Saturday, May 23, 2020

The lost savings Funds would have cushioned the crisis in Ecuador


By Luis Fierro Carrión (*)

On May 11, Norway's sovereign wealth fund decided to liquidate 3% of the fund's value, to support the government's efforts to combat the COVID-19 pandemic and boost economic recovery.

That withdrawal of 3% of the value was equivalent to 37 billion dollars. This is so because the fund has accumulated a value of 1.18 trillion dollars. It is the largest sovereign wealth fund in the world; it is followed by SWFs from China (China Investment Corporation), Abu Dhabi, Kuwait, and Saudi Arabia, all with more than $ 500 billion in assets at the end of 2019.

In Latin America, some countries have stabilization and savings funds, but with much smaller amounts. For example, Chile has an economic and social stabilization fund ($ 14.7 billion) and a Pension Reserve Fund ($ 9.4 billion). Other countries with smaller funds include Peru, Brazil, Mexico, Trinidad and Tobago, Colombia, and Bolivia (all linked to the export of natural resources). Venezuela had a substantive fund, but with its protracted crisis it has vanished.

In the case of Norway, the fund has the official name of “Global Government Pension Fund”, and was created in 1990 to save the oil income that the Nordic country was receiving; The objective was to reduce the volatility of tax revenues due to the fluctuation of oil prices in the international market. A secondary objective was to reduce the macroeconomic impact of oil revenues, which in other countries (including Ecuador) has generated the so-called “Dutch disease”, in which the productivity of other economic sectors was affected.

The "Tiny Funds" in Ecuador

In Ecuador, apart from the international reserves, there were some attempts to create a stabilization or savings fund:

• In 1998, the Petroleum Stabilization Fund (FEP) was created to accumulate the surpluses of oil revenues above the budget.
• In 2002, the “Fund for Stabilization, Social and Productive Investment, and Reduction of Public Debt” (FEIREP), a trust managed by the Central Bank, was created.
• Later, in 2005, at the initiative of then Minister Correa, the FEIREP was transformed into the “Account of Productive and Social Reactivation” (CEREPS); 20% of its income went into a “Savings and Contingency Fund” (FAC), apart from the unused CEREPS balances at the end of the fiscal year. The FAC had among its specific objectives to be able to attend natural disasters and other emergencies.
• In 2006, the “Ecuadorian Investment Fund in the Energy and Hydrocarbon Sectors” (FEISEH) was created, fed with the income of Block 15 (after the declaration of expiration of the Occidental oil contract), as well as the Eden-Yuturi fields and Limoncocha.

Between these “tiny funds”, as then President Rafael Correa derogatively called them, savings equivalent to 12.1% of GDP were accumulated (https://flacsoandes.edu.ec/web/imagesFTP/9431.WP_018_CGiraldo_01.pdf ). Apart from this, the balance of public debt was reduced.

During the Constituent Assembly, an Organic Law was approved in 2008 for the “Recovery of the Use of State Petroleum Resources and Administrative Rationalization of Debt Processes”. In practice, it meant the elimination of these funds and facilitating the contracting of additional debt.

Oil revenues and fuel subsidies

During the decade of Correa's government, the country had oil revenues for a total of $95,581 million (35% of all oil revenues in the history of the country, in real terms, according to a study by Alberto Acosta and John Cajas, “A Wasted Decade”). Between 2007 and 2016, the non-financial public sector had total revenues of $ 283 billion. 

Notwithstanding this massive level of income, not only were the savings and contingency funds eliminated, but the net international reserve was left in negative terms; and Correa bequeathed a total public debt of about $ 60 billion.

Of the total oil revenue, about $ 23 billion (a quarter) was used for fossil fuel subsidies. This subsidy is very regressive, as more than 50 % benefits the two quintiles with the highest incomes: apart from which a significant part of the subsidy escapes by contraband. The subsidy also encouraged fossil fuel consumption, with adverse effects on climate change, health, pollution, etc.

After a failed attempt in October 2019 to eliminate subsidies for extra gasoline and diesel (the subsidy for super gasoline had previously been eliminated), on May 19 the President issued Decree 1054, which establishes a new market price system for extra gasoline, extra gasoline with ethanol and diesel. A “price band” system was established, taking into account the cost of fuels, the marketing margin, plus a monthly variation limit of +/- 5%.

In the initial period of application of this new price system, the result was that the price decreased, given the significant drop in the international price of crude oil and derivatives in international markets. Thus, the retail price of extra gasoline (including the commercial margin) decreased to $ 1.75 per gallon, and the price of diesel decreased slightly to $ 1 per gallon.

The Ministry of Economy and Finance will design the “necessary compensation instruments as a consequence of the application of the price band system”. Minister Martínez indicated that the government is analyzing social protection mechanisms in the event of sustained growth in the prices of gasoline and diesel. There is a preliminary proposal to increase the Human Development Bonus cash transfer program by $ 10 and compensate the most vulnerable in the event of an increase in public transport tickets. Another alternative is to subsidize public transport (either to users or carriers). 

Laws approved by the Assembly

In the laws approved by the Assembly, the Solidarity Law or COVID-19 and the Law on Public Finances, there are two aspects to highlight regarding the issue of oil revenues.

On the one hand, the possibility of contracting insurance to hedge the risk of lower oil prices is introduced, as the Mexican government has regularly done (Minister Martínez argued that previously he did not have the legal backing to do so, which will now be made possible by a provision of the Public Finance Regulation Law).

On the other hand, a Fiscal Stabilization Fund is created again, from income from the exploitation and commercialization of non-renewable natural resources (oil, gas, mining) that exceed what is contemplated in the annual public budget.

Obviously, with current prices, it will not be possible in the short term to accumulate resources in the fund, nor to contract a price insurance, but the reform is designed for the future, so that, if another pandemic, natural disaster or abrupt fall in the prices of exports occurs, Ecuador has a financial “cushion” – a cushion that the Correa government took away from us.


(*) This is an English translation of the article published by “Revista Gestión” on May 23, 2020.

The author is an economist from the Catholic University of Ecuador (PUCE), with graduate degrees from the University of Oregon and the University of Texas at Austin. He was a staff member of the IDB from 1997 to 2013, and Representative of Ecuador to the IMF in 2006. Advisor on climate finance and development issues. Personal opinions.

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