Ecuador - Industrial development problems and prospects

Report No. 1186-EC Industrial Development Problems and Prospects Ecuador October 7, 1976 tL Industrial Projects Department FOR OFFICIAL USE ONLY Document of the Wo.- This document has a 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.  This report is based on the findings of an Industrial Sector Mission which visited Ecuador in September- October 1975. The mission was composed of Irwin Baskind (Chief), Enrique Low, Guy Prenoveau and Mario Sarquis (Consultant). PRINCIPAL ABBREVIATIONS USED NPC -- National Planning Council BNF -- Banco Nacional de Fomento COFIEC - Compania Financiera Ecuatoriana de Desarollo CV-CFN - Comision de Valores - Corporacion Financiera Naccional CENDES - Centro de Desarollo Industrial CURRENCY EQUIVALENTS Currency Unit Sucre (S/.) S/. 1.00 - US$O.04 US$1.00 = SI. 25.00 SI. 1 million = US$40O,O0O GOVERNMENT OF ECUADOR FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY ECUADOR INDUSTRIAL SECTOR SURVEY Table of Contents SUMMARY OF PRINCIPAL CONCLUSIONS AND RECOMMENDATIONS CHAPTER I - INTRODUCTION - RECENT TRENDS AND PRINCIPAL CHARACTERISTICS OF THE INDUSTRIAL SECTOR A. Introduction - Scope of the Report B. General Overview of the Industrial Sector C. Main Characteristics D. Resource Endowment E. Infrastructure CHAPTER II - MAIN ELEMENTS OF INDUSTRIAL POLICY A. Principal Industrial Incentive Laws B. The Special Problem of Small and Artisan Industries C. Export Promotion D. Price Policy E. Labor and Wage Policies F. The Andean Common Market CHAPTER III - THE FINANCIAL SYSTEM A. General Characteristics B. The Elements of the Financial System CHAPTER IV - PROSPECTS FOR FUTURE INDUSTRIAL GROWTH A. General Sectoral Strategy B. Possibilities for Major Subsectors C. Regional Disparities D. The Special Problems of Small Scale and Artisan Industry E. Progress and Prospects Under the Andean Pact. Thb document hau a restricted distribution and may be used by recipients only in the performance of their omcial duties. Its contents may not otherwise be disclosed without World bank authorization.  Table of Contents (Cont'd) ANNEX 1 AGRO-INDUSTRIAL OPPORTUNITIES ANNEX 2 FINANCIAL SYSTEM STATISTICAL APPENDIX Table 1 - GDP by Economic Activities Table 2 - Structure of Industrial Value Added Table 3 - Employment and Productivity - 1973 Table 4 - Import Dependence of Industry Table 5 - Incentive Legislation-principal features Table 6 - Exports of Manufactured Products Table 7 - Distribution of Factories, by size, 1973 Table 8 - Structure of Imports, 1967-1974 Industrial Projects Department October 7, 1976  SUMMARY OF PRINCIPAL CONCLUSION AND RECOMMENDATIONS Recent Trends and Principal Characteristics of Industrial Sector i. Ecuadorian industry has shown rapid growth in the last decade (1965-1974) with an average annual real growth rate of 9.4% compared to 5.4% for GDP. Nevertheless, the sector continues to account for a relatively small share of total output, some 17.2% of GDP in 1974 at current prices, reflecting essentially the limited market size of the country with its low level of per capita income ($410 in 1973) and relatively small population. ii. The emergence of a dynamic industrial sector in the last half of the 1960's had its roots in the evolutionary changes in the physical and in- stitutional infrastructure in the 1950's. A National Planning Council was established in 1953; in 1957 an Industrial Development Law was enacted and the first five year road development plan was initiated. Substantial invest- ments were also made in the power sector with generating capacity as well as power generation tripling in the decade. Intensive geological and associated explorations which ultimately led to the discovery of petroleum resources in the 1960's were also initiated in this period. In the 1960's, further insti- tutional development occurred with the creation of an Industrial Development Center (CENDES) and two long-term financial intermediaries, one in the public sector (CV-CFN) and one in the private sector (COFIEC). iii. Prior to the discovery of hydrocarbon resources, the Ecuadorian economy was essentially based on agricultural resources. Cultivation is presently concentrated along the Coast and in various fertile valleys in the Sierras. Nevertheless there exists considerable scope for expansion of agricultural output, bringing into cultivation major land areas not now com- mercially cultivated in the coastal area and to some extent on the eastern slopes of the Andes, partly because of remoteness from existing markets. In addition significant increases in yields on existing cultivated land are possible through improved farming techniques, including irrigation, fertilizer use and the use of higher yield varieties. iv. Non-metallic minerals are available in substantial supply to meet the increasing demand for construction materials arising from the cur- rent period of increased growth but further surveys are required to deepen knowledge of these resources for future development. There are some traces of non-ferrous ores which might be economically exploited and additional studies are underway to determine viability; there are only minor traces of ferrous ores. v. The discovery of a major crude petroleum field in the Oriente area in 1967 and its subsequent exploitation beginning at the end of 1972 have radically changed the economic perspectives for the country. Never- theless there is considerable uncertainty as to the extent of these resources with the current estimate of proven reserves at 1.5 billion barrels. Earlier estimates of proven and unproven reserves had been in the range of 5 billion barrels. Further exploratory work is required to establish the extent of the  reserves, data which are necessary for investment decisions to obtain optimum use of crude petroleum. Relatively extensive dry natural gas has also been found in the Guayas region. At present, there is little exploitation of this resource but a major fertilizer complex is now in the planning stages; a substantial portion of the output of this facility would be for export. Other projects to use this resource are being developed, including the possibility of a direct reduction steel mill using imported iron ore to meet estimated future domestic steel needs. vi. The structure of industry is typical of a country at the early stages of development with output heavily concentrated in basic consumer goods. Recent growth has been particularly marked in branches supplying the construction industries (plywood, cement, glass, metal bars, etc.) and there have been some simple mechanical engineering industries estab- lished; average size of establishment remains relatively small although the newer units have tended to be substantially larger. Direct links to expanded petroleum development have been limited. Exports of manufactured products represent no more than 7 to 8% of the gross value of the sector's output, although for a number of manufactured traditional products, such as sugar, cocoa and seafood, the share approaches 40%; these industrial products have in recent years accounted for 10 to 15% of an increasing total export value due to the emergence of new export lines. vii. Total employment in industry amounts to less than 12% of the econo- mically active population. There has been substantial growth in factory employment in recent years but at present this component represents only 25% of total employment in industrial activities. The remainder is found in the small and handicraft type of enterprises with low productivity; as a conse- quence, these units represent only 30% of value added in the sector. New jobs generated by the growth in factory output currently represent only a little more than 10% of the estimated annual inflow of new entrants into the employ- ment market; nevertheless there appears to be little open unemployment as construction and service sectors have offered substantial new job opportun- ities recently. Factory employment continues to be heavily concentrated in the two main urban centers, Quito and Guayaquil, representing 78% of total. viii. The recent boom in overall economic growth, based on the newly exploited petroleum resources and the price increase in 1973, has stimulated investment in a number of industries serving the local market including consumer goods, construction materials as well as some simple capital goods. Favorable treatment of investment and liberalization of capital goods imports in early 1973 also have played a role in this growth. The expansion in capacity does not yet appear to be reflected in changes in output as many delays have been encountered in getting the new plants on stream, including problems arising from the shortage of skilled technical and managerial personnel. Present high production rates reflect mostly better utilization of existing capacity.  M1ain Elements of Industrial Policy ix. Industry in Ecuador follows essentially a pattern of free enter- prise with government efforts mainly devoted to the creation of supporting infrastructure and services and policies affecting taxation, tariffs and finance. The development of petroleum refining and petrochemical production by government agencies will bring about a larger share of public enterprises in the country's industrial sector. Comprehensive industrial development laws have been in force since the first law was enacted in 1957; modifications have been introduced periodically and in 1973 a major revision was undertaken which emphasized regional decentralization of new industry. The main features of all of these laws have been varying degrees of exoneration from taxes and from tariffs on imported raw materials and/or capital goods. x. Until the recent inflow of petroleum income, tariff revenues were the single largest source of government revenue and were imposed for that purpose. Balance of payments criteria were paramount in establishing quanti- tive restrictions, particularly on finished goods, as well as in setting prior deposits. Overall, average tariff levels and dispersion were not excessive and nominal protection and effective protection were more or less the same. While incentive laws provided tariff exoneration for imported raw materials, thus in principle raising effective protection, the narrowness of the market restrained investment in uneconomic activities and domestic competi- tion was sufficient to keep domestic prices close to import prices for most of the consumer goods (textiles and foods) representing the bulk of the industrial sector's output, the production of which is not characterized by economies of scale. xi. Imports were considerably liberalized in early 1973 but the subsequent reemergence of the foreign exchange gap led in mid-1975 to an increase in tariffs, some prohibitions on imports of consumer goods and a selective tariff surcharge of 30%, as well as an increase in prior deposit requirements. Although it is too soon to evaluate the effect of the recent changes, there is little doubt that with the growing internal market, distortions are being introduced by the present system combined with the exonerations granted under the investment incentive laws. Although in the longer-run Ecuador's tariff structure will depend upon negotiations within the Andean Group for a Common External Tariff, a correction of the present system is essential to avoid misallocation of resources. One measure which has been used in other countries to restrain imports of so-called luxury goods, while not stimulating production through high effective protection, is to impose large sales taxes on those items which are applied equally to imports and domestic output. xii. The revision of the incentive law in 1973 provided considerably greater tax exemptions for industries defined as priority and in general for those to be established outside the two existing main centers of activity  - iv - (Quito and Guayaquil). These features appear overly generous in nature and are not consistent with the principles of tax equity and with the need to avoid weakening the tax base from the long-term point of view of government revenues. Moreover, they are biased in favor of capital intensive investment and have encouraged the establishment of some industries with unnecessarily high import content. In mid-1975, the Government established a review committee to assess the results of the law; it would be useful to complete this analysis as soon as possible. xiii. Another feature of the 1973 investment law was the expansion of a limited direct incentive system for non-traditional exports which had been instituted in 1971. Under the new system, incentives are given to manufactured exports in accordance with past performance up to a maximum of 15% of the gross value; non-processed non-traditional agricultural exports receive 4%. The Government is now considering a further revision of the law which, inter alia, would establish a scale of payments for products in accor- dance with domestic value added. Experiences with similar schemes in other developing countries have indicated their usefulness in developing export-con- sciousness in the early stages of development but also have drawn attention to the fiscal burden of such systems over the long-run; those countries are generally moving towards greater dependence on exchange rate policies to influence exports and promote efficient resource allocation. For many resource- based products where future export growth potential appear to exist for Ecuador at the present time, it seems likely that direct efforts at improving marketing facilities may have as much impact as these incentives. Much more effort is required to determine for the specific products involved the possible barriers to export expansion in order to define the specific measures required. Among other policies which may also be adopted to stimulate manufactured exports, are improvement of transport and storage facilities, provision of finance and of special promotional activities and the establishment under appropriate safeguards of free trade zones. xiv. While most prices in Ecuador are set by market forces, a number of major consumption goods are subject to price ceilings; price supports to stimulate production are provided for a few agricultural based items. The overall effect has been to introduce important distortions and misalloca- tion of resources, with scarcities developing for products whose prices are fixed too low and over-production for those with prices fixed too high. Notable examples are found in the case of sugar, where the low fixed price relative to world market prices has disrupted distribution and has encouraged diversion of output including the use of sugar as an intermediate good in producing items not subject to price control; similarly in the case of plywood, the low domestic fixed price has encouraged illegal export to neighboring countries. On the other hand, prices of soy beans have been set relatively high while prices of the final product are set relatively low (vegetable oils for cooking). This has, in fact, encouraged processors to import raw materials rather than rely on locally produced higher priced inputs.  Financial System and Policies xv. Comprehensive data on the supply of long-term capital to industry are lacking, but general indications are that the bulk of these funds continue to originate outside the organized capital market and financial intermediaries. A system of instruments and institutions, relatively sophisticated given the current stage of development of Ecuador, have been created which are increasingly being used, but in order for them to play a more useful role in accelerating future industrial growth, it will be necessary to undertake important changes and modifications. xvi. The two development finance corporations, CV-CFN and COFIEC, were created at a time when there was need to channel required external resources into the development effort. Although CV-CFN originally was de- signed as a Goverrunent agency (Comision de Valores) for public bond issues and regulations, since its reorganization in 1964 it has primarily performed as a source of long-term finance for the private sector. In this sense both corporations with Bank Group assistance have performed relatively well. Many of the new industrial installations have had support from one or both which in the period of foreign exchange constraint was essential and which helped to attract additional long-term funds from domestic sources. xvii. CV-CFN depends upon the Government for its equity; during 1974, as a result of large public savings, the Government increased its equity con- tribution by 50%. In spite of substantial borrowings from the World Bank, IDB and other foreign institutions, its debt/equity ratio has been rather low and could have supported considerable borrowing in local markets. Recently it has been able to raise additional resources in the local market through bond issues which are highly liquid. xviii. COFIEC, on the other hand, has had considerable difficulty in raising its equity base even with a relatively profitable performance. This appears to reflect the general difficulty in attracting equity capital, among other things, as a result of the existing tax system which discriminates against dividend income, thus favoring lending operations as compared to direct investment. At the same time, the interest rate ceiling (12% maximum by law) and the structure of commissions, by not offering sufficient spread on medium and long-term loans, has forced COFIEC into a high proportion of short-term financial operations (including in particular foreign exchange guarantees) which are relatively more profitable, thus interfering with proper resource mobilization. Aside from the desirability of improving the condi- tions under which this institution operates so that it can fulfill its objec- tives, appropriate adjustments in the basic policies affecting interest rate and tax structures are necessary particularly in view of the establishment of new financial intermediaries. These are required for the country's overall financial system to contribute more effectively to the accelerated growth of industry which is both possible and desirable.  - vi - Prospects for Future Industrial Growth xix. The current resource position of Ecuador and its limited market size suggest that in the next decade, substantial increases in per capita income can only be achieved through adequate expansion of exports increas- ing the relative share of the latter in GDP. While the sector can play an important role in this strategy, industry will be only one part. Moreover, the decision whether to industrialize a particular exportable resource should be taken after full evaluation of the net foreign exchange earning capacity of that resource as compared to exporting it in its simplest form and of the alternative uses of the capital investment involved. In order to achieve these higher growth rates, attention will have to be given to expanding further the infrastructural base and, in particular, to developing local managerial and technical skills. xx. Considerable effort is now being expended in planning the indus- trialization of the recently discovered hydro-carbon resources. Unless proven reserves of petroleum are substantially raised through increased exploration, further expansion of refinery capacity for petrochemical develop- ment, which could not be on stream before the early 1980's, does not appear viable. However, even if reserves prove more extensive, consideration should be given to alternative investment of available funds in activities with better economic and social rates of return and more direct employment effects and consequent impact on income distribution. Similarly, in the case of development of dry natural gas-based industries, production paths should seek to maximize value; thus a proposal for using gas in a direct reduction steel mill should be evaluated against alternative uses of that resource. Part of the capital requirements for these projects, primarily those which are export-oriented, are expected to be supplied by potential consumers and therefore would have no alternative use from the point of view of Ecuador; thus what is required is a blend of investment, utilizing the non-renewable hydrocarbon resources to assure a large flow of export earnings in their lifetime combined with the investment of domestic funds in developing new sources of employment and export earnings among the currently underutilized agricultural and related resources. Another critical aspect affecting sup- plies available for export is the present policy for relatively low internal prices which has encouraged rapid growth of domestic consumption of petroleum. xxi. Significant opportunities exist for agro-industrial development oriented towards exportable products. Among the possibilities which have been identified are expansion of sugar refining particularly bringing into cultivation land not currently commercially cultivated, fish products, fruits and vegetables for processing (both canning and dehydration), banana flour for animal feed and non-food products such as wood products, abaca and other hard fibres, sorbitol (derived from corn) and castor oils. To develop these items, important revisions will be required in price policies (see xiv. above)  - vii - and considerable investment in infrastructure, in particular, comprehensive system of feeder roads and port improvement, will have to be undertaken. luch of this development would be concentrated in underutilized land in the coastal area and the largely undeveloped eastern slopes. xxii. Additional opportunities for expansion of agro-industries will arise from growing domestic incomes providing expanding markets, particularly for meat and dairy products. Production of these items are well suited for the Sierras, as are certain high value export oriented crops (e.g. pro- cessed garlic and onions). Growth in domestic incomes and investment will also provide further opportunities for industries producing a wide range of consumer, goods and particularly construction materials while the expansion of the industrial base is expected to promote some backward integration favoring the establishment of industrial chemical, metal product and some mechanical engineering industries. xxiii. Within the Andean Common Market, Ecuador has been given special treatment reflecting its status as relatively less developed. The first stages of trade liberalization have seen considerable expansion in its ex- ports of manufactured products, largely the traditional processed foods such as fish and cocoa products, but including some advanced manufactures such as domestic appliances. Projects for items not previously produced in the country but freed from trade restrictions by partner countries and for items assigned to Ecuador under the regional program for metal-mechanical industries have been delayed in implementation largely reflecting shortages of technical skills and know-how. xxiv. Various measures have been introduced to promote the development of small and medium industries, as well as artisan activities. The most recent step was the enactment in 1973 of a special incentive law offering further exonerations from taxes and tariffs for these enterprises, originally defined in terms of a maximum of approximately $60,000 invested in machinery and equipment but raised to approximately $200,000 in August 1975. Aside from their even more overly generous features and other undesirable characteristics already noted (see xii. above), these incentive laws have tended to discourage the expansion of individual beneficiary enterprises beyond those limits or at best to encourage legal fragmentation of units. Modifications suggested include a time limit on benefits for the enterprises and no restrictions on possible expansion of beneficiary during that period. Other measures to assist small industry should include intensified technical assistance programs and the construction of industrial estates. While the latter has been pro- posed for a number of years, implementation of existing projects has been very slow owing to previous lack of financial resources and, in particular, shortage of managerial and organizational personnel. Consideration should also be given to the creation of a guarantee fund which could facilitate lending to smaller enterpises.   CHAPTER I INTRODUCTION - RECENT TRENDS AND PRINCIPAL CHARACTERISTICS OF THE INDUSTRIAL SECTOR A. Introduction - Scope of the report 1.1 The recent discovery of important hydro-carbon resources on the eastern slopes of the Andes Moutain and the external conditions which have led to substantial increases in prices of these commodities, have provided to Ecuador a major opportunity to change radically its economic status. In the early 1970's Ecuador had the third lowest per capita income on the South American continent. There exists some uncertainty as to the precise extent of the new resources which would primarily affect the length of time during which additional resources would flow to the Government for effective utilization. Nevertheless, there is a reasonable possibility that over the next decade Ecuador will have available to it foreign exchange and domestic resources which can permit it to stimulate substantial increases in per capita incomes, as well as to improve its distribution by absorbing into the money economy a major share of the rural population, which now lie largely outside it. 1.2 This report concerns itself with the possible role of industry in achieving the dual objectives of raising income and improving its distribu- tion. At the present time, that role is extremely small with the sector accounting for no more than 17% of GDP and only 11% of the economically active population. This role is nevertheless consistent with the existing low level of per capita income and the small population of the country. 1.3 In this connection, it must be stressed that the fundamental objective of economic policy must be to find all economically sound means for raising the proportion of exports to GDP. For it is only through such a dynamic process of growth that a country the size of Ecuador can raise per capita incomes and have the opportunity to improve its income distri- bution. 1/ This can best be illustrated by the events of the past few years as GDP growth rates in excess of 12% have been associated with the increase in exports' share of total product from 15.5% in 1972 to 26.3% in 1974_(in current prices). The need to find further export possibilities becomes more pressing if the hydro-carbon resources are not as extensive as originally contemplated. 1.4 Manufacturing industry may not and need not be the primary source of the export potential. To the extent that world market conditions for basic agricultural products originating from the country permit further expansion of these exports, the agricultural sector itself can make such a contribution. 1/ See Chapter IV.  - 2 - As regards supplies of mineral resources which could be exported, current knowledge suggests only limited availabilities but, as pointed out later, there is need for further survey work to explore some indications of econo- mically exploitable ore deposits. 1.5 As regards the hydro-carbon resources, considerable attention is now being given to their further industrialization in the form of refined petroleum and petrochemical products. If the crude petroleum resources are limited, it may be difficult to justify economically refinery capacity for petrochemical development which would be additional to refineries which are already on stream or under construction. Nevertheless, even if further reserves are proven, it is necessary to evaluate the net additional foreign exchange earnings from exporting petrochemical products as compared to con- tinued export of crude petroleum, and the possible alternative uses of the investment funds required for constructing refining capacity in other export- oriented industries. The question must be asked whether such funds could not have higher economic and social returns, through direct employment generation and consequent impact on income distribution, if they were applied to other types of more labor intensive export-oriented industries; this is especially so since not only is petrochemical production heavily capital-intensive but it also has few backward and forward links given the current Ecuadorian indus- trial structure. 1.6 From a practical point of view what is required is a blend of investment, utilizing the non-renewable hydrocarbon resources to assure a high flow of export earnings in their lifetime and, at the same time, de- veloping new sources of employment and export earnings among the currently underutilized other resources of the country. To explore the latter, this study provides a brief survey of the existing industrial structure of the country, how it has achieved its current level and what are the principal bottlenecks to further expansion, and then turns to possible areas of growth, with emphasis on those directions which could have the most favor- able impact on income generation and distribution. Special attention is given to major policy issues affecting the sector as well as to the mobil- ization of financial resources for these activities. B. General Overview of the Industrial Sector 1.7 Ecuadorian industry has shown rapid growth in the last decade with an average annual real growth rate of 9.4% compared to 5.4% for GDP. Nevertheless the sector continues to account for a relatively small share of total output, some 17.2% of GDP in 1974 at current prices, reflecting essentially the limited market size of the country with its low level of per capita income ($410 in 1973) and small population (estimated at 7 mil- lion in 1975).  - 3 - Industrial Output Industrial Share in Average annual rate GDP (end of period of growth in current prices) 1950-1955 3.9 15.0 1956-1960 5.6 15.7 1961-1965 7.7 17.2 1966-1970 8.4 19.0 1971-1974 10.4 17.2 Source: Mission estimates based on NPC and Central Bank data; the national accounts have recently been substantially revised and the data are not completely comparable. 1.8 The emergence of a dynamic industrial sector since the 1960's has its roots in the evolutionary changes in the physical and institutional infrastructure initiated in the 1950's. Data from the National Planning Council (NPC) indicate that throughout the period from 1950 through 1960, manufacturing value added represented 15 to 16% of total output. Some minor structural changes occurred during this period but the pattern of activity was typical of a country at the earliest stages of development, with output heavily concentrated in basic consumer goods - food, bever- ages, tobacco, textiles, clothing and shoes. The newer industries which were established during this period were largely associated with construc- tion activities. In turn, a substantial proportion of this production was used in the infrastructure investment undertaken at the time, which helped to set the stage for the accelerated growth characterizing more recent periods. 1.9 It was during the 1950's that the first steps were taken to elaborate an integrated development strategy. 1/ The National Planning Council was established in 1953; in 1957 an Industrial Development Law providing a range of incentives to new industries was enacted and the first five year road development investment program was initiated. Sub- stantial investments were also made in the power sector with electric generating capacity more than doubling during the decade of the '50s. In 1/ See the paper by Galo H. Salvador, of the National Planning Council, Industrial Development Strategy and Policies, UNIDO document ID/WG.176/4, 3 May 1974.  - 4 - the early '60s the institutional framework was further strengthened, with the establishment in 1962 of the Industrial Development Center (CENDES) to promote industrial investment and to provide technical assistance to manufacturing enterprises. In 1964, the Securities Commission (Comision de Valores) was expanded into a National Financial Corporation (CV-CFN) to provide long-term financial assistance to industry; a private sector investment corporation (COFIEC) was created in 1966. 1.10 The period 1965-1970 witnessed a further rise in manufacturing activity as its annual rate of growth substantially exceeded that of total product and its share in GDP in 1970 rose to 19%. The accelerated growth rate of industry was sustained during 1970-1974 but in this period, largely as a result of the emergence of crude petroleum production and associated activity, total product in real terms also increased at approximately the same rate. 1/ This period has been marked by investment in many new branches, continuing the trend toward diversifying the structure of output (see Statis- tical Appendix Table 2). 1.11 The expansion of petroleum output has for the time being had essentially an indirect effect on Ecuadorian industry with development of that sector generating direct demand for local products only in connection with construction; even in these instances, however, the limited existing production facilities have not been able to meet this demand and recourse has had to be made to imports of such items as cement. Indirectly, how- ever, there has been considerable impact. Much of the increased revenues accruing to Government has gone into infrastructure development which is essential if the fragmented market is to become integrated; these expendi- tures in turn have raised aggregate income and have supported continued demand expansion for basic consumer goods which comprise the major part of industry's output. Finally, the foreign exchange constraint to overall growth has been greatly reduced. C. Main Characteristics 1.12 Employment in manufacturing industries accounts only for 11.5% of total employment in the country, compared with a share of 46.5% for agri- culture. While open unemployment has not yet been considered a major prob- lem in Ecuador, (the unemployment rate being 6%), the annual average number 1/ In constant (1970) prices, the share of industry in 1974 remained un- changed as compared to 1970 (19%). However, due to the four-fold increase in crude petroleum prices during this time span, the share of that activity in total output in current prices has grown dra- matically. Thus, industrial value added in 1974 in current prices represented only 17.2% of total output.  - 5 - of new entrants in the employment market is now over 60,000 and the factories do not generate more than 7,000 new jobs each year. Moreover, the prevailing low-productive employment, primarily in the rural areas, is an evidence of the underutilization of manpower in Ecuador. Thus, the process of industrial- ization should focus not only on increasing employment and income in the indus- trial centers, but also in generating adequate development linkages with other sectors. Another element in employment absorption is construction activities. In the last few years, there has been considerable increase in both industrial and commercial construction as well as public works, which have generated many jobs particularly in Quito and Guayaquil and have contributed to the general appearance of little open unemployment in those cities. Many modern rela- tively large scale enterprises have been established during these past decades but employment generated by industrial activities continues to be heavily concentrated in small and handicraft type enterprises with low productivity. Small industry (defined as enterprises with less than seven employees) plus artisan activities accounted for 85% of the total actively employed in the sector in 1963 and 75% in 1973. As regards total value added, however, the share was 49% and 30% in these two years respectively. 1.13 As regards employment, NPC has estimated distribution in 1972 as follows: Total Productivity (in thousands) % (in thousand S/) Factory 53 20.9 82.2 Work-shops 64 25.2 15.8 Home-workers 137 53.9 11.5 Total 254 100 1.14 As regards the category of home-workers ("artesania casera"), this is believed to include many persons wanting to supplement family income who would not be available for employment outside the home. 1.15 The limited degree of industrialization achieved by the country is further seen in the relatively small average size of manufacturing establish- ments. Data from the 1973 Industrial Survey, covering 1,174 manufacturing enterprises with more than seven employees, indicate that only 74 factories had a gross value of output exceeding $2 million; it is estimated that this survey reached 75% of all industrial units and most likely a higher percent- age of the larger ones. Moreover, these larger units accounted for 56% of value added manufacturing but only 34% of employment (Statistical Appendix Table 7).  - 6 - 1.16 The structure of industry is consistent with this early de- velopmental stage, heavily concentrated in basic consumer goods (Statis- tical Appendix Table 2). Some 60% of total value added is represented by food, beverages and tobacco, clothing, shoes and furniture. Among more advanced manufactures, included in the output of the chemical indus- tries are such consumer items as soap, cosmetics and paint; the principal items among metallic products include metal furniture and accessories, household appliances and the assembly of radio and television sets. 1.17 Average investment per job created in manufacturing was 68,000 sucres in 1974, compared with 34,000 sucres for the economy as a whole and 26,000 sucres in agriculture. However, while the average incremental captial- labor ratio for large industries was S/. 617,000, it was only S/. 28,000 for small industries. 1/ 1.18 With the existing resource endowment, linkages between manufacturing industries and domestic production of raw materials and intermediate goods are limited to agricultural materials and non-metallic minerals. Thus, as industry has become more diversified in recent years, it has become increasingly dependent upon imports for basic inputs; to some extent, exist- ing investment incentive laws have tended to favor activities with high import content. Branches of activity such as metal and engineering products, plastics and basic metals which have experienced annual rates of increase of more than 20% in the past decade, import as much as 90% of their inputs. For the sector as a whole, 34% of its raw material requirements in 1965 were imported but by 1973 the figure had risen to 49%. Nevertheless, it must be kept in mind that, given the size of Ecuador, the share of imports (and exports) in GDP is likely to increase if per capita income is also going to increase. There exist a number of industries with low import content which can be expanded but many others will continue to require imports. Provided an appropriate overall strategy for export development is adopted, the import dependence of industry need not be a major concern; the policy implications are discussed in Chapter IV. 1.19 Industrial factories in Ecuador are largely located in the two main urban centers, Quito and Guayaquil. These two cities generated about 81% of the value of output and 78% of employment in factory manufacturing. 1/ OAS: Un programa de Accion a corto y mediano plazo para combatir el desempleo en Ecuador.  The recent rapid growth of industry in Cuenca 1/ has not as yet represented a substantial departure from the existing pattern of regional development. The table below summarizes the regional distribution of factory and artisan employment. Total Industrial Employment by Provinces, 1974 (in percent) Region Factory Artisan Total Pichincha (Quito) 38.2 17.9 23.8 Guayas (Guayaquil) 39.9 16.7 20.7 Azuay (Cuenca) 5.2 17.8 14.2 Rest of the country 16.7 47.6 41.3 TOTAL 100.0 100.0 100.0 Source: Industrial Census, Population Census. 1.20 At the present time, exports of manufactured products play only a small role in total industrial output although for a few items external marketing is important. In 1973 (the latest year for which data are available), total manufactured exports represented 7 to 8% of the gross value of the sector's output but for food products about 15%. For the traditonal items such as sugar 2/ and related products and for processed cacao, exports accounted for some 40% of the value of their production. Among the non-traditional and more advanced manufactures, foreign sales represented no more than 5% of output; only in the case of pharmaceuticals did these shipments account for as much as 15%. As regards the importance of manufactured exports in total, these items have accounted for 10 to 15% (see Statistical Appendix Table 6). 1.21 General indications are that the expansion in non-traditional manufactured exports experienced during 1974 and 1975, much of this in the context of Andean trade liberation, has slightly raised the percentage of trade in output. For example, exports of consumer durables such as household appliances are currently accounting for 25 to 40% of their production levels. 1/ The construction of the new petroleum refinery at Esmeraldas, which is also the terminal of the pipeline from the Oriente, has led to some expansion in that area as well. 2/ A much higher export price as compared to the domestic sales price prevails for sugar, thus overstating the proportion of export value to total sales value. In volume terms, exports account for 20-25% of production in the last few years.  -8- 1.22 Little information is available on actual capital formation in industry although, on the basis of application for benefits under the various industrial incentive laws, it is known that many new enterprises are in the process of being organized. Moreover, the improved liquidity situation stimulated some balancing, modernization and expansion of older plants to obtain higher production levels. New Enterprises Classified Expansions Registered Estimated Investment Estimated Investment Number (million sucres) Number (million sucres) 1972 25 492.8 32 217.4 1973 58 1366.9 27 236.4 1974 49 1312.8 29 608.0 Source: NPC 1.23 The limited sample of firms the mission visited suggests, however, that much of the expansion in output in the last few years has resulted from more efficient utilization of existing capacity. A 1972 NPC survey estimated capacity utilization in that year at about 60% defining capacity as two-shifts for most enterprises, three-shifts for process industries. A number of branches, particularly those producing consumer goods, which in the earlier survey had achieved between 50% to 75% utilization, were in late 1975 producing close to capacity limits. In addition, interviews with entrepreneurs and financial institutions suggest substantial delays in bringing new plants on stream, reflecting domestic shortages of construction materials, longer delivery periods for imported capital equipment and, in particular, shortages of technically skilled manpower. 1.24 The Central Bank has prepared a statistical series on imports of capital goods for industry which includes replacement parts, accessories and other equipment items besides machinery. The increase in these imports in real terms in 1974 and 1975 has been substantial. 1/ It is likely that 1/ It will be recalled that capital goods imports were considerably liberalized in early 1974.  - 9 - the installation of the new capacity these represent will first be felt in 1976. 1/ Imports of Capital Equipment for Industry Current Value (FOB) Volume Index Year (in US$ million) (1970=100) 1965 22.2 70.0 1966 27.1 96.1 1967 36.4 103.1 1968 37.3 102.2 1969 33.3 110.6 1970 38.5 100.0 1971 57.0 158.4 1972 68.0 116.9 1973 75.2 187.4 1974 210.3 405.2 1975 /a 273.0 457.3 /a Estimated by mission on the basis of import data for 8 months. Source: Banco Central, except as noted. 1.25 There are indications that the shortage of skilled labor and, in particular, managerial personnel has represented a serious bottleneck to implementing industrial investment plans. This is not completely unexpected in view of the previous limited industrial base and opportunities and the recent rapid expansion. In part, this shortage has been overcome by con- tracting expatriate personnel, by intensive on-the-job training abroad and by expanding domestic training programs for technical and executive person- nel. Among the latter, particular importance is attached to technical and vocational training through SECAP (which is being assisted under a Bank loan) and the establishment in early 1976 of an Advanced Management Training Insti- tute in Guayaquil sponsored by the private sector. 1.26 It should also be noted that the generally improved economic condi- tions which has led to substantial increases in salaries for skilled and man- agement personnel (in both the private and public sector) have resulted in 1/ For example, imports of equipment for the petroleum refinery may have amounted to as much as $70 million in the two years; this in- stallation is not expected to begin operations until early 1977.  - 10 - some return from abroad of trained and experienced Ecuadorians who had left the country due to previously existing limited opportunities. D. Resource Endowment 1.27 Until the development of petroleum exploitation in the early 1970's, Ecuador's economy was essentially based on agricultural resources. In the 1960's these primary activities accounted for some 46% of the economically active population although only about one-third of total output, due to prevailing low average productivity. Moreover, some two-thirds of indus- trial output was agro-based representing not only basic subsistence items for local consumption (e.g. processed food) but a number of exported processed items of relative importance in total exports (e.g. sugar, cocoa products, processed seafood). 1.28 Nevertheless, there remains the potential for substantial expansion of agricultural production, particularly for those items which can be exported after further processing. Not only can output be raised through increasing yields on presently utilized land, but there are substantial opportunities for growth through bringing into cultivation much cultivable land currently unutilized; to achieve these objectives, particularly developing new resources, would require a series of integrated policy and infrastructure investment de- cisions. Because of the basic importance of this sector to further indus- trial, economic and social development of Ecuador, a special study has been made of agro-industries and their requirements, which appears as an annex to this report. In subsequent sections dealing with policy and infrastructure needs, some of the main findings are summarized. 1.29 In addition, related resources such as forests and fish and shell- fish are similarly significantly underutilized and represent important areas for possible expansion. These are also discussed in the annex. 1.30 As regards non-metallic minerals, resources exist in sufficient quantities to permit substantial expansions in output of construction materials based on these minerals (e.g. cement, glass, ceramics and sanitary- ware). Utilization was limited by low demand levels until the recent con- struction boom. Many new plants based on these materials are now being built or are in the planning stages. However, industry sources have indicated that knowledge of these resource availabilities remains fragmentary and there is need for more intensive surveys to serve as a basis for further expansion in view of the expectation of continued high demand. 1.31 There is also need for developing better knowledge of mineral resources. A comprehensive mineral survey has yet to be completed while detailed investigations of specific zones which have been identified as of  - 11 - possible interest also need to be undertaken. At the present time there appear to be only limited ferrous and non-ferrous ore deposits; however, there are indications of supplies of such items as silver, zinc and antimony which might be economically exploited. 1.32 As regards hydro-carbon resources, present estimates are for proven reserves of 1.5 billion barrels in the Oriente area, as compared to earlier estimates of proven and unproven reserves of over 5 billion barrels. Thus, there is need for intensified exploration to clarify the actual extent of these fields, data essential for future investment decisions. In addition, substantial reserves of dry natural gas have been found in the Guayas region. E. Infrastructure 1.33 In 1950 the only transport connection between the major cities of Guayaquil and Quito was a railroad line; the two areas of population concentration, the coastal plains and the Andean valleys, were otherwise not connected. According to a recent transport sector survey by the Bank, highway infrastructure has expanded considerably since the late 1950's, the network increasing by 50% between 1963 and 1973; Bank lending has played an important role in this development. But general road conditions remain inadequate in view of projected traffic volumes. Not only do these trans- port problems tend to limit the market for industrial products but lack of secondary and feeder roads has been a major deterrent to bringing new cul- tivable land into use. The same study also notes inefficiencies in the truck transport, railway and the ports systems which have adverse effects on dis- tribution costs and in particular -could present serious bottlenecks to future expected export expansion. Highway Network (Kilometres) Paved Gravel Earth Total 1963 8,143 7,211 15,624 1970 2,850 8,150 11,300 22,300 1973 3,419 7,107 12,012 22,538 Source: Bank Transport Study 1.34 As regards energy, a substantial expansion of installed capacity for generating electric power has occurred since the early 1950's, more than doubling in both of the 1950's and 1960's, primarily based on many thermal plants. With economic activity and consequently potential demand rising rapidly, recent investment has turned towards larger hydro-electric stations  - 12 - in the mountainous areas and a major energy sector investment program is now in implementation. 1.35 In spite of these developments, the principal cities of Quito and Guayaquil currently continue to experience shortages in power avail- ability which has deterred or delayed a number of new industrial invest- ments. However, the completion by 1976/77 of the first phases of new hydro- stations, as well as the completion of investment in transmission and dis- tribution systems, are expected to reduce this factor as a bottleneck to further growth. Nevertheless, power availability will continue to be con- centrated in certain areas; in its 1973-1977 development plan, NPC estimated that by the end of that period, it would be possible to serve only some 45% of the population with the completion of the projects for generation, trans- mission and distribution then anticipated. 1/ Electric Energy: Availability and Use Installed Capacity (thousand KW) Generation (Million KVA) 1953 55 167 1961 145 411 1969 269 858 1972 357 1,117 1974 405 1,421 Source: INECEL, UN Statistical Yearbooks 1/ NPC estimated that during the period 1973-1977, gross investment in electricity generation and distribution would amount to 8.5% of total gross investment, as compared to the level of 2.6% actually achieved in 1968-1972.  - 13 - II. MAIN ELEMENTS OF INDUSTRIAL POLICY A. PRINCIPAL INDUSTRIAL INCENTIVE LAWS 1/ General Background 2.1 Industry in Ecuador follows essentially a pattern of free enter- prise with Government efforts centered on the creation of supporting infra- structure and services and in the areas of taxation, tariff and finance. Manufacturing operations are generally developed by private enterprise, although the Govenment has directly entered and is planning to enter in a few cases with state-owned enterprises or sharing public investment with the private sector, either because the projects require large funds or because private investors were reluctant to enter in those fields on account of their newness or risk. The development of fertilizer and petrochemical products by government agencies in the near future may bring about a larger share of public enterprises in the industrial sector of Ecuador. At pre- sent, the Government has equity and has played a major role in creating enterprises concerned with sugar and cement production. 2.2 In 1957, the Government enacted the first comprehensive industrial development law which provided a range of incentives for industries which meet priority needs of the country. Ten separate criteria were set out in the law, which were to be used as the basis for assigning applicant enter- prises within three major classifications; these criteria included such elements as use of domestic raw materials, contribution to local technological development and use of domestic labor. The principal incentives related to exemption, in part or in full, from duties on imported raw materials and capital goods on a graded scale according to the classification of the enterprise. The decision to place an application in any one of these cate- gories was left to an inter-ministerial committee. 2.3 During the next 15 years, various modifications were introduced and in 1973 a major revision and consolidation of the entire structure was under- taken. This was designed also to bring into consideration other elements of the Government's industrial strategy. At present, Government's policy of in- dustrial incentives has four major objectives: (i) accelerate industrial growth and thus increase value added for the economy and use the resource endowments more efficiently; (ii) generate employment opportunities in the urban areas and thus absorb manpower migrants from the rural areas and improve their income; 1/ Financial incentives are treated separately in Chapter III.  - 14 - (iii) generate additional sources of foreign exchange and thus diversify the economy heavily dependent on oil exports; (iv) attain a better regional balance of output, which as pointed out in Chapter I, is heavily concentrated in Quito and Guayaquil. Also, these incentives are geared to fulfill Ecuador's commit- ments and goals with the Andean Pact. To reach these objectives, the Govern- ment uses several policy incentives: in addition to the financial system (see Chapter III), these include tariff protection, quantitative restrictions and tax incentives. Tariff Protection and Quantitative Restrictions to Imports 2.4 Tariffs may be used to protect industry, to obtain government revenues or to deal with balance-of-payments difficulties. Until the recent inflow of revenues from petroleum activity, the main objective of tariffs on imports was to be an income source for the Government and their levels were generally fixed with this objective in mind. In 1972, tariffs represen- ted 11.4% of total Government revenues and were at the time the largest single source of revenue. During the period of the 1960s and early 1970's, balance- of-payments problems on occasion led to imposing quantitative restrictions, particuarly on finished goods. A major.restructuring of tariffs was intro- duced in 1974 to gear import tariffs to promoting industrial development, although at the same time reducing the overall tariff level. In mid-1975, due to an emerging balance-of-payments gap, tariffs were again raised, the tionetary Board established prohibitions for automobiles and a few other items, re-established the system of prior deposits and introduced a selective tariff surcharge of 30% on non-essential goods (list II, see below). 2.5 Tariff rates average 30 to 35% of the total value of imports. However, rates are relatively dispersed between categories of goods and the tariff schedule by itself is thus capable of generating higher effec- tive protection rates. Duties on industrial raw materials and capital goods are low. High tariffs exist on fairly simple goods (e.g. textiles, food products). Consumer durables (including electricial and transport equipment) tend likewise to have relatively high tariffs. Moreover, each category has enormous diversity buried in the average; for instance, textiles have high protection on synthetic fibers but low on cotton textiles, and metal products have low protection for foundry products but high for wire products. 2.6 Various exemptions from import duties are applied. Total or partial exemptions include those relating to imports from the Andean and other LAFTA sources, inputs for industries that the Government wishes to stimulate, imports for the public sectors and other ad hoc exemptions. Furthermore, Decree 786 in 1975 specified that imports of raw materials, intermediate goods, and capital goods for industries covered by the in- dustrial incentive laws would be exempt from the import duty surcharge.  - 15 - To a large extent, these tariff exemptions favor mostly capital goods im- ports and hence reduce the cost of capital vis-a-vis the cost of labor. 2.7 Among quantitative restrictions, direct prohibition of imports provides the maximum degree of protection; these have been used only spar- ingly, most recently for automobiles and some "luxury" consumer goods. In this category of measures, prior deposits have been the most widely used, although only for some products; in severe balance-of-payments diffi- culties import prohibitions have also been used. To administer the prior deposit system, Ecuadorian authorities established a system of two lists -- list I ("essential" goods) and list II ("non-essential" goods). Import li- censes are required for all items. 2.8 In 1974 list II covered only an 11% of imports but in September 1975, the list was revised and its coverage increased to approximately 15% of total imports. The Monetary Board reclassified importable items by splitting list I into segments A and B ("essential" and "semi-essential" goods, respec- tively). An advance import deposit requirement was introduced in the amount of 20% for items in list I-B and 30% for items in list II. Before an importer applies for the necessary import permit, he has to deposit with the Central Bank the given amount, expressed as a percent of import value, which remains deposited, earns no interest and erodes by inflation, until 180 days after date of deposit, even if the goods have not yet arrived. On the basis of total value of imports, the advance import deposit 1/ is equivalent to a sur- charge of less than 2% and a contraction of money supply of approximately 10%. 1/ It should also be noted that since 1973, 80% of any import duties to be imposed have to be paid at the time of the deposit. This has not been included in the subsequent estimates.  - 16 - IMPORTS PERMITS BY LIST (In millions of dollars) Jan. - Sept. 1971 1972 1973 1974 1974 1975 List I 261.5 287.5 474.4 851.2 597.7 636.5 List II 42.4 41.0 58.0 107.4 78.0 102.0 TOTAL 303.9 328.8 532.5 958.5 675.7 738.5 (As percent of total) List I 86.0 87.5 89.1 88.8 88.5 86.2 List II 14.0 12.5 10.9 11.2 11.5 13.8 TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 2.9 Although there are no studies of effective protection, the im- pression is that it has been low, but this situation may be changing. Calculations of effective protection would require the undertaking of detailed price comparisons between domestic production and import values to determine the composite effect of licensing, tariff redundancy, tariff exoneration and prior import deposits. This type of comparison has not been done, although it would be useful in view of the negotiations for the Andean Common Market external tariffs. 2.10 For many simple consumer goods subject to high tariffs, (e.g. tex- tiles and foods) which are not subject to economies of scale, production conditions have permitted domestic competition which has tended to reduce local prices to the CIF import price; in this connection, the possibility of contraband trade has also served as an element of competition. In the case of the large consumer items the imports of which have been subject to quotas, the narrowness of the market in the past restrained entry into production of these goods even though the extent of effective protection was high. 2.11 With the widening of the market as a result of recent economic growth the latter situation is tending to change. The mission visited some newly established enterprises where costly technologies are being applied and prices of the final product are considerably higher than in other neighboring countries. The experience of other similarly small developing countries in attempting to achieve an inward-oriented growth  - 1 7 - demonstrates the need for the authorities to keep under review the pos- sible distortions the system of protection is fostering. 1/ There is particular need for a revision of the existing situation with a view to encouraging internal industrial integration. 2.12 The longer-term structure of tariffs for Ecuador will depend upon the negotiations within the Andean Pact for the Common External Tariff. Although the Andean Common Market represents a substantially larger market for each of the member countries, a development strategy based on regional import substitution can still provide only limited scope for growth. The implications of Ecuador's membership in the Andean Group are examined later in this chapter. Other Incentives: Tax Exemptions 2.13 The revision of the law in 1973 provided certain changes in the extent of exemption from tariffs and the creation of a new or "special category" with considerably liberalized exemptions; it also consolidated various incentives which had derived from other laws, notably exoneration from income, stamp and related taxes. At the same time, however, it added new elements to reflect the priority given by the Government to specific directions in industrial growth. 2.14 In order to promote investment in the relatively less developed regions of the country, special benefits have been accorded to enterprises to be established in all provinces other than Pichincha (Quito) and Guayas (Guayaquil); maximum levels are afforded to eight provinces 2/ (see Statistical Appendix Table 5). Another feature of the law is establish- ment of export incentives in the form of tax certificates to exporters of non-traditional products; for industrial products the amount of these certi- ficates varied from 7 to 15% of the value of exports depending upon the total value of the product exported in the previous year; further consideration of export incentives is presented in a subsequent section. 2.15 Finally, the revision contained a list of 79 products which are classified as "Special Category" (receiving maximum benefits under the 1/ One measure which has been used in other countries to restrain imports of so-called luxury goods, while not stimulating local production through high effective protection, is to impose large sales taxes on those items which are applied equally to imports and domestic output. 2/ Among these provinces is Azuay (Cuenca) which had already been the sub- ject of limited tax privileges dated from 1954.  - 18 - law) as well as 82 items classified as Category A (with somewhat lower levels of benefits). t4oreover, in order to qualify, facilities to manu- facture these products have to meet certain technical standards specified in the regulation, in particular minimum "installed capacity" (not otherwise defined), but including other details such as percentages of imported in- puts. These lists could, however, be amended through special edicts by the Inter-ministerial Committee charged with administering the law. 2.16 Investors interested in producing products which have not yet been classified under the existing regulations for the Industrial Incentive Law may apply to the Ministry of Industries for such classification, which are reviewed by the committee. At present, the criteria used in this process have been reduced to six; those that: (i) are directed to export markets; (ii) have important employment effects; (iii) correspond to allocations of industrial programing in the Andean Group; (iv) help to achieve a better regional distribution of industrial activities; (v) generate a larger domes- tic value added; and (vi) have important backward or forward linkages that help the development of the country. Examples of industries in the Special Category are the following: meat packing industries, fruit juices, banana and banana flour, wood processing, fishing, paper pulp, abaca, some chemicals, some machinery and equipment, watches. Examples of products in Cate- gory A are sugar, fish meal, mushrooms, coal, tires, other chemicals, metals other than steel. 2.17 Actual operation of industrial incentives continues to allow a substantial degree of discretion to the authorities in granting the tax benefits. Since the list of industries eligible for incentives is periodically amended on the basis of experience, needs and requests, an industry that has a given classification at a given time may be included later on in another class or totally excluded from the benefits of the law. Another factor is the process of evaluation itself. An examination is made of each application before an authorization is given to the in- dividual firm; this includes an analysis of proposed capacity, import re- quirements, location and profitability of the new investments. To assure that these decisions are properly taken, to induce investment in efficient industries and to avoid wasteful loss of revenues, the country would need very elaborate arrangements to coordinate the decisions and very good information on industrial technology, production costs as well as prices, which even in the most advanced countries are difficult to obtain. In practice, however, the authorities have applied generous and flexible criteria, tending to favor investment over considerations of tax equity or of the flexibility of the tax system. 2.18 Although not enough time has elapsed to fully evaluate the impact of the new incentive system, the general impression is that some industrial investments have been induced as a result of the tax and tariff advantages. But there is no certainty that these investments are appropriate or that a diversion of resources to non-optimal uses has not resulted from distortion  - 19 - in prices (caused by the incentive system). The system certainly has some undesirable effects: (1) being directed to stimulate investments in equip- ment, they induce the use of capital intensive technology; 1/ (2) breaking the progressivity of tax rates, they benefit more taxpayers in the upper income brackets; (3) they also have a budgetary cost. In granting these incentives on a selective basis, the argument has been made that increased output in particular industries would hasten economic development, perhaps because of the linkages or external economies that characterize these in- dustries. Investment incentives of various kinds are granted as means of attracting capital to these industries. But in addition to increasing out- put of favored industries, tax incentives induce substitution of capital for labor in these industries. The question arises whether capital could be attracted to these industries without encouraging substitution of capital for labor. As long as the policy is to increase investment in industry a dis- tortion in factor utilization is produced. An incentive related to investment in a given industry encourages capital-intensive production. However, the ultimate reason for the subsidization of investment is not to increase indus- try capital stock per se, but to increase output. 2.19 A further element which must be considered is the fiscal cost of the exemption. It is true that the non-petroleum sources of revenue of the economy now represent a small percentage of Government revenues. Never- theless a further reduction of these sources may be undesirable, not only because of the long run perspectives for public revenues, but also to ensure that the Government is able to have some means to control aggregate demand. 2.20 It is recognized that in the earliest stages of industrialization, it may be important that the sector have an initial period of relatively higher profitability because of the special difficulties associated with investment in that period. In these circumstances it is advisable to allocate the tax advantages with moderation, for example: crediting the investments only in the year in which they were made and avoiding the possibility of carrying forward the benefits for five years after investment. Also, it is preferable to provide a credit against tax liabilities rather than a tax exemption, because tax credits are independent of the tax brackets of the individual taxpayer. Tax credits are deductible from the calculated tax, while tax exemptions are deductible from the tax base. 2.21 Finally, the description above of the rather elaborate mechanism for providing selectivity in granting the incentives and the overlapping of criteria (if not contradiction) suggests the need for simplification of the law. 1/ Similarly, as noted in the previous section, the tariff exonerations on capital goods tend to favor the use of capital.  - 20 - 2.22 Aware of some of the difficulties experienced in the operation of these incentives, the Government in mid-1975 appointed an inter-ministerial group to consider the need for revision of the entire system including those aimed at small industries. Drafts are being prepared by the Ministry of In- dustries but action by the larger group has not yet been taken. B. THE SPECIAL PROBLEM OF SMALL AND ARTISAN INDUSTRIES 2.23 Government policy has long been concerned with promoting or assist- ing small or artisan industries; some features of the measures cited above are inter alia designed to stimulate those activities. It will be recalled that for many years an important export and employment-generating activity had been the hand-weaving of Panama hats in the area of Cuenca; world de- mand for this item has almost disappeared in the post-World War II period, and attempts have been made to find alternative uses of the skills developed. 2.24 The major policy action in this particular area was taken in 1973 with the promulgation of a special law for the Promotion of Small and Artisan Industry. This law also provided for extensive tax exemptions; as compared to the general investment law, this law provided for more generous deductions for investment or reinvestment from income tax liabilities. In that same year the scope of the law was modified to allow maximum benefits for activities located outside Pichincha and Guayas. The original definition of small and artisan industry was any establishment with less than 1.5 million sucres (approximately $60,000) invested in machinery and equipment; this was modified in August 1975 raising the limit to 5 million sucres (approximately $200,000). 1/ 2.25 In addition to these measures to aid small and artisan industry the Government has undertaken a number of other specific activities. In the 1963-1973 Development Plan, major emphasis was put on building industrial estates as a means of reducing those infrastructure deficiencies, particu- larly in areas other than Quito and Guayaquil, which appear to be hindering new investment. Implementation of these proposals was extremely slow, partly due to lack of funds as well as the shortage of appropriate operational staff; it was not until 1974 that construction began on the first phase of a major estate construction site in Cuenca. 1/ However, any existing enterprise with between 1.5 and 5 million sucres which had already been classified under the general investment law could not qualify for benefits under the Small Industry law.  - 21 - 2.26 Other measures have included the creation of numerous training centers and technical assistance programs for artisan industries. 1/ Finally, as discussed in Chapter III, special finance and credit facil- ities have also been provided for small and medium industry. C. EXPORT PROMOTION 2.27 Practically all of the investment promotion measures cited in the previous sections have contained certain features designed specifically to assist exports of non-traditional products. Mention was made of the 1973 version of the investment law which provided for incentives to exporters in the form of tax certificates, the amount depending upon past performance; this actually represented an extension of the fixed subsidy of 4% of export value which had been inaugurated in 1971. The incentives currently in effect cover not only industrial products but also non-processed agricultural commodi- ties which previously had not been exported; the latter receive a flat 4% incentive. Other features of the investment law include full exoneration of duties on raw materials which are used for producing exported items, the standard "drawback" system, and also temporary admission system. 2.28 The Government is considering a decree which would consolidate the various measures for export promotion and centralize the administration of the incentives which now follow diverse procedures. The proposal would promote the creation of export firms who would be responsible for inter- national marketing of a large range of products; as the regulations are presently structured, only producing firms can obtain the benefits of the various export incentives and most of these enterprises are either too small or at present cannot afford to develop adequately the marketing function. In addition, the proposed decree would revise the incentive system and estab- lish a scale of cash payments for products in accordance to domestic value added rather than historical performance. In this connection, it should be noted that other developing countries which have used similar incentive systems have incurred substantial fiscal losses after these systems have been in operation for relatively long periods of time. They are therefore tending to curtail these payments, choosing instead to follow more flexible exchange rate policies. It does appear, however, that in the initial period of opera- tions the incentives did play a major role in developing an export-conscious- ness among entrepreneurs and served to offset the relatively large costs and risks associated with new export undertakings. 1/ A Pan-American Institute for Artisan Industries, with support from the OAS, has been established in Cuenca while an IDB regional program for promoting artisan exports from the Andean region has also been head- quartered in that city.  - 22 - 2.29 Given the existing extent and structure of Ecuadorian industry, there is need to develop export promotion policies suited to the range of actual product possibilities. Much more effort is required to determine for the specific items the barriers to export expansion in order to define the specific measures required. 2.30 To promote non-traditional exports, several additional policies should be considered: (i) the creation of free zones, where industries can grow free of import duties and with low administrative costs; (ii) tech- nical assistance to export industries, particularly the small and medium industries, to achieve quality acceptable in external markets; (iii) further efforts in financing exports, with special emphasis on new enterprises; (iv) investment in the improvement of transport infrastructure and provision of transport and storage systems with a view to attending specific markets; and (v) drawback systems. D. PRICE POLICY 2.31 In general, the market mechanism determines prices for most of the commodities in Ecuador; however, Government intervenes in a few cases, either with price controls or with price supports. Articles of popular consumption are subject to price ceilings determined by the Superintendency of Prices. On the other hand, prices of other commodities, primarily agricultural pro- ducts, receive price supports designed to stabilize prices and stimulate pro- duction. There are thus three separate purposes underlying price interven- tion: to stimulate production of some goods, to avoid large increases in prices of commodities of popular consumption and to avoid monopolistic profits. 2.32 As a consequence of this lack of coherence, the administration of price policy is a matter of great complexity. Some prices are too low. They attempt to protect the consumers but generate scarcities that distort resource allocation: i.e. a low price of sugar, far below world market prices, gene- rates scarcities in the domestic market because suppliers tend to sell their output for use as an intermediate product for articles not subject to price controls. As the scarcity becomes more evident, the Government is forced to establish export prohibitions, 1/ quotas and other kinds of restrictions. New investment to produce commodities subject to price regulations are also discouraged; i.e., the low price of milk has discouraged many farmers from dairy business and milk scarcity is becoming a chronic problem in Ecuador. 1/ In the case of plywood which also has a fixed price, in spite of the legal prohibition on exporting, and the physical difficulties in trans- porting the item, some supplies are known to have reached markets in neighboring countries where prices are more in line with international demand conditions.  - 23 - 2.33 On the contrary, other prices are too high. The Government with a desire to stimulate diversification of agricultural production sets price supports for some commodities (e.g. soya beans). These prices have become much higher than world market prices; import restrictions become necessary to maintain a relatively inefficient domestic output, and prices of raw materials are therefore artificially high, while often the prices for final product are kept in line with world market prices for those items. 2.34 Thus, from the point of view of economic efficiency price controls clearly generate undesirable distortions of resource allocation: scarcities and over-production of the commodities affected result from prices that are too low or too high. From the point of view of income distribution, price ceilings are geared to protecting the income of the poor, but this objective is not usually reached because of the resulting scarcities, which affect the poor. Also, if investment declines in view of price ceilings, employment opportunities in industry are reduced. 2.35 Therefore, a gradual reduction of price controls may prove advis- able to eliminate these distortions. However, this process requires some caution to avoid increasing price expectations in moments of inflationary pressures and a sudden release of price ceilings should be avoided. 2.36 An important area where there is room for effective Government action, is that of stock management for price stabilization and improved marketing facilities. For many producers a stable price is a more important tool to stimulate his investment than a high price. Thus, a mechanism where a few commodities are subject to some degree of Government intervention in inventory management would avoid drastic changes in prices. E. LABOR AND WAGE POLICIES 2.37 The cost of labor in Ecuador has not represented a major drawback to industrial growth. In fact, wages and salaries in Ecuador are in line with wages and salaries in the other countries of the Andean Group. However, three institutional factors tend to increase the cost of labor: (i) the labor law; (ii) the strength of labor unions; (iii) the existence of a gener- ous social security system. 2.38 (i) Labor Law. As in many other countries, the Labor Law in Ecuador grants to the workers a set of minimum rights and benefits: minimum wages, severance payments, profit sharing, vacations, holidays and maximum hours of work. These legal provisions affect the demand for labor since the loss of flexibility, arising from the provisions that restrict mobility in the labor market, induces the use of capital intensive technology; and the fringe bene- fits and other payments increase the cost of labor by about 40%.  - 24 - 2.39 The Labor Law estabishes a minimum set of rights to the worker, but most of the wages and benefits paid by the large and medium size firms are substantially above these minimum standards. For them, collective bargaining is more important in determining the cost of labor. Thus, where collective bargaining is strong, labor income is relatively high. At the other extreme, in the informal sector, the minimum standards of the Labor Law do not apply for there is a large group of self-employed, artisans and other groups that either escape the labor contract or have an excep- tional legal treatment. 2.40 (ii) The growth of labor unions in Ecuador has been relatively weak compared with other countries. Recently, however, it has become a more influential force as a result of the process of industrialization and urbani- zation. 1/ Labor unions negotiate collectively benefits above those of the labor laws: (i) wages, three or four times the minimum level; (ii) additional fringe benefits, generous vacations; (iii) increases in holidays; (iv) larger percentages of profit sharing; and (v) payments for overtime work, etc. Notwithstanding the benefits in social legislation it appears that the cost of labor in Ecuador is low relative to other countries in the Andean Pact. AVERAGE DAILY WAGE OF WORKERS (IN MODERN INDUSTRY) Including Other Costs (In dollar equivalents - 1975) Ecuador 1.70 Colombia 2.10 Venezuela 6.80 Peru 4.20 Source: IBRD staff estimates. F. THE ANDEAN COMMON MARKET 2.41 Under the conditions of the Cartagena Agreement creating the Andean Common Market, a common external tariff was to be agreed upon by 1980/85. A common minimum external tariff was to be implemented by 1975 but has been postponed in view of difficulties in the negotiations. The Common Market's 1/ In late 1975 and early 1976, some labor unrest has occurred, causing temporary shutdowns of major industrial facilities.  - 25 - Junta has drafted a common external tariff, based on effective rates of protection, but no agreement has been reached in this difficult area. The proposed rates are lower than those applied in most of the member countries, but still appear high enough to involve a bias against primary production and exports. The external tariff will oblige Ecuador to abandon the system of generous tariff exemptions to industrialists, and, to the extent that overly protected enterprises have been established, will decrease their profitability. On the whole, however, in the long-run Ecuador appears to be in a favorable position within the Group, as indicated in the preceding paragraph (see table above). 2.42 The adoption of Decision No. 24, regulating foreign investments and the transfer of technology has substantial implications concerning the level and direction of investments. All new foreign investments require Government approval and an effort will be made to direct these investments to the areas of priorities. There are limits on profit remittances abroad and the payment of royalties is subject to Government approval. In some cases these rules do not apply: for example, industries that export more than 80% of their value of production are exempt from these provisions.l/ 2.43 Considerable uncertainty now surrounds the pace of implementation of these basic decisions. Some governments have felt that decision 24 should be modified. As already noted, there are differences among governments relating to the fundamental structure of the external tariff. As suggested in the earlier section of this chapter on tariff policy, an externally oriented development strategy is important for the Group; even with the larger market it represents, there is need to ensure the growth of export-oriented indus- tries. 2.44 Within intra-Andean trade, Ecuador benefits through a number of arrangements including special concessions granted to it and Bolivia, as relatively less developed countries. In addition, within the regional programing undertaken for the metal-mechanical and petro-chemical indus- tries, products have been assigned to it. Progress achieved in utilizing these concessions and prospects for future growth are examined in the last chapter. 1/ Ecuador and Bolivia also have special treatment under this decision.  - 26 - CHAPTER III THE FINANCIAL SYSTEM A. GENERAL CHARACTERISTICS 3.1 This review is primarily concerned with those institutions and in- struments which are closely linked to the financing of industry and does not include the review of housing banks, insurance companies and similar inter- mediaries. Briefly, the financial system may be divided into various segments, namely: the monetary authorities, the banking system, the non-bank financial intermediaries, the special funds, the security exchanges and the unsupervised market. The main elements of the system are outlined below. Main Elements of the Financial System A. Monetary Authorities - Monetary Board - Central Bank of Ecuador - Bank Superintendency B. The Banking System - The Central Bank - Private Commercial Banks - Banco National de Fomento C. Non-Bank Financial Intermediaries 11 - Comision de Valores - Corporacion Financiera Nacional (CV-CFN). - Compania Financiera Ecuatoriana de Desarollo S.A. (COFIEC). D. Special Funds - Fondo Nacional de Desarrollo (FONADE) - Fondo Nacional de Preinversion (FONAPRE) 1/ Since this report was drafted, a number of new non-bank financial intermediaries have been organized. These institutions, as well as the two existing agencies, are analyzed in the appraisal report for the third DFC loan, to be issued shortly.  - 27 - E. Security Exchanges F. The Unsupervised Mlarket Debt-Financing 3.2 The total volume of credit (defined as the value of credit opera- tions in each year) extended by the banking system and by CV-CFN and COFIEC in the period 1970-1974 is shown in the following table. Except for CV-CFN, available statistics make no distinction between short and long-term credit, although it may be reasonably assumed that Banco de Fomento, CV-CFN and COFIEC are the major sources of the long-term financing. The mission esti- mates that during 1974, only about 15% of total credit extended by the bank- ing system, CV-CFN and COFIEC had terms over one year. This no doubt re- flects the predominantly commercial orientation of the business sector in Ecuador. Overall, the commercial banks dominated the scene. Their share of total credit went from about 68% in 1970 to 72% in 1973. However, during 1974 it dropped to about 62% due partly to the restrictions placed on overall portfolio growth and partly to the emerging importance of Banco Nacional de Fomento and CV-CFN during 1974. The unfreezing during 1975 of certain portions of the portfolio of the commercial banks combined with incentives under the Fondos Financieros mechanism may again change their relative position in the future. Volume of Credit Extended by Source (in million sucres) Non-Bank Banking System Intermediaries Total Central Commercial Banco Nacional Year Bank /a Banks de Fomento CV-CFN COFIEC 1970 2,578 8,054 678 145 359 11,814 1971 2,363 9,079 763 410 444 13,059 1972 2,546 10,542 808 302 633 14,831 1973 2,229 12,888 1,508 363 831 17,819 1974 3,313 15,668 3,640 1,266 1,306 25,193 Source: Memoria del Gerente General del Banco Central del Ecuador, 1973-1975; operating reports of CV-CFN and COFIEC. /a Credit to commercial banks and BNF excluded.  - 28 - 3.3 The volume of industrial credit extended by the same entities during 1970-1974 is shown below. Industrial credit accounted for about 20% of total credit in 1970 but rose to 25% in 1974. However, the relative impor- tance of the Central Bank went down from 37% in 1970 to 17% in 1974; that of the commercial banks increased from 46% in 1970 to 58% in 1973, but for the reasons given earlier, dropped back to 46% in 1974. Furthermore, the share of Banco National de Fomento was small, while that of CV-CFN increased substan- tially in 1974, and that of COFIEC has grown steadily. The average value of industrial credit operations has gone up over the years; it has, of course, varied considerably from one institution to the other. 1/ Apparently, there is no study showing the breakdown of industrial loans by size. Volume of Industrial Credit Extended by Source (in million sucres) Non-Bank Banking System Intermediaries Total Central Bank Commercial Banco Nacional Year Banks de Fomento CV-CFN COFIEC 1970 905 1,134 104 131 199 2,473 1971 970 1,266 127 265 236 2,864 1972 759 1,631 150 291 367 3,198 1973 627 2,215 222 333 439 3,836 1974 1,090 2,913 503 1,118 752 6,376 Source: See previous table. 3.4 As to geographical location, 49% of the industrial credit granted by the banking system went to the Guayaquil area, 39% to the Quito area and 12% to the rest of the country. Although CV-CFN and COFIEC have not published the geographical breakdown of their operations, it is well known that these are also highly concentrated in the Guayaquil and Quito areas. 1/ In 1974, an average industrial loan amounted to US$47,040 at the Central Bank, US$2,640 at commercial banks, US$2,560 at Banco National de Fomento, US$359,620 at CV-CFN, and US$49,160 at COFIEC. In the case of CV-CFN the average value covers only project financing and does not take guarantee operations into account.  - 29 - Equity Financing 3.5 At the end of 1973, the 426 existing industrial companies 1/ had combined assets of S/. 13,390 million and an aggregate debt-to-equity ratio for 1.54:1. There are a number of factors which contribute to this high ratio. About one- third of the total share capital of these firms was in the hands of foreign investors which often prefer to lend to their businesses because debt financ- ing offers greater ease of repatriation. Local investors are also prone to lend to their own businesses rather than inject new equity because of the dis- criminatory tax rate on dividend income. Interest income is taxed once at the source at the rate of 8% and does not form part of personal income. Cash dividends on the other hand are subject to a withholding tax of 20%; the share- holder must include cash dividend income in his personal income, calculate his total income tax and deduct what he has paid on the withholding tax. This discrimination in tax treatment is of major importance in the problem of de- veloping an appropriate capital market in the country and its implications are dealt with in subsequent sections. B. THE ELEMENTS OF THE FINANCIAL SYSTEM The Monetary Board 3.6 The Monetary Board is the highest monetary policy body in Ecuador and, in this capacity, it regulates the volume and distribution of credit in the supervised market. Effective September 11, 1975, the Minister of Finance is no longer President of the Monetary Board. The post is now held by a representative of the President of the Republic. Members continue to in- clude the Ministers of Finance, of Industry, Commerce and Integration, and of Agriculture, and the President of the NPC; the Bank Superintendent and the Manager of the Central Bank act as advisors; and finally, the three representatives of the private sector which before the change had full membership now participate in the discussions, but no longer vote in the decisions of the Board. The Central Bank 3.7 The Central Bank is principally responsible for the issue of money and the exercise of some of the measures of monetary control. It handles 1/ See Superintendent of Companies, "Sintesis 1964-1974". The firms included here are: "companias anonimas, de economia mixta y en comandita por acciones."  - 30 - a fair volume of credit, including the account of the Fondo Nacional de Desarrollo, and administers the Fondos Financieros. As of December 31, 1974, its total assets amounted S/. 21,595 million, including S/. 6,986 million of claims on the public sector (Central Government and official financial insti- tutions). 3.8 The volume of credit extended by the Central Bank in the period 1970- 1974 is estimated below. The figures do not include rediscount operations; the "other" category includes the public sector. Central Bank-Volume of Credit (in million Sucres) Year Commerce Agriculture Industry Other Total 1970 797 215 905 661 2578 1971 728 159 970 507 2363 1972 1159 109 789 489 2546 1973 1111 124 627 367 2229 1974 1492 89 1090 642 3313 Source: Banco Central del Ecuador 3.9 The Central Bank administers the Fondos Financieros which consist of six funds with local resources and two with foreign resources from USAID and IBRD loans (Annex 2). The resources of these funds are used by the Central Bank to rediscount loans made by commercial and development banks to eligible borrowers under the provisions of each funds. Normally, the inter- mediary lends up to 90% of the cost of the project at 9% and rediscounts 80% of the value of the loan at 3%. 1/ However, these rediscount facilities apply only to the last two years of any contract. The intermediary which partici- pates in this scheme is assured on its own funds of average gross yields which 1/ Exceptionally, under IBRD loan 22-EC, the intermediary lends at 12% for loans above S/. 625,000 and rediscounts at 7% the equivalent of 70% and 75% of the value of the loan for milk cattle and meat cattle projects respectively.  - 31 - vary with the life of individual loans from 33% for up to 2 years, 1/ but the return is much lower if held for longer time periods. Moreover, two other aspects of the mechanism also favor short-term operations, namely: (i) the relatively small resources of the funds and (ii) the fact that no intermediary can use more than 5% of the resources of any individual fund. In the circum- stances, intermediaries are bound to opt for the short-term operations which offer greater return. 3.10 Two of the eight funds of the Fondos Financieros are aimed at assisting small-scale and artisan industries, namely the Fondo Financiero Industrial and the USAID Technical and Credit Assistance to Small Industry Program. The former has worked relatively well; during 1975, the Ecuadorian Government increased its resources from S/. 200 million to S/. 400 million. The latter has not worked too well because of administrative complexities and at the end of December 1975 was up for renegotiations and/or an exten- sion of the closing date. 3.11 Two complaints have been most frequently heard about these funds. First, that the personal and real guarantees required by the financial in- termediaries are often beyond the capability of the small borrowers. In view of the fact that commercial banks participate in the mechanism, consi- deration should be given to establishing a guarantee fund in the Central Bank so that small borrowers are not unduly by-passed. Second, that there is a lack of easily accessible and practical technical assistance. In November, 1975 the Minister of Industry announced the creation of the National Center for the Promotion of Small and Artisan Industry (CENAPIA) which, among other things, will supervise the use of the funds of the Fondos Financieros mechanism and provide techncial assistance in the areas of accounting, indus- trial engineering, and product design and marketing. 2/ The Commercial Banks 3.12 There are 20 national and four foreign commercial banks operating in Ecuador (May 1976). As of December 31, 1974, their combined liabilities stood at S/. 22,904 million, classified as follows: 3/ 1/ Intermediary's own resources: 20%, yielding 9%; plus a spread of 6% on 80% of the loan, yield: (.20 x .09) + (.80 x .06) = 33% .20 2/ Measures to assist small-scale industries are discussed in Chapter IV. 3/ The data refers to the 18 national and four foreign commercial banks operating at that date.  - 32 - Amount (in million Sucres) % of Total Deposits 12,239 54 Bonds 2,738 12 Letters of Credit 3,469 15 Other Obligations 3,039 13 Equity 1,419 6 Source: Banco Central del Ecuador, 1974-No. XLVIII-560. 3.13 The liabilities of the commerical banks are somewhat concentrated, with about 55% in only five of the national banks and another 23% in the foreign banks. Ownership is also fairly concentrated, although only one bank - albeit one of the largest - is still family-owned. 3.14 The volume of credit extended by the commercial banks in the period 1970-1974 according to main sectors is given below. Recent measures of commer- cial portfolio ceiling and directed investment are expected to change the traditional mix of beneficiaries. The source does not indicate the content of the "other" category which has shown considerable growth; this may include however, construction activities. Commercial Banking System - Volume of Credit (in million Sucres) Year Commerce Agriculture Industry Other Total 1970 5,573 841 1,134 506 8,054 1971 6,521 749 1,266 544 9,079 1972 7,097 1,035 1,631 778 10,542 1973 8,610 1,103 2,215 960 12,888 1974 10,018 1,123 2,913 1,614 15,668 Source: Banco Central  - 33 - Banco Nacional de Fomento 3.15 As of December 31, 1974, the total liabilities of Banco Nacional de Fomento (BNF) stood at S/. 6,904 million, as follows: Amount (in million sucres) % of Total Deposits 1,868 27 Borrowings 2,963 43 Other 441 6 Equity 1,632 24 Source: Banco Central del Ecuador, 1974-No. XLVIII-560. 3.16 Banco Nacional de Fomento receives deposits and in this sense differs most clearly from the other development banks. Also striking is the fact that its debt/equity ratio was only 3.2:1 at the end of 1974. This low leverage may reflect market conditions and the instruments at Banco de Fomento's disposition, as well as the lack of aggressivity in attracting de- posits. 3.17 For BNF, volume of credit extended in the period 1970-1974 is shown below. The salient feature of this table is the accelerated growth which took place in the last two years. The volume of credit to small-scale and artisan industries has, however, represented a small percentage of its operations. One major reason given for this is Banco de Fomento's requirement that it should have first ranking as a creditor. Accepting this condition virtually bars a borrower from obtaining credit elsewhere. If BNF is to fulfill its development role, it should accept pari passu ranking. The problem of personal guarantees mentioned above aTso applies to Banco Nacional de Fomento.  - 34 - Banco Nacional de Fomento-Volume of Credit (in million Sucres) Year Commerce Agriculture Industry Other Total 1970 27 543 104 4 678 1971 37 593 127 6 763 1972 66 587 150 5 808 1973 143 1,136 222 7 1,508 1974 346 2,776 503 16 3,640 Source: Banco Central del Ecuador. 3.18 Primarily oriented toward aiding agriculture, BNF has more than 50 branches throughout the country but only 15 deal with industry. In an effort to improve its capacity for aiding small enterprises, it is now receiving assistance from the Inter-American Development Bank. This program includes technical assistance to borrowers through special centers jointly organized by BNF and other government agencies such as SECAP and CENDES. CV-CFN 3.19 The Comision de Valores - Corporacion Nacional de Fomento (CV-CFN) was originally established to regulate the securities market but in 1964 its responsibilities were expanded to include long-term financing. It receives funds directly from the Government, issues bonds in the local market and borrows from bilateral and multilateral aid agencies; it has received World Bank funds through two credits and a third is now in the appraisal stage. In connection with its international borrowing, in the 1960's the foreign exchange constraint represented a major obstacle to industrial growth and the mobiliza- tion of those resources was a major purpose of the corporation. 1/ 1/ CV-CFN and COFIEC (see next section) have shared in two World Bank loans designed to promote the development of financial intermediaries. The first in 1971 (721-EC) was for $8 million, divided equally between the two agencies. The second in 1973 (930-EC) was for $20 million, of which $8 million was used by CV-CFN and $12 million by COFIEC. In addi- tion, CV-CFN was the intermediary for a tuna fishing development loan (555-EC) with the Government of Ecuador, being responsible for sub- lending for boats and other fishing equipment. Detailed discussion of the functions and objectives of both institutions are to be found in the appraisal reports for these loans.  - 35 - 3.20 CV-CFN mainly invests in and lends to large and medium-sized in- dustry; additionally, it administers the Fondo de Promocion de Exportacion, maintains rediscount facilities for loans to small industry, and finances pre-investment studies. At the end of 1974, CV-CFN's portfolio consisted of 23% equity investments and 77% loans. 3.21 CV-CFN's industrial loans are for periods of up to 12 years for fixed assets and 5 years for permanent working capital. They cover up to 70% of the cost of new projects and up to 100% of expansions; the beneficiary, however, must provide guarantees equivalent to 142% or 125% of the value of the loan depending on whether these are mortgages on land and buildings or liens on machinery, equipment and inventory. Strict enforcement of this re- quirement is bound to discourage many potentially worthwhile entrepreneurs. It is felt that the good quality of its appraisals, should permit relaxing these guarantee requirements. This comment also applies to COFIEC. CV-CFN: Volume of Credit (in million Sucres) Year Commerce Agriculture /a Manufacturing Other Total 1970 12 2 131 -- 145 1971 35 45 265 65 /b 410 1972 9 2 291 -- 302 1973 26 4 333 -- 363 1974 143 5 1118 -- 1266 Source: CV-CFN 1973 and 1974 Annual Reports. This does not include either the financing through FOPEX or the rediscounting facilities. /a Includes fishing. /b This covers one operation in the public utility sector. 3.22 At the end of 1974, CV-CFN's total resources amounted to S/. 2,302 million, consisting of 39% equity, 34% foreign borrowings from institu- tional sources, 9% from the Ecuador Social Security Institute, 7% from its own 5-year domestic bonds, and 11% from miscellaneous sources. Most striking is CV-CFN's low debt/equity ratio of barely 1.6:1. With growing demand for investment funds, the Corporation has undertaken to expand its operations and has played an important role in the growth in industrial financing. On the one hand, it has begun to enter the foreign guarantee market. To obtain additional local currency resources, it has recently begun to issue 8%, 10-year, income tax-free bonds in the local market, with the standing offer  - 36 - of repurchase at sight and at par. At first these bonds were selling almost exclusively "privately" among a small group of long-time investors (mainly insurance companies). In the hope of developing a broader market, CV-CFN has now begun, with some success, to offer them through its representative on the Security Exchanges. These bonds are in effect short-term instruments and the quantity issued by CV-CFN should be monitored closely. However, in a country like Ecuador, this a very important step in developing a market for long-term instruments. In other countries in similar stages of development, it has taken some time before any long-term instruments (other than real-estate mortgage bonds) became firmly established in the local money markets. But, it is hoped that the Ecuadorian public will quickly become used to these type of long-term instruments and will look for such alternatives to supple- ment the traditional savings accounts; there is some evidence of small-saver interest in these instruments. 3.23 Among its other activities, CV-CFN finances 90% of the cost of pre-investment studies at 8% for up to 10 years with varying grace periods, using its own funds and any other resource which may be obtained from other institutions, local or foreign. At the end of 1974, some S/. 11 million of CV-CFN's capital was earmarked for this type of operation. In addition, it expected to receive S/.1 million from Fondo Nacional de Preinversion (FONAPRE) in the latter part of 1975. During 1974, less than S/. 2 million was used to finance pre-investment studies. 3.24 Fondo de Promocion de Exportaciones (FOPEX) lends for "non-tradi- tional" exports. 1/ Its loans are for up to two years at 8%, rediscounted in the Central Bank at 4%. At the end of 1974, the total assets of the Fund amounted to S/. 74 million, and were insufficient to meet financing require- ments. An additional S/. 100 million has been requested from the Government but has not yet been allocated. Because of the scarcity of available funds, terms have in effect been reduced to one year or less. During 1974, a total of 76 operations with a value of V/. 309 million were financed. 3.25 Rediscount operations for small industry have been made by CV-CFN at 5% to commercial banks and 3% to Banco Nacional de Fomento. At the end of 1974, it held rediscounted receivables worth S/. 51 million, equivalent to about 3% of its loan portfolio. During 1974 a total of S/. 30 million was rediscounted. These facilities appear to constitute a duplication of the Fondos Financieros mechanism, which offers 3% rediscount facilities to commercial and development banks alike, and might be consolidated with those of the Central Bank. 1/ For this purpose, petroleum, bananas, coffee and cocoa in grain, and sugar are considered traditional exports.  - 37 - 3.26 In connection with financing of small industries, CV-CFN has been charged with undertaking a feasibility study for the establishment of a special financial intermediary for these types of enterprises. While the equity composition of this entity has not yet been defined, the Government has already pledged to contribute funds to its creation. COFIEC 3.27 The private development finance corporation - Compania Financiera Ecuatoriana de Desarollo (COFIEC) - was created in 1966 and, like its public counterpart, one of its principal functions in its initial stages, was to channel foreign exchange resources to private sector investment. Among its original shareholders was the IFC. 1/ 3.28 COFIEC also mainly invests in and lends to large and medium-sized industry, but it has been more flexible than CV-CFN as to size and type of projects financed and up to now has been more heavily involved in foreign guarantee operations. Its portfolio at the end of 1974 amounted to S/. 1,248 million, with equity investments representing a mere 2%, project loans 49%, and combined short-term operations, mostly guarantees and letters of credit, 49%. 3.29 At the end of 1974, COFIEC's total resources amounted to SI. 1,325 million and its total debt to equity was about 8:1. 2/ In spite of this high leverage, COFIEC has raised relatively little money in the domestic market. Almost from the start it has been hard-pressed to increase its equity. In the Ecuadorian context, COFIEC has been relatively profitable, e.g., about 15% in 1973 and 1974, and its shares should be attractive to the many industrialists who sooner or later will have an expansion to finance and to foreign banks who wish to strengthen their relationship with local banks. Still, it has not been easy to raise the additional capital needed to maintain its rela- tively fast growth. Enforcement of resolution 24 of the Andean Pact restricts the participation of foreign investors in financial institutions, although recently the Ecuadorian Government has ruled that retained earnings on behalf of foreign shareholders could be reinvested provided their percentage of ownership did not increase. COFIEC has primarily issued stock dividends 1/ In addition, COFIEC has shared in two World Bank loans for assisting the development of financial intermediaries (see previous section on CV-CFN). Also COFIEC has made use of the Fondo Financiero mechanism established under the Bank's loan for livestock development, 222-EC. 'N (See Annex II). 2/ This includes letters of credit. Under IBRD Loan 930-EC, COFIEC's debt/equity ratio, excluding letters of credit, must not exceed 7:1.  - 38 - and has thus eliminated a number of potential shareholders who look for a cash dividend. The growth of its equity base has been as follows: Paid-in Capital End of year (million sucres) 1966 19.6 1967 36.0 1968 45.o 1969 57.1 1970 64.0 1971 65.4 1972 72.0 1973 90.0 1974 120.0 At the end of 1975, the Board of Directors voted to increase the equity base to 200 million sucres. It is clear that one of the major factors which has restrained this growth has been discriminatory treatment of dividend income, mentioned earlier. 3.30 The structure of COFIEC lending is as follows: COFIEC - Volume of Credit (in Million Sucres) Year Manufacturing Agriculture /a Construction Others Total 1966 47.8 /b /b 10.0 57.8 1967 111.3 5.8 11.1 12.9 141.0 1968 137.6 29.8 3.3 47.6 218.3 1969 209.0 55.4 48.3 57.7 370.4 1970 198.5 38.4 49.4 72.5 358.9 1971 229.0 30.5 63.7 121.3 444.4 1972 366.7 44.5 108.8 113.4 633.4 1973 439.1 51.5 202.7 137.2 830.5 1974 752.1 99.6 268.9 184.9 1,305.5 Source: COFIEC /a Includes livestock and fishing. /b Included under "others".  - 39 - Other Non-Bank, Financial Intermediaries 3.31 Five new privately-owned non-bank financial intermediaries in Quito, Guayaquil and Cuenca, are being set up and should start operations sometime in 1976. Additionally, as noted earlier, one possibly mixed-capital small-industry-oriented development bank is being set up at the initiative of the Government which has already announced it would participate with an equity investment of S/. 50 million. It has been suggested that this new bank might acquire the industrial portfolio of Banco Nacional de Fomento and take over that portion of the rediscounting of small industry loans which CV-CFN currently undertakes. Fondo Nacional de Desarrollo 3.32 Although kept in an account of the Central Bank, the resources of the Fondo Nacional de Desarrollo (FONADE) are not administered by the Central Bank. Allocation of available funds is made by an inter-ministerial com- mission. The resources of FONADE come from that portion of the Government's tax receipts on oil exports in excess of US$7.42 per barrel. By the end of 1974, the fund had been given S/. 3,342 million and had disbursed S/. 2,313 million. In order of importance, S/. 536 million was allocated for the con- struction of the state petroleum refinery, S/. 505 million for emergency works, S/. 502 million for project financing at Banco Nacional de Fomento, S/. 250 million for project financing at CV-CFN, S/. 200 million for discount- ing purposes at the Central Bank under the Fondos Financieros' mechanism and the remaining S/. 320 million for projects of various ministries and other development agencies. Of the S/. 835 million received by FONADE in the first five months of 1975, about S/. 532 million went to the state petroleum re- finery, S/. 156 million was used to finance the import of grain and heifers, S/. 50 million was transferred to FONAPRE and the remaining S/. 97 million went to finance projects of various ministries. Fondo Nacional de Preinversion 3.33 Fondo Nacional de Preinversion (FONAPRE) was created in the middle of 1974 for the purpose of financing preinvestment studies for priority projects, public and private, within the priorities established by the National Planning Board. Its resources to date amount to about S/. 300 million of which the Government and FONADE contributed S/. 200 million and the remaining S/. 100 million was obtained from IDB in December 1974. At the end of 1974, FONAPRE had approved S/. 171 million of credit for 8 of the 24 requests it had then received. FONAPRE does not carry out studies although it approves and sometimes helps in the preparation of their terms of reference. In the future, it intends to reach the private sectors through the development banks and two loan agreements have been signed to this effect with CV-CFN (S/. 1 million) and COFIEC (S/. 5 million).  - 40 - The Security Exchanges 3.34 There are security exchanges in both Quito and Guayaquil, but they handle a negligible volume of industrial securities. On a typical day the Quito Exchange will handle a volume of securities of between S/. 5 and S/. 10 million and Guayaquil usually less. The bulk of the transactions covers Government and mortgage bonds. During 1975, only four companies other than CV-CFN and COFIEC had outstanding bonds and only eight companies had been authorized to have their stock quoted on the exchanges. The Unsupervised Market 3.35 There seems to be a consensus among public officials and bank representatives that the unsupervised market has been very small. However, the decision to freeze the commercial portfolio of the commercial banks at the May 1975 level may have created conditions favorable to the development of such a market. One method used is where a commercial bank acts as broker and guarantor for private placements with its commercial and industrial cus- tomers. For this service, the bank collects a fee of up to 4% depending on the risk involved. There is evidence that such transactions have been going on, although bankers are not eager to discuss them. Measures Affecting the Flow of Resources to Industry 3.36 The principal monetary instruments which directly or indirectly affect the flow of resources to industry are legal reserve requirements, minimum capital requirements, portfolio ceilings, directed investments, open market operations, advance import deposit requirements, and interest and rediscount rates. These are presented in the following paragraphs. 3.37 Legal Reserve Requirements. All banks 1/ and savings and loan associations are subject to minimum reserve requirements on deposits and other specified liabilities. Previously, these requirements could be ful- filled by deposits in the Central Bank and by bonds of CV-CFN. The amount held in these bonds could be up to half of the total. Since June 1973, however, they can only be fulfilled with deposits in the Central Bank. When the legal reserve requirements exceed 25% of a bank's total sight deposits, the Central Bank pays interest on the excess (only up to 30%). 1/ Includes the Commercial Banks, the Banco Nacional de Fomento, the Housing Bank, Cooperations Bank and all Savings and Loan Associations, but excludes CV-CFN and COFIEC.  - 41 - 3.38 The prevailing requirements (October 1975) for private commercial banks are 35% for sight deposits,I/ 20% for time and savings deposits, and 35% for all foreign currency deposits. When foreign currency deposits are held by foreign-owned banks, the reserve requirement is 50%. For the Banco Nacional de Fomento, the Ecuadorian Housing Bank and the savings and loan associations (whose capital does not exceed S/. 100 million) all deposits are subject to a 10% reserve requirement. The reserve requirement for savings and loan associations whose capital exceeds S/. 100 million is 15%. The only exception is time deposits with the Ecuadorian Housing Bank, which are subject to an 8% reserve requirement. Sight deposits at the Cooperative Bank have a 32% reserve requirement but saving and time deposits only 10%. As of January 1973, the interest paid on commercial banks' reserve deposits was fixed at 8%. At the end of May 1975, the level of excess reserves was about 4% of the minimum required. 3.39 Minimum Capital Requirements. All banks may be subject to minimum capital and reserve requirements with respect to loans, investments, and other operations. The prevailing requirements refer to: (a) guarantees and accept- ances on foreign loans, which cannot exceed five times the paid capital and re-- serves of the bank's commercial section; (b) first trust mortgage loans which are allowed up to 20% of their savings department paid capital and reserves; (c) loans secured by real estate, which cannot exceed 50% of paid capital and reserves of their commercial department; (d) mortgage bonds which can be issued up to 20 times the paid capital and reserves of their mortgage department; and (e) investments in acceptances and guarantees on local currencv, which cannot exceed 100% of paid capital and reserves of their commercial department. Under special circumstances, the Superintendency of Banks may authorize an increase of this limit up to 150%. 3.40 The minimum capital regulations were changed in October 1973 bv Decree 1146 which doubled capital requirements for commercial, savings, and mortgage banks. The new minimum capital requirements in Quito and Guayaquil are: for commercial banks S/. 20 million; for savings, and mortgage banks S/. 6 million; in all other cities minimum capital requirements are SI. 10 million and S/. 4 million, respectively. In addition, Decree 1146 greatly increased the lending capacity of the commercial banks and of other types of banks having a commercial credit section by more than halving the required ratio between paid-in capital plus reserves and the liabilities to the public, i.e. from 15% to 6.7%. Portfolio Ceilings 3.41 The Monetary Board uses ceilings on bank credit as a tool to control monetary expansion. Until recently, a ceiling on credit expansion of 3% per 1/ In May 1976, this was reduced to 32%.  - 42 - quarter (12% per annum) was in force. Previously, banks that exceeded these expansion limits could not have recourse to the Central Bank for advances or rediscounts until their portfolios were reduced to the permitted limits. Subsequently, this prohibition was substituted for a fine. In June 1975, as a strong anti-inflationary measure, the Monetary Board froze the credit ceiling at the levels reached on 'lay 31, 1975, with the exception of productive credit for firms classified under the Fishing and Industrial Promotion Laws. With the freezing of the commercial portfolio of the commercial banks, many businesses may have been left without adequate means to finance the continuously increas- ing value of wholesale and dealer inventories, and may have had to resort to the unsupervised market.l/ Directed Investments 3.42 To assist certain sectors, in particular the small entrepreneurs, farmers and artisans, the local and foreign commercial banks are required to invest 20% and 25% respectively of their portfolio in loans which qualify under the Fondos Financieros mechanism (see earlier section). Banks which fail to reach the prescribed levels must make up the difference by purchas- ing 4% Government Development Bonds, a rather unattractive alternative. Effective January 1975, another measure obliges the banks to relend a minimum of 80% of their deposits in the provinces where they originate. In 1974, about 80% of the banks' deposits had originated in the Quito/Guayaquil areas whereas 87.6% of their portfolio covered loans to Quito/Guayaquil accounts. 3.43 Open Market Operations. In October 1972, the Monetary Board authorized the Central Bank to issue short-term bonds with the objective of developing the mechanism of open market operations to help in regulating the overall liquidity of the system. These "stabilization bonds" are for 90 and 180 days, bear no interest, but sell at a discount. In April 1973, the Mlonetary Board prohibited the acquisition of Central Bank stabilization bonds by the Government and other public agencies, by private institutions of a social character, and by banks and other financial companies which were legally compelled to keep their deposits at the Central Bank. The objective of this measure was to assure the absorption of these bonds by the private sector, rather than resulting in a mere change in the composition of Central Bank liabilities. The amount in circulation has declined steadily from the peak figure of S/. 420 million in October 1973 to only S/. 195 million in August 1975 as a consequence of the Government's decision to reduce their yield by reducing the amount of discount at the time of sales. i/ In April and July 1976, modifications in these ceilings were intro- duced to provide some additional liquidity to the financial system.  - 43 - 3.44 Advance Import Deposit Requirements. The Monetary Board can require importers to place a stipulated amount in deposits with the Central Bank as a condition for the granting of an import license. From March 1961 up to February 1973, advance import deposits had been required and variations in the requirements had been frequently utilized as an instrument of balance of payments and monetary management. On February 26, 1973, all prior import deposits were eliminated. However, Regulation 788 of September 11, 1975 re-introduced import deposit requirements for certain goods. (See Chapter II). 3.45 Interest and Rediscount Rates. The legal maximum rate of interest is 12%. Within this limit, the Monetary Board has the power to set interest and rediscount rates for all types of loans and deposits. The present interest and rediscount rate structure established by Monetary Board Resolution 755 of January 1975 represents the first change since 1970. Since 1972, banks also have been empowered to charge commissions on their credit transactions; these have ranged from 1% per quarter for guarantees to one half of 1% for letters of credit. 3.46 Annex 2 presents a comparison of the rates which existed before and after January 1975. The maximum lending rate for large industrial and for commercial credit regardless of the life of the loan has remained unchanged at 12% while the corresponding rediscount rate has increased from 8% to 10%, and the rediscount and the interest rates for agricultural, livestock, artisanal and small-scale industrial credit have gone down 1% or 2%. Insofar as banks operate with Central Bank funds through rediscounts, the new set of interest and rediscount rates increased the margins earned by credit insti- tutions on their loans to agriculture and small industry (which reflects their higher risk and slower turnover), and reduced the margin on commercial loans. 3.47 With the inflation rates in 1973 and 1974 of between 15% and 20%, the legal maximum rate of interest of 12% and the effective rates of 14-16% - after adding allowable commissions - were negative in real terms. So were the 8% and 9% rates charged by Banco de Fomento and the 9% charged under the Fondos Financieros mechanism. However, progress was made in curbing inflation during 1975, and by the end of June 1976 it is estimated to have dropped to about a 9% annual rate. 3.48 In general, an interest and rediscount rate structure should provide (i) a margin sufficient to enable the intermediaries to recover reasonable costs and to obtain a return on equity high enough to avoid erosion of their capital; and (ii) a compensation sufficient for the intermediaries to attract savings. While it is almost impossible to assess the reasonableness of the operating costs of the financial intermediaries, at the level of inflation prevailing in 1974, their combined return on equity was too low to avoid erosion of their capital. These returns were about 13% for commercial banks, almost nil for Banco Nacional de Fomento, 7% for CV-CFN and 15% for COFIEC.  - 44 - It is of course too early to tell how they fared during 1975, or will fare in 1976, with considerably reduced levels of inflation and the application of the new rate structure. 3.49 The question of the adequacy of interest rates to attract re- sources to the financial intermediaries is a complex issue. In order to simplify the discussions it is convenient to distinguish between short and long-term resources. In the domestic market substantial short-term resources have been mobilized by the commercial banks through savings de- posits and, to a lesser degree, term deposits. During the-period of high inflation in 1973/74, savings deposits, although earning only 6%, continued to grow (from December 1972 to December 1974 by about 50%). It would appear that the bulk of these deposits reflect essentially liquid balances held in relatively small deposits; in the absence of more liquid instruments in small denominations, 1/ these deposits can be expected to continue to grow more or less proportional to genetal income growth. 3.50 The institutions which until now have been primarily concerned with mobilizing long-term resources for project financing are COFIEC and CV-CFN. As pointed out in the earlier discussion of CV-CFN, with its ready access to government funds, including the recent contribution from FONADE, it has recorded relatively low debt/equity ratios; (at the end of 1974, it was only 1.6:1) and could well afford to incur more debt. Recent operations suggest much more aggressive policies in that direction. 3.51 The case of COFIEC is much more difficult. Discrimination against dividend income has limited its capacity to expand its equity base while the interest rate ceiling has forced it to move towards a high proportion of short-term operations, such as the foreign exchange guarantees, which can earn adequate profits. Particularly with the recent reduction in infla- tion rates, it appears likely that only a moderate increase in the effective interest rate (including commissions) for long-term lending would permit it in turn to offer long-term bonds to the public with a sufficient spread to be profitable.2/ With its present debt/equity ratio, however, unless there is an increase in its equity base, COFIEC can only incur that debt by cutting down some of its short-term operations (largely the foreign guarantees). 1/ However, see the above discussion of CV-CFN's recent liquid bond issues. 2/ In July 1976, the Government was studying a new rate structure to in- troduce a commission to increase the return of Commercial banks, BNF and the non-bank financial intermediaries on their medium and long- term loans to the productive sectors of the economy.  - 45 - 3.52 In summary, given its stage of development, Ecuador has developed a relatively sophisticated financial structure which has played a role in the recent industrial expansion. Nevertheless, important adjustments and modifications are required to permit it to contribute to accelerated develop- ment in the future which is both desirable and possible. The earlier dis- cussion has concentrated on only a few limited aspects of the problems of creating an appropriate capital market. The institutions dealt with provide a relatively important portion of new investment requirements of industry, but probably well under half. The growth of modern industry requires the pari passu development of a modern capital market. Thus the problems faced by these institutions reflect the policy issues which the Government must face in one way or another if it is to mobilize financial resources and effectively use the resources of the private sector. 3.53 Although complete data are not available, it appears that financial intermediaries currently play a minor role in providing long-term capital for industry. As a rough measure, the data in para 1.24 indicate total imports of capital equipment for industry in 1973 of $75 million, including replace- ment parts. Normally, for countries such as Ecuador which import virtually all their capital goods requirements, these items account for 50 to 60% of total industrial investment costs, suggesting gross industrial investment of the order of $150 million in that year. Data on long-term lending to in- dustry by COFIEC, CV-CFN and BNF (given in earlier sections of this chapter) indicate that some $30 million was provided by these intermediaries in 1973.  - 46 - CHAPTER IV PROSPECTS FOR FUTURE INDUSTRIAL GROWTH A. GENERAL SECTORAL STRATEGY 4.1 For a country the size of Ecuador and with its relative resource endowments, substantial increases in per capita incomes can only be achieved through adequate expansion of exports, of a magnitude which in all probabi- lity would increase the relative share of the latter in GDP. 1/ There are obvious limits to the country's petroleum resources particularly in the light of the current uncertainty on the extent of proven and probable resources. Horeover, growing internal consumption will over time reduce exportable supplies. Thus, maintenance of a dynamic, growing economy requires the assurance that, as it becomes necessary to curtail exports based on those resources, there will have been developed other export possibilities which can at least in part take up that slack. This suggests the need to develop industrial activities which are export oriented. 4.2 A second critical consideration is the need to develop industries which will provide widest possible employment opportunities so as to achieve the objective to improve income distribution. The direct effects of the petroleum sector development on employment are extremely limited; utilizing the funds made available from petroleum exports in financing construction projects has currently been the major indirect source of employment generation. The rate of employment absorption in industry (now estimated at about 10% of the annual increment to the labor force) is unlikely to rise in the next decade as much as necessary to become the principal source of new jobs. Thus, it is urgent to focus industrial investment on activities which have links to other sectors of the economy where additional employment opportunities can be generated. There exist excellent possibilities for expansion in output of agricultural products (including forest and fish and shellfish), particu- larly of items which can be subjected to additional processing and which have favorable world market prospects. Given the overall employment genera- tion from this orientation, highest priority should be given to pursuing this approach. 1/ While econometric models have not defined precisely the relationship between the ratio of exports to GDP and per capita incomes at different population levels, it is abundantly clear from examination of existing data, as well as from any logical consideration of the price of autarchy, that smaller countries must have high trade levels to achieve high incomes. Examples are found in countries such as Belgium, Denmark and Finland with populations of 5-10 million where exports represent 30 to as much as 50% of GDP.  - 47 - 4.3 In connection with the measures required to obtain further expansion of the industrial sector, it is important to recall the need for continued efforts at improving the physical infrastructure (see Chapter I). In parti- cular, major efforts will be required to ensure an adequate supply of man- agerial and technical skills (see para. 1.25). B. POSSIBILITIES FOR MAJOR SUBSECTORS 4.4 In the 1973-1977 Development Plan, the target annual growth rate of the industrial sector for the quinquennium was set at 10.1%. During each of the first three years of this period, the actual expansion achieved has been slightly over 11%. It was earlier noted that most of this favorable performance has been due to fuller utilization of existing capacity. While there is indication of considerable new production capability, both in terms of expansions of plant and new enterprises, much of this has yet to come on stream. 4.5 Thus, providing overall demand can be maintained, prospects are for sustained growth of the sector in the next few years. Much of the new capacity, however, is domestic-market oriented, indicating the need for special efforts to identify and promote the creation of industrial activities for export. In the rest of this section, some principal areas of potential growth are examined, first from the point of view of export possibilities, then considering domestic demand. 4.6 With an excellent agricultural resource base, much of which is currently either underutilized or unutilized, there is need to focus attention on agro-industrial development oriented in particular towards exportable products. Among the possibilities which have been identified are expansion of sugar refining (increasing yields both at the plantation and refinery levels, as well as bringing into cultivation land not currently commercially culti- vated), fish products, and fruits and vegetables for processing (including both dehydration and canning). A major project is now being examined for producing banana flour for animal food for export to Western Europe, based on traditional banana varieties grown in the northern coastal regions; this area had previously been the main source of this product but the introduction of new types more suitable for current transport methods and the development of the ports in the southern part of the country had resulted in a shift in location of the major export plantations. 4.7 Agro-industrial products which offer excellent employment and investment opportunities are expected to experience increased local demand as a result of the growth in domestic incomes and consumption. Aside from  - 48 - the export-oriented items cited above which can also be expected to have substantial local marketing opportunities, there exist possibilities for substantial increases in dairy and meat production. A number of slaughter- houses and dairy plants are currently under construction while others are in the pipelines of the financial corporations awaiting allocation of foreign exchange or completion of feasibility studies. Other proposals relatively advanced for financing include canning of tomato and citrus products and animal foodstuffs. 4.8 There are also a number of non-food agro-industrial products which have excellent possibilities, including for export. The country cur- rently exports castor seeds and proposals have been made to establish refining facilities for further processing of this item. A widely used chemical, sorbitol, is a derivative of corn; studies have been made examin- ing viability for its production in the Sierra region. A.loreover, Ecuador has been given special concessions by its Andean Pact partner countries for this product. 4.9 In a related field, known forestry resources are adequate to permit considerable expansion of wood products industries; several new mills for sawnwood and plywood for construction purposes are being built or have recently begun operation. A study to determine possibilities for industrial exploitation of the forest resources in the Northwest (Cayapas) was recently undertaken with UNDP financing and supervised by the Bank; analysis was made of alternative schemes and a recommendation was made to proceed with an integrated pulping-sawmill complex. But at present the project's sponsors (a mixed enterprise involving CV-CFN and the private sector) have chosen to implement the proposal in extended stages and, in the first phase, adding a plywood mill to the original proposal. There remain some areas of the country where only limited data are available on the extent of forestry resources and studies are now being planned for examining exploitation potential. Given current domestic demand, particularly for packing materials for bananas, expansion in output of these products would go largely towards import substi- tution. However, world market conditions continue to favor some export of high quality plywoods. 4.10 The development of petrochemical and related products, based on crude petroleum and natural gas resources, present vastly complex technical, financial and economic problems: the various technical routes (and con- sequent difference in product streams), the extremely high capital costs for these facilities and the limitations of the local (and even Andean) market implying the need to export to third areas in one form or other a substantial portion of final output. Basic decisions have been taken and construction is underway for the Esmeraldas petroleum refinery (55,000 bbls/day), producing primarily fuels, and a system of pipelines for trans- porting refined products to consuming centers within the country.  - 49 - 4.11 In addition, a joint venture has been formed for the development of a fertilizer complex in the Guayas area based on dry natural gas which *has been found in that province; preliminary planning for this project is now underway. A substantial proportion of this output would be for export. 4.12 Under consideration are an additional refinery for 100,000 bbls/day for petrochemical production and an integrated basic steel plant of 400,000 tons/year, utilizing natural gas and electric power, but requiring imported ores; 1/ the latter would be primarily for domestic consumption. Various units within the Government are examining these possibilities, including the State Petroleum Exploration Corporation (CEPE), the Armed Forces Industrial Department (DINE) and the Ministry of Industries. 4.13 A critical element in these decisions is the assignment to Ecuador of a series of products within the petrochemical industry programing of the Andean Group. Under the recent decision, 16 products or groups have been assigned to Ecuador although only one on an exclusive basis. Present estimates are that as much as 70% of the target production of these items for the country would have to be exported to third countries. 4.14 While these projects will, when completed, clearly change the structure of Ecuadorian industry, their complexity means that many years will be required before that is achieved. Of the investment mentioned in the previous paragraphs, only the Esmeraldas refinery, due to initiate operations in early 1977, can be expected to be on stream before the end of the decade. 4.15 The decisions relating to petroleum refining (whether for fuels or petrochemical processing) have been made more complex with the emerging uncertainty on the extent of the available reserves. This has pointed up the need for further testing and exploration which the Government has partially resumed. Another key policy aspect, however, is the low domestic pricing for and low taxes imposed on gasoline and fuels which have resulted in an extremely rapid growth rate of consumption now estimated at 11% per year. Gasoline prices for consumers in Ecuador are currently among the lowest in the world and, in terms of foreign exchange earnings foregone, represent an excessive burden to the economy. 2/ 1/ As noted in Chapter I there are some indications of ferrous ore deposits in the Andes but more intensive exploration is required to ascertain the extent of these deposits as well as economic feasibility of exploitation. 2/ If, as is likely, the domestic price elasticity of demand for gasoline is less than one, the present policy also represents a substantial loss in net revenue for the Government.  - 50 - 4.16 With the growth in incomes and investment, a number of import- substitution industries have now become economically viable production opportunities. These include a wide range of consumer goods. However, among the most important are those associated with construction, not only for residential purposes but also for commercial, industrial and public works use. These include cement, glass, ceramics (including sanitary ware), structural steels and hardware. Some expansion of these items is already underway, particularly the major cement plant at Cotopaxi in the public sector which is being jointly financed by IDB and the Canadian Government. But others in the private sector are slow in implementation, in part due to the difficulties in obtaining capital. 4.17 At the same time, the expansion of the industrial base will provide opportunities for some backward integration which has not yet been possible. This is the case for some industrial chemicals, metal products (e.g. gas cylinders and small boilers) and simple items from the mechanical engineering industries such as diesel engines, small transformers and electric motors. 4.18 The availability of petroleum and natural gas resources, even if there is some uncertainty over their extent, presents an important oppor- tunity to Ecuador to accelerate its overall economic growth in the longer run. Generating both foreign exchange and public revenue, these two re- sources can serve as the basis for fundamental investment decisions and careful consideration of the various alternative uses are required to achieve maximum benefits. In the case of petroleum, with the current level of proved reserves less than earlier anticipated and with installed refinery capacity to reach a total of some 100,000 bbls/day by 1977, 1/ questions arise as to the viability of implementing the proposal for an additional 100,000 bbls/day refinery for petrochemical production which could not be on stream before the early 1980's. Should oil extraction continue at the current rate, leaving aside the target of doubling the rate by the end of this decade, the reserves might not be able to support further refinery expansion. 4.19 Nevertheless, even if further reserves are proven, an additional consideration which must be analyzed is the net foreign exchange earnings from. exporting petrochemicals as compared to continued export of the crude and the possible alternative uses of investment funds for other export- oriented industries; allowance would have to be made for servicing the loans required to finance the costs of refinery construction, a high proportion of which would represent imported equipment. 1/ In addition to the 55,000 bbls/day refinery at Esmeraldas now under construction, there are four smaller older plants totalling 44,000 bbls/day capacity.  - 51 - 4.20 In the case of dry natural gas, the situation is somewhat different in that its export either unprocessed (as LNG) or in the form of a refined product (e.g. ammonia) requires substantial investment. Even in this instance, however, the final use of the gas should aim to maximize its value; thus the proposal to construct a direct reduction steel mill, in which the gas would be essentially used as energy must be evaluated against alter- native uses of that resource. 1/ 4.21 It may be expected that a significant portion of the capital for these plants (except for the domestic-market oriented steel mill) would be provided from external sources, particularly from the potential markets or consumers, and consequently there would be no alternative possible use in Ecuador for these funds. However, some domestic capital and local manage- rial resources would also be required. The question, therefore, arises whether such funds could not have higher social and economic returns, through direct employment generation and consequent impact on income distribution, if they were applied to export oriented agro-industries, in particular the infrastructure investment necessary to stimulate those activities; this is especially so since the backward and forward links from most of the invest- ment for petroleum refining and petrochemical development are limited in the case of Ecuador. From a practical point of view, what is required is a blend of investment, utilizing the non-renewable hydrocarbon resources to assure a high flow of export earnings in their lifetime and developing new sources of employment and export earnings among the currently underutilized agricultural and related resources. C. REGIONAL DISPARITIES 4.22 The marked differences in resources endowment described earlier between the coastal plains and the eastern Andean slopes on the one hand, and the Andean mountain regions on the other, require approaches adapted to those differences if a reasonably balanced growth objective is to be reached. The coastal plains offer possibilities of additional labor intensive agro-indus- trial development with excellent export potential; this type of development on the eastern slopes may also be possible although not for a number of years in view of the needs for colonization and further infrastructure development. In connection with the latter point, petroleum exploitation in the last few years has brought with it relatively substantial road and transport develop- ment, helping to open up these areas. 4.23 Further growth of the Andean mountain region cannot follow this path, except in some exceptionally large fertile valleys such as those 1/ Moreover, these types of mills concurrently use large quantities of electric energy which also must be cheap, i.e. have little alternative use.  - 52 - near Quito and Ambato. For the most part land resources will permit on the one hand small intensive cultivation of high value vegetable crops, and, on the other, dairy development; these items will be primarily for local consumption, although some possibilities for exports (e.g. processed garlic and onions) do appear to exist. To provide additional income generating opportunities, use must be made of the highly developed manual dexterity found in these areas through the development of skill-intensive industries; while a start has been made in this direction, particularly in the Cuenca area (e.g. watch-making, starting with assembly but gradually increasing local production of parts), there is need for accelerating efforts and implementing projects which have existed as plans for many years, especially a number of labor intensive industries assigned to Ecuador within the Andean Group. D. The Special Problems of Small-Scale and Artisan Industry 4.24 As pointed out in Chapter II, an elaborate set of policies and institutions have been developed to promote the growth of small and artisan industries. Justification for this attention has derived from several con- siderations: (1) in view of market size and, in particular, of the fragmentation of the market due to transport problems, it is felt that such industries are best suited to meet demand; (2) these types of industries are generally less capital intensive and more labor-using; (3) small industries are the "training grounds" for entrepreneurial skills required for larger, more complex enterprises. (4) the rich, artistic tradition of the Ecuadorians. 4.25 The expanded incentive law for small industries adopted in 1973 and the general improvement in economic perspectives have led to a rapid expansion in the number of enterprises applying for these benefits. In 1973, 131 new enterprises were classified to receive benefits under the law, involving investment estimated at 128 million sucres; in 1974 there were 217 enterprises with investment of 289 million sucres. The revision in August 1975 raising the size limit to 5 million sucres invested in machinery and equipment has apparently brought a further increase in new applications.  - 53 - 4.26 The experience gained in recent years has pointed to a number of shortcomings in this approach. The apparently overly generous nature of the tax exonerations granted and the implications for public sector financial mobilization have already been noted in Chapter II dealing with the general problem of fiscal incentives. One result of the current system of permanent tax exonerations for small industry has been to discourage the expansion of individual enterprises; once they pass the legal limit they lose that benefit. At best, it has encouraged a diversification of output of a given enterprise which permits it to be legally fragmented into two or more units so as not to lose the tax-free status. 4.27. To avoid weakening the tax base and to avoid disincentives to small industry growth, tax exonerations should be extended for a fixed time period (four to five years) on a contractual basis to a qualified applicant which would retain that benefit independent of its growth during the term of the contract. 4.28 Among other measures which can be taken to assist in the develop- ment of these enterprises is an expanded program of technical assistance. With the participation of UNDP/UNIDO, CENDES is currently operating a general technical assistance effort while within the Ministry of Industry there was created in November 1975, a National Center for Promotion of Small and Artisan Industry (CENAPIA) which inter alia will be responsible for providing assistance to these units. Details of the functioning, organization and budget resources of the latter are not yet available but this Center has absorbed the functions of a special unit which had been previously operating within the Ministry with apparently little impact. With the definition of small industry now expanded to enterprises with up to $200,000 equivalent in machinery and equipment and given the relative importance of these enterprises in the total number of factories, there appears to be little practical reason for this division of labor. Exceptions would arise in the case of artisan workshops, which are defined in a separate law and have special assistance programs. 4.29 Since the first development plan issued in 1963, considerable emphasis has been given to the establishment of industrial estates as a tool for helping in the development of smaller enterprises. Implemen- tation of the proposal has proven extremely difficult, however, and it has only been in the last year 1/ that construction began on a site at Cuenca, representing the first phase (18 hectares) of a 65 hectare proj- ect. While lack of financial resources has played a major role in the slow progress achieved until the present, shortage of experienced person- nel for the management of this type of undertaking has also been critical. 1/ In the mid-1960's, two small industrial parks were constructed in the cities of Tulcan and Ibarra, 2.5 and 0.5 hectares respectively; these have apparently attracted mainly artisan workshops.  - 54 - 4.30 With a view to accelerate the growth of these projects by stimu- lating investment in their construction, a law for the promotion of indus- trial parks was promulgated in November 1975, providing tax and other benefits for industrial park corporations and for shareholders. It is anticipated that these enterprises will be of mixed ownership, including in the public sector CENDES and possibly the regional autonomous develop- ment corporations in the areas concerned. Excluded from benefits, however, are industrial parks established in the provinces of Pichincha (Quito) and Guayas (Guayaquil). 4.31 Nevertheless, some private groups are proceeding with site devel- opment, of limited size, in those two areas, where recent growth, both of industry and commerce, has caused numerous problems. In the case of Guayaquil, the rapid expansion of economic activity has resulted in major transport and communication difficulties for existing industrial enterprises and the provincial association of small industrialists has attempted to interest the Government in a relocation plan to move these firms to an indus- trial park outside the present city limits as part of an urban redevelopment effort. 4.32 In this connection, it is not expected that the parks to be con- structed will impose size limitations on clients other than those necessary to ensure reasonably diverse occupation of space available. While industrial parks are not specifically restricted to small industries, in the situation of the country it can be expected to attract primarily such enterprises. E. PROGRESS AND PROSPECTS UNDER THE ANDEAN PACT 4.33 Exports to Andean Pact countries 1/ benefit under various arrange- ments. As of January 1, 1971, exports of a heterogeneous group of 37 products from both Bolivia and Ecuador were freed of all tariff and quantitative restrictions by the other partner countries. NPC tabulations for these items indicate an increase in Ecuadorian exports from $0.5 million in 1970 to $17.4 million in 1974. A substantial share of this trade has been in items such as fish, cocoa and other food products, amounting to $11.6 million in 1974. At the same time, however, non-traditional exports have also risen sharply, in the case of domestic appliances to more than $3 million in 1974, representing about 80% of the total of exports of these items in that year. 1/ Bolivia, Chile, Colombia and Peru through Dec. 31, 1973; Venezuela entered on January 1, 1974.  - 55 - 4.34 Much of this trade came from enterprises which had been in exist- ence before the concessions were granted. Efforts to promote projects to produce items on the free list which are currently not produced in the country have had limited success. However, some plants are now under con- struction, to produce such items as tire valves, welding equipment and electro-mechanical tools; arrangements for establishing others have not yet been finalized (e.g. sorbitol and some other chemicals). 4.35 Within the regional agreement for metal-mechanical industries, approved in 1973, there has similarly been slow implementation of projects for items assigned to Ecuador and only two installations are now actually operating. Of special interest is a highly labor-intensive plant assembl- ing watches in Cuenca, with a development plan to increase gradually local content. Projects for other items within this agreement, such as centri- fuges, small hydraulic presses, measuring instruments and dairy equipment are still in the promotion stage. 4.36 Agreement has also been reached recently on a regional petro- chemical program, with a broad assignment of products to the participating countries. 1/ The Government is currently considering measures to implement these proposals and it is considering to seek a series of joint ventures with foreign technical partners for that purpose. As regards a proposed program for the automotive industries presented by the Andean Group Commis- sion, the participating governments have not yet reached agreement. 4.37 Practically all of the projects designed to take advantage of these concessions which are now in construction or operation have required substantial inputs of foreign technical know-how. In a few cases, non- Ecuadorian partners have been firms from other Andean Pact countries (primarily Colombia and Peru) which have similar product lines or are the principal consumers of the items concerned. As noted earlier, the shortage of managerial and technical skills in the country remains a major constraint to further industrial growth. The efforts to attract foreign technical partners which are essential to adequate development of these industries may be encountering difficulties as a result of uncertainty over Andean Pact decisions regulating foreign investment. 1/ See para. 4.13.   ANNEX 1 Page 1 AGRO-T'DUJSTPIAL OPPOPIUNITIES 1. (;!:NERA1L CH4ARACTIRISTICS OF AGRICULTURE Ecuador, with a total land area of about 284,000 square kilometers, including the Galapagos Islands, is divided into three distinct regions by the Andes crossing the country from north to south; the fertile Pacific coastal plane (the Costa); the highland region (Sierra); and the eastern tropical lands of the Anazon River Basin (Oriente). Soil fertility varies greatly, ranging-from rich soils on the Costa to eroded hillsides in the Andes. Rainfall varies widely; in the Costa region the rainy season is from D)ecember through May, and annual precipitation varies from 12 to 150 inches 'jitlh sharp differences among districts. In the Sierra, rainfall occurs mostly between October and May and varies from 15 to 50 inches. In Oriente, annual rainfall is more than 120 inches distributed over the entire year. The Ecuadorian economy is essentially agricultural based. IWith the exception of wheat, oilseeds and a moderate amount of temperate-climate fru.ts, the domestic agricultural output supplies the food needs of the country; before the development of the petroleum resourcs, this sector was the nain source of foreign exchange through exports of bananas, cocoa beans and products, sugar and coffee (See Table 1). In the last 10 years, its annual rate of growth has been 3.7%, below the rate of growth of CUP and, as a, consequence, its share in total product has declined from 35" in 1965 to 247' in 1974. 1/ 1/ 'o .r ces for the two -e.i's ,re n.it conrletely comparable and probably ; tr-atic the decline.  ANNEX 1 Page 2 'The nost recent estimates of Land use (1973) are as follows: Percent of MiLlion Total [lartial ha. Area Areas lotal Land and Inland Water 28.4 100 Area not used for agriculture 7.6 27 foal Area used for Agriculture 20.8 73 Forests 14.8 52 Permanent Pastures 2.2 8 Arable Lanid 3.8 13 100 Irrigated 0.5 2 13 N.ot irrigated 3.3 11 87 Total Area harvested 1.8 6 lon Irrigated (0.2 1 11 .Not irrigated 1.6 5 89 A considerable portion of the irrigated land is not currently cultivated and there is clearly scope for increasing arable land under cultivation. The Costa produces banana, coffee, cocoa beans, sugar, rice, tropical fruits, cotton, tobacco, soy and palm seeds, livestock products, hard fibers, citrus and tobacco. This region has the 59.7% of the national cultivated area and 34.9% of the pastures. The prevailing farm size is from nedium to big. The Sierra produces corn, potatoes, vegetables, fruits, wheat, dairy and livestock products. This region has 36.9% of the national cultivated area and 20.4% of the pastures. The prevailing farm size is from small to medium, many of them at subsistence production level. The opening of the Oriente region is associated with recent petroleum exploration and a number of colonization schemes are now in execu- -;on. However, because of its previous remoteness, there is insufficient IKnowledge of its real agricultural possibilities.  ANNEX 1 Page 3 Main crops and livestocks The areas harvested in 1973 with the main crops and their average yiJ?1ds are as follows: Average Yields Area Production Yields For South America Thousand ha. M. Ton Ton/ha. Tons/ha. /I /I Rice, paddy 85,000 134,000 1.58 1.7 Wheat 46,000 45,000 0.98 1.2 Corn 265,000 254,000 0.96 1.4 Barley 93,000 79,000 0.85 - Beans 66,000 32,000 0.48 - Potatoes 44,000 539,000 12.25 5.9 Yuca 54,000 741,000 13.72 13.2 All Bananas 197,000 3,650,000 18.53 15.4 Citrus 13,000 152,000 11.69 11.8 African Palm 9,000 13,000 1.44 - Soy Bean 1,000 1,500 1.50 Abaca 7,000 7,000 1.00 - Cotton 23,000 20,000 0.87 0.8 Cocoa bean 213,000 62,000 0.29 0.3 Coffee 227,000 52,000 0.23 0.5 Sugar cane 89,000 5,477,000 61.50 45.9 Pastures 2,314,000 / 1 Yields for Ecuador are for 1973 and yields from S.A. are average for 1961-69. Source: FAO. Ecuador has about 2.5 million head of cattle of which one-third are for milk production and two-thirds for meat. From the 800,000 head of milk- producing cattle (mainly Holstein, Brown Swiss and their inbreeding with "criollos"), only 400,000 are estimated to be in production. Forest resources One half of Ecuador's area is covered with forests, one of the country's valuable natural resources. Tropical forests cover most of the northern and eastern regions. There are some coniferous species in the southern areas on the western slopes of the Andes which are now being s urveyed.  ANNEX 1 Page 4 The total production of roundwood has averaged 5 mil)-ion cubic meters yearly. Almost 60% of this total has been used as fuel. The remainder has been used for sawnwood, plywood and board. t4ost of the land is exploited through concession. Forest land is poorly managed, cutting selected trees with commercial value and leaving the rest without any care for the young trees; there is need for strengthening forest management services. Fisheries Rich fishing grounds abound off the coast of Ecuador, including the Galapagos Islands. The production of fish and shellfish was nearly 110,000 tons in 1972. Of this tonnage 9,000 tons were shrimps and 99,000 tons of fish that were sold fresh and used for canning and fish meal. The main varieties of fish caught off the Ecuadorian coast are sardines, tuna and mackerel, all valuable species for industrialization. II. AGRO-INDUSTRIAL FACILITIES A. Current Situation The 1973 Industrial Survey contains data on 316 agro-industrial plants with a total permanent employment of 20,352 persons, processing products based on agricultural raw materials (Table 3). This tabulation includes only plants with seven or more employees. Seasonal and field employment created by agro-industries is diffi- cult to calculate because it varies from one product to another. Estimates give relations ranging from 4 to 15 time direct employment depending on the industry. This would mean indirect employment from 80,000 to 300,000 people. The total output value and added value of agro-industries are US$304,692,000 and US$95,824,000 (Table 3). In relation to the totals of the industrial sector the percentages are 46.1% for output and 38.6% for added value (See Table 3). Principal products (a) Sugar There are 3 mills with capacities for processing over 5,000 tons of cane per day and five others with less than 1,000 tons capacity. The three larger plants have heen werking at over 80% of their installed capacity. In  ANNEX 1 Page 5 1973 total production reached 246,000 tons of sugar of which 27% (66,000 tons) were exported. The high value added reflects the integrated nature of these operations. (b) Edible Oil The factories are currently operating at an average of 55% of their installed capacity. The country has to import 62% of crude oil requirements (30,000 tons/year of the equivalent in seeds) to meet the domestic market requirements. (c) Wlood, pulp and paper Sawmills are not integrated installations and only 40% of the standing tree is used, the remainder being left in the woods; sawdust is discarded. The production of Kraft pulp from bagasse in one plant is used by the same manufacturer to produce liner paper. The output of this machine is around 12,000 tons/year, used mainly for multiwall sugar bags. 1/ Ecuador is currently importing some 100,000 tons of cardboard only for banana boxes, and by the end of this decade its requirements for this use alone is expected to amount to 150,000 tons/year. (d) Canned and frozen fish, shellfish and fish meal In 1972, 46,000 tons of sea products were consumed in Ecuador; 3,000 tons of shrimps and 6,000 tons of tuna were exported frozen. Canned sardines and tuna were also exported, amounting to the 17% of the value of the fisheries' exports. Fishmeal is a recent development and only limited production is currently undertaken. (e) Banana flour There is one plant producing banana flour with a capacity of nearly 10,000 tons a year. The product is used as animal fodder, having a protein content between 50-55%. Small amounts have been exported to Europe. 1/ This plant also uses cardboard scrap obtained from banana box manufacturing.  ANNEX 1 Page 6 (f) Cocoa derivatives There are six plants obtaining cocoa derivatives. The installed capacity exceeds the actual production of cocoa beans. Industry is exporting semi-finished products such as cocoa liquor, cocoa butter and cocoa powder. J. Problems in expansion of agro-industries Marketing With the exception of farms owned by the processors (e.g. sugar) or those involved in the traditional export-oriented activities (e.g. bananas and cocoa) a general weakness of agriculture lies in inadequate marketing of the different crops. Most agro-industrial companies do not establish any contractual relationship with farmers regarding prices or quantities to be purchased. In addition, these enterprises as a rule do not give any sort of technical assistance to their suppliers. Moreover, producers are reluctant to join in cooperatives and similar organizations, that could help to solve marketing problems. Another factor is the lack of cold storage and the small capacity of grain silos and warehouses presented by the country. This weakness creates a problem in the flow of the main supplies to the existing agro- industries. Similarly, the lack of sufficient and properly maintained roads throughout the country forces the industries to use only the raw materials available within a relatively small radius, especially if their inputs are perishable. Current price policies 1/ The price of most agricultural products are set by the Superinten- dencia de Precios, an independent body; in most cases these are designed to keep prices low to consumers and, as a consequence, have often discouraged expansion of production. One example is sugar; at the time of the mission's visit the internal price was set at US$5.45 per 100 lbs., about a third of the prevailing pr,ice in the world market. The domestic price was recently raised to US$8.80 per 100 lbs. but still well below world market prices at that time. 1/ See also the discussion in Chapter II of the text of the report.  ANNEX 1 Page 7 Since total production exceeds local demand, the Government estimates the available exportable surplus and fixes an export quota for each enterprise, in proportion to its share in total output in the previous year. There is little incentive for any firm to expand output for export since that increment would be shared by all producers. One effect of this system is to encourage the use of sugar in the manufacture of products which are not subject to price control. Similarly, prices of construction plywood have been fixed and are well below export prices. In spite of the obvious difficulties in transport of these items, there nevertheless appears to have developed a substantial contraband trade with neighboring countries. In the case of milk, domestic prices are also set at relatively low levels discouraging output expansion. Recently, dairies were forced to import large quantities of relatively low-priced dry milk powder in order to increase their output for sale in local markets. On the other hand, prices for certain non-traditional agriculture items have been set above world market levels. In the case of oil seeds, for example, these have been set relatively high but, at the same time, the ceiling on the processed oil has been fixed at a low level. As a consequence, processors favor importing either seeds or crude oils. Current promotional efforts The country has an experienced agricultural research organization in INIAP (Instituto de Investigacion Agropecuario). With its programs, the Institute covers most of the main crops of the country, including the raw materials for agro-industries. However, the results of research and acquired foreign technology do not reach the farmer. The Agriculture Ministry is trying to organize an extension service for this purpose. Sector studies and individual projects are prepared in their different stages by the Ministry of Agriculture, the regional organizations, CENDES and CV-CFN, the latter also having the possibility of promoting and financing projects,. FONAPRE, another official agency, also finances feasibility studies. The number of agencies involved in studying and promoting new projects appears to be excessive and results in an ineffi- cient use of qualified human resources which are scarce in the country. The agencies mentioned above need to arrange a better division of labor.  ANNEX 1 Page 8 The Government, through the Ministry of Agriculture, has estab- lished lists of priorities for agricultural products. First priority has been given to: rice, corn, oilseeds, wheat, barley, bananas, beans, coffee, cocoa, cotton and sugarcane; industries based on these items will have full support from the Ministry's services. III. POTENTIAL PROJECTS AND LINES OF DEVELOPMENT A. Existing Pipeline With relatively underutilized cultivable land resources and with growth in domestic incomes, there has been considerable interest in the devel- opment of a number of agro-industries primarily oriented toward the internal market. These have included slaughterhouses and tanneries, dairies, small fruit and vegetable canning installations (and, indirectly connected to this problem, cold storage facilities), as well as some industrial items such as corn starch and processed wood. There are also some proposals for export- oriented items such as fish canning, castor bean processing and citrus processing. The two long-term financial intermediaries, CV-CFN and COFIEC, already have in their pipeline a relatively large number of small plants (or expansions of existing plants) in these categories. Percentage of Total Projects Agro-industries agro-industry Amount US$ Amount US$ No. millions No. millions No. Amount COFIEC 39 14.5 9 4.5 23.1 31.0 CV-CFN 14 17.7 8 5.9 57.1 33.3 B. Product lines for further development In the following paragraphs, brief descriptions are provided o, various agro-industrial possibilities which are either in the formt of proj- ects presented to the financial intermediaries fnr implementation or exist only as general proposals or pre-feasibilitv studies. Emphasis is given to those products which have export potentiaL.  ANNEX 1 Page 9 Livestock Cattle raising for beef production is primarily located in the Costa but there are programs to expand this activity in the newly opened areas of the Oriente. Existing slaughterhouses and meat packing facilities are limited and a limited number of new slaughterhouse projects have been proposed; some of these are in the pipeplines of the financial intermediaries. The industry is at present essentially domestic-market oriented. Processed meat exports to the Andean Group benefit from the special liberalization program extended to both Bolivia and Ecuador. This trade has grown relatively quickly but is still small in actual value; there is substantial trade with Peru in live animals, however. Prospects for further growth in processed meat trade with the Andean area appear good; there also appear to be excellent prospects for these exports to other neighboring countries, particularly in the Caribbean. Dairy production is concentrated in the Sierra. As in the case of meat products, Ecuador has benefited from the special liberaliza- tion of trade in these items within the Andean Group and has increased substantially cheese exports in recent years. As noted earlier in this annex, the main problem in expanding dairy output has been the relatively low fixed price set on milk. Processed Fruits and Vegetables Many citrus and tropical fruits (e.g. pineapple and babaco) are being cultivated in the Coastal areas; lack of cold storage facilities is one of the major factors limiting processing for export. A foreign firm has begun construction of a vegetable and fruit canning plant in Esmeraldas province with output primarily for export. Substantial expansion of this type of activity appears possible but a major effort would be required to organize production of appropriate types for processing and to phase cultivation to permit efficient use of processing facilities. Proposals for pineapple, orange and tomato canning have been presented to the finan- cial intermediaries. Vegetable processing in the Sierras also offers excellent possi- bilities. Preliminary studies have already been undertaken of dehydration of onion and garlic, high value crops for export which can provide important new income sources for farmers in these areas; no firm project proposal has been prepared, however.  ANNEX 1 Page 10 Fisheries Some preliminary FAO estimates of the potential annual fish catch indicate possibilities of more than doubling the actual production, particularly of tuna and sardines the processing of which can generate considerable employ- ment. 1/ There is need to pursue these studies to determine investment poten- tial. In the meantime, however, a number of projects have been presented to the financial intermediaries which would involve export-oriented processing plants for sardines in particular. Sugar While policy problems discussed above have tended to constrain sugar expansion, there is substantial scope for increasing output. IFC has recently joined with other lenders to finance an expansion of the San Carlos complex, the largest in the country, involving both modernization and new capacity. The recent increase in the domestic price has been instrumental in making the project financially viable. In addition, under the auspices of the regional organization of Esmeraldas province, a private company is being formed to set up a large scale sugar refinery using land now largely under pasture. Foreign financing is being sought for this project. In the case of the activities of the regional organization in the Guayas (CEDEGE), a number of its irrigation and cultivation expansion schemes anticipate sugar cane as a likely crop for cultivation but these are still in the planning stages. Appropriate price policy, however, is critical to financial viability of these ventures. Banana flour CENDES has undertaken a study of large scale installation to produce banana flour for export as animal foodstuff. The project is of special interest as it can offer employment to over 10,000 people (includ- ing farm workers). Moreover, it uses as raw material a well known crop and could le'ad to development of an area which has had limited growth recently. The province of Esmeraldas (in the northwest area of the country) had been the principal banana growing area but the crop was subject to infestation; moreover, the development of the ports in the southern areas of the country in the late 1950's and 1960's and the introduction of new varieties made it more economical to grow bananas for export in the southern area closer to those facilities. 1/ Fishmeal production, on the other hand, is highly capital intensive.  ANNEX I Page 11 At the present time, the only alternative use of the banana growing land in the province is as cattle pasture. Further development of banana cultivation for human consumption is limited by external market conditions. However, the production problems in the fishmeal industry may provide banana flour the opportunity of having a good market. Moreover in the longer- run with general prospects for increasing meat production, further expansion of demand for animal foodstuffs can be expected. A comparison of the pro- duction value per hectare between cattle and bananas for meal has been calculated under the following assumptions: (a) Banana-meal present price: US$250/ton; (b) Relation of raw material to meal: 5 to 1; (c) Price of bananas to the farmer calculated as 10% of selling price of the flour (same relation used for fish meal); (d) Yield of bananas: 20 ton/ha; (e) Animals per ha.: 1; (f) Extraction per year: 30% over the cattle stock; (g) Price of meat: US$1,200 per ton; (h) Weight per animal, slaughtered: 400 Kg. Product Yearly pro- Price per ton Gross income per duction - US$ ha. - US$ Ton/ha. Banana 20 25 1/ 500 Beef 0.120 1200 144 This calculation does not include the investment cost. Production can be obtained from cattle on the third year and in bananas the same year of plan- tation. 1/ Bananas for human consumption sell at about $100/ton, ex-plantation.  ANNEX i Page 12 While this calculation only refers to gross revenue and does not include costs, it does suggest a substantially more favorable return to banana cultivation. MIoreover, employment generation is much larger in this type of activity than in cattle growing. However, before further exploratory work on the project can be undertaken, it will be necessary to continue with experimentation on the technical processes to maximize extraction of the edible portion of the baniana (in particular, protein content). Forest Product Development The recent growth of construction activity, as noted in the main text, had led to substantial expansion in wood industries supplying items for that purpose such as sawnwood and plywood. Additional projects for con- struction items based on forestry resources are also in the pipelines of the financial intermediaries, including pressed wood boards and wood for furniture. The largest project proposals in this area, however, are designed to substitute local production for a major portion of the imported paper and board materials required for banana boxes. As noted earlier, the country currently imports almost 100,000 tons/year of these items and expects to require some 150,000 tons by 1980. With UNDP financing and the Bank as executing agency, a study examining industrial exploitation of forest resour- ces in Esmeraldas province (Cayapas) has been prepared; the raw material would be the local relatively long-fibered hardwood species. The main recommendation of the study is for the construction of a sawmill operation (190,000 cubic meters/year) with a pulping facility and paper machine to provide 50,000 tons/year of corrugating medium; total capital costs were estimated at $57 million at prices prevailing in the first quarter of 1974. At a later stage, facilities would be added to produce 115,000 tons/year of linerboard. 1/ Further testings of the wood for pulping characteristics were also recommended, particularly to determine suitability for the liner- board production. At the same time, pre-feasibility studies have been undertaken by other government agencies of a proposal to produce 55,000 tons/year of pulp 1/ There would be no requirement for imported pulp for corrugated medium but it would still be necessary to import long-fiber chemical pulp (some 35 to 50%) to mix with the local pulp if linerboard were to be manufactured locally. At a later date, however, long-fiber pulp could be made from plantation pine.  ANNEX 1 Page 13 from bagasse which, combined with imported long-fibered pulp, would be used to produce 44,000 tons/year of corrugating medium and 66,000 tons/year of linerboard. Total capital costs were estimated at $37 million, presumably in 1973 prices. The company organized to implement the Cayapas project, a mixed venture including the private sector and CV-CFN, has recently decided to implement the recommendations of the feasibility study in stages. The first stage will include the sawmill operation plus a plywood mill; at a later stage, the corrugated medium plant will be added. Given the current market for this product, the potential foreign exchange savings, and the employment benefits which could occur from the Cayapas project, (both direct employment in the mill [around 1,000 for the plant including only corrugating medium] as well as indirect employment in forest management and logging) there is need to accelerate implementation It is likely that the difficulties in mobilizing equity capital as a result of discriminatory tax treatment (examined in the main text of this report) may be a factor favoring the staged approach of the promoting company. In addition, the possible competition from the bagasse project, which would most likely be located nearer the banana box manufacturer in Guayas, may tend to defer quick implementation. In these circumstances, it would be prudent for the agencies involved to consider other possible paper uses for bagasse pulp, (e.g. industrial and tissue papers). It must also'be noted that a project of the size contemplated would have huge requirements for bagasse which would raise serious logistic problems; moreover given the real cost of energy, the actual bagasse surplus (i.e. available for uses other than for fuel) may be below those requirements. Other Non-food Products Considerable attention is being given to the production of castor oil, from processing of castor seeds, 1/ which has wide industrial uses and can form the basis for relatively large chemical complexes. A small project for this processing has been proposed for submission to the finan- cial agencies; it is believed that this would be both for exports and 1/ The country now exports substantial quantities of the seed with no additional processing.  ANNEX 1 Page 14 domestic markets to cover current needs for the oil (mainly soap products and related items). The Guayas regional organization has, however, been studying a major complex based on castor seeds to produce substantial quantities of castor oil for use in plastics manufacturing and other indus- trial chemicals. This type of project has been under consideration for a number of years but it has not been possible to implement it. There may be substantial export potential for this product as it can compete with some petrochemical-based products where prices have been rising recently. In addition, the pressed cake after oil extraction has use as either ferti- lizer or as aninal feed (providing a toxic residue is first removed). There are also some important industrial chemicals derived from corn which have been of interest. One corn-based product, sorbitol, has been assigned to Ecuador in the first stage of trade liberalization of the Andean Group; this item has wide industrial use including as a humidifying agent in packaged foods as well as in the manufacture of plastics. CENDES has prepared some pre-feasibility studies relating to this product but has not as yet been able to bring it to the point of financing. Another corn-based product which is of interest is starch, with substantial use in the manufacture of adhesives (e.g. for use in the assembly of banana cartons) as well as in textile finishing; in this case also it has not been possible to move the various project proposals to the implementing stage.  ANNEX 2 Page 1 FINANCIAL SYSTEM INTEREST AND REDISCOUNT RATES AS OF JULY 1975 (annual rates in percent) Before Since Jan. 75 Jan. 75 A. CREDIT RATES CHARGED BY CENTRAL BANK 1. Discount rate 8 8 2. Rediscount and other lending rates: a. To Commercial Banks Agricultural, fisheries and artisan credits (redisc.) 8 6 Industrial credits (redisc.) 8 7 Commercial credits (redisc.) 8 10 Special advances 5 7 Advances to cover reserve require- ments 10 12 b. To National Development Bank (BNF) and Cooperative Banks Rediscounts and advances: Agricultural, fisheries and artisan credits 1/ 4 3 Small-scale industry 2/ 7 3 Commercial credits 8 10 c. To Public Sector Finance Corporation Industrial rediscounts and advances - 7 Rediscounts FOPEX 3/ 4 d. To Private Sector Finance Corporation Rediscounts and advances 9 8 e. To Financial Institutions through Fondos Financieros General rediscounts 3 Rediscounts under Livestock Develop- ment Program 4/ - 7 f. To Private Individuals Direct credits and discounts 12 12 1/ Including rediscounts of credits to Empresa Nacional de Almacenamiento v Comercialization (ENAC). 2/ Regulation 755 of January 1975 set this rate at 4%; however, regulation 781 of July 1975 set it at 3% and extended it to Commercial Banks. 3/ Fondo de Promocion de Exportaciones. 4/ Including private Financieras.  ANNEX 2 Page 2 Before Since Jan. 75 Jan. 75 A. CREDIT RATES CHARGED BY CENTRAL BANK g. To Private Individuals through Fondos Financieros Agricultural, fisheries, artisans - 7 Industry for purchase of agricultural raw materials 7 Other industrial credit - 8 Advances for future exports 6 6 Reliquidation after export failure 12 12 h. To Public Sector Central Government 3 3 Others 5 5 1/ CHARGED BY COMMERCIAL BANKS Maximum rate on credits 12 12 Maximum rate overdrafts 8 8 CV-CFN through FOPEX 8 (max.) CV-CFN on rediscount of credits to small-scale and artisan industries: Commercial Banks 5 BNF 3 CHARGED BY NATIONAL DEVELOPMENT BANK AND COOPERATIVE BANKS Agricultural credit (max.) 8 9 Small-scale and artisan industries (max.) 10 9 Commercial credits (max.) 12 12 ENAC _ 4 2/ CHARGED UNDER FONDOS FINANCIEROS Credits under Livestock Development Program 3/ 12 Other lending operations 9 1, Inclutding private Financieras. 2 Cominercial and Developnmo-t Banks have access to this mechanism. X Lor credits of more than B/. 625,n00 (222-EC).  ANNEX 2 Page 3 Before Since Jan. 75 Jan. 75 B. DEPOSIT RATES Pass book savings Commercial Banks 6 6 Savings and Mortgage Banks 7 7 Deposits with Commercial Banks a) 31-180 days, maximum interest 7 7 b) 181-360 days, maximum interest 8 8 c) Over 360 days, maximum interest 9 9 Deposits with Savings and Mortgage Banks a) 31-180 days, maximum interest 8 8 b) 181-360 days, maximum interest 9 9 c) Over 360 days, maximum interest 10 10 Cedulas Hipotecarias, Government Bonds and other securities issued by stock companies 12 12  ANNEX 2 Page 4 B F 0 N D 0 S F I N A N C I E R 0 S i. The Fondos Financieros mechanism covers eight funds, six with local and two with foreign resources. The resources, purpose and special features of these funds are as follows: a) Fondo Financiero Agricola Resources: S/. 1,000 million Purpose: Short, semi-permanent and long-cycle crops as well as fertilizers., pesticides and herbicides. b) Fondo Financiero Ganadero Resources: S/. 180 million Purpose: Acquisition, feeding and slaughtering of cattle, hogs sheep and goats; acquisition and feeding of meat and egg producig poultry; feeds for the above; mineral salts and veterinary products; seeds, expansion and improvement of grazing land; and fertilizer, pesticides and herbicides. c) Fondo Financiero Agricola y Ganadero - Activos Fijos Resources: Special fund of the Federal Government Purpose: Territorial improvement; rural construction and installations; agricultural machinery and equipment; storage and other input distribution establishments; extension of services to improve productivity; acquisition of milk and meat reproduction cattle; and acquisition of feeder cattle. d) Fondo Financiero Industrial Resources: S/. 400 million Purpose: Working capital for up to S/. 4 million; Fixed assets for up to S/. 5 million. Borrower: Local industry and artisans with fixed assets not in excess of S/. 5 million, excluding land and buildings. Excluded: Soft drinks, alcoholic beverages, drugs, cosmetics, deodorants and similar products.  ANNEX 2 Page 5 e) Fondo Financiero Pesquero Resources: S/. 120 million Purpose: Working capital and fixed assets up to S/. 5 million. Borrower: Individual, company or corporation with fixed assets not in excess of S/. 5 million, excluding land and buildings. f) Fondo Financiero Turistico Resources: S/. 100 million Purpose: Working capital and fixed assets for touristic establishments, hotels and restaurants up to S/. 5 million. Borrower: Individuals or companies registered under the Tourist Development Law, whose fixed assets are not over S/. 2.5 million. g) Fondo Financiero-AID Loans 518-L-032, 033, 034 (i) Agricultural Enterpise Promotion Program. Resources: US$ 2.75 million Purpose: Working capital, fixed assets and marketing for up to S/. 3 million for individuals and companies and S/. 250,000 per member for cooperatives. Terms: Up to 10 years, including up to 3 years of grace. (ii) Agricultural Development and Diversification Program. Resources: US$5.96 million Purpose: Oleagenous, crops and cocoa production; marketing up to S/. 1.5 million for individuals and companies and S/. 300,000 per member for cooperatives. Terms: Up to 10 years, including up to 3 years of grace. (iii) Technical and Credit Assistance to Small Industry Program. Resources: US$4 million  ANNEX 2 Page 6 Purpose: Working capital and fixed assets of small industry, i.e. with fixed assets not in excess of S/. 5 million, excluding land and building. Each credit limited to S/. 750,000. Terms: Working capital up to 2 years, including 6 months of grace; fixed assets up to 6-7 years, including up to 2 years of grace. h) Fondo Financiero - IBRD Loan 222-EC Resources: US$8 million Free-Limit: S/. 2.5 million Purpose: Credit for meat cattle up to 12 years, including up to 5 years of grace; credit for milk cattle up to 9 years, including up to 3 years of grace. 2. The funds are used by the Central Bank to rediscount 80% of the value of eligible loans at 3%, except under IBRD loan 222-EC where for loans above S/. 625,000 the rediscount rate is 7%. The loans are made at a maximum of 9% (IBRD loan 222-EC, at 12%) for maximum possible terms which vary according to the nature of the project, as follows: - short-cycle crops - up to 360 days - semi-permanent crops - up to 5 years - long-cycle crops - up to 10 years - inputs, fattening and slaughtering of livestock and poultry - up to 2 years - working capital 1/ for artisan activity, small industry, fisheries and touristic services - up to 2 years - construction and acquisition of fixed assets - up to 7 years. 1/ Working capital includes any element of cost which finds its way into inventory; it does not include accounts receivable.  STATISTICAL APPENDIX Table 1 t ECUtADOR: ODP BY ECONCHIC ACTIVITIES - 1970-74 1970 1971 1972 1973 1974 (Millions of suores at 1970 prices) Agriculture -8,804 9,001 9,037 9,261 9,450 Mining 449 643 1,668 3,645 3,329 Manufacturing 5,713 6,204 6,657 7,176 8,012 Flectrioir, gas & water 418 441 459 466 479 ConstrUCtion 1,387 1,998 1,565 1,790 1,957 TrEde 3,2341 3,,457 3,555 41,099 5,634 Trasnsport & storAge 2,Q91 2,110 2,320 2,614 2,720 services 8,012 7,965 8,802 9,522 10,725 GDP at factor cost jo,108 3,3X822 34,063 38,573 42,306 As percent of GDP) Agriculture 29.3 28.3 26.5 24.0 22.3 Mining 1.5 2.0 4.9 9.4 7.9 Manufacturing 19.0 19.5 19.5 18.6 18.9 Electricity, gas & water 1.4 1.4 1.3 1.2 1.2 Construction 4.6 6.3 4.6 4.7 4.6 Trade 10.7 10.9 10.4 10.6 13.3 Transport & storage 6.9 6.6 6.8 6.8 6.4 Services 26.6 25.0 25.9 j247.7 2g4 TOTAL 100.0 100.0 100.0 100.0 100.0 Source: Ban _ataff e8t1_tmles, taken from Ecuador: Eoonomic Memorandum, Report No. 1033-EC, February 12, 1976.  STATISTICAL APPENDIX TABLE 2: ECUADOR - STRUCTURE OF INDUSTRIAL VALUE ADDED 1970, 1972, 1974 (as percent of total) Industrial Branches 1970 1972 1974 31 Food, beverages and tobacco 44.8 37.8 40.4 32 Textiles and clothing 13.3 16.5 15.8 33 -Wood and wood products (incl furniture) 3.1 3.6 3.4 34 Paper and printing 9.2 7.9 7.5 35 Chemicals and products 15.6 17.5 16.8 36 Non-metallic minerals 5.4 5.8 5.6 37 Basic metals 0.5 1.7 1.6 38 Metal products amd machinery 7.3 8.5 8.1 39 Other manufactured products 0.5 0.7 0.8 Total 100.0 100.0 100.0 Source: Mission estimates based on data from Indastrial Censuses and Central Bank; details may not add to totals due to rounding.  Table 3 : ECITADORz FACTCRY MANIFAC