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Country Report February 2003

Ecuador

February 2003

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

Ecuador at a glance: 2003-04

OVERVIEWThe president-elect, Lucio Gutiérrez, took office on January 15th 2003. Theminority of congressmen whose parties backed Mr Gutiérrez�s successfulpresidential bid are outnumbered by opposition representatives, setting thestage for a confrontation between Congress and the executive. Many of thepresident�s plans will be frustrated. The government will pursue IMF support,without which Ecuador risks falling behind on its external obligations. Growthwill be modest in 2003, before higher oil output in 2004 leads to strongerexpansion. The non-oil productive sector is vulnerable to real exchange-rateappreciation. The current-account balance will stay substantially in deficit, butwill be funded largely by foreign direct investment in the oil industry.

Key changes from last month

Political outlook• Representatives of pro-government parties have been shut out of many

congressional committees and congressionally appointed roles by the anti-government majority in the legislature. This will weaken the executive�sposition. A re-organisation in the armed forces suggests that Mr Gutiérrez isfirming his power base in the event that he is seriously challenged by thepolitical establishment.

Economic policy outlook• The government is pursuing a stand-by agreement with the IMF, which

appears increasingly disposed to sign a deal with Ecuador in the first quarter.The government has reduced fuel subsidies, and will send proposals toincrease tax revenues to Congress.

Economic forecast• The Economist Intelligence Unit has raised its inflation forecast for 2003-04

slightly, in response to fuel and utilities tariff rises. High oil prices, ifsustained, have the potential to lift oil export revenues above what wecurrently forecast.

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Ecuador 1

Country Report February 2003 www.eiu.com © The Economist Intelligence Unit Limited 2003

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2003-047 Political outlook8 Economic policy outlook9 Economic forecast

12 The political scene

15 Economic policy

19 The domestic economy19 Economic trends21 Employment, wages and prices23 Agriculture23 Oil and gas24 Financial and other services26 Infrastructure

26 Foreign trade and payments

List of tables9 International assumptions summary11 Forecast summary17 Summary of yield expected from fiscal measures in 200318 Tax collection in 200219 Comparison between old and new national accounts20 Components of gross domestic product21 Gross domestic product growth by sector21 Consumer price inflation23 Oil production and exports25 Bank deposits and lending27 Merchandise exports27 Merchandise imports28 Balance of payments

List of figures11 Gross domestic product11 Sucre real exchange rates20 Gross domestic product22 Consumer price inflation

Ecuador 3


Summary February 2003

The president-elect, Lucio Gutiérrez, took office on January 15th 2003. Theminority of congressmen whose parties backed Mr Gutiérrez�s successfulpresidential bid are outnumbered by opposition representatives, setting the stagefor a confrontation between Congress and the executive. Many of the president�splans will be frustrated. The government will pursue IMF support, withoutwhich Ecuador risks falling behind on its external obligations. Growth will bemodest in 2003, before higher oil output in 2004 leads to stronger expansion.The non-oil productive sector is vulnerable to real exchange-rate appreciation.The current-account balance will stay substantially in deficit, but will be fundedlargely by foreign direct investment in the oil industry.

Following his inauguration as president Mr Gutiérrez has appointed a diversecabinet. A respected orthodox economist, Mauricio Pozo, has taken over at theMinistry of Economy and Finance. Mr Gutiérrez has installed former armycolleagues in several key ministries and the state oil company. He has alsoprecipitated the retirement of senior members of the armed forces. Acongressional majority has been formed that broadly opposes the government.It has taken control of most congressional committees, leaving the pro-government parties with little influence in Congress.

The outgoing government has left a precarious fiscal position, which the newadministration is trying to remedy. The IMF has signalled its readiness to sign astand-by agreement provided the government can take action to close the fiscaldeficit. The government has decreed cuts in fuel subsidies, and cuts in non-socialstate expenditure. It has also announced tax reforms that require congressionalapproval.

The Central Bank has released a revised set of annual and quarterly nationalaccounts denominated in dollars the main effect of which is to increaseestimates of the size of the economy. Gross fixed investment and governmentconsumption provided the main stimuli to growth of 3.5% year on year in thethird quarter of 2002. Growth is estimated to have reached 3.3% in 2002.Inflation has fallen. Production and export of crude oil declined in January-November 2002. Bank deposits rose in 2002 while new lending activitywas firm.

The trade deficit has widened as modest export growth has been outstripped byrapid growth in imports. The rate of import growth slowed in the fourth quarterof 2002, following the arrival of the majority of the raw materials and capitalgoods related to the construction of the new heavy crude oil pipeline.Remittances diminished slightly in January-September 2002.

Editors: Charles Seville (editor); Fiona Mackie (consulting editor)Editorial closing date: January 29th 2003

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2003-04

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Ecuador


Political structure

Republic of Ecuador

Presidential

The president, elected for a four-year term, appoints the cabinet and provincialgovernors. Lucio Gutiérrez won the presidency in a second-round run-off of thepresidential election in November 2002 and his term runs until January 2007.

Unicameral Chamber of Representatives (Congress); 100 members are electedprovincially by proportional representation from open slates and for a four-year period;voting is compulsory for all persons between the age of 18-65

Congress selected a new Supreme Court with life tenure in October 1997 fromnomination lists presented by electoral colleges and civic groups

October 2002 (congressional and first-round presidential); November 2002 (second-roundpresidential); next elections due in October 2006 (congressional and presidential), with asecond round run-off in November 2006.

The president and his cabinet, predominantly independents

Partido Social Cristiano (PSC); Izquierda Democrática (ID); Partido Roldosista Ecuatoriano(PRE); Partido Renovador Institucional Acción Nacional (PRIAN); Partido SociedadPatriótica 21 de Enero (PSP); Democracia Popular (DP); Movimiento Unidad PlurinacionalPachakutik-Nuevo País (MUPP-NP); Movimiento Popular Democrático (MPD); PartidoConservador (PC); Concentración de Fuerzas Populares (CFP); Partido SocialistaEcuatoriano (PSE); Patria Solidaria (PS); Partido Libertad (PL); Unidad Alfarista; PartidoConservador (PC). Outside Congress: Confederación de Nacionalidades Indígenas delEcuador (Conaie).

President Lucio GutiérrezVice-president Alfredo Palacio

Administration secretary Patricio AcostaAgriculture & livestock Luis MacasCulture & education Rosa María TorresEconomy & finance Mauricio PozoEnergy & mines Carlos ArboledaEnvironment Edgar IschForeign relations Nina PacariHousing Nelson AlvarezInterior Mario CanessaLabour Felipe MantillaNational defence Nelson HerreraPublic health Francisco AndinoPublic works Estuardo PeñaherreraSocial welfare Luis MaldonadoTourism Doris SolísTrade & industry Yvonne Baki

Luis Ycaza

Miguel Dávila

National legislature

Legal system

National elections

National government

Main political organisations

Key ministers

Official name

Central Bank board president

Superintendent of banks

Form of state

The executive

Ecuador 5


Economic structure

Annual indicators1998 a 1999 a 2000a 2001 a 2002 b

GDP at market prices (Su trn) 107.4 161.3 340.0 449.6 519.6GDP (US$ bn) 19.7 13.7 13.6 18.0 20.8

Real GDP growth (%) 0.4 -7.3 2.3 5.6 3.3Consumer price inflation (av; %) 36.1 52.2 96.1 37.7 12.5 a

Population (m) 11.7 b 11.9 b 12.0b 12.2 b 12.4

Exports of goods fob (US$ m) 4,326.0 4,615.0 5,137.0 4,862.0 4,929.6Imports of goods fob (US$ m) 5,458.0 3,028.0 3,743.0 5,325.0 5,978.7

Current-account balance (US$ m) -2,099.0 917.0 920.0 -670.0 -1,493.2Foreign-exchange reserves excl gold (US$ m) 1,619.7 1,642.4 947.0 839.8 714.6 a

Total external debt (US$ bn) 15.6 15.3 13.3 14.0 b 14.4Debt-service ratio, paid (%) 29.8 26.2 17.4 23.2 b 20.1Exchange rate (av) Su:US$ 5,446.6 11,786.8 24,988.4 25,000.0 25,000.0 a

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2001 % of total Components of gross domestic product 2001 % of totalAgriculture 12.1 Private consumption 68.0Industry 36.8 Government consumption 10.0

Services 51.1 Fixed investment 22.8Stockbuilding 2.2

Exports of goods & services 31.2Imports of goods & services 34.2

Principal exports fob 2001 US$ m Principal imports cif 2001 US$ mOil and derivatives 1,899 Raw materials 1,983

Bananas and plantain 847 Capital goods 1,661Shrimp 280 Consumption goods 1,419Canned fish 268 Fuel & lubricants 297

Main destinations of exports fob 2001 % of total Main origins of imports cif 2001 % of totalUS 38.3 US 24.7Peru 7.3 Colombia 14.4Colombia 7.0 Japan 6.6

Italy 4.3 Venezuela 5.5Venezuela 3.6 Chile 5.0

6 Ecuador


Quarterly indicators2001 20021 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Non-financial public-sector balance (US$ m)Revenue 1,176.4 1,349.6 1,278.0 1,156.1 1,390.2 1,707.0 1,653.6 n/aExpenditure 1,171.3 1,205.6 1,110.5 1,459.8 1,252.7 1,521.3 1,463.3 n/aBalance 5.0 144.0 167.5 -303.7 137.5 185.7 190.3 n/aOutputGDP at constant 2000 prices (US$ m) 4,191.5 4,165.7 4,218.1 4,173.7 4,191.6 4,326.3 4,363.8 n/aGDP at constant 2000 prices (% change, year on

year) 7.4 4.6 5.6 3.0 0.0 3.9 3.5 n/aEmployment, wages and pricesUnemployment Quito, Guayaquil, Cuenca (% of the

labour force) 11.8 10.8 10.5 8.6 8.7 8.8 8.7 8.3Underemployment (% of the labour force) 55.8 49.9 43.7 40.9 36.6 31.5 29.7 33.7Real minimum wage index (Sep 1994-Aug

1995=100) 102.6 98.1 92.9 92.9 103.1 100.0 99.2 97.5Consumer prices, Quito (1995=100) 863.7 902.1 916.5 953.4 990.7 1,021.2 1,029.8 1,047.9Consumer prices (% change, year on year) 67.6 39.6 28.9 24.1 14.7 13.2 12.4 9.9Producer prices (1995=100) 1,220.5 1,230.8 1,249.3 1,127.2 1,217.1 1,316.4 1,322.2 1,298.6Producer prices (% change, year on year) 13.2 6.2 -4.1 -13.2 -0.3 7.0 5.8 15.2Financial indicatorsExchange rate Su:US$ (av) 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000Exchange rate Su:US$ (end-period) 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000Deposit interest rate (%) 7.2 6.7 6.3 6.2 5.8 5.2 5.3 n/aLending interest rate (%) 16.4 15.2 15.4 14.8 15.5 15.0 15.0 n/aM1 (end-period; US$ m) 1,615 1,713 1,853 1,933 2,029 2,166 n/a n/aM1 (% change, year on year) 19.6 37.5 58.3 39.9 25.6 26.4 n/a n/aM2 (end-period; US$ m) 4,433 4,562 4,746 4,920 5,287 5,392 n/a n/aM2 (% change, year on year) 29.3 25.4 28.0 21.4 19.3 18.2 n/a n/aSectoral trendsCrude oilProduction (m barrels/day) 0.43 0.42 0.42 0.41 0.39 0.40 0.40 0.40Exports (US$ m) 467 450 475 330 317 464 565 493Spot prices (Oriente-29; US$/barrel)a 23.0 23.7 22.8 16.0 17.8 22.9 24.4 24.0Foreign trade (US$ m)Exports fob 1,227 1,249 1,181 1,021 1,102 1,284 1,324 1,290Imports cif -1,171 -1,347 -1,357 -1,487 -1,434 -1,730 -1,680 -1,587Trade balance 56 -98 -176 -466 -332 -446 -356 -297Foreign payments (US$ m)Merchandise trade balance 130 -30 -100 -398 -235 -349 -254 n/aServices balance -128 -130 -121 -143 -123 -145 -147 n/aIncome balance -318 -427 -308 -311 -292 -318 -343 n/aNet transfer payments 410 434 404 392 352 372 400 n/aCurrent-account balance 93 -153 -125 -460 -298 -440 -344 n/aReserves excl gold (end-period) 733 976 912 840 777 904 901 715

a Gulf, composite assessment.

Sources: IEA, Monthly Oil Market Report; IMF, International Financial Statistics; Banco Central del Ecuador, Información Estadística Mensual; Oil Market Intelligence.

Ecuador 7


Outlook for 2003-04

Political outlook

Lucio Gutiérrez, a former army colonel, was inaugurated as president onJanuary 15th. Mr Gutiérrez was one of the leaders of the military-indigenouscoup that ousted the then-president, Jamil Mahuad, in January 2000. Hecampaigned for the presidency with the support of a loose coalition of left-wingand indigenous groups and parties, of which the main components are theMovimiento Unidad Plurinacional Pachakútik-Nuevo País (Pachakútik, orMUPP-NP), which mostly represents the large indigenous population, the PartidoSociedad Patriótica 21 de Enero (PSP, a new party formed by Mr Gutiérrez andhis former army comrades, which has an anticorruption and nationalistplatform) and the tiny, formerly hard-left, Movimiento Popular Democrático(MPD). So far, the PSP has taken the upper hand in the alliance, whilePachakútik�s influence over economic policymaking has clearly been less than itexpected. The cool reception of Pachakútik to the package of spending cuts andrevenue-raising measures announced in mid-January may be a sign of troubleahead.

Mr Gutiérrez and his orthodox minister of economy and finance, Mauricio Pozo,will pursue a close relationship with the IMF, placing them at odds with thetone adopted during most of the presidential campaign, and in direct conflictwith the indigenous movement. Pachakútik has gone so far as to call forMr Pozo�s removal. An outsider propelled to office by voter disenchantmentwith established political leaders, Mr Gutiérrez will be under pressure from thepopulation to deliver on his campaign promises to prioritise social investmentand income redistribution at a time when a major fiscal adjustment is requiredto avert default on external debt. So far, however, Mr Gutiérrez appears to haveretained the support of a majority of the population.

The new government faces a largely hostile Congress which views Mr Gutiérrezwith suspicion. Pachakútik, the PSP and the MPD control no more than 20 seats,but the executive needs 51 votes to pass legislation in the 100-member Congress.The large traditional parties dominate the new Congress and have formed adisparate anti-government majority controlling 56 votes. The cornerstone of thisbloc is the pro-business, Guayaquil-based Partido Social Cristiano (PSC), thelargest party in the legislature with 25 seats. Guillermo Landázuri, thecongressional leader of the 16 legislators belonging to Izquierda Democrática(ID), will preside over Congress for the next two years, and Mr Gutiérrez�sopponents will preside over a majority of the powerful congressionalcommittees. The majority which voted for Mr Landázuri was composed of thePSC, ID, the Partido Renovador Institucional Acción Nacional (PRIAN) andDemocracia Popular (DP). The populist Partido Roldosista Ecuatoriano (PRE) alsochose to side against the government.

Traditional political forces have little stake in seeing Mr Gutiérrez succeed, andare likely to frustrate many of his plans. They might be able to use theircongressional majority and control of the higher courts to force him out ofoffice. How Mr Gutiérrez would respond to such a direct challenge is unclear.

Domestic politics

8 Ecuador


Changes in the armed forces high command to install officers more supportiveof the government may have been designed to pre-empt any such attempt.Mr Gutiérrez�s plans to promote a constitutional reform, which would involvereducing the number of deputies in Congress and depoliticising the highercourts, could be viewed as threatening by the established parties.

Under the new foreign minister, Nina Pacari, an experienced member ofPachakútik, the current government will bring different priorities to foreignpolicy from those of its predecessor, although the Economist Intelligence Unitexpects pragmatism to prevail over Pachakútik�s left-leaning stance. Thegovernment will lobby harder to secure the rights of Ecuadorean migrantsabroad, many of whom are from indigenous ethnic groups, and it will seek toplay a part diplomatically in monitoring and resolving the civil conflict inColombia. Having visited European governments in December (including majorshareholders in the IMF), Mr Gutiérrez also intends to maintain good relationswith the US. He will not seek to renegotiate the treaty under which the US isusing an air force base at Manta for regional antidrugs operations. However, hewill resist any attempt to broaden the uses of the base to include militaryassistance to Colombian forces fighting left-wing rebels.

Economic policy outlook

Dollarisation commits the government to a very strict fiscal policy and, in thelonger term, will also require numerous reforms to improve competitiveness if itis to help the country prosper. It will be very difficult to drive these policiesforward. Structural economic reform to improve competitiveness facesformidable obstacles in the shape of local business and political interests thatbenefit from the status quo, as well as from left-wing politicians and unions.We do not expect the government to press for the privatisation oftelecommunications and electricity, but it will sponsor other reforms. The newgovernment has taken quick fiscal action to try to secure an IMF deal and weexpect it to attempt to follow Fund prescriptions. In turn, the Fund appearsincreasingly disposed to help Ecuador, but support will be dependent onCongress passing at least some of Mr Gutiérrez�s tax reforms.

The fiscal outlook for the forecast period is challenging. The government knowsit will need to aim for fiscal surpluses in order to help generate the resourcesneeded to meet a heavy debt-repayment schedule. A fund to capture above-budget revenues and direct them to debt repayment or a stabilisation account isin place, but contains loopholes and may not function as intended. Reckless andcorrupt spending in 2002 strengthened doubts that the recent record of boom-and-bust fiscal policy can be overcome. The non-financial public-sector deficit isestimated to have ended 2002 in surplus by 0.7% of GDP, a similar level to thatin 2001, but this was only achieved because the administration of the thenpresident Gustavo Noboa left US$722m in unpaid bills, including wages. Thegovernment ran up arrears because, in the absence of an IMF deal, it had littleaccess to official or private lending in order to finance the repayment of externaldebt. We expect the government to continue to prioritise making external debtrepayments, subordinating its current spending commitments in the short term,

Policy trends

International relations

Fiscal policy

Ecuador 9


in the hope that it can quickly obtain an IMF deal. Reducing outgoings andincreasing revenue by reducing fuel subsidies will bring significant savings, buttax reforms will rely on the willingness of Congress to approve them. Thebudget for 2003, which must be approved by the end of February, could also beamended by Congress.

Despite having made public his reservations about dollarisation early in hiscampaign, Mr Gutiérrez has pledged to maintain the policy. If the governmentproves unable to meet obligations and judges that the exchange-rate system issuffocating exports, it could in theory opt to reissue a national currency, but onlyat a serious economic cost. Dollarisation deprives the Banco Central del Ecuador(the Central Bank) of an independent monetary policy; monetary growth andeffectively the level of economic activity are therefore determined by thequantity of foreign inflows. Further government borrowing on the domesticmarket could prevent interest rates from falling in the forecast period.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2001 2002 2003 2004Real GDP growthWorld 2.1 2.7 3.2 3.9US 0.3 2.5 2.4 3.4EU 1.4 0.8 1.3 2.2Exchange rates¥:US$ 121.5 125.3 124.8 124.0US$:� 0.896 0.946 1.083 1.080SDR:US$ 0.785 0.772 0.732 0.733

Financial indicators¥ 2-month private bill rate 0.17 0.10 0.10 0.10US$ 3-month commercial paper rate 3.61 1.70 1.26 3.08

Commodity pricesOil (Brent; US$/b) 24.5 25.0 26.6 19.6Gold (US$/troy oz) 271.1 309.8 316.3 290.0Food, feedstuffs & beverages (% change in US$

terms) -1.9 13.1 11.5 -3.1Industrial raw materials (% change in US$ terms) -9.8 2.0 4.0 5.4

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

We expect the US economy, which accounts for around 38% of Ecuador�smerchandise exports, to grow by 2.4% in 2003 and by 3.4% in 2004. However,the US is at risk of a renewed slowdown or recession if domestic consumerconfidence falters. Spare capacity and heavy debts will limit corporateinvestment. In view of the fragility of the US recovery, the US Federal ReserveBoard (the US central bank) will keep interest rates low in 2003. As over half ofEcuador�s debt stock is contracted at variable interest rates, lower US rates willhelp to reduce the country�s debt-servicing costs. Growth in the Andean regionaleconomy, the importance of which as an export market has risen in recent years,will be weak. Uncertainty surrounding the consequences of US military actionagainst Iraq will keep oil prices firm in the first half of 2003, but oil prices will

International assumptions

Monetary policy

10 Ecuador


ease in the second half and fall further in 2004. Ecuador is highly vulnerable to asudden drop in oil prices.

We expect growth, estimated at 3.3% in 2002, to slow in 2003. Demand has beenboosted by strong wage increases in the public sector and rapid growth ingovernment consumption, both of which are unsustainable. Nevertheless,multilateral funding looks increasingly set to shore up business confidence. Weforecast only modest growth in the oil sector in 2003, despite the opening of theOleoducto de Crudos Pesados (OCP, the heavy crude oil pipeline) in the fourthquarter, with the first sizeable expansion in output coming in 2004. Theinvestment plan of the state-owned oil company, Petroecuador, for 2003 projects8% growth in output, but the investment budget of the company, whichaccounted for 56% of oil production in 2002, is determined by the governmentand will be vulnerable to cuts in state expenditure. Private oil companies willincrease output but their appetite for investment continues to be dampened by atax dispute with the government. In the other main sector, agriculture, most ofthe major exports face sector-specific problems. The strong exchange rate willweigh heavily on the growth prospects of the non-oil sector in 2003-04.

Monthly increases in consumer prices have slowed sharply since the secondquarter of 2002, and the 12-month rate ended the year at 9.4%, the lowest figureon record. This is still well above the annual rate of inflation in the US,estimated at 1.5%. The reduction in inflation will be small in 2003; a freeze ongovernment-set electricity prices was ended in January, petrol prices were raisedby an average of 32%, and public-sector wages were raised by over 40% by theprevious administration. The cost of non-tradeable goods and services, prices forwhich plummeted during the 1999 crisis, will continue to rise above the averagerate owing to inertia. Increases in the cost of domestically produced tradeablegoods will damage the competitiveness of the productive sector relative toimports. Inflation will fall in 2004 as these pressures work their way throughthe system.

Although dollarisation has brought economic stability, inflation has rapidlyeroded the competitiveness of exports and, perhaps more markedly, that of ind-ustries competing against imported goods. The real exchange rate is at historicallyhigh levels and cannot be brought down without a period of painful deflation orby abandoning the dollar. A lower rate of inflation will reduce the pace of realexchange-rate appreciation against the currencies of Ecuador�s developed countrytrading partners in 2003-04. Nevertheless if regional currencies weaken againstthe US dollar, Ecuador will lose further competitiveness�even if it succeeds inlowering inflation. US dollar weakness against other major world currenciesmay provide some respite.

Export earnings will be dependent on the performance of a handful of keycommodity exports on world markets, especially oil. Oil export volumes willincrease once the new heavy crude oil pipeline is operational in the fourthquarter of 2003, but growth in oil output will not be as great as formerly hopedowing to a lack of investment by both private oil companies and Petroecuador.We expect average oil prices to fall in 2004, diminishing earnings despite the

Inflation

Economic growth

External sector

Exchange rates

Ecuador 11


volume increase. Demand for imported consumer goods and capital goodsimports for the oil pipeline has slowed significantly after a phase of rapidgrowth. We expect a persistent trade deficit over the forecast period, althoughthe deficit will narrow in 2003. The current account will remain in deficit owingto a structural deficit on the income account caused by higher repatriations ofearnings by foreign investors and debt interest payments. Remittances senthome by Ecuadoreans working abroad have become the most reliable source ofexternal inflows. Having grown rapidly in recent years, they levelled off in 2002and are not forecast to grow significantly in 2003-04.

Forecast summary(% unless otherwise indicated)

2001a 2002 b 2003c 2004c

Real GDP growth 5.6 3.3 2.5 3.6Industrial production growth 4.9 1.6 4.1 6.9Gross agricultural production growth 4.5 2.5 3.0 2.5

Unemployment rate (av) 8.1 7.7 a 9.5 9.5Consumer price inflation (av) 37.7 12.5 a 8.0 5.2

Consumer price inflation (year-end) 22.4 9.4 a 7.3 4.7Short-term interbank rate 15.5 15.1 a 13.8 14.1

NFPS balance (% of GDP) 0.7 0.7 3.0 2.0Exports of goods fob (US$ bn) 4.9 4.9 5.3 4.9Imports of goods fob (US$ bn) 5.3 6.0 6.0 5.7

Current-account balance (US$ bn) -0.7 -1.5 -1.1 -1.3Current-account balance (% of GDP) -3.7 -7.2 -4.9 -5.0

External debt (year-end; US$ bn) 14.0b 14.4 14.7 14.8Exchange rate Su:US$ (av)d 25,000.0 25,000.0 a 25,000.0 25,000.0Exchange rate Su:¥100 (av)d 20,571.1 19,944.2 a 20,040.1 20,161.3

Exchange rate Su:� (year-end) 22,032.5 26,235.0 a 27,375.0 26,750.0Exchange rate Su:SDR (year-end) 31,418.2 33,988.0 a 34,320.8 33,967.2

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Annualaverage free rate.

12 Ecuador


The political scene

Lucio Gutiérrez enjoyed a comfortable victory over Alvaro Noboa in the secondround run-off of the presidential election on November 24th, obtaining 54.8%of the 5.1m valid votes cast to Mr Noboa�s 45.2%. He was inaugurated onJanuary 15th, and promised to reduce poverty and improve basic services. Theformer coup leader, who played a key role in the ouster of former presidentJamil Mahuad in 2000, also promised to combat corruption, attacked theprevious administration for fiscal mismanagement, and pledged to attractforeign investment. The most controversial part of the inauguration speechfocused on political reforms. Mr Gutiérrez plans to re-organise the judicialsystem to lessen the influence of political parties over the higher courts, such asthe Supreme Court. He has also proposed to cut the number of legislators inCongress (already recently reduced from 123 to 100 for the 2003-07 presidentialterm). In the knowledge that Congress is very unlikely to pass these measuresMr Gutiérrez has suggested that he could seek approval for them by a popularreferendum. Yet enabling this process in itself would require congressionalapproval. Pursuit of political reforms could distract the government from moreurgent economic policy priorities and risks confrontation with traditionalpolitical forces.

In his first few weeks in office, Mr Gutiérrez has revealed a tendency towardsmaking hasty statements he later has to retract. In the most serious of these, heaccused all former presidents of corruption, provoking an angry response fromLeón Febres Cordero, who served as president in 1984-88. As the de facto leaderof the largest party in Congress, the Partido Social Cristiano (PSC), Mr FebresCordero arguably has the power to make or break the Gutiérrez administration.

Mr Gutiérrez moved quickly to appoint his cabinet, the diversity of whichreflects the range of forces backing him. Five of the ministers are former militaryofficers or associated civilians with prior links to Mr Gutiérrez. Five othersbelong to the ethnic Pachakútik movement, represent minority grass-rootsmovements or have left-wing backgrounds, while four are pro-businessconservatives. Two other ministers have links with populist local politicians andlittle by way of ideology. The contradictory positions of different members ofthe cabinet could prove a source of weakness or instability. The key post ofminister of economy and finance was awarded to Mauricio Pozo, an orthodoxeconomist with a good reputation abroad and links to the private sector inQuito. His appointment was seen as proof that the new administration wasserious about reaching agreement with the IMF, but has generated discontentamong his more radical indigenous and left-wing supporters. Criticism hasintensified from some quarters since the announcement of Mr Pozo�s economicplan to win support from the IMF (see Economic policy). The Confederación deNacionalidades Indígenas del Ecuador (Conaie, the main lobby grouprepresenting indigenous people in Ecuador) accused him of being too pliant tothe Fund�s demands, but some indigenous members of the government havedefended him.

Lucio Gutiérrez is inauguratedas president

Cabinet appointments differ inpolitical views

Ecuador 13


The new minister of the environment, Edgar Isch, is a member of the left-wing Movimiento Popular Democrático (MPD) with strong views on theenvironment. He has expressed doubts about the soundness of theenvironmental audit which gave the all-clear to the building of the Oleoducto deCrudos Pesados (OCP, the heavy crude oil pipeline). The former president,Gustavo Noboa, dismissed environmental concerns and insisted that the projectshould go ahead. Given the powers of the environment ministry over theactivities of the all-important oil industry, the appointment of Mr Isch hasgenerated some unease among foreign investors.

The most controversial aspect of the cabinet and other senior appointments isthe extent to which Mr Gutiérrez has drawn on personal contacts, relatives (notentirely uncommon in Ecuador) and former army colleagues to staff topgovernment posts. He has installed former army colleagues in the key spendingministries of public works and social welfare which offer the most opportunitiesfor patronage-driven policies. For the first time both the new minister of energyand mines, Carlos Arboleda, and the chief executive of the state-owned oilcompany, Petroecuador, are also from a military background. There are concernsthat this could signal the beginning of a period of renewed political influenceand economic power for the military, which continues to enjoy higher prestigewith the public than civilian politicians.

Some observers are concerned at an apparent bid by Mr Gutiérrez to increasehis personal sway over the armed forces. During the first days of his presidency,Mr Gutiérrez forced more than 18 top army officers into retirement. Heappointed General Octavio Romero as commander-in-chief of the army, andplaced Second Admiral Victor Rosero in charge of the navy, passing over othermore senior or experienced officers in the process. These appointments,designed primarily to put trusted officers in charge, also appear to be a form ofretribution for the role of the senior officer corps in prosecuting and retiringMr Gutiérrez and his comrades after the January 2000 coup. One priority hasbeen to dismantle a group of senior naval officers in Guayaquil that aregenerally dependent and subservient to the city�s upper classes and to de factoPSC leader León Febres Cordero. This group of navy officers played a crucial rolein ending the January 2000 coup and installing Gustavo Noboa, a member ofthe Guayaquil elite, as president. It is believed that the navy admiralty backedup a threat by Mr Febres Cordero to lead the secession of Guayaquil from therest of Ecuador if Mr Gutiérrez and his supporters were allowed to remain inpower.

Following the result of congressional elections held at the end of October(November 2002, page 13), Congress will be controlled by parties opposed to theGutiérrez administration. Most of the larger parties outside Mr Gutiérrez�selection coalition opted to form an alliance, but they are an ideologicallydisparate group. The Partido Social Cristiano (PSC), the largest party in thelegislature, waived its right to nominate the next Speaker (a powerful positioncarrying with it the ability to influence the congressional agenda) and allowedthe centre-left Izquierda Democrática (ID), the second largest party in Congress,to appoint its congressional leader Guillermo Landázuri as Speaker. The

Perceived nepotism andenhanced role for military

Mr Gutiérrez prompts changesin senior military ranks

Congress is controlled byopponents of Mr Gutiérrez

New environment ministermay take tough stand

14 Ecuador


opposition majority took control of 16 of the 18 congressional committees,which scrutinise all legislation in their areas of competence, and is seeking toplace its candidates in the main supervisory agencies�posts such as thecomptroller-general, the attorney general, and regulators such as the bankingsuperintendency.

The ten congressmen belonging to the Partido Renovador Institucional AcciónNacional (PRIAN), the party of defeated presidential candidate Alvaro Noboa,also opted to side with the opposition. This was apparently in return for apromise that a PRIAN member would become the next Chairman of theTribunal Supremo Electoral (the Supreme Electoral Tribunal or TSE, the bodyoverseeing elections), which was duly fulfilled at the end of January. Mr Noboahas complained in the past that partisan control of the TSE allowed large-scaleelectoral fraud which prevented him from winning the presidency in theprevious elections in 1998. Congress refused to nominate any representativesfrom the PSP, Mr Gutiérrez�s own party, angering the president, who wasplanning to appeal against the decision. The Partido Roldosista Ecuatoriano(PRE), with 15 seats in Congress, appears to have lost out once again on itsperennial demand for greater representation on the Supreme Court, and is notsupporting the government.

The new alliance between the PSC and ID puts an end to more than twodecades of bitter rivalry between the two parties and shows that both considerMr Gutiérrez and his alliance of minority and left-wing parties a serious threat.The establishment alliance may have the intention of using its dominance ofCongress to block the new president�s policymaking initiatives. Like hispredecessor, Gustavo Noboa, he may have to rely on veto powers to passlegislation, but is in a numerically weaker position in Congress, and may havetrouble mustering the two-fifths majority needed to defend a veto. There arealso restrictions on the uses of the presidential veto. It is not supposed to beused to introduce new clauses into legislation, only to reject text already passedby Congress. Considerable mutual distrust between the establishment elites andMr Gutiérrez, based not only on political differences but also class rivalry, couldspill over into serious confrontation.

The respected and veteran indigenous peoples� rights activist Nina Pacari, amember of Pachakútik, has been appointed as the next minister for foreignaffairs. Ms Pacari has experience in important public posts, notably the secondvice-presidency of Congress between 1998 and 2000. Many believe that, as anindigenous woman, she can refresh Ecuadorian diplomacy, but the Pachakútikmovement to which she belongs is noted for its opposition to globalisation, theFree-Trade Area of the Americas (FTAA), orthodox economic policies, the role ofthe US in Latin America and especially the US presence at the Manta air base.The leadership of Pachakútik has strongly opposed further Ecuadorianinvolvement in Colombian affairs. The most sensitive issue in relations betweenthe two countries is the status of the Manta air base. There is controversy overwhat Ecuador should do if the US asks to use the base to supportcounterinsurgency operations in Colombia. Pachakútik policy has been tooppose any such move, but refusal to bow to US wishes could bring damaging

Appointment of foreignminister generates uncertainty

PRIAN sides with opposition

The establishment feelsthreatened by Mr Gutiérrez

Ecuador 15


reprisals. The US will also monitor whether the new minister attempts to drawcloser to left-wing leaders in the hemisphere such as Hugo Chávez, Fidel Castroor Luiz Inácio Lula da Silva. So far there are few indications that the direction offoreign policy will be much altered.

Economic policy

The new president, Lucio Gutiérrez, inherits a fragile fiscal position from theprevious government. In order to compensate for the exaggerated growth inspending during the first half of the year (November 2002, page 17), theadministration of Mr Gutiérrez�s predecessor, Gustavo Noboa, tried to apply thebrakes during the fourth quarter of 2002. Investment was reduced to aminimum and transfers to local governments were almost completelysuppressed. Even with the benefit of a rebound in oil prices, the Ministry ofEconomy and Finance managed to keep current on external debt amortisationonly by delaying some items of current expenditure. In an attempt to boost itscash revenues in its last few weeks in office, the government tried to arrange anoil-backed loan from two international oil-trading companies. This controversialmortgaging of future oil revenues would have brought in downpayments ofUS$245m, but caused a political outcry. The adjudication of these contracts washalted by the comptroller-general�s office because the government had notfollowed the proper procedures. The end-of-year non-financial public-sectorsurplus is estimated to have been smaller than the US$350m, or 1.7% of GDP,that was needed.

An IMF mission in December determined that the size of the �floating debt�(unpaid bills) bequeathed to the Gutiérrez administration was US$722m. AroundUS$350m-400m of this is related to corrupt or last-minute transactions, whichthe Gutiérrez government plans not to honour. The decision should not haveany serious consequences for domestic creditors.

The fiscal shortfall has forced the new government to take rapid action tostabilise the fiscal accounts, of the kind that Mr Gutiérrez had vowed to avoidduring his presidential campaign. The initial phase consisted of policies thatcould be enacted immediately by the executive without congressional approval.Mr Gutiérrez announced in a televised address on January 19th that petrol(gasoline) and diesel prices would be raised by an average of 29%. Petrol pricescan be set by a presidential decree that is implemented by Petrocomercial, thefuel distribution arm of the state-owned oil company, Petroecuador. The price ofa gallon of extra gasoline, the most commonly used, rose by 32% to US$1.48,including the regulated profit margin for the final distributor and value-addedtax (VAT). The prices of extra and super gasoline were already at or above cost.The price of diesel fuel was increased by 16%, but at US$0.93 per gallon, asubsidy of about 2�3 US cents per gallon remains. The most controversialmeasure for business was a 33% increase in the price of bunker, a fuel used forgenerating electricity and in heavy industries such as cement. The governmentaims to collect US$350m via these fuel price rises, but given the impact onconsumption of higher prices, a figure of US$300m is more realistic.

The new government faces afragile fiscal position

New finance ministerannounces economic plan

16 Ecuador


Mr Gutiérrez did not adjust the price of cooking gas and pledged that this wouldbe frozen for the remainder of the year. Removing the cooking-gas subsidy hasbeen a long-standing IMF policy recommendation and was included as acondition in the last stand-by agreement signed in April 2000. Mr Noboaplanned to partially roll back the subsidy in the first quarter of 2002, but pulledback from implementing it. Cooking gas is sold at a government-set price ofUS$1.50 per cylinder, far below its market price of US$5.60, but touching thesubsidy, which costs the government around US$200m a year, would be highlyunpopular as it would directly affect the poorest sectors of society.

The other main element of the plan is a tax reform proposal which seeks togenerate about US$80m of additional revenue in 2003. This will involvelowering the threshold for income tax, thereby expanding the number oftaxpayers, reducing tax exemptions, possibly introducing a one-time excise taxon luxury automobiles, establishing a national real estate property tax, andmodifying the current vehicle registration tax. The Partido Social Cristiano (PSC)has pledged to resist any tax rises, and not all the measures will be passed.Proposals requiring legislative approval include the following.

• A cut of 20% in the salaries of the small number of public-sectoremployees who earn more than US$1,000 per month, including the president.The amount of savings this generates will be marginal, but it should help tomarket the programme to the population.

• A public-sector salary freeze in 2003. This will be an important means ofkeeping spending under control and satisfying an IMF condition.

• Reforms to the labour code affecting the public sector. These will reducethe cost of retiring civil servants, tax severance benefits and compensation, pushforward wage unification in the public sector and abolish profit-sharing inpublic firms and government-controlled companies. The proposals are certain tomeet opposition: the tax and customs reforms will be strongly resisted by theprivate sector and by the PSC, which is strongly committed to higher taxation.Labour reform will encounter the adamant opposition of civil service unions.

• Cuts in spending on goods and services approaching US$72m, plusobtaining about US$104m from government agencies and public enterprisesthrough spending cuts and the transfer of surpluses to the central government.This would take the form of a 10% reduction in the central government�s budgetfor 2003 except in the social welfare, health, housing and education ministries.

• Direct support to the poorest sectors of society by raising the bono solidarioto US$15 from US$11 per month. The bono solidario is a cash transfer for singlemothers, the handicapped, the poor, the elderly, and other at-risk groups. Thiswill cost the government about US$50m annually.

• Reform of the Corporación Aduanera del Ecuador (CAE, EcuadorianCustoms Corporation), the body dominated by representatives of the privatesector that administrates the corruption-ridden customs administration. Thegovernment intends to place the CAE under the direct control of the financeministry and the tax authority, the Servicio de Rentas Internas (SRI). Corruptionin customs is estimated to cost Ecuador US$600m a year in lost revenue.

Tax reform planned

Cooking-gas subsidy remainsin place

Ecuador 17


Mr Noboa attempted a similar reform but his efforts were frustrated by private-sector lobbies.

Summary of yield expected from fiscal measures in 2003(US$ m)

Gross yield of fiscal measures 600Revenue sources 424 Fuel price increases 340 Other 84Spending cuts 176 Goods & services 72 Government agencies & public enterprises 104Minus cost of rise in bono solidario 50Net yield of fiscal measures 550

Source: El Comercio, Ministry of Economy and Finance, Corporación de Estudios para el Desarrollo (Cordes).

Aside from the need to repair the public finances, these policies are aimed atsecuring support from the IMF. In January, the Fund warmly welcomed the stepstaken by the new government and signalled its intention to sign a stand-byagreement with Ecuador. Obtaining official financing is important becauseEcuador has little chance in 2003 of being able to run a fiscal surplus largeenough to fund debt repayments, which are estimated to be 30% higher in 2003than 2002. An IMF stand-by agreement would be accompanied by lendingworth at least US$240m, and Fund backing would release funds worth up toUS$300m from other multilateral organisations. The letter of intent could besigned as soon as mid-February, during a scheduled visit to the US byMr Gutiérrez. One prior action still pending is to clear about US$80m in arrearswith the Paris Club and technical arrears with multilaterals. The governmentseems to be intent on making these payments.

The reaction to the petrol price rises, which translate into increased transportcosts, and lead to higher prices in most sectors, has been for previouslyquiescent. unions and popular organisations to protest at the measures, angrythat the government has adopted IMF prescriptions. Left-wing and indigenouspoliticians and commentators have failed to bring forward feasible alternativeproposals and, in private, many Pachakútik leaders concede that thegovernment�s approach may be unavoidable and the only responsible way ofconfronting the deficit, at least in the short run. Yet even if the coalition of forcesbacking Mr Gutiérrez holds together, serious doubts remain regarding thewillingness of Congress to pass the bills necessary to carry out the fiscal andlabour-code reforms, which will be necessary to secure IMF support.

At the end of January the government sent the 2003 budget to Congress, whichmust approve it by February 28th. The budget should be passed relatively intactbecause Congress can only reallocate amounts, not amend the total spending orrevenue. The budget plans US$6.7bn in expenditures, which is 17% higher thanthe 2002 budget but only 6.3% over initial year-end estimates of actual spending.Tax revenues are projected to grow by around 8%, roughly in line with inflation,as long as the tax rises in Mr Pozo�s economic plan are passed. The budget isbased on a conservative assumption for oil prices of US$18/barrel for Ecuador�scrude mix (given the discount applied to Ecuador�s heavy crude on world

Government aims to win IMFsupport

The 2003 budget is set to bepassed by Congress

18 Ecuador


markets, this is equivalent to about US$22/b for West Texas Intermediate). Thebudget aims to generate a primary surplus of about 5.4% of GDP and a smalloverall surplus. If the measures Mr Gutiérrez proposes are adopted and thegovernment complies fully with an IMF agreement, Ecuador will almost be ableto close its US$1.2bn financing gap. However, the arrival of around half theresources needed depend on full compliance with the IMF programme,implementation of the proposed tax reform, and continued strong oil prices.

Tax collection posted solid results in the fourth quarter. The Servicio de RentasInternas (SRI, the tax authority) boosted tax collection by 13.9% over budget in2002. Total tax collection grew by 16.8%, well above inflation. Excise taxcollection grew fastest year on year (by 16.7%), although value-added tax (VAT)receipts, which grew by 16.4%, represent a much larger contribution. The increasein income tax collection was not far behind, growing by 14.9%. Using the revisedGDP figures, tax revenue was 10.3% of GDP in 2002, little changed on theprevious year. One of the keys to tax collection performance continues to begood administration. Recognising the job done by the head of the SRI, Elsa deMena, Mr Gutiérrez renewed her term for another four years in a widely-praiseddecision. Between 1998 and 2002 tax collection has more than doubled and theefficiency in collection of VAT and income tax has increased by 200% and 400%respectively.

Tax collection in 2002(US$ m)

Revenue budgeted Tax collection % over budget targetVAT 1,613 1,692 4.9Income tax 589 671 13.8Special consumption tax (ICE) 226 257 13.8

Total tax revenue 2,478 2,704 9.1

Source: Servicio de Rentas Internas (SRI).

A legal dispute over the rebate of VAT claimed by private oil companies(November 2002, page 19) continued during the fourth quarter of 2002 withoutresolution. Mr Gutierrez has made no recent announcements on the issue. Over50 private oil companies that are pressing the SRI to reimburse a proportion ofthe VAT they have paid since 2000 were not able to take the dispute tointernational arbitration. The SRI argued that tax disputes must be settled inEcuadorian courts and was backed by the Noboa government. Ecuadorianrulings have mostly favoured the SRI. The courts have judged that the plaintiffcompanies were only due the extra payments incurred by the rise of 2percentage points in VAT from 10% to 12% which took place after the contractwas signed.

After the Consejo Nacional de Telecomunicaciones (Conatel, the nationaltelecommunications council) halted the auction of a third national mobiletelecoms licence in November, the urgent need for extra capacity in the sectorwas revealed. During the holiday, demand for services grew so much that forover a week both of the current cellular service providers, BellSouth and Porta,suffered the collapse of their systems. Conatel responded by issuing fines andprohibiting BellSouth from selling any more lines until it was satisfied that the

Tax collection surpass budgetforecasts

Wireless telecoms licenceauction suspended

Courts favouring Ecuador inoil companies� tax dispute

Ecuador 19


company was capable of expanding its service to more clients. The ruling was inplace for over a month before being lifted at the end of January 2003. In thesame month, the delayed auction was successfully conducted.

As part of the measures needed to reduce the fiscal deficit and satisfy acondition imposed by the IMF, Mr Gutierrez was forced in January to reverse hispredecessor�s decision to freeze the adjustment of electricity rates. Rates werebeing raised at a rate of 5% per month in order to bring them up to market levelsand improve the finances of the electricity distributors in preparation forprivatisation. Mr Noboa froze electricity rates in April 2002 (May 2002, page 18)in response to fears over the impact on inflation and complaints frombusinesses that they were losing competitiveness as a result. Electricity costswere frozen at 7.9 US cents per kwh for small residential consumers and about9.4 US cents for industrial consumers. The target rate, estimated to represent themarginal cost of production, is 10.38 US cents per kwh. The Consejo Nacional deElectricidad (Conacel, National Electricity Council) will implement monthlyincreases of about 1.8% per month to consumers of between 100 kwh and200 kwh per month, and about 3.3% per month for those that consume morethan 200 kwh monthly. This new rate adjustment schedule will be applied forsix months before the policy is assessed. After six months, the cost of electricitywill be nearer market levels.

The domestic economy

Economic trends

In the fourth quarter of 2002, the Banco Central del Ecuador (BCE, the CentralBank) released a revised set of annual and quarterly national accounts.Following UN-approved methodology, the new accounts are also denominatedin US dollars and rebased from 1975 to 2000. By adjusting the weights ofdifferent sectors to a more recent estimate, GDP data should be more accurate.These changes have led to an increase in the estimated size of the economy andchanges in the growth rates of its components compared with the previous data.The new national accounting methodology splits the economy into 17 sectors asopposed to just nine under the old formula. For example, oil-related activity isno longer confined to one sector but two. The oil sector includes mainlyextraction while industrial activities, such as refining, are classified asmanufacturing. A revised historical GDP series was published as this reportwent to press and will be used as the basis for our future reports.

Comparison between old and new national accountsa

Annual growth rate GDP US$ m GDP per capita US$Old New Difference Old New Difference Oldb Newc Difference

1994 4.3 4.7 0.4 16,880 18,573 1,693 1,504 1,764 260

1995 2.3 1.7 -0.6 18,006 20,196 2,190 1,571 1,879 3081996 2.0 2.4 0.4 19,157 21,268 2,111 1,638 1,939 301

1997 3.4 4.1 0.7 19,760 23,636 3,876 1,655 2,111 4561998 0.4 2.1 1.7 19,710 23,255 3,545 1,621 2,035 4141999 -7.3 -6.3 1.0 13,769 16,674 2,905 1,109 1,429 320

Rebased national accountsboost GDP

Electricity tariffs will beincreased

20 Ecuador


2000 2.3 2.8 0.5 13,649 15,934 2,285 1,079 1,338 259

2001 5.6 5.1 -0.5 17,982 21,024 3,042 1,396 1,729 3332002d 3.6 3.3 -0.3 20,574 24,417 3,843 1,569 1,968 399

a "Old" indicates series based on the old National Accounts in sucres using 1975 as the base year. "New" indicates series based on the newNational Accounts in US$ using 2000 as the base year. b Applies the old national accounts series to the old population series based on the 1990population census. c Applies the new national accounts series and the new population series based on the 2002 population census. d EconomistIntelligence Unit forecasts.

Source: Banco Central del Ecuador.

According to the new Central Bank data, quarter-on-quarter growth slowed from3.2% in the second quarter to 0.9% in the third quarter of 2002. Year-on-yearfigures showed less of a slowdown, with growth of 3.5%, down from 3.9% in thesecond quarter. Full-year figures have yet to be published but official estimatesput growth at 3.3% in 2002. Gross fixed investment and governmentconsumption provided the main stimuli to growth in the third quarter. Grossfixed investment was up as result of increased spending on construction. Therise in government consumption is explained by an increase in current spendingowing to an increased wage bill. The recovery of goods and services exportscontinued thanks largely to high oil prices. Imports slowed sharply quarter onquarter, reflecting the end of the import phase of the project to build the heavycrude oil pipeline. Equally, it was this project that had caused the surge inimports in the second quarter.

Components of gross domestic product(% change, quarter on quarter)

2001 20023 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Private consumption 0.9 1.4 -0.1 2.7 0.5Government consumption 0.7 -1.0 4.9 1.5 4.5

Gross fixed investment 2.5 3.0 -0.9 3.3 4.5Exports of goods and services 1.6 5.4 -3.7 1.8 3.6

Imports of goods and services 4.2 2.5 -0.2 4.7 0.6GDP 1.3 -1.1 0.4 3.2 0.9

Source: Banco Central del Ecuador, Cuentas Trimestrales.

Growth slows in third quarter

Ecuador 21


Using the new national accounts, the Central Bank reports that construction wasthe fastest growing sector in the third quarter, reflecting continuing work on theoil pipeline, power interconnection projects with Colombia and Peru (seebelow), and an expansion of house building. The fishing sector, whichcontributes just 1-2% of GDP (although fish processing forms part of themanufacturing sector), contracted in the third quarter year on year. Thecontraction was caused in part by the changeover by tuna processing firms fromcans to pouches, in order to qualify for the zero tariff applied by the US.However, it also reflected the usual slowdown in fishing in the third quarter.Financial services were the second highest growing sector in the third quarter,but growth was constrained by the political uncertainty caused by thepresidential elections that took place during this period.

Gross domestic product growth by sector(% change, quarter on quarter)

2001 20023 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Agriculture 0.7 -0.4 4.4 1.3 0.7

Fishing 0.9 0.6 0.9 8.8 -5.1Mining & petroleum 1.6 -1.3 -2.8 3.8 1.0

Manufacturing 2.7 -28.6 22.0 13.4 -1.9Electricity, gas & water 2.1 0.7 0.5 2.3 0.6

Construction 1.7 2.5 2.1 2.2 7.2Retail 1.3 1.4 -1.4 3.3 -0.2Transport -1.5 4.7 -3.2 2.1 1.0

Financial services 7.2 -0.2 2.2 4.5 2.7Other non-government services 0.8 0.3 0.3 1.5 1.1

Government services 0.7 -1.6 0.9 1.1 -0.7GDP 1.3 -1.1 0.4 3.2 0.9

Source: Banco Central del Ecuador, Cuentas Trimestrales.

Employment, wages and prices

Consumer price inflation continued its downward trend in the last quarter of2002, ending the year at 9.4%. The non-tradeables sector recorded by far thehighest price inflation at 8.26% while tradeable goods prices rose by just 0.96% inthe year as a whole. Of the non-tradeables, rents, fuel and utilities contributedthe most to price inflation.

Consumer price inflation(% change)

2001 2002Monthly Annual Monthly Annual

Jan 7.0 78.7 1.8 16.5

Feb 2.9 67.2 1.1 14.4Mar 2.2 58.8 1.1 13.2Apr 1.7 46.5 1.5 13.0

May 0.2 39.6 0.5 13.4Jun 0.5 33.2 0.4 13.3

Jul 0.2 30.4 -0.1 12.9Aug 0.4 29.2 0.4 12.9Sep 2.0 27.2 0.6 11.3

Marked disinflation occurredin 2002

New data provides moredetailed GDP breakdown

22 Ecuador


Oct 1.2 25.3 0.6 10.7

Nov 1.6 24.6 0.7 9.7Dec 0.7 22.4 0.3 9.4

Source: Banco Central del Ecuador, Información Estadística Mensual.

The decline in the rate of inflation has slowed the rate of real exchange-rateappreciation. Revised data from the BCE reveal that the multilateral real effectiveexchange-rate index (REER) strengthened by 2.6% in the second quarter and 0.1%in the third, compared with 5.6% in the first quarter. However, in November, theREER depreciated for the first time in four months. This REER depreciation inpart reflected currency appreciation among some of Ecuador�s trading partners.The Colombian peso, for example, strengthened against the US dollar in Octoberand November from around Ps2,900:US$1 to below Ps2,700:US$1 (although ithas since weakened to about Ps2,950:US$1).

The nominal minimum wage of US$140 per month remained unchangedthroughout 2002. In real terms it rose by an average of 2.6% year on year. Thegovernment has set a nominal increase in the minimum wage of 8% for 2003,which is the same as expected inflation for the year. It remains far short of theestimated monthly cost of the basic basket of goods per household, which wasUS$353 in December 2002 according to the Instituto Nacional de Estadísticas yCensos (INEC, National Statistics and Census Institute). Employers arguedagainst such a massive rise, on the grounds that it would fuel a large increase incost-push inflation, which would erode purchasing power and probablyincrease unemployment. However, in addition to the 8% increase, the minimumwage will be supplemented by a disproportionate increase in one of the array ofbonus payments that workers are entitled to under minimum wage legislation.(November 2002, page 24). In 2002 Congress increased the so-called �14thsalary� payment to US$108 from just US$8. Consequently the average monthlysalary increase will be 12.7%, which is higher than the expected inflation rate.Workers earning above the minimum wage are not guaranteed an 8% increase,and will have to negotiate settlements with their employers privately. The 14thsalary payment applies across the board.

Real exchange-rate appreciationslows

Changes to the minimumwage are set to come into force

Ecuador 23


Agriculture

Agricultural output rose by 6.1% year on year in the third quarter of 2002.Output of some crops for domestic consumption declined in the face of foreigncompetition, but others increased. Export agriculture performed well. Cocoaexport earnings boomed thanks to the high international prices prevailingduring 2002, rising by 55.1% year on year. Banana output reportedly rose by 14%year on year as growers sought to take advantage of higher prices. Thepersistence of administered prices, however, acts as a disincentive to producers.The official price that exporters are supposed to pay to growers for an 18-kg boxof bananas was revised up and fixed at US$3.20 in December, a level lastreached in 1999.

According to the BCE, revenues from flower exports grew by 16.8% year on yearin the 11 months to November, despite the volcano eruption in early November(November 2002, page 24). Producers in the north of the country claim,however, that the volcano damaged the �summer flower� crop, which shouldhave been sold in the US and Europe over the Christmas period and onSt Valentine�s Day. These times of the year generally account for 35% of annualrevenue for flower exporters. The problem was exacerbated by the closure of theairport, which held up the transport of flower exports at Christmas. Flowerproducers from the southern highlands were unaffected by the volcano. Theyreport growing demand in the US and Europe and firm sales. The news isencouraging as the cut flower export industry, in view of the stiff competition itfaces from lower-cost producers in neighbouring Colombia, is considered to beone of the sectors of the economy most vulnerable to damage from thestrengthening real exchange rate.

Oil and gas

Crude oil production averaged 393,273 barrels/day in January-November 2002,representing a 3.8% fall year on year. Production from the state-owned oilcompany Petroecuador fell by 2.5%, while private production decreased by 5.4%.The fall in output was partly caused by an industrial dispute at the refinery inEsmeraldas and technical problems, which together caused the refinery to workat 85% of its capacity. Exports of crude oil fell by 7% year on year. However,despite the volume decrease, earnings rose by almost 2% thanks to highinternational oil prices, prompted by market uncertainty over the strike inVenezuela and the threat of US intervention in Iraq. The price of a barrel ofEcuadorian crude averaged US$21.42 in January-November, 12% higher than inthe same period in 2001.

Oil production and exports(Jan-Nov)

2001 2002 % changeProduction (b/d) Crude 408,727 393,273 -3.8 Derivatives 52,576 48,425 -7.9

Oil export earnings increasethanks to high prices

Agricultural output increasedin third quarter

Flower exports grow despitesetbacks

24 Ecuador


Exports ('000 barrels) Crude 83,193 77,396 -7.0 Derivatives 13,408 12,138 -9.5Exports (US$ m) Crude 1,622 1,669 2.9 Derivatives 168 193 14.9Memorandum items Average crude price ($/b) 19.12 21.42 12.0 Volume transported (b/d) 387,026 369,121 -4.6

Source: Petroecuador, Banco Central del Ecuador, Información Estadística Mensual.

In October, Chilean oil company Enap pledged to invest US$83m in Ecuador todrill and explore several oil wells in the Amazonian region of the country. Theobjective is to confirm 51m barrels of crude oil reserves, and extract them over aperiod of 15 years. The Chilean company will provide technology, capital andmachinery under a specific service contract with Petroproducción, a subdivisionof Petroecuador. Enap will assume full operational costs and administration ofthe fields located in the Ecuadorian Amazon, and should receive ascompensation of between 4,500b/d and 9,000b/d, or around 30-50% of totalexpected production in the fields.

Building work has been periodically interrupted in places, but the constructionof the Oleoducto de Crudos Pesados (OCP, heavy crude oil pipeline) isscheduled to be finished in March, with tests continuing until mid-year. In earlyJanuary, the OCP consortium announced that overall work on the pipeline was80% complete, with more than two-thirds of the pipeline construction workfinished. The first barrel of oil transported through the pipeline is expected to beexported sometime in August or September.

Financial and other services

The fourth quarter registered significant monthly variations in the behaviour ofbank deposits due to the uncertainty caused by the presidential elections. Afterincreasing by 1.8% year on year in September, total deposits declined in Octoberand November, especially demand deposits. However, by December, totaldeposits had increased by 16.8% compared with 2001 in nominal terms and by6.8% discounting inflation. Term and savings deposits grew at a faster rate yearon year, both in nominal and real terms, in December. Demand depositsclimbed by 20%, while term and savings grew by 15.2%. These rises reflect thearrival of the 13th salary payment at Christmas. As a result of efforts to clean upbanks� loan portfolios, total credit recorded a decrease relative to the level in theprevious year (see below). However, this reflected a sharp fall in the number ofnon-performing loans rather than a decline in lending overall. Credit, excludingnon-performing loans, grew quite strongly in 2002, principally as consumerstook advantage of low interest rates by historical standards. The average lendingrate in the 11 months to November was 14.2%.

Volatility in the fourth quarter

Chilean oil firm plans newinvestment

OCP construction schedule ison track

Ecuador 25


Bank deposits and lending(US$ m)

Nominal Real2001 2002 % change % change

DecTotal deposits 5,063 5,914 16.8 6.8 Demand deposits 1,690 2,028 20.0 9.7 Term & saving deposits 3,373 3,886 15.2 5.4

NovTotal credit 5,616 5,145 -8.4 -16.5 Performing loans 2,813 3,447 22.6 11.7 Non-performing loans 2,229 1,130 -49.3 -53.8

Source: Banco Central del Ecuador, Información Estadística Mensual

The banking superintendency�s Unidad de Reestructuración de Créditos (URC,the credit restructuring unit) together with a government-appointed advisor,Roberto Toso, completed a debt-restructuring project in December 2002. TheURC was established in February 2001 to restructure the debts of companiesand private individuals totalling US$50,000 or more in an effort to strengthenthe financial system. Of the US$1.46bn in loans assigned to the URC and MrToso (US$993m and US$464m respectively) to recover, only US$625m wererecovered after two years of negotiation.

The restructured bad loans are held by various banks, and the terms governingthem vary in each case. The average weighted interest rate of the restructuredloans held at public banks is 10.98% with an average maturity of 144 months. Forprivate financial institutions the terms are 14.93% and 66 months. Most of theloans had been made to agricultural producers, who had been severely affectedthe effects on the weather pattern caused by El Niño in 1997-98 and the 1999economic crisis. The highest concentration of loans declared unrecoverable arein the shrimp industry, which was decimated by El Niño and subsequently hitby disease.

The liquidation of Filanbanco, formerly the country�s largest bank, which wasplaced in state hands and closed down in July 2001, continues to be held up.Almost all the legal steps required before its assets can be liquidated have beentaken. However the process is yet to actually start because of a dispute betweenthe authorities and the board of creditors overseeing the completion of theliquidation process. They have not been able to agree on the selection of anagent to collect Filanbanco�s outstanding loans. The former president of theboard of creditors, Oscar Ayerve, is now an advisor to Mr Gutiérrez. This isexpected to speed up the liquidation process, but problems are still likely to beencountered. The US Embassy made a complaint alleging that an Ecuadorianaffiliate of a US firm had been discriminated against in the selection processbecause its application was discarded without due consideration. Mr Ayervesays that one of the reasons for the decision is that the company did notpurchase the bidding rights before the stipulated deadline. But other interestsappear to lie behind the protracted delay�including debtors who do not want tosee the process through and rent-seekers who are competing for lucrative feeincome on the collection of up to US$1bn in loans.

Outstanding agricultural debtsare restructured

Filanbanco liquidationdelayed

26 Ecuador


Infrastructure

The auction of a third mobile telecoms licence held by the Consejo Nacional deTelecomunicaciones (Conatel, National Telecommunications Council), whichhad been held up owing to legal opposition by existing mobile operator PortaCelular in November, went ahead in January. The envelope containing the offerof the third bidder, Andinatel, the state-owned telecoms firm covering themajority of the highland region, was opened on January 13th. It totalled US$31m,just above the minimum asking price of US$30.5m. The adjudication of thelicence has been delayed until late February.

The government launched the Agenda Nacional de Conectividad (NationalConnectivity Agenda) on December 26th. This aims to increase access totelecoms services, in particular the Internet, and has a range of projects toachieve this in addition to improving the dissemination of information by thegovernment over the web. To increase the number of Internet connections, itoffers a basic fixed tariff on telephone costs to connect to the Internet.

Colombia could become the second most important source of power for Ecuadorafter the Paute hydroelectric dam. A 212-km-long interconnection line between theColombian city of Pasto and Quito completed at the end of December 2002 willenable the transport of 1,500 gwh of electricity per year, equivalent to the outputprovided by a 200 mw power station. Ecuador has also signed a contract withColombia to allow electricity distributors from both countries to trade electricityfreely. The interconnection brings significant benefits, helping to prevent electricityrationing during periods of low rainfall. It will also help to reduce electricity costsin Ecuador by reducing the country�s dependence on more expensive and lessenvironmentally friendly thermoelectric plants during the dry seasons. Ecuador�sstate-owned electricity transmission company, Compañía Nacional deTransmisión Eléctrica (Transelectric), which invested US$30m in the project,expects to obtain an hourly saving of US$20,000 during the rainy season andbetween US$12,000 and US$16,000 in the dry season. This is the first project of itskind but Ecuador has agreed a similar one with Peru which should start up inMarch 2003. The three countries have different climate cycles which allowsdiversification of weather risks.

Foreign trade and payments

According to the Banco Central del Ecuador (BCE, The Central Bank) exportearnings, measured on a customs basis, rose by 4.4% in January-November 2002compared with the same period in 2001. Traditional export earnings as a wholegrew by 5.9% during this period, led by non-oil exports. Cocoa and bananas didparticularly well; prices in the international cocoa market reached historic highsdue to speculation and production shortages, while banana prices alsoincreased, albeit more modestly. Shrimp export earnings were lower year onyear as a result of lower world prices, but export volumes were up by 3.2% in2002, according to the national industry chamber, the Cámara Nacional deAcuacultura. Year-on-year growth in monthly export volumes, which was

Export earnings are upyear on year

Mobile licence auction goesahead

Internet project launched

Power interconnection projectwith Colombia complete

Ecuador 27


negative throughout the first half, turned positive in July. Canned fish and cutflowers led a very slight increase in non-traditional exports. Others, especiallyvehicles exports, which surged in 2001 as regional manufacturers tookadvantage of cheaper costs, suffered from the appreciating real exchange rate.

Merchandise exports(US$ m; fob; customs basis; Jan-Nov)

2001 2002 % changeTraditional exports 3,038.1 3,218.6 5.9 Oil 1,790.9 1,859.7 3.8 Crude 1,622.1 1,666.8 2.8 Products 168.8 192.9 14.3 Non-oil 1,247.2 1,358.9 9.0 Bananas 781.7 896.3 14.7 Shrimp 266.2 244.2 -8.3 Cocoa beans & products 79.6 110.3 38.6 Coffee beans & products 40.3 32.1 -20.3 Tuna & other fish 79.4 76.0 -4.3Non-traditional exports 1,299.2 1,311.0 0.9 Canned fish 241.6 316.2 30.9 Vehicles 98.2 29.2 -70.3 Metal manufactures 82.0 73.5 -10.4 Flowers 211.0 255.7 21.2 Textiles 21.6 18.5 -14.4 Chemicals 64.5 70.0 8.5 Leather, plastic & rubber

manufactures 62.0 62.8 1.3 Fruits juices & conserves 53.6 49.5 -7.6 Fishmeal 21.8 11.7 -46.3 Others 442.9 423.9 -4.3

Total exports 4,337.3 4,529.6 4.4

Source: Banco Central del Ecuador, Información Estadistica Mensual.

The import bill increased in the first 11 months of 2002, although at half the rateof 2001. A slowdown in real exchange-rate appreciation and the conclusion ofimports related to the construction of the Oleoducto de Crudos Pesados (OCP,heavy crude oil pipeline) are likely to have influenced this result. Consumergoods were the fastest growing group, reflecting an increase in bank lending tothe consumer. Intermediate and capital goods posted strong growth fuelled bydemand from the construction sector, especially the OCP. Monthly data onimports, however, show import growth slowing, with the import bill forNovember only 7% higher year on year.

Merchandise imports(US$ m; fob; customs basis; Jan-Nov)

2001 2002 % changeConsumer goods 1,203.1 1,546.1 28.5 Non-durables 648.2 832.7 28.5 Durables 554.9 713.4 28.6Intermediate goods 1,653.7 1,951.6 18.0 Agriculture 201.6 214.7 6.5 Industrial 1,305.7 1,438.1 10.1 Construction 146.4 298.8 104.1

Import bill rises

28 Ecuador


Capital goods 1,428.7 1,762.1 23.3 Agriculture 37.2 27.6 -25.8 Industrial 810.8 1,080.0 33.2 Transport equipment 580.7 654.5 12.7

Fuel & lubricants 242.5 217.7 -10.2Total imports 4,528.0 5,477.5 21.0


The trade deficit reached US$838m in the nine months to September 2002,compared with the small surplus recorded in the same period in 2001. This wasthe major factor leading to the widening in the current-account deficit. Incomefrom tourism rose modestly, although there are signs that higher prices arebeginning to deter some travellers. Outflows in the form of interest payments onexternal debt fell as international interest rates were lower. Remittances, whichhave played a major part in financing the boom in private consumption in2000-02, were slightly lower year on year, although they did pick up in the thirdquarter. Judging by local reports from Azuay province (the region with thehighest concentration of emigrants) the rate of emigration was little changed in2002 compared with the previous year, allowing the possibility that overallremittance inflows will continue to grow in 2003-04 despite tougher globalconditions. The deficit was comfortably financed by foreign direct investment,although this was lower than in the same period in 2001.

Balance of payments(US$ m; Jan-Sep)

2001 2002Merchandise exports 3,738 3,836Merchandise imports -3,737 -4,674

Trade balance 1 -838Tourism credits 321 335

Other 135 150Services & income credits 719 758Interest on external debt -610 -541

Tourism debits -253 -272Other -402 -411

Services & income debits -2,154 -2,148Services & income balance -1,435 -1,390Transfers balance 1,248 1,124

Current-account balance -186 -1,104Foreign direct investment (net) 1,028 908

Other investment -694 -159Capital-account balance 343 758Errors and omissions -335 449Financing 178 -103Change in reserves (- indicates

increase) 20 -101


Trade deficit widens in thirdquarter

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