Ecuador - Current economic position and prospects

R E S T R I C. T E D R e p o r t N o. WH-58-a This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT CURRENT ECONOMIC POSITION AND PROSPECTS OF ECUADOR July 29, 1957 Department of Operations Western Hemisphere  CURRENCY EQUIVALENTS U.S. $1 a S/15,00 S/i a U.S. $0.07 S/1,000,000 a U.S. $67,000  TABLE OF CONTENTS PAGE BASIC DATA SUMM12AARY I INTRODUCTION 1 II RECENT EC5MONlOIC GROilTH AND PROSPECTS 1 A. Agriculture 3 Technology 4 Controls 5 Credit 7 Be Industry 8 C. Miinerals 10 III MONEY AND BANKING 11 IV PUBLIC FINANCE 13 V CAPITAL FORMATION 15 VI THE BALANCE OF PAYT,ENTS 13 VII A. External Debt 19 VII CREDITIORTHINESS 20  APPENDICES Page Appendix A: Estimate of exchange earnings in 1961 22 Appendix B: Public Investments and their financing, 1957-1960 24 STATISTICAL APPENDIX Table No. External Debt 1. Summary of Ecuador's External Public Debt Outstanding 25 December 31, 1956 2. Eptimated Contractual Interest and Amortization 27 Payments on Ecuador's External Public Debt National Accounts 3. National Income by Industrial Origin, 1950-1955 29 4. Expenditures on Gross National Product, 1950-1954 30 5. Structure of Industry in 1955 31 6. Structure of Agriculture in 1954 32 Production 7. Agricultural Production, 1950_1955 33 8. Area Planted to Principal Agricultural Crops, 1950-1955 34 9. Agricultural Yields, 1950-1955 35 10, Average Yields of Selected Agricultural Products in 36 Ecuador and other Countries, 1954 11. Industrial Production, 1950-1956 37 12. Production of Electric Power, 1950-1956 38 13. Electric Povwer Industry, 1955 39 14. 1Iinerals Production, 1950-1956 4o 15. Consumption of Petroleum Products, 1950-1956 41 Public Finance 16. Central Government's Cash Budget, 1950-1956 42 17. Central Government's Cash Budget, 1950-1956: Sources 43 of Borrowed Funds 18. Consolidated Revenues and Expenditures of the Public 44 Sector, 1950-1954 19. Financial Resources and Expenditures of Public Sector, 45 by Authority and Purpose, 1950-1954 20. Annual Purchases of Negotiable Securities by the Social 46 Insurance Funds, 1951-1956 21. Annual Investments and Resources of the Comision Nacional 7 de Valores, 1950-1955 22. Public Recipients of Customs Revenues, 1950-1954 48 Capital Formation 23. Composition of GrossDomestic Fixed Capital Formation, by 49 Type of Investment and Economic Sector. 1950-1954 24. Financing of Public Investments, 1950-1956 50  STATISTICAL APPENDIX (Continued) Page Capital Formation (con't) 25. Investment Expenditures of Public Sector, by 51 Authority and Purpose, 1950-1955 26. Investment Expenditures of Public Sector, by 52 Authority and Purpose 195l and 1955 Money and Banking 27. Changes in the IJoney Supply, 1950-1956 53 Balance of Payments 28. Balance of Payments of Ecuador, 195C-1956 54 29. Ecuador's Merchandise Exports, 1950-1956 55 30. Ecuador's Three Main Exports, 1950-1956 56 31. Destination of Mlajor Exports in 1956 57 32. Merchandise Trade by Geographical Area, 1950-1955 58 33. Ecuador's Merchandise Imports, 1950-1955 59 34. Imports of Capital Goods, 1950-1955 60 35. Purchases and Sales of Foreign Exchange by 61 the Central Bank, 1950-1955 36. Ecuador's International Reserves, 1950_-1955 62 Frices 37. Terms of l'rade, 1950-1956 63 38. Cost of Living Index, 1950-1956 64  BASIC DATA Area 102,000 square miles Population 3.9 million (1957 estimate) Average annual rate of increase (1950-1956) 3% Gross National Product, 1956 11.8 billion sucres % originating in agriculture (1955) 33% % devoted to gross investment 15% Average annual rate of increa3e in real terms (1950-1955) 5% Cost of living (1950 = 100) 116 Average annual rate of increase (1950-1956) 2% lM1illions of dollars Merchandise Exports, 1956 96 Bananas 37 Coffee 30 Cacao 18 Others 11 Exports of goods and services as % of G.N.P. 17% Foreign Exchange Reserves of Central Bank M4ay 31, 1957 Miillions of U.S. dollars 20.5 % of 1956 imports, c.i.f. 21% Public Finances Millions of sucres Government revenues, 1956 959 As % of Gross National Product 8% Public sector revenues as % of Gross National Product in 1954 19% Government expenditures, 1956 1,110 % of expenditures for investment, 1955-56 21% % of expenditures for investment, 1950-54 10% External Public Debt (December 31, 1956) 0i74 million  StJvfUiRY Ecuador's agricultural export economy has shown itself to be flexible and responsive to market incentives and should continue to be so. Its potential for expansion is substantial. The country's rich agricultural lands on the Pacific side of the Andes are far from being fully utilized. An expanding road network, financed in part by the Bank, is opening new lands to cultivation and is also making Dossible all weather communications between areas which were formerly inaccessible to major market areas during parts of the year. There is also a large potential for raising the productivity of agriculture through improving the level of technology and management on the farm. Ecuadorian industry has been expanding even more rapidly than agriculture, and its further development is being encouraged along the lines indicated by Ecuador's natural advantages in producing agricultural materials and foods. The rate of investment and savings has been increasing. Though the future of Ecuador's important banana industry wirhich accounts for 40% of all exchange earnings is somewhat uncertain, on the whole the long-term prospects for the Ecuadorian economy appear good. During the next few years, Ecuador will probably have more difficulty in solving its economic problens than in the recent past. Because of the prospect of coffee and cacao price declines and rather level banana exnorts, export values and hence the availability of imports and fiscal revenues derived from trade are not likely to increase much in the immediate future. The strains of adjusting to a change from the expansionary influences of a period of rising coffee prices and rapidly expanding banana markets have already begun to be felt. There may even be difficulties in maintaining investment at its recent rate. But the prospects for the sound economic and financial planning that wrill be especially necessary during the next few years appear good. The new government that took office in September, 1956 has improved markedly the climate of economic decision. It does not ap':ear to be a government that will overextend itself rashly during the next few years when economic adjust- ments may be difficult. It is dealing firmly with the pressing fiscal problems it inherited from the previous administration. The Government is also takning steps to rationalize public economic policy as much as possible. It has or- ganized with the Bank's assistance, but at its own expense, a special economic mission to examine the machinery of economic policy making and execution and initiate reforms in the fiscal and banking fields. There is, accordingly, a case for external borrowing that will help Ecuador maintain her rate of investment during the next few years. The immediate burden of previous increases in external public debt is heavy. But moderate service payments which are scheduled with reference to the time pattern of Ecuador's present obligations would not increase peak debt service burdens beyond those called for on the existing debt. Borrowing at long-term would lengthen the average maturity of Ecuador's external debt as two-thirds of the amortization payments scheduled through 1960 represents repayment of suppliers' and private bank credits.  I INTRODUCTION 1. The last economic report on Ecuador was presented in February, 1956, (WH44-a). This reoort found that though long-term development potentials were good, real incomes in cuador were unlikely to grow during the second half of this decade as rapidly as they did dturing the 1950-54 period of expanding export markets and improving terms of trade. It also found that while Ecuador still had an abundance of exploitable resources, a flexible economy, and a rate of saving and investment that should assure the continued development of these resources, it also had a number of problems which, if not resolved, could compromise the fullest realization of the country's development potential. By far the most serious of these problems was the fragmented and inflexible finances of the public sector. 2. The structural findings still apply. Ecuador's external prospects have not changed fundamentally during the past year and a half, and the still feeble coordination of the public finances continues to make for a less than satisfactory allocation of the limited financial resources of the public sector. But there has been a significant improvement in the climate of economic decision during the short period the new government has been in office. The most immediate fiscal and monetary problems are being dealt with firmly. Practices such as paying road contractors with dollar bonds which were singled out for special criticism in the last economic report have now been stopped. ;liost important, efforts are being made to rationalize public economic nolicy as much as possible. The Government has organized with the Bankts assistance, but at its own ex- pense, a special economic mission to examine the machinery of economic policy making and execution and initiate agreed reform in the fiscal and banking fields. This mission, which will be in Ecuador for one year until the spring of 1958, is headed by Mr. Harry G. Curran, a senior official of the British Treasury on leave of absence for this purpose. It is staffed by Ecuadorians by staff members of the Bank, the International 14onetary Fund and the Jnited Nations who have been lent to the Nission for varying periods of time; and will be aided in specific fields by outside banking, budget and tax experts. This qualitative improvement in economic climate is the most important change that has taken place since the writing of the last economic report, II RECENT ECONOMIC GROWTH AND PROSPECTS 3. The years since World War II have been rather good years for Ecuador: real incomes increased sufficiently to provide for substantial improvement in the standard of living of a population that has been growing at the rapid  rate of about 3% each year. With the help of improving terms of trade, real incomes are estimated to have increased by some 7% per annum over the decade since the war. But output has also been increasing rapidly. The production of goods and services is estimated to have increased in volume by 5% per year on the average during 1950-1955. 4. This growth appears to have taken place in all sectors of the Ecuadorian economy. Agriculture, industry, commerce and services have all expanded. Ecuador is slowly industrializing - industry has recently begun to contribute a slightly increasing proportion of the national income - but agriculture still remains the principal economic activity, from which one-third of the national income originates. 5. Economic growth has not been even. In some years Ecuador's real income increased by well over 10% while in other years it barely increased by 1%. But year to year fluctuations in the fortunes of an economy such as Ecuador's are not surprising. Ecuador is predominantly agricultural, her exports consist almost exclusively of primary agricultural products, and the economy is therefore subject to all the vicissitudes of sharp fluctuations in crops and in export markets. What is important, looking back over the postwar decade, is that these fluctuations have occurred about a steady trend of fairly rapid growth. 6. Real gross investment is estimated to have doubled in annual volume during the decade since the war. In rate, annual gross investment has ranged between 10% and lh% of the gross national product in real terms. As Ecuador does not produce capital goods in significant amounts, this investment effort has been largely based on Ecuador's ability to increase the availa- bility of investment goods through exports from its banana plantations, its coffee and cacao groves, and its rice fields. 7. Because of the close relationship between exports and economic development, much of Ecuador's postwar expansion has reflected the series of world market developments which have been favorable to Ecuador's exports during this period. The increased level of rice exports during 19L6-b8 owed its origins to the difficulties immediately after the war in increasing rice production in Asia. The banana era began when production problems in Central America, originating in part from neglect of plantations during the war, caused that region's exports to the United States to decline sharply. Ecuador filled this gap. Coffee and cacao expansion was stimulated by postwar world price improvements which were substantial, not only by comparison with prices for those same products before and during the war, but also by comparison with the increase in the general level of prices during this period. The rice boom was brief, and has since left Ecuador with a problem sector in agriculture. But the result of the other developments has been that Ecuador has become the world's first banana exporter; and that bananas, cacao and coffee - with bananas leading - now produce 90% of Ecuador's exchange earnings from exports. 8. As far as can be seen at this moment, the various favorable ex- ternal factors mentioned above have virtually disappeared. Banana exports appear to have reached a plateau. The expansion of cacao and coffee  - 3 - production should continue as recently planted trees come into production, but cacao prices have already dropped sharply and coffee prices promise to decline. Ecuador may thus be said to have entered a new period in its postwar pattern of economic expansion. Export earnings in 1955 and in 1956 were lower than in 195$. Since export earnings are pivotal to Ecuadorian expansion, these developments have produced the strains that might have been expected to result from a tendency of the export sector to shrink relative to the econcmy as a whole. Fiscal strains have developed both because budgetary revenues are in large part derived from taxes on foreign trade and also because the public investment effort has continued to increase. Recourse to debt for financing public investments has increased sharply. Foreign exchange reserves have fallen sharply. The pressures on the external position have been further exaggerated by what appear in retrospect to have been unfortunate changes in the tariff law and by difficulties in gearing monetary policy closely to external developments. 9. During the next few years exchange earnings are unlikely to increase significantly (Appendix A). But in view of the long-term development potential - there is still abundant basis, through opening new lands and improving technology, for expanding substantially the range and volume of agricultural production both for export and for domestic consumption and for the continuation of the current expansion of industry - the next few years appear likely to be more a period of readjustment rather than a permanent flattening of Ecuador's growth prospects. In this perspective, and since both private and public investment are directly dependent on imported materials, Ecuador's principal problem for the near future is likely to be to maintain a rate of investment consistent with continued economic growth. 10. There is no compelling reason for Ecuador not to be able to maintain such a rate of investment. However, in view of the constricted margins for waste and misallocation, even more importance than in the past must be assigned to the program, only now getting under way, to introduce some discernible rationalization and coordination of financial resources and decisions in the public sector. For it is on those basic facilities - most notably transportation - which in Ecuador are provided overwhelmingly by public authorities, that the continued development of the Ecuadorian economy will largely continue to be based. A. ACRICULTURE 11. Ecuador's agricultural economy has been expanding, most rapidly in the export sector whose production comprises some 40% of the value of all agricultural output, but also in the domestically-oriented sector. The LJ For statistical references see Tables 6 to 10 .  prospects are for a continuation of this expansion to provide both for an expanding volume of exports and for an increase in food production at least high enough to keep pace with growing domestic consumption. 12. This expansion is likely to be both extensive and intensive. In spite of the fact that virtually all agricultural expansion to date has been the result of increasing areas under cultivation rather than in- creasing yields, there is still a large area of cultivable land available for further development; only some 10% of the arable land in the Costa is now estimated to be under cultivation. There are even larger areas on the eastern side of the Andes but these are still virtually unexplored and in- accessible and are unlikely to become important as long as the Costa remains open for development. The intensive development potential rests on the fact that yields for virtually all crops are substantially lower than the yields obtainable both in other countries and on well-run farms in Ecuador. Efforts are being made to realize the potential in both direc- tions, though there are still many obstacles to be overcome. 13. Though the grain and cattle producing Andean Sierras have many large estates, this part of Ecuador is on the whole overcrowded. E.x_ cessively small land holdings have in some places become a primary obstacle to improving agricultural methods and yields. Ecuadorls main extensive development potential is thus restricted to the coastal low-_ lands. New highways built since the war have opened up coastal lands, and roads now under construction or being planned promise to provide the basis for a continued extension of Ecuadorls agricultural frontiers. The major coastal crops are bananas, coffee, cacao, sugar cane and cotton. 14. The potential from improved yields, hom-evers is not restricted to any particular area. Equally in the Costa and in the Sierra, Eouador's presently low agricultural yields reflect the fact that there is generally little guidance in or regard for conservation of the soils little main- tenance of fertility by the use of fertilizers, little proper handling and processing of crops, and little kniowledgeable selection of high yielding plant varieties and techniques for combatting pests and plant diseases. Technology 15. The-problem of agricultural technique is most critical in the case of bananas. Because of sigatoka diseases which has become widespread throughout all but the southern banana producing regions, the amount of exportable stems produced per liectare has been falling on most northern and central farms. Average yields are being maintained only by the con- tinued opening of new plantations which are fertile and disease-free during the first years of production and by the good practices of the large established plantations on which some tvo-fifths of the exportable bananas are grown. 16. The Banana Producers Association, with the help of loan funds originating from United States surplus commodity sales to Ecuador  -5- (P.L. h8o funds), is implementing a program to control sigatolca and improve techniques on the farm. It is estimated that, with proper pest and disease control and with the use of fertilizers, the yield of banana stems of ex- portable quality can readily be increased threefold, from 200 to 600 stems per hectare. Increased yields of this magnitude would far more than cover the additional cost of better care on most farms. Because of the importarce of bananas in Ecuador's economy - they currently provide over 40/O of Ecuador's export earnings and represent the major economic activity in large areas of the Costa - it is umlikely that the banana campaign will-be allowed to fail. Dut if for any reason this campaign is not successful, Ecuador's production of exportable bananas could drop noticeably within tvno years. 17. The disease risks arising from a continuation of present poor tech- niques are not as heavy rDr as immediate in other crops as in bananas; but the rewiards for better technology are no iless and steps are being taken to introduce improvements in various directions. There is a Cacao Institute which has been growing and distributing improved cacao plants developed at the Point IV experimental farm. These plants have much higher yields than those presently obtainable and are resistant to the witch-broom disease which plagued Ecuador's native cacao plants in the past. There is a Coffee Institute which has been disseminating information about the benefits to the fanrer of proper picking and proper processing of the coffee on the farmn With the help of P.L. 480 funds, the Institute has been helping farmers finance the purchase of depulping machines and the construction of drying platforms necessary for proper processing. The Institute has also begun to buy washed coffee and ripe coffee cherries for processing at its new plant, both at prices intended to provide in- centives to farmers to handle and process their coffee better. There is also a Cotton and a !fheat Institute, both of which are engaged in programs to discover and distribute higher yielding and disease-resistant seeds most appropriate to Ecuadorian soils and climate. 18. But to put agricultural technology in its proper perspective, the prospects of increasing yields remain less immediate than the obvious gains in sight from further ex:tensive development in agriculture. Apart from efforts to overcome the pressing problems in bananas and to improve the coffee industry, tne work of the crop Institutes is rather modest in scale; and with inertiaagainst changes in methods and the very fewi people presently available in Ecuador to work as technical advisers and extension agents, changes in agricultural procedures will most probably be somewhat slow. Controls 19. Ecuador resembles agricultural communities in many other parts of the world in that it has over the years instituted a variety of price and trade controls on agricultural products. How-ever, the often complicated admin- istrative mechanisms which have been set up in Ecuador to solve  - 6 - particular economic problems or to achieve particular economic goals appear to be hindering rather than fostering the countryts agricultural development. 20. Their principal defect is to inhibit the operation of normal economic incentives to improve the volume and quality of agricultural production on the farm. Ileat prices are fixed without regard for quality. prohibitions on the export of wool have forced the local price of wool well below world market prices. This has proven attractive to local wool buyers but it has effectively prevented the upgrading of Ecuadorls sheep population and wool production. The subsidization of rice growers by fixing the purchase price for rice without regard for quality has contributed to a progressive de- terioration in the quality of rice produced. Cotton prices have also been fixed wvithout regard to quality. The general effect has been to leave producers little incentive to use fertilizers and improved seeds or breeding stock. In cases, the intention has been to set a price floor to protect the small grower from a few large buyers, but without quality differentia_ tion the disincentives have been serious. There has been no disincentive in the price fixed for sugar, but in this case there has also been no economic rationale for supporting a domestic price above the ,world market price when production conditions and costs on the Costa are judged able to support a profitable export trade at world prices even lower than exist at present. 21. There are other negative policies in agriculture. To protect local producers, restrictions on internal as well as external trade exist. The export of dairy products from the milk-surplus Sierra to milk-short Guayaquwil on the coast is being prevented, though milk products remain short in Guayaquil and rich dairy potential remains underdeveloped in the Sierra, There are export prohibitions on a ntumber of Sierra food crops which have inhibited expansion for neighboring export markets except where the economic incentives to export have been so strong that smuggling has developed. Until the recent depreciation of the Colombian peso, the illicit export to Colombia of grain produced near the border was steady and substantial. 22. Of course these controls do not dominate Ecuadorian agriculture. Flexibility in developing new crops, in considerable part through the response of small producers to market forces, still remains one of the most important characteristics of Ecuador's agriculture and one of the most important ingredients of Ecuador's recent economic gro7wth. Oilseeds areone of the most promising new lines of agricultural development. The potential in fisheries is also impressive. This restrictive pattern of administrative control is sufficiently pervasive, however, to warrant a comprehensive review, especially as it bears most heavily on the least dynamic parts of Ecuador's agricultural economy.  -7- Credit 23. One of the major weaknesses in the agricultural development picture is the lack of medium and long-term credit for farm improvement and de- velopment. To a very considerable extent the expansion of Ecuadorian agri- culture in recent years may be said to have been self_financed. Less than 3% of the anmual lending by commercial banks is for agriculture, and that mostly at short-term. The Sistema de Bancos de Fomento, most of whose loans are for agriculture, constitute the only source of agricultural credit in any amount; but these are also mainly at short-term, and in small amounts. Four-fifths of the annual loans made by the Sistema are for periods of less than one year, and for sums of less than the equivalent of 6,700. 2h. Ecuador has been fortunate in having bananas to "finance" much of the longer-term development on the Costa in recent years. In contrast to coffee and cacao, wLhich do not yield fruit until some three to six years after planting, banana plants bear fruit tw