ECUADOR ECON WEEKLY: FALLING FDI, REVISED PRICE CONTROLS,

UNCLAS QUITO 000374

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR MEWENS

E.O. 12958: N/A
TAGS: ECON EINV EPET EAGR EFIN EC
SUBJECT: ECUADOR ECON WEEKLY: FALLING FDI, REVISED PRICE CONTROLS,
SOCIAL SECURITY TO INVEST IN GOVERNMENT PROJECTS

REF: A) Quito 191 B) 07 Quito 2277 C) Quito 36
D) Quito 365


1. (U) The following is a weekly economic update for Ecuador that
reports notable developments that are not reported by individual
cables.

Investment Outflows Driven by the Petroleum Sector
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2. (SBU) Net foreign direct investment (FDI) in Ecuador declined
34% in 2007 ($178 million vs. $271 million in 2006). The first
three quarters of 2007 appeared to reflect a modest recovery (reftel
a) from already poor performance in 2006. However, the fourth
quarter of 2007 showed a net outflow of almost $300 million. Net
FDI (inflows minus outflows) for 2007 was the lowest in at least six
years, and down sharply from the peak of $871 million in 2003.


3. (SBU) The petroleum sector accounted for the large drop in FDI in
the last quarter of 2007. The mining/petroleum sector registered
$483 million in outflows for the quarter, more than erasing the
small net inflows in the first part of the year (the sector for the
year as a whole had $418 million in net outflows). We understand
that much of the outflow was repatriated profits, which some
analysts say is an annual practice. However, the investment
situation was clearly aggravated when the windfall income tax was
increased to 99% in October (reftel b). Almost all the petroleum
companies froze their investment plans after the announcement, so
they did not have any incentive to retain profits in country to pay
for future investments. In addition, we understand private drilling
companies have shipped many of their drilling rigs out of Ecuador,
which may show up as an investment outflow, and clearly signals that
the private petroleum companies will not be resuming investment in
the near future.

Price Controls for Milk
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4. (U) On April 23, the Correa administration made its first
adjustment to the milk price controls it imposed in January (reftel
c). It raised the maximum prices by five cents/liter in several
categories, and eliminated price controls on the most upscale
category of milk, long life ultrapasteurized milk in one liter
boxes. It did, however, impose price controls on ultrapasteurized
milk in less expensive packaging, leading one producer to complain
that he may have to stop producing the less expensive version.

Social Security to Invest in Government Projects
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5. (U) The Ecuadorian Social Security Institute (IESS) announced
that it will invest $578 million of its assets in petroleum,
electricity and mining projects. It will reportedly invest $100
million in developing a field in Block 15 (which was seized from
Occidental Petroleum in 2006) and $50 million in Coca Codo Sinclair,
Ecuador's largest hydroelectric project. The Minister of Mines and
Petroleum suggested that IESS could invest in the to-be-established
state mining company (reftel d).


6. (SBU) Comment: In part, it appears that the government would
like to use IESS savings to fund some of its ambitious investment
program, but it also looks like the IESS board is looking for
potentially better returns. Currently, the pension fund is invested
in Central Bank accounts and government bonds, which garner a low
rate of return, and the government has reduced the volume of bonds
that it is placing with IESS. At this time, the government has more
cash than it can spend, given its limited ability to implement
investment programs, high petroleum revenue and increased control
over the old petroleum funds. But if it can ever increase its
capacity to implement projects, it may need to rely on IESS funds as
well.

Speculation about New Debt Issuance
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7. (SBU) Financial analysts report there is a growing expectation
in Ecuador's financial community that Finance Minister Fausto Ortiz
might restructure some of Ecuador's external debt in 2008 or 2009,
although there is no suggestion he will do so in the near future.
Ecuador risk spreads fell after the GOE abandoned suggestions it
might default and instead regularly paid its debt obligations.
Ortiz publicly suggested that the GOE may be ready to issue new
bonds in 2009. If so, Ecuador could use the new bonds to replace a

portion of its outstanding commercial debt, which carry relatively
high interest rats; two of the issuances included call options that
give the government the right to retire some of the debt. Visiting
investment analysts have said that there might be appetite for a new
Ecuadorian placement, but only after investors have seen the new
constitution.

Petroecuador Unable to Spend Its Investment Budget
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8. (U) Petroecuador reported low budget spending for the first two
months of 2008. As a result, on April 16, Petroecuador's Board of
Directors announced the creation of a budget-monitoring commission.
According to the company, it had budgeted $115.3 million in
investment for January and February, or 7% of total investment
planned for 2008 ($1.7 billion). Instead, it spent only $49.6
million on investment. Also between January and March, Petroecuador
spent $577.9 million on current expenses; $435 million of this was
used to import oil derivatives. The Ministry of Petroleum and Mines
expressed frustration that the state-owned company has not been able
to move forward with its joint rehabilitation of the mature Sacha
field with Venezuelan petroleum company PDVSA.

JEWELL