The Big Idea
Ecuador | IMF execution risks
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Although Ecuador’s program for the International Monetary Fund looks for only moderate adjustments next year, the target is still challenging. The country plans to cut fuel subsidies next month and may launch tax reform in November. This is quite ambitious ahead of general elections early next year. Progress on austerity will depend on the ability of President Daniel Noboa to sustain high approval ratings. He has to balance populism against austerity with re-election necessary to complete the IMF program. Approval ratings are not only a critical leading indicator of frontloaded austerity but also critical for re-election and a mandate for later austerity over a multi-year adjustment process. Ecuador’s current commitment to the IMF program should allow bond prices to recover back to recent highs.
The targeted unwind of fuel subsidies appears imminent with final planning underway for execution next month. This would deliver significant savings of near 0.5% of GDP. The timing seems unusual with prior expectations that the IMF would backload most of the austerity measures after the elections, especially after the goodwill of adopting tax reform earlier this year. These permanent savings would provide some carryover benefits for hitting fiscal targets next year. It’s a balancing act to execute austerity measures and maintain high approval ratings.
The early preview to June shows a further decline in approval ratings from 61% to 53.1% from Click pollster (June 8-12). This is similar to a recent poll from CB Consultora from 62.5% in May to 54.3% in June. Cedatos still shows stable approval ratings at 59.6% in early June. The levels, trends and relative comparisons are equally important on gauging the strength of the Noboa administration. Keep in mind that there is no serious competition. The Click report shows implicit low approval ratings for Correismo (23%-29% approval ratings for Quito and Guayaquil Correista Mayors). So, theoretically, the approval ratings could fall to a low floor (maybe above core Correista support of 30%). However, this underestimates the importance of a strong political mandate necessary to execute an unpopular IMF program. President Noboa probably needs approval ratings at 50% or above to assure a first-round win and a dominant block in the legislature.
The unwind of fuel subsidies comes as an unexpected surprise. This builds on a track record of effective policy management after successful tax reform. The Noboa administration seems willing to continue to adopt austerity measures ahead of elections. However, it is too soon to have conviction on what if any austerity measures are politically feasible later this year. It will depend on a minimum threshold of popular support. This is not easy with chronic electricity shortages, unresolved security issues and weak economic growth. It’s also not easy to predict approval ratings on weak data transparency for the real economy. The IMF expects only 0.1% GDP growth for 2024 and a slow 1.2% recovery in 2025. The consumer confidence data has been rising and reached muti-year highs in April 2024. The expectations index is highly volatile but remains above 50 to reflect maximum confidence in April 2024. These expectations may reflect improving future conditions (Click report has similar 55% future improving expectations) with austerity measures strongly pro-cyclical for an economic slowdown this year.
The initial proposal for tax reform would be much less controversial with a focus on reducing exemptions as opposed to the prior VAT hikes. It’s still early for specifics. The roll-off of the temporary taxes next year should be partly offset by full-year higher 15% VAT rates but will also require 0.4% of additional measures. This is quite conservative compared to the 2.0% of tax revenues from the 2024 tax reform. However, the political environment is less than ideal for any tax hikes during a full-blown political campaign. The tax officials suggest a draft reform before year and that would be effective in 2025. If the political agenda dominates against tax reform, then there is still flexibility to meet the fiscal targets. The lower subsidies would provide some savings with upside potential on tax collection efficiency.
It’s also important to emphasize that the successor IMF program upgrades the monitoring framework with high frequency monthly review of the fiscal data. This is intended to reduce the execution risks with a contingency back-up plan to meet quarterly targets. There are no details about the contingency measures; however, this monitoring framework shows unique commitment that would enhance implementation. The stabilization approach is not (yet) transformational, but President Noboa deserves credit with a reduction in subsidies complementing the recent tax reform and an overall consistent approach at tackling the fiscal problem. The success on subsidy cuts should allow for a full recovery in bond prices back to recent highs and then maybe another pause for reassessment of additional measures near year-end and ahead of election risks.
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