Quito, Ecuador
Agosto 10, 2000
Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431
Dear Mr. Köhler:
1. Attached is a supplement
to the memorandum
of economic policies of the Government of Ecuador for 2000, dated April 4, 2000.
It describes recent developments under the economic program, including key
policy adjustments to alleviate some of the social costs of the economic
crisis, and to keep the program on track. Also attached is a supplement
to the technical memorandum of understanding which
lists the policy actions to be taken prior to consideration by the Executive
Board of the Fund of the first review of the Stand-By Arrangement.
2. As described in the supplement, the review process has been delayed
due to ministerial changes in the government. We therefore request that the
schedule of purchases under the Stand-By Arrangement be rephased, and that the
third purchase, initially scheduled for end-August, be eliminated together with
its corresponding review, and that the amount of this purchase be divided
equally into the three remaining purchases (which will all remain subject to
the completion of a review).
3. The Government of Ecuador request waivers for the non-observance of
the performance criteria for central government non-interest payments arrears
for end-April, and for the increase in cooking gas prices in July. Furthermore,
the Government of Ecuador requests that the end-August indicative target for
the floor on the “excess” freely
disposable international reserves of the central bank be converted to a
performance criterion.
4. The Government of
Ecuador reaffirms its commitment to maintain close relations with the Fund and
consult on the adoption of policy measures that may be needed during the period
of the program.
Sincerely yours,
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Luis G. Iturralde M.
Minister of Economy and Finance |
José Luis Ycaza
President of the Board of the Central Bank of Ecuador |
I. Background
1. The economic program that the administration of President Noboa put
in place in March this year, and which is supported by a Stand-By Arrangement
from the Fund, has already made good progress in stabilizing financial
conditions and laying the basis for economic recovery. This memorandum
describes recent developments under the program, including key policy
adjustments to alleviate some of the social costs of the economic crisis, adapt
to recent developments and keep the program on track. Except as modified in
this memorandum, the objectives, policies, targets, and commitments of the
economic reform program remain as described in the original memorandum of
economic policies dated April 4, 2000.
II. Recent Developments
2. Macroeconomic developments under the program generally were as
expected or better.
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Economic activity in the first
half of 2000 appears to have held up better than expected. Real GDP fell
by about 1½ percent (year-on-year) in the first quarter; investment fell
sharply, but the decline in consumption appears to have bottomed out.
Manufacturing sales increased slightly in the first five months of the year;
unemployment has declined marginally; and business confidence indicators have improved.
However, inflation is running at a much higher rate than projected, as prices
have adjusted more rapidly to the earlier depreciation of the sucre.
-
The fiscal position is stronger
than projected. The NFPS was broadly in balance in the first four months of the
year, against an expected deficit of 2.4 percent of revised GDP in the program.
Revenues exceeded program estimates by the equivalent of 1.2 percent of
GDP, owing mainly to stronger oil prices (US$23 a barrel in the first half of
the year compared to US$20 a barrel assumed in the program) and more buoyant
tax revenues. Expenditures were below program by 1.1 of GDP, mainly reflecting
shortfalls in investment spending that we expect to be reversed in the second
half of the year.
-
The banking system is more liquid
than anticipated. The unfreezing of US$1.2 billion of time deposits in
open banks, which began on March 13, proceeded faster than expected as
many banks converted to cash the bank bonds that were issued in lieu of frozen
deposits. About US$560 million of frozen deposits were paid out in cash in
the period March–June, but the deposit base of the banking system increased by
about the same amount, suggesting that most of the time deposits unfrozen have
remained in the banking system. However, banks’ external credit lines fell by a
further US$38 million in May (to US$774 million), bringing the
cumulative decline this year to about US$200 million; credit to the
private sector remains flat; and banks’ nonperforming loan ratio reached
47 percent in June.
-
The dollarization of the economy
is proceeding rapidly. Central bank sucre liabilities that are legally required
to be fully backed by free disposable reserves (FDIR) have fallen sharply,
reflecting maturing central bank sucre-denominated bonds and a decline in sucre
currency in circulation. “Excess” FDIR (i.e., above the amount needed for the
required backing of sucre liabilities and bankers’ deposits at the central
bank) increased to US$256 million by end-April (adjusted for the
accumulation of external arrears and shortfalls in program disbursements),
US$90 million above the program target, and further to US$334 million
by end-May.
-
Program performance criteria. The
quantitative performance criteria for April were met with the exception of that
for domestic non-interest payments arrears. Data on the end-June quantitative
performance criteria will be supplied to the Fund prior to consideration of the
first review by the Executive Board.
3. Several policy measures have been implemented:
-
A package of fiscal revenue and
expenditure measures was introduced on May 25. This included: (i)
increases in the prices of diesel and gasoline of 66–92 percent, and in
other fuels of between 90–333 percent; (ii) elimination of the import
tariff surcharge on electric appliances, parts and accessories, agricultural
machinery, and second-hand engines (no reduction was assumed in the program);
(iii) increases in public sector pay that averaged about 60 percent
(in addition to a 10 percent public sector wage increase granted in April,
the program had provided for further increases of 20 percent each in
July and October); (iv) an increase in the monthly cash transfer to the poor
(the bono solidario) of 75 percent (the program had provided for
50 percent); (v) increased spending on rural housing, pensions, child
health and education programs, and infrastructure; and (vi) increases in
electricity tariffs of up to 50 percent with monthly adjustments
thereafter.
-
Steps have been taken to keep the
banking strategy on track. In June, the Junta Bancaria approved resolutions
that: (i) establish a mainly voluntary scheme to restructure large viable debts
to banks of households and corporations, with incentives for creditor and
debtor participation; (ii) solve the main problems detected in the creation of
the bank liquidity support fund; (iii) establish loan classification and
provisioning rules according to international standards; and (iv) strengthen
“fit and proper” requirements and internal control procedures of banks. In
addition, the Junta Bancaria approved a strengthening plan for the
superintendency of banks, and rules for access to the central bank’s liquidity
recycling facility have been clarified to ensure the participation of banks
whose capital adequacy ratio falls below the regulatory minimum provided they
have an agreed capital strengthening program with the central bank.
-
Discussions with external
creditors also have moved forward, although more slowly than originally hoped.
A meeting was held with private creditors on May 16 to discuss Ecuador’s
adjustment program and medium-term economic prospects to lay the basis for a
debt exchange offer in late July. Negotiations to normalize relations with
Paris Club creditors were held on May 18–19, and it is the government’s
intention to conclude the negotiations at a second meeting in early September.
III. The Government’s Macroeconomic Program
for 2000
4. The key objectives of the program and broad strategy set out in the
original memorandum of economic policies remain unchanged.
5. The macroeconomic framework of the program has been revised slightly,
as indicated in Box 1 below. The revisions take into account indications that
the economic activity appears to be holding up better than expected, inflation
will be higher than programmed, and oil exports are likely to perform better
than projected, increasing the external current account surplus.
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IV. Fiscal Policy and Social Safety Net
6. The combined fiscal deficit target (in U.S. dollar terms) of the
program remains unchanged. However, the composition between the targets for the
nonfinancial public sector (NFPS) and the quasi-fiscal balance of the central
bank have been revised slightly to take account of a negotiated reduction in
the interest rate (from 12 percent to 6 percent) on most of the
central bank’s portfolio of government bonds (resulting in lower interest
payments and a smaller deficit of the NFPS, and a corresponding reduction in
the quasi-fiscal surplus of the central bank). In relation to GDP, the targeted
fiscal adjustment in 2000 is now larger because nominal GDP for 2000
has been revised upwards mainly to reflect the higher inflation and consequent
different real exchange rate path. The combined fiscal deficit would decline
from 7.2 percent of GDP in 1999 to 2.7 percent of (revised) GDP
in 2000, consistent with a reduction in the NFPS deficit over the period
from 6 percent of GDP to 2.8 percent (Box 2). In spite of the increases
granted in May, public sector wages would still fall sharply in real terms this
year, and by 0.9 percentage points of GDP (to 6.3 percent)
from 1999.
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7. In terms of expenditure priorities, the most important objective of
the government is to ensure that the adverse impact of the adjustment program
on the most vulnerable groups is minimized. Efforts are underway to improve the
targeting and efficiency of existing social spending programs, as well as
developing approaches to poverty alleviation in the context of a structural
adjustment loan from the World Bank. The government intends to maintain
spending on social programs this year broadly equal to the level of 1999
in real terms. Priority also is being given to making up the shortfall in the
public investment program to provide support for economic activity and poverty
alleviation (in particular where projects are labor-intensive and/or provide
access to vital services), and ensuring that long-term development objectives
are not compromised.
8. For the remainder of this year, fiscal revenues will be safeguarded
through four measures: (i) there will be no further reductions in import
tariffs, including the temporary import tariff surcharge in 2000 unless
compensating revenue measures are introduced; (ii) certificates of frozen
deposits will remain ineligible for the payment of taxes and import duties;
they also will be ineligible for payment in any financial institution, public
or private, other than the issuer of the certificate, except at market prices;
(iii) electricity tariffs are being moved to levels that will permit the full
clearance of arrears to the public sector by electricity distribution
companies, and to allow them to remain current on payments to the state-owned
generating companies; and (iv) the elimination of the financial transactions
tax, which is envisaged in the Ley para la Promoción de la Inversión y la
Participación Ciudadana (Ley Trole II) submitted to congress in mid-July, will
be delayed until end-2000 when the associated loss of tax revenue will be
compensated by measures to be included in the forthcoming tax reform (see
below). The government has already sent a letter to congress proposing this
revised timetable.
9. The government brought forward to May many of the increases in fuel
prices planned for July and October, and in some cases increased prices of
fuels to levels higher than had been envisaged to pay for needed social
spending and increases in public sector wages. To alleviate the social impact
of the fuel price increases, the government delayed raising the price of
cooking gas, which is important in the household budget of the urban poor. The
Government of Ecuador requests a waiver for the non-observance of the
performance criteria on the increase in cooking gas prices July. The timetable
for further increases in domestic fuel prices, and for the increase in cooking
gas prices originally programmed for July, will be determined at the time of
the second review under the Stand-By Arrangement.
10. The second review under the Stand-By Arrangement also will: (i) set
the performance criteria for end-October 2000; and (ii) reconsider the
fiscal program to determine how much of any higher than programmed fiscal
revenues will go into additional spending on social programs, and how much into
deficit and debt reduction, the balance depending in part on the financing
assurances for the program. The government will continue to keep fiscal
developments under constant surveillance, and will take any additional steps
that may be needed, including further increases in domestic fuel prices, to
meet the fiscal objectives of the program.
11. In September 2000, the government will submit to the congress a
proposal for a comprehensive tax reform aimed at increasing revenues from the
tax system to help achieve fiscal sustainability while reducing fiscal dependence
on oil revenues and distortions from taxation. The main elements of the reform
will be as described in the original memorandum of understanding.
V. Monetary Policy and Financial Sector Restructuring
12. The government believes that market imperfections in Ecuador’s
financial system require the continuation of some form of usury ceiling on
interest rates, although it recognizes that the ceiling needs to be implemented
in a manner that does not interfere with financial intermediation (in particular,
that higher risk customers do not lose access to the formal financial markets).
To give greater transparency to the setting of the ceiling and to reflect the
latest market developments, the government has included in the Ley Trole II an
amendment to the calculation of the usury rate, setting it at 1.5 times
the central bank’s active reference rate on new commercial bank loans. The
central bank also will apply the usury ceiling in a flexible manner, when
needed, to counter stresses in the banking system.
13. To further safeguard efficient financial intermediation, the Junta
Bancaria will reduce the provisioning that commercial banks are required to
make on corporate and consumer loans that carry interest rates above
18 percent and 23 percent, respectively.1
In any event, the special provisioning requirements are set to expire in
March 2001. A time table for removing the restrictions on the fees that
can be charged by financial institutions in lieu of interest payments will be
established at the time of the second review of the program.
14. The government has made substantial progress in implementing
policies to support the strategy to restructure and strengthen the financial
system. A particularly important measure is the scheme approved by the Junta
Bancaria last June to restructure the large debts of households and
corporations. The scheme aims at facilitating economic recovery by easing the
liquidity positions of firms and households, while improving banks’ asset
quality. Incentives to encourage creditor participation include: (i) a flexible
classification system for restructured loans is to be applied to loans entering
the scheme to encourage banks to recognize implicit losses; and (ii) the
failure to restructure a nonperforming loan within the timeframe provided by
the scheme will result in the loan being reclassified as a “loss” with a
100 percent provisioning requirement. To encourage debtor participation, debtors
who continue in arrears for more than 90 days after the deadline for
restructuring would be subject to special foreclosure procedures (the
“coactiva”) To facilitate these procedures, the Executive Board of the
Corporación Financiera Nacional (CFN) will approve a resolution establishing a
system for applying the “coactiva” to the nonperforming credits of private
banks. In conjunction with the multilateral institutions, the government is
developing mechanisms to monitor closely the implementation of the household
and corporate debt restructuring scheme to ensure that it meets its objectives.
15. To provide incentives for the recapitalization of banks from private
sources, an amendment to the financial institutions law was included in the Ley
Trole II that will allow shareholders to retain ownership and control of a bank
if its capital adequacy ratio falls below the regulatory minimum of
9 percent, but remains above 1.8 percent, provided a capital
strengthening program had been agreed with the superintendency of banks. The
superintendent of banks also will grant access, when needed, to such banks to
the central bank’s liquidity recycling facility.
VI. Financing of the Program
16. Reassessing the prospects for net external financing (including
recent disbursements of program loans from the World Bank and the IDB), the
external financing gap for 2000 is estimated at US$1.4 billion
(9.8 percent of revised program GDP). The government intends to meet this
gap by means of exceptional support from the official international community
and an orderly resolution with private external creditors to achieve a more
sustainable debt and debt-service position.
17. The authorities have requested a meeting with Paris Club creditors
in early September with a view to reaching agreement on the rescheduling of
arrears and debt service obligations. The basis for the discussions with
creditors will be the assumed financing needs of the government’s fiscal
program supported by the Stand-By Arrangement with the Fund. In addition, the government
intends to go to the market with a debt exchange offer in late July 2000
aimed at normalizing relations with external private creditors. The government
will consult with the Paris Club and the Fund in advance of making this offer,
with a view to ensuring that the offer is consistent with program financing,
and the goal of restoring medium-term fiscal and external sustainability.
18. In June the government entered into negotiations with a foreign bank
with a view to normalizing arrears of about US$218 million on external
credit lines of intervened banks. In addition, meetings have been arranged with
foreign creditor banks in July to seek the maintenance of their exposure under
interbank and trade-related credit lines.
VII. Other Structural Policies
19. In the Ley para la Promoción de la Inversión y la Participación
Ciudadana the government intends to further advance the structural reform
process begun in the Ley de Transformación Económica approved by the congress
last March. The new law will expand the scope of private sector activity,
permitting the privatization of public utilities, the state airline TAME,
roads, seaports and airports, postal services, and the extraction of
nonrenewable natural resources. The regulatory frameworks for the petroleum,
mining, electricity, and telecommunications sectors also are to be reformed in
order to facilitate privatization and/or joint ventures. Measures also are
included to further increase labor market flexibility, including longer
probation periods for workers, use of part-time labor, and greater functional
mobility for workers within firms.
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