Ecuador - Current economic position and prospects

Report No. 1382-EC FILE COPY CLirrent Economic Position and Prospects of Ecuador April 'I, 1977 Latin A/merica and Caribbean Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restri ted distribution and may be used by recipients only in i he performance ol their official Cluties Its c onlents may not otherw se he disclosed without World Bank authorization  CURRENCY EQUIVALENTS 1 Sucre = uS$o.o4 1 US$ = 25 Sucre Fiscal Year: January 1 to December 31  FOR OFFICIAL USE ONLY Glossary of Ecuadorean Institutions (Abbreviations) BNF Banco Nacional de Fomento CEDEGE Comision de Estudios para el Desarrollo de la Cuenca del Rio Guayas CEPE Corporacion Estatal de Petroleo Ecuatoriana CREA Centro de Reconversion Economica del Azuay, Caflar y Morona- Santiago ENAC Empresa Nacional de Almacenamiento yComercializacion Agropecuarios ENPROVIT Empresa Nacional de Productos Vitales FONADE Fondo Nacional de Desarrof o FONAPAR Fondo National de Participacion INECEL Instituto Ecuatoriano de Electrificacion INIAP Instituto Nacional de Investigaciones Agropecusrias JUNAPLA Junta Nacional de Planificacion MAG Ministerio de Agriculture y Ganaderia MOP Ministerio de Obras Publicas PREDESUR Programa de Desarrollo del Sur This document has restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   TABLE OF CONTENTS COUNTRY DATA Page No. MAP SUMMARY AND CONCLUSIONS ....................................... i - vii Chapter I: RECENT ECONOMIC DEVELOPMENT ...................... 1 The Impact of Petroleum .. ............... .......... *. I Social Development . ............................. .. ....... 3 Investment and Savings ............................. 3 Public Finances . ....................... .. ..................... . 4 Balance of Payments ......... 8 Chapter II: MAJOR SECTORAL ISSUES ........................... 11 Petroleum ........................*.. .......... 11 Agriculture ........................................................... 15 Industry .............................*....... .. .. 20 Electric Power .......................................... ....... .... 21 Transport ......................... 0........* *............. 23 Education .................................. ...... 24 Housing and Urban Development ............... ............. 27 Chapter III: PUBLIC INVESTMENT PROGRAM AND DEVELOPMENT PROSPECTS .................................. 29 Growth and Petroleum Prospects ..... ...................... 29 Public Sector Prospects ...... . ............................ 30 Public Investment Program ...... .......................... 32 Balance of Payrnents and Creditworthiness ........ ......... 39 STATISTICAL APPENDIX This economic report is based on the work of a mission that was in Ecuador from August 15 to September 10, 1976 and on discussions of a first draft with the Ecuadorean authorities in February 1977. The mission comprised Guy Pfeffermann (Chief), Juan Giral (General Economist), Carmen Martinez (Invest- ment Analyst), Rangaswamy Vedavalli (Petroleum Economist), Nathan Koenig (Consultant, Agriculture), Eugenio Salazar (Consultant, Electric Power), Jose Veniard (Transport Specialist), Ruth McCrea (Research Assistant) and Amalia Kriegsman (Secretary). Michaela Rubin helped edit the report. Three annexes complete the main volume: Annex I on agriculture, Annex II on public investment projects and Annex III on population.   COUNTRY DATA -ECUADOR 1 of 1 AREA POPULATION DENSITY 271,000 km2 6.6 million (1974) 24 per km2 Rate of Growth: 3.4% (from 1960-1974) POPULATION CHARACTERISTICS (1974) HEALTH (1973) Crude Birth Rate (per 1,000) 37.5 Population per physician 2,110 Crude Death Rate (per 1,000) 9.9 Population per hospital bed 470 Infant Mortality (per 1,000 live births) 70.2 INCOME DISTRIBUTION (1970) DISTRIBUTION OF LAND OWNERSHIP (1968) 7. of National Income, Highest Quintile .Oeyp Owned by top 107o of owners Lowest Quintile .. % Owned by smallest 277. of owners ACCESS TO PIPED WATER (1974) ACCESS TO ELECIRICITY (1974) % of Dwellings - Urban 83.2 % of Dwellings 41 Rural 13.4 (Urban) (82) (Rural) C 8) NUTRITION (1968) EDUCATION (1974) 2/ Daily Calorie intake per capita 2,078 Adult literacy rate77 3/ 69 Primary School enrollment7%- 96 GNP PER CAPITA in 19 US!: us$ 550 GROSS NATIONAL PRODUCT IN 1975 ANNUAL RATE OF GROWTH (%. constant prices) Mln. Sucres % 1960-65 1965-70 1970-75 GNP at Market Prices 105,760 100.0 4.3 6.0 9.3 Gross Domestic Investment 32,815 31.0 15.5 GrOss National Saving 25,520 24.1 21.2 Resource Gap 4,420 4.2 Export of Goods, NFS 24,567 23.2 15.6 Import of Goods, NFS 28,987 27.4 12.7 OUT. LABOR FORCE AND PRODUCTIVITY IN 1975 Value Added Labor Force5/ V. A. Per Worker6/ Mln. Sucres % Mln. % Sucres X of total Agriculture 7/ 23,058 22.7 0.9 43.4 25,620 47.9 Industry 87 28,984 28.5 0.3 15.8 96,613 180.6 Services - 49,588 48.8 0.7 36.8 70.840 132.4 Unallocated . , .__ Total/Average 101,630 100.0 1.9 100.0 53,489 100.0 GOVERNMENT FINANCE General Government i0/ Central Government _ (S/ Mln.) % of GDP (S/I Mln.) % of GDP 1976 1976 1975 1975 1972-74 Current Receipts 23,398 18.7 16,391 15.5 16.2 Current Expenditure 16,518 13.2 11,242 10.6 10.4 Current Surplus 6,880 5.5 5,149 4.9 5.8 Capital Expenditures 7,795 6.2 t,055 6.7 5.6 External Assistance (net) .. 236 - -, MONEY. CREDIT and PRICES - 1971 1972 1973 1974 1975 (million sucres at end of period) Money and Quasi Money 8,577 10,339 13,166 17,669 19,690 Bank Credit to Public Sector (net) 2,233 1,821 211 -1,458 -2,410 Bank Credit to Private Sector 7,093 7,826 9,433 13,115 17,908 Money and Quasi Money as % of qeji 21.1 22.3 20.8 19.6 18.6 General Price Index (1970=100)- 113 122 140 179 201 Annual Percentais/Change in: General Price Index - .. 8.0 14.8 27.9 12.3 Bank Credit to Public Sector (net) .. -18.5 -88.4 -791.0 -65.3 Bank Credit to Private Sector .. 10.3 20.5 39.0 36.5  2 of 2 COUNTRY DATA - ECUADOR (CONT) BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1972-76) 1974. 1975 1976 US $ Mln % (Millions of US $) Bananas 135 15.3 Coffee 90 10.2 Exports of Goods, NFS 1,235 1,073 1,362 Cocoa 45 5.1 Imports of Goods, NFS 1,043 1,192 1,277 Sugar 18 2.0 Resource Gap (deficit = -) 192 -119 85 Petroleum 484 54.9 Factor Payments (net) -183 -78 -T6 All Other Co dities 109 12.5 Net Transfers 18 29 21 Total 7FT lOO.O Balance on Current Account 27 -168 30 Direct Foreign Investment 77 41 20 Net MLT Borrowing -15 93 EXTERNAL DEBT, DECEMBER 31. 1975 Disbursements 65 142 Amortization 80 50 *. US $ Mln. Capital Grants 14/ - - - Other Capital (net) 23 -24 .. Public Debt, incl. Guaranteed 429.5 Increase in Reserves -112 58 -189 Non-Guaranteed Private Debt (- increase) Total Outstanding & Disbursed 429.5 Gross Reserves (end year) 349.9 285.6 514.6 Net Reserves (end year) 339.4 245.5 435.0 15/ DEBT SERVICE RATIO for 1975 RATE OF EXCHANGE (OFFICIAL) x Through - 1971 Public Debt, incl. guaranteed 4.T Non-Guaranteed Private Debt -- US $ 1.00 = S/ 25.00 Total Outstanding & Disbursed 4.7 S/ 1.00 = US $0.04 IBRD/IDA LENDING (DECEMBER 31. 1975) (MILLION US$) Since - 1971 IBRD IDA US $ 1.00 = S/ 25.00 S/ 1.00 = US $0.04 Outstanding & Disbursed 43.0 28.4 Undisbursed 36.2 10.1 Outstanding incl. Undisbursed 79.2 38.5 not available not applicable 1/ Data from National Institute of Statistics, or Ministry of Public Health, unless otherwise noted. 2/ From 1974 Population Census, persons 10 years old and over. 3/ Ministry of Education 4/ World Bank AElas , 1976 5/ Total labor force figures from 1974 census; unemployed persons are allocated to the sector of their normal occupation. 6/ Very rough estimate, as value added figures are for 1975 while labor force figures are for 1974. 7/ Includes agriculture, livestock, forestry, fishing, and hunting. 8/ Includes manufacturing, mining, public utilities and construction. 2/ Includes trade, transportation and public and private services. 10/ Includes Central Government, FONADE, FONAPAR and other special accounts. 11/ Includes Central Government, FONADE and FONAPAR. 12/ IMF data. 13/ GDP deflator. 14/ SDR Allocation. 15/ Ratio of debt service to exports of goods and non-factor services.  EICnen ~'~ Omgo QUIT GALAPAGOS ISLAN/OS 7E0oan 73Do OrulE P 4 0 I C(AI Rp e AAt t .OPNOC Pa,ZtIOG ~ tttQt- .T, 01tI SCF tAR,E 'Orh~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~9~ __~~~~~~~~~O s D ROC~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ tO ~ ~ ~ ~ 00t ,OOtM onons~~~~~~~~4 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I '-a--~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~m. tOO G~~~~~AL IA ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~ KLMER A ILOMA ZRA COT Guaya.600 . 9'0' 7'0   SUMMARY AND CONCLUSIONS General i. The development performance of Ecuador since World War II has been good. National accounts do not do full justice to the improvements and changes that have transformed the quality of life during these decades, and to the further progress achieved since petroleum began to be exported in 1972. The country's economy, which was quite undeveloped thirty years ago, has reached the stage where production is fairly diversified and where the standard of living of the Andean population is somewhat higher than in neigh- boring countries owing mainly to better soil and climate. Of course, Ecuador still has a long way to go, and while petroleum exports of about US$75 per person per year undoubtedly help, considerable domestic efforts as well as external assistance will continue to be needed to diversify exports and to improve the quality and range of social services, particularly education. But with gradual improvements in public administration and rising petroleum revenues, Ecuador's outlook is better than it was in the past. The Government intends to step up public investment in an effort to address some of the main economic and social problems of the country. The revenues from petroleum provide the financial basis for an ambitious public investment program in two ways: in the form of export earnings and of public revenues that can be used as counterpart to externally borrowed funds. The ability of the Government to finance such an investment program depends largely on the rate of growth of petroleum production and exports. Perhaps the most critical focus of economic management and development policy is the maintenance of a balance between petroleum revenues on the one hand and the ability of the public sector to carry out effective investment projects on the other. Until now this balance has been maintained by and large, but the growth performance would undoubtedly suffer should petroleum revenues cease to grow or should public investment exceed the physical and administrative absorptive capacity of the economy which remains limited. ii. Petroleum policies will have a decisive influence on Ecuador's growth prospects. The central problem is that conventional crude reserves are now being extracted faster than they are being replaced, owing to the virtual absence of exploration and development activity. Unless sustained investment in exploration and development is resumed, crude petroleum exports are likely to fall after 1980. Owing to managerial, technical and financial limitations, the State Petroleum Corporation (CEPE) cannot yet be expected to undertake alone an investment program including substantial exploration and development on the one hand and various other projects on the other (such as further refining capacity, a natural gas plant, a petro-chemical complex and various pipelines). Therefore cooperation between CEPE and foreign petroleum enterprises under a workable arrangement is necessary to ensure continued expansion of petroleum production.  - ii - iii. Domestic consumption of petroleum products has been rising at twice the average rate for all Latin American countries, spurred on by retail prices which are among the lowest in the world. Premium gasoline is now being sold at less than US020/gallon at the pump. A very substantial increase in gaso- line prices is urgently needed to discourage wasteful consumption, and to provide CEPE with a reasonable amount of savings. iv. In order to avoid a drop in petroleum exports the Government intends to stimulate investment in the sector. The allocation of public funds to CEPE is to be increased and investment by Texaco (CEPE's minority partner in the major production area) is to be encouraged. Increased investment in explora- tion, development and transport could lead to an increase in production from 65.9 million barrels in 1976 to around 85 million barrels in 1979. A sustained investment program of about US$50 million per year would make it possible for the Government to step up petroleum output further during the 1980's. The country's in situ petroleum reserves are large enough to warrant such an investment. Fiscal and Monetary Management v. The fiscal situation of Ecuador has improved in two important respects during the past few years. First, the emergence of petroleum reve- nues has relaxed the public savings constraint that had in the past held back the pace of progress in the public sector. Second, a significant number of earmarked revenues have been consolidated, affording the Central Government better control over fiscal management. Perhaps the most important recent policy measure in the field of public finances has been the creation of FONADE (National Development Fund), which channels petroleum revenues into public investment. While this might be considered another case of earmarking, there is no doubt that the Fund is of utmost importance for what it achieves (the possibility to finance priority investment projects) as well as for what it avoids (the allocation of petroleum revenues, which are non-renewable, to government consumption expenditure). Nevertheless problems of fiscal manage- ment have not been eliminated. For example, in 1975 when petroleum revenues declined a serious problem had to be confronted, reflecting the public sector's dependence on the level of petroleum production and the weakness of non- petroleum revenue collection. But a basis has now been laid for a more ambitious public investment effort, which did not exist in the past. vi. The need to strengthen non-petroleum public revenues will become more acute as more public investment projects are prepared, and as the improv- ing absorptive capacity of public agencies makes it possible to carry more of them out. The Government is in a relatively fortunate position owing to the considerable scope that exists now for increasing non-petroleum revenues. Possible areas for action include income taxes (only 180,000 persons now pay income tax), real estate taxes, import duties, and a host of tax exemptions many of which are not clearly justified. Ample scope also exists for increas- ing prices of goods and services sold by publicly owned agencies, particularly INECEL (electric power) and CEPE (petroleum products).  - iii - vii. The fiscal problems of 1975 have now been resolved, and the remain- ing Central Government deficit is compatible with an improvement in the balance of payments and a reduction of inflation. It is clear, however, that the present austerity policies will have to continue during the next few years in order (a) to maintain the Central Government deficit within reasonable limits, (b) to maintain a sufficient public savings capacity to limit the need for external borrowing once public investment acquires greater momentum, and *(c) to allow for an increasing flow of banking credit to the private sector. A 15 percent annual average rate of increase in current expenditures in current prices can be considered reasonable in the public sector. This rate is based on the assumption that the impact of inflation on public wages and salaries is minimized, that other current expenditures are closely scrutinized and that new additions to the Government's labor force are limited to a minimum consistent with development objectives and the public investment program. A faster rate of increase could be reflected in a significant reduction in public savings. Even at 15 percent per year it is likely that current savings will decline in the early 1980s in the absence of new revenue measures. But the scope for new revenue measures is wide, as suggested in paragraph v above. Monetary management has traditionally been particularly important in Ecuador. The Central Bank plays a decisive role in regulating imports. Monetary management and import regulation have been fairly restric- tive since mid-1975. The main instruments used to this effect are the minimum reserve requirement on demand deposits of private banks, ceilings on credits for a wide range of purposes, and advance import deposit requirements. Furthermore, the import of private automobiles has been banned between mid-1975 and early 1977. As a result of these measures and of the favorable export growth, the international reserve position of Ecuador has improved sharply during 1976, and inflation has been cut down from a peak of about 23 percent in 1974 to about 11 percent in 1976. Sectoral Issues viii. Ecuador is among the few developing countries with enough fertile land to expand agricultural and livestock output at reasonable cost. Over the years agriculture has been the most important sector in employment, exports and out- put, but for much of the past decade production has lagged behind the rate of growth of the population. This report suggests a package approach that could lead to more dynamic growth. A package could comprise the following elements: (a) a departure from the "crop-by-crop" system of technical assistance to farmers and the creation of an extension service that would advise farmers as farm operators; (b) more emphasis on research in oilseeds, grain sorghum, fruits, vegetables, poultry and pulses, and a wider diffusion of improvements in livestock nutrition and health;  - iv - (c) further expansion of medium and long-term agricultural credit not only through the Banco Nacional de Fomento but also other insti- tutional channels, and a diversification away from excessive concentration of credit on rice and cotton; (d) a thorough independent study of agricultural subsidies, which have been unnecessarily costly in the past and have neither helped raise output nor contain inflation; (e) investment and training to create a more effective agricultural marketing system, particularly an expansion of private and public storage facilities; (f) the continuation of the on-going feeder road construction program with a view to increasing the all-weather feeder road network by 3,000 km within the.next five years; (g) the formulation of clear priorities for rural development and the creation of a national program which might include the regional institutions now active in this field as well as an effective central office which would coordinate and allocate the material and financial resources on a project-by-project basis. These measures are complementary and mutually supportive. They can achieve a broad improvement in the condition of the bulk of the population in a rela- tively short time while serving national development objectives. Even a slight absolute improvement in the living standards of the bulk of the rural population would represent a substantial relative improvement for the persons concerned. ix. A recent World Bank report reviews the main issues relating to industry. 1/ Ecuador's industrial development has been quite successful so far, based on the expansion of small private firms in a great variety of activities. As some of the main obstacles to development are gradually removed (especially the shortage of medium and long-term credit and the deficient physical infrastructure), continued rapid growth can be expected without departing greatly from the successful historical pattern. The intro- duction of large industrial projects involving substantial direct public intervention might divert scarce physical, financial, technical and managerial resources to the detriment of the economy, unless the economic and social merits of such projects match those of private projects. x. Ecuador is among the Latin American countries with the lowest elec- tric power capacity per head, and demand is expected to grow rapidly in the next ten years. Fortunately the country's hydroelectric potential is good. The main issues relate to the financing of sector expansion and to the capability of INECEL -- a public corporation recently put in charge of an 1/ "Industrial Development Problems and Prospects" (No. 1186-EC, October 7, 1976).  - v - ambitious national power expansion program -- to plan and manage its oper- ations. A review of the national electrification investment program is advisable, given the magnitude of the problems to be resolved prior to imple- mentation and the heavy impact which its financing may have on Ecuador's future indebtedness. In addition to strengthening INECEL's capability to plan and manage its own operations, the Government may consider whether it is realistic to expect the utility to discharge the wide range of functions allocated to it. The Government has adopted sound legislation on the pricing of electric power. It should now decide whether to continue subsidizing the use of petroleum in electric power generation. xi. The first priority in transport is to improve road maintenance to obviate the need for periodical reconstruction, and to improve the trunk network between major towns. Secondly, the national feeder road construction program mentioned in paragraph (viii) above deserves the continued support of the Government. Thirdly, only ports and pipelines cover their expenditures out of revenues earned for the services provided. The extraordinarily low price of gasoline has encouraged road transport, and user charges do not cover the costs of an adequate level of maintenance. Consequently, there is an urgent need on these grounds alone to raise the domestic price of petroleum derivates. The sharp decline in rail freight during the past decade is also associated with the subsidization of road transport. Investment in railroads is not warranted so long as this discrimination continues. xii. Strengthening education and making it more responsive to the needs of an expanding economy are necessary conditions for further social and economic progress. A major effort is required to improve the quality of primary schools and to make full primary education available to all, parti- cularly in the rural areas. The on-going rural development program ("nuclearizacion") is a step in the right direction. Another critical issue is the recent deterioration in the quality of higher education, as a result of a relaxation of entrance requirements for secondary school leavers. This policy will not contribute to alleviate the country's shortage of qualified cadres, nor will it improve the social and economic opportunities of the poorer students, since very few of them have access to secondary school or indeed to complete primary education. What is needed is an increase in the share of public resources allocated to primary and technical education rather than to the universities, which have absorbed a very large share of funds in the past few years. xiii. The housing shortage cannot be estimated precisely but a need for improvement is clear. The greatest need is for water supply in the rural areas and in the suburbs of Guayaquil. The situation in Quito also requires investment. At the moment the slum families are spending more for water bought from trucks than the more affluent families pay for piped water. Even if full operating and maintenance costs were charged for public water supply the poorer residents would pay less than they do now. The Ecuadorean Housing Bank has introduced some imaginative policies to help low income families acquire houses, but its scope is very small. Experiments with self-help housing have not been successful in Ecuador, and an expansion of credit for  - vi - cheap conventional housing possibly coupled with "sites and services" invest- ment may be the most promising way to reduce the housing shortage. Public Investment xiv. Project preparation has improved in the public sector, but weak project preparation, which has traditionally been one of the major obstacles to social and economic development in Ecuador, remains a major problem. Much remains to be done to improve project preparation, particularly in agriculture and rural development, education, health and public industries. Such improve- ment is essential when public investment projects are to be submitted to external financing agencies. One of the most serious new problems confronting the Government of Ecuador is the need to set out priorities among competing agencies and investment projects. In the past, the small number of projects under preparation attenuated the need for planning in this respect. In the future this need will increase as more projects are prepared, owing partly to the activities of FONAPRE, and as petroleum revenues cease to grow at a fast rate. xv. This report includes a public investment program which would meet the priority needs of the country without intolerably straining the physical and financial capacity of the public sector. In all likelihood such a program would be consistent with continued rapid growth without undue pressure on prices or on the external debt servicing capacity, especially as many of the investment projects will take longer to be carried out than is projected by the Government because of probable delays. Investment in petroleum aims at increasing production to 260,000 barrels/day by 1979. As mentioned earlier, this will require financial and technical involvement on the part of foreign petroleum enterprises. The program also includes a natural gas plant and some pipelines. The electric program of the Government includes the completion of the Pisayambo hydro-electric plant, the completion of the larger Paute hydro- electric plant, thermal units for Guayaquil, Quito and Santo Domingo, the ancillary transmission investment, and a rural electrification program. Work is also expected to begin on the Toachi dam in the 1980s. The Government's industrial program includes a fertilizer plant feeding on the natural gas deposits of the Gulf of Guayaquil, an African palm oil refinery, investment in cement plants and several industrial parks. In transport, the program includes highway construction and investment in ports and small airports. An ambitious hospital construction program is included in the program but is stretched out over five years rather than two years contemplated by the Ministry of Public Health. A large number of agricultural investments are included in the program, but a number of rural development and irrigation projects which seem to duplicate other proposed projects are left out. The large Daule-Peripa Project has been replaced by smaller rural development and irrigation projects in the same area. A rural telecommunications project and a rural education project are also included in the program. Further projects are listed in Annex II but are not included in the public investment program for 1977-81 because the thorough studies that are called for are likely to move most of these projects beyond 1981. These projects include a steel mill based on  - vii - imported pellets and natural gas from the Gulf of Guayaquil, an automotive industry foreseen by agreements with other Andean Group member countries, two new airports at Quito and Guayaquil, and a petro-chemical complex to be fed by additional petroleum production. xvi. The total cost of the public investment program, including financ- ial investment, is in the order of US$4.3 billion over the five-year period 1977-1981 (commitments). The annual expenditure on public investment would be fairly even over the years, and would average about US$650 million per year at 1976 prices, or over US$800 million in current prices. The program involves commitments from external sources in the order of US$2.8 billion over the five-year period. The domestic savings required to carry out the program should pose no problem so long as petroleum output rises. Balance of Payments and Creditworthiness xvii. The balance of payments problems of Ecuador hinge essentially on petroleum policies discussed in the sectoral chapter and on the pace of execution of the public investment program. Traditional exports (bananas, coffee and cocoa) are not expected to rise much in the future, and other exports (fish, manufactures, tourism, etc.), even though quite dynamic, are too small to make much difference before the 1980s. The current account balance of payments deficit can be expected to widen significantly towards the end of the decade unless sufficient petroleum development and exploration investment is begun soon. Even if the petroleum expansion program goes forward, the current account deficit can be expected to widen from US$36 million (1972-76 average) to about US$216 million by 1981. Gross external borrowing in the order of US$290 million per year will be required. The increase in debt service that would result from external borrowing a scale should not pose serious problems. Ecuador's debt service ratio is low (4.7% in 1975 and 6.8% in 1976) and may increase to about 12.3% by 1981 if the external financing required to carry out the public investment program were obtained. This is a tolerable level, so long as the bulk of external credits is used for productive projects with relatively short gestation periods. On balance, the development prospects of Ecuador are favorable so long as a substantial petroleum development and exploration program goes ahead as soon as possible.   Chapter I. RECENT ECONOMIC DEVELOPMENTS The Impact of Petroleum 1. Before petroleum became the major export item in 1973, Ecuador's GDP growth was led by agricultural production for exports, mainly cocoa, coffee and bananas. The average annual GDP growth rate was 5.5% from 1960 to 1972. The terms of trade deteriorated sharply during this period, mainly because of steadily declining world prices for bananas. Toward the end of that period heavy investment in petroleum began to yield output and the economy gained a new impetus as a result. The following sections trace some of the effects of petroleum on the economy, particularly on growth, public finances and the balance of payments. 2. Petroleum exports started in 1972 and by the end of 1973 a substan- tial volume (53.6 million barrels) was being exported; the increase in world prices for petroleum in 1973 and 1974 further strengthened Ecuador's export performance and terms of trade turned sharply in favor of that country. Petroleum exports have influenced the growth of GDP, government revenues and foreign exchange earnings decisively, and have enabled Ecuador to break two major constraints that had held back more rapid development in the past: low domestic savings and the limited import capacity. These had required frequent emergency economic measures in the past. 3. The real rate of GDP growth averaged nearly 9% between 1972 and 1976. Petroleum accounted for 13% of GDP and over one-half of total export earnings in 1975. The following model is an attempt to show the impact of petroleum on the economy. The table below is based on the relationship between import capacity and GDP and compares the actual 1972-75 trends with the hypothetical trends that would have prevailed in the absence of petroleum exports. Even in 1972, the first year when petroleum was exported, GDP would have been smaller by 12% in the absence of petroleum exports; by 1975 GDP would have been 38% below the actual value, about US$300 per capita rather than about US$500.  - 2 - THE ECONOMY WITHOUT PETROLEUM (in millions of 1970 sucres) 1972 1973 1974 1975 A. Actual Economy (including petroleum) GDP 37,986 44,944 51,036 53,719 Real Purchasing Power of Exports (including petroleum) 6,330 9,271 14,179 11,242 Imports 6,559 7,322 11,323 12,108 B. "No Petroleum" Economy GDP Estimates 33,783 35,381 39,987 33,400 Real Purchasing Power of Non-Petroleum Exports 6,247 4,864 3,781 3,740 Import Estimates 5,465 5,241 5,871 6,220 C. Ratios A/B GDP 1.124 1.270 1.276 1.608 Real Purchasing Power of Exports 1.013 1.906 3.750 3.006 Imports 1.200 1.397 1.929 1.947 Source: Mission estimate 4. The petroleum boom quickened the pace of development in most sectors of the economy, notably industry, commerce, transport and power (these sectors are reviewed in Chapter II). Agriculture, which remains the single largest contributing sector to GDP and the country's largest employer, has not bene- fited as much as other sectors from the new petroleum revenues (see Chapter II and Annex I). Petroleum production reached a peak in 1973 and declined in 1974 and 1975, but growth resumed in 1976. 5. The rapid expansion of aggregate demand was accompanied by infla- tionary pressures, particularly in 1974 when imported inflation was at its strongest in recent years. Inelastic domestic supply of many food items (wheat, vegetable oils) compounded the pressures. The consumer price index rose from an annual rate of 9% in 1971 and 8% in 1972 to 13% in 1973, 23% in 1974, and slowed down to 14.5% in 1975 and 10.6% in 1976.  -3- Social Development 6. There are so few statistics on social development and income dis- tribution and employment in Ecuador that discussion of these issues can only be limited. However, social progress over the last decade is apparent from a number of indicators. Urban surveys registered an open unemployment rate of 5.5% in 1968 and 5.3% in 1975, which, if accurate, would be low compared with other Latin American countries. Health facilities have been growing, and general and infant mortality rates have declined, even though malnutrition still exists in part of the Coastal areas and of the Sierra. Housing con- ditions have improved with the construction boom. More homes are connected to electricity services, water supply and sewerage. Petroleum revenues also allowed the Government to give substantial financial support to the educa- tional system, and teacher employment increased. School enrollment, however, grew even faster and the student/teacher ratio worsened, particularly in the universities. The population has increased at a rapid rate. The Costa has become the most populous region, owing largely to migration from poorer areas in the Sierra, while the Quito area has also attracted a large number of migrants. Fertility levels are high and although regional and rural-urban fertility differentials do exist, the fertility of urban areas is still quite high. An analysis of population growth and composition, fertility, mortality, family formation and migration, family planning and population projections is presented in Annex III. The Annex is based on imperfect data and its major conclusion--the rapid rate of growth of population--is subject to the uncertainty of the data base, an assessment of which lies beyond the scope of this report. Investment and Savings 7. Private and public investment as well as the country's savings capacity have expanded considerably since 1970, even though the national accounts may exaggerate the share of investment in GDP. External capital inflows for petroleum investment in the early 1970s, and later the expansion of the savings capacity, were undoubtedly associated with a rising investment/ GDP ratio. Investment in construction, industrial machinery and transport equipment rose considerably. Private investment was stimulated by strong demand pressures, increased access to credit and high profit margins. Gross national savings financed a rising share of total investment as petroleum revenues increased (see tables below).  - 4 - GROSS DOMESTIC INVESTMENT AND GDP /1 (ratios) 1970 1971 1972 1973 1974 1975 Gross domestic fixed investment/GDP .17 .24 .21 .19 .22 .28 Private fixed investment/GDP .12 .18 .16 .13 .16 .19 Public fixed investment/GDP .05 .06 .05 .06 .06 .09 Public fixed investment/Gross domestic fixed investment .31 .26 .24 .33 .28 .31 Changes in stocks/GDP .04 .03 .02 .05 .03 .03 /1 Current prices. Source: Central Bank of Ecuador and mission estimates. FINANCING OF INVESTMENT (in percentages) 1970 1971 1972 1973 1974 1975 Gross National Savings 64 66 80 97 101 85 Net Capital Inflows 36 34 20 3 -1 15 Source: Central Bank of Ecuador Public Finances 8. The increase in the rate of growth of public investment in recent years directly reflects the emergence of petroleum revenues as a major source of public sector financing. Until 1971 public sector revenues and savings were low and social and economic infrastructure lagged behind needs. The fiscal burden of the General Government amounted to only 12% of GDP. Periodic revisions of the tax system were undertaken to raise additional revenues and maintain equilibrium in the fiscal accounts in the face of rising current expenditures. Petroleum exports and the increase in petroleum prices improved public sector finances substantially after 1972. The induced expansion of  - 5 - economic activities also resulted in higher yields from non-petroleum taxes. The fiscal burden of the General Government reached 18.1% in 1975 (see Table 5.7, Statistical Appendix). 9. Between 1971 and 1974 current expenditures doubled and investment expenditures tripled in current terms. Public sector deposits in the banking system went up, whereas net credit to the public sector and foreign indebted- ness was reduced as revenues outpaced expenditures. At the same time, rising public expenditures fed inflation. In the second half of 1974, a decline in petroleum production slowed down the flow of government revenues and in 1975 a more cautious expenditure policy was pursued. This policy also helped reduce demand pressures and slowed down the rate of inflation. While central government expenditures grew at a much lower rate in 1975 and 1976, they still grew faster than revenues, and the total budget including FONADE and FONAPAR moved from a surplus to a deficit position of 7% and 8% of current revenues in these two years. 10. In the past, revenues were earmarked for special agencies and accounts, where at times they lay idle. This made it difficult to manage public sector finances properly. The creation in 1971 of the National Participation Fund (FONAPAR) helped rationalize the allocation of fiscal revenues among provincial councils, municipalities and other public sector entities. To gain more control over expenditures, tax resources were also reallocated between the Central Government and the public agencies. In 1974 the National Development Fund (FONADE) was established to channel petroleum tax revenues into development projects, concentrating on fixed and financial investments. 1/ The recent establishment of a unified account for the Central Government budget and the extrabudgetary special accounts will help avoid some of the difficulties associated with the earmarking of funds at the Central Government level. 11. At present government finances are administered through the Central Government budget; extrabudgetary accounts, including the Armed Forces; FONADE, and FONAPAR. Together they are here referred to as "General Government". 12. Total current revenues of the General Government grew at 35.7% per year between 1970 and 1975, increasing their share in GDP from 12% to around 18%; buoyancy of total revenues to GDP was 1.71. 2/ The importance of petro- leum in the performance of the fiscal accounts becomes evident when one compares it with non-petroleum revenues and their buoyancy to non-petroleum GDP of .98 for the same period. 1/ FONADE's share of income taxes on petroleum was 47.7% in 1976. A break- down of its expenditures is presented in Table 5.6 of the Statistical Appendix. 2/ Excludes petroleum revenues allocated to INECEL and CEPE (see Table 5.7, Statistical Appendix).  - 6 - 13. Nevertheless, the Central Government budget depends on non-petroleum taxes for about 79% of its revenues. Customs duties, income taxes and sales taxes are the main sources, and together they had a .86 buoyancy to non- petroleum GDP for the period 1970-75. While sales taxes and customs duties have responded well, income taxes have lagged behind total GDP but have kept slightly ahead of non-petroleum GDP. Tax exemption have been partly respon- sible for reducing the dynamism of these taxes. Over the past few years, non-petroleum export taxes have not been dynamic because of the sluggish performance of traditional exports. There is a need to improve the buoyancy of non-petroleum taxes. 14. Total Central Government expenditures amounted to about S/ 17.5 billion or 16.5% of GDP by 1975. 1/ In 1976 these expenditures are estimated at S/ 21.4 billion. Current expenditures of the Central Government budget rose at an annual rate of 28.8% between 1971 and 1975 and the real rate of expansion is estimated at about 11% per year partly reflecting more public employment. A July 1975 Census registered 110,000 employees for the Central Government as compared to 55,000 and 61,000 in tabulations of the Ministry of Finance for 1971 and 1972. 2/ Capital expenditures (excluding amortization) in the budget grew at an annual rate of 14.9% from 1971 to 1975, reaching a level of S/ 2.4 billion. These expenditures were mainly for fixed investment. A substantial proportion was for highway construction by the Ministry of Public Works. 15. While consolidated figures of the public sector savings and invest- ment performance are not reliable, the accounts of the Central Government are more accurate. The Central Government provided the main source of domestic financing for public investment in the period 1971-75. Central Government savings (including FONADE and FONAPAR) rose from 2% of current revenues in 1970 to 39% by 1974, allowing for a high fraction of investment to be financed out of current savings. 3/ Although savings declined following the 1975 fall in petroleum revenues, they were still at a level of around 30% in 1976. 16. Fixed public investment in the early seventies was highly concen- trated in highways (about 40%). Other sectors followed at a distance: energy (5%), water and sewerage (about 8%), and agriculture and irrigation (9%). Health and education investment were low (4% and 5.7% respectively). (See Table 5.11, Statistical Appendix.) More recently public investment in elec- tric power and petroleum have gained in importance. By 1975 electric power 1/ Excluding extrabudgetary accounts that cover a group of earmarked funds handled by the Treasury. Sources of revenues are taxes, transfers from FONAPAR, Central Government budget, etc. Only S/ 1.7 billion are fi- nanced out of taxes and services provided. 2/ Although the figures do not have the same coverage they are a rough indication of the increase in Central Government employment. 3/ In 1973 and 1974 current savings exceeded capital expenditures.  represented about 14% of public fixed investment, petroleum 18% and agri- culture 19%, while transport investment was reduced to 27%. 1/ The shift in the pattern of public investment reflects to a large extent the earmarking of petroleum royalties and heavy FONADE support for investment in petroleum (mainly the Esmeraldas oil refinery). 17. By 1975, public fixed investment reached S/ 9,013 million (US$360 million), 3.5 times the current 1971 level. In 1976 a further increase to S/ 11.5 billion (US$460 million) is estimated. Together with the surge in private construction activity, public investment has put pressure on the productive capacity, particularly in cement and iron. Imports of these products have increased sharply. 18. Petroleum Taxes. Petroleum taxation was modified at the end of 1975. 2/ The new system is in line with the practice in most OPEC countries of applying royalty and income taxes on petroleum. The changes brought the royalties to a level of 17% on total production 3/ and the income tax to 71.4% of taxable profits. 4/ Royalty revenues distribution among INECEL, the Armed Forces and Esmeraldas Province stayed the same. 5/ Taxes on exports of the Ecuadorean State Petroleum Corporation (CEPE) remained the same. The main recipients of the estimated revenues for 1976 from petroleum taxes and CEPE's share from exports are the Central Government (26.3%), FONADE (32.8%), the Armed Forces (10.8%), INECEL (10.3%), CEPE (7.8%) and special accounts of the Central Government (6.2%). (See Table 8.1, Statistical Appendix.) 19. On balance, fiscal management, which had been expansionary in 1973 and 1974 in the wake of booming petroleum revenues, has been prudent in 1975 and 1976, in line with the decline in petroleum exports since mid-1974 and the anti-inflation policy of the Government. Real expenditures rose appreciably over the two-year period, particularly in education, health and defense, but the main fiscal problem lies not so much with an increase in expenditure as with the low level of non-petroleum public revenues. 1/ This reduction in relative terms does not reflect a reduction in absolute terms. 2/ Decree No. 982, Official Registry No. 945, December 4, 1975. Decree No. 151, Official Registry No. 43, Mlarch 12, 1976. 3/ Based on .85 of the reference price minus production and transport costs for the Consortium, and the selling price minus export tax and transport cost through the pipeline for CEPE. 4/ Total revenue from exports and domestic consumption minus production and transport costs; royalty payments and some minor taxes. 5/ 47%, 50% and 3% respectively.  -8- Balance of Payments 20. The impact of petroleum revenues on the balance of payments has, of course, been particularly dramatic. In the late 1960's the combination of rising imports, notably for expanded public expenditure and for investment in petroleum, and of stagnating traditional exports resulted in a widening cur- rent account deficit. By 1971 net international reserves amounted to only one month's imports, in spite of high direct investment in petroleum and in- creased external borrowing. Even though the value of imports doubled in 1974 (reflecting a 60% real increase and a 28% increase in import prices) net international reserves increased to nearly US$340 million at the end of that year, reflecting the dramatic increase in petroleum export earnings. The rise in imports was related to: (a) international inflation; (b) rising domestic demand for agricultural products in the face of inelastic supply; (c) stepped up economic activity reflected in rising demand for imported capital goods and intermediate goods; and (d) a reduction in customs duties in April 1974. The structure of imports (net of petroleum derivates) changed during the past few years. Capital goods imports increased their share from 39% of imports in 1970 to 47% in 1975 (see Table 3.5, Statistical Appendix). 21. Despite the sharp rise in import prices the terms of trade became very favorable to Ecuador from 1973 onward as a result, mainly, of higher petroleum prices (see table below). IMPORTS AND GROSS DOMESTIC PRODUCT (in millions of sucres) 1970 1971 1972 1973 1974 1975 Imports of goods (current prices) 4,788 /1 7,670 7,105 9,938 20,345 25,148 /2 GDP (current prices) 33,970 40,569 46,405 63,141 90,152 105,760 Ratio M/GDP .141 .189 .153 .157 .226 .238 Imports of goods (constant 1970 prices) 4,788 5,550 4,829 5,895 9,351 10,593 /3 GDP (constant 1970 prices) 33,970 35,926 38,039 43,701 46,187 49,537 Ratio at constant prices M/GDP .141 .154 .127 .135 .202 .214 Terms of Trade Adjustment (1970=100) - -829 -1,134 +380 +4,251 +5,511 /1 Exchange rate used S/. 19.18 = 1 dollar. /2 Exchange rate used S/. 25.50 = I dollar. /3 Preliminary figure. Source: Central Bank and mission estimate.  - 9 - 22. Until recently foreign investment was low. 1/ Petroleum exploration and production since the late 1960s has brought substantial new investment to Ecuador. By 1973 the stock of foreign direct investment reached US$571 million of which 60% was in petroleum. Some increases were also registered in industry and commerce. As a result, profits on foreign investment started to rise from the US$12 million annual average for 1966-70 to US$128 million annual average for 1972-74, owing mainly to petroleum investment. Profit remittances abroad also increased (see Table 3.8, Statistical Appendix). Ecuador remains one of the countries with the least foreign investment in Latin America, with the exception of petroleum. 23. Starting in late 1974 petroleum production declined for reasons mentioned in paragraph 26 below, showing that increased dependence on petro- leum has not obviated occasional short-term management problems. A substantial cutback in imports became necessary, and the Government took the following measures. (i) the minimum reserve requirement on demand deposits of private banks was increased gradually to 35%, effective January 1, 1975; (ii) credit ceilings were frozen at the level reached on May 31, 1975; except for some production credits and for imports of raw materials intermediate products and capital goods for industry and agriculture; 2/ (iii) advance import deposit requirements were reintroduced; (iv) private automobile imports were banned by Monetary Board Resolution No. 774; (v) import items on List I and List II were reclassified; 3/ a 20% duty surcharge was imposed on category "B" goods, and a 30% duty surcharge was imposed on all List II imports. 1/ The total stock of foreign investment totalled US$103 million in 1966. 2/ As of December 31, 1975 the credit ceiling stood at S/ 6,232 million, approximately 50% of the private banks' amount of credit outstanding to the private sector. 3/ List I has two categories: "A" - essential goods, "B" semi-essential goods. List II includes non-essential and luxury goods.  - 10 - 24. Despite these measures the current account of the balance of pay- ments was negative in 1975 and international reserves declined. However, the package of measures listed above, the prudent fiscal policies that accom- panied them, as well as a significant reduction in international inflation resulted in a slow-down in imports during the second half of 1975 and averted a larger decline in international reserves. 1/ During 1976 the balance of payments improved. Net international assets increased by US$189 million by December 31. 25. In sum, while the rise in petroleum exports undoubtedly benefited the development of Ecuador, it has not obviated the need for skillfull short- term macro-economic management. The Ecuadorean authorities have been fairly successful in adjusting to short-term export shortfalls through a combination of direct import restrictions, monetary measures and prudent fiscal manage- ment. The authorities have also been prudent in their external borrowing policies. The debt service ratio reached 7.6% in 1974, 4.7% in 1975 and 6.8% in 1976. The low level reflects moderate external borrowing and the rapid rise in exports. 1/ A net gain of US$54.7 million was registered from August to December 1975.  - 11 - Chapter II. MAJOR SECTORAL ISSUES Petroleum 26. Petroleum exports began in 1972 while negligible in the world market they have since become a major factor in the Ecuadorean economy. 1/ During the last three years petroleum has contributed decisively to the rapid expan- sion in GDP; its direct contribution alone is in the order of 13%. Petroleum exports have averaged a little over half of total exports since 1973. The contribution of petroleum revenues to public finances is analyzed in Chapter I of this report; it has been very substantial and has enabled the Government to step up investment sharply. However, the rise of petroleum has not been steady. A peak production was attained in the first half of 1974. Thereafter production declined, owing to physical disruptions of the pipeline and to the uncertainty surrounding the relationship between the government and the foreign operating companies. In 1976 production increased again without resuming the early 1974 level. Most of the production is in the Amazon basin. The following table shows petroleum production and exports. PRODUCTION, CONSUMPTION AND EXPORTS OF PETROLEUM (1972-1976) 1972 1973 1974 1975 1976 Production (million barrels) /1 27.4 75.2 63.7 58.1 65.9 Domestic Consumption (million barrels) /2 1.1 16.6 18.9 15.7 19.9 Exports (million barrels) 25.0 59.0 43.8 42.6 47.1 Average daily production (thousand barrels) - 209.0 177.0 161.0 180.6 /1 Discrepancies between consumption plus exports and production reflect changes in stocks. /2 Excludes imports. Source: Table 8.12, Statistical Appendix. 27. Most of the oil produced is generated by a Consortium consisting of the State Petroleum Corporation (CEPE) and Texaco. The State Corporation owns 62.5% of the assets in the producing area (after the sale of Gulf's share to CEPE in late 1976) and Texaco 37.5%. The trans-andean pipeline which links the Consortium fields to the port of Esmeraldas is owned 50/50 by CEPE 1/ Ecuador is the member of OPEC with the smallest volume of petroleum exports.  - 12 - and Texaco. The pipeline has a capacity of 250,000 barrels/day and could be expanded to a maximum capacity of 400,000 barrels/day. The Government is also contemplating exports of petroleum by river to the Atlantic. 28. Ecuador has substantial proven reserves of petroleum. At the present state of technology the ultimate recoverable oil reserves in situ are estimated to be in the order of 5.3 billion barrels. This includes about 1.5 billion barrels of proved reserves lying in the Consortium area as well as probable reserves requiring further exploration. 29. Exploration has come to a virtual standstill, as evidenced by the falling number of exploration wells completed: 1970 (20), 1971 (17), 1972 (20), 1973 (9), 1974 (6), 1975 (3), 1976 (1). It would take some US$375 - 400 million in additional investment over five to seven years to increase proved reserves from two to about three billion barrels. This is required if the production level is to be increased to 350,000 or 400,000 barrels/day (about 115 - 130 million barrels/year) in the 1980's and sustained at that level without decline in the reserve/production ratio. Such an investment program would mainly include further development drilling, additional production facilities, secondary recovery facilities, the connection of new oil fields to the production facilities and the expansion of the throughput capacity of the pipeline; unless undertaken, the decline rate of output may be sharp in the early 1980s. 30. CEPE has assumed a broad range of responsibilities in production, transport, refining, distribution, etc., and is yet to be equipped with sufficient technical, managerial and financial capabilities to undertake on its own an ambitious exploration and development program. The Government is aware of the need to stimulate investment in petroleum. It's policy is to strengthen the financial capacity of CEPE by allocating additional investment resources to the corporation. CEPE plans to step up exploration and develop- ment investment during 1977. At the same time private investment will be encouraged. 31. As a result of this investment effort petroleum production should gradually increase without decline in the reserve/production ratio, which is a little under 20 years. If the effort begins in 1977 production could be expected to reach 250,000 barrels/day sometime during 1978 and to average 260,000 barrels/day in 1979, including some 10,000 barrels/day shipped to the Atlantic by river. Further expansion of petroleum output would require the expansion of the throughput capacity of the trans-andean pipeline and/or the development of fields outside the Consortium area. Ecuador's in situ reserves warrant an expansion of production, should the Government wish to step up petroleum exports. But it might be unrealistic to expect petroleum production to reach 350,000 to 400,000 barrels/day before the mid-1980's. 32. The trend in domestic consumption of petroleum products plays a central part in shaping the sectoral potential. The increase in domestic consumption has been sharper in Ecuador than in most other Latin American countries (12.1% per year during 1970-75, compared to about 6% for Latin  - 13 - America). There is no doubt that this trend is related to the heavy subsidi- zation of petroleum products in Ecuador. The following table shows recent retail prices in US cents per gallon 1/ for a range of common petroleum products in selected countries: COMPARATIVE PETROLEUM PRODUCT PRICES (USe/gallon) Ecuador Peru Venezuela Mexico Colombia Premium gasoline 18.6 121.0 31.0 61.7 18.5 Regular gasoline 16.4 76.0 - 43.1 - Diesel 14.2 10.9 - 9.8 - Kerosene 10.4 11.3 - - - Residual fuel 8.56 10.0 - 5.3 - Ecuadorean prices are among the lowest in the world and entail an implicit subsidy estimated at US$440 million during the 1972-75 period. The subsidy involves a squeeze on revenues for producers of petroleum and petroleum products for the domestic market. 33. Continued underpricing of petroleum products will erode export earnings to the extent that domestic consumption is allowed to continue grow- ing unreasonably fast. The value of continued subsidies at the present level will be at least US$250 million per year by 1980 at 1976 prices. 2/ Given the lack of large and dynamic non-petroleum exports, the country would pay a very heavy price for continued subsidies in slower growth and lower government revenues. The Government has been studying a revision of petroleum subsidies, but no decision has been taken yet to increase prices. The main direct beneficiary of present prices is the transport sector, which "absorbs" 70% of subsidies, followed by industry (23%), commerce (4%) and-home consumption (3%). 3/ 1/ Gallons are often 3.75 liters in Ecuador rather than 3.785; the difference does not alter the conclusion that petroleum products are extremely under- priced. 2/ Based on difference between domestic sales at present prices (US$1.48/ barrel) and domestic sales reflecting world prices for petroleum. 3/ No study exists of the ultimate incidence of the subsidy; given the fact that the trucking and busing industry is fairly competitive in Ecuador, it may be presumed that the main beneficiaries are the ultimate users of transport services and the producers of transported commodities.  - 14 - 34. The following table shows a plausible projection of petroleum production, consumption and exports, along the lines outlined in paragraph 31 above. The projection of domestic consumption (about 10.6% annual growth) is somewhat, but not much, below the 1970-75 average rate. Hence it does not reflect possible sharp increases in the real prices of petroleum products. Should prices be increased it is reasonable to suppose that the growth rate of domestic consumption would decline. But important as domestic pricing is, changes in prices alone cannot be expected to yield large additional exports. For illustration, if domestic consumption grew at 8% per year starting in 1977, rather than at the 10.6% projected here, exports would be higher by 1.36 million barrels in 1980, or about US$20 million at current prices. 1/ PRODUCTION, CONSUMPTION AND EXPORTS OF PETROLEUM (million barrels) /a 1977 1978 1979 1980 1981 Crude oil production 72.5 81.7 85.8 87.9 90.2 Domestic consumption 17.5 19.3 21.3 23.4 25.7 Exports 55.0 62.1 64.5 64.5 64.5 Export value (current US$ million) 708 862 963 1,029 1,099 /a The conversion of million barrels/year into thousands of barrels/day varies according to technical factors, but is usually based on 330 days/year. 35. As mentioned earlier, CEPE now has the major responsibility for petroleum management. Therefore the state of preparation of its investment program and the financial and managerial capability of the agency will have a decisive influence. At the moment, the agency is over-extended, and it will take several years to train a sufficient number of managers and technicians to undertake a major successful investment program with its own staff. CEPE salaries are too low to attract enough top personnel from the private sector. Some investments can be made on a turnkey basis (like the Esmeraldas refinery), but a combination of rigorous planning, better coordination with other public agencies and strong financial support is required even then. Lack of proper planning has led to a situation where the transport outlet for the Esmeraldas 1/ The US$20 million represents the additional exports that would be freed if domestic consumption slowed down its growth rate.  - 15 - refinery will be completed only several months after the refinery has become operational, thereby immobilizing about US$150 million in new investment, and causing a loss of revenue for CEPE. Furthermore, the subsidization of domestic sales of petroleum products deprives CEPE of revenue and makes it dependent on government transfers for its investment. 36. Among CEPE's major investment projects are additional exploration and development of CEPE areas, further refining capacity, a natural gas plant at Shushufindi, an ammonia/urea/methanol plant based on the natural gas of the Gulf of Guayaquil, a petrochemical complex, and various pipelines. Many of these projects may require external financing. 37. In sum, the central problem is that conventional crude reserves in the Amazon basin are now being extracted faster than they are being replaced owing to the virtual absence of exploration and development activity. Unless sustained investment in exploration and development is resumed crude petroleum exports are unlikely to increase and may well decline soon. In order to avoid such a situation the Government plans to step up public investment in the petroleum sector during 1977 and to encourage complementary private investment. As a first step the Government intends to increase output to the present capacity of the trans-andean pipeline by 1978. Further increases in production are feasible during the 1980's, provided the investment effort is sustained over the next five to six years. 38. Ecuador also may have good prospects for natural gas exploitation in the Gulf of Guayaquil. The geological possibilities of discovering commercial reserves are to be explored. If sufficient amounts of natural gas are found, this could be used as feedstock for a proposed fertilizer industry. It is therefore urgent to step up exploratory drilling activities. Agriculture 1/ 39. Ecuador is among the few developing countries with enough fertile land to expand output at reasonable cost. The Guayas Basin, the Northern Costa (particularly the province of Esmeraldas which includes areas that have yet to be opened up) as well as parts of the Sierra (where there is much scope for yield increases) are promising in this respect. Over the years, years, agriculture, including livestock and fisheries, has played a leading role in employment, exports and output, but its relative contribution has gradually declined as other sectors grew rapidly. Over much of the past decade agricultural production has lagged behind the needs of the expanding population, and this has been reflected in a steady rise in food imports (imports of wheat, vegetable oils, animal fats, milk products and oats alone increased from US$14.5 million in 1970 to about US$60 million in 1975). Many of the imported items could be economically produced in Ecuador, but this 1/ A more detailed discussion is presented in Annex I.  - 16 - would require an effective extension system, improved marketing conditions and a re-orientation of research (see recommendations below). More rapid agricul- tural growth is required if the living standard of the majority of the poorer Ecuadoreans is to improve. 40. A basis for increasing agricultural production has been laid through the work of INIAP (Instituto Nacional de Investigaciones Agropecuarias), the agricultural research institute of the Ministry of Agriculture. Over the past 14 years INIAP has been concerned with research and experimentation on rice, corn, wheat, barley, oats, oilseeds, oil palm, bananas, cocoa, coffee and livestock, including beef, dairy animals and swine. Through these efforts INIAP has accumulated valuable information and technology adapted to some of the country's major needs. The problem is to transfer this to the majority of farmers and enable them to put it to use. A policy package involving exten- sion, research, credit, price supports, marketing and rural development including a national program of all-weather feeder roads could go a long way toward solving this most difficult problem and giving the sector a renewed impetus. 41. The present technical assistance service provided by the Ministry of Agriculture does not meet the needs of the farmers. First, the technical assistance personnel is small and its services reach a minority of farmers. Second, the technicians specialize in individual crops, and do not advise farmers from the standpoint of their total farm operations. The existing system could be replaced by an agricultural extension service capable of advising on "farm management". The organization would absorb the staff now employed in crop-by-crop technical assistance, improve training, and hire additional staff in order to reach more farmers. 42. While INIAP is the research arm of the Ministry of Agriculture, an established agricultural extension service could be its educational arm. Both could have the same organizational status. Such an undertaking would also require developing a national extension training program and establishing institutional relationships (e.g. with universities) to help build capabili- ties with improvements in agricultural curricula including extension tech- niques. With necessary backstopping of qualified subject-matter specialists and trained supervisors such an extension service would operate on a regional basis through offices and sub-offices providing services tailored to meet local farm needs. 43. An effective extension service would bring more and more farm prob- lems into the open. Thus, INIAP needs to intensify and expand its research and development work in anticipation of oncoming requirements. INIAP could increase its emphasis on applied or adaptive research in such areas as fruits, vegetables, poultry and pulses. Attention should be given to oilseeds, particularly soybeans in view of the need to increase output to replace imports. Practical research is also needed to bring about the introduction of grain sorghum, which could lower feed grain prices. While INIAP had done considerable work in cattle, there remains a need for more aggressive applied  - 17 - research. The general areas involve nutrition and health deficiencies, conception and reproduction failures, high mortality rates among calves, and other problems of a similar nature, which have held down meat and milk produc- tion. Small farm management studies should be undertaken and incorporated into the applied research program. 44. Even though the volume of agricultural credit has increased rapidly during the 1970s, only a small fraction of farmers (under 10%) have access to credit from institutional sources. 1/ The Banco Nacional de Fomento (BNF), provides almost 70% of total institutional credit to agriculture. Crops financed by BNF cover only about 13% of the country's total harvested area. Furthermore, agricultural credit is concentrated on a few crops: of BNF's total 1975 credits for crop production, 42% was for rice and 17.6% for cotton. BNF can undoubtedly improve its credit operations particularly by increasing the volume of medium and long term credit. Other institutional sources of credit such as private banks and the Cooperatives' Bank should also play a larger role. Since institutional credit is generally less costly than other forms of credit, the critical issue is access and improved institutional capability. Finally, the basis for lending should be the individual farm as a business enterprise, its credit needs and creditworthiness. 45. Price policies are carried out through price supports and subsidies, price controls, and different regulatory actions affecting exports and imports. Policy remains heavily consumer-oriented, even though in the past two years there has been a modest change in favor of producers. Price controls or guidelines are in effect at the wholesale and retail levels for a large number of food items, including meat, milk, sugar, rice and wheat flour. Producer prices notably of wheat, milk and rice, have been influenced by the Government. In 1975 a support price for wheat was announced shortly before planting time, but was later modified to the detriment of producers. At the same time, imported wheat sold to millers has been subsidized at substantial cost to the Government. Until a recent increase, the price ceiling on fluid milk (at producer and consumer levels) has led to diversion of production to cheese, butter and other dairy products, resulting in a shortage of consumer fluid milk supplies. The rice subsidy has been particularly costly in 1976. Pro- ducer prices were set so high that the production of rice increased sharply, exceeding domestic demand; owing to a lack of storage space and a decline in the world price of rice 26,000 tons had to be exported, at a cost to the Government exceeding US$4.6 million. 2/ 1/ It is not possible to estimate the share of investment credit, owing to the nature of credit statistics. 2/ Farmers were paid US$300-317 per ton; the f.o.b. price (Guayaquil) was US$177 per ton. Furthermore, the Government incurred marketing and storage costs.  - 18 - 46. From the standpoint of producers, price supports and subsidies can be useful tools as production incentives, provided they are suitably timed and directed, and are broadly consistent with the realities of the market- place. In order to avoid costly experiences, price supports should not as a rule exceed international price levels that may conservatively be expected to prevail once a crop is harvested. An analysis leading to specific recommen- dations on agricultural subsidies in Ecuador is beyond the scope of this report, but an effort of this kind is urgently called for. Such an exam- ination for each commodity covered should be concerned with the respective interests of producers and consumers (especially as classified by income levels), as well as with the costs and benefits to the national economy. 47. The present agricultural marketing system provides weak production incentives and lacks the facilities required in producing and marketing centers for orderly handling, storage, distribution, and utilization of output without undue waste. The most acute shortage is in adequate storage space, particularly in producing areas and at commodity assembly points. Small farmers have virtu- ally no on-farm storage facilities, and the harvest consequently may be left in the open. The price small farmers obtain for their marketed crops is dras- tically depressed owing to lack of storage. The total deficiency in storage facilities amounts to at least 250,000 metric tons. About 120,000 metric tons of storage space in the form of silos and warehouses is needed to meet the requirements of ENAC, the State Marketing Agency, for grain alone. Also, there is a need to improve facilities in major market centers, particularly in wholesaling foodstuffs in Guayaquil. 48. There is need for a package approach to the marketing problem, which at the start could consist of the following components: silos and warehouses, refrigerated facilities, wholesale market in Guayaquil, technical assistance and training in marketing, and the establishment of grades and standards as well as a market news service. In addition to public marketing improvements, encouragement should also be given to private enterprises, for example through government loans for private construction and maintenance of facilities for storing and handling agricultural products in the marketing chain. 49. Another serious problem is the lack of feeder roads which inhibits production and seriously impedes the rapid farm-to-market movement of products, especially perishables. The poorer producers who live farthest from the main roads are particularly affected. While a start has been made by the Ministry of Public Works in expanding the system of all-weather feeder roads, a stronger commitment is needed to ensure continuity of construction over a reasonably long period. 1/ It calls for a national strategy consistent with the require- ments for profitable agricultural expansion in the different provinces. For- mulation of this kind of strategy would not only involve the Ministry of Public Works, but also other government agencies, notably the Ministry of Agriculture. 1/ See Transport Section below.  - 19 - 50. Several regional public organizations are engaged in rural develop- ment. 1/ These include the Southern Development Program (PREDESUR), CREA, which operates in the Cuenca area, CEDEGE in the Guayas basin and others. One of the most active development organizations is PREDESUR. It channels public funds and external loans into 57 projects, most of them small. PREDESUR has a limited but high-caliber staff and operates through contracts with public and private agencies and firms for works such as construction of access roads, agricultural technical assistance services, reforestation, agricultural exper- imental stations, potable water facilities, experimental fish and shrimp farms, etc. PREDESUR uses petroleum revenues and external loans in a manner that brings public agencies into competition with private contractors. The experi- ence of PREDESUR and of the other regional development agencies may provide a basis for a national rural development program which would include all such agencies. A national rural development policy defining expenditure priorities and an effective administrative framework are needed as a basis for such a program. The recent creation of a rural development task force in the Planning Office (JUNAPLA) may help in defining a policy in this respect. Perhaps the most effective organization would combine a flexible field struc- ture with an operational central governing body in the capital, which would coordinate and allocate the material and financial resources on a project-by- project basis. In this way all relevant public agencies as well as private contractors could become involved in what might become a most important long-term effort to bring to the poorer areas the means for improving living standards. 51. There is need for departure from the piecemeal approach in planning and programming agriculture in favor of more comprehensive short-term and long-term goals. Coupled with this are the requirements for strengthened administration, control of sectoral activities, closer monitoring of programs, and improved overall integration and coordination. The major responsibility will continue to be with the Ministry of Agriculture. Besides improved courses of action and a more effective marshalling of human and financial resources, the Ministry of Agriculture needs to address the problems and needs of the individual farmers, because the farm operator and his or her motivation for producing, in the final analysis, determine actual output levels. A major concern of the Ministry of Agriculture should be to overcome existing program fragmentation with the resulting dispersion and duplication of effort and internal competition for limited financial and trained manpower resources. 52. In sum, unlike most developing countries, Ecuador has a good potential for agricultural expansion, including livestock and fisheries. The different lines of action mentioned earlier all form part of a package. They are complementary and mutually supportive. If a serious effort is made on such a package of policies and programs, there is no doubt that agri- cultural and livestock development will accelerate. This policy package could 1/ These organizations are trying to deal with regional development. The discussion in this section is concerned only with rural aspects of their activity.  - 20 - achieve a broad improvement in the living conditions of the bulk of the population, while at the same time serving the national development objec- tives. Furthermore, even a slight absolute improvement in the standard of living of the bulk of the rural population would represent a substantial relative improvement for the persons concerned. Industry 53. The manufacturing sector has developed quite rapidly during the past decade, owing to the existence of an active domestic entrepreneurial group and of a liberal environment including a fairly adequate institutional and legal framework. Because of the country's small size most manufacturing has been for import-substitution. A total of about 800 establishments (about one-half of all industrial establishments in Ecuador) have benefited from tax and import duty exemptions under the industrial development law. While this liberal environment may have led to excessive imports of capital goods in relation to Ecuador's resource endowment, it has undoubtedly encouraged the development of a reasonably profitable and dynamic manufacturing sector consisting almost exclusively of small firms. The main obstacles to further development are the shortage of medium and long-term investment credit, 1/ the uncertainty surrounding the treatment of foreign investment and the uncertain prospects for continued rapid expansion of export earnings, which may bring about a scarcity of imported equipment and raw materials. If physical condi- tions such as power shortages, poor communications, water and fuel shortages improve, this will also help stimulate industry, outside Guayaquil where these problems are not acute. 54. A recent report 2/ analyzes the main issues relating to the indus- trial sector. The Government is considering an ambitious industrial develop- ment strategy predicated on continued progress in Andean Group integration, which includes Venezuela, Colombia, Ecuador, Peru and Bolivia. This strategy notably includes the development of a steel industry based on the natural gas of the Gulf of Guayaquil, of a petrochemical complex, of an automobile indus- try, and of the further development of metal-mechanical and agro-industries. A thorough study of the viability of the steel industry is required before 1/ Resolutions No. 894 and 927 of the Monetary Board have recently estab- lished a new system of commissions for medium and long-term financing, which raises effective interest rates to an average of about 15 percent; this is intended to promote the development of financieras and thereby to increase the supply of medium and long-term industrial financing. These rates also apply to loans in other productive sectors. 2/ "Industrial Development Problems and Prospects -- Ecuador" (Report No. 1186-EC, October 7, 1976).  - 21 - proceeding with the project because Ecuador has no iron ore and the costs of production are likely to be high, especially if the required port facilities are included in the costs. Furthermore, natural gas might be used more economically for other purposes. An efficient petrochemical complex requires large additional amounts of refined petroleum products. Therefore it may not be warranted to plan on building a petrochemical complex before the 1980s. The prospects for setting up a viable automotive industry producing for Andean market should be thoroughly reviewed before a decision involving public funds is made, so as to avoid the high unit costs typical of similar enterprises in other Latin American countries. Conversely, good prospects for growth and exports exist in agro-industries, particularly if agricultural and livestock policies develop along the lines outlined elsewhere in this report. Likewise, there is scope for expansion in many light metal-mechanical industries. Finally, the feasibility of the ammonia-urea plant will depend on whether enough natural gas is found in the Gulf of Guayaquil and on the world market for fertilizer. 55. In sum, Ecuador's industrial sector has been quite successful so far, based on the expansion of small private firms in a great variety of activities. As some of the main obstacles to development are gradually removed (especially the shortage of medium and long-term credit and the defi- cient infrastructure) continued rapid expansion can be expected without departing greatly from the successful historical pattern. The introduction of large-scale industrial projects involving substantial direct public par- ticipation might divert scarce physical, financial, technical and managerial resources to the detriment of the economy, unless the economic and social merits of such projects at least equal those of private projects. Electric Power 56. Even though electricity output and consumption have increased rapidly in recent years, Ecuador is among the Latin American countries with the lowest installed capacity per head. Demand, which has been growing at more than 13% per year in the recent past, is forecast by INECEL to continue to grow at a rate of 12-13% per year during the next decade. Consequently, there is a need for expansion in generation and transmission. Fortunately, Ecuador has a good potential for hydroelectric expansion. 57. Substantial progress has been made toward the creation of a unified national power system. INECEL is responsible for power sector planning and financing, construction and operation of a national grid, organization and supervision of regional systems for power distribution and sector regulation, including the setting of tariffs. INECEL receives some US$60 million each year in petroleum revenues. Tariff regulations have been set out by decree, which prescribe that all electric power companies will have to revalue assets and attain an 8.5% rate of return on investment by the early 1980s. In the past INECEL's role was limited to providing subsidies to small power companies, most of which operate at a loss, owing to low productivity and low tariffs. 58. INECEL's proposed National Electrification Program provides for the completion of the Pisayambo plant (a 70 MW hydroelectric plant which will  - 22 - serve parts of the Sierra including the Quito area) , and of the Paute plant (a 500 M4W hydroelectric plant in the Cuenca area, 200 MW of which should be installed by 1982). Work on another hydroelectric project (Toachi) might begin in the early 1980s. In addition, INECEL plans several complementary thermal units (204 MW for the Guayaquil area to be completed by 1979, 30 MW for Quito planned for completion in late 1977 and 100 MW for Santo Domingo now at a preliminary stage of study). Finally, transmission investment in the order of US$220 million is being contemplated. Altogether these works, which do not include rural electrification, would cost some US$1.2 billion over the 1977-85 period and would increase Ecuador's installed capacity from 551 MW to about 1,455 MW. 59. Clearly this program is ambitious, especially in the light of INECEL's limited experience, which may lead to substantial delays. The problems en- countered in the construction of the Pisayambo hydroelectric plant point to possible pitfalls. The concept of the plant was changed (from multi-purpose to pure energy generation) and, owing to construction delays, costs have es- calated substantially. As a result, the cost of electricity from Pisayambo sold in Quito will exceed 30 US mills per KWH, which is high for hydro- generated power. The completion date of the much larger Paute project has also been postponed several times. 60. The need for substantial foreign and local financing may also result in delays in implementing the program. Until the Paute unit begins to produce power in 1982, petroleum revenues allocated to INECEL and the utility's own internal cash generation (which is expected to be very small), may cover about one-half of the annual investment costs. The balance of the requirements would have to be borrowed, and the amounts involved are large for Ecuador. 61. Part of INECEL's present financial difficulties reflect the oper- ating deficits of nearly all regional distribution companies which INECEL has a legal obligation to support. Only the Quito enterprise can do without INECEL subsidies. Substantial tariff increases would be required in all power companies, especially in the local and municipal ones, if the 8.5% rate of return on investment prescribed by the electricity legislation is to be attained. 62. Owing to government regulations, the fuel purchased by all thermal generating plants in the country (including private factory-owned units) is sold at less than one-third of the world price. If the world price were charged, electricity rates would have to go up by at least 50% to maintain present rates of return of the power companies. This subsidy favors the use of petroleum products and cannot easily be justified socially and economically. 63. The Government plans to expand the electrification of the rural areas and has instituted a 10% surcharge on industrial and commercial tariffs to finance such a program. At present only about 8% of the rural population is connected to a source of electric power. Owing to low per capita incomes and the geographical dispersion of the rural population, rural electrification  - 23 - cannot be expected to be financed by users alone. The amount of the needed government contribution will depend in part on the extent to which the program (which has not yet been formulated) emphasizes social improvements in the form of domestic consumption, or economic improvements in the form of farm electri- fication. The technical aspects of rural electrification do not pose problems, but the program would add further to INECEL's managerial burden. Its finan- cial viability will hinge largely on the careful selection of investments, the application of appropriate tariff policies and on effective collection of the rural electrification surcharge. In view of INECEL's other urgent tasks, a step-by-step approach might be most prudent (for example a US$20 million program over three or four years to begin with). 64. A review of the national electrification investment program is advisable, given the magnitude of the problems to be resolved prior to its implementation and the heavy impact which its financing will have on Ecuador's future indebtedness. INECEL should update the underlying market forecast and consider which items could be reduced or postponed in order to make the program more manageable and financially viable. In addition to strengthening INECEL's capability to plan and manage its operations, the Government will have to consider whether it is realistic to expect the utility to discharge the wide range of functions allocated to it. Finally, the Government should decide whether to continue subsidizing the use of petroleum products in electricity generation. Transport 65. Ecuador's geography is forbidding from the transport point of view. The railroad between the coast and the Sierra, for example, is one of the steepest of its kind, ascending by about 10,000 feet in less than 50 miles. The Sierra itself is divided into numerous separate valleys. While the Costa is relatively flat, high rainfall in some areas and adverse soil charac- teristics make highway construction and maintenance costly. Most transport in Ecuador is by road. 66. The institutions dealing with transport at the levels of municipal- ities, provinces, and local entities are greatly affected by regionalism. This makes it difficult for the Central Government to devise or carry out a balanced national program. Furthermore, coordination between the transport sector and other sectors of the economy, notably agriculture, is limited. This is important, for example, in planning feeder roads. 67. The first priority should be to improve road maintenance. The sorry condition of many main roads suggests that much more could be done in this area. Better maintenance would obviate the need for periodical recon- struction of highways. A substantial proportion of the rural population is cut off from the highway system, particularly when it rains. This impedes agricultural progress among the poorer farmers (see agricultural section above). The Government's national feeder road program, which absorbs about one-third of the Ministry of Public Works' investment budget should therefore continue to receive the highest priority. Second, there is a need to improve  - 24 - the trunk road network between the major towns. The ambitious railroad modernization program prepared by SOFRERAIL cannot be justified so long as road transport is subsidized to the extent it is now. Even under the most favorable set of circumstances the proposed railroad modernization program is unlikely to have a positive rate of return on investment. Expansion of small airports and of small ports (notably Esmeraldas) should all be weighed once the feasibility studies have been critically reviewed. In sum, the main priorities in transport are (a) improving road maintenance while completing the trunk road system; (b) carrying on with the feeder road program, and (c) increasing road user charges to a more realistic level. 68. Only ports and pipelines cover their expenditures from revenues earned for the services provided. The extraordinarily low price of gasoline has encouraged road transport, and user charges do not cover the costs of an adequate level of maintenance. Consequently, there is an urgent need on these grounds alone to raise the domestic price of petroleum derivates to cover at least their costs of production. The sharp decline in rail freight during the past few years is also associated with the subsidization of road transport. Education 69. There is scope for increasing the number of well trained personnel in the public sector, industry and other productive sectors of the economy. Strengthening the education system and making it more responsive to the needs of an expanding economy are necessary conditions for further social and economic progress. There are no plans at present, however, to strengthen the education system. 70. Household survey show, as might be expected, a close relationship between education and income. Furthermore, the following table suggests that the income spread between persons without schooling, and persons with primary and secondary education has remained stable between 1968 and 1975.  - 25 - INCOME AND EDUCATION Index of Index of Average Average Education Level Income /1 Income /2 (1968) (1975) None 100 100 Lower primary education 133 166 Upper primary education 173 Lower secondary education 228 268 Upper secondary education 382 Higher education (lower) 570 461 Higher education (upper) 882 Average 230 /1 Urban and rural. /2 Urban only. Source: Sector Analysis of Elementary Education, Ministry of Education, 1975, and Encuesta de Poblacion y Ocupacion, Area Urbana, 1975. Since the mid-1960s most of the expansion in the education system has been at the secondary and higher levels, where, as the above table suggests, the scarcity of graduates is greatest. The following table shows the respective trends:  - 26 - TEACIHERS AND STUDENTS (1965-74) Indices (1965-66 = 100) 1965-66 1970-71 1974-75 1970-71 1974-75 Primary students 800,507 1,018,438 1,234,217 127 154 Primary teachers 21,429 26,625 31,114 124 145 Ratio (primary) 37.4/1 38.3/1 39.7/1 - - Secondary students 117,268 216,727 334,465 184 285 Secondary teachers 9,230 15,699 20,677 170 224 Ratio (secondary) 12.7/1 13.8/1 16.2/1 - - University students 15,395 38,857 114,389 252 743 University teachers 1,754 2,867 4,771 163 272 Ratio (higher) 8.8/i 13.6/1 24/1 - - Ratio of secondary/ primary students 14.6/100 21.3/100 27.1/100 - Ratio of university/ primary students 1.9/100 3.8/1 9.3/100 - Source: Ministry of Education. While primary school coverage increased during the last decade, the quality of education has not improved. Many rural schools only offer one, two or three grades. This level of education is associated with an income well below the average. Furthermore, curricula in rural areas have not, with a very few exceptions, evolved toward preparing children for earning a living in agri- culture or livestock activities. The continued severe deficiency in primary education has been accompanied by substantial increases in costs: primary teachers' basic salaries went up from about S/.600/ month in 1966 to about S/.3,000/month in 1976, more than doubling in real terms, without apparent improvement in quality. There is a clear need for more efforts to make full primary education available, particularly in the rural areas, and to shift instruction to subjects that will be useful to pupils once they leave school. The ongoing rural development ("nuclearizacion") program is a first step toward providing at least the physical facilities required. 71. The table on teachers and students suggests that the number of university students has increased much beyond the ability of the system to  - 27 - educate them. This is a result of a more and more liberal access policy for secondary school leavers, which has been reflected in a sharp decline in quality of instruction. So, for example, there are now 500 - 600 medical students at the Quito University, when capacity is about 100. In the country as a whole, there are now over 2,000 medical students when the capacity is 500. A policy which centers on the quantity of students at the cost of a sharp decline in quality will not contribute to alleviating the country's acute shortage of qualified cadres. Far from reducing inequality at the university level, the lowering of standards puts an extra premium on education abroad, which only very few Ecuadorians are in a position to obtain, and thus exacer- bates the difference between the majority of students and a small privileged minority. Nor will this policy improve the social and economic opportunities of the poorer people, since very few of them have access to secondary school or indeed to complete primary school. What is needed is an increase in the share of resources for primary and technical education (along the lines of SECAP with emphasis on agriculture as well as industry), and a corresponding decrease in the share for universities, which have absorbed a disproportionately large share of funds in the past few years. Housing and Urban Development 72. The housing shortage cannot be estimated quantitatively in the absence of relevant statistics. But the need for improvement is clear from the 1974 housing census and from a household survey of Guayaquil slum dwellers. The census suggests that lack of adequate water supply is a pervasive problem. Of all houses only 42% benefit from public water supply (whether in the house or in a nearby street). The worst shortage is in the rural areas (87% of houses without connection); among urban centers, the worst shortage exists in the Guayaquil area, in the northern province of Imbabura, and in the coastal provinces of Esmeraldas, Manabi and Los Rios. Altogether, over one million urban population have to rely on wells, cisterns, or have to purchase water from trucks (usually at high cost). About 5% of houses, probably sheltering some 350,000 persons, rely on trucks for water; of these, 65% are in the Guayaquil area. 73. Of Ecuador's total population of 6,552,046 (1974 population census), 41% are urban (2,706,677). The census data underestimate the urban popula- tion, however, because the distinction between "urban" and "rural" is adminis- trative and does not depend on the size of the towns and villages where people live. The Guayaquil area has experienced the fastest large scale urbanization, owing to a high birth rate and to considerable migration. The slums surrounding Guayaquil are therefore of particular interest. Most houses are built on stilts above the rivers. There is no industry in the slum area, apart from a few small businesses (making cement blocks, furniture, matresses, clothing, etc.) and artisan shops. Of persons over the age of seven, 42% are functionally illiterate 1/ and umemployment is very high. Of those employed, most men are craftsmen, workers or vendors, and most women are employed in 1/ A.I.T.E/R.E.D.A.M. "Encuesta socio-economica", August 1974.  - 28 - personal services or as craftswomen. Expenditure on food absorbs 42% of family income. Interviews with "community leaders" clearly show the perceived priorities: 53% of those interviewed stated that potable water was the first priority; the next priorities perceived are sewerage, drains and public lighting. Significantly, the poorest slum families spend almost 2% of their income on water; their absolute expenditure on water exceeds that of the more affluent residents. Even if full operating and maintenance costs are charged for public water supply, the poorer residents would pay less than they do now purchasing water from trucks. Further investment in water supply is also required in the areas surrounding the city of Quito. 74. The Ecuadorean Housing Bank has introduced some imaginative policies to help low income families acquire houses. Interest rates on mortgages vary according to income; no downpayment is required in certain cases for low in- come families. Furthermore, the Bank has legal powers to expropriate land against compensation and to prepare "sites and services". The cheapest houses financed in 1976 cost about US$3,000. Unfortunately, the scope of the Housing Bank is very small in relation to the needs. Since experiments with self-help housing construction have not been successful in Ecuador, an expansion of housing credit for conventional construction possibly coupled with investment in "sites and services" might be the most appropriate way to reduce the housing shortage.  - 29 - CHAPTER III PUBLIC INVESTMENT PROGRAM AND DEVELOPMENT PROSPECTS 75. The Government is expected to undertake a significant development effort in the next five years through stepped up public investment in key sectors of the economy. The main sources of financing are expected to be increasing petroleum revenues and substantial foreign financing. Ecuador's ability to achieve its development objectives will be closely related to the following issues: (a) the maintenance of a reasonable balance between petroleum production, domestic consumption and exports on the one hand and the absorptive capacity of the economy and in particular of the public sector on the other; (b) the continuation of austerity measures in the public sector to generate adequate savings to finance the local cost contri- bution to a significantly expanded public investment program; (c) careful consideration by the Government to project selection and their priorities, as well as to a balanced composition of public investment; (d) measures to accelerate the growth of agriculture and sustain the momentum of industry to increasingly satisfy domestic demand and generate new sources of exports and growth. The first three issues are dealt with in the following sections. The last one in Chapter II. Growth and Petroleum Prospects 76. The economic outlook is closely related to petroleum developments and public investment levels. In the immediate future petroleum production and exports are the main determinants of GDP growth. In order to raise petro- leum production it will be necessary to channel substantial revenues into investment for exploration and development. At present it seems feasible to increase production to 260,000 barrels/day by 1979, provided the measures out- lined in paragraphs 30 and 31 above are taken. This is one of the most critical issues for economic management and the development prospects of the country. 77. Assuming petroleum production of 260,000 barrels/day by 1979 and public investment growth of about 12% per annum (in real terms), the real rate of growth of the economy can be expected to exceed 6% per year for the period  - 30 - 1977-81. 1/ Growth rates might be even higher if petroleum production is raised above 260,000 barrels/day. Growth projections for the public invest- ment program represent a significant slowdown from the 28% real annual rate of the last three years. Yet public investment would still grow faster than private investment, and increase its share in GDP. Public investment projec- tions take into account the preparation stage of projects and the absorptive capacity of the public agencies involved. Absorptive capacity is low in some of the key agencies of the public sector, and the projections aim at a real- istic assessment of what can be done without seriously straining the construc- tion sector and without exerting undue inflationary pressures. 78. As the investment plans are implemented, fixed private investment may rise at a real rate of 9% per year in the period 1977-81. Private invest- ment was very dynamic in 1974 and 1975, particularly in the industrial sector. Some slowdown occurred in 1976, perhaps because of over-expansion in earlier years. It is assumed that private investment will regain its dynamism, spurred on by domestic demand and the expansion of exports. 79. Total investment would expand at a rate of 11% per year in real terms during 1977-81 if public and private investment grew as projected above. A substantial increase in external financing would be needed as the resource gap and the current account deficit of the balance of payments widen. The savings rate (domestic savings as a percent of GDP) would remain high during the period. If the ratio of investment over GDP goes up as projected, the share of investment financed out of foreign savings would have to increase slightly (see Table 2.9 Statistical Appendix). 80. Government consumption is expected to grow at a real rate of 6% per year compatible with operating expenditures related to the investment program and other services. This expansion would be in line with recent trends and with the Government's policy of avoiding excessive demand pres- sures originating in public expenditure. Private consumption could under these assumptions follow a growth path somewhat below that of non-petroleum GDP (about 5% real annual growth). Public Sector Prospects 81. Given the substantial public investment effort contemplated by the Government, present austerity measures would have to be continued in the future to (a) maintain the global deficit of the Central Government at a level compatible with liquidity conditions and price stability; (b) maintain the current savings capacity of the public sector and allow the financing of a significant share of the public investment program, and (c) allow an increasing flow of banking credit to the private sector. 1/ Price rises for the period 1977-81 are considered to be at the level of 8-10% experienced lately. This is based on a rate of international inflation of 7.5% per year for the period and the continuation of present prudent monetary and fiscal policies.  - 31 - 82. Revenue projections hinge on developments in the petroleum sector. In 1975, petroleum revenues (including royalties and CEPE's surplus on oil exports) represented about 9.5% of total GDP and almost 47% of total fiscal revenues. If petroleum output rises to 260,000 barrels/day by 1979, petroleum revenues of the public sector can be expected to grow by 17.5% per year to US$1,080 million in current prices by 1981. 1/ If most of the increase in petroleum revenues is channeled to FONADE and CEPE the annual rate of growth of current revenues of the Central Government would be 14.3% at current prices (see Tables 5.8 and 5.10, Statistical Appendix), but unless measures are taken, non-petroleum revenues are not likely to be very dynamic. 83. Assuming the continuation of austerity policies, current expendi- tures are projected to increase at an average annual rate of 6% in real terms. This rate is based on the assumption that the inflationary impact on wages and salaries in the public sector, as well as increases in public employment are minimized, yet be consistent with development objectives and the investment program. Nevertheless, in view of the rising level of public investment it is reasonable to assume a need for higher current savings in the early 1980s. To achieve higher public savings, the Government could: (a) reallocate present petroleum revenues as well as channel new increases in petroleum revenues into investment; (b) raise tariffs and prices of goods and services provided by public agencies, particularly for electricity, gasoline and petroleum products so that energy agencies can finance a reasonable share of their investment out of their own savings; (c) improve tax administration and revise non-petroleum taxes. 84. Should petroleum revenues become less dynamic, non-petroleum taxes will have to provide additional revenues. To this end, overall tax adminis- tration and control needs to be greatly improved. For the short run the Government has already devised measures to minimize income tax evasion 2/ such as changing inspection methods, more frequent inspections, and computerizing taxpayers roll. For the medium and long term more strict and comprehensive tax measures may be called for. With improved cadastral information a raised assessment value and tax rate on real estate could make the municipalities and provincial councils less dependent on Central Government budget support. Sales tax yields have been inadequate owing to evasion in retail and wholesale trade, hotels and restaurants. An increase in the value added tax would offset the slow growth of foreign trade tax revenues reflecting continued progress in Andean group integration. Corporate exemptions merit careful review--with industrial development the revenue loss may prove to be substantial. 1/ Including general government and petroleum revenues of INECEL and CEPE. 2/ At present only 180,000 people pay income taxes.  - 32 - 85. Since gasoline prices at present are among the lowest in the world, gasoline taxation increases are especially warranted. Increases in the gasoline tax and/or prices are particularly important because of its distri- butive incidence and because of the need to cut down domestic consumption. One portion of the price raise could accrue to CEPE for savings, while another could go to the Central Government for allocation to other agencies. With the CEPE refinery at Esmeraldas due to start operations during 1977, there is an opportunity to revise the subsidy on gasoline. 86. In sum, present austerity policies of the public sector would have to continue in the future in order to maintain an adequate level of current savings and provide the local counterpart funds required for the expanded public investment. Given the magnitude of the proposed public investment effort additional measures might be required in non-petroleum taxes and gaso- line taxation. Public Investment Program 87. Weak project preparation has traditionally been one of the major obstacles to social and economic development in Ecuador and improvement is particularly needed in agriculture and rural development, education, health and industry. The creation of the National Preinvestment Fund (FONAPRE) in 1974 is an important step in the direction of better project preparation. Nevertheless, much remains to be done in this area. Over the next five years the government plans to make a substantial investment effort consistent with the likely financial resources of the country and the anticipated improvements in project preparation and execution. The program would involve an annual increase in public investment of about 20% per year (12% in real terms). 88. Public investment has increased rapidly during the past three years and is estimated to have reached a level of US$460 million in 1976. The Government's public investment program for the years 1977-81 is likely to average disbursements of about US$654 million per year during 1977-81. The total commitment cost of the public investment projects requiring external financing for this period is in the order of US$4.3 billion (US$3.8 billion without financial investment). Tables 1 and 2 of Annex II show the list of public investment projects, their likely costs and the distribution of exter- nal loan commitments over the 1977-81 period. tlajor investment is concen- trated in agriculture, petroleum, power, transport and industry. The program (including financial investment) would require external financial commitments in the order of US$2.8 billion. 89. The following table shows the distribution of public investment by sectors. Investment in the order of US$900 million is included as "Other Investment" to accommodate projects identified in the project list whose economic feasibility has not yet been determined. These commitments are mostly in 1980 and 1981. Financial investment by public intermediaries mostly for agriculture and industry is also included.  - 33 - PUBLIC INVESTMENT PROGRAM 1977-81 Sector Estimated Total Cost Distribution (US$ million) (percent) Agriculture 407.3 9.5 Petroleum 531.3 12.3 Power 645.0 15.0 Industry 354.1 8.2 Transport 376.6 8.7 Tourism 26.6 0.6 Telecommunications 95.4 2.2 Public Health 105.5 2.5 Education 36.5 0.8 Urban Development 88.0 2.0 Water and Sewerage 131.8 3.1 Fisheries 67.5 1.6 Preinvestment 30.0 0.7 Other Investment /1 900.0 21.0 Total 3,795.6 88.2 Lines of Credit 505.7 11.8 Grand Total 4,301.1 100.0 /1 Refers to projects included in the Project List, whose economic feasibility has not yet been determined. Agriculture 90. The Government's public investment program in agriculture represents a substantial increase over the past levels. It reflects a desire to increase investment in rural development projects while continuing investment in commodity-centered projects. The following table shows an investment level of US$407.3 million for 12 projects There would be an additional level of commit- ments of financial investment, in the form of agricultural production credits to farmers, mostly through Banco Nacional de Fomento (BNF). Of particular importance is a US$75.0 million credit for a Cocoa Rehabilitation Program which would provide credit to the cocoa farmer, giving particular attention to the needs of the small farmer.  - 34 - PUBLIC INVESTMENT PROJECTS IN AGRICULTURE 1977-81 Total Estimated Estimated Estimated External Year of Project Cost Financing Commitment (US$ million) (US$ million) 1. Agricultural Marketing and Storage 58.6 12.0 1977 10.0 1978 20.0 1979 2. Tungurahua Rural Development 30.0 15.0 1978 3. Puerto Ila-Chone 40.0 20.0 1979 4. Milagro II 40.0 20.0 1978 5. Guayas Water Management 40.0 20.0 1981 6. Cayambe Rural Development 20.0 10.0 1980 7. Forestry Development 20.0 10.0 1981 8. Esmeraldas Rural Development 50.0 25.0 1981 9. Manuel J. Calle Irrigation 21.0 10.9 1978 10. Latacunga-Ambato Irrigation 18.2 10.0 1977 11. Colonization Nangaritza 19.2 11.5 1978 12. Carrizal Chone Irrigation 28.8 14.2 1979 13. Forestry Development 21.5 2.4 1979 Total 407.3 211.0 Source: Annex II, Table 2. Petroleum 91. Public investment in petroleum is to be carried out by CEPE. A major portion of the programmed investment involves the five-year development program, aimed at a gradual increase of petroleum production in line with the Government's policies outlined in Chapter II. This program will require com- plementary private investment. Public investment in development and explora- tion has been estimated at US$230.9 million. The table does not include financial investment involved in payments for purchase by CEPE of Consortium shares of the Gulf Oil Corporation. Other major investment includes the exploitation of the Gulf of Guayaquil gas through the construction of an ammonia-methanol plant.  - 35 - PUBLIC INVESTMENT PROJECTS IN PETROLEUM 1977-81 Total Estimated Estimated Estimated External Year of Project Cost Financing Commitment (US$ million) (US$ million) 1. Development Program 230.9 10.0 1977 34.7 1978 34.7 1979 34.7 1980 34.7 1981 2. Esmeraldas Maritime Terminal (Phase II) 35.0 15.0 1978 3. Shushufindi Gas Plant 21.0 16.0 1978 4. Shushufindi Poliduct 36.0 30.0 1978 5. Esmeraldas Quito Poliduct 45.4 36.4 1977 6. Amonia-llethanol Plant (Guayaquil Gulf Gas) 163.0 81.5 1979 Total 531.3 327.7 Source: Annex II, Table 2. Power 92. Investment in electric power is the responsibility of INECEL. The projects listed below are part of Ecuador's efforts to increase electricity production and distribution in line with the policies reviewed in Chapter II. The "Regional Distribution System" is a five-year program aiming at the purchase by INECEL of the small regional distribution companies.  - 36 - PUBLIC INVEST1MENT PROJECTS IN POWER 1977-81 Total Estimated Estimated Estimated External Year of Project Cost Financing Commitment (US$ million) (US$ million) 1. National Transmission System (Paute Phases C, D) 73.0 44.0 1977 2. Regional Distribution System 178.0 16.4 1977 16.4 1978 16.4 1979 16.4 1980 16.4 1981 3. Toachi Hydroelectric Project 334.0 176.0 1981 4. Rural Electrification 60.0 45.0 1979 Total 645.0 347.0 Source: Annex II, Table 2. Industrv 93. The Covernment's industrial investment program is designed to meet demand for such products as vegetable oil, sugar and cement, and to stimulate development outside the Quito and Guayaquil areas. These projects will be carried out through Corporacion Financiera Nacional (CV-CFN). The total cost of these projects is US$354.1 million.  - 37 - PUBLIC INVESTMENT PROJECTS IN INDUSTRY 1977-81 Total Estimated Estimated Estimated External Year of Project Cost Financing Commitment (US$ million) (US$ million) 1. African Palm Oil 25.0 15.0 1978 2. New Sugar Mills 150.0 25.0 1978 65.0 1979 3. Cemento Cotopaxi 74.7 35.5 1978 4. Cayapas Pulp and Paper 92.1 55.3 1981 5. Industrial Parks 12.3 7.8 Total 354.1 203.6 Source: Annex II, Table 2. Transport 94. Public investment in transport will be heavily concentrated in roads, in line with the priorities listed in Chapter II above. The Quito-Aloag free- way project is included assuming that the economic assessment of that section of the Pan-American Highway warrants that investment.  - 38 - PUBLIC INVESTMENT PROJECTS IN TRANSPORT 1977-81 Total Estimated Estimated Estimated External Year of Project Cost Financing Commitment (US$ million) (US$ million) Road Transport 1. Duran-Boliche 20.0 8.0 1977 2. Puerto Ila-Garrapata 13.0 5.2 1977 3. Quito-Aloag Expressway 35.0 21.0 1978 4. Cumbe-Pasaje 30.0 18.0 1977 5. Quininde-Chila 6.1 3.7 1978 6. Loja-Zamora 8.0 4.8 1978 7. Quiroga-Pichincha 7.7 4.6 1978 8. Cuenca-Azogues 9.0 5.4 1979 9. Cumbe-Loja 25.2 15.1 1979 10. Sesme-Jama 8.2 4.9 1979 11. Suma-Pedernales 17.2 10.8 1980 12. National Feeder Road 144.0 11.0 1978 11.0 1979 11.0 1980 11.0 1981 Total Road Transport 323.4 145.5 Airports Cuenca, Machala, Coca and Pastaza 32.0 24.0 1978 Total Airports 32.0 24.0 Ports Esmeraldas Phase I 21.0 12.8 1978 Total Ports 21.0 12.8 Source: Annex II, Table 2.  - 39 - Other Major Projects 95. Annex II of the Report includes a detailed brief for each public investment project under preparation. Thus, a number of projects that have yet to be justified or that may not be ready for commitment during the 1977-81 period are included. The most important of these projects are a petrochemical complex based on increased petroleum production. The economic feasibility of this project will hinge on Ecuador's petroleum production in the 1980s. Feasibility studies are expected to begin in 1977. The Government recently initiated studies for a steel plant based on imported pellets and on the (yet uncertain) natural gas deposits of the Gulf of Guayaquil. The economic and technical feasibility of this project seems uncertain at this point. In electric power, Annex II includes the Coca Hydroelectric Project which may be justified in the early 1980s. The automotive industry project is also included for the early 1980s. As mentioned in Chapter II, the economic feasibility of this project, which would serve the Andean Group market, remains to be established. The Quito and Guayaquil airport projects may be economically justified in the 1980s, but require thorough further analysis; project briefs are included in Annex II. Balance of Payments and Creditworthiness 96. Balance of payments developments will be largely influenced by the rate of execution of public investment programs and by government decisions on petroleum (see para 38 above). Petroleum output and exports will have a major influence on the level of public investment that Ecuador can finance, both because of the foreign exchange generated and because of the contribu- tion to the local counterpart funds required to complement external borrowing. The investment program outlined in this report may cause financial strains unless petroleum output rises to 260,000 barrels/ day by 1979. 97. It is clear that the growth of exports will depend heavily on petro- leum. Other traditional exports are not expected to increase much above the (high) 1976 level, given foreseeable production and marketing conditions. 1/ Presently, there are no new exports that can be expected to contribute much to total economic growth. 98. Around 1980, new export items will be required to provide a further stimulus to the economy. As mentioned earlier, new production and export possibilities exist in further expansion of petroleum as well as in agro- industries, forestry, mining, natural gas and industrial products. 1/ An increasing proportion of cocoa is being processed and exported as industrial products. Exports of these products are estimated to expand in the near future at 14% per year. Banana sales to EEC countries and Japan recently registered a decline; no substantial expansion in exports is foreseen for the period 1977-81. Coffee and cocoa export volumes are projected to grow slowly. Sugar exports may grow at 4.5% per year in volume.  - 40 - 99. Exports to the Andean Group may have been adversely affected by effective devaluations in other member countries, placing the sucre at a dis- advantage. Tourism has been growing by US$3-3.5 million per year but re- presents less than 2% of total exports of goods and non-factor services. In the long run tourism could be a much more significant source of growth and foreign exchange. 100. As noted earlier, import management has been fairly successful in the past and is expected to continue to be so in the future. Total imports of goods are expected to continue to be regulated by the use of credit poli- cies and other restrictions including, if necessary, measures such as a new ban on private automobile imports. Total imports of goods and non-factor services are projected to grow at a real rate of 5.1% per year as a result of further increases in capital goods imports associated with the public invest- ment program, and of continued fairly rapid growth in imports of primary and intermediate goods (about 8.4% per year in real terms) reflecting continued industrial growth. Fuel and lubricant imports will be significantly reduced on account of the new Esmeraldas refinery. 101. Under the assumptions of petroleum output at 260,000 barrels/day and exports at 64.5 million barrels by 1979, the current account deficit of the balance of payments is expected to increase from an average US$62 million per year (1977-79) to over US$200 million per year around 1981. Detailed balance of payments projections are presented in Statistical Appendix Table 3.10. 102. New private direct foreign investment is not expected to be very dynamic, in spite of the likely expansion of foreign investment in industry and commerce. The lack of dynamism in the other sectors reflects the Govern- ment's petroleum policies as well as uncertainty surrounding Andean Group regulations on foreign private investment. 103. Average external borrowing in the order of US$290 million per year would be required to finance the public investment program outlined in this report, and to cover the widening current balance of payments deficit while amortizing debts and maintaining about 4 months' imports in reserves. The increase in debt service that would result from external borrowing at such a scale should not pose serious problems. The debt service ratio would increase to about 12.3% by 1981 if the external financing required by the public investment program is obtained. This is a tolerable level, so long as the bulk of external credits is used for productive projects with relatively short gestation periods. On balance, the development prospects of Ecuador are favorable so long as a substantial petroleum development and exploration program goes ahead as soon as possible.  CURRENT ECONOMIC POSITION AND PROSPECTS OF ECUADOR ANNEX I AGRICULTURE   AGRICULTURE 1. Ecuador is among the few developing countries with fertile land resources and growth potential. The Guayas basin, the Northern Costa (parti- cularly the province of Esmeraldas which includes areas that have yet to be opened up) as well as parts of the Sierra (where there is much scope for yield increases) are particularly promising in this respect. With a popula- tion of around 7 million increasing at a rate of about 3.4 percent per year, the country's economy is primarily oriented to agriculture which in 1975 contributed one-fifth of total GDP (at constant 1970 prices). Until the recen-t development of the petroleum resource, agriculture was the main source of foreign exchange earnings derived primarily from exports of bananas, cacao, coffee, and sugar. 2. About one-fourth of Ecuador's land area comprises the Costa, or coastal plain, which stretches from the Pacific Ocean to the Andes Mountains. This part of the country has mostly medium-sized and large farms. It produces the important export crops in addition to supplying the economy with a range of other commodities including rice, oilseeds, cotton and other fibers, tobac- co, various tropical fruits, and livestock products. 3. Another fourth of the land consists of the Sierra or highlands, situated between two Andean chains, the Western and Eastern Cordilleras, and includes an inhabited plateau 3,000 meters above sea level. Most of the coun- try's small to medium-sized farms are located in the Sierra and there is a considerable amount of farming on a subsistence basis. This region is an important producer of potatoes, various fruits and vegetables, milk and milk products, meat and other livestock products, pulses, wheat, corn barley, and oats. 4. The remaining one-half of the Ecuadorian mainland comprises the Oriente, or eastern jungle, which is formed by the gentle slopes east of the Andes, covered with dense tropical forests, and the flat valleys of the upper reaches of the Amazon tributaries. This part of the country is associated with recent developments in petroleum and interest in colonization. Relatively little is known, however, about its agricultural potential. Ecuador's popula- tion is about equally divided between the Costa and the Sierra with only about 3 percent in the Oriente. 5. The following sections review the main problems of the sector (paragraphs 6-51) and offer policy and program recommendations (paragraphs 52-66). A. Recent Performance 6. Over the years, agriculture, including forestry and fisheries, has been by far the largest single employer. In 1971 agriculture employed more than one-half of the labor force, contributed 26.8 percent of the GDP (in constant 1970 prices), and was the source of over 90 percent of the country's export earnings. By 1975, agriculture provided about 45 percent of the  - 2 - employment in the country, contributed 20.6 percent of the GDP, and was the source of 44 percent of the total value of exports that year. Despite defi- ciencies in the available data, the general evidence confirms the trend indicated by the statistics. 7. Over much of the past decade agricultural production has lagged behind the needs of the country's expanding population. Using 1961-65 as a base of 100, the indices of per capita agriculture and per capita food pro- duction averaged well below that level during the 1966-69 period after which there was some increase. This was followed by a decline in these indices in 1974 which continued into 1975. The lagging overall performance of the Ecuadorian agricultural sector and the population growth trend since the 1961-65 base period are indicated in the following table: INDICES OF AGRICULTURE AND FOOD PRODUCTION (1961-65=100) Average Production Item 1966-69 1970 1971 1972 1973 1974 1975 Crops 110 133 132 136 136 136 143 Total Agriculture 111 133 133 139 140 141 147 Total Food 110 131 133 139 144 140 152 Per Capita Agriculture 96 105 102 103 100 98 98 Per Capita Food 95 104 102 103 103 97 102 Index of Population (1961-65 Pop. 4,824,000=100) 116.1 126.0 130.4 135.0 139.7 144.5 149.3 Source: Economic Research Service, U.S. Department of Agriculture. 8. In the overall rather flat trend of agricultural production, the best showing has been made in some of the food items. This has been particu- larly true recently in the case of rice, potatoes, corn, bananas, sugar, and livestock products especially milk. The production levels for different com- modities over recent years in Ecuador are shown in the following table:  - 3 - AGRICULTURAL PRODUCTION BY COMMODITY (1,000 metric tons) Average Average Commodity 1961-65 1966-70 1971 1972 1973 1974 1975 Wheat 61 64 60 50 44 54 48 Rice, paddy 173 190 150 189 228 241 321 Corn 130 120 110 130 120 142 146 Barley 87 104 69 62 57 56 57 Beans, dry 24 33 38 30 35 36 30 Potatoes 277 302 400 473 539 503 658 Cotton 4 5 4 5 6 13 8 Cottonseed 8 9 .7 8 8 17 16 Castor beans 22 13 17 20 20 21 16 Bananas /L 2,213 2,446 3,000 3,100 3,200 2,800 3,000 Coffee 48 61 66 66 52 71 49 Cocoa beans 40 59 65 58 43 72 75 Sugar, raw centrifugal 165 202 249 249 268 268 292 Sugar, noncentrifugal 35 39 40 40 40 40 40 Beef and veal 33 40 47 60 62 63 65 Mutton and lamb 3 5 8 7 7 8 8 Pork 14 22 24 26 28 30 31 Milk 188 207 225 254 270 279 290 /1 Export quality Source: Based on statistics from Ecuador's Ministerio de Agricultura y Ganaderia (MAG) and information from producer, trend and other relevant sources as compiled by the Agricultural Research Service, U.S. Department of Agriculture. In general, the table indicates an order of magnitude in the output of commodities and is comparable with the MAG statistics.  - 4 - 9. To the extent that domestic agricultural production has fallen short of consumption requirements, imports have had to fill the gap. This has en- tailed an increasingly heavy expenditure of foreign exchange. Food import expenditures rose from US$14.5 million in 1970 to around US$60 million a year in 1974 and 1975. Among the food commodities imported, the greatest costs have consistently involved wheat whose imports rose steadily from somewhat over 80,000 metric tons in 1970 to more than 200,000 in 1975. Other leading food imports included vegetable oils, animal fats, milk products, and oats as shown in the following table: PRINCIPAL FOOD COMMODITY IMPORT EXPENDITURES (1,000 US dollars - c.i.f.) Item 1970 1971 1972 1973 1974 1975 Wheat 6,662.8 3,917.8 9,924.0 16,494.0 35,473.6 33,518.4 Vegetable oils 3,338.5 6,479.1 6,920.2 11,333.5 4,647.0 12,311.1 Animal fats 3,515.6 2,878.8 1,760.0 732.4 7,960.0 7,418.2 Milk products 954.1 968.1 1,553.8 2,041.9 1,529.9 3,044.7 Oats 775.9 840.1 825.5 929.9 1,836.9 2,901.5 Source: 1970-73, Anuarios de Comerio Exterior. 1974-75, Banco Central del Ecuador import permits granted. 10. The continuing shortfall in food production in relation to the needs of an expanding population has been reflected in consumer prices. 1/ Using 1970 as a base of 100, the consumer food price index for 1975 stood at 215.5 while the general price index was at 186.9. By mid-1976 the food price index had risen to 234.2 while the general price index had moved up to 207.9 with the monthly rate of increase for each being somewhat slower than in the previous year. B. Productivity 11. In the past, gains in agricultural output have been achieved by increasing total area in production. The country's biggest need now is to 1/ Official consumer price index covering low and medium income families of Quito, Guayaquil, Cuenca, and Portoviejo - four major population centers.  - 5 - increase land and labor productivity. To accomplish this objective would require a far greater application of science and technology than hitherto. 12. A scientific and technological basis for increasing agricultural production (especially in the Sierra) has been laid through the work of the Instituto Nacional de Investigaciones Agropecuarias (INIAP), an autonomous agency under the Ministerio de Agricultura y Ganaderia (MAG). Over the past 14 years INIAP has been concerned with research and experimentation to develop techniques for increasing crop and livestock production, including rice, corn, wheat, barley, oats, oilseeds, oil palm, bananas, cacao, coffee, as well as beef, dairy animals and swine. 1/ INIAP plans to expand its investigation activities to include fruits, vegetables, poultry, and it is just starting work with pulses. 13. Through its efforts INIAP has accumulated valuable information and technology adapted to the needs of Ecuadorian agriculture. The problem lies in transferring this knowledge to the majority of the country's farmers. An effective agricultural extension service would be the appropriate medium. 14. The first formal agricultural extension program in Ecuador -- under the Servicio Cooperativo Interamericano de Agricultura (SCIA) -- dates back to the early 1950s. Until the early 1960s the extension service was reasonably well administered. Regional supervisors were trained by sub-agencies in the different geographical zones of the county, and SCIA essentially functioned as a mobile educational and training medium. After the mid-1960s SCIA's effec- tiveness declined sharply, mainly as a result of high personnel turnover and reduced efficiency and morale of staff members. By 1967, SCIA's budget was depleted. 2/ 15. At the same time, a number of affiliates of MAG emerged with special- ize commodity production programs. Today there are six agencies of this king: Programa Nacional Del Banano y Frutas Tropicales; Programa Nacional de Arroz, Maiz y Control de Piladoras y Molinos; Programa Nacional del Algodon y Fibras Vegetables; Programa Nacional de Granos Clima Templado; Programa Nacional del Cafe; and Programa Nacional de Cana de Azucar. These commodity programs pro- vide "technical assistance" rather than "extension". 16. Nowhere in the current organization chart of MAG is there an indi- cation of the existence of an agricultural extension service. This reflects a transition from farmer education to dispensing individual commodity program technology (including related seeds, fertilizers, insecticides). 17. Under the present organization commodity program specialists pro- viding technical assistance no longer see the problems and needs of an indi- vidual farm as a whole since their aim is to promote a specific crop or 1/ The private sugar mills have their own technical assistance. 2/ Extension agents had to buy their own gasoline for driving from the city to rural areas.  - 6 - product. This has led to competition between specialists (agents and inspec- tors) in their attempt to get farmers to plant a specific crop. The focus of attention is on the large farms where the least promotional effort is needed, while small farms are neglected. 18. Approximately 1,300 professionals, including agricultural engineers, veterinarians, and agronomists, are employed by the different agencies pro- viding technical assistance in the field. Their training is generally limited to learning one "technological package" which they promote. In addition, more than 500 professionals are engaged in field work for at least six other public agencies, providing technical assistance in connection with developing other projects or supervising farm credit. Many farmers think that few "technical assistance workers" have a feel for agriculture because of their urban back- ground. 19. Prospects for improvement in agricultural performance are poor unless the needs of the individual farm as an operating unit are dealt with realistically. Conveying to most farmers the knowledge and technology needed to increase output calls for a vigorous program of institutional development and related manpower training. Without adequate extension and teaching institutions agriculture will continue to grow too slowly for the expanding population. (For recommendations see paragraph 55-58.) 20. Agricultural performance has also suffered from: (a) Some government policies, particularly with respect to commodity prices; (b) Inadequate physical infrastructure; (c) Basic deficiencies in the marketing system and structure; (d) Lack of institutional credit for small and medium farmers; and (e) Fragmentation of programs and the multiplicity of government agencies engaged in such activities as increasing production of a specific commodity, directing individual rural development proj- ects, or promoting particular irrigation or drainage operations. The respective agencies and programs compete with each other for the very limited financial and trained manpower resources avail- able, resulting in considerable dispersion and duplication of effort. C. Major Government Policies 21. Apart from general objectives of improving output and providing more adequate supplies from national sources, there is a lack of long-range agri- cultural policy and strategy. Agricultural program planning and policy imple- mentation have been mostly on a piecemeal basis with usually a maximum 5-year horizon.  -7- Price Policies 22. - Policies affecting commodity prices have been most uncertain. Carried out through various means including price supports and subsidies, price controls, and different regulatory actions affecting exports and imports, agricultural price policy remains heavily consumer-oriented. In the last two years there has been some change in orientation in favor of producers to stimulate production of certain commodities for the domestic market. But in most instances, the incentive has not been sufficient. 23. Price controls are in effect at the wholesale and retail levels for a large number of food items in an effort to regulate inflation. Fixed prices are set for such key foods as meat, milk, sugar, rice, and wheat flour. Numer- ous products are covered by guideline prices which are not as closely observed as are the fixed prices. The guidelines cover such items as fruits, vegetables, beans, potatoes, and eggs. 24. Farmers have not in the past been assured that a government policy will remain effective for the stated period. In 1975, for example, the Govern- ment announced 1-2 months before planting time that the price of wheat would be supported at 250 sucres per quintal (100 pounds). 1/ Shortly after the farmers had planted their wheat, the Government announced a support price change from 250 sucres per quintal to 200 sucres per quintal. 2/ The farmers would get the difference in the form of a certificate good for 30 sucres in fertilizer and 20 sucres in improved seed. Since seed and fertilizer were not needed until the next planting cycle many small producers sold their certificates to intermediaries at a heavy discount. 25. Despite production incentives total wheat output is short of re- quirements and imports have to fill the gap. Since July 1973, the Government has been paying millers a subsidy on the cost of imported wheat above 3,224 sucres (US$129) per metric ton c.i.f. Guayaquil, in an effort to maintain a national wholesale flour price of 253 sucres per quintal (US$10.12 per hundred- weight) at the mill. 26. While the milling industry has been generally satisfied with the wheat import program, the cost to the Government has been significant as world wheat prices rose substantially after the subsidy was instituted. Neverthe- less the wheat import subsidy has not stabilized the price of bread. 27. In the case of milk, until recently the Government fixed maximum prices on all sales in the chain from the producer to the consumer. As an incentive to the producion of fluid milk and to prevent increases in consumer prices, the Government paid dairy farmers a subsidy on their deliveries of fluid milk to receiving plants. Producers who sold their fluid milk to other places did not receive the subsidy. For fluid milk delivered to processing plants, producers received a subsidy payment of 54 centavos per liter in the 1/ US$220/metric ton. 2/ US$176/metric ton.  - 8 - form of fertilizer and a balanced feed for their cattle. The subsidy has resulted in some production increases. Since fluid milk prices were con- trolled more rigidly than prices of other dairy products, plant operators tended to use greater quantities of their fluid milk for more profitable dairy products such as butter and cheese. This resulted in shortages of fluid milk supplies for the consumer. The subsidy was ended effective September 25, 1976 and fluid milk prices were raised at producer and resale levels. 28. As an incentive to expand rice production, the Government established producer support prices equ4l to or above international levels. With a con- siderable amount of technical assistance and related credit made available under its national rice program, both small and large producers brought about increases in output which reached a peak in 1975. Unforeseen marketing prob- lems, however, made the distribution of the large crop difficult and costly. There was a great shortage of storage space. International rice prices had declined sharply in relation to Ecuador's high official price and many farmers were unable to repay Government loans because intermediaries were not paying the official rice prices. 29. The Government dealt with this problem through its storage and marketing organization, Empresa Nacional de Almacenamiento y Comercializacion Agropecuarios (ENAC) affiliated to MAG. ENAC agreed to purchase rice from a number of mills at the official price of 360 sucres per quintal 1/ for long grain milled rice and 340 sucres per quintal 2/ for medium grain rice. Rice acquired by ENAC is either resold in the domestic market or exported. For domestic sale, the rice is turned over by ENAC to Empresa Nacional de Productos Vitales (ENPROVIT) at a margin over cost and the grain is resold to the trade. Surplus rice is sold by ENAC for export. 30. Out of the 1975 crop, the initial sale of surplus rice for export amounted to 26,000 metric tons. The price paid was US$177 per metric ton, f.o.b. Guayaquil. This particular lot of rice represented an average cost to ENAC equivalent to US$352 per metric ton, not counting procurement, handling, and other costs entailed in the transaction. Thus, the cost to the public sector of this transaction exceeded US$4.6 million. (For recommendations on commodity price supports and subsidies see paragraphs 61-62). Infrastructure and Marketing 31. To get farm production to the market requires physical infrastructure and auxiliary services, both of which are presently inadequate, and have held back agricultural growth. For many farmers, and particularly small producers, ready access to commodity collection or market centers is limited because of a lack of all-weather secondary or feeder roads. The marketing system neither provides strong production incentives, nor does it afford the facilities required for orderly handling, storage, distribution, and use of the total output without 1/ US$317/metric ton. 2/ US$300/metric ton.  - 9 - undue waste. The prevailing uncertainties and deficiencies tend to increase market risks and result in wider handling and distribution margins to the detri- ment of producers and consumers in terms of costs and deterioration or waste of product. 32. The biggest handicap is the insufficient adequate storage space avail- able to government and to the private sector. The problem has been particularly serious in the case of rice, but also for corn, wheat, oilseeds, and cotton. It prevails throughout the agricultural production and marketing chain, from pro- ducer to intermediary to the ultimate distributor. 33. The shortages of storage facilities are particularly acute in the pro- ducing areas and at commodity assembly points. Small farmers have virtually no on-farm storage facilities and at times, as in the case of cotton, the pro- duct is stored in producer homes. For the most part, the harvest of small farmers is left in the field until sold. 34. In the case of potatoes, for example, both small and large farmers usually sell their crop to intermediary buyers as soon as it comes out of the ground and even earlier in some instances. For a short time supplies are abundant and prices low. Produccers forego the opportunity for a higher return which they could have achieved with adequate storage facilities. 35. The total deficiency in storage facilities amounts to at least 250,000 metric tons total capacity. About 120,000 metric tons of storage space in the form of silos and warehouses is needed to meet the requirements of ENAC for grain alone. The need for additional storage facilities may be expected to increase further by 1985. (For recommendations see paragraphs 63-64). 36. The Government has only recently placed priority on expanding secondary or feeder road construction. The funding of the Ministerio de Obras Publicas (MOP) for building feeder roads has been increased from 300 million sucres in 1974 to 600 million sucres in 1976. These funds represent about one-third of the total MOP budget. Construction will center on feeder roads on which trucks can travel under all weather conditions. Construction costs are stimated by MOP at about 1 million sucres per kilometer. 37. The lack of feeder roads which permit all-weather transport of agricultural commodities seriously impedes rapid farm-to-market deliveries. This is particularly critical for perishables such as milk, fruits and vegetables. Poorer producers who live farthest from the main roads suffer the greatest losses. Their production potential is weakened while consumers are deprived of more ample supplies which otherwise would be available at perhaps a lower cost. (For recommendations see paragraphs 69-70.)  - 10 - Credit 38. For the most part, the supply of agricultural credit has been on a selective basis and has fallen far short of needs. 1/ Most farmers have to rely on trade intermediaries, suppliers, or money lenders, while larger producers usually have access to credit from banks and other institutional sources. 39. Of the total volume of credit supplied in 1975 by the banking system, 16.6 percent (or the equivalent of US$186 million) went to the agri- cultural sector. This compared with 17.6 percent in 1974 and an average of 13.4 percent during the previous five years. The US$186 million figure is equivalent to about 20 percent of agricultural value added. Countries that have a more developed agriculture have a higher ratio of farm credit to total value added in agriculture. 40. The leading supplier of agricultural credit is the public Banco Nacional de Fomento (BNF). In 1975, loans made by this institution represented nearly 69 percent of the total credit extended to agriculture by the entire banking system. This compares with an average of 36 percent in the 1970-72 period, about 48 percent in 1973, and close to 70 percent in 1974. Trends in agricultural lending by the Banco Nacional de Fomento are shown in the fol- lowing table: VOLUME AND NUMBER OF LOANS MADE BY THE BANCO NACIONAL DE FOMENTO, AVERAGE 1970-72 AND ANNUALLY 1973 THROUGH 1975 (volume in millions of sucres) Average 1970-1972 1973 1974 1975 Purpose Volume Number Volume Number Volume Number Volume Number Crop production 233.3 11,702 593.4 16,219 1,405.3 25,053 1,766.3 29,314 Livestock 238.9 7,450 412.0 9,064 856.6 13,467 1,013.9 11,937 Machinery, equipment and infrastructure 75.7 863 123.1 1,187 359.6 2,608 275.9 2,063 Totals 547.9 20,015 1,128.5 26,470 2,621.5 41,128 3,056.1 43,314 Source: Banco Nacional de Fomento 1/ It is not possible to separate out investment credit, owing to the nature of the statistics.  - 11 - 41. While the funds lent by BNF rose substantially between 1970 and 1974, the increase between 1974 and 1975 was negligible. The average size of loans, which increased during the early 1970's, stabilized in real terms in 1975 (for crops, machinery and other investment, the average loan size went down in real terms; loans for livestock continued to increase in real terms). In spite of the rapid increase in agricultural lending since 1970, the vast majority of farmers have no access to institutional credit. AVERAGE SIZE L OF BANCO NACIONAL DE FOMENTO AGRICULTURAL LOANS Current Sucres Constant 1970-72 Sucres Average Average Purpose 1970-72 1973 1974 1975 1970-72 1973 1974 1975 Crop production 19,900 36,600 56,100 60,300 19,900 30,100 37,500 35,200 Livestock 32,100 45,500 63,600 84,900 32,100 37,500 42,500 49,600 Machinery, equipment and infrastructure 87,700 103,700 137,900 133,700 87,700 85,400 92,200 78,100 /L Rounded figures based on volume and number of BNF loans. 42. Most of the loans made by BNF have been for crop production largely on a short-term basis but usually for no more than one year. Next have been the livestock loans which may also include financing for pastures. Of the livestock loans made in 1975, somewhat over 50 percent were for a period of not over two years with about 38 percent exceeding five years. In the category of machinery, equipment and infrastructure, about 40 percent of such 1975 loans were for one to two years and somewhat less for over five years. 43. In its peak lending year, 1975, BNF financed crop production on about 214,500 hectares of land. This is equivalent to only about 13 percent of Ecuador's total land area from which crops were harvested, of which 38 percent was in rice. 44. Almost 60 percent of total BNF credit for the 1975 crop production went to finance only two crops, 42 percent going to rice and 17.6 percent to cotton. Next was corn with 9.6 percent of the total, while 5 percent went for the production of potatoes, 3.4 percent for coffee and smaller percentages to 33 additional crops. 45. In summary, the record shows that BNF credit has served a relatively small part of the country's need for agricultural financing and loans were too concentrated to enhance overall national output. Too few of the farmers have been reached by this institution's lending operations. (For recommendations, see paragraphs 59-60.)  - 12 - Land Reform 46. Since tabulation of the 1974 agricultural census has not been completed, the 1968 National Agricultural and Livestock Survey provides the only basis for ascertaining the magnitude of changes in land tenure structure sinced 1954. 1/ Between 1954 and 1968, there was an increase in the number of farms but a decline in the average farm size, attributed, inter alia, to implementation of agrarian reform (titles to subsistence plots given to tenants), colonization programs, fragmentation resulting from inheritances, and subdivision of estates by larger landowners in an attempt to minimize loss under agrarian reform. Despite the increase in the number of farm holdings, the overall distribution pattern by farm size has not changed significantly in this period. Based on 1968 data, about 85% of all farm units may be classified as "subfamily," i.e., too small to provide full and productive employment. 2/ Partial data from the 1974 census - suggests that the number of holdings increased to 600,000 and the total area to 8 million ha. This would imply a further reduction in average farm size from 14.9 ha in 1968 to 13.3 ha in 1974. 47. In spite of an increasing trend in the number of farms, land distribution still remains relatively skewed. The Gini coefficient of land distribution in 1968 was estimated at 0.82, declining from 0.86 in 1954, thus suggesting only minimal improvement in the land distribution from 0.86 in 1954, thus suggesting only minimal improvement in the land distribution pattern. 3/ Slightly more than 470,000 farms, almost 74% of total land holdings, had less than 5 ha, accounting for only 10% of total area and less than 20% of the total value of crop production. It is this stratum which makes up the mass of campesinos representing almost 90% of the rural labor force. 48. At the other end of the scale, nearly 10,000 farms, each with over 100 ha, account for slightly over 47% of total farmland and 35% of the value of agricultural products. Private ownership of farms between 1954 and 1968 increased two-fold. In 1968, about 76% of the total number of holdings (480,000 farms) were owner-operated. The remaining 24% consisted of renters, sharecroppers and other mixed forms of tenure. 1/ An agricultural census was taken in 1954 and an agricultural survey was completed in 1968. The latter is not entirely comparable with the 1954 census data and seriously deficient with respect to data reliability. 2/ CIDA. Tenencia de la Tierra y Desarrollo Socio-Economico del Sector Agricola, Ecuador. Washington, D.C.: Organization of American States, 1965. The study considers farms of less than 10 ha as sub- family units. 3/ C.S. Blankstein and Clarence Zuvekas, Jr., "Agrarian Reform in Ecuador: An Evaluation of Past Efforts and the Development of a New Approach," in Economic Development and Cultural Change, XXIII, 1; (October, 1973), p. 84.  - 13 - 49. The enactment of the Land Reform, Idle Lands and Settlement Act in mid-1964 provided the foundation for increased efforts toward modernizing the land tenure systems. The law was revised in 1967, and in 1973 a new law was passed. The chief executing agency is the Ecuadorian Institute for Agrarian Reform and Colonization (Il.RAC), which also has responsibility for supervising "planned" and "spontaneous" colonization schemes. 50. Until now, the measures which have been introduced have been sporadic and modest in scope and results have fallen short of expected targets. From its inception until 1974, the program has had about 55,000 recipients (less than 10% of farm holdings), redistribut:ing about 1 million ha of arable land. The impact of the program has fluctuated considerably on an annual basis as well as by regions. Almost 80% (about 797,000 ha) of the total land transferred resulted from colonization schemes. The most pronounced effect of the agrarian reform has been the transformation of hacienda retainers and workers into minifundistas; by and large, the holdings of the beneficiaries are too small to provide a family with adequate farm income. 51. The weakness of the program is reflected in the institutional arrange- ments themselves. In part, the disappointing results can be attributed to (a) failure of IERAC to mobilize adequate financial resources; (b) lack of support and cooperation among other governmental agencies (technical services and infrastructure facilities for IERAC projects); (c) rapid turnover of offi- cials; and (d) absence of sound, efficient and prompt legal procedures. 1/ D. Policy and Program Recommendations Approach and Orientation 52. A departure from the piecemeal approach in planning and programming in favor of more comprehensive goals both on a short-term and long-range basis is badly needed. Coupled with this are requirements for strengthened adminis- tration, effective control of sectoral activities, closer monitoring of prog- rams, and improved integration and coordination. 53. The national planning office, Junta Nacional de Planificacion (JUNAPLA), could play a key role in providing the basis for the transformation required in agriculture. Major responsibility, however, will continue to rest with MAG. Both institutions need to strengthen their organizational capacity and staffing capabilities. 54. A major concern of MAG should be to overcome existing program frag- mentation with the resulting dispersion and duplication of effort and internal 1/ The 1973 Law, unlike previous laws, places greater emphasis on the question of criteria for expropriation. However, the controversial Article 25 which provided for expropriation of "insufficiently exploited" land starting 1 January 1976 is, for the time being, in limbo.  - 14 - competition for limited financial and trained manpower resources. Action should focus on the farmers' needs and be guided by feasibility. The farmer and his motivations for producing ultimately determine output levels. Extension 55. The present system of technical assistance oriented to specific crops could be replaced by an agricultural extension service capable of dealing with the needs of the individual farmer from the standpoint of his total farm operation. The organization would absorb the presently employed commodity technical assistance specialists and provide training to broaden the base of technical know-how. Through additional qualified personnel such an improved extension service would permit diffusion of knowledge and transfer of tech- nology already accumulated through agricultural research. The objective would be to reach the majority of the country's farmers and help them improve their performance. 56. While INIAP serves as the research arm of MAG, an established agri- cultural extension service could be its educational arm. Both could have the same organizational status. Such an undertaking would also require a national extension training program and institutional relationships (e.g. with univer- sities) to improve agricultural curricula including extension. With necessary backstopping of qualified subject matter specialists and trained supervisors, such an extension service would operate on a regional basis through offices and sub-offices providing services tailored to meet local farm needs. Research 57. An effective extension service would bring more and more farm prob- lems into the open and this will require expansion and possibly a reorienta- tion of agricultural research. In anticipation of future requirements research should be conducted on the possible exploitation of land resources in the high plateau ("paramo") of the Sierra as well as in the Oriente region. INIAP could also expand its applied or adaptive research to fruits, vegetables, poultry, and pulses. Particular attention should be given to oilseeds in view of growing vegetable oil imports. Research work could center on soybeans since it is not only a valuable provider of vegetable oil but also an impor- tant source of protein for human and animal consumption. Likewise there is a need in getting practical research underway so that grain sorghum may be introduced. This could rapidly add to assured grain supplies for livestock feeding at more reasonable prices, and go some way toward overcoming nutri- tional deficiencies and expanding the output of livestock products. At present, hard corn is virtually the only feed grain grown in the country. 58. While INIAP has done a considerable amount of work relating to cattle, several paramount problems can only be dealt with through an aggresive program of applied research. The general areas involve nutrition and health deficiencies, conception and reproduction failures, high mortality rates among calves, and other problems of a similar nature. All these have long held down levels of meat and milk production and have seriously inhibited increases in  - 15 - cattle numbers. The application of research results with the advice and guidance of extension should move forward with an initial goal of cutting calf mortality in half and increasing calving rates by one-third. Credit Availability and Distribution 59. Between the lending institution on the one hand and the farmer borrower on the other there are ample opportunities for improving agricultural credit practices to the benefit of both. The amount of medium and long-term agricultural credit needs to be increased substantially. Credit should be made available to far more farmers and be more equitably distributed among the different crops of the country. BNF as the major source of agricultural financing can improve its operations. But institutional sources of credit, such as private banks and the Cooperatives' Bank, should play a much bigger role in agricultural lending. 60. The criterion for lending should be the farmer's creditworthiness rather than the size of the farm. Since institutional credit is generally less costly than other forms of credit, the critical issue is access rather than the precise cost of credit. Nevertheless the recent increase in interest rates for agricultural credit (13 percent maximum rate including commissions since late 1976) might lead to a broader coverage as lending for agriculture has become more attractive. The farm should be financed as an operating unit, and credit be geared to its overall needs as well as to its production potential. Commodity Price Supports and Subsidies 61. Experience indicates that even with the best of intentions, price supports and subsidies do not always achieve the desired results as production incentives for a variety of reasons linked largely to inadequate planning. In order to prevent costly experiences, price supports--as, for example, in the case of rice--should not exceed international price levels that may be expected to prevail after the crop is harvested. Otherwise, marketing difficulties are almost certain to be encountered and losses incurred. 62. Considering the use made of commodity price supports and subsidies since their initial introduction by the Government in 1973, an in-depth study and analysis of their operation and impact is now timely. Such an examination for each commodity covered should be concerned with the respective interests of producers and consumers as well as the costs and benefits from the stand- point of the national economy. Agricultural Marketing Needs 63. The most pressing shortage is in storage facilities available to ENAC, the government market intervention agency. Also, there is a need to improve facilities in major market centers, particularly in wholesaling food- stuffs in Guayaquil. The development of vocational skills in the public and  - 16 - private sectors, provision of basic marketing services and promotion of agro- industries might contribute to increasing efficiency in the marketing system and lowering distribution costs. 64. A package approach to the marketing problem could consist of the following components: Silos and warehouses, refrigerated facilities, whole- sale market in Guayaquil, technical assistance and training in marketing, and the establishment of grades and standards as well as a market news service. The private sector should be encouraged to invest in marketing facilities. Incentives could be in the form of government loans to finance private con- struction and maintenance of storage facilities. Rural Development Program 65. Ecuador does not have a national rural development policy or program. Regional public organizations engaged in rural development do exist, however. I/ These include Programa de Desarrollo del Sur (PREDESUR), Centro de Reconversion Economica de Azuay (CREA), Comision de Estudios para el Desarrollo de la Cuenca del Rio Guayas (CEDEGE), and others. Each of these regional agencies operates independently, thereby precluding a unified approach. 66. One of the most active of the public organizations engaged in rural development is PREDESUR which operates in the southern parts of the country. It receives financing from the Fondo Nacional de Desarrollo (FONADE), the Inter-American Development Bank, and other sources. At present 57 projects are being implemented most of which are small. PREDESUR has a limited but high-caliber staff. It operates through contracts ("convenios") with public and private agencies for works such as construction of access roads, agricul- tural technical assistance services, reforestation, etc. PREDESUR thus uses petroleum revenues and external loans in a manner that brings public agencies into competition with private contractors. 67. The experience of PREDESUR and other regional development agencies may provide a basis for a national rural development program, which could in- clude all such agencies. What is needed is a national rural development policy defining expenditure priorities and an effective administrative framework. The recent creation of a rural development task force in the Planning Office (JUNAPLA) may help in defining a policy in this respect. Perhaps the most effective organization would combine a flexible field structure and a central governing body in the capital. The field organization would channel project proposals to the central office, which would coordinate and allocate material and financial resources on a project-by-project basis. 68. In this way all relevant public agencies as well as private con- tractors could become involved in a most important long-term effort--improving the living standards of the poorer areas of Ecuador. 1/ These organizations are trying to deal with regional development. The discussion in this section is concerned with the rural aspects only.  - 17 - All-Weather Feeder Roads 69. While a start has been made by MOP in expanding the system of all- weather feeder roads, a commitment is needed to insure continuity of construc- tion over a reasonable period of time. Such a course calls for a national strategy consistent with the requirements for profitable agricultural expan- sion in the different provinces. 70. Formulation of this kind of strategy could not only involve MOP but also other government agencies including MAG in particular. It should be feasible to increase the all-weather feeder road network from 8,000 kilometers at present to 11,000 in the next five years. The expenditure involved would be in the order of US$24 million per year. Conclusion 71. Unlike most developing countries, Ecuador has an excellent potential for agricultural expansion. The preceding recommendations attempt to outline the main areas where action is possible and likely to yield good results. The different lines of action (creation of an extension system geared to needs of the farm as an operating unit, research in promising import-substituting crops and livestock, much broader availability of credit, more rational and less costly price policies, the setting up of an adequate marketing system, an effort at nationwide rural development, and the establishment of a 5-year program for all-weather rural roads) all form part of a package. They are complementary and mutually supportive. 72. If a serious effort is made on such a package of policies and programs, there is little doubt that agricultural and livestock development will accelerate. This set of development policies can achieve a broad improvement in the living conditions of the bulk of the population, while at the same time serving the national development objectives. Furthermore, even a slight absolute improvement in the standard of living of the bulk of the rural population would represent a substantial relative improvement for the persons concerned.   CURRENT ECONOMIC POSITION AND PROSPECTS OF ECUADOR ANNEX II LIST OF PROJECTS   ANNEX II LIST OF CONTENTS 1. Introduction 2. Table 1: Public Investment Program 1977-1981 Totals by Sector 3. Table 2: Public Investment Program 1977-1981 List of Projects by Sector 4. Description of Public Sector Projects for External Financing   ECUADOR LIST OF PROJECTS SUITABLE FOR EXTERNAL FINANCING Introduction 1. As indicated in Volume I, Ecuador's economic prospects will be sig- nificantly affected by the choices made in the decisions regarding public investment. The findings of this Report indicate that: a) Investment is needed in the petroleum sector to sustain the momentum of growth and to provide the basis for diversification of exports and renewal of the agricultural base; b) Agriculture is of the highest priority for Ecuador's long-term future and employment requirements, social progress and national integration goals; and c) Improvements in electrical energy deserve particular attention. 2. There has been some progress in Ecuador in laying the foundations for development-oriented investments, somewhat in contrast with the past situation. There has been a substantial improvement in project preparation activity. 3. This volume contains the complete list of projects of the public sec- tor of Ecuador as of February 1977 for which external financing is sought for the years 1977-1981. The projects included in the list represent the efforts in project preparation of all public sector institutions and do not necessarily reflect the priorities of the Government. The projects are listed individually in Table 3. As the gross total of these projects exceeds the improving but still modest absorptive capacity of the economy, there has been a classification of their priorities. Those considered to be of the highest priority are pre- sented in Table 2 and are part of the public investment program for years 1977- 1981.  A summary of this list according to sector is in Table 1. The public invest- ment program proposes a total external financing of $2.8 billion in a five year program, and it provides a basis for a substantial rate of commitments. 1/ 4. The total project list reflects the basic objectives of Ecuador's development strategy. Major shares of the total external financing are directed to petroleum, agriculture and power in the first years, while industry and transport increase in later years. 5. Petroleum investment is geared to an increase in production to 250,000 barrels per day in 1978, and to a gradual increase in production to 350,000- 400,000 barrels per day in 1985. In addition, the Government of Ecuador plans to install a large petrochemical complex, but its economic feasibility is tied on Ecuador's ability to reach production of 350,000-400,000 barrels per day in 1985, and an Amonia-Methanol Plant that will exploit the natural gas resources located at the Guayaquil Gulf. 6. The agricultural sector includes various irrigation and rural develop- ment projects. Two projects are of special importance, the Agricultural Market- ing Project, providing storage facilities for agricultural production; a a proj- ect for the rehabilitation and renovation of cacao orchards, and for oilseed plantations. This project will increase foreign exchange earnings and substi- tute oilseed oil imports. 7. Energy projects have been selected from the National Electrification Program approved by the Government. 8. Industrial projects are few, and of minor importance, with the exception of the Iron Ore Project, the Naval Shipyard, and the Automotive Industry Development Project, that represent a total investment of $654.8 million. The economic feasibility 1/ All value figures in this annex are in current US dollars. They rest on a moderate inflation expectation (about 7% per year). To the extent that future cost increses are understated, these figures may have to be increased accordingly.  of these projects is contingent upon several factors presently being studied by the Government. 9. Two other large projects, the Guayaquil and Quito international air- ports are being analyzed by the Government, but final feasibility studies are not completed. 10. In order to increase the development of technical and managerial capabilities, the Government of Ecuador aims at attracting foreign investment participation in mixed enterprises, while maintaining a suitable degree of domestic participation in each enterprise. To this end, the petrochemical complex and the large industrial projects in the list, are designed to invite proposals of joint ventures from experienced companies in each field, and to seek external financing.   Table 1: ECUADOR: PUBLIC INVESTMENT PROGRAM 1977-1981 TOTALS BY SECTOR (In millions of US Dollars) Total Estimated Estimated External Financing Commitments Sector Cost 1977 1978 1979 1980 1981 I. Agriculture 407.3 22.0 67.4 56.6 10.0 55.0 II. Fisheries 67.5 30.0 10.5 13.0 - - III. Petroleum 531.3 62.4 79.7 116.2 34.7 34.7 IV. Power 645.0 60.4 16.4 61.4 16.4 192.4 V. Industry 354.1 - 83.3 65.0 - 55.3 VI. Road Transport 323.4 31.2 45.1 36.4 21.8 11.0 VII. Airports 32.0 - 24.0 - - - VIII. Ports 21.2 - 12.8 - - - IX. Tourism 26.6 - 20.2 - - - X. Telecommunications 95.4 65.5 - - - - XI. Health 105.5 37.0 27.5 11.0 - XII. Education 36.5 - 13.2 - - - XIII. Urban Development 88.0 - 20.0 - 25.0 _ XIV. Water and Sewerage 131.8 27.0 26.0 28.1 - - XV. Preinvestment 30.0 8.0 - 6.0 10.0 - XVI. Other Projects /1 900.0 - - 100.0 420.0 240.0 Sub-Total Sectors 3,795.6 343.5 446.1 493.7 537.9 588.4 XVII. Lines of Credit 1. Banco Nacional de Fomento (Agriculture) /2 339.7 65.8 66.3 28.8 48.8 28.8 2. CV-Corp. Financiera Nacional (Industry) 166.0 16.7 61.2 24.0 20.0 30.0 Sub-Total Lines of Credit 505.7 86.5 127.5 52.8 68.8 58.8 GRAND TOTAL 4,301.1 430.0 573.6 546.5 605.8 647.2 /1 Refers to projects included in the Project List (Annex 2) but whose economic feasibility has not yet been determined. /2 Financial investment for agriculture is mostly by Banco Nacional de Fomento but includes a small portion by private banks.  Table 2: ECUADOR: PUBLIC INVESTMENT PROGRAM 1977-1981 LIST OF PROJECTS BY SECTOR (In millions of US Dollars) Total Executing Proposed Estimated Estimated External Financing Commitments Sector/Name of Project Agency Lender Cost 1977 1978 1979 1980 1981 I. Agriculture 1. Agricultural Marketing IBRD/IDB/ and Storage ENAC Others 58.6 12.0 10.0 20.0 - - 2. Tungurahua Rural Dev. MAG/INHERI IBRD 30.0 - 15.0 - - 3. Puerto Ila Chone MAG IBRD 50.0 - - 20.0 - 4. Milagro II Irrigation INHERI IBRD 40.0 - 20.0 - - - 5. Guayas Water Management INHERI/CEDEGE IBRD 40.0 - - - - 20.0 6. Cayambe Rural Dev. MAC Undetermined 20.0 - - - 10.0 - 7. Forestry Development MAC IBRD 20.0 - - - - 10.0 8. Esmeraldas Rural Dev. MAG/INHERI IBRD 50.0 - - - 25.0 9. Manuel J. Calle Irrig. INHERI Undetermined 21.0 - 10.9 - - 10. Latacunga-Ambato Irrig. INHERI IDB 18.2 10.0 - - - 11. Colonization Nangaritza PREDESUR IDB 19.2 - 11.5 - - - 12. Carrizal Chone Irrig. C.R.M. Undetermined 28.8 - - 14.2 - - 13. Forestry Development MAG IDB 21.5 - - 2.4 - - Total Agriculture 407.3 22.0 67.4 56.6 10.0 55.0 II. Fisheries 1. Posorja Fishing Port Min.Natural Resources Undetermined 8.8 - 5.3 - - - 2. Manta Fishing Port Manta Port Authority IBRD 8.7 _ 5.2 - 3. Artisan Fishing Project Min.Natural Resources IDB 20.0 - - 13.0 4. Fishing Vessels Min.Natural Resources Undetermined 30.0 30.0 - - Total Fisheries 67.5 30.0 10.5 13.0  Table 2: (cont'd) ECUADOR: PUBLIC INVESTMENT PROGRAM 1977-1981 LIST OF PROJECTS BY SECTOR (page 2) (In millions of US Dollars) Total Executing Proposed Estimated Estimated External Financing Commitments Sector/Name of Project Agency Lender Cost 1977 1978 1979 1980 1981 III. Petroleum 1. Development Program CEPE Undetermined 230.9 10.0 34.7 34.7 34.7 37.7 2. Esmeraldas Maritime Terminal (Phase II) CEPE Undetermined 35.0 - 15.0 - - - 3. Shushufindi Gas Plant CEPE IDB 21.0 16.0 - - _ _ 4. Shushufindi Poliduct CEPE Undetermined 36.0 - 30.0 - - - 5. Esmeraldas-Quito Poliduct CEPE Undetermined 45.4 36.4 - - - 6. Amonia-Methanol Plant (Guayaquil Gulf Gas) CEPE Undetermined 163.0 - - 81.5 - - Total Petroleum 531.3 62.4 79.7 116.2 34.7 34.7 IV. Power 1. National Transmission System (Paute Phase C.D.) INECEL Undetermined 73.0 44.0 - - - - 2. Regional Distribution System INECEL Undetermined 178.0 16.4 16.4 16.4 16.4 16.4 3. Toachi Hydroelectric Proj. INECEL Undetermined 334.0 - - - - 176.0 4. Rural Electrification INECEL IBRD/Other 60.0 - - 45.0 - - Total Power 645.0 60.4 16.4 61.4 16.4 192.4  Table 2: (gont'd) ECUADOR: PUBLIC INVESTMENT PROGRAM 1977-1981 LIST OF PROJECTS BY SECTOR (page 3) (In millions of US Dollars) Total Executing Proposed Estimated Estimated External Financing Commitments Sector/Name of Project Agency Lender Cost 1977 1978 1979 1980 1981 V. Industry 1. African Palm Oil CV-CFN IBRD 25.0 - 15.0 - - - 2. New Sugar Mills CV-CFN Undetermined 150.0 - 25.0 65.0 - 3. Cemento Cotopaxi CV-CFN Undetermined 74.7 - 35.5 - - - 4. Cayapas Pulp & Paper Cayapas Industries Undetermined 92.1 - - - -55.3 5. Industrial Parks CV-CFN Undetermined 12.3 - 7.8 - _ - Total Industry 354.1 - 83.3 65.0 - 55.3 VI. Road Transport 1. Duran Boliche 2OP TBRD 20.0 8.0 - - - 2. Puerto-Ila Carrapata MOP IBRD 13.0 5.2 - _ _ 3. Quito-Aloag Expressway HOP Undetermined 35.0 - 21.0 - - 4. Cumbe-Pasaje MOP Kuwait 30.0 18.0 - - - - 5. Quininde-Chila MOP Kuwait 6.1 - 3.7 - _ 6. Loja-Zamora MOP Undetermined 8.0 - 4.8 - - 7. Quiroga-Pichincha htOP Undetermined 7.7 - 4.6 - _ _ 8. Cuenca-Azogues MOP Undetermined 9.0 - - 5.4 - 9. Cumbe-Loja MOP Undetermined 25.0 - - 15.1 - - 10. Sesme-Jama MOP Undetermined 8.2 - - 4.9 - _ 11. Suma-Pedernales MOP Undetermined 17.2 - - - 10.8 - 12. National Feeder Road MOP Undetermined 144.0 - 11.0 11.0 11.0 11.0 Total Road Transport 323.4 31.2 45.1 36.4 21.8 11.0  Table 2: (cont'd) ECUADOR: PUBLIC INVESTMENT PROGRAM 1977-1981 LIST OF PROJECTS BY SECTOR (page 4) (In millions of US Dollars) Total Executing Proposed Estimated Estimated External Financing Commitments Sector/Name of Project Agency Lender Cost 1977 1978 1979 1980 1981 VII. Airports 1. Cuenca, Machala, Coca and Pastaza DAC Undetermined 32.0 - 24.0 - - - Total Airports 32.0 - 24.0 - - - VIII. Ports 1. Esmeraldas Phase I Esmeraldas Port Auth. Undetermined 21.2 - 12.8 - - - Total Ports 21.2 - 12.8 - - - IX. Tourism 1. Guayaquil Hotel Dir.Turismo/ CV-CFN Undetermined 11.4 - 8.0 - - - 2. Various Hotels Dir.Turismo/ CV-CFN Undetermined 15.2 - 12.2 - - - Total Tourism 26.6 - 20.2 X. Telecommunications 1. Rural Telecommunications IETEL IDB 18.0 12.0 - - - - 2. Expansion of Local Telephone System IETEL ERICSSON 77.4 53.5 Total Telecommunications 95.4 65.5  Table 2: (cont'd) ECUADOR: PUBLIC INVESTMENT PROGRAM 1977-1981 LIST OF PROJECTS BY SECTOR (page 5) (In millions of US Dollars) Total Executing Proposed Estimated Estimated External Financing Commitments Sector/Name of Project Agency Lender Cost 1977 1978 1979 1980 1981 XI. Health 1. Quevedo Hospital Min.Health Undetermined 1.1 1.1 - - 2. Esmeraldas Hospital "i 2.5 2.5 - - - - 3. Manta Hospital " " 5.8 2.9 - - - - 4. Chone Hospital " " 3.4 1.7 - - - - 5. Azogues Hospital " ' 3.4 1.7 - - - 6. Santo Domingo Hospital t" 3.4 1.7 - - - _ 7. Pasaje Hospital t" 3.4 1.7 8. 21 hospitals & health centers " " 8.9 4.1 - - - _ 9. Guayaquil Children's Hospital " ' 14.6 7.3 - - - - 10. South Quito Hospital " t 5.0 5.0 - - - 11. Machala Hospital " i 3.5 3.5 - - - 12. Guaranda Hospital " 2.1 2.1 - - - = 13. Rural Hospitals and sub-centers " 45.0 - 27.5 11.0 - _ Total Health 105.5 37.0 27.5 11.0 - _ XII. Education 1. Rural Education Min.Education IBRD 36.5 - 13.2 - - - Total Education 36.5 - 13.2 - - - XIII. Urban Development 1. Guayaquil Municip.Guayaquil IDB 50.0 - - - 25.0 - 2. Quito Municip.Quito IDB 38.0 - 20.0 - - _ Total Urban Development 88.0 - 20.0 - 25.0  Table 2: (cont'd) ECUADOR: P11BLIC INVESTMENT PROGRAM 1977-1981 LIST OF PROJECTS BY SECTOR (page 6) (In millions of US Dollars) Total Executing Proposed Estimated Estimated External Financing Commitments Sector/Name of Project Agency Lender Cost 1977 1978 1979 1980 1981 XIV. Water & Sewerage 1. Quito Suburban Area Municipal Water Water Services Enterprise Undetermined 24.6 - - 14.9 2. Pita-Tambo Phase II Same as above IDB 28.2 - 20.0 - 3. Oro Province Water Services IEDS IDB 13.0 10.0 - - 4. Guayaquil Sewerage Munic.Guayaquil IDB 24.0 17.0 - - 5. Rural Water & Sewerage Systems IEDS Undetermined 22.8 - 16.0 - 6. Water & Sewerage in Caniar, Azuay & Morona IEDS Undetermined 19.2 - - 13.2 Total Water & Sewerage 131.8 27.0 26.0 28.1 - XV. Preinvestment 1. Preinvestment II FONAPRE IDB 12.0 - - - 10.0 2. Project Preparation I FONAPRE IBRD 12.0 8.0 - - - 3. Project Preparation II FONAPRE IBRD 6.0 - - 6.0 - Total Preinvestment 30.0 8.0 - 6.0 10.0 - XVI. Other Projects 900.0 - - 100.0 420.0 240.0  Table 2: (cont'd) ECUADOR: PUBLIC INVESTMENT PROGRAlK 1977-1981 LIST OF PROJECTS BY SECTOR (page 7) (In millions of US Dollars) Total Executing Proposed Estimated Estimated External Financing Commitments Sector/Name of Project Agency Lender Cost 1977 1978 1979 1980 1981 XVII. Lines of Credit (i) Agriculture 1. Agricultural Credit I (IBRD) BNF IBRD 21.3 17.0 - - - - 2. Agricultural Credit II (IBRD) B'NF IBRD 26.7 - - 20.0 - 3. Cacao Program BNF Undetermined 75.0 - 37.5 - - _ 4. Agricultural Credit (IDB) BNF IDB 26.7 20.0 - - - - 5. Other Projects BNF Undetermined 190.0 28.8 28.8 28.8 28.8 28.8 339.7 65.8 66.3 28.8 48.8 28.8 (ii) Industry 6. DFC IV CV-CFN IBRD 37.7 - - - 20.0 - 7. Industry C1T-CFN '-ndetermined 1