Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Ecuador

February 9, 2006

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report for the Article IV consultation with Ecuador may be made available at a later stage if the authorities consent.

Public Information Notice (PIN) No. 06/15
February 9, 2006

On January 25, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Ecuador.1


Despite a difficult political environment, economic growth is estimated to have exceeded 3 percent in 2005, with the non-oil sector expanding by 3½ percent. The strong growth in the oil sector that followed the completion of the new oil pipeline in 2003 has tapered off, but high oil prices have helped bolster confidence and underpin domestic demand. However, employment growth remains sluggish, with little change in unemployment from 2004.

After declining in early 2005, inflation picked up in the second half of the year. The 12-month headline inflation rose from 2 percent in June 2005 to 4.4 percent at the end of the year, in a context of strong growth in bank credit and public spending.

In recent years, non-financial public sector (NFPS) primary surpluses have been maintained consistently above 4 percent of GDP, reflecting mainly high oil revenues, which have helped to reduce public debt from over 90 percent of GDP at end-2000 to 43 percent of GDP at end-2005. However, the underlying fiscal stance weakened in 2005. While the primary surplus of the NFPS is projected at 4.2 percent of GDP, the non-oil deficit is projected to have increased to 5 percent of GDP in 2005, driven by the growing cost of fuel subsidies and the continued rapid expansion of recurrent spending, especially on wages and pensions.

The external current account deficit is estimated to have remained unchanged at about 1 percent of GDP, reflecting rapid import growth which offset strong increases in oil and non-oil exports led by shrimp and metal products. While oil sector FDI inflows increased, non-oil FDI remained low in 2005, at less than 1 percent of GDP.

Banking system credit and deposits grew strongly in 2005, while liquidity remained at comfortable levels and other stability indicators continued to improve. Moreover, there was no evidence of spillover effects on deposits or on interest rates from political developments. However, banking intermediation is still well below pre-crisis levels and deposits are overwhelmingly at short maturities.

The authorities successfully regained access to international capital markets with a US$650 million bond issue in December 2005. The EMBI spread declined in the past year, but remains the widest among Latin American countries.

Executive Board Assessment

The Executive Directors commended the Ecuadoran authorities for lowering inflation to international levels and reducing substantially the ratio of public debt to GDP. These achievements, together with high international prices for Ecuador's oil exports, have contributed to a generally positive macroeconomic performance and increasing confidence in 2005, which was reflected in the successful placement by Ecuador of an international bond in December 2005. Directors acknowledged the resilience of the economy in the face of the difficult political environment.

Directors expressed concern, however, about the broader orientation of policies. In particular, the non-oil fiscal deficit has increased significantly, reflecting mainly the rising cost of fuel subsidies and difficulties in controlling recurrent spending. Recent changes in the fiscal responsibility law, the pension system, and the new tax incentives legislation risk weakening the macroeconomic policy framework. Directors urged the authorities to take advantage of the current favorable external environment to address underlying vulnerabilities, especially in the fiscal area and the financial system, to ensure long-run macroeconomic stability, strong and sustained growth, and increasing job opportunities.

Directors commended the authorities for their plan to strengthen the fiscal policy stance in 2006 to address the recent increase in inflationary pressures and to put the public finances on a more sustainable track. They supported the authorities' intention to restrain recurrent spending, strictly prioritize capital and social spending, and take steps to ensure that projects are evaluated, prioritized, and monitored effectively. Directors urged the authorities to resist pressures for more spending in the pre-election period, and welcomed their plans to use proceeds from the recent international bond issue only for debt management purposes.

Directors stressed the need to strengthen the institutional framework for promoting fiscal discipline, reduce dependence on oil revenue, increase budget flexibility, and improve the quality of government spending. Most called for a redesign of the fiscal responsibility law to target a lower debt-to-GDP ratio, improve transparency in the fiscal rules, increase accountability, and encourage the efficient use of the country's oil wealth. The authorities should follow through on plans for tax reform, in particular to eliminate exemptions, broaden the tax base, and simplify the tax system. Directors emphasized the importance of developing a coherent civil service reform to control wage costs, and of moving ahead with plans to reform the pension system and set it on a sound actuarial foundation. They supported the authorities' request for Fund technical assistance on the pension reform. Directors recommended that highly distortional fuel subsidies be reduced substantially and that the social safety net to protect the most vulnerable groups be strengthened to help them cope with the subsidy cuts.

Directors welcomed the ongoing efforts to improve financial sector supervision and regulation, including the progress already made in implementing some of the 2004 Financial Sector Assessment Program recommendations. They urged the authorities to move ahead with other FSAP recommendations to strengthen the banking system, which will help to improve efficiency and achieve a durable reduction in interest rates. Directors welcomed the recent passage of anti-money laundering legislation and a law to strengthen credit bureaus, and the plans to strengthen the payment system and bankruptcy procedures. At the same time, they stressed the need to develop an effective deposit insurance system and a mechanism to provide an adequate lender-of-last-resort function. Also, outstanding issues from the 1998-99 banking crisis need to be resolved, in particular the liquidation of the remaining closed banks, and the return of deposits frozen in these banks. While agreeing that the high costs of intermediation and constraints on access to credit need to be addressed, Directors expressed grave concerns about the provisions in the banking reform bill that would introduce administrative controls on interest-rate spreads and the allocation of credit, as these could stifle the needed expansion of financial intermediation and jeopardize banking system stability.

Directors observed that a significant intensification of structural reforms will be needed to sustain competitiveness, improve the investment climate, and strengthen the economy's resilience to adverse shocks. Slow progress on key structural reforms is preventing the economy from reaping the full benefits of dollarization—in particular, low interest rates and a stable investment and trade environment—and could threaten the sustainability of the dollarization regime in the future.

Directors agreed that a high priority should be given to developing the petroleum sector, including through a comprehensive reform of PetroEcuador. They urged the authorities to define a timetable for administrative reforms at PetroEcuador, including the external financial audit of the company, and the auctioning of new fields for exploration and extraction. It will also be important to eliminate legal uncertainties and strengthen the regulatory framework in the petroleum sector, and to ensure market-based price setting for oil refining and retailing, in order to attract the needed increase in private investment to the sector.

Directors observed that the formal dollarization of Ecuador's economy poses a challenge to maintaining competitiveness, and highlights the importance of raising economic efficiency, increasing labor market flexibility, and improving the investment climate. In that context, Directors supported the authorities' plans to contract with the private sector for the management of the public enterprises in the electricity distribution and telecommunications areas. They noted that, to attract more private investment for the essential expansion of electricity generating capacity, electricity subsidies will need to be reduced and intra-sector debts resolved as planned, and electricity tariffs will have to be set to reflect real generation and distribution costs.

Directors commended the authorities' efforts to finalize a free trade agreement with the United States, which, apart from promoting increased trade and competition, could improve the investment climate. Directors urged the authorities to continue to support multilateral trade liberalization initiatives as well.

Directors noted that data provision to the Fund is adequate for surveillance, but encouraged the authorities to continue to address remaining shortcomings, including in certain areas of the balance of payments statistics, fiscal accounts, and labor market data. They welcomed Ecuador's participation in the Special Data Dissemination Standard (SDDS).

Table 1. Ecuador: Selected Economic and Financial Indicators

  2002 2003 2004 2005

(Annual percentage changes; unless otherwise indicated)

National income and prices


Real GDP

3.4 2.7 6.9 3.2

Real GDP per capita

1.9 1.2 5.4 1.2

Consumer price index end-of-period

9.4 6.1 1.9 4.3

Real effective exchange rate (depreciation -) 1/

11.3 -1.3 -4.6 -2.9

Banking system


Liabilities to the private sector

18.2 18.6 27.1 21.2

Credit to the private sector

13.6 4.5 28.6 26.2

EMBI Ecuador (bps, end of period)

1,801 799 690 669
(In percent of GDP, unless otherwise indicated)

Public finances



26.0 25.4 27.0 28.0

Non-interest expenditure

21.5 20.7 22.0 23.8

Primary balance (deficit -)

4.5 4.7 5.0 4.2

Overall balance (deficit -)

1.0 1.7 2.3 1.7

Total public debt

58.2 52.6 46.5 43.2


11.3 10.4 10.0 9.5


46.9 42.2 36.5 33.7

Saving investment balance


National saving

22.8 25.9 26.7 26.3

Gross investment

27.7 27.7 27.8 27.2

Foreign saving = - external current account balance

4.9 1.7 1.1 1.0

Sources: Central Bank of Ecuador; Ministry of Finance; and IMF staff estimates and projections.
1/ October data for 2005.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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