Ecuador's 2010 Budget: Optimistic Assumptions, large

C O N F I D E N T I A L QUITO 001059

SENSITIVE
SIPDIS

E.O. 12958: DECL: 2019/12/23
TAGS: EFIN ECON ETRD EINV EC
SUBJECT: Ecuador's 2010 Budget: Optimistic Assumptions, large
Deficits, Scarce Financing

REF: QUITO 1026

CLASSIFIED BY: Heather M. Hodges, Ambassador, U.S. Department of
State, EXEC; REASON: 1.4(D)

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Summary

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1. (SBU) Marked by optimistic growth and revenue assumptions, a
record-level fiscal deficit, and a conspicuous lack of detail about
sources of financing, Ecuador's 2010 budget passed the National
Assembly December 22. President Correa's administration submitted
the 2009 and 2010 budgets simultaneously in November to the
National Assembly, along with the constitutionally-required "Plan
for Well-Being" Budget Plan covering 2009 to 2013. Private analysts
have criticized the GoE's delay in submitting the 2009 budget and
the unrealistic assumptions included in the 2010 budget. Critics
predict the 2010 fiscal deficit will be up to a third larger than
anticipated, and this does not even take into account the fiscal
impact of the current electricity crisis. Many analysts consider
the GoE's fiscal situation unsustainable, and given difficulty in
obtaining external financing, the GoE faces either cutting social
programs or committing to the risky strategy of using official
reserves to finance the fiscal gap. End Summary.



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2009 Budget Proposal and the Plan for the Good Life

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2. (SBU) Ecuador's National Assembly approved the 2009 consolidated
public sector budget proposal on December 22. President Correa's
government had finally submitted the 2009 budget to the National
Assembly on November 6, just weeks before the end of the fiscal
year. According to the budget, Ecuador will end 2009 with a fiscal
deficit of US$1.82 billion (3.6% of GDP) and a primary fiscal
deficit (excluding payment of interest on debt) of US$1.22 billion
(2.4% of GDP). Real annual GDP growth, as calculated by the Central
Bank, is estimated at 0.98% for 2009. (This contrasts sharply with
the clear consensus in the private sector that the Ecuadorian
economy is facing a contraction for full year 2009.)




3. (SBU) Also on November 6, Ecuador's National Planning Secretary
sent the National Assembly the "Plan Nacional Para el Buen Vivir,
2010-2013" (roughly translated as the "national plan for
well-being"),which defines 12 national economic and social
development objectives. These include the reduction of social
inequality and improvement in the quality of life, peace,
employment, political participation, and national sovereignty. This
plan also aims to establish an economic system focused on the
redistribution of factors of production and the promotion of local
industries. Depending on international oil prices, the plan
contains different investment scenarios for the four year period,
ranging from US$18.9 to 22.3 billion. The National Assembly has not
yet approved this plan.



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2010 Budget Forecasts 6.8% Growth

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4. (SBU) The National Assembly also approved the 2010 consolidated
public sector budget proposal December 22, which the GoE had also
submitted to the National Assembly on November 6. The National
Assembly subsequently requested that the GoE allocate more
resources for local governments and divert US$58 million earmarked


for debt payments to fund education and health programs. The final
version incorporates these suggestions.




5. (SBU) The GOE proposed a US$21.28 billion budget for 2010, an
11% increase over the US$19.17 billion budget proposed for 2009.
The 2010 budget is based on macroeconomic assumptions that many
economic analysts consider significantly optimistic. The most
criticized assumption is the expectation of 6.81% real annual GDP
growth, as calculated by Ecuador's Central Bank. (Comment: local
analysts, along with the World Bank, ECLAC, and Wall Street banks,
all estimate 2010 real growth in the much lower 1- 3% range.)
Optimistic revenue estimates, dependent on the almost 7% growth
figure, are also seen as unrealistic. The budget estimates total
revenues in 2010 of US$17.09 billion, up 9.7% from the US$15.57
billion estimate for 2009 (and down from US$20.8 billion in 2008).




6. (SBU) Analysts have also criticized the budget's estimate of an
average price for Ecuadorian crude oil of US$65.9 per barrel during
2010, and for expecting the oil and natural gas extraction industry
to grow 1.3% in 2010, when oil production has decreased every year
since 2006. (The Central Bank estimates the non-oil economy will
grow at a 7.7% annual pace.) Although the current price of
Ecuadorian crude is close to $65/bbl, other countries such as
Venezuela and Mexico have used estimates closer to $50, which
analysts have noted is a more prudent strategy in the current
highly-volatile global economy.




7. (SBU) The GoE has changed the way it calculates the 2010 budget
compared to prior years, so it is difficult to compare statistics
between the various budgets, particularly with regards to
expenditures. However, the well-known Ecuadorian consulting company
"Fiscal Policy Observatory" estimates that the 2010 budget includes
a roughly 30% increase in expenditures over 2009. This compares to
an approximately 18% decline in expenditures in 2009 and about a
70% increase in spending in 2008.




8. (SBU) Approximately US$5.8 billion or 27.43% of the 2010 budget
is allocated to cover public sector salaries. Since taking office
the Correa government has dramatically increased the size of the
public sector in terms of both number of employees and higher
wages. The public sector wage bill has increased 66% between 2007
and 2010 (projected). Public investment is projected at US$3.8
billion (17.91% of the budget) in 2010, and capital expenditures
and repayment of public debt US$3.86 billion (18.15%),with debt
payments totaling about US$1 billion. (The estimated total debt to
GDP ratio in 2010 is 23.2%, while the estimated external debt to
GDP ratio is 15.3%.) The budget also estimates 2010 inflation at
3.35%, basically equivalent to 2009, and projects a slightly
positive trade balance compared to the US$1.33 billion trade
deficit estimated for 2009.




9. (C) Comment: In private conversations with Econoffs, Central
Bank officials have explained that they derived the budget's
macroeconomic assumptions based on data and assumptions (e.g., for
the price of oil) provided by the Finance Ministry and the National
Planning and Development Secretariat (SENPLADES). While the almost
7% growth figure is achievable using these data and assumptions,
Central Bank officials emphasize that there are "a lot of
assumptions that are questionable."



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2010 Budget Deficit and Sources of Financing

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10. (SBU) Under the aforementioned macroeconomic assumptions, the
2010 budget proposal reflects a fiscal deficit of US$3.085 billion
and a primary fiscal deficit of US$2.38 billion, equivalent to 5.4%
and 4.3% of nominal GDP respectively. Finance Minister Viteri has
announced that the budget deficit will be funded with new debt, as
Ecuador expects to obtain external financing of about US$2.18
billion and internal financing of US$1.69 billion. The Ministry of
Finance has mentioned the following external sources of financing:
the Inter American Development Bank (US$ 971 million),the Andean
Development Corporation (US$ 458 million),and "friendly"
governments such as Russia, China and Iran. Domestically, financing
would come from the State Social Security Institute (IESS).




11. (C) Local economic analysts have expressed serious doubts about
the GoE's ability to find sufficient sources of internal or
external financing to cover the fiscal gap. Central Bank officials
informed Econoffs privately that the Finance Ministry refused to
discuss details of sources of financing with the Central Bank,
calling it "top secret."




12. (C) Expected multilateral financing is significant, but
project-specific and only covers about a third of the anticipated
fiscal gap. Funding from IESS is questionable, as it has already
allocated much of its liquid resources for 2010. A senior Finance
Ministry official told Econoffs December 10 that it has not proven
as easy as expected to raise financing from non-traditional foreign
sources. President Correa recognized as much during various
speeches in December, calling Chinese requirements for lending to
Ecuador -- particularly linked to US$ 1.7 billion in financing for
a hydroelectric dam in Ecuador -- "humiliating for the country,"
and claiming that, "not even the IMF treated us this way."



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Private Analysts Consider 2010 Fiscal Plan Unsustainable

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13. (U) Local analysts consider it hypocritical that the GOE plans
to finance the budget deficit for 2010 with new debt after GOE
officials have spent the last few years severely criticizing debt
contracted by previous governments. Ex-Finance Ministers and local
economists Mauricio Pozo and Fausto Ortiz have both publicly
questioned the ability of the GoE to obtain sufficient public
financing to cover 2010 planned expenditures, and have also
questioned the costs of raising financing from nontraditional
sources such as China. While there is a clear role for private
investment to help reenergize the economy, both Ortiz and Pozo
point out that the GoE's policies of deemphasizing the role of the
private sector and promoting State intervention in the economy have
created strong disincentives to private investment.




14. (C) Jaime Carrera, head of the Fiscal Policy Observatory
think-tank, has been one of the most consistent and vociferous
critics of GoE fiscal policies and the assumptions included in
recent budgets. In meetings with Econoffs, he described the 2010
budget as "populist" and "destructive" and argued that the
projected spending increase in 2010 was "unsustainable." He
disputed that GoE public investment will have much of a stimulative
impact on domestic consumption and growth, arguing that much of
"investment" will actually go to pay government salaries. He also
argued that any expansionary impact of recent spending would be
offset by the increased tax burden on businesses and increased
controls on the financial sector. He estimated much lower economic
growth in 2010 and also expected revenues to come in well below
budget estimates. Therefore, he predicted the 2010 fiscal gap would
likely exceed US$4 billion, or roughly a third larger than the
GoE's already record-level (in nominal terms) estimate.


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Power Shortages Impact on the Budget

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15. (SBU) Ecuador has faced severe power shortages since November
2009, with private estimates of economic losses on the order of US$
1 billion. Although GoE officials dispute this figure, they admit
to capital expenditures of US$ 245 million so far to increase power
supplies, and are facing hundreds of millions more to add capacity
and pay fuel and electricity subsidies. These investments and
expenditures were not included in the 2009 and 2010 budgets and
will thus contribute to an even larger than anticipated fiscal gap.




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Comment

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16. (C) Most private analysts believe the 2010 budget has
overestimated growth and revenues and is highly unrealistic in
terms of maintaining a high rate of growth for public spending. As
Ecuador is a dollarized economy, eliminating the GoE's ability to
print money, analysts, therefore, have major concerns about fiscal
stability, given the lack of financing, the difficulty in
increasing tax rates, and declining oil sector production. These
analysts predict the GoE will face a difficult task of maintaining
the level of expenditure growth envisioned in the 2010 budget. The
two obvious solutions to this situation are either to cut funding
for politically important social programs or resort to the use of
official reserves to fund the fiscal gap. So far, it appears the
GoE, at the behest of President Correa, is pursuing the latter
strategy (septel). Current reserve levels of about US$4.5 to 5
billion are sufficient to allow the GoE to continue a high rate of
expenditure growth through 2010 while avoiding a liquidity crisis.
However, this is a high risk strategy that will leave Ecuador
vulnerable to more severe fiscal and economic problems in 2011.
HODGES