Ecuador

Ecuador

Country Report Ecuador Ecuador at a glance: 2003-04 OVERVIEW The president-elect, Lucio Gutiérrez, will take office in January 2003. The minority of...

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Country Report

Ecuador Ecuador at a glance: 2003-04 OVERVIEW

The president-elect, Lucio Gutiérrez, will take office in January 2003. The minority of congressmen who support Mr Gutierrez are outnumbered by representatives of the largest party in the legislature, the PSC, which may go on the offensive against him. The Economist Intelligence Unit expects the next government to attempt to tighten fiscal policy in order to be able make debt repayments, and to initiate talks with the IMF on a stand-by agreement. Without rapid progress, Ecuador will probably fall behind on its external obligations. Pipeline construction and private consumption will drive modest growth 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 funded largely by foreign direct investment in the oil industry.

Key changes from last month Political outlook • Mr Gutiérrez won the second-round run-off election for the presidency on November 24th, and will take office on January 15th 2003. His overtures towards his opponents and the political centre, and the prospect of having to impose austere economic measures, run the risk of alienating his core supporters.

Economic policy outlook • The scale of overspending in 2002 has become more and more evident. Even though revenue came in above budgeted levels, the outgoing administration has resorted to an oil securitisation loan to balance its books for the year, damaging the fiscal outlook for 2003.

Economic forecast • Economic activity slowed during the election period. The failure to restore confidence by reaching an agreement with the IMF leaves Ecuador at risk of default, setting off a chain of events that could result in the abandonment of dollarisation.

December 2002 The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom

The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group. London The Economist Intelligence Unit 15 Regent St London SW1Y 4LR United Kingdom Tel: (44.20) 7830 1007 Fax: (44.20) 7830 1023 E-mail: [email protected]

New York The Economist Intelligence Unit The Economist Building 111 West 57th Street New York NY 10019, US Tel: (1.212) 554 0600 Fax: (1.212) 586 0248 E-mail: [email protected]

Hong Kong The Economist Intelligence Unit 60/F, Central Plaza 18 Harbour Road Wanchai Hong Kong Tel: (852) 2585 3888 Fax: (852) 2802 7638 E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2002 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN 0269-7165 Symbols for tables “n/a” means not available; “–” means not applicable Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK.

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Outlook for 2003-04 Political outlook Domestic politics

The November 24th presidential elections were won decisively by Lucio Gutiérrez. His emergence as president from a crowded field of contenders is the result of widespread voter disenchantment with established political leaders. A former army colonel, Mr Gutiérrez was one of the leaders of the militaryindigenous coup that ousted the then-president, Jamil Mahuad, in January 2000. He campaigned for the presidency with the support of a loose coalition of leftwing and groups and parties, of which the main components are the Movimiento Unidad Plurinacional Pachakútik (MUPP), which mostly represents the large indigenous population, the Partido Sociedad Patriótica 21 de Enero (PSP), a new party formed by Mr Gutiérrez and former army comrades on an anticorruption and nationalist platform, and the tiny Popular Democratic Movement (MPD). The MPD, which has roots in the extreme left, in recent years has changed into an interest-group-based political movement, with its main support in the teachers’ unions. The large traditional parties, which between them failed to propel a candidate into the second round of the presidential election, nevertheless retained their hold over Congress in October’s election. The pro-business, Guayaquil-based Partido Social Cristiano (PSC) will be the largest party in the legislature, controlling 26 of 100 seats in Congress. The party’s figurehead, León Febres Cordero, or more likely a trusted representative, will fill the powerful job of speaker of the house. If the PSC decides to oppose Mr Gutiérrez’s administration, perhaps in the hope of unseating him, it will make it very difficult for him to pass legislation. Mr Gutiérrez’s supporters will control no more than 20 votes in Congress and his choice of potential allies is limited. The centre-left Izquierda Democrática (ID) may wish to support him, but other powerful groups such as the populist Partido Roldosista Ecuatoriano would pose unacceptable conditions. Mr Gutiérrez will be under pressure from his supporters to deliver on his campaign promises to prioritise social investment and income redistribution at a time when a major fiscal adjustment will be required to avert default on external debt. Having campaigned on a left-wing platform until the second round, his efforts to move towards the political centre may alienate his supporters in the indigenous movement who oppose commitments with the IMF, membership of the Free-Trade Area of the Americas (FTAA), the US presence at the Manta airbase and strongly favour retaining costly subsidies on some important basic commodities and services, including cooking gas, gasoline and electricity. Thus far, there is little indication about the composition of new cabinet. The front-runners for the post of economy and finance minister are the Guayaquil banker and businessman, Mario Canessa, who has advised him during the campaign, and the chief executive of the Banco de Guayaquil, Guillermo Lasso. Widely regarded as honest, Mr Lasso served as Mr Mahuad’s first finance minister before resigning over policy disagreements. The indigenous leader, Nina Pacari, of Pachakútik, has been mentioned both as a potential foreign minister

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or interior minister. Pachakútik is lobbying for control of spending ministries such as social welfare, health, housing and education, causing some disagreements with the PSP, the other major partner in the coalition. International relations

The new government will bring slightly different priorities to foreign policy from its predecessor. It will lobby harder to secure the rights of Ecuadorean migrants abroad, many of whom are from indigenous ethnic groups, and it will seek to play a part diplomatically in monitoring and resolving the civil conflict in Colombia. Mr Gutiérrez intends to maintain good relations with the US and will not seek to renegotiate the treaty under which the US is using an air force base at Manta for regional antidrug operations. However, he will resist any attempt to broaden the uses of the base to include military assistance to Colombian forces fighting left-wing rebels.

Economic policy outlook Policy trends

Dollarisation commits the government to a very strict fiscal policy and will require numerous reforms to improve competitiveness if it is to work. Reckless spending in 2002 has strengthened doubts that the recent record of boom-andbust fiscal policy can be overcome. Structural economic reform to improve competitiveness faces formidable obstacles in the shape of local business and political interests that benefit from the status quo, as well as from left-wing politicians and unions. The Economist Intelligence Unit expects the incoming government to start talks with the IMF, albeit with some reluctance. Winning IMF support will be difficult. The president-elect, Lucio Gutiérrez, will be reluctant to impose structural adjustment measures aimed at long-term stability because these would raise the cost of living or cause job losses in the short term, but has warned that such measures may be necessary. The conditions attached to any future IMF programme are likely to include the lifting of subsidies on cooking gas, hikes in the cost of gasoline to deliver extra revenue and cuts to the public-sector payroll.

Fiscal policy

The fiscal outlook for the forecast period is very challenging. There is a serious lack of transparency in the public finances, given the level of corruption-related transactions, the extent of which can only be estimated. The outgoing government has admitted that there will be a deficit of around US$250m in 2002, but advisors to Mr Gutiérrez believe that it could be far higher. At the end of November the Economy and Finance Ministry ordered Petroléos del Ecuador (Petroecuador, the state-owned oil company) to forward sell around 22% of its crude and fuel oil production for the next two years with the aim of raising US$245m in down payments from international oil trading companies. The resources would be transferred by Petroecuador to the central government, which will pay interest on the down payments at the London interbank offered rate, plus a premium of 350 basis points (bps) on crude oil and 25 bps on fuel oil. That the ministry is mortgaging future oil revenue to meet current spending commitments in a year of high oil prices and above-budget tax and customs revenues underscores the depth of fiscal mismanagement in the past year.

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The oil-backed facility will reduce the amount of oil revenue available to the government in 2003, while cuts in import tariffs on materials used by exporters will also have a negative impact. Mr Gutiérrez’s advisors have requested that the budget for 2003 (January-December) be based on an oil price of US$18/barrel. Mr Gutiérrez has indicated that he is reluctant to introduce a package of harsh fiscal adjustment measures unless a scheme is in place to protect the poor from the impact of subsidy cuts; such a scheme would take time to implement, but may be unavoidable. The budget for 2003 must be presented to Congress by January 31st. Mr Gutiérrez is going to face conflicting pressures from his supporters, who want more funding for social projects, and the need for fiscal austerity to make debt payments. By mid-December Mr Gutiérrez will be expected to begin to name his cabinet team, giving some idea of which priorities will predominate. Monetary policy

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

Economic forecast International assumptions

International assumptions summary (% unless otherwise indicated) Real GDP growth World US EU Exchange rates ¥:US$ US$:€ SDR:US$ Financial indicators ¥ 2-month private bill rate US$ 3-month commercial paper rate Commodity prices Oil (Brent; US$/b) Gold (US$/troy oz) Food, feedstuffs & beverages (% change in US$ terms) Industrial raw materials (% change in US$ terms)

2001

2002

2003

2004

2.0 0.3 1.4

2.7 2.3 0.9

3.3 2.3 1.6

3.9 3.3 2.2

121.5 0.896 0.785

125.5 0.948 0.771

128.8 1.070 0.737

130.5 1.053 0.744

0.17 3.61

0.10 1.68

0.10 1.26

0.35 3.08

24.5 271.1

24.9 308.0

24.5 307.5

19.1 290.0

-1.9 -9.8

15.4 0.2

14.5 6.1

0.2 9.7

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

The Economist Intelligence Unit expects the US economy, which accounts for around 38% of Ecuador’s goods and services exports, to grow by 2.3% in 2003 and by 3.3% in 2004, but the US is at risk of a renewed slowdown or recession if

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the recent downward trend there in domestic consumer confidence is sustained. Spare capacity and heavy debts will limit corporate investment. In view of the fragility of the US recovery, the US Federal Reserve Board (the US central bank) will keep interest rates low. As more than one-half of Ecuador’s debt stock is contracted at variable interest rates, lower US rates will help to reduce the country’s debt-servicing costs. Growth in the Andean regional economy, the importance of which as an export market has risen, will be weak. Uncertainty surrounding the consequences of US military action against Iraq will keep oil prices firm into 2003, but oil prices will ease in the second half and fall further in 2004. Ecuador is highly vulnerable to a sudden drop in oil prices. Economic growth

We expect growth, estimated at 3.3% in 2002, to slow in 2003, owing to a tight fiscal situation, policy uncertainty and possible political unrest. Demand has been boosted by strong wage increases in the public sector and rapid growth in government consumption, both of which are unsustainable. Domestic investment is unlikely to recover until the new government clarifies its economic policy direction. The IMF will be reluctant to lend to Ecuador in order to help it service its commercial debt, especially given the degree of fiscal mismanagement in 2002 but it appears that multilateral funding will be increasingly necessary to shore up business confidence. We forecast only modest growth in the oil sector in 2003, despite the opening of the new oil pipeline in the fourth quarter, with the first sizeable expansion in output coming in 2004. Petroecuador has already announced that its own production will remain broadly unchanged in 2003. The company’s investment budget, determined by the government, has proved highly vulnerable in the past to cuts in overall state expenditure. Private oil companies’ appetite for investment continues to be dampened by a tax dispute with the government. In the other main sector, agriculture, most of the major exports face sector-specific problems. Manufacturing will face increasing pressure from the appreciation of the real exchange rate. The strong exchange rate will weigh heavily on the growth prospects of the non-oil sector in 2003-04.

Inflation

Monthly increases in consumer prices have slowed sharply since the second quarter of 2002, and the 12-month rate is on a downward trend. Inflation is nevertheless expected to be around 10% by year-end, well above the annual rate of inflation in the US, estimated at 1.5%. Inflationary pressures will persist in 2003-04 if the tariffs charged for telecommunications and electricity services by state-owned utilities are raised and as subsidies are lifted on cooking gas, although this prospect is not a certainty. The cost of non-tradeable goods and services, prices for which plummeted during the 1999 crisis, will continue to rise above the average rate owing to inertia, and increases in the cost of domestically produced tradeable goods will damage the competitiveness of the productive sector relative to imports.

Exchange rates

Although dollarisation has brought economic stability, inflation has rapidly eroded the competitiveness of exports and perhaps more markedly, that of industries competing against imported goods. Ecuador is at risk of falling prey to “Dutch disease” if booming inflows from oil exports distort prices upwards in the non-oil sector. The real exchange rate is already at historically high levels and

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cannot be brought down without a period of painful deflation or by abandoning the dollar. Disinflation will reduce the pace of real exchange-rate appreciation against the currencies of Ecuador’s developed country trading partners in 200304, but if regional currencies weaken against the US dollar, Ecuador will lose further competitiveness even if it succeeds in lowering inflation. External sector

Export earnings will show little dynamism in the forecast period. Oil export volumes will increase once the new heavy crude oil pipeline is operational in the fourth quarter of 2003, but growth in oil output will not be as great as formerly hoped owing to a lack of investment by both private oil companies and Petroecuador. We also expect oil prices to fall in 2003-04, diminishing the benefits from higher export volumes. Demand for imported consumer goods and capital goods imports for the oil pipeline has slowed significantly after a phase of rapid growth, but we expect trade deficits to persist in the medium term. The current-account will remain in deficit owing to a structural deficit on the income account caused by higher repatriations of earnings by foreign investors and debt interest payments. Remittances sent home by Ecuadoreans working abroad have become the most reliable source of external inflows. Having grown rapidly in recent years, they levelled off in 2002 and are not forecast to grow significantly in 2003-04. Forecast summary (% unless otherwise indicated) Real GDP growth Industrial production growth Gross agricultural production growth Unemployment rate (av) Consumer price inflation (av) Consumer price inflation (year-end) Short-term interbank rate NFPS balance (% of GDP) Exports of goods fob (US$ bn) Imports of goods fob (US$ bn) Current-account balance (US$ bn) Current-account balance (% of GDP) External debt (year-end; US$ bn) Exchange rate Su:US$ (av)d Exchange rate Su:¥100 (av)d Exchange rate Su:€ (year-end) Exchange rate Su:SDR (year-end)

2001 a 5.6 4.9 4.5 8.1 37.7 22.4 15.5 0.7 4.9 5.3 -0.7 -3.7 13.6 b 25,000.0 20,571.1 22,032.5 31,418.2

2002 b 3.3 1.6 2.5 8.5 12.5 9.6 15.0 -1.8 4.9 6.1 -1.6 -7.8 14.2 25,000.0 19,920.3 25,750.0 33,550.8

2003 c 2.2 4.1 3.0 9.5 7.7 6.8 13.8 0.6 5.1 6.1 -1.5 -6.5 14.5 25,000.0 19,417.5 26,625.0 33,770.3

2004 c 3.5 6.9 2.5 9.5 4.3 3.5 14.1 1.9 4.9 5.9 -1.5 -6.0 14.7 25,000.0 19,157.1 26,125.0 33,518.7

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Annual

average free rate.

Editors: Charles Seville (editor); Justine Thody (consulting editor) Editorial closing date: December 5th 2002 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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