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After close to nine years of vilifying the private sector as “mercantilist” and greedy, president Rafael Correa has asked it for a life preserver. (Photo: UN)
Wednesday, October 7, 2015
Perspectives

Ecuador in Recession, Woos Investors

As Ecuador enters recession the government attempts to woo investors again.

LATINVEX SPECIAL
Analytica

Ecuador’s GDP shrank 0.3 percent in the second quarter of this year, meeting the colloquial definition of a recession – two straight quarter-on-quarter declines in the economy – according to the data provided by Ecuador’s central bank (BCE) this week. The country is thus experiencing its second recession since president Rafael Correa took office in January 2007 after a 0.1 percent decline in the first quarter (corrected down from the 0.5 percent reported originally). Even the latest BCE growth target of 0.4 percent for this year, the second cut from the original 4 percent target (slashed to 1.9 percent in June), will pose a challenge to meet.

Reasons for the situation become clear on the demand side. Several key indicators pointed downwards in quarter-on-quarter comparisons. Exports of goods and services, marked by the plunge in the price of oil, but also the overall deterioration of Ecuador’s terms of trade due to the revaluation of the dollar, the currency, in global markets, fell 1.8 percent on the quarter. Imports dropped 1.9 percent thanks to the administration’s move to stymie the outflow of dollars through punitive duties up to 45 percent. Totaling $6.93 billion, they fell below $7 billion for the first time since the second quarter of 2012. Household spending declined 0.5 percent for the second straight quarter, reflecting how consumers have begun to feel the pinch and/or are trying to cut spending given the fears about how the economy may fare. Investment (gross capital formation), including both the private and public sector, which the BCE doesn’t report separately, fell by another 1.4 percent after a 2.1 percent drop in the first quarter. All of this couldn’t be offset by government spending which, thanks to a round of debt issuance, rose 1.3 percent in the quarter after edging just 0.1 percent higher in the first quarter. Ecuador thus fell into recession even though the public sector spent $3.8 billion – the most it has ever spent before in a quarter – and despite the second-highest quarterly investment level ever – $7.06 billion – according to the BCE data.

In a press conference, BCE president Diego Martínez refused to acknowledge the recession. “We’re still presenting positive inter-annual (growth) rates, for that reason I wouldn’t dare to speak of recession,” he said, pointing to the 1.0 percent annual growth rate from the second quarter of last year. He did acknowledge the difficulty in increasing the deficit, which would require $8 billion in new loans, of which around half appears to have been disbursed so far this year, with just three months left in 2015. Additionally, spending cutbacks mentioned by Martínez according to the BCE data will only have gone into effect from June, thus exacerbating the difficulties of the economy.

Ahead of the oil crisis, the administration said that it had decoupled the economy from the influence of oil. There is perhaps a little truth in this as the data show that even before the plunge in the price of the fuel, the economy started to decelerate. Recent annual growth peaked at 5.7 percent in the fourth quarter of 2013, and has since decelerated in annual terms in every quarter, except for the 3.2 percent year-on-year growth of the first quarter of 2015. An end to the economic doldrums is thus nowhere in sight. The administration has insisted on portraying Ecuador as an outperformer among South American economies. It’s not: when the commodities boom floated the region’s economies, it grew along with the rest, despite unorthodox economic policies. Now, it’s sinking with the rest too.

FRIENDS FOR NOW

After close to nine years of vilifying the private sector as “mercantilist” and greedy, president Correa has asked it for a life preserver. This week, he introduced, as expected, fast-track “emergency” legislation aimed at attracting the funds from the private sector that the public sector can no longer provide to continue to attempt to cover Ecuador in cement, i.e. major infrastructure projects. The congress thus has until October 28 to change or refuse the public-private partnership (PPP) bill, otherwise, like the controversial hydrocarbons (oil) industry bill in 2010, it will go into effect unchanged as submitted. The bill includes some generous tax breaks, but has already sparked some controversy, and the goal of raising some $6.5 billion of investment capital will require more than this law to be fulfilled.

On paper, the tax proposal is attractive, according to business leaders. It includes a 10-year suspension of the 22 percent income tax for new investments in the project portfolio and of the 5 percent currency export tax when the money goes to repay loans from foreign countries, including some previously considered tax havens. The private sector will be permitted to invest to a greater extent in “strategic sectors” like oil and electricity. The bill allows build-operate-transfer projects. It also pledges to cut red tape, including the particularly onerous and tedious procedure of obtaining sanitation permits, which extends to all kinds of legally sold foods. In seeking to alleviate the woefully low levels of foreign direct investment, the bill aims to give private companies the same legal status as the state-controlled companies that have failed to come up with the hoped for capital, particularly Venezuela’s state oil company, PdVSA.

The law for unclear reasons resuscitates a local tax for Guayaquil to fund a hospital there; the city’s chamber of industries has already complained about the revival of what it called a “zombie tax” contrary to the spirit of the bill. While a minor issue economically, it does reflect the conceptual difficulties the administration has with a law of this type. It raises the question of why a law aimed at attracting global investment would put an important local area of business, Guayaquil, at a disadvantage, and of why such a bill would include a hospital that should be included in laws regarding the health sector.  

A fundamental conceptual issue with the law is that it continues to obey the government model based on control of the economy. Approval of investment will hinge on a government-controlled “inter-institutional committee,” which also raises transparency issues. Another problematic discretional element of the bill is its handling of conflict resolution, which may be domestic “or” international arbitration, without specifying when either may be called upon. Whether the projects in the portfolio can work without subsidies will also matter to potential investors as the government and private sector may disagree on whether a project will, in the end, make money. In the current economic situation, it’s not clear that this bill goes far enough in abandoning the heterodox economic policy that has stifled the economy. Correa’s insistence on the inheritance and real estate windfall gains taxes signals the opposite. In the end, the law may not be any more successful than the government’s 2010 “production code,” which failed to stimulate private investment.

This commentary originally appeared in Ecuador Weekly Report published by Analytica. Republished with permission.

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