Ecuador: Austerity Without Unrest?

President Lasso will likely aim for spending containment rather than tax hikes.

BY LATIN AMERICA ADVISOR
Inter-American Dialogue

Ecuadorean President Guillermo Lasso said Sept. 2 that he aims to cut the country’s fiscal deficit next year in half, to approximately $2.4 billion, including by laying off state workers and other austerity measures. Lasso also said many people who benefit from fuel subsidies don’t need government assistance, but Lasso’s predecessor, Lenín Moreno, faced massive protests in 2019 after he tried to do away with the popular subsidies and was forced to reverse their cancellation. How critical is it for Ecuador to cut its deficit as much as Lasso is suggesting? How likely are Lasso’s plans to face large-scale protests? What types of cuts can Lasso make, and what should he avoid cutting, in order for his plan to win acceptance among the public and in the National Assembly?

Walter Spurrier, president of Grupo Spurrier and director of Weekly Analysis in Guayaquil, Ecuador: In October 2019, then-President Moreno raised prices to eliminate fuel subsidies except for cooking gas. Leonidas Iza, an Indigenous leader who was preparing a Columbus Day uprising, changed the leitmotif of the protest to the fuel hike and almost toppled Moreno, who had to withdraw the measure. Moreno retook raising prices at a 5 percent monthly clip; Lasso has maintained the hike. The population seems to have reluctantly accepted the price crawl. Iza toys with the idea of a new uprising in October, but he is unlikely to muster popular support. Lasso will have to cut bureaucracy while avoiding tax hikes for the middle class; financing sources have dried up. Lasso has already reduced the number of employees in the president’s office by 30 percent. The public sector payroll is 10 percent of GDP, three points above the Latin American average, and yet public services are deficient. In Ecuador, public sector layoffs are very costly but unavoidable as current spending is dead weight. Layoffs would be unpopular with those who are cut or those who feel they are next in line. However, Lasso’s popularity is sky high, and he must draw on that popularity to stabilize the economy as soon as possible. Private investment, which he sorely needs, hinges on the perception that Lasso will straighten out the economy, paving the way for his re-election or a similar-minded president in 2025. Investors dread an Argentina-like scenario with Correa returning to power under the cover of a protégé as president.

Carolina Caballero, associate, and Lisa Schineller, managing director and lead analyst, both for Sovereign & International Public Finance Ratings at Standard & Poor’s: Large and persistent fiscal deficits, as growth slowed and oil prices declined, underpinned a doubling in Ecuador’s debt burden between 2015 and 2020. Tight financing conditions forced Ecuador to implement austere policies, in addition to debt restructuring last year. Nonetheless, financing needs still remain large and depend on official financing given small local capital markets.

Notwithstanding President Lasso’s strong approval ratings, we believe there is limited room to maneuver in a context of a complex political landscape, institutional weaknesses and still-stressed socioeconomic conditions. Therefore, our ‘B-’ rating assumes a more gradual fiscal adjustment, with the general government deficit falling to around $2.9 billion in 2022-2023. This implies debt stabilizing just above 60 percent of GDP. The Lasso administration has already internalized various political constraints and society’s rejection of tax hikes, and it will target a less ambitious tax reform than the one included in the initial IMF program. This implies more adjustment in expenditures, but still with an eye to balancing pressures in society and the National Assembly. In our view, there may be some gains from payroll cuts in decentralized entities; however, at the central government level this could prove challenging, as most personnel is related to the provision of education, health and public safety. That said, we think the bulk of public sector reduction would come from cuts in infrastructure spending, which even though has considerably fallen from its record in 2014, it is still above the share dedicated by regional peers. To help limit the negative hit on the economy, we expect the government to continue to advance policies conducive to a friendlier environment for private investment.

Jaime Reusche, vice president and senior credit officer in the Sovereign Risk Group at Moody’s Investors Service: President Lasso will face resistance to any austerity measures he imposes because there is little flexibility on the structure of expenditures, given that capital spending has already been reduced significantly over the past five years. The margin to cut goods and services purchases is limited such that the focus has shifted to the wage bill. Politically, the president enjoys strong approval levels given the success of the vaccination campaign, providing some degree of acceptance for spending cuts. However, both the opposition and political allies to the government will be less tolerant of drastic reductions in public spending. The government has been careful in not attracting too much attention to the painful fiscal measures integral to its deficit reduction strategy, and this will support deficit reduction efforts. Beyond political opposition to fiscal measures, the government will find it challenging to meet its fiscal targets if the economy slows markedly following this year’s rebound. For the fiscal measures to be effective in stabilizing public finances, sustainable economic growth will need to be supportive of government revenues. Ecuador’s economy struggles to grow due to its dependence on public spending, and without extensive competitiveness-enhancing reforms that will require ever more political capital to enact. Fiscal challenges will increase as the liquidity relief from recent debt restructuring wanes. If successful, fiscal adjustment is only a first step to avoid relapsing into the liquidity issues that the sovereign faced in the past. The following step is the more challenging one as it entails a restructuring of the economy.

Todd Martinez, senior director in the Sovereigns Group at Fitch Ratings: Ecuador’s fiscal deficit is no longer very high. However, it is a key macroeconomic vulnerability in the context of narrow financing options, so it is important to reduce. President Lasso’s plan to halve the fiscal deficit in 2022 requires a significant consolidation effort, but even this represents a relaxation of the adjustment envisioned in the prior IMF program.

Lasso hasn’t detailed his fiscal plan, which will likely emerge soon when the IMF board approves a revised program, but it appears he will aim for a slower adjustment more focused on spending containment than tax hikes. Lasso, who thinks raising taxes (even a low 12 percent VAT rate) would complicate the economic outlook, may see this as a political nonstarter and appears to have convinced the IMF of this view. He even wants to cut some taxes, and already did so for import tariffs. Yet while spending cuts may sound more politically palatable now, they could also prove unpopular when details emerge. Laying off enough workers to generate major fiscal savings could face a backlash, and teachers are pushing for wage hikes after the courts overturned one approved by the prior government. Social groups are mobilizing against fuel price increases required under a new subsidy scheme introduced last year, and Lasso has stood firm on this so far. Greater clarification around a fiscal consolidation plan, and confidence in its political viability, will be key to any upside potential for Ecuador’s sovereign rating, which we recently affirmed at B-/stable.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor

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