IMF Executive Board Concludes 2015 Article IV Consultation with Ecuador

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The FINANCIAL — On September 25, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Ecuador.

Supported by positive terms of trade and large public investments, growth averaged 4.5 percent over the past decade, while social indicators improved. Reflecting Ecuador’s goals of diversifying energy production and improving infrastructure and social equality, the overall fiscal position of the non-financial public sector (NFPS) deteriorated from balance in 2011 to a deficit of 3.5 percent of GDP in 2012–14, mainly driven by high capital spending. The poverty rate and the GINI coefficient fell, respectively, from 38 percent and 0.54 in 2006 to 22.5 percent and 0.47 in 2014, while the unemployment rate declined significantly. Financial stability was preserved, supported by dollarization. In 2014, growth moderated to 3.8 percent in line with developments in the region, according to IMF.

Since the fourth quarter of 2014, the economy has been hit by external shocks and is slowing down. The sharp decline in the international oil price, by about half for the Ecuadorian mix, significantly undercut oil revenues. In addition, competitiveness is being eroded by the real appreciation of the exchange rate—by 16 percent year-over-year through June 2015.

The authorities responded rapidly to the shocks by cutting public spending, introducing balance of payment safeguards, and containing minimum wage growth. As a result, non-oil imports have been declining significantly from April 2015, and the 2015 fiscal deficit is expected to be contained to the original budget target. Nonetheless gross financing needs remain large, and international access to credit has tightened.

In the face of the economic slowdown, bank liquidity conditions have tightened, credit growth has slowed, and non-performing loans have risen (albeit from a low level). Despite the slowdown, inflation is picking up, reflecting changes in transport tariffs as well as in food prices and utilities.

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Due to the shocks and expected adjustment, the economy is projected to contract somewhat in 2015, while the external position deteriorates. Growth prospects are also revised down going forward, due to the need to restore competitiveness, and in light of the effect of lower oil prices on investment and production. Risks to the outlook relate mainly to availability of external financing, additional softness in oil prices, persistent dollar appreciation, potential domestic financial system pressure, and natural disasters.

Executive Board Assessment

Executive Directors welcomed the resumption of successful on-site Article IV consultation discussions with Ecuador, and looked forward to enhanced collaboration. They commended the impressive results in economic and social indicators over the past decade. They noted, however, that as an economy that is heavily dependent on oil revenues and is fully dollarized, Ecuador has recently been hit by sharply declining commodity prices and real exchange rate appreciation. The outlook is further clouded by a possible tightening of external financing conditions and the country’s exposure to natural disasters. Directors welcomed the authorities’ response to these shocks so far and encouraged further efforts to build policy buffers, preserve financial stability, and strengthen competitiveness.

Directors commended the authorities for their significant adjustment efforts to contain the fiscal deficit, and encouraged them to develop a contingency plan ensuring that any shortfalls in financing are addressed through further cuts in non-priority expenditure, while avoiding short-term financing from the central bank. They also called for the removal of distortionary import surcharges as soon as possible and within the announced timeframe. Directors stressed the importance of rebuilding fiscal buffers over time and recommended the authorities to sustain efforts to rationalize expenditure, contain public sector wage growth, continue the plan to overhaul fuel subsidies while protecting the poor, improve tax collection, and continue the reform process of the pension system.

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Directors agreed that near-term challenges will also center on securing adequate liquidity in the financial sector, and improving regulation and supervision. While financial stability indicators do not show signs of stress, possible lags in responses and the continuing economic slowdown warrant close monitoring. Directors encouraged the authorities to improve the clarity of regulations, strengthen crisis management and supervision, and verify the resolution framework with a view to maintaining confidence and ensuring a rapid response to shocks. If pressures persist, relaxing banks’ reserve requirements should be considered. Regulatory restrictions on bank activities—especially interest rate caps, penalties on investing abroad, and domestic liquidity requirements—should be progressively lifted, credibility in the system of electronic money should be ensured, and directed lending should be discontinued. Directors also encouraged the authorities to strengthen the AML/CFT framework, and undertake a new financial sector assessment (FSAP) in light of significant changes to the financial landscape since the last assessment.

Directors underscored that improving competitiveness is key to safeguard the external balance and sustain medium-term growth. They welcomed reforms and investment in infrastructure, education, and private sector development, but also stressed the importance of efforts to contain wage growth and address labor market rigidities. More broadly, Directors supported reforms aimed at improving productivity, crowding-in the private sector, attracting foreign direct investment, diversifying the economy, and promoting trade integration.

 

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