crude production uses only 70 percent of new pipeline capacity; lack of new exploration licenses since 1998; legal uncertainties and politicized price-setting deter private investment. - Investment needed: investment to restore output to mid-1994 levels estimated at US$0.5–1 billion. - Recommended reforms (Box 3): - Develop coherent oil sector policy specifying PetroEcuador’s role; strategy to restore PetroEcuador production; plan to auction new exploration and production licenses. - Implement comprehensive reform of PetroEcuador including external financial audit. - Liberalize domestic fuel market: deregulate prices; curtail PetroEcuador’s wholesale distribution and storage monopoly. - In renegotiations, establish clear transparent rules for private sector participation. ### Fiscal Developments, Short-Term Outlook, and Staff Recommendations - Fiscal stance in 2005 weakened; NFPS Primary balance (percent of GDP): 2003 = 4.7; 2004 = 5.0; 2005 = 4.2. - Non-oil primary balance (percent of GDP): 2003 = 0.7; 2004 = -0.4; 2005 = -2.6; 2006 = -2.2 (projection). - Box 1 macro outlook (staff projections and assumptions): - Oil futures assumption: average WTI oil price of US$61 per barrel in 2006. - Staff projects Real GDP growth = 2¾ percent in 2006; CPI inflation = 3 percent in 2006; External current account deficit ≈ 1 percent of GDP in 2006. - NFPS surplus projected = 4.9 percent of GDP in 2006. - Short-term risks: - Spending pressures from interest groups and large cash holdings could challenge recurrent spending limits. - Oil price sensitivity: every US$1 decline in the price of oil would reduce the central government overall balance by about 0.1 percent of GDP. - Inappropriate policy initiatives (FRL changes, pension system, tax incentives, draft banking bill) increase risk of damaging legislation undermining confidence and banking system stability. - Staff recommendations: - Aim for a higher primary surplus in 2006 than currently programmed; resist spending pressures. - Use proceeds from recent bond issue and FLAR loan to retire short-term debt and high interest Global 2012 bonds. - Strengthen institutional fiscal framework: reduce earmarking and subsidies; ensure appropriate use of limited oil wealth. - Begin drafting new FRL for next government: enhance transparency of target variables; target debt-to-GDP substantially lower than 40 percent; fiscal rule for non-oil balance consistent with intertemporal efficiency and equity. - Staff estimates central government non-oil primary deficit in the range of 1½–3 percent of GDP would be consistent with keeping oil wealth constant in real terms and reducing debt-to-GDP to safe levels. - Boost tax revenue by simplifying and broadening tax base; introduce simplified turnover tax for small businesses; eliminate low-yield taxes. - Reduce budget rigidities: contain wage bill via civil service reform; reduce revenue earmarking; reduce fuel and electricity subsidies; reduce government contributions to pensions. - Prepare consensus-building groundwork for politically sensitive reforms (e.g., gradual reduction of fuel subsidies and electricity tariff increases beginning April 2006). ### Medium-Term Scenarios and Staff “Active” Policy Scenario - Medium-term risks (passive scenario): - Annual real GDP growth could average about 2¼ percent over next five years if current trends persist. - NFPS surplus projected to decline by 2½ percentage points of GDP over medium term under passive scenario. - Banking system fragility persists: limited confidence, short deposit maturities, absence of deposit insurance or lender-of-last-resort. - Risk of severe cash flow problems and disorderly exit from dollarization under negative shocks. - Staff “active” policy scenario (medium term): - Fiscal consolidation: reduce non-oil primary deficit by between 2–3 percent of GDP through widening tax base, lowering fuel and pension subsidies, containing wage bill, and reducing revenue earmarking. - Reallocate spending toward public investment and social spending while sustaining large primary surpluses; higher oil revenue from increased production. - Public debt would fall to about 20 percent of GDP by 2010. - Growth outcomes: Real GDP growth would reach 4½ percent in 2010, reflecting efficiency gains from reforms to public enterprises, better oil resource management, stronger banking supervision, trade liberalization, and improved investment climate. ### Financial Sector — Reform Priorities and Legislative Risks - FSAP (2004) findings: financial system more resilient since 1998–99 crisis but vulnerabilities remain. - Key needs: - Improve supervision and regulation; increase minimum capital requirements. - Establish a well-financed liquidity fund (lender-of-last-resort); establish a limited-coverage deposit insurance system. - Strengthen creditor rights and improve bankruptcy procedures. - Authorities’ work plan: - Submit bankruptcy and creditors’ rights bill in Q1 2006. - Finalize draft legislation to strengthen payments system. - Continue implementing regulations tightening definition of liquidity and capital; develop better risk management practices. - Constraints: legal obstacles and political environment have limited progress on liquidity fund, deposit guarantee system, resolving frozen deposits, and liquidating closed banks. - Mission stance: strongly cautioned against administrative controls on interest rates and credit allocation; recommended durable reduction in interest rates and higher intermediation come from macro stability and FSAP reforms. - Staff strongly supports authorities’ stand against the draft banking law that caps spreads and mandates directed lending; recommends opposing deleterious banking-law provisions, including via presidential veto if necessary. ### Electricity, Telecommunications, Competitiveness, and Labor Market - Electricity sector problems: - Politicized tariff setting; poorly managed distribution companies with intra-sector debts; highest generation costs in South America. - Authorities plan private sector management for telecommunications and electricity distribution and to raise electricity tariffs to substantially reduce the electricity-consumption subsidy from April 2006. - Mission cautions to depoliticize tariff-setting and exercise caution in payment guarantees to private generators. - Competitiveness: - No clear evidence dollarization caused cost-competitiveness problems, but risks exist from U.S. dollar strength, rising inflationary pressures if public spending rises, and low investment with real wages rising faster than productivity. - Ecuador ranks very low in cross-country competitiveness and business climate assessments. - Mission recommends reducing labor market rigidities, including eliminating the 15 percent mandatory profit-sharing required from private firms, to improve economic efficiency and employment growth. - Authorities view a free trade agreement (FTA) with the United States as key; discussions reportedly advanced and negotiations expected to conclude in February 2006. ### Key Statistics and Tables (selected exact figures) - Real GDP growth (annual percent changes): 2003 = 2.7; 2004 = 6.9; 2005 = 3.2; 2006 (proj) = 2.7. - CPI Inflation, end-of-period: 2003 = 6.1; 2004 = 1.9; 2005 = 4.0; 2006 = 3.0 (Box 1 table). Other references record end-2005 CPI = 4.4 percent. - External current account (percent of GDP): 2003 = -1.7; 2004 = -1.1; 2005 = -1.0; 2006 = -0.9 (Box 1 table). - NFPS Primary balance (percent of GDP): 2003 = 4.7; 2004 = 5.0; 2005 = 4.2; 2006 = 4.9. - Non-oil primary: 2003 = 0.7; 2004 = -0.4; 2005 = -2.6; 2006 = -2.2. - NFPS Public debt (percent of GDP): 2003 = 52.6; 2004 = 46.5; 2005 = 43.2; 2006 = 40.0. - Gasoline and cooking gas subsidies amount to 5¼ percent of GDP. - Oil prices: Oil price Ecuador mix (US$ per barrel): 2002 = 21.4; 2003 = 26.4; 2004 = 31.8; 2005 = 41.7; 2006 = 46.5. WTI oil price entries: 2002 = 26.1; 2003 = 31.1; 2004 = 41.5; 2005 = 56.5; 2006 = 60.6. - Central government primary expenditure (US$ millions): 2003 = 4,183; 2004 = 4,649; 2005 = 5,294; 2006 (proj) = 5,901. - Central government non-oil primary balance (US$ millions): 2003 = -275; 2004 = -551; 2005 = -966; 2006 = -1,255. - Exports (US$ millions): 2002 = 5,050; 2003 = 6,240; 2004 = 7,911; 2005 = 10,090; 2006 (proj) = 11,105. - Oil exports (US$ millions): 2002 = 2,061; 2003 = 2,607; 2004 = 4,234; 2005 = 5,875; 2006 = 6,630. - Non-oil exports (US$ millions): 2002 = 3,789; 2003 = 3,633; 2004 = 3,677; 2005 = 4,215; 2006 = 4,475 (derived). - Banking indicators: - Liabilities to the private sector (annual % change): 2002 = 18.2; 2003 = 18.6; 2004 = 27.1; 2005 = 20.0 / 21.2 reported in different tables. - Credit to the private sector (annual % change): 2002 = 13.6; 2003 = 4.5; 2004 = 28.6; 2005 = 21.9 / 26.2 depending on table. ### Data Provision, Technical Assistance, and Statistical Issues - Data provision adequate for surveillance but statistical base uneven; shortcomings in balance of payments, fiscal accounts, and labor market data. - Authorities requested technical assistance from STA on balance of payments; ROSC update interest for FY2007. - Ecuador subscribed to SDDS. - Government finance compilation deteriorated after SIGEF introduction; recommendation to resume reporting annual central government GFS data (most recent reported annual GFS data were for 1994). - STA mission (July 2002) recommended improvements in travel services estimates, surveys of direct and portfolio investment, recording external debt transactions, and recording reserve assets. - Staff noted remaining deficiencies in profit remittances estimates, non-oil direct investment, and private capital flows; authorities requested TA. ### IMF Executive Board and Staff Statements (January–February 2006) - Executive Board concluded Article IV consultation on January 25, 2006. - Board and Directors: - Commended lower inflation and public debt reductions. - Expressed concern about rising non-oil fiscal deficit due to fuel subsidies and recurrent spending; recent legislative changes risk weakening macro framework. - Recommended strengthening fiscal stance in 2006, restraining recurrent spending, prioritizing capital/social spending, and using favorable external environment to address vulnerabilities. - Statement by the Staff Representative (January 25, 2006): - Minister committed to fiscal discipline; President signed decree to cut spending by 1 percent of GDP relative to Congress-approved budget. - Authorities’ new fiscal target consistent with staff recommended NFPS primary surplus of 5.2 percent of GDP. - Authorities intend to use excess financial resources to repurchase high-interest external debt and short-term domestic debt. - Plans to strengthen fiscal transparency and expenditure management; staff concerned about planned role for public banks. - IMF Public Information Notice (PIN) No. 06/15 (Executive Board conclusion date February 9, 2006) summarized the above macro snapshot and Board views. *Source: Executive Summary and selected excerpts from IMF staff report _cr0698.* ### Executive Summary ...................................................................................................... ### _cr0698 - Executive Summary ### Background - Macroeconomic performance in 2005 was generally positive, aided by high international oil prices. - Output growth is expected to exceed 3 percent. - Inflation: 12-month CPI inflation rose from less than 2 percent in June 2005 to 4 percent at the end of the year, driven by strong growth in bank credit and public spending. - External sector: external sector performance was strong; the external current account deficit is estimated to have remained unchanged at about 1 percent of GDP. - Financial markets: robust deposit growth and a successful international bond issue resumed access to markets; Ecuador issued a US$650 million 10-year bullet bond in December 2005 with a yield of 10.75 percent (95 basis points below the existing 2012 global bond); the EMBI spread remains the widest among Latin American countries despite declines. - Public finances: NFPS primary surpluses have been consistently above 4 percent of GDP; public debt fell from over 90 percent of GDP in 2000 to 43 percent of GDP in 2005; the non-oil deficit is projected to have increased to 5 percent of GDP in 2005 due to fuel subsidies and rapid recurrent spending growth. - Political context: political conditions were turbulent in 2005; Congress dismissed President Gutierrez in April; President Palacio became Ecuador’s sixth president in the last 8 years; the government faces a weak political base with no party affiliation or representation in Congress and strong pressures for more public spending ahead of the October 2006 elections. ### Key Recent Developments and Risks - Real sector: - Non-oil sector expanded by 3½ percent in 2005. - Employment growth remained sluggish; unemployment averaged 10.7 percent, little changed from 2004. - Strong oil-sector growth following the 2003 pipeline completion has tapered off, but high oil prices bolstered domestic demand. - Prices and wages: - Inflation picked up in the second half of 2005. - Real minimum wage growth increased (figure data provided in source). - External flows: - Non-oil FDI remained low, at less than 1 percent of GDP; oil sector FDI inflows increased. - Real exchange rate has depreciated recently. - Monetary and financial sector: - Banking system credit and deposits grew strongly in 2005; liquidity remained at comfortable levels. - Bank intermediation remains below pre-crisis levels; deposits are overwhelmingly at short maturities. - Stability indicators improved: declining NPL ratios and higher capital-to-risk-weighted-assets (figure data provided in source). - Bank lending rates declined; country risk (EMBI+) declined but remained well above the Latin American average. - Fiscal developments and 2006 program: - Authorities aim for an overall primary surplus above 4¾ percent of GDP in 2006. - Budget proposal envisages wages and pensions growth of 4 percent in 2006 (vs. 15 percent a year during 2002–05). - Capital spending projected to rise by some 40 percent in 2006. - Under current WEO oil price projections, the program would be consistent with an increase in the NFPS surplus to 4.8 percent of GDP from 4.2 percent in 2005 and a decline in public debt to 40 percent of GDP. - The non–oil deficit would remain unchanged, reflecting a further substantial increase in the cost of fuel subsidies. - The 2006 fiscal program appears adequately funded, reflecting the recent bond issue and approved disbursements in January 2006 from FLAR; authorities expect to receive US$400 million in budget support financing from multilaterals, half of which appears well in train. ### Structural Reform Progress and Policy Framework Concerns - Little progress on structural reforms recommended in the 2004 Article IV consultation; several measures implemented in the last year weakened the macroeconomic policy framework. - Legislative outcomes: - Congress rejected multiple oil and electricity reform attempts and an omnibus reform bill containing measures on oil, electricity, fiscal area, pensions, labor market, and financial system. - In December 2005, Congress again rejected an electricity reform bill. - Fiscal institutional changes: - In June, Congress approved a reform to the Fiscal Responsibility Law (FRL) that eliminated the FEIREP oil fund, removed capital spending from the ceiling on primary expenditure growth, and increased earmarking of oil revenues. - Pension reform: - Congress approved a bill returning accumulated assets of the Social Security Institute’s (IESS) reserve fund to employees every three years. - The supplementary fund had assets of US$780 million (2¼ percent of GDP); this reduction in pension system assets is not matched by a corresponding reduction in pension system obligations. - The reform increases the actuarial deficit of the pension system and potentially complicates central government liquidity management because about half of the IESS’s portfolio is invested in government paper. ### Key Issues and Staff Recommendations - Central message: Ecuador should do more to use favorable external conditions to strengthen the macroeconomic policy framework and advance structural reform; stronger long-run growth and the sustainability of dollarization depend on improved fiscal policies and structural reforms to strengthen public finances, the financial system, and the investment climate. - Fiscal policy in 2006: - In light of recent inflationary pressures and the need to save a higher share of the oil windfall, the authorities should aim for a higher primary surplus than currently programmed and firmly resist spending pressures from powerful interest groups. - Fiscal reforms (institutional): - Strengthen the institutional framework for fiscal policy to: - (i) strengthen the budget’s resilience to shocks, including through further improvements in debt sustainability; - (ii) increase budget flexibility by reducing earmarking and subsidies; - (iii) ensure appropriate use of the country’s limited oil wealth. - Banking system: - Strengthen efforts to implement the 2004 FSAP recommendations. - Staff strongly supports the authorities’ stand against the dangerous banking system law currently being discussed in Congress. - Investment climate: - Address deficiencies in the business environment, including labor market and regulatory issues in key sectors such as oil, energy, and telecommunications. *Source: Executive Summary of IMF staff report _cr0698.* ### Box 1. Modifications to the Fiscal Responsibility Law ### Box 1. Modifications to the Fiscal Responsibility Law ### Modifications to the Fiscal Responsibility Law (FRL) - The June 2005 reform of the FRL aimed to increase resources for capital and social spending but "weakened the overall framework for promoting fiscal discipline." - Specific changes: - Removed capital spending from the 3.5 percent cap on annual real increases in central government primary expenditure. - Retained the requirement that the non-oil fiscal deficit decline by 0.2 percent of GDP per year; this provision was violated in both 2004 and 2005. - Eliminated the FEIREP oil fund, bringing heavy crude oil revenues into the budget and reallocating resources formerly earmarked for debt buybacks toward social spending and credits aimed at reactivating the economy. ### Staff concerns about the FRL modifications - Increased budgetary pressures from more resources being made available to the budget. - Funds earmarked for economic reactivation are to be managed by two public development banks "beset by management and institutional problems," raising the risk of misuse. - Increased revenue earmarking has raised budget rigidities relative to the original law. - Further reduced likelihood that heavy crude oil revenues would be used for external debt buybacks as originally intended. - The tax base has been eroded by a government-supported law granting generous tax incentives: - The law would provide a 10–12 year tax holiday (on income taxes, custom duties, and municipal taxes) for new companies undertaking a minimum investment of US$2–7 million in strategic sectors, including hydroelectricity generation, oil refining, and production of high technology instruments. - Staff concluded the law’s effectiveness to encourage investment is doubtful, but it would weaken the tax base and complicate tax administration. - Financial sector progress: - Superintendency of Banks tightened capital and liquidity regulations per 2004 FSAP recommendations. - Congress approved new anti-money laundering legislation and a law to strengthen credit bureaus. - A new banking law recently sent to Congress raises serious concerns (see Box 2). ### Box 2 — Draft Banking Sector Law (summary) - Objectives in draft bill: channel more credit to productive activities and reduce cost of financial intermediation. - Key provisions in the draft: - Cap intermediation spreads: central bank required to set a ceiling on lending rates at 300 basis points above the central bank’s reference rate (the 3-month prime rate for the corporate sector) and a floor on deposit rates at 70 percent of the reference rate; abolish all fees and commissions on loans. - Directed lending: banks required to lend at least 75 percent of their deposits to productive sectors; remaining deposits to be placed in the central bank; central bank would determine allocation of credit among productive sectors based on their GDP share; stiff fines for non-compliance. - Staff and authorities’ concerns: - The draft could result in a sharp reduction in financial intermediation. - Credit allocation guidelines could undermine prudent credit management and threaten banking system soundness and stability. - Congressional consideration: - Congress is reportedly considering eliminating directed lending from the bill and relaxing intermediation caps by setting them according to credit type—commercial, mortgage, consumer, and micro-credit. ### Fiscal rule indicators and related facts (as reported) - The provision to reduce the non-oil fiscal deficit by 0.2 percent of GDP per year was violated in both 2004 and 2005. - Gasoline and cooking gas subsidies amount to 5¼ percent of GDP. - The 2004 civil service reform applies only to 25 percent of public servants, excluding teachers, health workers, and the military. ### Macroeconomic outlook (short-term staff projections and assumptions) - Oil futures assumption: average WTI oil price of US$61 per barrel in 2006. - Staff projects: - Real GDP growth: 2¾ percent in 2006 (non-oil GDP expanding at a similar pace). - CPI inflation: 3 percent in 2006. - External current account deficit: about 1 percent of GDP in 2006. - NFPS surplus: 4.9 percent of GDP in 2006 (slightly higher than authorities’ program), reflecting lower capital spending more than offsetting somewhat higher current spending. ### Short-term risks highlighted by staff - Spending pressures: strong demands for spending increases from powerful interest groups and large cash holdings from recent credit disbursements could challenge limits on recurrent spending and capital transfers to subnational governments. - Oil price sensitivity: every US$1 decline in the price of oil would reduce the central government overall balance by about 0.1 percent of GDP. - Inappropriate policy initiatives: recent legislative changes (to the FRL, pension system, tax incentives, and the draft banking bill) increase the risk of damaging legislation that could sharply deteriorate confidence and spill over to the banking system. ### Historical and near-term indicators (Ecuador: Main Economic Indicators, 2003–06) - Real GDP growth: 2003 = 2.7; 2004 = 6.9; 2005 = 3.2; 2006 = 2.7 - CPI Inflation, eop: 2003 = 6.1; 2004 = 1.9; 2005 = 4.0; 2006 = 3.0 - External current account (percent of GDP): 2003 = -1.7; 2004 = -1.1; 2005 = -1.0; 2006 = -0.9 - NFPS Primary balance (percent of GDP): 2003 = 4.7; 2004 = 5.0; 2005 = 4.2; 2006 = 4.9 - of which: non-oil primary: 2003 = 0.7; 2004 = -0.4; 2005 = -2.6; 2006 = -2.2 - NFPS Overall balance (percent of GDP): 2003 = 1.7; 2004 = 2.3; 2005 = 1.7; 2006 = 2.2 - NFPS Public debt (percent of GDP): 2003 = 52.6; 2004 = 46.5; 2005 = 43.2; 2006 = 40.0 ### Medium-term risks and baseline outlook - Low growth scenario risks: - Annual real GDP growth could average about 2¼ percent over the next five years if current trends persist. - Oil production trending downward due to low investment by PetroEcuador and failure to attract private investment. - Non-oil sector unlikely to sustain growth above long-run average of 2.6 percent. - Continued high poverty and unemployment rates and increased social pressures. - Deteriorating fiscal outlook: - NFPS surplus projected to decline by 2½ percentage points of GDP over the medium term under a passive scenario. - Large financing gaps, crowding out of public investment, gradually declining oil revenues, recurrent spending pressures, and limited access to credit could lead to severe cash flow problems and increase the risk of default or disorderly exit from dollarization. - Banking system fragility: - Depositors’ reluctance to lengthen deposit maturities indicates limited depth of confidence improvements. - Absence of deposit insurance or lender of last resort raises systemic risk. - Increased susceptibility to shocks: - Though debt-to-GDP would decline gradually, below-average performance or lower oil prices could resurface fiscal and external sustainability problems. ### Staff “active” policy scenario (medium term, as proposed by staff) - Fiscal consolidation targets and reforms: - Reduce the non-oil primary deficit by between 2–3 percent of GDP through measures to widen the tax base, lower fuel and pension subsidies, contain the wage bill (in part through civil service reform), and reduce revenue earmarking. - Reallocate spending toward public investment and social spending while sustaining large primary surpluses, boosted by higher oil revenue from increased production. - Public debt would fall to about 20 percent of GDP by 2010. - Growth outcomes: - Real GDP growth would reach 4½ percent in 2010, reflecting efficiency gains from reforms to public enterprises, better management of oil resources, stronger banking supervision/regulation, trade liberalization, and measures to improve the investment climate. ### Policy recommendations and priorities (staff emphasis) - Strengthen fiscal discipline in 2006 and resist pressures for spending increases beyond program levels; authorities intended to fully offset additional transfers to subnational governments implied by Congress’s reclassification of oil revenues by reducing discretionary capital spending (0.4 percent of GDP). - Use proceeds from recent bond issue and FLAR loan to retire short-term debt and high interest Global 2012 bonds to generate cashflow savings and reduce rollover risk. - Begin work on a new draft fiscal responsibility law for the next government: - Enhance transparency (definitions of target variables such as capital spending or the non-oil balance) and strengthen accountability of the Minister of Finance. - Target a debt-to-GDP ratio substantially lower than 40 percent. - Develop a fiscal rule for the non-oil balance consistent with intertemporal efficiency and equity. - Staff estimations suggest a central government non-oil primary deficit in the range of 1½–3 percent of GDP would be consistent with keeping oil wealth constant in real terms and reducing debt-to-GDP to safe levels. - Improve fiscal management: - Boost tax revenue by simplifying and broadening the tax base; strengthen rules related to transfer pricing; introduce a simplified turnover tax for small businesses; eliminate low-yield, administratively cumbersome taxes. - Reduce budget rigidities: control growth of the wage bill through comprehensive civil service reform; substantially reduce revenue earmarking; reduce large subsidies for fuel and electricity; reduce government contributions to pensions. - Begin groundwork and consensus building for politically sensitive reforms (e.g., gradual reduction of fuel subsidies and announced electricity tariff increase beginning April 2006). *Source: IMF staff report excerpt titled "Box 1. Modifications to the Fiscal Responsibility Law."* ### 19. Following the changes made by Congress to the pension system in 2005, and a ### _cr0698 - 19. Following the changes made by Congress to the pension system in 2005, and a ### Pension reform and fiscal burden - Following congressional changes in 2005 and a ruling that portions of the 2001 social security reform were unconstitutional, authorities began preparations for a comprehensive pension reform. - Agreed objectives for pension reform: - Substantially reduce the pension system’s actuarial deficit. - Lower the government’s pension contribution, which is required to be 40 percent of the total pension bill and “imposes a heavy burden on the budget and benefits mostly middle and upper classes.” - Authorities are in discussions with the Social Security Institute to resolve the government’s outstanding debt to that agency. - The authorities have requested Fund technical assistance to design the pension reform. ### Long-run growth and competitiveness — overall assessment - Structural reforms needed to: - Sustain competitiveness. - Improve the investment climate. - Increase long-run economic growth and employment. - Policy targets agreed with mission: - Enhance the petroleum sector. - Diversify the export base. - Reduce fiscal and financial system vulnerabilities. - Increase efficiency of public enterprises. - Advance trade liberalization. - Contain domestic wage and price pressures. ### Enhancing the oil sector — findings - Management problems and declining crude production at PetroEcuador, inadequate refining capacity, frozen domestic prices, and rising imports of oil products have prevented full benefit from high international oil prices. - Sizable investment is needed to reverse PetroEcuador’s output decline and improve refining capacity. - Authorities plan a comprehensive administrative reform of PetroEcuador, including an external audit as a key first step, with possible World Bank technical assistance. - Authorities plan to auction new fields for exploration and exploitation in coming months and indicated additional private investment is needed in extraction and refining. - To attract private investment the mission highlighted the need to eliminate legal uncertainties and depoliticize the setting of oil derivative prices. ### Box 3 — Policy Reforms for More Efficient Oil Resource Management - Key issues: - Total production increased slowly except for a large increase in 2004; private output offset a 40 percent decline at PetroEcuador since 1994 reflecting underinvestment and governance problems. - Private crude production uses only 70 percent of the capacity of the new pipeline and is unlikely to increase significantly because of relatively low investment, reflecting: - Uncertainty about the legal framework (outstanding disputes on VAT reimbursement, charge of contract violation against the largest producer, government’s announcement to renegotiate all contracts). - Lack of new exploration licenses since 1998. - Total refining capacity has not increased since the late 1980s due to PetroEcuador problems and private-sector reluctance given politicized price-setting for oil derivatives. - Domestic oil derivative prices frozen since early 2003; increased consumption and unchanged refining capacity, partly due to cross-border smuggling to Peru and Colombia (where the retail price is more than four times higher), have almost doubled import volumes of oil derivatives in the last 4 years. - The total value of the subsidy reached 5¼ percent of GDP this year, severely reducing Ecuador’s net oil windfall gain. - Policy recommendations: - Develop a coherent oil sector policy specifying PetroEcuador’s role, a strategy for restoring production in PetroEcuador’s light crude oil fields, and a plan to auction new exploration and production licenses for undeveloped Amazon fields. - Implement a comprehensive reform of PetroEcuador to improve administrative efficiency, governance, and transparency; undertake a financial audit as a first step. - Liberalize the domestic fuel market: deregulate prices and curtail PetroEcuador’s monopoly in wholesale distribution and storage to improve the climate for private downstream investment. - In planned renegotiations with oil companies, establish clear and transparent rules for private sector participation to avoid ad hoc governance problems. - Investment estimate: - The investment needed to restore output to mid-1994 levels is estimated at US$0.5–1 billion. ### Competitiveness issues — findings and recommendations - No clear evidence so far that dollarization has been associated with cost-competitiveness problems, but risks exist: - Further strengthening of the U.S. dollar relative to Ecuador’s main trading partner currencies. - Threat of rising inflationary pressures, especially if public spending continues to rise fast. - With low investment, real wages could rise faster than productivity. - Ecuador ranks very low in cross-country competitiveness and business climate assessments; narrow export base dominated by volatile commodities increases external vulnerability. - Authorities view a free trade agreement (FTA) with the United States as key; discussions reportedly well-advanced and negotiations expected to be concluded in February 2006. - Mission recommendations: - Continue trade liberalization at the multilateral level. - Reduce labor market rigidities, including eliminating the 15 percent mandatory profit-sharing required from private firms, to improve economic efficiency, the investment climate, and promote employment growth. ### Electricity and telecommunications - Inefficiencies in public enterprises in electricity and telecommunications drain fiscal resources and obstruct growth. - Electricity sector problems: - Highly politicized tariff setting. - Poorly managed distribution companies generating losses, leading to large intra-sector debts. - Deterred private investment in generation, resulting in the highest generation costs in South America. - Authorities’ measures: - Put telecommunications and electricity distribution companies under private sector management. - Raise electricity tariffs to substantially reduce the electricity-consumption subsidy from April 2006. - Continue working with Congress on the electricity reform bill. - Mission cautions: - Depoliticize tariff-setting decisions to attract private management and investment. - Exercise caution in the design and scope of payment guarantees to private generators to minimize risk of sizable government liabilities. ### Reducing vulnerabilities and improving efficiency in the financial system - FSAP (2004) findings: - Financial system more resilient since the 1998–99 crisis but remaining vulnerabilities require action. - Key needs: improve supervision and regulation; increase minimum capital requirements; establish a well-financed liquidity fund (lender-of-last-resort); establish a limited-coverage deposit insurance system; strengthen creditor rights; improve bankruptcy procedures. - Authorities’ work plan includes: - Submit to Congress a bankruptcy and creditors’ rights bill in the first quarter of 2006. - Finalize draft legislation to strengthen the payments system. - Continue implementing regulations tightening the definition of liquidity and capital. - Develop better risk management practices. - Constraints to progress: - Legal obstacles and a difficult political environment have limited progress on setting up an adequately-financed liquidity fund, strengthening the deposit guarantee system, resolving frozen deposits, or liquidating remaining closed banks. - Mission stance on banking system bill in Congress: - Strongly cautioned against administrative regulations to determine interest rates and credit allocation as envisaged in the bill. - Emphasized that durable reduction in interest rates and expansion of intermediation depends on macroeconomic stability, reduction of vulnerabilities, and progress on FSAP reform priorities. - Authorities expressed concern about the bill and indicated efforts to correct its shortcomings. ### Staff appraisal — macroeconomic overview and policy priorities - 2005 performance: - Macroeconomic performance generally positive despite political difficulties; high international oil prices aided resilience. - Strong growth in the oil sector after the new pipeline in 2003 has tapered off; high oil prices bolstered sentiment and underpin non-oil growth. - Confidence in the financial system improved with strong expansion in deposits and credit, further declines in interest rates, and continued public debt reduction. - Ecuador regained international market access with a US$650 million bond placement in December 2005, the first voluntary international issue since 1997. - Concerns: - Non-oil deficit has risen due to difficulties in controlling spending and rising fuel subsidy costs. - Recent structural reforms (changes to fiscal responsibility law, pension system, and tax incentives law) have weakened the policy framework. - Recent increase in inflation is worrisome. - Recommended fiscal and structural priorities: - Strengthen fiscal policy stance in 2006 to address inflationary pressures and place public finances on a sustainable track. - Sustain restraint on recurrent spending envisaged in the draft budget and moderate planned growth in capital expenditures. - Resist pressures for more spending, including offsets to Congress’s changes to the draft budget ahead of the October 2006 elections. - Use proceeds from the recent bond issue strictly for debt management purposes. - Strengthen institutional framework for fiscal discipline; reduce dependence on oil revenue; increase budget flexibility; improve quality of government spending. - Consider redesigning the FRL to target a debt-to-GDP ratio substantially lower than 40 percent; increase transparency in fiscal rules; improve accountability; strengthen compatibility of fiscal rules with efficient use of oil wealth. - Implement tax reform to eliminate exemptions, broaden the tax base, and simplify the tax system. - Reduce revenue earmarking and poorly-targeted subsidies; move quickly to reduce the cooking gas subsidy and prepare for substantial reduction of all other fuel subsidies while strengthening the social safety net. - Develop coherent civil service reform to control wage costs; move ahead with pension system reform. - Improve procedures for evaluating, prioritizing, and monitoring projects as resources are freed for capital and social spending. - Oil sector actions urged: - Define timetable for administrative reforms at PetroEcuador, including an external financial audit and auctioning of oil fields to private investors. - Develop and implement an investment plan to reverse PetroEcuador’s crude production decline and strengthen refining capacity. - Eliminate legal uncertainties and strengthen the regulatory framework to attract private investment. - Liberalize the domestic oil derivatives market, depoliticize price setting, and phase out PetroEcuador’s wholesale market monopoly. - Financial system actions urged: - Follow through on 2004 FSAP recommendations to address banking vulnerabilities, improve efficiency, and achieve a durable reduction in interest rates. - Create an effective deposit insurance system and enable the central bank to provide an adequate lender-of-last-resort facility. - Strongly oppose the banking reform bill to introduce administrative controls on interest-rate spreads and credit allocation, including through presidential veto if necessary. - Competitiveness and structural reforms: - Focus macroeconomic policy on reducing recent inflationary pressures. - Endorse plans to contract private management for electricity distribution and telecommunications, reduce electricity subsidies, and settle intra-sector debts. - Depoliticize electricity tariffs to allow them to reflect costs and attract private investment in lower-cost generation. - Staff viewed positively efforts to finalize an FTA with the United States as a catalyst for governance and legal security reforms. - Stress the importance of increasing labor market flexibility and improving customs to raise economic efficiency and improve the investment climate. *Source: IMF staff report extracted from the provided content unit.* ### 36. The lagging reform agenda has become ever more urgent as time has gone by ### _cr0698 - 36. The lagging reform agenda has become ever more urgent as time has gone by ### Urgency of the reform agenda - The lagging reform agenda has become ever more urgent as time has gone by without its implementation. - Many of these reforms imply confronting powerful vested interests and changing long-established relations between the government and the private sector, and between the private sector and the rest of the world. - These obstacles have been compounded by the lack of a strong political base or congressional representation by successive governments. - Policy recommendation: - It will therefore be crucial for the authorities to devise an effective strategy to build the necessary consensus in favor of this reform agenda. - In this context, the authorities should endeavor to place these issues at the forefront of next year’s election campaign discussions. ### Data provision and statistical base - Finding: - Data provision for surveillance purposes is adequate overall but the statistical base remains uneven. - Shortcomings exist in certain areas of the balance of payments statistics, the fiscal accounts, and labor market data. - Actions requested and interests: - The authorities have requested technical assistance from STA in the area of balance of payments. - The authorities have expressed interest in having an update of the ROSC in FY2007. - Subscription: - Ecuador has subscribed to the SDDS. ### Exchange restriction: blocked deposits - Finding: - Ecuador maintains an exchange restriction in the form of blocked deposits in closed banks. - Staff recommendation: - Since there exists no formal timetable to resolve the problem, staff does not recommend Board approval of this restriction. *Source: _cr0698 - 36. The lagging reform agenda has become ever more urgent as time has gone by* ### 39. It is expected that the next Article IV consultation with Ecuador will be held on the ### _cr0698 - 39. It is expected that the next Article IV consultation with Ecuador will be held on the ### Social Indicators - GDP per capita in US$ (2004): 2,325 - Literacy rate 1/: 91 - Unemployment (November 2005): 9.7 - Life expectancy at birth (years): 74 - Estimated poverty rate: 35 - Infant mortality (per 1,000 live births): 25 - Note: 1/ Based on percent of population aged 15+. ### National income and prices (annual percentage changes; unless otherwise indicated) - Real GDP: 2002: 3.4; 2003: 2.7; 2004: 6.9; 2005: 3.2; 2006 (projection): 2.7 - Oil: 2002: -6.7; 2003: 11.8; 2004: 33.2; 2005: 1.4; 2006: 1.0 - Non-oil: 2002: 4.9; 2003: 1.5; 2004: 3.1; 2005: 3.5; 2006: 3.0 - Domestic demand (contribution to growth): 9.1; 1.9; 5.3; 7.4; 3.7 - Foreign balance (contribution to growth): -5.7; 0.8; 1.6; -4.2; -1.0 - Real GDP per capita: 1.9; 1.2; 5.4; 1.2; 1.3 - Consumer price index period average: 12.6; 7.9; 2.7; 2.4; 3.4 - Consumer price index end-of-period: 9.4; 6.1; 1.9; 4.0; 3.0 ### Banking system - Liabilities to the private sector 2/: 18.2; 18.6; 27.1; 20.0; 12.2 - Credit to the private sector: 13.6; 4.5; 28.6; 21.9; 11.6 - Average deposit rate (in percent) 3/: 5.1; 5.0; 3.8; 4.0... - Average lending rate (in percent) 3/: 15.4; 13.5; 9.8; 10.5... - EMBI Ecuador (bps, end of period) 3/: 1,801; 799; 690; 642... - EMBI spread Latin America (bps, end of period) 3/: 1,007; 521; 420; 288... - Note: 2/ In 2004–06 includes a broader definition of deposits in all open financial institutions. 3/ November data for 2005. ### External sector (US$ millions and percent of GDP where indicated) - Exports (US$ millions): 2002: 5,050; 2003: 6,240; 2004: 7,911; 2005: 10,090; 2006 (proj): 11,105 - Oil exports (US$ millions): 2,061; 2,607; 4,234; 5,875; 6,630 - Non-oil exports (US$ millions): 3,789; 3,633; 3,677; 4,215; 4,475 (derived from totals) - Exports (annual percent changes): 7.7; 23.6; 26.8; 27.6; 10.1 - Oil: 8.5; 26.5; 62.4; 38.8; 12.9 - Non-oil: 7.6; 21.6; 1.2; 14.6; 6.2 - Imports (annual percent changes): 19.9; 2.8; 20.1; 27.5; 8.6 - Terms of trade, national accounts data (deterioration -): 4.3; 2.9; 7.0; 5.5; 3.3 - Real effective exchange rate (depreciation -) 4/: 11.3; -1.3; -4.6; -3.3... - Net foreign assets at the Central Bank (in millions of US$): 1,008; 1,160; 1,437; 2,108; 2,784 - Note: 4/ September data for 2005. ### Public finances (central government / public sector; percent of GDP) - Revenue: 26.0; 25.4; 27.0; 28.0; 28.6 - Non-interest expenditure: 21.5; 20.7; 22.0; 23.8; 23.7 - Primary balance (deficit -): 4.5; 4.7; 5.0; 4.2; 4.9 - Interest bill: 3.5; 3.0; 2.7; 2.5; 2.7 - Overall balance (deficit -): 1.0; 1.7; 2.3; 1.7; 2.2 - Total public debt: 58.2; 52.6; 46.5; 43.2; 40.0 - Domestic: 11.3; 10.4; 10.0; 9.5; 8.9 - External: 46.9; 42.2; 36.5; 33.7; 31.1 ### Saving–investment balance (percent of GDP) - National saving: 22.8; 25.9; 26.7; 26.3; 26.4 - Gross investment: 27.7; 27.7; 27.8; 27.2; 27.3 - Foreign saving = - external current account balance: 4.9; 1.7; 1.1; 1.0; 0.9 ### Memorandum items (selected) - Foreign direct investment (in millions of US$): 1,275; 1,555; 1,160; 1,540; 1,573 - Use of Fund resources (percent of quota): 75.0; 86.8; 61.4; 18.1; 5.0 - Non-oil balance of the NFPS (percent of GDP): -3.0; -2.4; -3.1; -5.0; -5.0 - Central government deposits in cuenta unica (in millions of US$): 118; 922; 156; 283; 33 - Oil price Ecuador mix (US$ per barrel): 21.4; 26.4; 31.8; 41.7; 46.5 - Oil price WTI (US$ per barrel): 26.1; 31.1; 41.5; 56.5; 60.6 - Nominal GDP (millions of US$): 24,311; 27,201; 30,282; 32,667; 35,351 ### Central Government Operations, Net Accounting (2003–2006; in millions of US$ and percent of GDP) - Non-oil Revenue (US$ millions): 2003: 3,778; 2004: 4,098; 2005: 4,328; 2006 (proj): 4,647 - Taxes: 2,789; 3,166; 3,778; 4,076 - VAT: 1,583; 1,720; 1,978; 2,117 - Income tax: 592; 702; 936; 1,016 - Excises: 181; 202; 222; 242 - Import duties: 382; 454; 574; 625 - Domestic sales of petroleum derivatives 1/: 568; 478; -18; -110 - Other non-oil revenue: 420; 455; 568; 681 - Primary expenditure (US$ millions): 4,183; 4,649; 5,294; 5,901 - Current: 2,866; 3,255; 3,848; 4,116 - Wages and salaries: 1,864; 2,049; 2,377; 2,507 - Purchases of goods and services: 329; 363; 401; 449 - Other: 673; 843; 1,071; 1,160 - Transfers to Social Security: 231; 331; 430; 473 - Bono de Desarrollo Humano: 168; 173; 167; 192 - Capital: 1,317; 1,395; 1,446; 1,785 - Capital Spending: 675; 736; 774; 929 - Transfers to Municipalities: 642; 658; 672; 856 - Non-oil Primary balance (US$ millions): -275; -551; -966; -1,255 - Interest (US$ millions): 827; 814; 856; 1,009 - Non-oil Overall balance (US$ millions): -1,102; -1,364; -1,822; -2,264 - Oil revenue from exports (US$ millions): 1,072; 1,604; 2,171; 2,482 - Primary Balance (US$ millions): 797; 1,053; 1,205; 1,227 - Overall balance (US$ millions): -292; 403; 492; 18 - Central government operations (percent of GDP): Revenue 13.9; 13.5; 13.3; 13.1; Primary expenditure 15.4; 15.4; 16.2; 16.7; Primary balance 2.9; 3.5; 3.7; 3.5; Overall balance -0.1; 0.8; 1.1; 0.6 - Memorandum: Real growth in primary expenditure (percent): -5.4; 10.2; 8.9; 5.8 - Note: 1/ Transfers from PetroEcuador generated by the domestic sales of oil derivatives net of derivative import costs. ### Central Government Financing (2003–2006; in millions of US$) - Gross financing needs: 1,737; 2,826; 3,374; 2,022 - Central government deficit: 29; -240; -349; -218 - Deposit build-up (+): 113; 985; 606; 5 - Amortization: 1,594; 2,587; 2,866; 1,775 - External amortization: 680; 802; 936; 941 - Domestic amortization: 914; 1,784; 1,929; 834 - NFPS: 558; 1,132; 1,113; 629 - Private Sector 1/: 356; 652; 816; 205 - Debt buybacks: 0; 38; 129; 740; 0 - Gross identified financing: 1,252; 2,708; 3,300; 1,204 - Bond issues: 1,082; 2,580; 3,083; 764 - Domestic bond issues: 1,082; 2,580; 2,433; 764 - NFPS domestic: 795; 1,797; 1,532; 629 - Private sector domestic: 286; 784; 901; 135 - Loan disbursements: 336; 241; 298; 439 - External project loans: 276; 198; 194; 319 - Exceptional/program financing: 485; 118; 738; 18 - Rescheduling/debt relief: 70; 100 - FLAR: 0; 0; 0; 400 - IDB: 100; 0; 0; 198 - WB: 130; 0; 0; 100 - CAF: 100; 117; 73; 120 - IMF: 85; 0; 0; 0 - Memorandum: Multilateral Financing: 415; 118; 738; 18 - Notes: 1/ Includes public financial institutions. 2/ For 2005, includes bilateral financing from Venezuela in the amount of US$200 million. 3/ Includes the refund of contributions to the social security reserve fund (totaling 2.2 percent of GDP) in 2005-06. 4/ For 2005, reflects the value of discount given on the December 2005 bond issue. ### Operations of the Nonfinancial Public Sector, Net Accounting (2003–2006) - Revenue (US$ millions): 6,908; 8,177; 9,155; 10,123 - Revenue from oil exports: 1,096; 1,638; 2,207; 2,516 - Non-oil revenue: 5,658; 6,202; 6,818; 7,377 - Taxes: 3,164; 3,595; 4,321; 4,655 - Social security contributions: 900; 1,024; 1,106; 1,163 - Domestic sales of petroleum derivatives 1/: 568; 478; -18; -110 - Other: 1,027; 1,106; 1,409; 1,670 - Primary expenditure: 5,635; 6,674; 7,785; 8,386 - Current: 4,305; 5,062; 5,894; 6,182 - Wages and salaries: 2,288; 2,586; 2,945; 3,076 - Purchases of goods and services: 948; 1,032; 1,144; 1,210 - Social Security Benefits 2/: 516; 665; 1,047; 1,041 - Capital: 1,460; 1,612; 1,890; 2,204 - Fixed capital spending: 1,446; 1,628; 1,860; 2,176 - Primary balance (US$ millions): 1,273; 1,504; 1,370; 1,737 - Interest (US$ millions): 820; 797; 808; 972 - Overall balance (US$ millions): 453; 707; 562; 765 - Percent of GDP (selected): Revenue 25.4; 27.0; 28.0; 28.6; Primary balance 4.7; 5.0; 4.2; 4.9; Interest 3.0; 2.6; 2.5; 2.7; Overall balance 1.7; 2.3; 1.7; 2.2 - Memorandum: Real growth in primary expenditure (percent): -1.9; 16.5; 11.6; 2.2 - Notes: 1/ From 2003 onward, includes revenues accruing to the oil stabilization fund (FEIREP). 2/ Includes the refund of contributions to the social security reserve fund (totaling 2.2 percent of GDP) in 2005-06. ### Nonfinancial Public Sector Financing (2003–2006; in millions of US$) - Gross financing needs: 1,543; 2,122; 2,425; 2,237 - Deposit build-up (+): 362; 425; 516; 786 - Amortization: 1,098; 1,519; 1,792; 1,202 - External: 743; 836; 976; 997 - Domestic 1/: 356; 683; 816; 205 - Additional debt reduction: 777; 691; 250 - Gross identified financing: 1,051; 2,004; 2,352; 1,419 - NFPS surplus 3/: 453; 707; 562; 765 - Bond issues: 286; 784; 1,551; 135 - Domestic bond issues: 286; 784; 901; 135 - Loan disbursements: 356; 298; 306; 490 - External project loans: 316; 267; 299; 419 - Exceptional/program financing: 492; 118; 738; 18 - Rescheduling/debt relief: 77; 100 - FLAR: 0; 0; 0; 400 - IDB: 100; 0; 0; 198 - WB: 130; 0; 0; 100 - CAF: 100; 117; 73; 120 - IMF: 85; 0; 0; 0 - Memorandum: Total debt (percent of GDP): 52.6; 46.5; 43.2; 40.0 - Domestic: 10.4; 10.0; 9.5; 8.9 - External: 42.2; 36.5; 33.7; 31.1 - Notes: 1/ Includes public financial institutions. 2/ Includes financial assistance to public banks. 3/ Includes the refund of contributions to the social security reserve fund (totaling 2.2 percent of GDP) in 2005-06. 4/ For 2005, includes bilateral financing from Venezuela in the amount of US$200 million. 5/ Information about the financial position of some agencies within the NFPS is incomplete. 6/ For 2005, reflects the value of discount given on the December 2005 bond issue. ### Summary Accounts of the Financial System (selected items) - Net foreign assets (Central Bank, in millions of US$): 2002: 1,008; 2003: 1,160; 2004: 1,437; 2005: 2,108; 2006 (proj): 2,784 - Net domestic assets (Central Bank): -704; -839; -839; -1,046; -1,624; -2,244 (various years) - Central bank fully backed liabilities: 304; 321; 321; 391; 485; 540 - Banking system liabilities to the private sector (deposits): 5,757; 6,830; 4,291; 5,365; 6,438; 7,229 (selected years) - Memorandum items: - M2 (percentage change): 18.7; 19.1; ...; 27.1; 20.0; 12.2 - M1 (percentage change): 31.1; 19.2; ...; 28.5; ... - Net credit to private sector (percentage change): 13.6; 4.5; ...; 28.6; 21.9; 11.6 - Public sector deposits at central bank: 1,027; 1,235; 1,235; 1,507; 2,110; 2,713 - Central government deposits "cuenta unica": 118; 929; 221; 564; 134; 6 - Notes: 1/ The previous methodology included open and closed commercial banks, the new one includes only open commercial banks. 2/ Does not exclude loan provisions starting in 2003 new methodology. 3/ Includes the BNF, CFN, finance companies, cooperatives, savings and loans, and the BEV. 4/ Includes the BCE, open commercial banks, and the other financial institutions. ### Balance of Payments (selected, US$ millions and percent of GDP; projections to 2010) - Current account (US$ millions): -471; -345; -312; -308; -413; -869; -1,048; -1,328 (years given) - Trade account (US$ millions): -107; 291; 372; 553; 172; -498; -911; -1,375 - Exports, f.o.b. (US$ millions): 6,240; 7,911; 10,090; 11,105; 11,175; 11,103; 11,127; 11,231 - Petroleum products: 2,607; 4,234; 5,875; 6,630; 6,485; 6,222; 5,980; 5,806 - Imports, f.o.b. (US$ millions): -6,346; -7,620; -9,719; -10,552; -11,002; -11,602; -12,038; -12,606 - Of which: oil sector investment 1/: -886; -582; -884; -902; -934; -959; -987; -1,016 - Of which: oil derivatives: -676; -867; -1,464; -1,575; -1,549; -1,524; -1,502; -1,493 - Services (net): -2,140; -2,558; -2,800; -3,091; -2,944; -2,861; -2,760; -2,716 - Of which: interest payments: -1,114; -1,164; -1,031; -1,142; -1,019; -924; -857; -827 - Transfers (net): 1,776; 1,922; 2,116; 2,229; 2,358; 2,491; 2,624; 2,763 - Capital account: 742; 655; 1,214; 416; 306; 200; 1,103; 1,541 - Net public sector capital: -33; -515; 12; -578; -673; -590; -402; -388 - Direct investment: 1,555; 1,160; 1,540; 1,573; 1,636; 1,686; 1,741; 1,820 - Of which: oil sector: 1,265; 896; 1,360; 1,387; 1,438; 1,476; 1,518; 1,562 - Other net private sector capital 2/: -780; 10; -338; -578; -657; -897; -236; 110 - Overall balance (US$ millions): 270; 309; 902; 108; -108; -669; 562; 13 - Financing and reserves: - Net foreign assets at the BCE (increase -) 3/: -152; -277; -671; -676; 856; 9; -156; -313 - Net foreign assets at the BCE (in millions of US$): 1,160; 1,437; 2,108; 2,784; 2,776; 2,207; 2,363; 2,676 - Selected ratios (percent of GDP or percent of exports GNFS): - Current account (percent of GDP): -1.7; -1.1; -1.0; -0.9; -1.1; -2.2; -2.5; -3.0 - Non-oil current account (percent of GDP): -4.3; -8.6; -9.8; -10.6; -9.9; -10.0; -9.4; -9.1 - Total external debt (percent of GDP): 59.5; 53.4; 49.9; 44.4; 38.4; 32.9; 29.9; 27.8 - Total external debt service ratio (as percent of exports GNFS): 33.4; 37.3; 30.9; 29.8; 29.7; 26.4; 21.9; 21.1 - Memorandum: LIBOR interest rate (percent): 1.23; 1.79; 3.63; 4.51; 4.65; 4.68; 4.68; 4.68 - Notes: 1/ Imports of goods related to new foreign investments in the oil sector. 2/ Includes errors and omissions. 3/ Includes liabilities to the IMF and excludes deposits of the FEIREP oil fund. 4/ For 2005, reflects value of discount given on the December 2005 bond issue. ### Medium-Term Scenarios (Passive and Active; selected series) - Passive Medium-Term Scenario (selected): - Real GDP (annual percent changes): 1997: 4.1; 1998: 2.1; 1999: -6.3; 2000: 2.8; 2001: 5.1; 2002: 3.4; 2003: 2.7; 2004: 6.9; 2005: 3.2; 2006: 2.7; 2007: 2.2; 2008: 2.2; 2009: 2.2; 2010: 2.2 - Consumer prices period average (percent): 4.2; 4.7; -25.2; -10.1; 22.4; 9.4; 7.9; 2.7; 2.4; 3.4; 3.0; 3.0; 3.0; 3.0 - Total public debt (gross, percent of GDP): 62.5; 65.9; 101.6; 91.4; 70.2; 58.2; 52.6; 46.5; 43.2; 40.0; 36.5; 33.7; 33.1; 32.8 - Oil price (Ecuador mix, US$ per barrel): 15.5; 9.2; 15.1; 24.6; 19.1; 21.4; 26.4; 31.7; 41.1; 46.5; 45.1; 43.8; 42.6; 41.9 - Active Medium-Term Scenario (selected): - Real GDP (annual percent changes): same historical series through 2005; projections differ: 2006: 2.7; 2007: 3.6; 2008: 4.0; 2009: 4.2; 2010: 4.5 - Consumer prices end-of-period and period average projections vary modestly from passive scenario - Total public debt (gross, percent of GDP): declines more steeply under active scenario: 2006: 39.8; 2007: 34.7; 2008: 30.0; 2009: 25.3; 2010: 19.6 - Memo: Private investment under active scenario rises to 24.3; 24.7; 25.0; 25.0 in projections ### Key economic and market indicators (2000–2006; selected) - Real GDP growth (percent): 2000: 2.8; 2001: 5.1; 2002: 3.4; 2003: 2.7; 2004: 6.9; 2005: 3.2; 2006: 2.7 - CPI inflation (period average, percent): 2000: -7.7; 2001: 37.7; 2002: 12.6; 2003: 7.9; 2004: 2.7; 2005: 2.4; 2006 (proj): 3.4 - Short-term interest rate (percent) 1/: 5.5; 5.1; 5.0; 3.8; 4.0... - EMBI spread (bps, end of period) 1/: 2,866; 1,233; 1,801; 799; 690; 642... - Current account balance (percent of GDP): 5.3; -3.3; -4.9; -1.7; -1.1; -1.0; -0.9 - Net FDI inflows (percent of GDP): -1.6; 6.3; 5.2; 5.8; 3.8; 4.7; 4.4 - Exports growth (US$ value, GNFS): 12.6; -3.7; 8.2; 14.3; 27.1; 24.6; 9.7 - Gross international reserves (GIR) in US$ billion: 1.2; 1.1; 1.0; 1.2; 1.4; 2.1; 2.8 - Total gross external debt (percent of GDP): 86.0; 69.0; 67.1; 59.8; 53.4; 48.7; 44.2 - Public sector overall balance (percent of GDP): 1.0; -0.5; 1.0; 1.7; 2.3; 1.7; 2.2 - Public sector gross debt (percent of GDP): 91.4; 70.2; 58.2; 52.6; 46.5; 43.2; 40.0 - Financial sector (selected): - Capital in percent of risk-adjusted assets: 13.1; 13.5; 14.4; 14.9; 14.5; 14.8... - NPLs in percent of total loans: 34.7; 13.4; 8.4; 8.4; 7.9; 6.4; 5.7... - FX deposits (percent of total deposits): 100.0 (dollarized system) - FX loans (percent of total loans): 100.0 (dollarized system) - Notes: 1/ November data for 2005. 2/ January-September data for 2005. 3/ Nonfinancial public sector. 4/ Public sector gross debt net of deposits in the banking system. 5/ Includes banking system, which is fully dollarized. ### Vulnerability indicators and MDG table references - Table 10: Ecuador: Selected Vulnerability Indicators (projections; source: Central Bank of Ecuador; Ministry of Finance; and Fund staff estimates and projections). - Table 11: Ecuador: Millennium Development Goals (historical series headings present: 1990, 1994, 1997, 2000, 2003, 2004). *Sources: Central Bank of Ecuador; Ministry of Finance; and Fund staff estimates and projections.* ### 1. Eradicate extreme poverty and hunger 2015 target = halve 1990 $1 a day poverty and malnutrition rates ### 1. Eradicate extreme poverty and hunger 2015 target = halve 1990 $1 a day poverty and malnutrition rates ### Goal 1 — Eradicate extreme poverty and hunger (indicators and values) - Population below $1 a day (percent): ...2.0 17.7......... - Poverty gap at $1 a day (percent): ...0.5 7.1......... - Percentage share of income or consumption held by poorest 20%: ......3.3......... - Prevalence of child malnutrition (percent of children under 5): ......14.3......... - Population below minimum level of dietary energy consumption (%): ......5.0......... ### Goal 2 — Achieve universal primary education (indicators and values) - Net primary enrollment ratio (percent of relevant age group): 97.8...97.0 99.4 99.5... - Percentage of pupils reaching grade 5 (percent): ......77.0 78.0...... - Youth literacy rate (percent ages 15-24): .........96.4...... ### Goal 3 — Promote gender equality (indicators and values) - Ratio of girls to boys in primary and secondary education (percent): ......100.7 100.6 100.4... - Ratio of young literate females to males (percent ages 15-24): .........100.1...... - Share of women employed in the nonagricultural sector (percent): 37.3 40.2 39.6 40.2 41.1 41.1 - Proportion of seats held by women in national parliament (percent): 5.0...4.0 17.0 16.0 16.0 ### Goal 4 — Reduce child mortality (indicators and values) - Under 5 mortality rate (per 1,000): 57 43...32 27 27 - Infant mortality rate (per 1,000 live births): 43 34...27 24 24 - Immunization, measles (percent of children under 12 months): 60 72 75 84 99 99 9 9 9 9 9 (as presented) ### Goal 5 — Improve maternal health (indicators and values) - Maternal mortality ratio (modeled estimate, per 100,000 live births): .........130...... - Births attended by skilled health staff (percent of total): .........91.3...... ### Goal 6 — Combat HIV/AIDS, malaria and other diseases (indicators and values) - Contraceptive prevalence rate (percent of women ages 15-49): 52.9 56.8...65.8...... - Number of children orphaned by HIV/AIDS: .................. - Incidence of tuberculosis (per 100,000 people): 202.4 180.1 164.9 151.1 138.4 138.4 - Tuberculosis cases detected under DOTS (percent): .........5.3 36.9 36.9 ### Goal 7 — Ensure environmental sustainability (indicators and values) - Forest area (percent of total land area): 43.1......38.1...... - Nationally protected areas (percent of total land area): ............18.3 18.3 - GDP per unit of energy use (PPP $ per kg oil equivalent): 5.9 5.9 5.3 54 8... - CO2 emissions (metric tons per capita): 1.6 1.3 1.7 2...... - Access to an improved water source (percent of population): 69.........86... - Access to improved sanitation (percent of population): 56.........72... - Access to secure tenure (percent of population): .................. ### Goal 8 — Develop a Global Partnership for Development (indicators and values) - Youth unemployment rate (percent of total labor force ages 15-24): 13.5 14.9 18.9 13.5...... - Fixed line and mobile telephones (per 1,000 people): 47.8 60.3 86 135 311.6 311.6 - Personal computers (per 1,000 people): 1.9 9.8 16.8 21.7 31.1... ### Source notes and goal targets (text excerpts) - Source: World Development Indicators database. - Note: In some cases the data are for earlier or later years than those stated. - Goal 1 targets: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger. - Goal 2 target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling. - Goal 3 target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015. - Goal 4 target: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate. - Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio. - Goal 6 targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases. - Goal 7 targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers. - Goal 8 targets: Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address the Special Needs of the Least Developed Countries. Address the Special Needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications. --- ### Projections and public/external debt sustainability (selected figures) - Public sector debt (percent of GDP), baseline 2000–2010: 91.4, 70.2, 58.2, 52.6, 46.6, 43.0, 40.0, 36.5, 33.7, 33.1, 32.8 - Change in public sector debt (annual): -9.8, -21.1, -12.0, -5.7, -6.0, -3.6, -3.1, -3.5, -2.8, -0.7, -0.3 - Identified debt-creating flows (4+7+12): 3.7, -22.0, -10.4, -7.4, -7.7, -5.1, -5.5, -3.6, -1.1, -1.0, -1.0 - Primary deficit (percent of GDP): -7.7 -4.6 -4.4 -4.2 -5.0 -4.2 -4.9 -4.0 -1.8 -1.8 -1.9 - Revenue and grants (percent of GDP): 27.6, 24.2, 26.1, 25.4, 27.0, 28.0, 28.6, 27.7, 27.0, 26.1, 25.6 - Primary (noninterest) expenditure (percent of GDP): 19.9, 19.6, 21.7, 21.2, 22.0, 23.8, 23.7, 23.8, 25.2, 24.4, 23.7 - Automatic debt dynamics (percent of GDP contribution): 11.3, -17.4, -6.0, -3.2, -2.7, -0.9, -0.5, 0.3, 0.7, 0.8, 0.8 - Contribution from interest rate/growth differential: 11.3, -17.4, -6.0, -3.2, -2.7, -0.9, -0.5, 0.3, 0.7, 0.8, 0.8 - Contribution from real interest rate: 14.3, -13.9, -4.0, -1.8, 0.6, 0.4, 0.5, 1.1, 1.5, 1.5, 1.5 - Contribution from real GDP growth: -3.0, -3.5, -2.0, -1.4, -3.3, -1.4, -1.1, -0.8, -0.8, -0.7, -0.7 - Residual, including asset changes (2-3): -13.5, 0.9, -1.6, 1.7, 1.7, 1.6, 2.4, 0.2, -1.7, 0.3, 0.8 - Public sector debt-to-revenue ratio (percent): 331.5, 289.7, 223.4, 207.0, 172.6, 153.6, 139.6, 131.7, 125.1, 126.6, 128.1 - Gross financing need (percent of GDP): 3.2, 4.2, 2.3, 1.2, 1.9, 1.9, 1.3, 1.9, 3.8, 3.3, 3.3 - Gross financing need (in billions of U.S. dollars): 0.5, 0.9, 0.5, 0.3, 0.6, 0.6, 0.5, 0.7, 1.5, 1.4, 1.5 - Selected key macro-fiscal assumptions (real GDP growth, percent): 2.8, 5.1, 3.3, 2.7, 6.9, 3.2, 2.7, 2.2, 2.2, 2.2, 2.2 - Average nominal interest rate on public debt (percent): 6.3, 6.8, 5.7, 5.8, 5.6, 5.7, 6.9, 7.4, 7.7, 8.2, 8.5 - Inflation rate (GDP deflator, percent): -7.0, 25.5, 11.9, 8.9, 4.1, 4.6, 5.4, 4.3, 3.3, 3.5, 3.5 - Growth of real primary spending (deflated by GDP deflator, percent): 7.3, 3.7, 14.2, 0.4, 11.2, 11.6, 2.2, 2.3, 8.2, -1.0, -0.4 - External debt (percent of GDP), baseline 2000–2010: 82.9, 68.4, 66.8, 59.5, 53.4, 49.9, 44.4, 38.4, 32.9, 29.9, 27.8 - Change in external debt (annual): -15.1, -14.6, -1.6, -7.3, -6.1, -3.5, -5.5, -6.0, -5.5, -3.1, -2.0 - Identified external debt-creating flows (4+8+9): -5.2, -23.1, -9.6, -11.1, -8.7, -5.3, -4.8, -4.2, -2.9, -2.3, -1.7 - Current account deficit, excluding interest payments (percent of GDP): -12.8, -1.5, 0.7, -2.4, -2.7, -2.2, -2.4, -1.6, -0.1, 0.5, 1.1 - Exports (percent of GDP): 37.2, 27.2, 25.4, 26.6, 29.6, 34.2, 34.7, 32.9, 31.2, 29.7, 28.5 - Imports (percent of GDP): 29.3, 29.8, 30.4, 28.1, 30.4, 35.5, 35.5, 34.7, 34.7, 34.0, 33.6 - Net non-debt creating capital inflows (negative percent of GDP): -4.5, -6.3, -5.2, -5.7, -3.8, -4.7, -4.4, -4.3, -4.2, -4.1, -4.1 - Automatic debt dynamics (external): 12.1, -15.3, -5.0, -3.0, -2.2, 1.6, 2.0, 1.8, 1.5, 1.4, 1.2 - External debt-to-exports ratio (percent): 223.0, 251.8, 262.8, 223.7, 180.0, 145.8, 128.1, 116.8, 105.6, 100.4, 97.4 - Gross external financing need (in billions of U.S. dollars): 2.1, 2.9, 3.9, 4.1, 4.3, 4.3, 4.2, 4.2, 4.1, 3.2, 3.3 - Gross external financing need (percent of GDP): 13.5, 13.8, 16.0, 15.0, 14.3, 13.1, 11.8, 11.2, 10.2, 7.6, 7.3 *Source: World Development Indicators database; projections and debt-sustainability tables as presented in the source PDF.* ### Section 2(a) in the form of a freeze on demand and savings deposits in closed banks. This ### _cr0698 - Section 2(a) in the form of a freeze on demand and savings deposits in closed banks. This ### Exchange restriction and timing - Section 2(a) in the form of a freeze on demand and savings deposits in closed banks was approved by the Executive Board on March 21, 2003 until December 31, 2003. ### Article IV consultation and recent contacts - On July 26, 2004, the Executive Board concluded the 2004 Article IV Consultation. - Authorities requested intensified surveillance; missions visited Quito in December 2004, and May and August 2005. ### Technical assistance (selected entries) - MAE FSAP January 2004 - September 2003 — MAE: Assist in the design of a strategy for dealing with banks’ systemic problems. - January 2000 — STA: Assist in the preparation of the central bank accounts under dollarization. - January 2000 — MAE: Role of central bank under dollarization. - February 2001 — STA ROSC April 2002 - STA Balance of Payments statistics July 2002 - FAD; STA; ROSC — Monetary and financial statistics December 2003; March 2004 ### Resident Representative - Mr. Jorge Guzman, stationed in Quito since September 2005, replaced Mr. David Yuravlivker. ### Relations with the World Bank (as of September 1st, 2005) — key figures and operations - IBRD/IDA Operations (in millions of U.S. dollars) - Total loans: 2,603.47 (Commitments) ; 2,393.16 (Disbursements) ; 210.31 (Undisbursed) ; 1,704.17 (Repaid) ; 688.99 (Outstanding) - Active loans: 290.4 (Commitments) ; 80.09 (Disbursements) ; 210.31 (Undisbursed) ; 7.50 (Repaid) ; 72.59 (Outstanding) - Closed loans: 2,313.07 (Commitments) ; 2,313.07 (Disbursements) ; 0.0 (Undisbursed) ; 1,696.67 (Repaid) ; 616.4 (Outstanding) - Active loans (by loan purpose) - Total: 259.09 (Commitments) ; 82.76 (Disbursements) ; 176.3 (Undisbursed) - Adjustment: 100 (Commitments) ; 0 (Disbursements) ; 100 (Undisbursed) - Rural development: 25.2 (Commitments) ; 15.1 (Disbursements) ; 10.10 (Undisbursed) - Health: 45 (Commitments) ; 32.28 (Disbursements) ; 12.72 (Undisbursed) - Water: 32.0 (Commitments) ; 25.24 (Disbursements) ; 6.76 (Undisbursed) - Power: 23 (Commitments) ; 6.74 (Disbursements) ; 16.26 (Undisbursed) - Governance: 33.86 (Commitments) ; 3.4 (Disbursements) ; 30.46 (Undisbursed) - IFC Operations (as of September 1st, 2005) — Loans / Equity / Participation (Commitments; Net total held by IFC; Total undisbursed) — data structure present but numeric detail not provided in extract. - IBRD Loan Transactions (calendar year) — Disbursements, Repayments, Net lending (includes IDA repayments) - Disbursements: 2001: 123.6 ; 2002: 25.2 ; 2003: 152 ; 2004: 28 ; 2005: 23 - Repayments: 2001: 76.5 ; 2002: 86.4 ; 2003: 93 ; 2004: 83 ; 2005: 50 - Net lending: 2001: 47.1 ; 2002: -61.2 ; 2003: 58 ; 2004: -55 ; 2005: -27 - Bank engagement Base Case scenario: US$250 million per year: US$100 million for adjustment and $150 million for investment. - Recent project approvals and status: - PRODEPINE II (US$36 million in FY04) — now cancelled. - Institutional Reform (US$30 million in FY04) — being redesigned by increasing component by approximately $30 million. - Fiscal Consolidation Programmatic (US$100 million in FY05) — currently on hold due to policy reversals on the program supported by the loan. - Planned for FY06: - Three investment operations and one adjustment operation: Rural Roads (US$20 million), Education (US$35 million), Bono de Desarrollo Humano (currently being defined), Human Development Programmatic (US$100 million — slipped from last year). ### Relations with the Inter-American Development Bank (as of September 30, 2005) — key figures - IDB OPERATIONS (In millions of U.S. dollars) - Active loan portfolio total (approved and not fully disbursed) - Total (historical) Approved: 503.56 ; Disbursed: 3,982.63 ; Undisbursed: 240.48 - Source note: The total amount approved is US$4,771.0 million. The difference represents cancellations. The outstanding debt to the Bank is US$1,879.0 million. - IDB LOAN TRANSACTIONS (In millions of U.S. dollars) - Disbursements by year: 1999: 141.5 ; 2000: 237.7 ; 2001: 165.0 ; 2002: 86.0 ; 2003: 157.2 ; 2004: 48.5 - Repayments by year: 1999: 106.8 ; 2000: 124.2 ; 2001: 113.6 ; 2002: 136.1 ; 2003: 139.2 ; 2004: 163.7 - Net lending by year: 1999: 34.7 ; 2000: 113.5 ; 2001: 51.4 ; 2002: -50.1 ; 2003: 18.0 ; 2004: -115.2 - IDB pipeline for 2005–06: - Lending program of eleven operations totaling U$320 million. - Non-reimbursable technical cooperation program of approximately US$8 million. - Planned fast-disbursing programmatic loan for US$100 million to improve competitiveness; investment loans in tourism, potable water, environment, urban infrastructure rehabilitation, natural-disaster prevention. ### Statistical issues and data quality (summary) - Macroeconomic data: In spite of shortcomings, macroeconomic data are adequate for surveillance purposes. - SDDS: Ecuador subscribed to the Special Data Dissemination Standard (SDDS) in March 1998; meets specifications for coverage, periodicity, and timeliness. Advance release calendar and metadata posted on the Fund’s Dissemination Standards Bulletin Board. A data ROSC module completed in March 2003. - Real sector: - Two series of national accounts compiled using 1975 and 1993 base years, following 1968 SNA and 1993 SNA respectively. - Authorities published GDP series for 1993–2001 in current and constant 2000 dollars at end-2002; extension to 1965 planned but not completed. - Preliminary quarterly NA reported with about a three-month lag. - Monthly producer price index (PPI) published starting in 1998. - Labor market data: monthly surveys by a private university; national statistics bureau does annual survey. Reliable data on public sector employment unavailable. - Government finance: - Compilation and reporting of central government data deteriorated after introduction of SIGEF. - Above-the-line data for some nonfinancial public sector entities suffer long reporting lags and unreliable information. - When ownership of public companies was transferred to the Solidarity Fund in 1999, financial information on these companies was no longer recorded. - Local government data available only annually. - Recommendation: resumption of reporting annual data on the budgetary central government for publication in the GFS Yearbook; most recently reported annual GFS data were for 1994. - Monetary accounts: - Major effort in 2000 by the central bank, with Fund support, to adapt balance sheet presentation to official dollarization. - Remaining issues resolved during a monetary and financial statistics mission in March 2004. - Introduction of a sectorization matrix improved sectorization of financial instruments and resident/nonresident distinction. - Public sector deposits properly identified in sectoral balance sheet of depository corporations. - Offshore bank data compiled to same standards as onshore banks but not yet available. - External sector: - Balance of payments and IIP statistics compiled and disseminated by the CBE. - Ecuador reports to STA quarterly balance of payments statistics and annual IIP data for publication in IFS and the Balance of Payments Statistics Yearbook. - Data mainly compiled according to BPM5 methodology. - STA mission (July 2002) recommended improvements: estimates of travel services, surveys of direct investment and portfolio investment, recording external debt transactions, recording reserve assets. - Remaining deficiencies in estimating profit remittances, non-oil direct investment, and private capital flows. - Authorities requested technical assistance; STA, with support of WHD, is considering a TA mission on balance of payments statistics in early FY 2007. ### Table of Common Indicators Required for Surveillance (as of December 20, 2005) — selected items and dates - Exchange Rates: latest observation 11/30/05. - Reserve/Base Money: Oct. 2005 (Date of latest observation); Dec. 2005 (Date received); Frequency: D D D. - Broad Money: Oct. 2005 (latest observation); Dec. 2005 (received); Frequency: W W W. - Central Bank Balance Sheet: Oct. 2005; Dec. 2005; Frequency: W W W. - Interest Rates: Nov. 2005 (latest observation); Dec. 2005 (received); Frequency: W W W. - Consumer Price Index: Nov 2005 (latest observation); Dec 2005 (received); Frequency: M M M. - Revenue, Expenditure, Balance and Composition of Financing – General Government: July 2005 (latest observation); Sept 2005 (received); Frequency: M M M. - Revenue, Expenditure, Balance and Composition of Financing – Central Government: July 2005 (latest observation); Sept 2005 (received); Frequency: M M NA. - External Current Account Balance: 3/31/05 (latest observation); Jul 2005 (received); Frequency: Q Q Q. - GDP/GNP: 2004 (latest observation); July 2005 (received); Frequency: Q Q Q. - Gross External Debt: 8/30/01 (latest observation); 9/15/01 (received); Frequency: M M M. - Footnote definitions and assessments provided in original table (methodological soundness and accuracy and reliability ratings correspond to data ROSC/Substantive Update findings). ### Statement by the Staff Representative on Ecuador (January 25, 2006) — key points - Ministerial change: Mr. Diego Borja replaced Ms. Magdalena Barreiro as finance minister in the Palacio government. - Staff team visited Quito on January 17–18, 2006 to meet Mr. Borja; additional information on inflation became available. Information does not alter staff appraisal. - Inflation: - 12-month CPI inflation rate increased to 4.4 percent (projected inflation was 4.0 percent) in December 2005, largely reflecting surging housing rent inflation and education costs. - Minister’s commitments and fiscal measures: - Minister committed to fiscal discipline and to orient fiscal policy toward reducing recent inflation pressures. - President signed a decree to cut spending by 1 percent of GDP from the budget approved by Congress (cuts in recurrent spending across ministries and cancellation of low-priority capital projects) to bring overall central government spending back in line with the government’s original budget proposal. - Authorities’ new fiscal target for 2006 is consistent with the staff report’s recommended nonfinancial primary surplus of 5.2 percent of GDP. - Authorities intend to use excess financial resources to repurchase high-interest external debt and short-term domestic debt. - Plans to strengthen fiscal transparency and expenditure management, including mechanisms to improve governance, transparency, and public accountability for funds earmarked in the Fiscal Responsibility Law. - Staff expressed concern about the important role planned for public banks, given their poor past record in governance and administration. - No significant changes to existing reform proposals in oil, electricity, telecommunications, the financial system, or trade policy. - Authorities plan preparatory work on tax reform and reduction of fuel subsidies but thought it unlikely to launch initiatives before the October elections. ### IMF Public Information Notice (PIN) No. 06/15 — Executive Board conclusion (February 9, 2006) - On January 25, 2006, the IMF Executive Board concluded the Article IV consultation with Ecuador. - Background macroeconomic snapshot: - Economic growth estimated to have exceeded 3 percent in 2005, with the non-oil sector expanding by 3½ percent. - Strong growth in the oil sector following completion of the new oil pipeline in 2003 has tapered off, but high oil prices bolstered confidence and domestic demand. - Employment growth remains sluggish, with little change in unemployment from 2004. - Inflation: 12-month headline inflation rose from 2 percent in June 2005 to 4.4 percent at end-2005, in a context of strong growth in bank credit and public spending. - Non-financial public sector (NFPS) primary surpluses have been consistently above 4 percent of GDP in recent years, reflecting mainly high oil revenues. - Public debt reduced from over 90 percent of GDP at end-2000 to 43 percent of GDP at end- (text cut off in provided excerpt). *Source: Excerpts from the IMF staff report content provided.* ### 2005. However, the underlying fiscal stance weakened in 2005. While the primary surplus of ### _cr0698 - 2005. However, the underlying fiscal stance weakened in 2005. While the primary surplus of ### Fiscal stance and public finances - The underlying fiscal stance weakened in 2005. - Primary balance (NFPS) is projected at 4.2 percent of GDP in 2005. - The non-oil deficit is projected to have increased to 5 percent of GDP in 2005, driven by: - growing cost of fuel subsidies, and - continued rapid expansion of recurrent spending, especially on wages and pensions. - Revenue and expenditure indicators (percent of GDP): - Revenue: 28.0 - Non-interest expenditure: 23.8 - Primary balance (deficit -): 4.2 - Overall balance (deficit -): 1.7 - Total public debt: 43.2 percent of GDP - Domestic: 9.5 percent of GDP - External: 33.7 percent of GDP - Net debt of the NFPS projected to have closed 2005 at 34 percent of GDP, down 4 percentage points from 2004, 11 percentage points from 2003, and 30 percentage points since 2001. - Authorities’ fiscal actions and considerations: - President’s Executive Decree of January 13 reduced the projected 2006 budget deficit by US$316 million. - Authorities plan to restrain recurrent spending, strictly prioritize capital and social spending, and ensure projects are evaluated, prioritized, and monitored effectively. - Authorities plan to use proceeds from the recent international bond issue only for debt management purposes. - Authorities consider a bottom-up approach to raising public awareness about fuel subsidy inefficiency and inequity; eventual reduction of subsidies seen as politically contingent. - Authorities recognize need to control fiscal spending in 2006 to avoid build-up of demand pressures on inflation. ### External sector and external financing - External current account deficit estimated at about 1 percent of GDP in 2005 (unchanged). - Rapid import growth offset strong increases in oil and non-oil exports led by shrimp and metal products. - Oil sector FDI inflows increased in 2005; non-oil FDI remained low, at less than 1 percent of GDP. - Foreign saving = external current account balance: 1.0 percent of GDP (2005). - National saving: 26.3 percent of GDP (2005). - Gross investment: 27.2 percent of GDP (2005). - Ecuador regained access to international capital markets with a US$650 million bond issue in December 2005 (noted also as government placement of a 10-year global bond for $595 million in late 2005; proceeds to be devoted to repaying or buying back other debt obligations). ### Banking system and financial sector - Banking system developments in 2005: - Liabilities to the private sector: 21.2 (annual percent change) - Credit to the private sector: 26.2 (annual percent change) - EMBI Ecuador (bps, end of period): 669 (2005) - Banking system credit and deposits grew strongly in 2005; liquidity remained at comfortable levels and other stability indicators continued to improve. - No evidence of spillover effects on deposits or on interest rates from political developments. - Remaining issues: - Banking intermediation still well below pre-crisis levels. - Deposits overwhelmingly at short maturities. - Need to develop an effective deposit insurance system and a mechanism to provide an adequate lender-of-last-resort function. - Outstanding issues from the 1998–99 banking crisis need resolution, notably liquidation of remaining closed banks and return of deposits frozen in these banks. - Directors’ concerns about banking reform bill provisions that would introduce administrative controls on interest-rate spreads and allocation of credit; risk of stifling expansion of financial intermediation and jeopardizing banking system stability. - Progress and reforms: - Ongoing efforts to improve financial sector supervision and regulation, including implementation of some 2004 FSAP recommendations. - Passage of anti-money laundering legislation and a law to strengthen credit bureaus. - Plans to strengthen the payment system and bankruptcy procedures. ### Monetary and price developments - Consumer price index end-of-period: - 2002: 9.4 - 2003: 6.1 - 2004: 1.9 - 2005 (end): 4.3 (table) / CPI inflation closed 2005 at 4.4 percent (statement by Eduardo Loyo) - Real GDP and inflation context: - Real GDP growth: 2002: 3.4; 2003: 2.7; 2004: 6.9; 2005: 3.2 - Real GDP per capita: 2002: 1.9; 2003: 1.2; 2004: 5.4; 2005: 1.2 - Real effective exchange rate (depreciation -), October data for 2005: 2002: 11.3; 2003: -1.3; 2004: -4.6; 2005: -2.9 - Inflation drivers noted: - “Imported” inflation stemming from nominal effective depreciation and trading partner inflation. - Residential rents accounted for 60 percent of yearly inflation observed in 2005; rent increases were uneven across regions and residence types. ### Executive Board assessment and Directors’ recommendations - Executive Directors commended authorities for: - Lowering inflation to international levels. - Reducing substantially the ratio of public debt to GDP. - Resilience of the economy despite difficult political environment. - Directors expressed concern about broader policy orientation: - Significant increase in non-oil fiscal deficit due to rising fuel subsidies and difficulties in controlling recurrent spending. - Recent changes in the fiscal responsibility law, the pension system, and new tax incentives legislation risk weakening the macroeconomic policy framework. - Recommended policy priorities and reforms: - Strengthen fiscal policy stance in 2006 to address inflationary pressures and put public finances on a more sustainable track. - Restrain recurrent spending; strictly prioritize capital and social spending. - Use current favorable external environment to address fiscal and financial system vulnerabilities. - Strengthen institutional framework for fiscal discipline, reduce dependence on oil revenue, increase budget flexibility, and improve quality of government spending. - Redesign the fiscal responsibility law to target a lower debt-to-GDP ratio, improve transparency in fiscal rules, increase accountability, and encourage efficient use of oil wealth. - Pursue tax reform to eliminate exemptions, broaden the tax base, and simplify the tax system. - Develop coherent civil service reform to control wage costs. - Move ahead with pension system reform to establish a sound actuarial foundation; support request for Fund technical assistance on pension reform. - Substantially reduce highly distortional fuel subsidies and strengthen the social safety net to protect the most vulnerable groups. - Intensify structural reforms to sustain competitiveness, improve the investment climate, and strengthen resilience to shocks. - Develop the petroleum sector through comprehensive reform of PetroEcuador, including: - Define a timetable for administrative reforms at PetroEcuador. - Undertake external financial audit of the company. - Auction new fields for exploration and extraction. - Eliminate legal uncertainties and strengthen regulatory framework. - Ensure market-based price setting for oil refining and retailing to attract private investment. - For electricity and telecommunications, contract with private sector for management of public enterprises; reduce electricity subsidies, resolve intra-sector debts, and set tariffs to reflect real generation and distribution costs. - Continue pursuit of free trade agreement with the United States and support multilateral trade liberalization initiatives. - Data and transparency: - Data provision to the Fund is adequate for surveillance, but remaining shortcomings should be addressed in balance of payments statistics, fiscal accounts, and labor market data. - Ecuador’s participation in the Special Data Dissemination Standard (SDDS) is welcomed. ### Key statistics from Table 1 (selected) - Real GDP (annual percent changes): 2002: 3.4; 2003: 2.7; 2004: 6.9; 2005: 3.2 (Proj. column shows 2005) - Real GDP per capita: 2002: 1.9; 2003: 1.2; 2004: 5.4; 2005: 1.2 - CPI end-of-period: 2002: 9.4; 2003: 6.1; 2004: 1.9; 2005: 4.3 - Real effective exchange rate (depreciation -), 1/ October data for 2005: 2002: 11.3; 2003: -1.3; 2004: -4.6; 2005: -2.9 - Banking system liabilities to the private sector (annual % changes): 2002: 18.2; 2003: 18.6; 2004: 27.1; 2005: 21.2 - Credit to the private sector (annual % changes): 2002: 13.6; 2003: 4.5; 2004: 28.6; 2005: 26.2 - EMBI Ecuador (bps, end of period): 2002: 1,801; 2003: 799; 2004: 690; 2005: 669 - Public finances (percent of GDP): - Revenue: 2002: 26.0; 2003: 25.4; 2004: 27.0; 2005: 28.0 - Non-interest expenditure: 2002: 21.5; 2003: 20.7; 2004: 22.0; 2005: 23.8 - Primary balance (deficit -): 2002: 4.5; 2003: 4.7; 2004: 5.0; 2005: 4.2 - Overall balance (deficit -): 2002: 1.0; 2003: 1.7; 2004: 2.3; 2005: 1.7 - Total public debt: 2002: 58.2; 2003: 52.6; 2004: 46.5; 2005: 43.2 - Domestic debt: 2002: 11.3; 2003: 10.4; 2004: 10.0; 2005: 9.5 - External debt: 2002: 46.9; 2003: 42.2; 2004: 36.5; 2005: 33.7 - Saving-investment balance (percent of GDP): - National saving: 2002: 22.8; 2003: 25.9; 2004: 26.7; 2005: 26.3 - Gross investment: 2002: 27.7; 2003: 27.7; 2004: 27.8; 2005: 27.2 - Foreign saving = external current account balance: 2002: 4.9; 2003: 1.7; 2004: 1.1; 2005: 1.0 ### Statement by Eduardo Loyo, Executive Director for Ecuador (highlights) - Authorities agreed to publish staff papers and intend to maintain quarterly consultations with Fund staff. - Recent macro developments: - Real GDP growth surpassed 3 percent in 2005 after 6.9 percent in 2004. - Non-oil GDP expected to have grown by 3.5 percent in 2005. - CPI inflation closed 2005 at 4.4 percent, compared to 2 percent in 2004. - Since 2003, real effective exchange rate has depreciated by nearly 10 percent. - Residential rents were key driver of 2005 inflation, accounting for 60 percent of yearly inflation. - Fiscal observations: - Non-financial public sector has posted primary surpluses between 4 and 5 percent of GDP; overall surplus around 2 percent of GDP. - Acknowledges trade-off between using oil windfalls to further reduce debt versus addressing dire social needs. - External and financial: - External current account deficit stable at around 1 percent of GDP. - Robust increase in bank deposits in 2005 and recovery in credit to the private sector; credit has not fully rebounded to pre-crisis levels. - Structural reforms: - Political fragmentation and upcoming general elections (scheduled for October) constrain reform progress; reforms often require congressional approval. *International Monetary Fund — staff report and Executive Board discussion excerpts (January 25, 2006).* ### 12. The reform agenda is long and I shall not delve into the many items on the merits of ### 12. The reform agenda is long and I shall not delve into the many items on the merits of ### Reform agenda and political constraints - Staff and the authorities broadly agree on many reform items; these were endorsed by the Executive Board during the last Article IV consultation. - Authorities are ready to advance preparatory technical work on a number of items, relying in some cases on technical assistance from the Fund and from other multilateral institutions. - Broader overtures to build social consensus must be managed with care to avoid "jamming the political radar screen" and preventing negative partisan positions from becoming overly crystallized in the heat of the electoral debate. ### IESS reserve fund and Congressional decision - The decision to return assets in the IESS reserve fund to employees after three years was not a government initiative; it was taken by Congress. - The government mitigated adverse fiscal implications by setting up a manageable schedule for the mandated transfers. ### Changes to the Fiscal Responsibility Law (FRL) - Prior to changes introduced in 2005, the FRL established: - (i) a declining ceiling on public debt; - (ii) a path for the non-oil fiscal deficit; - (iii) a ceiling on the rate of growth of primary expenditure. - Only the latter restriction was partially modified in 2005: the cap now applies to the rate of growth of current expenditure. - Interlocking checks on debt, deficits and expenditures remain in force; authorities are confident that fiscal consolidation progress will not be jeopardized by the extra degree of freedom targeted at investment spending. ### Elimination of FEIREP (part of FRL amendment) - Original purpose of FEIREP: devote 70 percent of its resources to retire debt, 20 percent for stabilization, and the rest for social expenditure. - The administration replaced this arrangement with incorporation of resources into the budget to finance debt buybacks, investment projects and social spending. - At the time FEIREP was eliminated: - there were no accumulated resources in the stabilization account; - the debt retirement account had been repeatedly used to finance spending via operations where debt was formally retired with FEIREP funds but an equivalent amount returned to the government in exchange for newly issued debt. - Primary rationale for elimination: address critical expenditure needs in social sectors and public infrastructure. - Government commitment: these resources will not be used to finance wages and pensions. ### Allocation of ex-FEIREP resources and safeguards - Authorities view FRL modifications, including FEIREP elimination, as instrumental to make budgetary management viable under strict compliance with legal provisions. - Ensuring additional on-budget revenues are put to the most efficient use, including debt retirement, is a top priority. - The Ministry of the Economy is designing procedures to ensure ex-FEIREP resources are allocated on a competitive basis and in accordance with economic merit rather than political pressure. - Intention: put in place safeguards to protect these funds from imperfections in the preexisting system of resource allocation, including issues in the operations of public development banks. - The government declared that these resources will not be allocated until adequate safeguards are in place. ### Financial sector reform and regulatory actions - Authorities are addressing many issues highlighted in the 2004 FSAP. - Recent steps: - Banking superintendency tightened regulations regarding capital and liquidity. - Congress approved legislation strengthening credit bureaus and incorporating a new AML framework. - Authorities concur with staff that a recently proposed Congress reform—capping intermediation spreads and directing lending to specific productive activities—would be deleterious. - While intermediation spreads remain high and some sectors face credit access difficulties, the government believes the Congressional remedies would likely worsen, not improve, conditions. - The Ministry of the Economy, the Central Bank of Ecuador and the Internal Revenue Service are designing policies to address high bank spreads and service fees without harming solidity and efficiency of the financial sector. ### Medium-term outlook and scenarios - Authorities take note of staff's medium-term scenarios and agree with their broad qualitative features, acknowledging large uncertainty around quantitative forecasts. - Authorities recognize: - Growth would be considerably enhanced by progress in key reforms. - Faster growth would translate into higher fiscal revenue and a faster decline in the debt-to-GDP ratio. - Staff conclusion noted by authorities: the debt burden would continue declining even in the no-reform scenario, reaching just over 30 percent of GDP in 2010. - Authorities caution that the passive scenario's growth would be insufficient to substantially reduce poverty and unemployment. - Commitment reiterated: maintain macroeconomic stability and make every effort to advance the reform agenda despite an adverse political context likely limiting short-run progress. *Source: IMF staff report text (section 12–18)* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0698.pdf_