Ecuador - The Economy Fiscal Policies

Fiscal policies

The Ecuadorian public sector, comprising the central government, state enterprises, and autonomous agencies operating on a national scale, expanded rapidly during 1972-77. Public-sector expenditures, adjusted for an average annual inflation rate of 14 percent, swelled about 65 percent during this period. Such increases were made possible because of the boost in revenue derived from a rise in international oil prices and the expansion of oil exports, especially during the 1972-74 period, when petroleum revenues rose as a proportion of GDP from 2 percent to 8.4 percent. Meanwhile, revenues from nonpetroleum commodity exports declined from 18.7 percent of GDP in 1972 to 13.8 percent in 1975. In effect, the government substituted the taxation of oil for the taxation of other traditional products.

This policy caused no harm until 1975, when the volume of petroleum exports began to moderate and oil revenues declined relative to GDP. As the gap between public revenues and expenditures widened, budget deficits became the norm, and the government resorted increasingly to foreign borrowing as a substitute for declining tax revenues from nonoil products. Between 1976 and 1979, the foreign debt more than quadrupled; after 1979 the rate of borrowing decelerated, but still the foreign debt had doubled by the end of 1986. In 1983, as foreign banks reduced the amount of credit available to the government, unpopular austerity measures were adopted to help reduce the public-sector deficit.

The oil bonanza encouraged the government to undertake two deficit-producing policies. First, the government used about 50 percent of total public revenues from oil exports to subsidize domestic consumption of such items as food products, electricity, and gasoline and other oil derivatives. Government subsidies to consumers reached a peak of 10 percent of GDP in 1981. Second, the government increased substantially its public-sector employment and public capital expenditures. Although the labor force increased at an average annual rate of only 2.8 percent between 1970 and 1984, public-service employment rose at an average annual rate of 7 percent during the same period. A moderate expansion in public capital expenditures during the 1974-82 period contributed to improvements in the transportation and utility infrastructure and also in water and sewerage systems. During this period, public capital spending increased from 7.3 percent of GDP to 10.1 percent of GDP. Overall government revenue, however, had declined by 1 percent of GDP between 1973 and 1982. The public-sector deficit in 1982 represented 7.5 percent of GDP, most of which was financed by foreign borrowing.

The sharp drop in the international price of petroleum in 1986, followed a year later by a US$700-million loss of oil revenue in the aftermath of the March 1987 earthquake, generated increased foreign borrowing by the government, reduced debt-service payments, and induced the government to print money to make up for revenue shortfalls. To help keep inflation down to 32.5 percent in 1987 (about a 5-percent increase over 1986), liquidity was restricted in the private sector by raising bank reserve requirements. This policy made it difficult to acquire a commercial loan during the second half of 1987.

Although oil production reached near-record levels of 310,000 barrels per day following the repair of the Trans-Ecuadorian Pipeline in August 1987, international crude oil prices remained low, averaging about US$17.70 for that year. The government's failure to raise domestic energy prices or reduce spending in other areas contributed to a fiscal deficit approaching 12 percent of GDP.

Real GDP improved 8 percent in 1988, mainly as the result of increases in crude petroleum exports. The government's deficit reached about 12 percent of GDP. The government controlled the fiscal deficit by doubling domestic fuel prices, eliminating wheat import subsidies, and increasing electricity rates by 40 percent for household users and 60 percent for industrial users.

In 1989 the fiscal budget totalled US$1.4 billion, of which 49 percent was financed by oil export revenues and most of the remainder through taxes. About 38 percent of expenditures went to meet foreign debt payments after April, 10 percent for internal investment, and the balance to meet internal debt payments and current government expenditures. During 1989 the Borja administration accelerated efforts to curtail public spending, but the deficit, 10 percent of GDP, was still too high to be fiscally sound. The government continued its tight money policies, sustaining high interest rates and strict credit requirements, especially for noncorporate consumers.

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