Ecuador - Current economic position and prospects

RETURN TO F S REPORTS DESK rl E C0PY RESTRICTED WITHI+N Report No. WH-181a ONE WEEK This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION CURRENT ECONOMIC POSITION AND PROSPECTS IN ECUADOR June 4, 1968 Western Hemisphere Departmerit  CURRENCY EQUIVALENTS Official Rate US$1. 00 = Sucres 18. 18 (S/) S/ 1.00 = US$0.055 S/ 1 million US$55,000 Free Rate (Average for 1967) US$1.00 = S/20.19 S/1.00 - US$0.0495  TABLE OF CONTENTS Pag,e No. BASIC DATA .............................. i - iii SUMMARY AND CONCLUSIONS ................. i I. BACKGROUND .................... 1 II. BALANCE OF PAYTENTS AND ECONOMIC GROWTH ............... 3 III. MONETARY POLICY AND PIIBLIC FINANCES ... ........... . 10 IV. EXTERNAL FINANCING AND CREDITWORTHINESS .............. 16 TABLES MAP This report is based on the findings of a mission to Ecuador in January-February 1968 composed of Messrs. M. Ballesteros and T. daCosta.  ECUADOR BASIC DATA Area: 102,000 square miles Population (June 1967) Est.: 5,508,ooo Rate of growth (1960-67): 3.4 percent Density per square mile: 55 Gross Domestic Product: (1967 market prices) 25.,044 million sucres National Income: (1967 factor cost) 21,031 million sucres Real rate of' GDP growth (percent) 1950-55 5.4 1955-60 4.6 1960-65 4.2 1965-67 (estimate) 5.1 1/ Per Capita GDP Market Prices (1967): US$244 1/ Per Capita National Income - (1967): US$205 Gross Domestic Product (1967 at current prices) 22,940 million at Factor Cost: sucres (1966 at current prices) 20,950 million sucres Average 1965-66 of which % Agriculture, forestry and fishing 34-4 Manufacturing 17.5 Construction 4.4 Public utilities 1.5 Percent of GDP (Market Prices): 1966 1955-66 Gross Investment 13.1 14.5 Gross Savings 11.8 13.1 Balance of Payments )13 1 4 Current Deficit ) Investment Income Payments 2.3 2.8 Central Government Current Revenues 8.7 (1967) 7.7 (1962-67) Public Sector Current Revenues 21.9 (1967) 21.0 (1955-67)  Relationship to Large Monetary or Custcms Area: Member of IAFTA, and Andean sub-region Money and Banking: (Million Sucres at Year-End) 1967 1966 1962-67 (Rate of Change per cent) Total Money Supply 3,281 3,005 10.4 Time and Savings Deposits 907 800 16.0 Commercial Bank Credit to Private Sector 3,376 2,849 8.8 Rate of Change of Prices (1966) 5.1 (1962-66) 3.2 Public Sector Operations: (Millions Sucres) 1962-67 (Rate of Change %) 1967 At Constant Prices Central Government Current Revenues 2,192 9.8 Central Government Current Expenditures 1,866 5.3 Current Account Surplus 326 Central Government Capital Expenditures 430 5.7 Public Sector Investment Expenditures 1,179 5.4 (1962-66) Total External Assistance to Public Sector 550 7.7 External Public Debt (US$): 1962 1967 Total Debt 107 217 (June 1967) Total Annual Debt Service 12 12 Debt Service Ratio 2/ 8 percent 6 percent Balance of Payments (US$): 1967 1962-67 (Rate of Change %) Total Exports 206 6.7 Total Imports 175 9.3 Net Invisibles -54 6.7 Current Account Balance -23 2.8 Commodity Concentration of Exports as Percentage of Total Exports Bananas (1966) 56 57 Coffee 19 16 Cacao 12 11  - iii - Gross Foreign Exchange Reserves: End 1967 1962-67 (Average) 69.1 53.8 (or 4.7 months (or 3.8 months imports) imports) 3/ External Financial Assistance (US$ Million) 1967 1962-67 Commitments 38e1 238.0 Disbursements 30rO 95.7 1/ Rate of exchange is weighted average of official and free market rates. 2/ Debt service at June 1967 as percentage of goods exports 1967. 3/ Excludes assistance obtained direct by non-government sector.  SUIlARY AND CONCLUSION1S 1. Ecuador has a population of 5.5 million, with an income per head of $205, placing it among the poorer countries of the Western Hemisphere. The rate of population growth averages 3.4 percent a year as a result primarily of a 25 percent decline in the death rate during the past decade. At 55 per sq. mile population density is nevertheless still relatively low. The Government is studying the question of population growth. 2. The rate of economic growth averaged 4.5 percent during the past decade. The main stimulus of growth was the development of exports, pri- marily of bananas. However, domestically oriented activities, namely manu- facturing, construction and public utilities, also grew rapidly in this period, increasing their relative share of GDP from 20 to 24 percent. Incentives for industrial development were strengthened in 1963, stimulating import substitution industries by protective measures. Further development of this kind is limited by the amnal scale of the domestic market. 3. Short-term monetary and balance of payment management has been generally sound. The rate of increase of domestic prices has averaged less than 3 percent in the past decade, and net exchange reserves have usually been maintained at the equivalent of 3-months' imports. A deviation from this traditional equilibrium in 1965 was corrected in 1966 by appropriate measures of fiscal and monetary policy. 4. While the prospects for continued adequate performance in the next two to three years are good, given political stability, the balance of payments and fiscal outlook point to the need to adopt additional measures in the pursuit of objectives given priority by the authorities. In view of the uncertain prospects for Ecuador's main exports, particularly bananas, diversification is receiving considerable attention from the Government. Promising new ventures are in preparation in the fields of fisheries, live- stock, oilseeds and forestry. In this connection, it may be advisable for the authorities to review the present dual exchange rate structure, which gives much of banana exports the opportunity of converting sale proceeds at the free market rate, presently 22 percent higher than the official rate. Unification of the exchange rate would improve the incentives for exports other than bananas, by eliminating the comparative advantage that bananas derive from the sale of a large proportion of exchange earnings through the free market. Assuming that unification takes place at or about the present free market rate, all exports would receive a substantial incentive, while at the same time the incentive for bananas would be comparatively reduced. There is also need to restrain the growth of current expenditures of the public sector. This is necessary in order to generate sufficient domestic resources for the expanded public investment effort contemplated without any significant increase in the overall ratio of taxation, which, at 16.5 percent of GDP, is already relatively high. 5. Ecuador's economic performance may be judged reasonably satis- factory, and the country is considered by the mission to be creditworthy for additional external lending. However, Ecuador is also a country which faces difficult and prolonged problems of adjustment arising out of the uncertain market prospects for its principal export crop. It is also a country with a rather low average per capita income where much of the population is living in conditions of extreme poverty. These consi- derations warrant concessional terms for part of the external assistance which Ecuador receives.  I. BACKGROUND 1. With a population of 5.5 million and a national income per head of US$205 Ecuador is one of the poorer countries in the Western Hemisphere. Its population is primarily rural (63 percent living in the countryside), generally backward and uneducated. Total area is 102,000 square miles and therefore population density - 55 persons per sq. mile - relatively low. The rate of population growth now averages 3.4 percent per year primarily as a consequence of a decline of 25 per- cent in the death rate during the last decade. The Government is studying the cquestion of population growth. 2. The economy of Ecuador achieved considerable growth during the past decade. Gross domestic product increased in real terms on the average by 4.5 percent per year, or 1.2 percent per capita. The prin- cipal factors underlying this economic expansion were continued increases in the production of export commodities, primarily bananas. Manufacturing, construction and public utilities also grew vigorously during this period; in fact, they increased at substantially higher rates than other produc- tive sectors, and their relative share of GDP increased from 20 to 24 percent during the decade, while agriculture's declined slightly from 36 to 34 percent. 3. The country is fragmented into three principal regions, divided by topography, economic characteristics and sentiment. The Sierra supports over half of the total population. Its uneven topo- graphy includes fertile areas where temperate agriculture flourishes, and arid, over-used lands. The rural population in the Sierra is poorer and more backward than the population either of the cities, or of the coastal plains. The cities of Quito, the capital, with 443,000 inhabitants, and Cuenca are the two largest urban areas of the Sierra. The Costa ranks next in population. Rainfall is abundant in many areas, except in the far south. Most of the country's exports come from this region, and Guayaquil is the country's largest city, port, and business center. The Oriente, though of equivalent size to the Andean and coEastal regions, has a population of only 97,000, no sizeable towns, ancd few roads. This area has untouched potential agricultural and forest resources. The recent discovery of petroleum in the northeast heightens its prospects as a major area of future economic activity. 4. Only in recent years have effective surface communications liriked the Sierra and the Costa. The strength of regional sentiment and regional differences is reflected in a distrust of the center (Quito) by the periphery (primarily Guayaquil). The authority of the Central Government in these circumstances has been chronically weak. The attempts of the Central Government to centralize public finances ancd introduce reforms have achieved only limited success.  - 2 - 5. The recent political history of Ecuador is that a military government fell in early 1966, over the issue of fiscal centralization, and was succeeded by an appointed civilian interim President, President Yerovi, in March 1966. Following elections, the National Assembly appointed in September 1966 another interim head-of-state, President Arosemena Gomez. Elections were being held in the beginning of June for a new President and Assembly which will take office in September 1968. Though the transition of Governments in the past has been peaceful, the country has been passing through a considerable period of political uncertainty which has militated against private sector confidence and a long-term approach to development problems by the authorities. The forthcoming Government, however, should be constitu- tionally assured of a four-year term, the first since 1963.  II. BAIA1iCE OF PMYNIM,TS AlND ECO0N01iC GROWTH A. Exports: The Problem of Diversification 6. Export growlth has traditionally provided the main stimulus to economic expansion in Ecuador during the past two decades, and successive booms in banana, coffee, cacao and rice exports largely account for the appreciable overall growth during the period as well as for its cyclical swings. Banana exports alone provide 54 percent of the country's total exchange earnings; coffee and cacao account for an additional 30 percent. However, deteriorating market prospects for these products have rendered diversification increasingly urgent in recent years. 7. The Bank's last economic report forecast a poorer perfoniance for banana exports than actually materialized during 1966 and 1967._/The report appropriately indicated the urgent need to proceed with export diversification in order to improve balance of payments prospects. The unexpectedly good banana export figures of the past two years have pro- vided an additional margin of time available, but in no way lessened the urgency of a far ranging export diversification effort. Aajor Exports 8. Bananas came to the forefront in the 1950's in response to market opportunities created by the virtual disappearance of Central American production owing to hurricanes and Panama disease. By the early 1960's, as improved roads opened up new areas, Ecuador became the world's leading exporter. 9. The market problem facing the industry stems from the fact that world production since 1960 has been growing at 5.6 percent per annum, while world consumption has been increasing at only 4 percent, with export prices declining on average by 3.8 percent annually. 10. European markets have been offsetting losses suffered by Ecuador in the U.S. market, but per capita consumption in Western Europe, the major Ecuadorian outlet, is already high, and demand is inelastic at the present low prices. A further factor in Europe will be ECOi policies. A common tariff of 20 percent ad valorem is scheduled for this year, which will inhibit exports to present low tariff countries. While ECM policies will probably permit a good increase of imports from Latin America over time, they are certain to protect existing supply facilities from associated states. In Eastern Europe, while Ecuador is now enjoying a surplus trade balance, prospects are limited by self-balancing require- ments within the trade agreements, and the market demand for East European exports has been low. Turning to the U.S. market, Ecuador hopes to restore its losses by the increasing competitiveness of Cavendish produc- / WH-157a, April 25, 1966.  - 4 - tion. However, of overriding importance in that market will be the autono- mous policies of the large fruit companies, with strong interests in other producing countries. 11. World consumption is expected to continue growing at about 4 per- cent annually, and a further 5-6 percent price decline is projected by the early 1970's. Because of its comparatively low cost production and its marketing initiatives, Ecuador is expected to hold its own with exports of around 1,425 metric tons in 1970, compared to 1,278 in 1967, the values being US$114 and US$108 million respectively. 12. The main problem in expansion of cacao production derives from poor cultural practices and disease. This crop which was once Ecuador's main source of export income, and in which it is still the world's largest producer of the flavoring variety, succumbed to "moniliat' and "witchbroom" diseases in the 1920's. Plantations which now cover 291,000 has. are generally old and ill-kept, and productivity is low. The cultivated area remained stationary until 1966, when available data indicate a big increase in new plantings, appearing to be of the filler (lower-priced) variety. However, new plantings will not begin to make an impact on production before 1970. 13. Cacao export earnings have benefited in recent years from the higher prices resulting from a sequence of poor harvests in Ghana, rising to US$17.2 million in 1966 and to approximately US$24.9 million in 1967. However, this high price situation is not expected to last; on the contrary, a 15 percent world price decline is expected by 1970. Because of high quality, Ecuador shoulci have little problem disposing of its potential production. Exports of 45,500 metric tons in 1970, however, are projected to earn only US$22.9 million, less than in 1967. 14. Coffee has alternated wqith cacao in the 1960's as the second most important export crop, and the area cultivated expanded from 158,000 has. in 1962 to 217,000 has. in 1966. Total output increased by 34 percent to a peak of 74,400 metric tons in 1966. Ecuadorian coffee is of high quality and there is good market acceptance for it in quota and non-quota countries alike. Internal consunption is also rising, and has been stimulated by an apparently very successful "instant-coffee" factory producing primarily for the domestic market. 15. In spite of two consecutive good harvests, Ecuador avoided a potential inventory problem by securing quota waivers and a basic quota increase from 552,000 bags in 1967/68 to 750,000 bags in 1968/69. Sales to markets of non-quota (knnex B) countries are expanding rapidly, and nearly one-third of total exports were sold to them in the past two years. Total exports in 1967 were 56,500 metric tons valued at US$40.0 million. Little or no decline in world prices is forecast through 1970, by which time Ecuador's exports are expected to amount to 60,900 metric tons, with a value of US$43 million.  -5- Secondary Exports 16. The main secondary exports are the well-established sugarcane and the more recent pyrethrum, while new and promising expansions are apparent in fisheries, forestry products, livestock, tea and mushrooms. 17. Over the period 1962-66, the area planted in sugarcane has increased by 54 percent to 98,200 has. Of a total output of 08,700 tons, by far the greater proportion is consumed locally for both direct and industrial usage. Nearly all of Ecuador's sugar exports go to the U.S. market. A large modern sugar factory, AZTRA, promoted by a French firm has recently been built; new plantings are envisaged to provide its raaw material. AZTRA has an arrangement to sell 30,000 tons of sugar per annum to Dreyfus in France, and intends to enter barter-type arrangements which, supplemented by a growing domestic confectionery and food industry, should help to utilize the new productive capacity. A larger U.S. quota for Ecuador, and larger market opportunities in LAFTA countries and Germany, are also being sought. 18. Pyrethrum exports, the extract of which is used in insecticide preparations, grewJ swiftly from US$0.3 million in 1960 to US$1.9 million in 1965, and fell backc to US$1.6 million in 1967. Argentina and the U.S. are the main markets. The present volume of exports is expected to continue, with some increase in value added locally as government policies encourage the present shift from the export of pyrethrum as the dried flower, to exports of pyrethrum extract. 19. One of the most immediate and promising new export possibilities is fish products. A UNDP survey has established that Ecuador's offshore w^aters are rich in fish resources. Only over the last 15 years has modern commercial fishery of any size developed, fish landings growing from 17,000 sh. tons in 1955 to 53,000 sh. tons in 1966. Foreign capital, including the large Del Monte enterprise, along with local capital, is now participating in creating processing facilities in Manta and Guayaquil. A semi-autonomous public agency, the National Fisheries Institute, is extending its activities which previously concentrated on research and extension services. Exports of fish (shrimps, followed by canned and fresh tuna, frozen lobsters and other sea foods) stood at US$6.3 million in 1966. Prospects, particularly for tuna, are excellent provided that harbor, storage, and purse seiner vessels can be acquired. Marketing opportunities, especially in U.S.A., are most favorable, and Ecuador is well placed to more than double its tuna exports immediately, as soon as the productive factors can be mobilized. A project has been prepared for acquisition of purse seiners for tuna fishing, wjhich is in an advanced stage of consideration by the IBRD. 20. Equally promising, but with a more distant impact, are plans to expand exploitation and development of Ecuador's forest resources. There is already a long established balsa wood industry, which is showing a lively capacity to adapt to far-reaching technological changes, and planning new expansion. Balsa exports rose from US$0.9 million in 1961 to US$3.1  - 6 - million in 1967. Extensive natural resources of hardwoods for lumber, veneer and plywood have been verified, and are expected to constitute a major source of new exports within the next decade. 21. Livestock is also a promising new development, and one which has benefited directly from State action. The Government has obtained a loan for livestock development from the IBRD, to be channelled to the private sector. Official health services are being improved and artificial in- semination centers installedL. Beef production is expected to increase from nearly 42,000 tons in 1963 to about 60,000 tons in 1970. Some cattle is exported to Peru, but the bulk of beef production is still domestically consumed. trith specialized production already beginning in the Costa and the establishment of refrigerated storage and meat-packing plants in Guayaquil exports are expected to rise considerably. Export Promotion Policies 22. Commendable though they are, the efforts of the authorities to promote exports should be stepped up. These efforts might initially be directed to affect the relative profitability of different export com- modities. It is widely acknowledged that bananas offer a substantially higher rate of return on investment than possible alternative crops like oilseeds, fruits, etc. This difference, however real it may be in itself, is enlarged by present tax and exchange provisions. The average effective rate of tax for banana exports, for example, is just 6 percent, while corresponding rates fo; coffee and cacao exports are approximately 8 and 10 percent respectively l/This considerable effective rate differential is largely explained by the fact that the official conversion factor from boxies to pounds substantially underestimates actual weight and hence the effective tax. Moreover, this faulty conversion allows exporters to declare and surrender foreign exchange receipts (at the official rate) far below. those actually received: Central Bank statistics show that exchange sur- rendered from banana exports amounted to US$51.6 million in 1965 and US$66.4 million in 1966, while actual value of banana exports is estimated at US$95.9 million and US$105.3 million respectively. The difference of about us$4o million annually was converted through the free market. This is made attractive by the wide differential between official and free rates, which has grown from 16 percent in January 1967 to 22 percent in April 1968. Coffee and cacao exports do not receive comparable advantages; purchases of exchange reported by the Central Bank in 1965 and 1966 coin- cide almost exactly with export value figures. On balanice, therefore, wthen subsidies and taxes are taken into consideration, banana exports may in fact not only not be taxed at present comparably with other products, but may well be receiving a net subsidy. / That is, the ratio of tax proceeds to value of exports. The nominal export tax rates are 21.4 percent of f.o.b. price for bananas, 9.4-9.6 percent for coffee, and 10 percent for cacao. j/ This inference is strongly reinforced by the fact that 41.5 percent of the banana export tax proceeds, in addition to substantial amounts of other export taxes, are earmarked for the National Banana Directorate, whose main function is to provide spraying services to banana growers free of charge.  - 7 - 23. Other exports are also subject to taxes, some ad valorem (3.4 percent for sugar, 10.0 percent for gold and silver jewelry), others specific (S/l,000 per unit of cattle, S/0.2 per kilo of seafood). 24. The overall effective structure of export taxes and exchange rates is ill-suited to encourage diversification, especially since exports of the crop whose market prospects appear dimmer, i.e. bananas, obtain preferential treatment legitimately and otherwise. Unification of the exchange rate would improve the incentives for exports other than bananas, by eliminating the comparative advantage that bananas derive from the sale of a large proportion through the free market. Assuming that unification takes place at or about the present free market rate, all exports would receive a substantial incentive, while at the same time the incentive for banana exports uould be comparatively reduced. 25. Substantial petroleum reserves were found in 1967 by Gulf-Texaco in the Putumayo region of Napo province in the Oriente, adjacent to the oil finds in Colombia. The six test-wells drilled are alleged to be already capable of supplying 9,000 barrels per day. Doubtlessly it will require further time and explorations to evaluate properly the full potential of this new oil field. Petroleum may hold promise for sub- stantial improvements in Ecuador's import and export situation by the mid- 1970's; in the shorter term, however, no significant impact is expected. B. Imports: The Problem of Substitution 26. Import growth prior to 1962 was moderate, averaging 2-3 percent per year. However, after 1962 imports increased considerably, rising by 33 percent in 1963, 18 percent in 1964 and 12 percent in 1965. Import growth was arrested in 1966 by the introduction of import surcharges and a tighter fiscal and monetary policy, but accelerated in 1967 when an 18 percent increase was registered. 27. To a large extent, import growth during 1963-65 was due to the stimulus given to manufacturing by the enactment of industrial development legislation. As the previous Bank report emphasized, the main brake on imports in Ecuador has been the relatively high tariff barrier. This became a strong incentive to local production of imported items, when importation of the necessary capital goods and raw and intermediate materials was freed from duties under industrial development legislation enacted during 1963 and 1964. The proportion of duty-free imports increased from 29 percent of total imports in 1963 to 39 percent in 1965. Value- added in manufacturing industry increased by nearly 40 percent between 1962 and 1966 (although with practically no increase in employment), and the share of industry in GDP increased from 15.3 to 17.4 percent. 28. Further import substitution on the scale observed during the mid- 1960's is not to be expected in Ecuador. There is a keen awareness among the authorities of the constraints that the relatively small domestic markets pose for additional economically justifiable import substitution as well as of the negligible employment gains achieved so far. Attempts  - 8 - are now being made by the official financial development corporation (Comision de Valores) and the Industrial Development Center (CENDES) to identify promising new industrial fields primarily export-oriented, largely to LAFTA member countries. C. Balance of Payments Prospects: Summary and Conclusion 29. Ecuador has for a number of years enjoyed a favorable balance on commodity trade by virtue of a substantially expanding market for its major export products and the successive developments of new export commodities. Import growth has in generaL been adequately restrained, partly by the non- expansionary monetary policy of the Central Bank, partly by direct or in- direct controls on imports, mainly prior deposits and high tariffs. These tools were vigorously and effectively employed in 1966 to deal with a fi- nancial crisis, which followed a sizeable fiscal imbalance in 1965 coinci- ding with relative stagnation of exports and continuation of the growth of imports induced by the industrial development legislation mentioned earlierl/ 30. The outlook for export earnings during the next two or three years is not promising. Imports, however, are expected to rise considerably, owing primarily to the high import content of the proposed investment projects. The prospects are for a deterioration in the commodity trade balance, which is expected to become negative by 1969. Balance of Payments, 1966-1970 (Million U.S. Dollars) Preliminary Projections 1966 1967 1965 1969 1970 Trade Balance 34 31 9 -6 -12 Exports, f.o.b. 187 206 210 218 227 Imports, f.o.b. -153 -175 -201 -22h -239 Services (net) -58 -63 -65 -67 -70 Transfers 8 9 10 12 14 Current Account Balance -16 -23 -46 -61 -68 Long-Term Capital 27 30 44 56 59 Direct private investment 8 12 12 13 14 Official Capital 19 18 32 b3 45 Drawings from pipeline (28) (30) (42) (32) (27) Drawings from new commitments (4) (25) (33) Amortization (-9) (-12) (-114) (-14) (-15) Basic Balance 11 7 -2 -5 -9 Short-term Capital and Change in Reserves (increase:-) -11 -7 2 5 9 Sources: Central Bank, Planning Board, and staff estimates. J Other factors, such as speculative build-up of inventories in antici- pation of higlher tariffs, are also mentioned as contributing to the observed increases in 1964 and 1965.  - 9 - 31. The limited export growth expected during 1968-70 is due to poor prospects for expansion in world markets and Ecuador's share in them of its major export products, bananas, coffee, and cacao. Non- traditional exports have been moving ahead, but more rapid diversifi- cation is beccming increasingly urgent. There are excellent prospects for substantial growth in exports of fisheries products, particularly tuna. Banana processing and by-products are receiving growing attention, and the market outlook for some of them (banana concentrate, syrup, etc.) is good. Beef-cattle also offers good export possibilities and, in the less immediate future, forestry products. While some attempts have been made in the past to encourage production of new export canmodities, a more clearly and sharply focused export development policy is now urgently needed. 32. Substantial increases in net long-term capital inflows are projected in 1968 and 1969, levelling off in 1970. Total drawings on official capital during the three-year period amount to US$163 million. The undisbursed balance of existing loans amounted to US$130 million at the end of 1967. Of this it is estimated that about US$100 million will be disbursed during the period 1968-70. The balance of total drawings (about US$60 million) will come from new cammitments of external debt. This is broadly consistent with the rate of ccmmitment assumed for new project loans of about US$4o-45 million annually from the Consultative Group, organized by the Inter-American Development Bank, and with the financing of public investment as presented in the next chapter. 33. Although prospects are for a negative basic balance (i.e. balance on current account plus net long-term capital inflow) in the three years 1968-70, the absolute amount is not excessive, reaching only US$9 million by 1970. Short-term capital movements could very well off- set this unfavorable basic balance and even allow further increases in international reserves. Fluctuations in short-term capital flows have been frequent and large, responding swiftly to changes in the political and economic situation and outlook. Should June 1968 elections set the stage for a period of prolonged stability, resumption of short-term capital inflows during 1968-70 might offset the negative basic balance without loss of international reserves. Looking beyond 1970, however, the overall balance of payments prospects depend heavily on continued increase in export diversification.  III. * ONETARY POLICY AND PUBLIC FINANCES A. Monetary Policy 3h. With the balance of payments just in equilibrium and sensitive to short-term capital movements, sound monetary and fiscal policies are in- dispensable for the maintenance of balance of payments equilibrium. Ecuador has in fact a history of conservative monetary management, and deviations from stability have generated prompt corrective measures. Price increases have averaged less than 3 percent annually over the last decade, and net international reserves have been maintained at a level equivalen-t to approximately 3 months' imports. 35. This stability results from the checks and balances inherent in Ecuador's divided political structure which were briefly pointed out in Chapter I. The regional and political divisions of the country off- set central authority, both within the public sector (i.e., between the Central Government and decentralized agencies), and between the Central Government and the business community. Being dominated by the sector of importers, the business community has a strong preference for price and exchange stability, and this preference also dominates the decisions of the Monetary Board which presides over Central Bank policy. The Central Government is the only public sector agency with access to Central Bank credit and consequently the only one which could exert inflationary pressures. However, the Central Bank's preference for stability has by and large prevailed and net credit demands by the Central Government have been resisted. 36. This tendency for the automatic restoration of economic equilib- rium has been demonstrated in the last three years after an abnormally wide deviation from equilibrium. In 1964-66, a government with reforming tendencies endeavored to undertake an ambitious development program with expenditure plans being substantially in excess of what could be realized in the way of revenue because of resistance from the private sector and from regional political groups to plans for increasing and centralizing revenues. The result was that the increases in government current expendi- tures were excessive, and the Government actually had to reduce the level of investment expenditures in 1965 and 1966. Being thus unable to deal with the eccnomic situation, it was relieved of office and replaced by an interim government which was compelled by the realities of the fiscal situation to carry out the revenue proposals of its predecessor. Thus inflationary developments of 1965 and early 1966 were curbed by the end of 1966. 1/ That is, demands for credit in excess of increases in cash balances of other public sector agencies. See more extensive discussion below, Sections B and C.  - 11 - B. Structure of the Public Sector 37. The structure and complexities of the Ecuadqrian public sector were analyzed at length in the previous Bank report .1 It consists of the Central Government, the municipal and provincial councils and a large group of autonomous agencies. The Central Government occupies a central but not a dominant position accounting for approximately 45 percent of total public expenditures. A relatively higher proportion of tax revenues is collected by the Central Government, but a complex transfer and ear- marking mechanism makes available to the Center only about 35 percent of total public current revenues. As a consequence, the Central Government has usually found itself with the necessity of borrowing to finance its investment and on occasion part of its current expenditures, while the autonomous sector has been "overfinanced", building up cash balances. On the whole, the net impact of the public sector on the economy has been neutral and at times deflationary, surpluses of the autonomous sector exceeding Central Government deficits. This fragmentation 2