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Ecuador 2013 | ECONOMY | REVIEW: ECONOMY

Government borrowing continues in support of a strong public investment program, while a widening trade deficit highlights dependence on international oil prices.

The Correa administration's policy of state-led investment, carried out, to some degree, on the back of Chinese loans, will keep the economy busy in 2013, although a weak external market is a worry as the current account falls into deeper deficit—it stood at $391.6 million in 1H2013—after a strong showing in 2011. After two years of above-average growth in regional terms—Ecuador's GDP expanded 8% in 2011 and 5% in 2012—the economy is expected to slow to 3.5% growth in 2013, in line with the regional average, according to the UN Economic Commission for Latin America and the Caribbean (ECLAC). Weak external markets, including poor outlooks in Europe, the US, and India, are somewhat to blame for the low growth prediction, which saw ECLAC revise its 2013 growth expectation for the Latin America region down from 3.8% to 3.5% in December 2012.

The government's budget targets just over 4% growth, based on a price per barrel of oil at $84.9—oil represents 14% of GDP, over 50% of export earnings, and around one-third of state revenues. In 2012, the region grew by a lower 3%, suggesting Latin America could indeed become a global growth engine if it can fulfill its FDI potential. In that regard, Ecuador had a modest year. While Latin American FDI was up 6.7% in 2012 to $173.4 billion, Ecuador attracted just $568 million according to the Central Bank of Ecuador (BCE), down 5% on 2011. Comparatively, Chile, a country with a similar population to Ecuador, received $17.3 billion, suggesting there is much work to be done to improve the country's investment environment. The medium-term outlook is encouraging, however, underlined by Standard & Poor's revision of Ecuadorean debt to “positive" from “stable." With the country still at the “B" rating, though, it remains nine notches below investment grade.

Unemployment dropped to 4.6% at the end of March 2013, from 4.9% in December 2012, while underemployment rose to 45% from 43.9%. Full employment stands at 48.4%, down slightly from 49.9%. The inflation rate was recorded at 2.39% in July 2013.

BUDGET

The government's proposed budget rose to $32.37 billion in 2013, up by 24% from $26.11 billion in 2012, according to the Ministry of Finance. The budget targets a rise in GDP of 4.05% in 2013, down from 5% in 2012. The inflation target is 3.93%.

The current administration has gained popularity on the back of large-scale government investment in recent years, a trend that does not look to be slowing down. In 2013, the budget calls for a deficit of $5 billion, which will mostly be closed by external financing, including significant contributions from China. Of the $32.37 billion budget, $1.29 billion will service the country's outstanding debt. A further $7.88 billion is accounted for by wages, while $7.60 billion has been earmarked for public investment.

China, Ecuador's largest lender, delivered the second installment of a loan to the country in August 2013, to the tune of $1.2 billion. This follows a $1.4 billion loan provided by China in February 2013, making China the country's largest lender.

The budget was drawn up on the assumption of an $84.9 average price per barrel of oil, up from $79.7 per barrel in 2012. Oil now accounts for 14% of Ecuadorean GDP, over 50% of its export earnings, and one-third of state revenues. Having banked on oil exports in recent years, the Correa administration has struck it lucky as the international price of crude remained high. In order to boost revenues, a renegotiation of oil contracts in 2010 imposed a profit ceiling of $32 per barrel on the country's extractors. While certainly boosting profits—an extra $1.5 billion was yielded as a result in 2011—it has highlighted the country's vulnerability to international prices. With WTI riding above $100 per barrel as of July 2013, there is little reason for short-term concern. If prices were to drop, however, Ecuador's economy could be left vulnerable.

TRADE

The trade deficit widened to $391.6 million in 1H2013, caused mainly by challenging external markets. Volumes also dropped by 2%, while prices fell 0.7%, meaning overall goods sold externally were worth $12.17 billion from January to June 2013, down on $12.26 billion during the same period the previous year. Imports were on the up over the first six months of the year, growing 6.5% from $11.77 billion to $12.26 billion. Overall import prices dropped, however, by 1.4%, according to Analytica. In 1H2012, the country's fortunes had been much different, with Ecuador logging a $487 million trade surplus. Oil represents over 50% of Ecuador's total export basket, while non-oil exports continue their slow recovery—between January and June 2013 the non-oil trade deficit narrowed by 3.4% to $4.2 billion, a figure higher than at any time in 1H2012. It is high oil prices, and the possibility of increased production, however, which could see Ecuador move back into the black in 2H2013.

In 1H2013, several industries saw declines in exports that could worsen in the face of an end to duties granted by the US. In some product groups, unit prices fell, including a 55.7% drop in pharmaceuticals and chemicals and a 33.7% fall in exported vehicles. Other categories also suffered in the first six months, with exports of tuna and other fish falling by 12.9% to $146.3 million. However, bananas, shrimp, and canned fish, the three largest export products after oil, saw growth in export value. Banana exports were valued at $1.23 billion in 1H2013, up by 6.5%, while shrimp was up 14.4% to $781.14 million and canned fish grew 12.7% to $712.49 million.

President Correa was also in Europe in 2013 as talks continued on an Ecuador-EU trade agreement. German Chancellor Angela Merkel backed increased EU-Ecuador trade relations, meaning that Ecuador's exporters could soon have cause for celebration should their products to be able to boast better access to the lucrative markets in the bloc. “I'm very optimistic and confident that we can successfully finalize these negotiations and reach an agreement by the first trimester of 2014," said Francisco Rivadeneira, Minister of International Trade.

FDI

Ecuador received the second lowest FDI haul in South America in 2012, pulling in just $568 million, placing it behind Paraguay. Total FDI in the region was up 6.7% to $173.4 billion, while inflows to Ecuador were down 5%. The economy, however, is in dire need of increased foreign investment as the long-term continuation of high public spending is restricted by foreign borrowing limitations. While there is hope that a planned mining law will, at long last, open up the country's sizeable mineral wealth to development, other changes are needed in the rule of law and the tax regime, which are targeted for reform. President Correa has announced that the administration expects to make $12.9 billion from taxes in 2013, around 40% of GDP, suggesting a dependence that could hold back development.

In 1Q2013, FDI totaled $95.1 million, down 56% on the quarter from $214.5 million and 13.3% less than the same period the year before. Latin American FDI reach could beyond $173 billion this year, according to ECLAC, again placing pressure on Ecuador to increase its flows.

NEW FRIENDS

In addition to strong budgetary support in terms of loans, China has sought to boost relations with Ecuador at both the public and private level. Ecuador's debt to China stands at $4.57 billion (36.4% of total foreign debt), with the country having borrowed $9 billion since President Correa took power. In exchange, China's state-owned firms have gained access to Ecuador's natural resources. In 2013 so far, the Far Eastern giant has provided loans worth $2.6 billion to Ecuador, as the Correa administration continues a course of high public spending, which, in some cases, has seen Chinese companies win significant contracts.

One such contract relates to the Pacific Refinery, a $12 billion project designed to bolster Ecuador's downstream sector and reduce oil-related imports, which currently stand at $4 billion a year. The China National petroleum Corporation (CNPC) recently entered into a 30% stake of the project, with 51% belonging to Petroecuador and the rest to Venezuela's PDVSA. In another Chinese link, the project is being financed by the Industrial and Commercial Bank of China. Another megaproject with Chinese involvement is the much-touted Coca Codo Sinclair hydroelectric facility, which is being built by Sinohydro. The $2.8 billion project is expected to add 1,500 MW of generation capacity to Ecuador's matrix, supplying 44% of the country's energy needs.