Ecuador - Current economic position and prospects

- -~~~~W M RETURN TO: REPORTS DESK RESTRICTED WITHIN - JJ ('fl-R e p o r t N o. WH-74a ONE WEEK This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to- them for the accuac or completenes of the inorato cotane herein INTERNATIONAL BANK FO:R RECONSTRUCTION AND DEVELOPMENT THE CURRENT ECONOMIC POSITION AND PROSPECTS OF ECUADOR June 9, 1958 Department of Operations Western Hemisphere ~v.b ,/  CURRENCY EQUIVALENTS U.S. $ 1 S S/ 15.00 1/ S/ 1 U.S. $ 0.07 S/ 1,000,000 _ U.S. $67,000 1/ Official buying rate. The free market rate is currently (April 1-15, 1958) about U.S.$ - S/16.6  TABLE OF CWN\TEII'TS Page Basic Data i Summrary A I INTRODUCTIOIJ 1 II R?.ECEOK3T ECONOMIC DEVELO01'J1"TS 1 AND Pi?S)SPECTS The postwar decade 1 1955 - 1956 2 1957 and prospects 2 A. Agriculture 3 B. Industry 4 C. iMinerals 5 III M(NEY A\D RANKING 6 IV LJT3LC FIINAUCE 9 V CAPITAL FOENtiATION 11 VI TRADE AND EXTERNAL DEBT 13 Export prospects for 1965 14 External public debt 17 VII CREDIH.1ORTHIP7ESS 18 STATISTICAL APPEN\DIX 19  - i - BASIC DATA Area 102,000 square miles Population (1957 estimate) 3.9 million Average annual rate of increase (1950-1957) 3% Gross Niational Product, 1956 11.3 billion sucres S originating in agriculture (1956) 34h' % devoted to gross investment l62 Average annual rate of increase in real terms (1950-1056) 5 1/2% Cost of Livilng (1950 = 100) 115 (1957) Average armual rate of increase (1950-1957) 2% Mlillions of dollars Merchandise Exports, 1957 97 Bananas 32 Coffee 30 Cacao 19 Others 16 Exports as % of G.N.P. 12% Foreign Exchange ?.eserves of Central Bank at end of 197 7 Milillions of U.S. dollars 25.5 0 of 1957 sales of exchange by Central Bank 29% Public Finances Millicns of sucres Central Government revenues, 1957 1,180 As % of Gross National Product 10, Public sector revenues as "I of Gross National Product in 1955 20% Central Government expernditures, 1957 1,193 a for invrestment 12% External Public Debt (June 30, 1957) $74 million L957 service payments as % of 1957 exports 11%  - ii - SUTiRAl Y 1. Developments in the Ecuadorian economy since the last economic report was oresented in .July 1957 have not altered any of that report's basic ccnclusions. Bcuador's long term economic orospects remain good. The potential for substantial growth in agricultural production for export and for domestic consumntion remains impressive. Road investments now underwTay are expected to bring rich new lands into cultivation and by no means exhaust the potential for still further extensive agricultural development on the Pacific side of the Andes. Agricultural technology is gradually being improved. Efforts of the Government to coordinate agricultural development efforts and improve the agricultural credit sys- tem promise to contribute much to the continued deve'opment of this pri- mary area of economic activity. Spreading sigatoka disease, which threa- tened to undermine the basis of Ecuador's important banana industry, it now anpears is being brought successfully under control. Industry pro- mises to continue tc exo_and in pace with the domestic market which it now serves. On the negative side, minerals nrospects still remain cloudy. The production of netroleum, Ecuador's most important mineral resource, will probably begin to decline in a few years unless new reserves now believed to exist are found; yet exnloration activities are being reduced because of the level at which the Government continues to fix prices of liquid fuels. 2. The last report which was written shortly after the nresent Government took office noted that this Government inherited serious financial problems. The rost serious of these were oroduced b:r the liberal expenditure policies adopted by the preceding Government towards the end of its term when the rather bouyant years of rapidly expanding exports were coming to an end. These problems have been confronted firmly and with success. The 1l957 budgetary results indicate that the trend towards increasingly unbalanced budgets financed in part by recourse to the Central Bank has stopned. However, the Government will have to resolve rather serious budgetary oroblems now in prospect if exoenditures are not to exceed non-inflationary sources of financing by a wide margin once again. 3. The rate of public investment expenditures apmears to have fallen from the levels reached during the latter years of the last administration. A reduction of investment expenditures has been one of the ways in which the Central Government has restored order to its finances. But because of better allocation of funds, esuecially in transportation where Government expenditures are now concentrated on projects being fin- anced by the recent IBRD highway loan, the productivity of these expenditures is being raised substantially. The lower level of mon- etary outlays is thus unlikely to compromise the continued develonment of those basic resources upon which Ecuador's future expansion depends. Efforts to rationalize economic policy making and administration are also  - iii- continuing. The Government has extended for a second year the Special Economic 1Nission which was originally organized in February 1957 for one year. IWith the continued support of the Government, this Mission will by the end of its term have helped Ecuador revise its monetary and banking legislation and administration, reorgaraize its system of development banks, reorganize its tax ard budget adrninistration, and simplify its tax structure. 4. Ecuador1s external public debt increased substantially during the second half of 1957 mainly for well conceived projects. However, the heavy burden of debt service that Ecuador faces during the next few years reflects primarily previous increases in debt, much of which were suppLiers' and bank credits at relatively short term. 5. A moderate expansion in export earnings is in prospect, and Ecuador should be able to adjust to unforeseen reductions in the real value of exports. However, in view of the rigidity introduced in the balance of payments in the next few years by existing debt service obligations, new borrowing which would offset the scheduled decline in service payments should be undertaken only for demonstrably produc- tive projects whose results would contribute to the balanced growth of the Ecuadorian economy.  PART I - INTRODUCTION 6. The last economic report on Ecuador was presented onJuly29, 1957 (WH 58-a). The structural characteristics and growth prospects of the Ecuadorian economy as described in that report remain substantially uncharged. The report?'s appraisal of the prospects for good economic and financial policies, made on the basis of only several months' per- formarce of a new Goverrment, has largely been confirmed by events. The most pressing of the problems that faced the new Government have been confronted with vigour and success. NeIwe and substantial problems remain to be resolved during the Government's remaining two and one half year's of office, but on the basis of performance to date the prospects for continued sound policies remains good. PAhRT II - RECEINT ECONCHIC DNOMOpNTIZNS A1D PROSPECTS The Postwar Decade 7. The years since World War II have been rather good years for Ecuador: real incomes increased sufficiently to provide for substantial improvement in the stanclard of living of a population that has been growing at the rapid rate of about 3% each year. This growth in income appears to have taken place in all sectors of the Ecuadorian economy: agriculture, industry, commerce and services have all expanded. But agriculture still remains the principal economic activity, from which one-third of the national income originates. 8. Economic growth has not been even. In some years Ecuador's real income increased by well over 10% while in other years it barely in- creased by 1%. But yeal to year fluctuations in the fortunes of an economy such as Ecuador's are not surprising. Ecuador is predominantly agricultural, her export;s consist almost exclusively of primary agricul- tural products, and the economy is therefore subject to all the vicissi- tudes of sharp fluctuations in crops and in export markets. What is important, looking back over the postwar years, is that these fluctua- tions have occurred about a trend of fairly rapid growth. With the help of improving terms of trade, real income are estimated to have increased by some 7% per annum over the decade since the war. In volume the production of goods and services is estimated to have increased by over 5% per year on the average during 1950-1956.  9. 'Much of Ecuador's postw,zar expansion has reflected the series of world market developments which have been favorable to Ecuador's exports during this period. The increased level of rice exports during 1946-48 owed its origins to the difficulties of increasing rice production in Asia immediately after the war. The banana era began when production problems in Central America, originating in part from neglect of plantations during the war, caused that region's exports to the United States to decline sharply. Ecuador filled this gap. Coffee and cacao exipansion was stimulated by postwar world price improvements which were substantial, not only by comparison with prices for those same products before ancd during the war, but also by comparison with the increase in the general level of prices during this period. The rice boom was brief, but expansion in other crops has been such that Ecuador has for several years been the wJorld's first banana exporter and that bananas, cacao and coffee-with bananas leading--now produce 90% of Ecuadorts exchange earnings from exports. 1955 - 1956 10. Beginning about l955, the cumulative expansionary effect of these favorable external factors began to weaken. The previous very large year-to-year increases in banana production began to level off. The expansion of cacao and coffee production continued as recently planted trees came into production but there were offsetting movements in prices. Ecuador may thus be said to have entered a newJ period in its postwar pattern of economic expansion about this time. Export earnings in 1955 and in 1956 were lower than in 1954. Since export earnings are pivotal to Ecuadorian expansion, these developments produced the strains that might have been expected to result from a tendency of the export sector to shrink relative to the econony as a whole. Fiscal strains developed both because budgetary revenues are in large part derived from taxes on foreign trade and because the public investment effort continued to increase. Recourse to debt for financing public investments increased sharply. Foreign exchange reserves fell sharply in 1955. The pressures on the external position and on the public finances were further exag- gerated by what appear in retrospect to have been unfortunate changes in the tariff law in 1954. 1957 and Prospects 11. Developments during 1957, as reported below, suggest that the readjustment problems which began so sharply in 1955 are being iego- tiated successfully. Though broad sectors of the Ecuadorian population will for years undoubtedly continue to live at subsistence levels outside the monetary econonmy, the prospects for continued if not spec- tacular growth within the expanding commercially integrated parts of Ecuador remain good. There is still abundant basis through better use of present lands, opening new lands and improving technology for expand- ing substantially thle variety and volume of agricultural production both for export and for domestic consumption, and for a continuation of the current expansion of industry.  A. Agriculture / 12. The last economic: report indicated that recent agricultural expansion would probably continue and provide both for an increasing volume of exports and for an increase in food production at least large enough to kcop pace with growing domestic consumption. This prospect has not changed. With road development and steady migration from the Sierra to the Costa, the extensive agricultural deielopment of the coastal area should continue. Only a small fraction of the rich culti- vable land on the coast has as yet been brought under cultivation. Agricultural -productivity should also increase. The continued efforts of the various crop institutes; the plans of the Ministry of Development, neTwly form,ed early in 19585, to improve agricultural extension services and establish agricultwral schools at the primarxy level; and the spreading network of "h--F" clubs patterned after the 4-H clubs of the United States-these should all help accelerate the acceptance of improved techniques both in the coast and the Sierra, though the gains from opening new areas will probably remain the principal source of agricul- tural development for many years. 13. The problem of agricultural technique has recently been most serious in bananas. Because of Spreading sigatoka disease, the amount and quality of exportable stems produced per hectare has been falling on most northern and central farms. Average yields and quality have been maintained by the continued opening of new plantations which are fertile and disease-free during the first years of production and by the good practices of the large established plantations on wThich some two-fifths of the exportable bananas are grown. WiJith bananas producing one-third of Ecuador's exchange earnings from exports and providing employment for many thousands of coastal farmers, the repercussions of a rapid disintegration of the banana industry would be serious indeed. However, the wide scale program to control sigatoka, which was only in prospect a year ago, is now underway. Private companies providing helicopters and airplanes under contract to producers, largely at the producerst expense, are working full time spraying about half of the plantations producing bananas for exports. Additional banana land is being treated by ground control equipment. Furthermore, the principal exporters have agreed with the Government not to buy infected barianas. The control of sigatoka is thus expected to insure the continued pro- duction for export of high quality bananas at present volume from these lands. WTith new lands being opened up and with the spreading use of fertilizers and better farm techniques, good quality banana production should continue to increase at least as fast as export markets permit. 14. The shortage of medium and long term credit for farm improvement and development, which was mentioned in the last report as a major weakness in the agricultural development picture, still continues, even though P.L. 480 ftnds amounting to P3 to ;: million will have been made available for agricultural development credits through the Sistema de Bancos de Fomento from U.S. surplus commodities sold to Ecuador in L/ See Tables 6 - 10.  -4 - 1956 and 1957. But there are prospects for improvement here, too. The Government is actively considering a thorough reorganization of the now insolvent Sistema de Bancos de Fomento along the lines recommended by Mr. Curran's Special Economic Mission. This is clearly a task of first priorityr whose results could inrfluence substcrntially the rate and direction of future growth in Ecuadorian agriculture. 15. Improvement may also be forthcormLing in various other aspects of agricultural development policy. The new Ilinistry of Development hopes to coordinate closely the lending activities of the syistem of de- velopment banks, w,ihen reorganized and the research and extension services of the various national and international bodies which now operate rather indepe-ndently0 Another of the Ilinistryls goals is -to consolidate muni- cipal commodity taxes, centralize their collection, and thereby eliminate their present tendency to divide local markets and inhibit production. At a more fundamental level, the Planning Board is now reviewing agri- cultural land laws and taxes with a view to developing a new agricul- tural law. Well-conceived legislation in this field, coupled with a well-directed agricultural credit program, would do much to insure the fuller use of existing lands and the proper development of new lands now being opened up by road development throughout the country. All these changes are unlikely to materialize immediately. Other needed changes in the field of price and trade controls, which now have the effect of providing disincentives rather than encouragement in increasing the quality and quantity of production of particular products, have yet to be initiated. But on balance, the changes that are in sight are in the right direction, and their combined effect on the volume and quality of agricultural production could be considerable. B. Industry 2/ 16. With the excepticn of petroleum, iwfhich is discussed in the following section, there has been no basic change in the industrial picture since the last economic report was written. Food and drinks, petroleum and textiles continue to account for the bulk of Ecuadorian industrial activity. This limited complex of industries has been expanding in pace with the domestic market for which it produces. The share of the national income originating each year in industry has remained a constant 16-17% during 1950-1956. The prospects are for con- tinued expansion of industry at least to keep pace iwith the growing demand for processed foods and drinks, clothing and textiles, and con- struction and other materials. The basic elements for continued expan- sion are being laid. Electric power production for industry increased during 1950-1956 at a rateequivalent to over 15% each year; increases in electric power capacity now planned should permit power production to increase at a comparable rate during the next years. Cement produc- tion increased at a similar rate during this period; here, too, recent increases in capacity should permit continued expansion as demand grows. j See Tables 5, 11-13.  - 5 - 17. To stimulate industrial growth even further the Government enacted an industrial development law in June 1957. This law is intended to encourage industries that process domestic raw materials, replace imports, and promise to increase exports without requiring corresponding increases in imports. It offers to approved applicants the financial incentives of accelerated depreciation and selective reductions in or exemptions from import duties and local taxes. It is still too early to appraise the effects of this law. But on the basis of applications submitted during 1957 it would appear that the present emphasis of Ecuadorian industry on consumers' manufactures and its dependence on importedequipment and raw materials is unlikely to change soon. Though most of the new industrial projects under develop- ment or in sight will be import-substituting at the final product stage --paper, synthetic fibre textiles, rubber tires, powdered milk, plastic wrapping materials, edible oils, brewery malt, tinned fish, etc.--most of the activities other than in foods and drinks are based at least in their initial stages on imported materials. With a limited market, the possiblities of large scale import substitution are limited. C. Iinerals 3 18. The minerals pictJure continues rather poor. The production of minerals other than petroleum--mainly -old, silver, lead and copper-- has been decreasing, and the prospects are for continued decline. Some feel that with extended geological surveys these prospects may change. First steps are now being taken to obtain basic geological information about those areas in which there are indications of minerals deposits. A U.N. geologist is now working in the field, and additional surveys are expected to begin soon. But some time will pass before the Govern- ment can obtain firm iniformation about the quantity and quality of even those few minerals deposits which are known to exist. At the moment, there is nIo basis for expecting any fundamental changes in the present picture. 19. As for petroleum, the only mineral resource of importance, the prospects remain cloudy. Total production has been increasing only very slowly in recent years and, without new discoveries, is not expected t;o increase further. Productivity in the oil fields has been declining steadily year by year. Though the total number of wells in production increased by 60% between 1951 and 1956, each well in produc- tion produced 20% less crude oil on the average in 1956 than in 1951. The productivity of many old wells has been increased recently by the successful application of secondary recovery methods (sandfracing), but this is expected at best only to delay an inevitable decline in produc- tion unless new reserves believed to exist deeper underground can be found and tapped successfully. 2 See Tables 14-16.  -6- 20. 1Wfith these production prospects, Ecuador is certain to become a consistently increasing net importer of petroleum products. Because of the rapid expansion of roads and motor vehicle traffic and the parallel exparnsion of electric power production, half of which is ther- mal, the consunmption of gasoline and diesel oil has been expanding by some 13'.1 each year and is expected to continue to -.ncrease by at least 1060 per annum during the next few years. Imports currently provide about one-third of the country's requirements of these petroleum products. In recent years the foreign exchange cost of these imports has been offset by earnings from exports of crude oil which the local refineries could not process. Through 1953 the pattern was for exports of crude oil to exceed imports of refinery proclucts by a small margin. But this surplus has since disappeared. In 1956 Ecuadcr's net petroleum deficit approached 02 miillion. With no changes in the present pic- ture it should approximate .$6 million by 1961. 21. The last economic report indicated that this picture would change when Anglo-Ecuadorian's refinery comes into production in 1958. It would double Ecuador's refinery capacity and eliminate for some time the need to import refinery products. IHowever, because Ecuador's petroleum product price problem has still not been resolved, Anglo- Ecuadorian stopped work on its refinery in March and will not resume construction until a new scale of liquid fuels prices adequate to make its operations remunerative are put into effect. According to the Company it has been losing money on all its domestic operations, and has been able to operate! without overall losses only because of profits earned on exports of crude petroleum. Once the new refinery comes into operation the exportable surplus of crude oil, and thus the company's net earnings at present fixed sale prices, would disappear. 22. Because of its increasing ur-ency the petroleum problem was discussed at length during the last Congress and is now under study by a special commission. But no decision about prices has yet (April 1958) been reached. How gasoline import subsidies that were formerly paid by Anglo-Lcuadorian will be financed while the present scale of prices for domestic sale continues also remains undetermined. 23. Even if the refinery does go on stream this year, in the absence of new petroleum discoveries it will delay but not alter the tendency of Ecuador to become increasingly dependent on imported fuels. The oil industry estimates that with the refinery Ecuador will by 1961 have to import some 700,000 U.S. barrels of crude oil annually at a cost of about ,2 million. Only new discoveries can prevent Ecuador's petroleum deficits from continuing to grow. This prospect makes even more urgent an early resolution of the price problem. W'ithout price changes planned exploration expenditures will be cut and the possibilities of finding new fields of oil thereby reduced. PART III - MIONE-Y AND PA ,CING 24. Ecuador's recent monetary history has on the whole been fairly good. The money supply has been increasing broadly in step with  - 7 - increases in the real national product. Domestic prices have increased less than import prices- the cost of living index was only 15?o higher in 1957 than in 1950. The free market dollar price for the sucre was higher at the end of 1957 than at any corresponding date in the last decade. Judged by its results, the pattern of moretary expansion has on balance been successful in helping to provide a stable financial environment for Ecuador's economic grouth. 25. This pattern has not been an even one. In addition to reflecting clear two year cycles of export growth, monetary developments during the past few years have also reflected expansionary pressures from the B3ancos de Foriento and from the Government. Through 1955 Central Panik "on tap" lending to the Bancos de Fomento provided funds for over ti-o-thirds of the Barcos new lending. Central Pank lending to the public sector increased very sharply during the closing years of the last aciministra- tion: more than half of the Central CGovernment's substantial increase in internal debt during 1955 and 1956 comprised new borrowing directly or indirectly from the Central Bank. iowever, these expansionary pres- sures, which were reviewzed in the last report and which led to a 14,, increase in the money supply during 1956, have now largely disappeared. Central Bank loans to the Bancos de Fomento and to the public sector both declined in 1957. During 1957 the money supply increased by only 4%., foreign exchange reserves continued to increase slowly, and price stability was maintaine(d. Percent increase during year 1950 1951 1952 1953 1954 1955 1956 1957 Money supply 29 -8 24 3 17 -6 14 4 Exports (sucre value) 105 -3 43 -7 36 -13 6 4 Source: I.MJ,F, International Finance Statistics, Central Bank. 26. :'lith the impending reorganization of the Sistema de Bancos de Fomento and the Government's success to date in restoring order to its finances, similar pressures for monetary expansion should not recur during the Government's remaining two and one half years of office. But the possibility of renewed financial pressures cannot be ruled out. Substantial new demands for Central 3ank financing could arise if the Government does not resolve the serious budgetary problems it faces in 1959 (see para