The Executive Board of the International Monetary Fund (IMF) approved a 27-month extended arrangement under the Extended Fund Facility for Ecuador on September 30, 2020. Under the new deal, Ecuador has already received a disbursement of $2 billion to ease the economic effects of the pandemic. As explained in the IMF Country Report 20/286, the country will receive a total of $6.5 billion in order to stabilize the economy, expand the coverage of social assistance programs, ensure fiscal and debt sustainability, and strengthen domestic institutions to lay the foundations for strong, job-rich, and long-lasting growth that benefits all Ecuadorians.
Shortly after the Executive Board’s meeting, Kristalina Georgieva, Managing Director and Chair of the IMF, stated that “the authorities have committed to unwind the crisis-related measures as the economy starts to recover. Fiscal sustainability would be anchored on the debt ceiling under the homegrown organic budget code (COPLAFIP) of 57 percent of GDP by end-2025. It would be underpinned by a combination of a progressive tax reform over the medium-term and expenditure measures that aim to align Ecuador with regional peers.”
As described in the Executive Summary of the request for an extended arrangement under the extended fund facility, the fiscal consolidation is envisaged to include both revenue and expenditure measures by the end of 2025. The suggested package is projected to include permanent measures balancing revenue increases (2.5 percentage points of gross domestic product (GDP)) and expenditure restraint (2.9 percentage points of GDP).
Future measures are aimed at restoring fiscal sustainability while protecting the common interest of the Ecuadorian population. Under the new accord, national authorities will have to implement a progressive tax reform by the end of September 2021.
It is estimated that in order to create a 1.38 yield (in percentage of GDP) by 2025, Ecuador will have to implement new value-added tax (VAT) collection measures including:
- a 3 percentage point increase in the VAT rate (from the current 12% rate);
- a reduction in VAT exemptions for universities; and
- elimination of a VAT refund to the elderly.
The rest of the revenue increase will have to be achieved by modifying tax norms on personal income tax (PIT) (0.65%), as well as corporate income tax (CIT) (0.10%) and others (0.39%).
New collection efforts would include measures such as:
- the addition of the 13th and 14th salaries (social benefits complementary to regular monthly wages) to the PIT base;
- modification to the PIT brackets to increase progressivity;
- VAT creditable against PIT;
- elimination of the reduced CIT rate for productive assets;
- introduction of accelerated depreciation;
- outflow tax creditable against the CIT;
- excise tax on gasoline;
- expansion of the base of the telecommunications tax; and
- introduction of an environmental tax on carbon dioxide emissions.
In order to reduce expenditure and accomplish the goal of contributing 2.9 percentage points of GDP by the end of 2025, future fiscal plans must include:
- reducing wages and salaries (by 0.6%);
- reducing costs of goods and services, excluding Covid-19-related spending (by 0.7%);
- reducing capital spending (by 2.1%); and
- reducing fuel subsidies (by 1.1%).
Despite the above, social spending by 2025 will increase by 0.9%.
To accomplish the reduction in capital spending, over the coming years Ecuadorian authorities will have to work on prioritizing capital spending toward projects that generate more growth and create jobs. To reduce the cost of goods and services, new reforms will need to be implemented to improve procurement practices, including increasing competition procedures, consolidating procurement where economies of scale exist, and improving electronic procurement.
The private sector will benefit from the implementation of new procurement procedures, as the new transparency of the process will bring greater competition and mitigate the risks of corruption within the purchasing process.
The historic fuel subsidy reform implemented in 2020 will allow the government to rebalance spending and direct efforts to social assistance. The introduction of an automatic fuel pricing mechanism is expected to generate savings of nearly $3 billion over the next five years.
Ecuador´'s economy has traditionally included high levels of public spending. Over the next five years, however, the national budget will have to prioritize capital spending to generate new jobs and growth. It is expected that the moderation in public spending will save about 2% of GDP in such period.
The IMF Country Report 20/286 explains that in the baseline scenario, public debt is expected to reach around 57% of GDP by 2025. Considering that projections for 2020 place public debt at 68% of GDP by the end of the year, investors can have greater confidence in their investments as the ratio will tend to decrease under the new economic scenarios.
It is important to note that the critical threshold for an emerging economy such as Ecuador is 70% of its GDP. The combination of fiscal reforms and better economic budgeting will cause a drop in financing needs in the medium term.
Ecuador has committed to improving the business climate by strengthening the rule of law. In the past, businesses have shown a low level of confidence in public institutions. The passing of new laws and the anti-corruption law, currently being debated in the National Assembly, is aimed at restoring trust in the public sector. The new anti-corruption law is expected to be enacted by the end of December 2020 to ensure that acts of corruption are criminalized in line with the United Nations Convention.
Under the Ecuadorian Constitution, the suggested tax reforms will need to be approved by the National Assembly. The most sensitive issue will definitely be the increase in VAT. It is evident that the current 12% rate is one of the lowest in the region, but it will be an uphill battle for the next president and the legislators to pass the necessary VAT reforms.
As for the other tax reforms, approving them will not represent much of a political battle. Over the last two decades, Ecuador has granted many tax benefits to incentivize investment, but the results have not been as successful as intended. It is evident that tax incentives are not the main driving force for international investors. Unfortunately, national businesses wrongly consider that granting tax benefits will attract new investment. The passing of new laws should be focused on providing stability and clear rules, rather than reducing the fiscal burden, which in the case of Ecuador is not as high as perceived.
Presidential elections are less than a year away. Candidates are now faced with the need to introduce plans for the implementation of the accords reached with the IMF. Most of the changes will have to be implemented by the next government, so their campaign platforms and government plans will have to consider the risks involved when discussing and implementing the reforms suggested by the IMF.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Diego Almeida Guzmán is the Senior and Technical Partner and Diego Andrés Almeida is Senior Consultant with Almeida Guzmán & Asociados.