Ecuador Special May 2016


Ecuador: Fallout from massive earthquake will restrain economic growth and increase fiscal pressures

May 12, 2016

A magnitude 7.8 earthquake hit large areas of Ecuador’s Pacific coast on 16 April with substantial effects on economic activity and devastating consequences for the country’s population. The government estimates that reconstruction costs will be around USD 3.0 billion, which represents approximately 3.0% of GDP. This will be difficult to finance given the country’s already-tight fiscal position. The government announced an emergency package to help pay for the reconstruction, which includes increases in several taxes, the possibility of privatizing state assets and the issuance of new bonds. While the reconstruction will add to mounting fiscal pressures on the government, the aid package is expected to contain some of it. However, since the government partially passed the burden on to the people, the measures are likely to restrain consumption and growth.

The earthquake, which mainly hit the coastal regions of Esmeraladas and Manabí, caused a death toll of at least 660 people and injured thousands. The magnitude of the economic damage was not as large as it could have been since Ecuador’s main areas of economic activity—Quito and Guayaquil—and the Esmeraldas refinery were largely unaffected by the earthquake. However, economic activity was severely disrupted in areas popular among tourists and in shrimp production.

In order to finance the rescue and reconstruction costs, President Rafael Correa announced an emergency package on 20 April. The measures within the package include an increase in the Value-added Tax (VAT) from 12% to 14% for one year, the levy of a one-off tax of 0.9% on people with wealth over USD 1.0 million and a one-off tax of 3.0% on profits. Moreover, Ecuadorean public employees will be asked to contribute with a portion of their salaries, from at least one day’s wages for those earning USD 1,000 a month and gradually increasing contributions for those with higher wages. The government estimates that together these fiscal measures will generate approximately USD 1.0 billion. On top of this, Ecuador has access to USD 300 million in emergency funding from the Ministry of Finance and a contingency credit line worth more than USD 600 million from multilateral lenders. Moreover, the government requested assistance from the IMF, despite the complicated relationship between the Correa administration and the Fund, owing to the President’s opposition to structural reform. Some additional measures that the government is contemplating in order to raise funds include the possible privatization of state assets and the issuance of new bonds.

The consequences of the earthquake are exacerbating Ecuador’s economic problems, which include subdued growth and an elevated fiscal deficit amid tight financing conditions. Dragged down by dwindling prices for oil—Ecuador’s key commodity export—economic growth has weakened notably over the course of the last year and GDP has been contracting since Q3 2015. Furthermore, low oil revenues increased the government’s financing needs and the government is still having trouble financing this year’s budget. The adverse impact of falling oil prices is amplified by the fact that Ecuador’s dollarized economy lacks the possibility to adjust to adverse external shocks via a flexible exchange rate.

The economic consequences of the earthquake further cloud Ecuador’s already-bleak growth prospects. Panelists surveyed for this month’s LatinFocus report see GDP contracting 2.7% in 2016, which is down 0.6 percentage points from last month’s forecast. For 2017, panelists expect the economy to return to mild growth and expand a soft 0.3%.

Author: Teresa Kersting, Economist

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