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Petroecuador, here represente by worlers at the La Libertad refinery, should be at least partially privatized, Analytica argues. (Photo: Petroecuador).
Wednesday, December 2, 2015

Ecuador: How to Fix the Economy

A blueprint for fixing the economy as Ecuador prepares for a future without Correa.


Credible media reports say that president Rafael Correa, conscious of the depth of the recession, would prefer not to have to deal with it under his leadership – hence his announcement not to run in 2017. So do some of his neighbors in Quito. Bolivian president Evo Morales, reflecting the Boliviarian presidents’ nonchalant way of commenting on each other’s affairs, said Correa will leave to improve ties with his family, above all his Belgian wife, Anne Malherbe, citing a private telephone call. What Correa’s successor – be he former vice president Lenín Moreno or an opposition politician like former banker Guillermo Lasso, who has already announced his candidacy – the ways out of the crisis can, to some extent, already be sketched. Whatever the reforms, they will hurt.

Even with the budget falling 17 percent next year to just shy of $30 billion, only about half of this amount will be covered with generously high estimated tax returns. Correa appears to seek to ensure the loyalty of the bureaucracy at least through next year by including a greater-than-inflation rise in spending on civil servants’ salaries. In the face of this, perhaps to an even greater extent than in the situation faced by Argentine president-elect Mauricio Macri, the first challenge will be to identify the true level of debt, including “pre-sold” oil to Chinese and Thai companies and other transactions the administration refuses to book as loans. To be fair, at least Ecuador has fixed its ties with financial markets, unlike Argentina. But much greater transparency is required to significantly reduce Ecuador’s country risk, the difference in interest investors charge between the price of US Treasury’s and Ecuadorian bonds to account for the risk of a default and which has surged to some 15 percent amid the fall in the price of oil. Once debt has been reviewed, i.e. audited, restructuring may be required to reduce the load of bilateral repayments by stretching them, according to the most negative scenarios of some private-sector economists. Future financial officials will have to tread a careful line between pursuing fair deals in and retaining the market’s trust. At least foreign commercial debt following the scheduled payment of the $650 million bond maturing in December won’t require another payment on principal until 2020. In any case, much like in the case of Argentina, a definite withdrawal of Correa from the 2017 campaign would be one measure for country risk to recover on the outlook of more orthodox economic policy. A new government will also have to review debt issuance procedures in general.

Another required step to clean up finances will be privatizations. Even before Correa, Ecuador’s state had accumulated numerous assets that, to a significant extent, have failed to be used properly and should be sold off. Under Correa, these have grown; the number of cabinet-level positions have nearly tripled to around 40. Real estate owned by the government, both urban and rural, should finally, and transparently, be sold, and leases be cancelled as new leadership cuts back bloated bureaucracy to the traditional 12-14 ministries, eliminating useless offices like the “secretariat for good living” and the “coordinating ministries,” including one for “political coordination” with legislators. At least 38,000, public-sector vehicles (a similar number as those of Japan) need to be sold off, and any president who sells the two new presidential planes will make a popular show of austerity. Whole industries continue mostly or largely in the hands of the state, including electricity, oil, and transport (aviation and highways) that could be put into more efficient, private hands, reducing their weight on the budget, with the state retaining oversight. Petroecuador and Petroamazonas should be at least partially privatized, beyond the minimal pledge made so far to sell off some gas stations. Hopefully, white elephants like several airports and the “Yachay” and “Ikiam” universities, among others, could be sold too. So should the confiscated parts of government’s media empire, which include two free-to air broadcasters. Unfortunately, the weak economy means that prices for these assets will fetch less than had they been sold in a more timely fashion. Hopefully, proceeds from the sale of assets will go to provide the basis for a state savings and investment fund, derided by Correa, but supported by many private-sector economists.

Public-sector staffing in general would have to be reviewed, excluding only essential positions in defense, police, health, social services, education, and the judiciary. Some analysts demand public sector salaries be cut to private-sector levels (yes, in Ecuador, the government pays significantly higher salaries than private employers), suggesting only those that make two monthly minimum wages or less (close to $760) be exempt. This would also reduce compensation for layoffs. The government also needs to audit and suspend some student scholarships, particularly for undergraduates overseas. The huge amount of $800 million the government spends annually on consultants, also requires pruning.

Current spending also includes incredibly wasteful subsidies on fuels. In Argentina, Macri has pledged currency “gradualism,” an approach aimed at avoiding spikes in inflation by dismantling the multiple exchange rates only gradually, rather than at once. In Ecuador, inflation would spike if fuel prices were to rise immediately in the wake of liberalization. The administration has so far eliminated around 10 percent of fuel subsidies, including high-octane gasoline and some other fuels, including some aviation fuel. Popular protest to this has been limited, but in the long run, the other subsidies must be reviewed. The moment to eliminate them is thus now that the prices for diesel and gasoline are low. In a speech to entrepreneurs in Quito, Lasso said that he wouldn’t eliminate the subsidy on liquefied petroleum gas given the reliance of low-income Ecuadorians on the fuel for cooking and their livelihoods. Still, smuggling would have to be impeded – a source told us that fuel truck after fuel truck continue to cross the border into Colombia at the San Miguel bridge in the Amazon territory. Another option would be to subsidize the cost of the LPG cylinder, rather than LPG distribution, by raising the monthly support paid to qualifying low-income households. This payment, too, requires a review – it may be too low, Mauricio Rodas, now Quito’s mayor, has said in the past, but it also needs to be focused on people who truly need it. Questionable subsidies are also flowing into agriculture and, via the social security bank, competing unfairly with banks in the mortgage market.

One of the main risks from the current downturn is, of course, unemployment. Lasso correctly identified jobs as the economy’s key requirement, considering that “underemployed” (people who don’t have a steady job) account for the majority of the workforce. It would be hoped for that deregulation and the retreat of the state from its current exaggerated positions would lead to more private-sector jobs. Key here will be local and foreign investment, for which institutional confidence would be the most important basis.

Admittedly, the Correa administration continues to seek to drum up support, thanks to the new public-private-partnership law. This however under the current political, legal, and institutional framework unfortunately falls short of requirements, particularly considering the progress among competitors in the region, particularly its direct neighbors, which have both larger domestic markets, free trade agreements with leading trading partners, and large infrastructure projects with private-sector participation. Here, Ecuador needs to stop blocking trade with Colombia and Peru, letting its exorbitant duties up to 45 percent expire (if not rolling them back sooner than planned) to secure their support for its accession to the free trade pact with the European Union.

All of this is clearly recognizable, but will take considerable political will. A few billion dollars of foreign investment would go a long way in Ecuador. Hopefully, as the bickering over the presidential campaign is already beginning, consensus can emerge that this is the right way to go. This will also help sustain the use of the dollar, the policy fixture on which almost everyone agrees.

This commentary originally appeared in Ecuador Weekly Report published by Analytica. Republished with permission.


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