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Ministry of Economy and Finance

Republic of Ecuador. Ministry of Economy and Finance. November 2000. C ontents. I. BACKGROUND II. THE DOLLARIZATION PROCESS III. LEGAL REFORMS IV. PROSPECTS OF THE DOLLARIZATION PROCESS. I. BACKGROUND. I. Background. THE 90’S, A DECAD E WITH ZERO GROWTH

Solomon
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Ministry of Economy and Finance

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  1. Republic of Ecuador Ministry of Economy and Finance 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 90’S, A DECADEWITH 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 • Contractionof 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. Current Account Balance 600 400 200 0 1998- 1998- 1998- 1998- 1999- 1999- 1999- 1999- 2000- 2000- -200 millions of dollars 1 2 3 4 1 2 3 4 1 2 -400 -600 -800 -1000 I . Background Ecuadorian oil prices 30 25 20 15 dollars 10 5 0 Jul-98 Jul-99 Jul-00 Nov-98 Nov-99 Sep-98 Sep-99 Mar-98 Mar-99 Mar-00 May-98 May-99 May-00 Jan-98 Jan-99 Jan-00 Central Government Balance 150 100 50 0 millions of dollars -50 Jul-99 Jul-00 Jan-99 Jan-00 Mar-99 Mar-00 Nov-99 Sep-99 May-99 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 6 4 2 0 Growth Rate -2 2001-I 1998-I 1997-II 2000-II 1996-III 1999-III 1995-IV 1998-IV 2001-IV -4 -6 -8 22 22 REPUBLIC OF ECUADOR REPUBLICA DEL 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.

  12. 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)

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

  14. 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)

  15. II. THE DOLLARIZATION PROCESS

  16. 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.

  17. 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:

  18. 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

  19. 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.

  20. II. The Dollarization Process Free Monetary Reserve 1000 800 600 millions of dollars 400 200 0 jul.-00 Jun-00 feb.-00 ene-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%

  21. 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

  22. 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

  23. 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

  24. 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.

  25. III. CURRENT SITUATION. LEGAL REFORMS

  26. 6 4 2 0 % -2 1998-I 2001-I 2000-II 1997-II 1996-III 1999-III 1995-IV 1998-IV 2001-IV -4 -6 -8 GDP Growth Rate

  27. Central Government Balance (GDP percent)

  28. Jan Feb Mar Apr Aug Oct Jul May Sep Jun Inflation 16,0 14,0 12,0 10,0 % 8,0 6,0 4,0 2,0 0,0

  29. Interest Rates 20.00% 15.00% 10.00% 5.00% 0.00% March April May June July August loan deposit

  30. 1100 1000 900 800 millions of dollars 700 600 July May April June March August January February • Deposits and credits are increasing. 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.

  32. 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

  33. 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

  36. 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 allowsgreater private sector stock ownership in telecommunication, electricity and other sectors. In the past, they were managed exclusively by the Goverment.

  37. 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

  38. IV. Dollarization prospects

  39. 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

  40. 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

  41. Expenses by Sector Public Debt $2,135.4 billion Total $ 4,932.3 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

  42. 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

  43. 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

  44. 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.

  45. 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)

  46. 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

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