Ministry of Economy and Finance

1
Ministry of Economy and Finance
Republic of Ecuador

• November 2000

2
Contents
I. BACKGROUND II. THE DOLLARIZATION
PROCESS III. LEGAL REFORMS IV. PROSPECTS OF THE
DOLLARIZATION PROCESS
3
I. BACKGROUND
4
I. Background

• THE 90S, A DECADE WITH ZERO GROWTH
• Average GDP growth rate 1.8 per annum. (The
  lowest in South America)
• Inflation rate 40 per annum (The highest in
  South America)
• In 1999 Ecuador reached its worse recession
  -7.3, the highest in Latin America.
• Capital flights of 1,278 billion in 1999
• Contraction of consumption in 1999 -10.1
• Reduccion of investments -34.7
• Labor migrated at historical record rates.

5
I . Background

• 2. ECONOMIC CRISIS IN 1999
• 2.1 External Factors
• The collapse of international oil prices
  affected fiscal accounts and the balance of
  payments .
• The International financial crisis closed the
  external financing market and created an
  unbalance in internal market conditions .

6
I . Background
Ecuadorian oil prices
30
25
20
15
dollars
10
5
0
Jul-98
Jul-99
Jul-00
Sep-98
Nov-98
Sep-99
Nov-99
Mar-98
Mar-99
Mar-00
Jan-98
May-98
Jan-99
May-99
Jan-00
May-00
Central Government Balance
150
100
50
0
millions of dollars
-50
Jul-99
Jul-00
Jan-99
Mar-99
May-99
Sep-99
Nov-99
Jan-00
Mar-00
May-00
-100
-150
-200
-250
7
I . Background

• 2.2 Internal Factors
• Deep Fiscal Crisis
• -7.2 of GDP that affected current and capital
  expenditures.
• Collapse of international oil prices.
• Tax collection reduction recession reduced the
  tax base
• Depreciation increased debt service
• Fuel subsidies, as a result of frozen domestic
  fuel prices

8
GDP Growth Rate
REPUBLICA DEL ECUADOR
REPUBLIC OF ECUADOR
9
I. Background

• FINANCIAL CRISIS AND FROZEN DEPOSITS
• The Goverment of Ecuador took over 60 of the
  assets of Ecuadorian banks and gave them
  disbursements and bonds to provide them with
  liquidity (approx., US 1,600 billion)
• In march 1999, deposits were frozen (currently,
  there are US 1,000 billion in frozen deposits)
• Some private debtors did not fulfill their
  financial obligations.

10
I. Background

• Social Sector reaction
• Political disagreement with Government
  Authorities

11
I. Background

• Default of public debt
• The interest service was 11.4 of GDP (35
  internal and 65 external)
• The weight of the public debt was unsustainable
  in the long term
• The default declaration lowered the credibility
  of the government, causing capital flights and
  devaluation.

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I. Background

• HYPERINFLATIONARY CONDITIONS
• Abandoning the target zones scheme wrecked a
  non-developing market
• Monetary policy attempt to control exchange rate
  and money lenders of last recourse
• Bank crisis caused the growth of the monetary
  base
• Monetary emission 152
• Depreciation of exchange rate 196.6
• Inflation 60.7 (Consumer prices)

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I. Background

• In other terms
• Unemployment, underemployment and informality
• Loss of purchasing power
• Criminality
• Repression
• Worsening of social crisis.

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I. Background

• SUMMARY
• The crisis was deep and widespread.
• Solving the crisis required a vast effort from
  several perspectives
• Monetary stabilization
• To recover fiscal solvency
• To stop and to revert capital flights
• To create growth opportunities
• To revitalize the real sector (production)

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II. THE DOLLARIZATION PROCESS
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II. The Dollarization Process

• It is a process whereby a foreign currency
  (the US dollar) replaces the local currency (the
  sucre) in its functions as unit of value and of
  account.

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II. The Dollarization Process

• Origin
• Through the colonization of a country that adopts
  the currency of the colonizing country
• Trough the autonomous and sovereign decision of a
  country that decides to use as its genuine
  currency the dollar. In this case, the decision
  may come from both the supply and the demand
  sides

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II. The Dollarization Process

• Consequences of dollarization -informal
• Pressure on exchange rate
• Pressure on interest rates
• Inflation
• Speculation
• Loss of purchasing power of local currency
• Weakening of financial sector

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II. The Dollarization Process

• Consequences of dollarization -official
• 100 of local currency is replaced with foreign
  currency.
• Local currency disappears.
• Prices, wages and contracts fixed in dollars.

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II. The Dollarization Process
Free Monetary Reserve
1000
800
600
millions of dollars
400
200
0
jul.-00
ene-00
feb.-00
Jun-00
mar-00
Apr.-00
May-00
Aug.-00
MINIMAL
WAGE
TOTAL
COMPONENTS
NOMINAL
WAGE Nº14
MONTHS
IPCU
REAL WAGE
VITAL
IN PROCESS OF
INCOME
WAGE
INCORPORATION
MARCH((2)
26,65
40
66,65
607,24
10,98
APRIL
26,65
40
66,65
669,17
9,96
MAY
26,65
40
66,65
703,64
9,47
JUNE
56,65
40
96,65
741,00
13,04
JULY
56,65
40
96,65
758,58
12,74
AUGUST
56,65
40
96,65
768,89
12,57
SEPTEMBER
56,65
40
8
104,65
797,17
13,13
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II. The Dollarization Process

• Advantages
• Exchange risk disappears
• Spread between domestic and international
  interest rates is reduced, which facilitates
  access to loans and the recovery of the economy.
• Facilitates financial integration admission of
  international banks into the country, and local
  mergers.
• Imposes obligation to achieve fiscal balance the
  key for economic stability

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II. The Dollarization Process

• Risks
• Irreversible process
• Vulnerability to external shocks
• Loss of seignorage (the country losses the
  difference between the cost of putting money in
  circulation and the value of goods that can be
  purchased with this money.)
• Conversion costs (Advertisement, nomenclature)
• Dependent on the US Federal Reserve
• Causes economic crisis due to lack of adequate
  fiscal management

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II. The Dollarization Process

• Specific Features
• The Ecuadorian monetary system is 90 dollarized
  and 1 works under the convertibility mode (in
  low denomination coins)
• There are constitutional limitations to the
  elimination of the sucre

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II. The Dollarization Process

• The dollarization process
• Determination of exchange rate 25,000 sucres
• Distribution among the population of dollar bills
  by the Central Bank of Ecuador (BCE)
• Minting of coins
• Exchanging sucres for dollars (180 180 days)
• Transition period (Initial 9 months . Extended
  to 6 months )
• Implementation of usury law
• BCE is no longer the currency issuing institute,
  except for minor coins and is no longer the
  money lender of last recourse.

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III. CURRENT SITUATION. LEGAL REFORMS
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GDP Growth Rate
27
Central Government Balance
(GDP percent)
28
Inflation
16,0
14,0
12,0
10,0

8,0
6,0
4,0
2,0
0,0
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Interest Rates
20.00
15.00
10.00
5.00
0.00
March
April
May
June
July
August
loan
deposit
30
Stock of Deposit
31
Debt Restructuring

• It included the PDI, Par, IE, Discount bonds,
  Eurobonds and the Paris Club.
• It reduced the debt stock (20).
• Government cash flow improves.
• In September 2000 Ecuador reached an agreement
  with the Paris Club and it will be reviewed in
  April 2001.

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Legal reforms

• Main objectives of recent legal reforms
• To arrive at economic stability
• Fiscal deficit 0.
• To set legal conditions to assure dollarization
  scheme
• To promote investments
• To facilitate the modernization and privatization
  of State companies

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Legal reforms

• Decrees that enable the implementation of
  dollarization
• Definition of concept of free use international
  reserves
• introduction of usury law
• Plans for the restructuring of banks
• Strengthening of control and supervision by
  Superintendency of Banks

34
Legal reforms

• The government is required to submit a budget
  forecasting a deficit no higher than 2.5 of GDP
• The average budget deficit must be balanced
  within the next three years
• Enhances smooth fluctuations in public sector oil
  revenues by enforcing the oil stabilization fund
• Legislation to permit privatization of telephone
  and electricity generation and distribution
  companies
• Legislation to enable the construction of a new
  heavy crude oil pipeline
• Introduces reforms to encourage labor flexibility

35
Legal reforms

• FINANCIAL SECTOR
• AGD is enabled to carry out special foreclosure
  procedures to collect non-performing loans
• MINING SECTOR
• Legal insecurity in this sector is eliminated
• FURTHER INITIATIVES TO FLEXIBILIZE LABOR MARKET
• Hourly contracts are permitted in permanent
  activities for 3-6 hours daily and for part-time
  jobs for up to 8 hours
• Severance payments are limited for salaries above
  US 1000

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Legal reforms

• .
• The reforms to the Law are based in four issues
• Modernization of Public Sector
• Reforms in the use of natural resources
• Reforms to the productive sector.
• Reforms to social norms.
• The law allows greater private sector stock
  ownership in telecommunication, electricity and
  other sectors. In the past, they were managed
  exclusively by the Goverment.

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Legal reforms

• Law offers several economic incentives for
  investment in
• Electric Sector
• Oil Sector
• Banking Sector
• Mining Sector
• Telecommunications
• TV and Radio
• Aviation and Airports

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IV. Dollarization prospects
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IV. Prospects of Dollarization process
ECONOMIC INDICATORS INCLUDED
IN THE BUDGET PROPOSAL FOR 2001
GDP Growth
3.5
(million US)
Nominal GDP
17847
Inflation (end of year)
20
(per barrel)
Oil price
US 20
Central Government balance
0
(GDP)

• Balanced budget
• No new financing requirements

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Revenues
Expenditures
3,928.1 billion
3,928.1 billion
Interest payments 1,131.8 billion
Oil Exports 1,283.1 billion
Wages and Salaries 1,026.5 billion
VAT 1,008.0 billion
Fixed capital formation 65.5 million
Domestic Fuel Sales 534.1 million
Capital Transfers ( Local Gov. and others)
617.3 million
Taxes on foreign trade 426.2 mill
Income Tax 334.2 million
Current Transfers 205.7 million
Non-tax revenue 219.7 million
Goods and Services 152.3 million
Excise taxes 91.9 million
Solidarity Bonus 141 million
Other taxes 30.9 million
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Expenses by Sector

• Total 4,932.3 billion

Public Debt 2,135.4 billion
Social Sector 1,004.9 billion
Local Governments 458.1 million
National Defense 345.3 million
Public Infrastructure 295.2 million
Domestic Expenses 243.5 million
Economic Services 163.3 million
Administrative Services 156.2 mill.
National Treasury 123.8 million
Other State Agencies 6.7 million
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IV. Dollarization prospects

• Income policy 2001 and medium-term
• To adjust domestic fuel prices
• Tax reform. It will simplify and speed up the
  current system
• Increased collection of permanent taxes (SRI and
  CAE)
• Congress may not increase estimated income

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IV. Dollarization prospects

• Expenditure policy 2001 and medium term
• To improve the quality and control of
  expenditures
• To prioritize investment expenditures
• To protect social expenditures
• To increase expenditures depending on
  performance of permanent tax income
• Expenditures may not grow more than the inflation
  rate of the previous year
• Congress may not raise estimated expenditures

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IV. Dollarization prospects

• Financial Policy 2001 and medium term
• Debt reduction in the medium term. To avoid
  pressures on fiscal results and on fiscal cash
  flows.
• Oil stabilization fund This fund is built when
  international oil prices exceed the price
  forecasted in the budget.
• Reduction of arrears (floating debt)
• External and Internal debt renegotiations.

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III. Dollarization prospects

• To reduce inflation
• To reduce interest rates
• To recover economic credibility and stability in
  order to revert flight capitals
• To improve consumption levels through improved
  economic stability
• To reduce social pressure
• To target and protect social programs
• To reform the social security system (IESS)

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IV. Dollarization prospects

• To strengthen the financial system
• To follow the schedule to release frozen deposits
• To develop a transparent privatization process
• To promote the decentralization process to
  delegate local responsibility
• To improve the concession process
• To build the new heavy crude oil pipeline