The Business Year Special Report
Wide commitments • Focus: Ecuador and the IMF
ECUADOR IS ROLLING OUT TOUGH MEASURES AND REFORMS AS PART OF ITS THREE-YEAR AGREEMENT WITH THE IMF TO ENCOURAGE GROWTH AND RESTORE FISCAL ORDER.
THE COLLAPSE OF the price of oil since mid-2014 has punched a hole in Ecuador’s finances. The government has turned to the IMF for support for an economic plan to address the fiscal situation. On March 11, the IMF Executive Board approved an extended facility agreement with Ecuador that entails IMF funding for a total of USD4.2 billion to be disbursed over three years. Six organizations, mostly multilateral, have pledged USD6 billion in credit over the same three-year period. The program proposes four macro targets:
1. PROPPING UP THE INSTITUTIONAL FOUNDATIONS OF DOLLARIZATION
The IMF estimates an overvaluation of 31% in Ecuador’s real exchange rate. Being dollarized, Ecuador cannot use devaluation as a mechanism to grant competitiveness to its exports. Therefore, “the country will have to resort to policies that allow for an internal devaluation.” The main measure being contemplated is containing public spending, specifically the wage bill. In this way, unproductive consumption by the state will be reduced, which, by increasing demand, pushes up prices to the detriment of the private sector. It will also seek to render prices and salaries more flexible to facilitate external adjustment.
2. BOOST COMPETITIVENESS
AND CREATE EMPLOYMENT
Other reforms will seek to make Ecuador an interesting business destination to encourage job creation. To achieve this, the tax system will be reviewed, obstacles to the creation and operation of companies will be eliminated, incentives will be granted for private investment, and capital markets will be deepened, opening to international trade.
3. PROMOTE SHARED PROSPERITY
AND PROTECT THE MOST VULNERABLE Spending will increase in social assistance programs such as the Human Development Bonus.
4. IMPROVE TRANSPARENCY AND STRENGTHEN THE FIGHT AGAINST CORRUPTION
RETURN TO FISCAL ORDER
Over the three-year duration of the agreement, the government has committed to increasing the non-oil balance—including subsidies to fuels— by 5 percentage points of GDP (around USD5.4 billion). This will also make it possible to reduce the 49.2% debt estimated in 2019 to 36.6% in 2023. To achieve this, a combined strategy of increasing taxes and reducing expenses has been proposed.
The authorities are pushing for a tax reform to increase revenues by 1.6 percentage points of GDP (USD2.4 billion between 2019 and 2021). However, the assembly has rejected the tax bill, and the president has sent back a less ambitious tax proposal. The authorities also seek to simplify the tax system to make it more investment friendly and equitable. The taxes that distort economic activity will be gradually eliminated, predominantly the Foreign Currency Exit Tax.
On the expense reduction side, several measures will be adopted, ordered from highest to lowest based on the savings generated.
In 2021, a new reduction in fuel subsidies will be carried out. The government is working with the World Bank on a new mechanism to focus resources on vulnerable people. The estimated saving is USD1.5 billion (1.5 percentage points of GDP) between 2018 and 2021. The counterpart of the reduction in subsidies will be an increase in social spending equivalent to 1.2% of GDP.
The authorities seek to contain wage growth and reduce the payroll of the public sector by USD797 million between 2018 and 2021 (0.9 percentage points). Salaries in the public sector have risen by 78% since 2007 and are currently double that in the private sector. Additionally, public employment increased 23% between 2005 and 2015.
The plan does not take into account additional mining revenues, as the IMF and the authorities want to wean government finances from the dependency on natural resources revenues. The government foresees mining revenues of USD185 million in 2020 and USD323 million in 2021.
The biggest challenge to the IMF’s three-year agreement currently comes from the political side. The government requires great skill to negotiate tax increases and labor reform with the other political forces of the assembly. In addition, the authorities will have to be extremely skillful to convince the public of the need for adjustment and acquire support for measures that are unpopular: tax increases and the reduction of salaries and subsidies. Already, the elimination of the diesel subsidy had to be rolled back as a consequence of the indigenous uprising. ✖