IMF ON ECUADOR: "A HIGH LEVEL OF ANXIETY IS NOT

C O N F I D E N T I A L QUITO 002604 SIPDIS SIPDIS PASS TREASURY FOR MARIE EWENS E.O. 12958: DECL: 12/05/2017 TAGS: EFIN ECON EC SUBJECT: IMF ON ECUADOR: "A HIGH LEVEL OF ANXIETY IS NOT MERITED" REF: A. QUITO 1655 ¶B. QUITO 2373 Classified By: Classified by Charge Jefferson Brown. Reason: 1.4 b an d d. ¶1. (C) Summary. IMF staff are measured in their assessment of the Ecuadorian economy. They noted a number of weaknesses and risks, including uncertainty, falling investment, declining petroleum production, and weak growth. Even so, they do not foresee any major economic difficulties, and believe that the two biggest worries, the banking sector and loose fiscal policy, are manageable. The IMF forecasts economic growth of 1.5% in 2007 and 2.5% in 2008. End summary. ¶2. (U) IMF staff visited Ecuador November 5-19 for an Article IV review, and provided a debrief on November 15 for some diplomatic missions and multilateral lenders. Trevor Alleyne, Division Chief of the Western Hemisphere Department, led the IMF discussion. This debrief was supplemented by an additional conversation with Jorge Guzman, IMF Resident Representative, on November 28. ¶3. (C) Alleyne opened the discussion by noting that there is considerable uncertainty on the part of the private sector as to the direction of economic policy, growth in the second quarter was weak, investment has fallen, credit growth has slowed, and demand, particularly for durables, has weakened. ¶4. (C) Turning from this downbeat opening, Alleyne said that following their discussions with GOE officials, the IMF staff believes that "a high level of anxiety is not merited." He said that overall, some signals are positive, some mixed, and still others are negative. In short, he said, that the level of uncertainty is not that different than in prior years. Banking Sector -------------- ¶5. (C) Alleyne said that the two issues that they had thought would be most worrisome, banking and fiscal management, appear to be manageable. Of the two, they had been most worried about banking. Based on their discussions with GOE officials, they believe that the GOE intends to attempt to lower interest rates, but will focus its efforts on improving the efficiency of the banking sector rather than more draconian measures. ¶6. (C) Alleyne said that current banking law (reftel a) provides most of the banks room to work with, but the IMF is concerned that some smaller banks may not be profitable with the change from fee-based income to interest-based income. While he does not expect these smaller banks to cause systemic problem, he noted that the regulators are not well prepared to deal with them. He also added that the GOE's plan to merge the Central Bank and Superintendency of Banks could pose risks if not done properly. Fiscal Management -------------- ¶6. (C) Alleyne said that in contrast to two years ago, the government is flush with cash thanks to high oil prices. He said the question has shifted to whether the government will spend its revenue effectively. He said that there is no indication that the government is inclined to control spending, and noted that the government has increased current spending. However, the government does not have the capacity to spend as rapidly as it would like on the investment side. Alleyne said that the Ministry of Finance's new spending guideline is that current expenditures should not exceed current income excluding oil revenue, but continued that the IMF staff does not see signs that that rule is being applied. ¶7. (C) Even so, IMF staff does not anticipate a fiscal crisis in the next five years, based on IMF's baseline projections which use current oil futures to project oil prices. While it does not see indications of a crisis, Alleyne suggested that IMF staff disapproves of the GOE's loose spending, and cautioned that the prior experience has shown that booming resource prices often reverse course much more quickly than anticipated. ¶8. (C) One positive note, Alleyne said, is that the government plans to include fuel subsidies in the federal budget in onward years, which would make the subsidies more transparent and might create an environment where subsidies would be constrained in future years. Petroleum Sector -------------- ¶9. (C) Alleyne identified the petroleum sector as a possible concern, since the government has imposed revenue sharing requirements on the private sector that could reduce private sector investment (reftel b). Partially offsetting the likely decline in private sector production is that the government is pursuing a number of initiatives to improve production by the state oil company, Petroecuador. Exports -------------- ¶10. (C) Alleyne did not see any risks in the balance of trade. He noted that Ecuador is enjoying the benefits of high oil prices at the same time that non-petroleum exporters have been performing relatively well. Since Ecuador is dollarized, its currency has not appreciated as is often the case for countries experiencing a resource price boom. Indeed, the depreciating dollar has improved Ecuador's competitiveness in a number of markets. Economic Growth -------------- ¶11. (C) In a subsequent discussion with IMF Resident Representative Jorge Guzman, Guzman focused on the IMF's growth projections. He said that the IMF expects that the economy will grow only 1.5% in 2007 as a result of investor uncertainty. He said that the non-petroleum economy could shrink around 2.5%, and noted that would affect job creation since most employment is generated in the non-petroleum economy. ¶12. (C) Guzman said that the economy should grow around 2.5% in 2008, with the assumption that petroleum production will stabilize and the government increases its investment spending. He expects private oil production will drop, but that should be largely offset if Petroecuador bring production in the former Occidental fields up to its 2006 levels after a decline this year. ¶13. (C) He contrasted the modest growth in 2007-2008 to the relatively high levels Ecuador had enjoyed from 2002-2006. He said Ecuador's economic fundamentals are solid, and that if the government reduces the current high level of uncertainty growth could return to the 5% level. Comment -------------- ¶14. (C) The IMF briefing was of the glass-half-full variety. The IMF staff acknowledge that there are economic difficulties in Ecuador, notably pronounced investor uncertainty, loose fiscal policy, and risks of falling petroleum production. We share the IMF's view that the biggest worry would be if the GOE brought about a banking crisis. We are not as sanguine as the IMF staff, but the GOE has been talking to the private sector as it crafts a second round of banking reforms, and has sought assistance from the Inter-American Development Bank and USAID (septel). Therefore we hope that the next set of reforms will be better crafted than the first, which were drafted quickly and with little consultation (reftel a). In spite of those downsides, thanks to high oil prices and government spending it appears that the economy will muddle through over the next year or so, although economic performance could be better, as shown by Ecuador's neighbors. ¶15. (C) Another thing of note is that the mission simply took place. Correa had initially criticized the IMF, but current Finance Minister Ortiz is intent on rebuilding Ecuador's relations with the Washington-based multilateral lenders. Ortiz obviously had to obtain Correa's approval before the visit took place, but once he did the IMF staff had ready access to senior GOE economic officials. BROWN