Further austerity in Ecuador weighs on benefits of multilateral loan commitments

• On 11 March, the International Monetary Fund (IMF) executive board approved a USD4.2-billion Extended Fund Facility (EFF) for Ecuador, one of several multilateral finance agreements being pursued by the Ecuadorian government.
• Tapping the IMF implies Ecuador's acceptance of an economic and fiscal reform plan as a condition for the provision of financial support. The EFF aims to protect the poor and most vulnerable, foster job creation and productivity, support the dollarization regime, and improve the fight against corruption.
• Ecuador's government financing needs amount to approximately USD8.0 billion for 2019. The government's fiscal adjustment strategy has already facilitated a fiscal deficit reduction from 5.5% in 2017 to 3.0% in 2018. Further austerity measures to reduce fiscal deficit are highly likely. However, despite the expected benefits, economic growth will be hurt.

In total, Ecuador is seeking USD10.2 billion to support the government's economic policies until the end of its mandate in 2021. Other contributors include the Development Bank of Latin America (CAF), the Inter-American Development Bank (IDB), the World Bank, and the Latin America Reserve Fund. Of these loans, USD3.7 billion is earmarked for investment projects; the remainder of the funds are at the disposition of the government to spend as it pleases.

The USD10.2-billion package is likely to help support the level of Ecuador's international reserves. This will boost its liquidity position and support dollarization over the next three years, despite weaker external demand and softer oil prices in 2019-21.

Our macroeconomic outlook remains only modestly positive in 2019-21, projecting a sharp deceleration in 2019-20 in comparison with expected growth in the neighborhood of 1.0% in 2018. The context of deteriorated debt metrics, limited investor confidence, weak oil prices, and a relatively depressed economic growth outlook indicate that the government's fiscal position and its commitment to reform will be tested over the next three years.

Ecuador's government will continue to work on its fiscal adjustment strategy to meet its deficit reduction targets. We currently project a stronger fiscal position beyond 2019, as the medium-term balance of risks moderately improves. Persistent reductions in public investment could help improve fiscal balances but risk delays and cancellations to projects.

The government has pledged to reduce its public wage bill by USD1.0 billion over the next three years. It will also revise its list of social spending recipients to reduce welfare costs. It also plans to revise fuel subsidies - with the exception of socially sensitive diesel and gas - and implement further tax reform, in particular increasing value added tax (VAT) and eliminating the currency export tax (Impuesto Salida de Devisas: ISD). The government had already committed to gradual elimination of the 5% ISD before the IMF agreement was reached.

High debt repayments up to 2024 increase the pressure on the government's debt sustainability capabilities. We expect the government to work on a liability management strategy seeking to spread and extend its liabilities, and to capture concessional official funding where available.

On the downside, we assess increasing risks that could further deteriorate the current balance of risks:

• Large-scale public-sector protests force the government to rescind on its commitment to wage spending reductions.
• A fall in international oil prices; the sector accounts for about 26% of the country's budget and for more than 52% of export earnings.
• The cancelation of large-scale strategic mining projects; the sector is currently expected to attract foreign direct investment inflows in the three-year outlook, yielding an overall surplus in the external-accounts balance at about 1% of GDP.

On the upside, our baseline scenario assumes decreasing risks driven by the following factors:

• Completion of concessional loans from other official lenders, easing debt service risks and lowering Ecuador's borrowing costs.
• Government success in negotiating labor market adjustments with unions, indicating popular acceptance of the IMF deal.
• New commitments of foreign direct investment (FDI), particularly in the mining sector.
• Local elections were held on 24 March. The results are unlikely to threaten the implementation of IMF-backed austerity measures, also signaling that Correa's resurgence through Compromiso Social lacks political traction.