Ecuador is a country of 12.87 million inhabitants located on the equator in South America. The economy generated an estimated gross domestic product (GDP) of $13.6 billion in 2000 and provides formal sector jobs for about 2.9 million people. With 271,000 square kilometers, Ecuador is the size of the state of Colorado and contains dramatic geographical and biological diversity with rich economic potential. The country consists of four distinct regions: the tropical lowlands of the Pacific coast, the mountains and valleys of the Andean Sierra, the Amazon rain forest of the Oriente, and the Galapagos Islands.

Until the 1970s, Ecuador was an agrarian country dependent on commodity exports, such as cacao and bananas. Starting in 1972, oil development in the Amazon basin fueled a decade of rapid growth, averaging 9% annually, that financed expanded public services, state enterprises, infrastructure, and import-substitution manufacturing. When oil prices fell during the early 1980s, Ecuador failed to reduce inefficient state involvement in the economy. Consequently, the 1980s were a decade of stagnation under the burdens of debt and inflation. During the 1990s, Ecuador made some market-oriented structural reforms, but incomplete implementation failed to create sustainable growth. Falling oil prices, the El Niño weather phenomenon and the international financial crisis further exacerbated Ecuador's economic woes in the 1990s.

Petroleum production continues to be the mainstay of the Ecuadorian economy. The largely state-operated oil sector accounts for about 45% of public sector revenue and 50% of export earnings. Oil production is expected to further increase following the recent conclusion of a deal, after years of delay, to build the new Transandean Heavy Oil Pipeline (OCP, in Spanish) to transport Ecuador's crude to market. The project will reportedly generate 56,000 new jobs, inward investment of $3.5 billion (including direct project investment of over $1 billion), and as much as $730 million in annual royalties and tax payments once the pipeline becomes operational.

Ecuador is the world's largest exporter of bananas ($821 million). The country is also a major exporter of shrimp ($285 million). Exports of non-traditional products such as roses ($194 million) and tuna ($72 million) have grown in recent years. Ecuador's farmers also produce a variety of domestic consumption crops. Ecuador's protected industrial sector is largely oriented to producing for the domestic market. The services sector provides some modern infrastructure. Tourism plays an increasingly important role in the Ecuadorian economy and is now the third-largest source of foreign exchange (after petroleum and repatriated capital from emigrants). Tourism to Ecuador in 2000 increased 27%, with 637,000 visitors spending more than $400 million.

The public sector continues to be inefficient and suffers from endemic corruption. The Government has begun efforts to privatize the electricity sector, although initial interest from investors has been modest. The petroleum and telecommunications sectors would also benefit from increased private participation. The Government has made some efforts to reform and streamline Ecuador's outdated tax system, and has indicated that it will pursue further tax reform in the second half of 2001. The dysfunctional judicial, public pension and education systems remain in desperate need of reform.

In early 1999, falling public confidence in the economy, a faltering bank system and a large (unfinanced) budget deficit combined to send the local currency (the sucre) plunging and inflation soaring. In March, to prevent a systemic financial crisis, President Jamil Mahuad declared a week-long national bank holiday and froze most of the country's bank deposits. The move, along with an announcement later in the year that Ecuador would adopt the dollar as its official currency, was deeply unpopular and Mahuad was removed in a coup d'etat in January 2000.

Vice President Gustavo Noboa constitutionally succeeded Mahuad in January 2000. Faced with the prospect of imminent hyperinflation, Noboa opted to implement Mahuad's policy of dollarization (with a fixed exchange rate of 25,000 sucres to the dollar). In April 2000, the Noboa Government signed an agreement with the International Monetary Fund for a one-year stand-by agreement. In September 2000, the Noboa Administration concluded negotiations with the Paris Club of official creditors for a one-year rescheduling of $880 million in debt and arrears.

As a result, the country's economic outlook has stabilized. After falling 7.3% in 1999, GDP grew 2.3% in 2000. The Central Bank projects that GDP will grow by 3.6% in 2001, the result of pipeline-related investment and a continuing recovery in demand.

However, serious economic problems remain. Poverty has more than doubled in the last five years. According to UNICEF, 70% of the population lived in poverty in 2000, up from 32% in 1995. The financial sector remains weak, and public confidence in Ecuadorian banks is extremely fragile.

Fiscal Policy

Dollarization has imposed a fiscal discipline not previously in evidence in Ecuador. The 2001 budget submitted by the Administration and approved by Congress was unrealistic and did not take into account the phase-out of the controversial financial transactions tax and customs surcharges imposed during the crisis in 1999. Faced with an unfinanced deficit, the Noboa Administration raised fuel prices and lowered subsidies on domestic cooking gas at the start of 2001. In May 2001, the Government raised the value-added tax from 12% to 14% (from June 1, 2001). Further fiscal reforms are planned to further streamline Ecuador's cumbersome tax system, reduce fiscal earmarking to allow the Government to better target spending, and improve efficiency at Ecuador's notoriously corrupt Customs Service. It is hoped that these measures, if implemented, will lead to medium-term fiscal stability.

Monetary and Exchange Policy

Ecuador announced its intention to adopt the dollar as its official currency at the start of 2000. The sucre and the dollar were permitted to circulate simultaneously for a period of one year. The official conversion rate was fixed at 25,000 sucres to the dollar during the transition period. Despite minor glitches, such as an initial lack of small change and low-denomination bills, the process proceeded remarkably smoothly. By the beginning of 2001, over 98% of transactions were being conducted in dollars and familiarity with the new currency was widespread throughout the country.

Dollarization has led to a marked deceleration in inflation. Inflation fell from an annual rate of 96.1% in 2000 to a projected annual rate of 46.6% in April 2001. Preliminary monthly inflation in May was just 0.2%, indicating that the rate of inflation will likely continue to fall throughout 2001.

Relations with International Financial Institutions

In April 2000, the Noboa Government concluded agreement with the International Monetary Fund for a one-year $300 million stand-by arrangement. The second review of the program was delayed to allow Ecuador additional time to comply with its commitments under the agreement. In May 2001, the IMF concluded its second review and approved the release of the third tranche of $48 million in funding. The IMF also agreed to extend the standby arrangement to the end of 2001. Ecuador has already announced its interest in a follow-on three-year Extended Fund Facility with the IMF at the conclusion of its standby arrangement.

Disbursement of the third tranche of IMF funds clears the way for the release of pending disbursements from the World Bank and the Inter-American Development Bank. It also allows for the entry into force of Ecuador's previously concluded Paris Club arrangement.

B. PRINCIPAL GROWTH SECTORS

Petroleum

Under the constitution, all subsurface resources are the property of the state. Petroleum is the basis for Ecuador's external economy, accounting for 19.6% of GDP. Exports of 86 million barrels of crude and 15.8 million barrels of refined products earned $2.4 billion, up from $1.47 billion in 1999. The price of Ecuadorian crude averaged $24.87 per barrel in 2000, up sharply from the $15.50 per barrel average in 1999. The average price for Ecuadorian crude in the first quarter of 2001 was $19.47 per barrel. Although the Government technically allows for free retail pricing of gasoline, wholesale margin controls effectively set the pump price.

The majority of crude production comes from fields in the Amazon basin originally developed by Texaco and now operated by Petroecuador, the state oil company. Remaining proven reserves are 4.1 billion barrels, according to Petroecuador. Private oil companies (e.g. Occidental, Oryx, YPF Ecuador) operating under service and participation contracts have brought new fields on line. The construction of the new oil pipeline is expected to spur further research, development and production.

Oil producers in the Oriente rely on the Trans-Ecuadorian Oil Pipeline (SOTE, in Spanish), with a nominal capacity of 325,000 barrels per day to move crude to the oil terminal at the port of Esmeraldas. Due to the capacity limits of the pipeline, the volume of crude extraction by private contractors is being rationed. Construction of the OCP, slated to begin in August 2001, is expected to more than double transit capacity.

Since Ecuador's oil concessions are largely located in the ecologically fragile Amazon rain forest, developments in the sector are of keen interest to the international environmental community. The Government has incorporated environmental criteria and requirements into the licensing process. The new oil pipeline has also attracted attention due to ecological concerns with the proposed transit route.

Mining

Ecuador has extensive, but underdeveloped, mining potential. According to a British Geological Survey completed in 2000, Ecuador is estimated to have 24.6 million ounces of gold, 56.4 million ounces of silver, and 680 million pounds of copper/molybdenum. The country also has significant quantities of nonmetallic minerals such as cement, marble, clay, and silica. These reserves are attracting international interest -- four well-known foreign mining firms have been granted large concessions in Ecuador over the past year.

In August 2000, the Government adopted a new mining law. The accompanying regulations were published in April 2001. The aim of the new law and regulations is to spur investment into the sector by enhancing legal protection for mining investors, eliminating royalties and addressing environmental concerns.

Under the new law, investors can acquire mineral rights for exploration and investment for an initial period of thirty years, indefinitely renewable, instead of having to acquire multiple rights for exploration and exploitation. Once the rights have been granted, the Government can only cancel them for lack of payment of the required licensing fees, known as "conservation patents."

The patents are no longer based on the type of material mined, but instead on the size of the concession area and the number of years in the exploration and/or exploitation process. The fees are $1/hectare during years 1-3; $2/hectare during years 4-6; $4/hectare during years 7-9; $8/hectare during years 10-12, with a maximum fee of $16/hectare from year 13 on. Concessions are limited to 5,000 hectares, but there is no limit on concessions that can be held by individuals or companies. Concession areas can be modified. As areas of exploitation are defined and established during exploration, the concession can be condensed, and consequently licensing fees reduced.

Concessions are now "transmittable" and "transferable." Ecuador defines "transmittable" as capable of being passed to heirs, and "transferable" as capable of being rented, leased, or sold. The new law eliminates the requirement that mining take place only in areas designated as special mining zones, opening up several areas that were previously off-limits.

The application process for mineral rights concessions is also clarified in the new regulations. Once an application is completed, the Ministry of Energy and Mines has 15 business days to approve or reject the application. Existing concessions and available areas can be found on the Ministry's Web page at www.mineriaecuador.com. The new regulations will eventually be posted on the Web page, too.

The new regulations define the Undersecretariat of Environmenal Protection in the Ministry of Energy and Mines as the controlling environmental authority for mining activities. This eliminates the previous requirement to obtain environmental clearances from up to 11 municipal, regional and national environmental bureaucracies.

The new Law of Mining also eliminates royalty payments. However, mining interests are still liable for all other taxes, including business, income, and value-added taxes.

Electricity

Ecuador has begun efforts to privatize its mostly state-owned electricity sector. Amendments to the 1996 Electrical Sector Law adopted by the Ecuadorian Congress in 1998 authorized greater private participation in the electrical sector, but did not permit private firms to obtain majority control over any distribution, generation or transmission firms controlled by the state (the vast majority). Further reform legislation passed in 2000 authorized private firms to purchase 51% of shares of virtually all distributors and generators. The exception was Empresa Hidropaute, the company that manages the Paute hydroelectric dam that accounts for a quarter of the nation's electrical power. This restriction was subsequently lifted by additional reform legislation passed in fall 2000.

The next phase of electricity sector reform involves the privatization of the 18 state-owned electricity distributors by the end of 2001 (there is currently one privately-owned distribution company that is being treated separately). The Government has divided these distributors into four parcels of roughly similar size (ranging from 384,000 - 703,000 users and 677-2,325 gigawatt hours/year each). The prequalification deadline was recently extended to June 29, 2001, at which time two firms had already submitted applications. The current target date for the actual auction of the distributorships is September 26, 2001.

Although some progress has been made in reforming the sector, major obstacles remain. The ownership structure of distributorships, which belong to various branches of the government (including provincial and municipal entities), complicates efforts to attract private investment. Additionally, under state control the Government has historically repressed electricity tariffs, forcing distributors to operate at a loss. In turn, this has hampered efforts to expand supply. To address this problem, the Government initiated monthly price hikes of 4% in May 2000. With inflation finally starting to decelerate sharply, these monthly increased are starting to make significant headway in bringing tariffs closer to the break-even point and increasing the attractiveness of the sector for private investors.

Telecommunications

A new law liberalizing the telecommunications market was adopted in March 2000. It was approved by CONATEL (the National Council of Telecommunications) in September 2000. Regulatory efforts are underway to clarify remaining areas of legal uncertainty to facilitate liberalization.

The Government has announced its intention to auction new telecommunications licenses in 2001. The tentative auction schedule is as follows: In September 2001, Ecuador plans to auction off licenses for wireless mobile telephone service. In October 2001, the Government plans to auction licenses to provide PCS (Personal Communications Service) cellular telephone service. In November, the Government will auction licenses to provide Broadband services for data transmission, which should improve internet connections in Ecuador.

Efforts are also underway to untangle the confusing web of Ecuadorian telecommunication agencies. Proposed legislation would merge the Superintendency of Communications (responsible for policing the sector) and CONARTEL, the National Council of Radio, Broadcasting and Television (which controls licensing) into CONATEL (which controls regulation). If implemented, this merger would simplify and clarify the rules of the game for telecom investors in Ecuador.

C. GOVERNMENT ROLE IN THE ECONOMY

The state has long played a significant role in the economy, characterized by bureaucratic regulation, unproductive subsidies, and state ownership of "strategic" economic assets. Federal budget expenditure accounts for 22% of GDP. Ecuador's armed forces are major economic players and run a large commercial empire that includes interests in aviation, agriculture, banking, transportation, shrimp, and flowers, among other areas. The government has also found itself managing a large part of Ecuador's financial sector, following state intervention to prevent a systemic banking collapse in late 1999. While some state-intervened financial institutions have been closed, none have been sold and many remain in government hands.

Structural Reform and Privatization

Ecuador has been slow to embrace the market-oriented reforms that have taken place elsewhere in Latin America. Fundamental structural changes needed to attract investment and spur growth have not been implemented despite new laws allowing greater private participation in the economy. There have been no serious proposals to privatize the large complex of companies owned by the military. Efforts to allow private pension funds have met stiff opposition from the bankrupt Social Security Institute and other groups.

Efforts to reduce the state's role in the economy are just beginning. In early 2000, legislation was passed to permit a broader role for private investors in the electricity, telecommunications and petroleum sectors. The Government is moving forward with privatization in the electricity distribution sector. Plans to permit greater private participation in the telecommunications sector are also proceeding. See "Principal Growth Sectors" for a further discussion.

Industrial Policy

The Ecuadorian government has largely abandoned formal industrial promotion policies characterized by tax breaks and subsidized credits. However, businesses do benefit from very generous government policies permitting debt restructuring over repayment or bankruptcy. Tax evasion by Ecuadorian business is also widespread. Some tax incentives in the fishing industry and for agricultural industrial investment still exist. Free trade zones and "maquila" procedures allowing companies to import goods duty-free for processing and re-export exist, but are not widely used.

D. BALANCE OF PAYMENTS SITUATION

Trade and Current Account

According to Central Bank balance of payments data, Ecuador had a current account surplus of $1.6 billion or 11.7% of GDP in 2000. Ecuadorian exports in 2000 were $4.8 billion, up 10% from 1999. The increase was largely due to higher prices for oil, Ecuador's largest export. Imports for the same period were $3.2 billion, up 15% from 2000, reflecting a recovery in demand after the economic collapse of 1999.

The United States maintained its position as both the primary market for Ecuadorian exports and the key supplier of Ecuador's import needs in 2000. The United States purchased $1.8 billion in Ecuadorian exports in 2000, or 38% of the total. The United States provides markets for Ecuador's crude oil exports, shrimp, bananas, coffee, and cut flowers. Other major Ecuadorian exports to the United States include fish, cocoa, sugar, plywood, and gold.

Imports from the United States registered a slight increase (1%) in 2000 to $932 million, accounting for 25% of the total. Paper products, construction equipment parts, electric generators, wheat, plastics, turbines, computers, corn, motor vehicles and parts, cotton, petroleum gases and oils, fertilizers and pesticides, telecommunications equipment, tire cord, pumps, domestic appliances and refrigeration equipment are among the U.S. products that have found a niche in the Ecuadorian market.

Ecuador's eight largest non-U.S. suppliers are Colombia, Japan, Venezuela, Chile, Germany, Mexico, Argentina, and Brazil, which together enjoy a 45% share of the Ecuadorian import market. Ecuador has free trade agreements with Colombia, Venezuela, and Chile, obtaining 26% of its imports from those countries in 2000, up from 23% in 1999. In January 1995, Ecuador instituted a common external tariff system with Colombia and Venezuela. Ecuador joined the World Trade Organization (WTO) in January 1996, but has yet to meet a number of its accession commitments.

Capital Account and Foreign Reserves

Ecuador posted a capital account deficit of $1 billion in 2000. Capital flight and undocumented imports, recorded as "other capital outflows", totaled $1.8 billion, a small improvement over last year's level of $1.9 billion. Direct investment in 2000 was $708 million, up 11% over the previous year. Direct investment in 2001/2002 is expected to rise sharply with the construction of the new oil pipeline. Theoretically, dollarization and decelerating inflation should mitigate capital flight and help bring the capital account back to a surplus. However, in the short term capital flight will likely remain high due continued economic and political uncertainty, the difficult investment climate, and a fragile banking system.

External Debt

The stock of public external debt was $13.37 billion at the end of 2000. External debt in 2000 was approximately 80% of GDP, a sharp improvement over the previous year when the debt-to-GDP ratio was 100%, due to the dramatic depreciation of the sucre prior to dollarization. Private external debt at the end of 2000 was $2.59 billion. Although Ecuador concluded negotiations in September 2000 with the Paris Club of official creditors for a one-year rescheduling of $880 million in debt and arrears, the agreement could not enter into force until the completion of the IMF's second review under the Ecuador standby program. Successful completion of the second review in May 2001 clears the way for the entry into force of the 2000 Paris Club, which should provide some interim debt relief.

E. INFRASTRUCTURE

Transportation

Several major carriers, including American and Continental, and several U.S. air cargo companies, service the two international airports in Quito and Guayaquil. Ecuador's TAME airline (owned and operated by the Ecuadorian military) provides connections within the country and abroad. There has been some discussion of bidding out concessions to build new airports, although the process is in the initial stages.

The containerized port of Guayaquil handles most of the country's imports and exports. The port is fully utilized, with ship turnaround times typically taking five days. The main oil terminal is located at Esmeraldas on the north coast. On the central coast, Manta handles much of Ecuador's cocoa and coffee exports as well as almost all tuna exports. Machala's Puerto Bolivar on the south coast is the major banana port. Municipal and provincial authorities in Manta have announced ambitious plans to expand Manta's port. While an expansion of capacity would be welcome, the most urgent need is for a modernization and rationalization of Ecuador's notoriously corrupt and inefficient customs service.

Ecuador has an extensive system of all-weather roads linking populated parts of the countries. While there are projects for expanding the road system in sparsely populated regions, repairing existing roads damaged by regularly occurring floods and mudslides, as well as maintenance and widening of other roadways, is deemed to be of greater urgency. Subsidized urban, intercity, and rural bus service is available throughout the country. Trucking companies move almost all in-country freight. Goods must be moved by national carriers when crossing the border with other members of the Andean Pact. The railroad system has been largely inoperative for the past decade, following damage by a major earthquake.

Telecommunications

While telecommunications has improved over the last few years, basic telephone service is still poor. State-owned Andinatel and Pacifictel provide basic telephone services, while two private companies (Bell South and Porta) provide cellular telephone services. Call-back and bypass services are illegal. Domestic and international dialing is available, although the completion rate is poor. Domestic telephone rates are still subsidized by international calling rates. Satellite and value-added services provided by the private sector include trunking, paging, Internet, and data transmission services.

Electric Power

Ecuador has an installed electricity generating capacity of 3,000 megawatts (MW), with an effective capacity of 2,2210 MW after transmission, plus 300 MW in new thermal capacity installed by the private sector in 1996. Hydroelectric power plants, including the 1,075 MW Paute hydro plant, account for over half of installed capacity and supply three-quarters of the country's current needs. Supplemental thermal power is often required during the dry season to avoid brownouts if rainfall is insufficient. Although a number of new thermoelectric plants have been opened, there is still an estimated power deficit of 120-150 MW.

Long suppressed electricity rates are finally being raised to encourage badly needed new investment into the sector. There has been a reduction in the cross-subsidization of low volume residential electricity users with higher commercial rates. Currently one private firm, EMELEC, provides distribution and generating services in Guayaquil. Several private companies operate thermal plants.

There is currently no natural gas market in Ecuador, although that could change once gas fields in the Gulf of Guayaquil and the Oriente are developed. Highly-subsidized liquefied petroleum gas (LPG) is the most common cooking fuel and large quantities are imported to meet demand.

Water and Irrigation

The National Council of Hydro Resources administers Ecuador’s surface and subsurface water resources. Urban water supplies are provided by municipally owned water utilities, while the Ministry of Urban Development and Housing provides technical assistance to rural municipalities and water boards. Regional bodies run several large-scale, highly subsidized flood control and irrigation schemes.

Access remains a problem. As of 1999, only 40% of Ecuadorian households had access to running water, and only 44% are connected to sewage systems. Municipalities are beginning to turn to private sector concessions to expand water and sewage availability. In early 2001, a $500 million twenty-year contract was awarded to Bechtel to provide potable water and sewage services in Guayaquil.