Good management of public finances by the National Government is one of the main aspects for the proper functioning of the dollarization system in Ecuador. This involves generating sufficient permanent income to cover public spending in essential sectors, as well as having access to financing under favorable conditions for necessary investments in public infrastructure.

The Non-Financial Public Sector (NFPS) [1]has historically shown overall negative results. Between 2018 and 2023, the NFPS reached its highest deficit in 2020, reaching USD 7.09 billion, equivalent to 7.4% of nominal Gross Domestic Product (GDP), as a consequence of the effects of the COVID-19 pandemic ( Figure 1 ). However, during the years 2021 and 2022, the global result of the NFPS showed improvement due to various factors, such as: i) growth of oil revenues due to the recovery in the operations of the Trans Ecuadorian Oil Pipeline System (SOTE) and the Heavy Crude Oil Pipeline (OCP), ii) increase in the international price of crude oil and, iii) higher tax collection due to improved economic activity and temporary contributions established in the Organic Law for Economic Development and Fiscal Sustainability.

Figure 1 . Global and primary result of the NFPS

In USD millions and percentage of GDP, 2018 – 2023

Source: Ministry of Economy and Finance and other NFPS entities

In 2023, according to preliminary figures from the Ministry of Economy and Finance (MEF), global NFPS deficit reached USD 3.81 billion, equivalent to 3.1% of the nominal GDP [2]. This mismatch is explained by a drop in total revenues of 3.8% compared to 2022, due to a 15% decrease in oil revenues, as a consequence of a reduction of USD 19.3 in the average price of Ecuadorian crude oil and of 1.2% in its production level [3]. Additionally, tax revenues decreased by USD 749 million compared to the previous year, due to a lower contribution of the Income Tax of natural persons and a decrease in tariff tax collection.

For the year 2024, given the decrease in oil revenues due to the closure of block 43-ITT; as well as the drop in tax collection due to a slowdown in the economy, it is estimated that fiscal financing needs exceed USD 9 billion. It should also be considered that the National Government will require additional resources to strengthen internal security.

This weak fiscal situation would generate difficulties in the payment chain of the national economy, derived from greater arrears with local governments and State contractors, causing a reduction in internal liquidity and generating a negative impact on economic activity. In the face of this fiscal scenario, the National Government would face difficulties in accessing external financing in good conditions, which would decrease the level of international reserves and deepen economic contraction.

Considering the lack of external financing and the reduction in oil exports, it is estimated that the level of International Reserves will decrease to levels close to the pandemic. As of January 26, 2024, International Reserves stood at USD 4.84 billion, which represented a decrease of 47.6% compared to the highest level reached in March 2022 of USD 9.23 billion ( Figure 2 ).

Figure 2 . International reserves

In USD millions, Jan. 2018 – Jan. 2024(*)

Source: Central Bank of Ecuador

This decrease in International Reserves was mainly due to the fact that the outflow of foreign currency from the payment of public sector’s foreign debt exceeded the inflows from external financing disbursements; as well as the decrease in oil revenues associated with the reduction in the internationally crude oil price.

In order to reduce fiscal deficit and allow the correct functioning of the Ecuadorian state and dollarization in the country, the Central Bank of Ecuador (BCE) considers necessary to implement structural reforms that guarantee higher revenues, lower expenses and access to external financing under favorable conditions.

Among possible reforms to organize public finances, the National Government has proposed an increase in the Value Added Tax (VAT) rate from 12% to 15%, which would generate around USD 1.3 billion in additional income per year.

It is important to highlight that this reform would not significantly affect the poorest families given that 90% of items of the Basic Family Basket (CFB) and 63% of the products and services it comprises are exempt from VAT. Additionally, this increase would have a marginal effect on inflation.

Additionally, at the regional level, Ecuador is the second country with the lowest VAT rate, only above Paraguay, and the collection of this tax in relation to the GDP of the Ecuadorian economy is below average for the region (Figure 3 ).

Figure 3 . VAT rate and collection with respect to GDP

Source: CEPAL and Central Bank of Ecuador

Among other measures that have been proposed in tax matters, is the self-withholding of Income Tax for large taxpayers, approved in the Law of Economic Efficiency and Employment Generation in December 2023. In this regard, it is worth nothing that, in the case of financial entities, they must pay the Internal Revenue Service (SRI) between 3% and 5% of their monthly income [4]. Additionally, the report for the second debate of the Organic Law Project to Confront the Internal Armed Conflict, the Social and Economic Crisis proposes a temporary tax between 5% and 25% on taxable profits of banks, savings and credit cooperatives and mutualists. These measures would impact the level of liquidity of the financial system, reducing its capacity to grant new credits required by the productive sectors and households. According to estimates by the Central Bank of Ecuador, the credit contraction generated by the self-withholding of Income Tax and the temporary tax on profits would cause a decrease in economic growth between 0.4% and 1.1% this year.

The solution to this serious fiscal crisis also requires prioritizing public spending on health, education and security. Along these lines, it is necessary to focus the fuel subsidy on the most vulnerable families. Evidence shows that this subsidy of USD 3.27 billion [5]disproportionately favors higher-income people and allows fuel smuggling and the production of narcotic substances.

Finally, the Monetary Policy and Regulation Board and the Central Bank of Ecuador consider the permanent increase in VAT and the targeting of subsidies to be a priority, as part of a comprehensive management program for public finances, in order to contribute to the good performance of private economic activity and the sustainability of dollarization in the country.

[1]Includes Central Government, Decentralized Autonomous Governments, Social Security Funds, and a sample of the most important non-financial public companies.

[2]The nominal GDP for 2023 is estimated at around USD 122.487 billion. This value is a preliminary figure subject to modification.

[3]Production calculated between January and November 2023 compared to the same period in 2022.

[4]Percentages were established by Resolution No. NAC-DGERCGC24-000000 dated January 12, 2024.

[5] Preliminary figure for 2023, subject to review.