Press Release No. 03/39

Press Release: IMF Approves US$205 Million Stand-By Arrangement for Ecuador

March 21, 2003

The Executive Board of the International Monetary Fund (IMF) today approved a 13-month SDR 151 million (about US$205 million) Stand-By Arrangement for Ecuador to support the country's economic and financial program through March 2004. The approval opens the way for the immediate release of SDR 30.2 million (about US$41 million).

In addition, the Executive Board approved the authorities' request to extend by one year the repayment expectations arising from a purchase under a Stand-By Arrangement approved on April 19, 2000. These repayments in an aggregate amount are equivalent to SDR 14 million (about US$19 million) and were expected to be made on August 30, 2003; November 30, 2003; and February 29, 2004. Purchases in the credit tranches are expected to be repaid in eight quarterly installments made within 2.25 and 4 years after the date of purchase. The extension granted by the Executive Board is allowed under the Fund's general policies governing repurchase expectations which authorize the Executive Board to extend repurchase expectations on request by a member with an insufficiently strong external position.

Following the Executive Board discussion, Horst Köhler, Managing Director, said:

"While the Ecuadoran economy had begun to recover following dollarization, policy slippages in 2002 led to a slowing of economic growth, continued payments arrears in the public sector, and rising concerns about the inconsistency of fiscal and wage policies with dollarization. In particular, rapid public sector wage increases undercut the fiscal position and contributed to the continued relatively high rate of inflation. In addition, structural reforms were suspended in key areas.

"The new administration has shown impressive leadership in dealing with a difficult economic situation. Immediately upon taking office, the new government acted to reverse the policy slippages in 2002 by implementing important decisive measures to boost revenues and control expenditures, balanced with social safety net support, and by announcing a broad program of economic reforms. These efforts aim at strengthening fiscal performance and boosting confidence and competitiveness, thus laying the basis for sustained improvement in the growth performance.

"Upfront fiscal measures are already helping to raise the public sector primary surplus and overcome the very difficult liquidity position in the Central Government that the authorities faced upon assuming office. It remains imperative to sustain the government's fiscal consolidation objectives, including through the customs reform that is already being advanced through Congress, and with the important reforms contemplated later this year in the civil service and the tax and revenue earmarking system. At the same time, greater attention should be paid to improving the living conditions of the poor, including by improving the targeting of the social safety net.

"The government has already acted to revive the reform agenda in other areas, including by unfreezing the tariffs of the public enterprises, and steps to deal with the lingering problem of the closed banks. The authorities are contemplating additional important initiatives to improve the functioning of the public enterprises in the electricity, telephone, and petroleum sectors. Directors strongly support these steps, because they can make a substantial contribution to lowering production costs in the economy.

"Recognizing the strong start made by the new government, the Fund anticipates continuing to work closely with the Ecuadoran authorities as they proceed with the implementation of their ambitious and comprehensive economic program," Mr. Köhler said.

ANNEX

Recent Economic Developments

Ecuador went through a difficult period in the 1990s, and per capita income stagnated. The 1998 oil price slump, damage from the El Niño weather phenomenon, and disease in the shrimp industry further complicated the situation. As a result, Ecuador experienced severe economic stress, culminating in accelerating inflation, which spilled over into a banking crisis, a deposit freeze, and the closure of some 18 banks, affecting half of total deposits and ended in a currency crisis.

The adoption of the U.S. dollar in January 2000 stabilized expectations, and economic activity began to turn around. Oil prices recovered, while imports surged due to a boom in domestic demand associated with the exchange rate-based stabilization. In 2001, demand was given further impetus by the start of the construction of a new private oil pipeline (Oleoducto de Crudos Pesados, OCP) and higher public sector spending.

However, economic growth slowed again to 3 percent of GDP in 2002 from 5.1 percent in 2001 due to policy slippages and faltering confidence. Fiscal discipline weakened with large increases in the wage bill, the granting of new revenue earmarking, and discretionary tax cuts. Inflation has dropped but remained still too high for a dollarized economy. Consumer price inflation came down from 91 percent at end-2000 to 9.4 percent by end-2002, but strong domestic demand (fiscal expansion), weak domestic supply (suspension of structural reforms), and wage-driven cost increases have prevented it from dropping to international levels. Wages have more than doubled since dollarization in early 2000 (led by the public sector), exceeding inflation over this period. The unemployment rate has dropped by half since 2000, to 8.5 percent at end-2002 recovering by end-2001 its pre-crisis level.

The external current account deficit widened to 5 percent of GDP in 2002 from 2.4 percent in 2001. While merchandise exports benefited from higher oil prices and continued growth of non-oil exports, imports grew rapidly on strong domestic demand, and an appreciating real effective exchange rate.

Program Summary

Within days of taking office on January 15, 2003, the new authorities started implementing a comprehensive and ambitious economic program. The program projects real GDP growth of 3.5 percent in 2003, and a decline in consumer price inflation to an end-of-period rate of 6-7 percent, after the initial adverse effect of the unfreezing of utility, fuels, and other prices. Assuming a cautious oil price of US$18 per barrel, the external current account deficit is projected at just over 5 percent of GDP in 2003.

The authorities' program has four building blocks: a package of immediate fiscal measures; fiscal structural reforms; liquidating closed banks and resolving other outstanding issues from the banking crisis; and reforms in the state enterprises.

The main objectives of the fiscal program are to address immediate liquidity constraints and to bring expenditure growth under control, consistent with the demands of dollarization. The government has already moved quickly to implement a package of revenue measures. Spending growth has been limited by a budgetary freeze on wages and other expenditure controls. According to the Fiscal Responsibility law approved in 2002, primary expenditures can grow annually to a maximum of 3.5 percent in real terms. The budget sent by the government and approved by congress in February is consistent with the primary expenditures fiscal rule. The social safety net has been strengthened to compensate the poor for the effects of some of the revenue measures.

In order to limit the growth in public sector spending and maintain revenue buoyancy, the authorities are planning a customs, civil service, and tax reform, thus laying a strong foundation for sustainable fiscal policies in the medium term.

The government has submitted to Congress a law to overhaul the customs administration and to bring it under the umbrella of the tax administration office (SRI).After passage of the customs law, the government will seek approval for a public sector wage unification and civil service reform law, which aims at achieving a lower nominal wage bill in 2004 through shrinking the size of government and reducing personnel. The wage unification aims at phasing in a broadening of the base for social security contributions and income taxes, akin to the reform in the private sector.

Finally, the authorities will seek the passage of a tax reform law to eliminate revenue earmarking not mandated in the constitution, and most tax exemptions, including special rules in the income tax system. The law would also cut some low-yielding taxes; increase fees for vehicles; and reduce the currently high standard deduction for income taxes .

The government also intends to reassess, with outside technical assistance, the operations of the social security system and the actuarial position of the general social security system (IESS) and the pension funds for the military and the police (ISSFA and ISSPOL).

While the private banking system has recovered well, the authorities plan to address some still unresolved issues, including the liquidation of Filanbanco, and the preparation for sale of Banco del Pacífico. The private banks and the authorities also have been discussing a strategy to replace the existing Liquidity Fund It is contemplated that the new Liquidity Fund would be administered by an independent private manager, who would keep most of the liquidity abroad.

Ecuador is an original member of the IMF. Its quota ¹ is SDR 302.3 million (about US$410 million); and its outstanding use of IMF credit currently totals SDR 226.7 million (about US$308 million).