Report No. 1186-EC

Industrial Development Problemsand Prospects EcuadorOctober 7, 1976 tLIndustrial Projects Department

FOR OFFICIAL USE ONLY

Document of the Wo.-

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may nototherwise be disclosed without World Bank authorization.

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This report is based on the findings of an IndustrialSector Mission which visited Ecuador in September-October 1975. The mission was composed of Irwin Baskind(Chief), Enrique Low, Guy Prenoveau and Mario Sarquis(Consultant).

PRINCIPAL ABBREVIATIONS USED

NPC -- National Planning CouncilBNF -- Banco Nacional de FomentoCOFIEC - Compania Financiera Ecuatoriana

de DesarolloCV-CFN - Comision de Valores - Corporacion

Financiera NaccionalCENDES - Centro de Desarollo Industrial

CURRENCY EQUIVALENTS

Currency Unit Sucre (S/.)S/. 1.00 - US$O.04US$1.00 = SI. 25.00SI. 1 million = US$40O,O0O

GOVERNMENT OF ECUADORFISCAL YEAR

January 1 to December 31

FOR OFFICIAL USE ONLY

ECUADOR

INDUSTRIAL SECTOR SURVEY

Table of Contents

SUMMARY OF PRINCIPAL CONCLUSIONS AND RECOMMENDATIONS

CHAPTER I - INTRODUCTION - RECENT TRENDS AND PRINCIPAL CHARACTERISTICSOF THE INDUSTRIAL SECTOR

A. Introduction - Scope of the ReportB. General Overview of the Industrial SectorC. Main CharacteristicsD. Resource EndowmentE. Infrastructure

CHAPTER II - MAIN ELEMENTS OF INDUSTRIAL POLICY

A. Principal Industrial Incentive LawsB. The Special Problem of Small and

Artisan IndustriesC. Export PromotionD. Price PolicyE. Labor and Wage PoliciesF. The Andean Common Market

CHAPTER III - THE FINANCIAL SYSTEM

A. General CharacteristicsB. The Elements of the Financial System

CHAPTER IV - PROSPECTS FOR FUTURE INDUSTRIAL GROWTH

A. General Sectoral StrategyB. Possibilities for Major SubsectorsC. Regional DisparitiesD. The Special Problems of Small Scale

and Artisan IndustryE. Progress and Prospects Under the Andean

Pact.

Thb document hau a restricted distribution and may be used by recipients only in the performanceof their omcial duties. Its contents may not otherwise be disclosed without World bank authorization.

Table of Contents (Cont'd)

ANNEX 1 AGRO-INDUSTRIAL OPPORTUNITIES

ANNEX 2 FINANCIAL SYSTEM

STATISTICAL APPENDIX

Table 1 - GDP by Economic ActivitiesTable 2 - Structure of Industrial Value AddedTable 3 - Employment and Productivity - 1973Table 4 - Import Dependence of IndustryTable 5 - Incentive Legislation-principal featuresTable 6 - Exports of Manufactured ProductsTable 7 - Distribution of Factories, by size, 1973Table 8 - Structure of Imports, 1967-1974

Industrial Projects DepartmentOctober 7, 1976

SUMMARY OF PRINCIPAL CONCLUSION AND RECOMMENDATIONS

Recent Trends and Principal Characteristics of Industrial Sector

i. Ecuadorian industry has shown rapid growth in the last decade(1965-1974) with an average annual real growth rate of 9.4% compared to 5.4%for GDP. Nevertheless, the sector continues to account for a relatively smallshare of total output, some 17.2% of GDP in 1974 at current prices, reflectingessentially the limited market size of the country with its low level of percapita income ($410 in 1973) and relatively small population.

ii. The emergence of a dynamic industrial sector in the last half ofthe 1960's had its roots in the evolutionary changes in the physical and in-stitutional infrastructure in the 1950's. A National Planning Council wasestablished in 1953; in 1957 an Industrial Development Law was enacted andthe first five year road development plan was initiated. Substantial invest-ments were also made in the power sector with generating capacity as well aspower generation tripling in the decade. Intensive geological and associatedexplorations which ultimately led to the discovery of petroleum resources inthe 1960's were also initiated in this period. In the 1960's, further insti-tutional development occurred with the creation of an Industrial DevelopmentCenter (CENDES) and two long-term financial intermediaries, one in the publicsector (CV-CFN) and one in the private sector (COFIEC).

iii. Prior to the discovery of hydrocarbon resources, the Ecuadorianeconomy was essentially based on agricultural resources. Cultivation ispresently concentrated along the Coast and in various fertile valleys in theSierras. Nevertheless there exists considerable scope for expansion ofagricultural output, bringing into cultivation major land areas not now com-mercially cultivated in the coastal area and to some extent on the easternslopes of the Andes, partly because of remoteness from existing markets.In addition significant increases in yields on existing cultivated landare possible through improved farming techniques, including irrigation,fertilizer use and the use of higher yield varieties.

iv. Non-metallic minerals are available in substantial supply tomeet the increasing demand for construction materials arising from the cur-rent period of increased growth but further surveys are required to deepenknowledge of these resources for future development. There are some tracesof non-ferrous ores which might be economically exploited and additionalstudies are underway to determine viability; there are only minor tracesof ferrous ores.

v. The discovery of a major crude petroleum field in the Orientearea in 1967 and its subsequent exploitation beginning at the end of 1972have radically changed the economic perspectives for the country. Never-theless there is considerable uncertainty as to the extent of these resourceswith the current estimate of proven reserves at 1.5 billion barrels. Earlierestimates of proven and unproven reserves had been in the range of 5 billionbarrels. Further exploratory work is required to establish the extent of the

reserves, data which are necessary for investment decisions to obtain optimumuse of crude petroleum. Relatively extensive dry natural gas has also beenfound in the Guayas region. At present, there is little exploitation of thisresource but a major fertilizer complex is now in the planning stages; asubstantial portion of the output of this facility would be for export. Otherprojects to use this resource are being developed, including the possibilityof a direct reduction steel mill using imported iron ore to meet estimatedfuture domestic steel needs.

vi. The structure of industry is typical of a country at the earlystages of development with output heavily concentrated in basic consumergoods. Recent growth has been particularly marked in branches supplyingthe construction industries (plywood, cement, glass, metal bars, etc.)and there have been some simple mechanical engineering industries estab-lished; average size of establishment remains relatively small although thenewer units have tended to be substantially larger. Direct links to expandedpetroleum development have been limited. Exports of manufactured productsrepresent no more than 7 to 8% of the gross value of the sector's output,although for a number of manufactured traditional products, such as sugar,cocoa and seafood, the share approaches 40%; these industrial products have inrecent years accounted for 10 to 15% of an increasing total export value dueto the emergence of new export lines.

vii. Total employment in industry amounts to less than 12% of the econo-mically active population. There has been substantial growth in factoryemployment in recent years but at present this component represents only 25%of total employment in industrial activities. The remainder is found in thesmall and handicraft type of enterprises with low productivity; as a conse-quence, these units represent only 30% of value added in the sector. New jobsgenerated by the growth in factory output currently represent only a littlemore than 10% of the estimated annual inflow of new entrants into the employ-ment market; nevertheless there appears to be little open unemployment asconstruction and service sectors have offered substantial new job opportun-ities recently. Factory employment continues to be heavily concentrated inthe two main urban centers, Quito and Guayaquil, representing 78% of total.

viii. The recent boom in overall economic growth, based on the newlyexploited petroleum resources and the price increase in 1973, has stimulatedinvestment in a number of industries serving the local market includingconsumer goods, construction materials as well as some simple capital goods.Favorable treatment of investment and liberalization of capital goods importsin early 1973 also have played a role in this growth. The expansion incapacity does not yet appear to be reflected in changes in output as manydelays have been encountered in getting the new plants on stream, includingproblems arising from the shortage of skilled technical and managerialpersonnel. Present high production rates reflect mostly better utilization ofexisting capacity.

M1ain Elements of Industrial Policy

ix. Industry in Ecuador follows essentially a pattern of free enter-prise with government efforts mainly devoted to the creation of supportinginfrastructure and services and policies affecting taxation, tariffs andfinance. The development of petroleum refining and petrochemical production bygovernment agencies will bring about a larger share of public enterprisesin the country's industrial sector. Comprehensive industrial developmentlaws have been in force since the first law was enacted in 1957; modificationshave been introduced periodically and in 1973 a major revision was undertakenwhich emphasized regional decentralization of new industry. The main featuresof all of these laws have been varying degrees of exoneration from taxes andfrom tariffs on imported raw materials and/or capital goods.

x. Until the recent inflow of petroleum income, tariff revenues werethe single largest source of government revenue and were imposed for thatpurpose. Balance of payments criteria were paramount in establishing quanti-tive restrictions, particularly on finished goods, as well as in settingprior deposits. Overall, average tariff levels and dispersion were notexcessive and nominal protection and effective protection were more or lessthe same. While incentive laws provided tariff exoneration for imported rawmaterials, thus in principle raising effective protection, the narrowness ofthe market restrained investment in uneconomic activities and domestic competi-tion was sufficient to keep domestic prices close to import prices for most ofthe consumer goods (textiles and foods) representing the bulk of the industrialsector's output, the production of which is not characterized by economies ofscale.

xi. Imports were considerably liberalized in early 1973 but the subsequentreemergence of the foreign exchange gap led in mid-1975 to an increase intariffs, some prohibitions on imports of consumer goods and a selective tariffsurcharge of 30%, as well as an increase in prior deposit requirements.Although it is too soon to evaluate the effect of the recent changes, there islittle doubt that with the growing internal market, distortions are beingintroduced by the present system combined with the exonerations grantedunder the investment incentive laws. Although in the longer-run Ecuador'stariff structure will depend upon negotiations within the Andean Group for aCommon External Tariff, a correction of the present system is essential toavoid misallocation of resources. One measure which has been used in othercountries to restrain imports of so-called luxury goods, while not stimulatingproduction through high effective protection, is to impose large sales taxeson those items which are applied equally to imports and domestic output.

xii. The revision of the incentive law in 1973 provided considerablygreater tax exemptions for industries defined as priority and in general forthose to be established outside the two existing main centers of activity

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(Quito and Guayaquil). These features appear overly generous in natureand are not consistent with the principles of tax equity and with the needto avoid weakening the tax base from the long-term point of view of governmentrevenues. Moreover, they are biased in favor of capital intensive investmentand have encouraged the establishment of some industries with unnecessarilyhigh import content. In mid-1975, the Government established a review committeeto assess the results of the law; it would be useful to complete this analysisas soon as possible.

xiii. Another feature of the 1973 investment law was the expansionof a limited direct incentive system for non-traditional exports which hadbeen instituted in 1971. Under the new system, incentives are given tomanufactured exports in accordance with past performance up to a maximumof 15% of the gross value; non-processed non-traditional agricultural exportsreceive 4%. The Government is now considering a further revision of the lawwhich, inter alia, would establish a scale of payments for products in accor-dance with domestic value added. Experiences with similar schemes in otherdeveloping countries have indicated their usefulness in developing export-con-sciousness in the early stages of development but also have drawn attention tothe fiscal burden of such systems over the long-run; those countries aregenerally moving towards greater dependence on exchange rate policies toinfluence exports and promote efficient resource allocation. For many resource-based products where future export growth potential appear to exist forEcuador at the present time, it seems likely that direct efforts at improvingmarketing facilities may have as much impact as these incentives. Much moreeffort is required to determine for the specific products involved the possiblebarriers to export expansion in order to define the specific measures required.Among other policies which may also be adopted to stimulate manufacturedexports, are improvement of transport and storage facilities, provision offinance and of special promotional activities and the establishment underappropriate safeguards of free trade zones.

xiv. While most prices in Ecuador are set by market forces, a numberof major consumption goods are subject to price ceilings; price supportsto stimulate production are provided for a few agricultural based items.The overall effect has been to introduce important distortions and misalloca-tion of resources, with scarcities developing for products whose pricesare fixed too low and over-production for those with prices fixed too high.Notable examples are found in the case of sugar, where the low fixed pricerelative to world market prices has disrupted distribution and has encourageddiversion of output including the use of sugar as an intermediate good inproducing items not subject to price control; similarly in the case of plywood,the low domestic fixed price has encouraged illegal export to neighboringcountries. On the other hand, prices of soy beans have been set relativelyhigh while prices of the final product are set relatively low (vegetable oilsfor cooking). This has, in fact, encouraged processors to import raw materialsrather than rely on locally produced higher priced inputs.

Financial System and Policies

xv. Comprehensive data on the supply of long-term capital to industryare lacking, but general indications are that the bulk of these funds continueto originate outside the organized capital market and financial intermediaries.A system of instruments and institutions, relatively sophisticated given thecurrent stage of development of Ecuador, have been created which are increasinglybeing used, but in order for them to play a more useful role in acceleratingfuture industrial growth, it will be necessary to undertake important changesand modifications.

xvi. The two development finance corporations, CV-CFN and COFIEC,were created at a time when there was need to channel required externalresources into the development effort. Although CV-CFN originally was de-signed as a Goverrunent agency (Comision de Valores) for public bond issuesand regulations, since its reorganization in 1964 it has primarily performedas a source of long-term finance for the private sector. In this senseboth corporations with Bank Group assistance have performed relatively well.Many of the new industrial installations have had support from one or bothwhich in the period of foreign exchange constraint was essential and whichhelped to attract additional long-term funds from domestic sources.

xvii. CV-CFN depends upon the Government for its equity; during 1974, asa result of large public savings, the Government increased its equity con-tribution by 50%. In spite of substantial borrowings from the World Bank, IDBand other foreign institutions, its debt/equity ratio has been rather low andcould have supported considerable borrowing in local markets. Recently it hasbeen able to raise additional resources in the local market through bondissues which are highly liquid.

xviii. COFIEC, on the other hand, has had considerable difficulty inraising its equity base even with a relatively profitable performance.This appears to reflect the general difficulty in attracting equity capital,among other things, as a result of the existing tax system which discriminatesagainst dividend income, thus favoring lending operations as compared todirect investment. At the same time, the interest rate ceiling (12% maximumby law) and the structure of commissions, by not offering sufficient spread onmedium and long-term loans, has forced COFIEC into a high proportion ofshort-term financial operations (including in particular foreign exchangeguarantees) which are relatively more profitable, thus interfering with properresource mobilization. Aside from the desirability of improving the condi-tions under which this institution operates so that it can fulfill its objec-tives, appropriate adjustments in the basic policies affecting interest rateand tax structures are necessary particularly in view of the establishment ofnew financial intermediaries. These are required for the country's overallfinancial system to contribute more effectively to the accelerated growth ofindustry which is both possible and desirable.

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Prospects for Future Industrial Growth

xix. The current resource position of Ecuador and its limited marketsize suggest that in the next decade, substantial increases in per capitaincome can only be achieved through adequate expansion of exports increas-ing the relative share of the latter in GDP. While the sector can playan important role in this strategy, industry will be only one part. Moreover,the decision whether to industrialize a particular exportable resource shouldbe taken after full evaluation of the net foreign exchange earning capacity ofthat resource as compared to exporting it in its simplest form and of thealternative uses of the capital investment involved. In order to achievethese higher growth rates, attention will have to be given to expandingfurther the infrastructural base and, in particular, to developing localmanagerial and technical skills.

xx. Considerable effort is now being expended in planning the indus-trialization of the recently discovered hydro-carbon resources. Unlessproven reserves of petroleum are substantially raised through increasedexploration, further expansion of refinery capacity for petrochemical develop-ment, which could not be on stream before the early 1980's, does not appearviable. However, even if reserves prove more extensive, consideration shouldbe given to alternative investment of available funds in activities withbetter economic and social rates of return and more direct employment effectsand consequent impact on income distribution. Similarly, in the case ofdevelopment of dry natural gas-based industries, production paths shouldseek to maximize value; thus a proposal for using gas in a direct reductionsteel mill should be evaluated against alternative uses of that resource.Part of the capital requirements for these projects, primarily those which areexport-oriented, are expected to be supplied by potential consumers andtherefore would have no alternative use from the point of view of Ecuador;thus what is required is a blend of investment, utilizing the non-renewablehydrocarbon resources to assure a large flow of export earnings in theirlifetime combined with the investment of domestic funds in developing newsources of employment and export earnings among the currently underutilizedagricultural and related resources. Another critical aspect affecting sup-plies available for export is the present policy for relatively low internalprices which has encouraged rapid growth of domestic consumption of petroleum.

xxi. Significant opportunities exist for agro-industrial developmentoriented towards exportable products. Among the possibilities which havebeen identified are expansion of sugar refining particularly bringing intocultivation land not currently commercially cultivated, fish products, fruitsand vegetables for processing (both canning and dehydration), banana flourfor animal feed and non-food products such as wood products, abaca and otherhard fibres, sorbitol (derived from corn) and castor oils. To develop theseitems, important revisions will be required in price policies (see xiv. above)

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and considerable investment in infrastructure, in particular, comprehensivesystem of feeder roads and port improvement, will have to be undertaken.luch of this development would be concentrated in underutilized land inthe coastal area and the largely undeveloped eastern slopes.

xxii. Additional opportunities for expansion of agro-industries willarise from growing domestic incomes providing expanding markets, particularlyfor meat and dairy products. Production of these items are well suitedfor the Sierras, as are certain high value export oriented crops (e.g. pro-cessed garlic and onions). Growth in domestic incomes and investment willalso provide further opportunities for industries producing a wide range ofconsumer, goods and particularly construction materials while the expansionof the industrial base is expected to promote some backward integrationfavoring the establishment of industrial chemical, metal product and somemechanical engineering industries.

xxiii. Within the Andean Common Market, Ecuador has been given specialtreatment reflecting its status as relatively less developed. The firststages of trade liberalization have seen considerable expansion in its ex-ports of manufactured products, largely the traditional processed foods suchas fish and cocoa products, but including some advanced manufactures suchas domestic appliances. Projects for items not previously produced in thecountry but freed from trade restrictions by partner countries and for itemsassigned to Ecuador under the regional program for metal-mechanical industrieshave been delayed in implementation largely reflecting shortages of technicalskills and know-how.

xxiv. Various measures have been introduced to promote the development ofsmall and medium industries, as well as artisan activities. The most recentstep was the enactment in 1973 of a special incentive law offering furtherexonerations from taxes and tariffs for these enterprises, originally definedin terms of a maximum of approximately $60,000 invested in machinery andequipment but raised to approximately $200,000 in August 1975. Aside fromtheir even more overly generous features and other undesirable characteristicsalready noted (see xii. above), these incentive laws have tended to discouragethe expansion of individual beneficiary enterprises beyond those limits orat best to encourage legal fragmentation of units. Modifications suggestedinclude a time limit on benefits for the enterprises and no restrictions onpossible expansion of beneficiary during that period. Other measures toassist small industry should include intensified technical assistance programsand the construction of industrial estates. While the latter has been pro-posed for a number of years, implementation of existing projects has been veryslow owing to previous lack of financial resources and, in particular, shortageof managerial and organizational personnel. Consideration should also begiven to the creation of a guarantee fund which could facilitate lending tosmaller enterpises.

CHAPTER I

INTRODUCTION - RECENT TRENDS AND PRINCIPALCHARACTERISTICS OF THE INDUSTRIAL SECTOR

A. Introduction - Scope of the report

1.1 The recent discovery of important hydro-carbon resources on theeastern slopes of the Andes Moutain and the external conditions which haveled to substantial increases in prices of these commodities, have providedto Ecuador a major opportunity to change radically its economic status.In the early 1970's Ecuador had the third lowest per capita income on theSouth American continent. There exists some uncertainty as to the preciseextent of the new resources which would primarily affect the length of timeduring which additional resources would flow to the Government for effectiveutilization. Nevertheless, there is a reasonable possibility that overthe next decade Ecuador will have available to it foreign exchange anddomestic resources which can permit it to stimulate substantial increasesin per capita incomes, as well as to improve its distribution by absorbinginto the money economy a major share of the rural population, which now lielargely outside it.

1.2 This report concerns itself with the possible role of industryin achieving the dual objectives of raising income and improving its distribu-tion. At the present time, that role is extremely small with the sectoraccounting for no more than 17% of GDP and only 11% of the economicallyactive population. This role is nevertheless consistent with the existing lowlevel of per capita income and the small population of the country.

1.3 In this connection, it must be stressed that the fundamentalobjective of economic policy must be to find all economically sound meansfor raising the proportion of exports to GDP. For it is only through sucha dynamic process of growth that a country the size of Ecuador can raiseper capita incomes and have the opportunity to improve its income distri-bution. 1/ This can best be illustrated by the events of the past few years asGDP growth rates in excess of 12% have been associated with the increase inexports' share of total product from 15.5% in 1972 to 26.3% in 1974_(incurrent prices). The need to find further export possibilities becomesmore pressing if the hydro-carbon resources are not as extensive as originallycontemplated.

1.4 Manufacturing industry may not and need not be the primary source ofthe export potential. To the extent that world market conditions for basicagricultural products originating from the country permit further expansion ofthese exports, the agricultural sector itself can make such a contribution.

1/ See Chapter IV.

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As regards supplies of mineral resources which could be exported, currentknowledge suggests only limited availabilities but, as pointed out later,there is need for further survey work to explore some indications of econo-mically exploitable ore deposits.

1.5 As regards the hydro-carbon resources, considerable attentionis now being given to their further industrialization in the form of refinedpetroleum and petrochemical products. If the crude petroleum resourcesare limited, it may be difficult to justify economically refinery capacity forpetrochemical development which would be additional to refineries which arealready on stream or under construction. Nevertheless, even if furtherreserves are proven, it is necessary to evaluate the net additional foreignexchange earnings from exporting petrochemical products as compared to con-tinued export of crude petroleum, and the possible alternative uses of theinvestment funds required for constructing refining capacity in other export-oriented industries. The question must be asked whether such funds could nothave higher economic and social returns, through direct employment generationand consequent impact on income distribution, if they were applied to othertypes of more labor intensive export-oriented industries; this is especiallyso since not only is petrochemical production heavily capital-intensive but italso has few backward and forward links given the current Ecuadorian indus-trial structure.

1.6 From a practical point of view what is required is a blend ofinvestment, utilizing the non-renewable hydrocarbon resources to assure ahigh flow of export earnings in their lifetime and, at the same time, de-veloping new sources of employment and export earnings among the currentlyunderutilized other resources of the country. To explore the latter, thisstudy provides a brief survey of the existing industrial structure of thecountry, how it has achieved its current level and what are the principalbottlenecks to further expansion, and then turns to possible areas ofgrowth, with emphasis on those directions which could have the most favor-able impact on income generation and distribution. Special attention isgiven to major policy issues affecting the sector as well as to the mobil-ization of financial resources for these activities.

B. General Overview of the Industrial Sector

1.7 Ecuadorian industry has shown rapid growth in the last decadewith an average annual real growth rate of 9.4% compared to 5.4% for GDP.Nevertheless the sector continues to account for a relatively small shareof total output, some 17.2% of GDP in 1974 at current prices, reflectingessentially the limited market size of the country with its low level ofper capita income ($410 in 1973) and small population (estimated at 7 mil-lion in 1975).

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Industrial Output Industrial Share inAverage annual rate GDP (end of period

of growth in current prices)

1950-1955 3.9 15.0

1956-1960 5.6 15.7

1961-1965 7.7 17.2

1966-1970 8.4 19.0

1971-1974 10.4 17.2

Source: Mission estimates based on NPC and Central Bank data; the nationalaccounts have recently been substantially revised and the data arenot completely comparable.

1.8 The emergence of a dynamic industrial sector since the 1960's hasits roots in the evolutionary changes in the physical and institutionalinfrastructure initiated in the 1950's. Data from the National PlanningCouncil (NPC) indicate that throughout the period from 1950 through 1960,manufacturing value added represented 15 to 16% of total output. Someminor structural changes occurred during this period but the pattern ofactivity was typical of a country at the earliest stages of development,with output heavily concentrated in basic consumer goods - food, bever-ages, tobacco, textiles, clothing and shoes. The newer industries whichwere established during this period were largely associated with construc-tion activities. In turn, a substantial proportion of this productionwas used in the infrastructure investment undertaken at the time, whichhelped to set the stage for the accelerated growth characterizing more

recent periods.

1.9 It was during the 1950's that the first steps were taken toelaborate an integrated development strategy. 1/ The National PlanningCouncil was established in 1953; in 1957 an Industrial Development Lawproviding a range of incentives to new industries was enacted and thefirst five year road development investment program was initiated. Sub-stantial investments were also made in the power sector with electricgenerating capacity more than doubling during the decade of the '50s. In

1/ See the paper by Galo H. Salvador, of the National Planning Council,Industrial Development Strategy and Policies, UNIDO document ID/WG.176/4,3 May 1974.

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the early '60s the institutional framework was further strengthened, withthe establishment in 1962 of the Industrial Development Center (CENDES)to promote industrial investment and to provide technical assistance tomanufacturing enterprises. In 1964, the Securities Commission (Comisionde Valores) was expanded into a National Financial Corporation (CV-CFN)to provide long-term financial assistance to industry; a private sectorinvestment corporation (COFIEC) was created in 1966.

1.10 The period 1965-1970 witnessed a further rise in manufacturingactivity as its annual rate of growth substantially exceeded that of totalproduct and its share in GDP in 1970 rose to 19%. The accelerated growthrate of industry was sustained during 1970-1974 but in this period, largelyas a result of the emergence of crude petroleum production and associatedactivity, total product in real terms also increased at approximately thesame rate. 1/ This period has been marked by investment in many new branches,continuing the trend toward diversifying the structure of output (see Statis-tical Appendix Table 2).

1.11 The expansion of petroleum output has for the time being hadessentially an indirect effect on Ecuadorian industry with development ofthat sector generating direct demand for local products only in connectionwith construction; even in these instances, however, the limited existingproduction facilities have not been able to meet this demand and recoursehas had to be made to imports of such items as cement. Indirectly, how-ever, there has been considerable impact. Much of the increased revenuesaccruing to Government has gone into infrastructure development which isessential if the fragmented market is to become integrated; these expendi-tures in turn have raised aggregate income and have supported continueddemand expansion for basic consumer goods which comprise the major partof industry's output. Finally, the foreign exchange constraint to overallgrowth has been greatly reduced.

C. Main Characteristics

1.12 Employment in manufacturing industries accounts only for 11.5%of total employment in the country, compared with a share of 46.5% for agri-culture. While open unemployment has not yet been considered a major prob-lem in Ecuador, (the unemployment rate being 6%), the annual average number

1/ In constant (1970) prices, the share of industry in 1974 remained un-changed as compared to 1970 (19%). However, due to the four-foldincrease in crude petroleum prices during this time span, the shareof that activity in total output in current prices has grown dra-matically. Thus, industrial value added in 1974 in current pricesrepresented only 17.2% of total output.

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of new entrants in the employment market is now over 60,000 and the factoriesdo not generate more than 7,000 new jobs each year. Moreover, the prevailinglow-productive employment, primarily in the rural areas, is an evidence ofthe underutilization of manpower in Ecuador. Thus, the process of industrial-ization should focus not only on increasing employment and income in the indus-trial centers, but also in generating adequate development linkages with othersectors. Another element in employment absorption is construction activities.In the last few years, there has been considerable increase in both industrialand commercial construction as well as public works, which have generated manyjobs particularly in Quito and Guayaquil and have contributed to the generalappearance of little open unemployment in those cities. Many modern rela-tively large scale enterprises have been established during these past decadesbut employment generated by industrial activities continues to be heavilyconcentrated in small and handicraft type enterprises with low productivity.Small industry (defined as enterprises with less than seven employees) plusartisan activities accounted for 85% of the total actively employed in thesector in 1963 and 75% in 1973. As regards total value added, however, theshare was 49% and 30% in these two years respectively.

1.13 As regards employment, NPC has estimated distribution in 1972 asfollows:

Total Productivity(in thousands) % (in thousand S/)

Factory 53 20.9 82.2

Work-shops 64 25.2 15.8

Home-workers 137 53.9 11.5

Total 254 100

1.14 As regards the category of home-workers ("artesania casera"), thisis believed to include many persons wanting to supplement family incomewho would not be available for employment outside the home.

1.15 The limited degree of industrialization achieved by the country isfurther seen in the relatively small average size of manufacturing establish-ments. Data from the 1973 Industrial Survey, covering 1,174 manufacturingenterprises with more than seven employees, indicate that only 74 factorieshad a gross value of output exceeding $2 million; it is estimated that thissurvey reached 75% of all industrial units and most likely a higher percent-age of the larger ones. Moreover, these larger units accounted for 56% ofvalue added manufacturing but only 34% of employment (Statistical AppendixTable 7).

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1.16 The structure of industry is consistent with this early de-velopmental stage, heavily concentrated in basic consumer goods (Statis-tical Appendix Table 2). Some 60% of total value added is representedby food, beverages and tobacco, clothing, shoes and furniture. Amongmore advanced manufactures, included in the output of the chemical indus-tries are such consumer items as soap, cosmetics and paint; the principalitems among metallic products include metal furniture and accessories,household appliances and the assembly of radio and television sets.

1.17 Average investment per job created in manufacturing was 68,000sucres in 1974, compared with 34,000 sucres for the economy as a whole and26,000 sucres in agriculture. However, while the average incremental captial-labor ratio for large industries was S/. 617,000, it was only S/. 28,000 forsmall industries. 1/

1.18 With the existing resource endowment, linkages between manufacturingindustries and domestic production of raw materials and intermediate goodsare limited to agricultural materials and non-metallic minerals. Thus,as industry has become more diversified in recent years, it has becomeincreasingly dependent upon imports for basic inputs; to some extent, exist-ing investment incentive laws have tended to favor activities with highimport content. Branches of activity such as metal and engineering products,plastics and basic metals which have experienced annual rates of increase ofmore than 20% in the past decade, import as much as 90% of their inputs. Forthe sector as a whole, 34% of its raw material requirements in 1965 wereimported but by 1973 the figure had risen to 49%. Nevertheless, it must bekept in mind that, given the size of Ecuador, the share of imports (andexports) in GDP is likely to increase if per capita income is also going toincrease. There exist a number of industries with low import content whichcan be expanded but many others will continue to require imports. Provided anappropriate overall strategy for export development is adopted, the importdependence of industry need not be a major concern; the policy implicationsare discussed in Chapter IV.

1.19 Industrial factories in Ecuador are largely located in the twomain urban centers, Quito and Guayaquil. These two cities generated about81% of the value of output and 78% of employment in factory manufacturing.

1/ OAS: Un programa de Accion a corto y mediano plazo para combatir eldesempleo en Ecuador.

The recent rapid growth of industry in Cuenca 1/ has not as yet representeda substantial departure from the existing pattern of regional development.The table below summarizes the regional distribution of factory and artisanemployment.

Total Industrial Employment by Provinces, 1974(in percent)

Region Factory Artisan Total

Pichincha (Quito) 38.2 17.9 23.8Guayas (Guayaquil) 39.9 16.7 20.7Azuay (Cuenca) 5.2 17.8 14.2Rest of the country 16.7 47.6 41.3

TOTAL 100.0 100.0 100.0

Source: Industrial Census, Population Census.

1.20 At the present time, exports of manufactured products play onlya small role in total industrial output although for a few items externalmarketing is important. In 1973 (the latest year for which data areavailable), total manufactured exports represented 7 to 8% of the grossvalue of the sector's output but for food products about 15%. For thetraditonal items such as sugar 2/ and related products and for processedcacao, exports accounted for some 40% of the value of their production.Among the non-traditional and more advanced manufactures, foreign salesrepresented no more than 5% of output; only in the case of pharmaceuticalsdid these shipments account for as much as 15%. As regards the importanceof manufactured exports in total, these items have accounted for 10 to 15%(see Statistical Appendix Table 6).

1.21 General indications are that the expansion in non-traditionalmanufactured exports experienced during 1974 and 1975, much of this in thecontext of Andean trade liberation, has slightly raised the percentage oftrade in output. For example, exports of consumer durables such as householdappliances are currently accounting for 25 to 40% of their production levels.

1/ The construction of the new petroleum refinery at Esmeraldas, which isalso the terminal of the pipeline from the Oriente, has led to someexpansion in that area as well.

2/ A much higher export price as compared to the domestic sales priceprevails for sugar, thus overstating the proportion of export valueto total sales value. In volume terms, exports account for 20-25%of production in the last few years.

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1.22 Little information is available on actual capital formation inindustry although, on the basis of application for benefits under the variousindustrial incentive laws, it is known that many new enterprises are inthe process of being organized. Moreover, the improved liquidity situationstimulated some balancing, modernization and expansion of older plants toobtain higher production levels.

New Enterprises Classified Expansions Registered

Estimated Investment Estimated InvestmentNumber (million sucres) Number (million sucres)

1972 25 492.8 32 217.4

1973 58 1366.9 27 236.4

1974 49 1312.8 29 608.0

Source: NPC

1.23 The limited sample of firms the mission visited suggests, however,that much of the expansion in output in the last few years has resultedfrom more efficient utilization of existing capacity. A 1972 NPC surveyestimated capacity utilization in that year at about 60% defining capacity astwo-shifts for most enterprises, three-shifts for process industries. Anumber of branches, particularly those producing consumer goods, which in theearlier survey had achieved between 50% to 75% utilization, were in late 1975producing close to capacity limits. In addition, interviews with entrepreneursand financial institutions suggest substantial delays in bringing new plantson stream, reflecting domestic shortages of construction materials, longerdelivery periods for imported capital equipment and, in particular, shortagesof technically skilled manpower.

1.24 The Central Bank has prepared a statistical series on imports ofcapital goods for industry which includes replacement parts, accessories andother equipment items besides machinery. The increase in these imports inreal terms in 1974 and 1975 has been substantial. 1/ It is likely that

1/ It will be recalled that capital goods imports were considerablyliberalized in early 1974.

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the installation of the new capacity these represent will first be feltin 1976. 1/

Imports of Capital Equipment for Industry

Current Value (FOB) Volume IndexYear (in US$ million) (1970=100)

1965 22.2 70.01966 27.1 96.11967 36.4 103.11968 37.3 102.21969 33.3 110.61970 38.5 100.01971 57.0 158.41972 68.0 116.91973 75.2 187.41974 210.3 405.21975 /a 273.0 457.3

/a Estimated by mission on the basis of import data for 8 months.

Source: Banco Central, except as noted.

1.25 There are indications that the shortage of skilled labor and, inparticular, managerial personnel has represented a serious bottleneck toimplementing industrial investment plans. This is not completely unexpectedin view of the previous limited industrial base and opportunities and therecent rapid expansion. In part, this shortage has been overcome by con-tracting expatriate personnel, by intensive on-the-job training abroad andby expanding domestic training programs for technical and executive person-nel. Among the latter, particular importance is attached to technical andvocational training through SECAP (which is being assisted under a Bank loan)and the establishment in early 1976 of an Advanced Management Training Insti-tute in Guayaquil sponsored by the private sector.

1.26 It should also be noted that the generally improved economic condi-tions which has led to substantial increases in salaries for skilled and man-agement personnel (in both the private and public sector) have resulted in

1/ For example, imports of equipment for the petroleum refinery mayhave amounted to as much as $70 million in the two years; this in-stallation is not expected to begin operations until early 1977.

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some return from abroad of trained and experienced Ecuadorians who had leftthe country due to previously existing limited opportunities.

D. Resource Endowment

1.27 Until the development of petroleum exploitation in the early 1970's,Ecuador's economy was essentially based on agricultural resources. In the1960's these primary activities accounted for some 46% of the economicallyactive population although only about one-third of total output, due toprevailing low average productivity. Moreover, some two-thirds of indus-trial output was agro-based representing not only basic subsistence itemsfor local consumption (e.g. processed food) but a number of exportedprocessed items of relative importance in total exports (e.g. sugar, cocoaproducts, processed seafood).

1.28 Nevertheless, there remains the potential for substantial expansionof agricultural production, particularly for those items which can be exportedafter further processing. Not only can output be raised through increasingyields on presently utilized land, but there are substantial opportunitiesfor growth through bringing into cultivation much cultivable land currentlyunutilized; to achieve these objectives, particularly developing new resources,would require a series of integrated policy and infrastructure investment de-cisions. Because of the basic importance of this sector to further indus-trial, economic and social development of Ecuador, a special study has beenmade of agro-industries and their requirements, which appears as an annex tothis report. In subsequent sections dealing with policy and infrastructureneeds, some of the main findings are summarized.

1.29 In addition, related resources such as forests and fish and shell-fish are similarly significantly underutilized and represent important areasfor possible expansion. These are also discussed in the annex.

1.30 As regards non-metallic minerals, resources exist in sufficientquantities to permit substantial expansions in output of constructionmaterials based on these minerals (e.g. cement, glass, ceramics and sanitary-ware). Utilization was limited by low demand levels until the recent con-struction boom. Many new plants based on these materials are now being builtor are in the planning stages. However, industry sources have indicatedthat knowledge of these resource availabilities remains fragmentary andthere is need for more intensive surveys to serve as a basis for furtherexpansion in view of the expectation of continued high demand.

1.31 There is also need for developing better knowledge of mineralresources. A comprehensive mineral survey has yet to be completed whiledetailed investigations of specific zones which have been identified as of

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possible interest also need to be undertaken. At the present time thereappear to be only limited ferrous and non-ferrous ore deposits; however,there are indications of supplies of such items as silver, zinc and antimonywhich might be economically exploited.

1.32 As regards hydro-carbon resources, present estimates are for provenreserves of 1.5 billion barrels in the Oriente area, as compared to earlierestimates of proven and unproven reserves of over 5 billion barrels. Thus,there is need for intensified exploration to clarify the actual extent ofthese fields, data essential for future investment decisions. In addition,substantial reserves of dry natural gas have been found in the Guayas region.

E. Infrastructure

1.33 In 1950 the only transport connection between the major citiesof Guayaquil and Quito was a railroad line; the two areas of populationconcentration, the coastal plains and the Andean valleys, were otherwisenot connected. According to a recent transport sector survey by the Bank,highway infrastructure has expanded considerably since the late 1950's, thenetwork increasing by 50% between 1963 and 1973; Bank lending has playedan important role in this development. But general road conditions remaininadequate in view of projected traffic volumes. Not only do these trans-port problems tend to limit the market for industrial products but lack ofsecondary and feeder roads has been a major deterrent to bringing new cul-tivable land into use. The same study also notes inefficiencies in the trucktransport, railway and the ports systems which have adverse effects on dis-tribution costs and in particular -could present serious bottlenecks to futureexpected export expansion.

Highway Network(Kilometres)

Paved Gravel Earth Total

1963 8,143 7,211 15,6241970 2,850 8,150 11,300 22,3001973 3,419 7,107 12,012 22,538

Source: Bank Transport Study

1.34 As regards energy, a substantial expansion of installed capacityfor generating electric power has occurred since the early 1950's, more thandoubling in both of the 1950's and 1960's, primarily based on many thermalplants. With economic activity and consequently potential demand risingrapidly, recent investment has turned towards larger hydro-electric stations

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in the mountainous areas and a major energy sector investment program is nowin implementation.

1.35 In spite of these developments, the principal cities of Quitoand Guayaquil currently continue to experience shortages in power avail-ability which has deterred or delayed a number of new industrial invest-ments. However, the completion by 1976/77 of the first phases of new hydro-stations, as well as the completion of investment in transmission and dis-tribution systems, are expected to reduce this factor as a bottleneck tofurther growth. Nevertheless, power availability will continue to be con-centrated in certain areas; in its 1973-1977 development plan, NPC estimatedthat by the end of that period, it would be possible to serve only some 45%of the population with the completion of the projects for generation, trans-mission and distribution then anticipated. 1/

Electric Energy: Availability and Use

Installed Capacity(thousand KW) Generation (Million KVA)

1953 55 1671961 145 4111969 269 8581972 357 1,1171974 405 1,421

Source: INECEL, UN Statistical Yearbooks

1/ NPC estimated that during the period 1973-1977, gross investment inelectricity generation and distribution would amount to 8.5% oftotal gross investment, as compared to the level of 2.6% actuallyachieved in 1968-1972.

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II. MAIN ELEMENTS OF INDUSTRIAL POLICY

A. PRINCIPAL INDUSTRIAL INCENTIVE LAWS 1/

General Background

2.1 Industry in Ecuador follows essentially a pattern of free enter-prise with Government efforts centered on the creation of supporting infra-structure and services and in the areas of taxation, tariff and finance.Manufacturing operations are generally developed by private enterprise,although the Govenment has directly entered and is planning to enter in afew cases with state-owned enterprises or sharing public investment with theprivate sector, either because the projects require large funds or becauseprivate investors were reluctant to enter in those fields on account oftheir newness or risk. The development of fertilizer and petrochemicalproducts by government agencies in the near future may bring about a largershare of public enterprises in the industrial sector of Ecuador. At pre-sent, the Government has equity and has played a major role in creatingenterprises concerned with sugar and cement production.

2.2 In 1957, the Government enacted the first comprehensive industrialdevelopment law which provided a range of incentives for industries whichmeet priority needs of the country. Ten separate criteria were set out inthe law, which were to be used as the basis for assigning applicant enter-prises within three major classifications; these criteria included suchelements as use of domestic raw materials, contribution to local technologicaldevelopment and use of domestic labor. The principal incentives related toexemption, in part or in full, from duties on imported raw materialsand capital goods on a graded scale according to the classification of theenterprise. The decision to place an application in any one of these cate-gories was left to an inter-ministerial committee.

2.3 During the next 15 years, various modifications were introduced andin 1973 a major revision and consolidation of the entire structure was under-taken. This was designed also to bring into consideration other elements ofthe Government's industrial strategy. At present, Government's policy of in-dustrial incentives has four major objectives: (i) accelerate industrial growthand thus increase value added for the economy and use the resource endowmentsmore efficiently; (ii) generate employment opportunities in the urban areasand thus absorb manpower migrants from the rural areas and improve their income;

1/ Financial incentives are treated separately in Chapter III.

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(iii) generate additional sources of foreign exchange and thus diversify theeconomy heavily dependent on oil exports; (iv) attain a better regional balanceof output, which as pointed out in Chapter I, is heavily concentrated in Quitoand Guayaquil. Also, these incentives are geared to fulfill Ecuador's commit-ments and goals with the Andean Pact. To reach these objectives, the Govern-ment uses several policy incentives: in addition to the financial system(see Chapter III), these include tariff protection, quantitative restrictionsand tax incentives.

Tariff Protection and Quantitative Restrictions to Imports

2.4 Tariffs may be used to protect industry, to obtain governmentrevenues or to deal with balance-of-payments difficulties. Until the recentinflow of revenues from petroleum activity, the main objective of tariffson imports was to be an income source for the Government and their levelswere generally fixed with this objective in mind. In 1972, tariffs represen-ted 11.4% of total Government revenues and were at the time the largest singlesource of revenue. During the period of the 1960s and early 1970's, balance-of-payments problems on occasion led to imposing quantitative restrictions,particuarly on finished goods. A major.restructuring of tariffs was intro-duced in 1974 to gear import tariffs to promoting industrial development,although at the same time reducing the overall tariff level. In mid-1975,due to an emerging balance-of-payments gap, tariffs were again raised,the tionetary Board established prohibitions for automobiles and a few otheritems, re-established the system of prior deposits and introduced a selectivetariff surcharge of 30% on non-essential goods (list II, see below).

2.5 Tariff rates average 30 to 35% of the total value of imports.However, rates are relatively dispersed between categories of goods andthe tariff schedule by itself is thus capable of generating higher effec-tive protection rates. Duties on industrial raw materials and capitalgoods are low. High tariffs exist on fairly simple goods (e.g. textiles,food products). Consumer durables (including electricial and transportequipment) tend likewise to have relatively high tariffs. Moreover, eachcategory has enormous diversity buried in the average; for instance, textileshave high protection on synthetic fibers but low on cotton textiles, andmetal products have low protection for foundry products but high for wireproducts.

2.6 Various exemptions from import duties are applied. Total orpartial exemptions include those relating to imports from the Andean andother LAFTA sources, inputs for industries that the Government wishes tostimulate, imports for the public sectors and other ad hoc exemptions.Furthermore, Decree 786 in 1975 specified that imports of raw materials,intermediate goods, and capital goods for industries covered by the in-dustrial incentive laws would be exempt from the import duty surcharge.

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To a large extent, these tariff exemptions favor mostly capital goods im-ports and hence reduce the cost of capital vis-a-vis the cost of labor.

2.7 Among quantitative restrictions, direct prohibition of imports

provides the maximum degree of protection; these have been used only spar-ingly, most recently for automobiles and some "luxury" consumer goods.In this category of measures, prior deposits have been the most widelyused, although only for some products; in severe balance-of-payments diffi-culties import prohibitions have also been used. To administer the priordeposit system, Ecuadorian authorities established a system of two lists --list I ("essential" goods) and list II ("non-essential" goods). Import li-censes are required for all items.

2.8 In 1974 list II covered only an 11% of imports but in September1975, the list was revised and its coverage increased to approximately 15% oftotal imports. The Monetary Board reclassified importable items by splittinglist I into segments A and B ("essential" and "semi-essential" goods, respec-tively). An advance import deposit requirement was introduced in the amount of20% for items in list I-B and 30% for items in list II. Before an importerapplies for the necessary import permit, he has to deposit with the CentralBank the given amount, expressed as a percent of import value, which remainsdeposited, earns no interest and erodes by inflation, until 180 days afterdate of deposit, even if the goods have not yet arrived. On the basis oftotal value of imports, the advance import deposit 1/ is equivalent to a sur-charge of less than 2% and a contraction of money supply of approximately10%.

1/ It should also be noted that since 1973, 80% of any import dutiesto be imposed have to be paid at the time of the deposit. Thishas not been included in the subsequent estimates.

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IMPORTS PERMITS BY LIST(In millions of dollars)

Jan. - Sept.

1971 1972 1973 1974 1974 1975

List I 261.5 287.5 474.4 851.2 597.7 636.5List II 42.4 41.0 58.0 107.4 78.0 102.0

TOTAL 303.9 328.8 532.5 958.5 675.7 738.5

(As percent of total)

List I 86.0 87.5 89.1 88.8 88.5 86.2List II 14.0 12.5 10.9 11.2 11.5 13.8

TOTAL 100.0 100.0 100.0 100.0 100.0 100.0

2.9 Although there are no studies of effective protection, the im-pression is that it has been low, but this situation may be changing.Calculations of effective protection would require the undertaking of detailedprice comparisons between domestic production and import values to determinethe composite effect of licensing, tariff redundancy, tariff exoneration andprior import deposits. This type of comparison has not been done, although itwould be useful in view of the negotiations for the Andean Common Marketexternal tariffs.

2.10 For many simple consumer goods subject to high tariffs, (e.g. tex-tiles and foods) which are not subject to economies of scale, productionconditions have permitted domestic competition which has tended to reducelocal prices to the CIF import price; in this connection, the possibility ofcontraband trade has also served as an element of competition. In the case ofthe large consumer items the imports of which have been subject to quotas, thenarrowness of the market in the past restrained entry into production of thesegoods even though the extent of effective protection was high.

2.11 With the widening of the market as a result of recent economicgrowth the latter situation is tending to change. The mission visitedsome newly established enterprises where costly technologies are beingapplied and prices of the final product are considerably higher than inother neighboring countries. The experience of other similarly smalldeveloping countries in attempting to achieve an inward-oriented growth

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demonstrates the need for the authorities to keep under review the pos-sible distortions the system of protection is fostering. 1/ There isparticular need for a revision of the existing situation with a view toencouraging internal industrial integration.

2.12 The longer-term structure of tariffs for Ecuador will dependupon the negotiations within the Andean Pact for the Common External Tariff.Although the Andean Common Market represents a substantially larger marketfor each of the member countries, a development strategy based on regionalimport substitution can still provide only limited scope for growth. Theimplications of Ecuador's membership in the Andean Group are examined laterin this chapter.

Other Incentives: Tax Exemptions

2.13 The revision of the law in 1973 provided certain changes in theextent of exemption from tariffs and the creation of a new or "specialcategory" with considerably liberalized exemptions; it also consolidatedvarious incentives which had derived from other laws, notably exonerationfrom income, stamp and related taxes. At the same time, however, it addednew elements to reflect the priority given by the Government to specificdirections in industrial growth.

2.14 In order to promote investment in the relatively less developedregions of the country, special benefits have been accorded to enterprisesto be established in all provinces other than Pichincha (Quito) and Guayas(Guayaquil); maximum levels are afforded to eight provinces 2/ (seeStatistical Appendix Table 5). Another feature of the law is establish-ment of export incentives in the form of tax certificates to exporters ofnon-traditional products; for industrial products the amount of these certi-ficates varied from 7 to 15% of the value of exports depending upon the totalvalue of the product exported in the previous year; further consideration ofexport incentives is presented in a subsequent section.

2.15 Finally, the revision contained a list of 79 products which areclassified as "Special Category" (receiving maximum benefits under the

1/ One measure which has been used in other countries to restrain imports ofso-called luxury goods, while not stimulating local production throughhigh effective protection, is to impose large sales taxes on those itemswhich are applied equally to imports and domestic output.

2/ Among these provinces is Azuay (Cuenca) which had already been the sub-ject of limited tax privileges dated from 1954.

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law) as well as 82 items classified as Category A (with somewhat lowerlevels of benefits). t4oreover, in order to qualify, facilities to manu-facture these products have to meet certain technical standards specifiedin the regulation, in particular minimum "installed capacity" (not otherwisedefined), but including other details such as percentages of imported in-puts. These lists could, however, be amended through special edicts bythe Inter-ministerial Committee charged with administering the law.

2.16 Investors interested in producing products which have not yet beenclassified under the existing regulations for the Industrial Incentive Lawmay apply to the Ministry of Industries for such classification, which arereviewed by the committee. At present, the criteria used in this processhave been reduced to six; those that: (i) are directed to export markets;(ii) have important employment effects; (iii) correspond to allocations ofindustrial programing in the Andean Group; (iv) help to achieve a betterregional distribution of industrial activities; (v) generate a larger domes-tic value added; and (vi) have important backward or forward linkages thathelp the development of the country. Examples of industries in the SpecialCategory are the following: meat packing industries, fruit juices, banana andbanana flour, wood processing, fishing, paper pulp, abaca, some chemicals,some machinery and equipment, watches. Examples of products in Cate-gory A are sugar, fish meal, mushrooms, coal, tires, other chemicals, metalsother than steel.

2.17 Actual operation of industrial incentives continues to allow asubstantial degree of discretion to the authorities in granting the taxbenefits. Since the list of industries eligible for incentives isperiodically amended on the basis of experience, needs and requests, anindustry that has a given classification at a given time may be includedlater on in another class or totally excluded from the benefits of thelaw. Another factor is the process of evaluation itself. An examinationis made of each application before an authorization is given to the in-dividual firm; this includes an analysis of proposed capacity, import re-quirements, location and profitability of the new investments. To assurethat these decisions are properly taken, to induce investment in efficientindustries and to avoid wasteful loss of revenues, the country would needvery elaborate arrangements to coordinate the decisions and very goodinformation on industrial technology, production costs as well as prices,which even in the most advanced countries are difficult to obtain. Inpractice, however, the authorities have applied generous and flexiblecriteria, tending to favor investment over considerations of tax equityor of the flexibility of the tax system.

2.18 Although not enough time has elapsed to fully evaluate the impactof the new incentive system, the general impression is that some industrialinvestments have been induced as a result of the tax and tariff advantages.But there is no certainty that these investments are appropriate or that adiversion of resources to non-optimal uses has not resulted from distortion

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in prices (caused by the incentive system). The system certainly has someundesirable effects: (1) being directed to stimulate investments in equip-ment, they induce the use of capital intensive technology; 1/ (2) breakingthe progressivity of tax rates, they benefit more taxpayers in the upperincome brackets; (3) they also have a budgetary cost. In granting theseincentives on a selective basis, the argument has been made that increasedoutput in particular industries would hasten economic development, perhapsbecause of the linkages or external economies that characterize these in-dustries. Investment incentives of various kinds are granted as means ofattracting capital to these industries. But in addition to increasing out-put of favored industries, tax incentives induce substitution of capitalfor labor in these industries. The question arises whether capital could beattracted to these industries without encouraging substitution of capital forlabor. As long as the policy is to increase investment in industry a dis-tortion in factor utilization is produced. An incentive related to investmentin a given industry encourages capital-intensive production. However, theultimate reason for the subsidization of investment is not to increase indus-try capital stock per se, but to increase output.

2.19 A further element which must be considered is the fiscal cost ofthe exemption. It is true that the non-petroleum sources of revenue of theeconomy now represent a small percentage of Government revenues. Never-theless a further reduction of these sources may be undesirable, not onlybecause of the long run perspectives for public revenues, but also to ensurethat the Government is able to have some means to control aggregate demand.

2.20 It is recognized that in the earliest stages of industrialization,it may be important that the sector have an initial period of relatively higherprofitability because of the special difficulties associated with investmentin that period. In these circumstances it is advisable to allocate thetax advantages with moderation, for example: crediting the investmentsonly in the year in which they were made and avoiding the possibility ofcarrying forward the benefits for five years after investment. Also, it ispreferable to provide a credit against tax liabilities rather than a taxexemption, because tax credits are independent of the tax brackets of theindividual taxpayer. Tax credits are deductible from the calculated tax,while tax exemptions are deductible from the tax base.

2.21 Finally, the description above of the rather elaborate mechanismfor providing selectivity in granting the incentives and the overlappingof criteria (if not contradiction) suggests the need for simplificationof the law.

1/ Similarly, as noted in the previous section, the tariff exonerationson capital goods tend to favor the use of capital.

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2.22 Aware of some of the difficulties experienced in the operation ofthese incentives, the Government in mid-1975 appointed an inter-ministerialgroup to consider the need for revision of the entire system including thoseaimed at small industries. Drafts are being prepared by the Ministry of In-dustries but action by the larger group has not yet been taken.

B. THE SPECIAL PROBLEM OF SMALL AND ARTISAN INDUSTRIES

2.23 Government policy has long been concerned with promoting or assist-ing small or artisan industries; some features of the measures cited aboveare inter alia designed to stimulate those activities. It will be recalledthat for many years an important export and employment-generating activityhad been the hand-weaving of Panama hats in the area of Cuenca; world de-mand for this item has almost disappeared in the post-World War II period,and attempts have been made to find alternative uses of the skills developed.

2.24 The major policy action in this particular area was taken in 1973with the promulgation of a special law for the Promotion of Small and ArtisanIndustry. This law also provided for extensive tax exemptions; as comparedto the general investment law, this law provided for more generous deductionsfor investment or reinvestment from income tax liabilities. In that sameyear the scope of the law was modified to allow maximum benefits foractivities located outside Pichincha and Guayas. The original definitionof small and artisan industry was any establishment with less than 1.5 millionsucres (approximately $60,000) invested in machinery and equipment; this wasmodified in August 1975 raising the limit to 5 million sucres (approximately$200,000). 1/

2.25 In addition to these measures to aid small and artisan industry theGovernment has undertaken a number of other specific activities. In the1963-1973 Development Plan, major emphasis was put on building industrialestates as a means of reducing those infrastructure deficiencies, particu-larly in areas other than Quito and Guayaquil, which appear to be hinderingnew investment. Implementation of these proposals was extremely slow, partlydue to lack of funds as well as the shortage of appropriate operationalstaff; it was not until 1974 that construction began on the first phaseof a major estate construction site in Cuenca.

1/ However, any existing enterprise with between 1.5 and 5 million sucreswhich had already been classified under the general investment lawcould not qualify for benefits under the Small Industry law.

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2.26 Other measures have included the creation of numerous trainingcenters and technical assistance programs for artisan industries. 1/Finally, as discussed in Chapter III, special finance and credit facil-ities have also been provided for small and medium industry.

C. EXPORT PROMOTION

2.27 Practically all of the investment promotion measures cited in theprevious sections have contained certain features designed specificallyto assist exports of non-traditional products. Mention was made of the1973 version of the investment law which provided for incentives to exportersin the form of tax certificates, the amount depending upon past performance;this actually represented an extension of the fixed subsidy of 4% of exportvalue which had been inaugurated in 1971. The incentives currently in effectcover not only industrial products but also non-processed agricultural commodi-ties which previously had not been exported; the latter receive a flat 4%incentive. Other features of the investment law include full exonerationof duties on raw materials which are used for producing exported items,the standard "drawback" system, and also temporary admission system.

2.28 The Government is considering a decree which would consolidatethe various measures for export promotion and centralize the administrationof the incentives which now follow diverse procedures. The proposal wouldpromote the creation of export firms who would be responsible for inter-national marketing of a large range of products; as the regulations arepresently structured, only producing firms can obtain the benefits of thevarious export incentives and most of these enterprises are either too smallor at present cannot afford to develop adequately the marketing function.In addition, the proposed decree would revise the incentive system and estab-lish a scale of cash payments for products in accordance to domestic valueadded rather than historical performance. In this connection, it should benoted that other developing countries which have used similar incentivesystems have incurred substantial fiscal losses after these systems have beenin operation for relatively long periods of time. They are therefore tendingto curtail these payments, choosing instead to follow more flexible exchangerate policies. It does appear, however, that in the initial period of opera-tions the incentives did play a major role in developing an export-conscious-ness among entrepreneurs and served to offset the relatively large costs andrisks associated with new export undertakings.

1/ A Pan-American Institute for Artisan Industries, with support from theOAS, has been established in Cuenca while an IDB regional program forpromoting artisan exports from the Andean region has also been head-quartered in that city.

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2.29 Given the existing extent and structure of Ecuadorian industry,there is need to develop export promotion policies suited to the range ofactual product possibilities. Much more effort is required to determine forthe specific items the barriers to export expansion in order to define thespecific measures required.

2.30 To promote non-traditional exports, several additional policiesshould be considered: (i) the creation of free zones, where industriescan grow free of import duties and with low administrative costs; (ii) tech-nical assistance to export industries, particularly the small and mediumindustries, to achieve quality acceptable in external markets; (iii) furtherefforts in financing exports, with special emphasis on new enterprises; (iv)investment in the improvement of transport infrastructure and provision oftransport and storage systems with a view to attending specific markets; and(v) drawback systems.

D. PRICE POLICY

2.31 In general, the market mechanism determines prices for most of thecommodities in Ecuador; however, Government intervenes in a few cases, eitherwith price controls or with price supports. Articles of popular consumptionare subject to price ceilings determined by the Superintendency of Prices.On the other hand, prices of other commodities, primarily agricultural pro-ducts, receive price supports designed to stabilize prices and stimulate pro-duction. There are thus three separate purposes underlying price interven-tion: to stimulate production of some goods, to avoid large increases inprices of commodities of popular consumption and to avoid monopolisticprofits.

2.32 As a consequence of this lack of coherence, the administration ofprice policy is a matter of great complexity. Some prices are too low. Theyattempt to protect the consumers but generate scarcities that distort resourceallocation: i.e. a low price of sugar, far below world market prices, gene-rates scarcities in the domestic market because suppliers tend to sell theiroutput for use as an intermediate product for articles not subject to pricecontrols. As the scarcity becomes more evident, the Government is forced toestablish export prohibitions, 1/ quotas and other kinds of restrictions. Newinvestment to produce commodities subject to price regulations are alsodiscouraged; i.e., the low price of milk has discouraged many farmers fromdairy business and milk scarcity is becoming a chronic problem in Ecuador.

1/ In the case of plywood which also has a fixed price, in spite of thelegal prohibition on exporting, and the physical difficulties in trans-porting the item, some supplies are known to have reached markets inneighboring countries where prices are more in line with internationaldemand conditions.

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2.33 On the contrary, other prices are too high. The Government witha desire to stimulate diversification of agricultural production sets pricesupports for some commodities (e.g. soya beans). These prices have becomemuch higher than world market prices; import restrictions become necessaryto maintain a relatively inefficient domestic output, and prices of rawmaterials are therefore artificially high, while often the prices for finalproduct are kept in line with world market prices for those items.

2.34 Thus, from the point of view of economic efficiency price controlsclearly generate undesirable distortions of resource allocation: scarcitiesand over-production of the commodities affected result from prices that aretoo low or too high. From the point of view of income distribution, priceceilings are geared to protecting the income of the poor, but this objectiveis not usually reached because of the resulting scarcities, which affect thepoor. Also, if investment declines in view of price ceilings, employmentopportunities in industry are reduced.

2.35 Therefore, a gradual reduction of price controls may prove advis-able to eliminate these distortions. However, this process requires somecaution to avoid increasing price expectations in moments of inflationarypressures and a sudden release of price ceilings should be avoided.

2.36 An important area where there is room for effective Governmentaction, is that of stock management for price stabilization and improvedmarketing facilities. For many producers a stable price is a more importanttool to stimulate his investment than a high price. Thus, a mechanism where afew commodities are subject to some degree of Government intervention ininventory management would avoid drastic changes in prices.

E. LABOR AND WAGE POLICIES

2.37 The cost of labor in Ecuador has not represented a major drawback toindustrial growth. In fact, wages and salaries in Ecuador are in line withwages and salaries in the other countries of the Andean Group. However,three institutional factors tend to increase the cost of labor: (i) thelabor law; (ii) the strength of labor unions; (iii) the existence of a gener-ous social security system.

2.38 (i) Labor Law. As in many other countries, the Labor Law in Ecuadorgrants to the workers a set of minimum rights and benefits: minimum wages,severance payments, profit sharing, vacations, holidays and maximum hours ofwork. These legal provisions affect the demand for labor since the loss offlexibility, arising from the provisions that restrict mobility in the labormarket, induces the use of capital intensive technology; and the fringe bene-fits and other payments increase the cost of labor by about 40%.

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2.39 The Labor Law estabishes a minimum set of rights to the worker,but most of the wages and benefits paid by the large and medium size firmsare substantially above these minimum standards. For them, collectivebargaining is more important in determining the cost of labor. Thus, wherecollective bargaining is strong, labor income is relatively high. At theother extreme, in the informal sector, the minimum standards of the LaborLaw do not apply for there is a large group of self-employed, artisansand other groups that either escape the labor contract or have an excep-tional legal treatment.

2.40 (ii) The growth of labor unions in Ecuador has been relativelyweak compared with other countries. Recently, however, it has become a moreinfluential force as a result of the process of industrialization and urbani-zation. 1/ Labor unions negotiate collectively benefits above those of thelabor laws: (i) wages, three or four times the minimum level; (ii) additionalfringe benefits, generous vacations; (iii) increases in holidays; (iv) largerpercentages of profit sharing; and (v) payments for overtime work, etc.Notwithstanding the benefits in social legislation it appears that thecost of labor in Ecuador is low relative to other countries in the AndeanPact.

AVERAGE DAILY WAGE OF WORKERS (IN MODERN INDUSTRY)

Including Other Costs (In dollar equivalents - 1975)

Ecuador 1.70Colombia 2.10Venezuela 6.80Peru 4.20

Source: IBRD staff estimates.

F. THE ANDEAN COMMON MARKET

2.41 Under the conditions of the Cartagena Agreement creating the AndeanCommon Market, a common external tariff was to be agreed upon by 1980/85.A common minimum external tariff was to be implemented by 1975 but hasbeen postponed in view of difficulties in the negotiations. The Common Market's

1/ In late 1975 and early 1976, some labor unrest has occurred, causingtemporary shutdowns of major industrial facilities.

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Junta has drafted a common external tariff, based on effective rates ofprotection, but no agreement has been reached in this difficult area. Theproposed rates are lower than those applied in most of the member countries,but still appear high enough to involve a bias against primary production andexports. The external tariff will oblige Ecuador to abandon the system ofgenerous tariff exemptions to industrialists, and, to the extent that overlyprotected enterprises have been established, will decrease their profitability.On the whole, however, in the long-run Ecuador appears to be in a favorableposition within the Group, as indicated in the preceding paragraph (see tableabove).

2.42 The adoption of Decision No. 24, regulating foreign investmentsand the transfer of technology has substantial implications concerning thelevel and direction of investments. All new foreign investments requireGovernment approval and an effort will be made to direct these investmentsto the areas of priorities. There are limits on profit remittances abroadand the payment of royalties is subject to Government approval. In some casesthese rules do not apply: for example, industries that export more than 80% oftheir value of production are exempt from these provisions.l/

2.43 Considerable uncertainty now surrounds the pace of implementationof these basic decisions. Some governments have felt that decision 24 shouldbe modified. As already noted, there are differences among governmentsrelating to the fundamental structure of the external tariff. As suggested inthe earlier section of this chapter on tariff policy, an externally orienteddevelopment strategy is important for the Group; even with the larger marketit represents, there is need to ensure the growth of export-oriented indus-tries.

2.44 Within intra-Andean trade, Ecuador benefits through a number ofarrangements including special concessions granted to it and Bolivia, asrelatively less developed countries. In addition, within the regionalprograming undertaken for the metal-mechanical and petro-chemical indus-tries, products have been assigned to it. Progress achieved in utilizingthese concessions and prospects for future growth are examined in the lastchapter.

1/ Ecuador and Bolivia also have special treatment under thisdecision.

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CHAPTER III

THE FINANCIAL SYSTEM

A. GENERAL CHARACTERISTICS

3.1 This review is primarily concerned with those institutions and in-struments which are closely linked to the financing of industry and does notinclude the review of housing banks, insurance companies and similar inter-mediaries. Briefly, the financial system may be divided into various segments,namely: the monetary authorities, the banking system, the non-bank financialintermediaries, the special funds, the security exchanges and the unsupervisedmarket. The main elements of the system are outlined below.

Main Elements of the Financial System

A. Monetary Authorities

- Monetary Board- Central Bank of Ecuador- Bank Superintendency

B. The Banking System

- The Central Bank- Private Commercial Banks- Banco National de Fomento

C. Non-Bank Financial Intermediaries 11

- Comision de Valores - Corporacion Financiera Nacional (CV-CFN).- Compania Financiera Ecuatoriana de Desarollo S.A. (COFIEC).

D. Special Funds

- Fondo Nacional de Desarrollo (FONADE)- Fondo Nacional de Preinversion (FONAPRE)

1/ Since this report was drafted, a number of new non-bank financialintermediaries have been organized. These institutions, as well asthe two existing agencies, are analyzed in the appraisal reportfor the third DFC loan, to be issued shortly.

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E. Security Exchanges

F. The Unsupervised Mlarket

Debt-Financing

3.2 The total volume of credit (defined as the value of credit opera-tions in each year) extended by the banking system and by CV-CFN and COFIECin the period 1970-1974 is shown in the following table. Except for CV-CFN,available statistics make no distinction between short and long-term credit,although it may be reasonably assumed that Banco de Fomento, CV-CFN andCOFIEC are the major sources of the long-term financing. The mission esti-mates that during 1974, only about 15% of total credit extended by the bank-ing system, CV-CFN and COFIEC had terms over one year. This no doubt re-flects the predominantly commercial orientation of the business sector inEcuador. Overall, the commercial banks dominated the scene. Their shareof total credit went from about 68% in 1970 to 72% in 1973. However, during1974 it dropped to about 62% due partly to the restrictions placed onoverall portfolio growth and partly to the emerging importance of BancoNacional de Fomento and CV-CFN during 1974. The unfreezing during 1975of certain portions of the portfolio of the commercial banks combined withincentives under the Fondos Financieros mechanism may again change theirrelative position in the future.

Volume of Credit Extended by Source(in million sucres)

Non-BankBanking System Intermediaries Total

Central Commercial Banco NacionalYear Bank /a Banks de Fomento CV-CFN COFIEC

1970 2,578 8,054 678 145 359 11,8141971 2,363 9,079 763 410 444 13,0591972 2,546 10,542 808 302 633 14,8311973 2,229 12,888 1,508 363 831 17,8191974 3,313 15,668 3,640 1,266 1,306 25,193

Source: Memoria del Gerente General del Banco Central del Ecuador, 1973-1975;operating reports of CV-CFN and COFIEC.

/a Credit to commercial banks and BNF excluded.

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3.3 The volume of industrial credit extended by the same entitiesduring 1970-1974 is shown below. Industrial credit accounted for about 20% oftotal credit in 1970 but rose to 25% in 1974. However, the relative impor-tance of the Central Bank went down from 37% in 1970 to 17% in 1974; that ofthe commercial banks increased from 46% in 1970 to 58% in 1973, but for thereasons given earlier, dropped back to 46% in 1974. Furthermore, the share ofBanco National de Fomento was small, while that of CV-CFN increased substan-tially in 1974, and that of COFIEC has grown steadily. The average valueof industrial credit operations has gone up over the years; it has, of course,varied considerably from one institution to the other. 1/ Apparently, thereis no study showing the breakdown of industrial loans by size.

Volume of Industrial Credit Extended by Source(in million sucres)

Non-BankBanking System Intermediaries Total

Central Bank Commercial Banco NacionalYear Banks de Fomento CV-CFN COFIEC

1970 905 1,134 104 131 199 2,4731971 970 1,266 127 265 236 2,8641972 759 1,631 150 291 367 3,1981973 627 2,215 222 333 439 3,8361974 1,090 2,913 503 1,118 752 6,376

Source: See previous table.

3.4 As to geographical location, 49% of the industrial credit granted bythe banking system went to the Guayaquil area, 39% to the Quito area and 12%to the rest of the country. Although CV-CFN and COFIEC have not publishedthe geographical breakdown of their operations, it is well known that theseare also highly concentrated in the Guayaquil and Quito areas.

1/ In 1974, an average industrial loan amounted to US$47,040 at the CentralBank, US$2,640 at commercial banks, US$2,560 at Banco National de Fomento,US$359,620 at CV-CFN, and US$49,160 at COFIEC. In the case of CV-CFN theaverage value covers only project financing and does not take guaranteeoperations into account.

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Equity Financing

3.5 At the end of 1973, the 426 existing industrial companies 1/ had combinedassets of S/. 13,390 million and an aggregate debt-to-equity ratio for 1.54:1.There are a number of factors which contribute to this high ratio. About one-third of the total share capital of these firms was in the hands of foreigninvestors which often prefer to lend to their businesses because debt financ-ing offers greater ease of repatriation. Local investors are also prone tolend to their own businesses rather than inject new equity because of the dis-criminatory tax rate on dividend income. Interest income is taxed once at thesource at the rate of 8% and does not form part of personal income. Cashdividends on the other hand are subject to a withholding tax of 20%; the share-holder must include cash dividend income in his personal income, calculate histotal income tax and deduct what he has paid on the withholding tax. Thisdiscrimination in tax treatment is of major importance in the problem of de-veloping an appropriate capital market in the country and its implications aredealt with in subsequent sections.

B. THE ELEMENTS OF THE FINANCIAL SYSTEM

The Monetary Board

3.6 The Monetary Board is the highest monetary policy body in Ecuadorand, in this capacity, it regulates the volume and distribution of credit inthe supervised market. Effective September 11, 1975, the Minister of Financeis no longer President of the Monetary Board. The post is now held by arepresentative of the President of the Republic. Members continue to in-clude the Ministers of Finance, of Industry, Commerce and Integration, andof Agriculture, and the President of the NPC; the Bank Superintendent andthe Manager of the Central Bank act as advisors; and finally, the threerepresentatives of the private sector which before the change had fullmembership now participate in the discussions, but no longer vote in thedecisions of the Board.

The Central Bank

3.7 The Central Bank is principally responsible for the issue of moneyand the exercise of some of the measures of monetary control. It handles

1/ See Superintendent of Companies, "Sintesis 1964-1974". The firmsincluded here are: "companias anonimas, de economia mixta y encomandita por acciones."

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a fair volume of credit, including the account of the Fondo Nacional deDesarrollo, and administers the Fondos Financieros. As of December 31, 1974,its total assets amounted S/. 21,595 million, including S/. 6,986 million ofclaims on the public sector (Central Government and official financial insti-tutions).

3.8 The volume of credit extended by the Central Bank in the period 1970-1974 is estimated below. The figures do not include rediscount operations;the "other" category includes the public sector.

Central Bank-Volume of Credit(in million Sucres)

Year Commerce Agriculture Industry Other Total

1970 797 215 905 661 25781971 728 159 970 507 23631972 1159 109 789 489 25461973 1111 124 627 367 22291974 1492 89 1090 642 3313

Source: Banco Central del Ecuador

3.9 The Central Bank administers the Fondos Financieros which consistof six funds with local resources and two with foreign resources from USAIDand IBRD loans (Annex 2). The resources of these funds are used by theCentral Bank to rediscount loans made by commercial and development banks toeligible borrowers under the provisions of each funds. Normally, the inter-mediary lends up to 90% of the cost of the project at 9% and rediscounts 80%of the value of the loan at 3%. 1/ However, these rediscount facilities applyonly to the last two years of any contract. The intermediary which partici-pates in this scheme is assured on its own funds of average gross yields which

1/ Exceptionally, under IBRD loan 22-EC, the intermediary lends at 12%for loans above S/. 625,000 and rediscounts at 7% the equivalent of70% and 75% of the value of the loan for milk cattle and meat cattleprojects respectively.

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vary with the life of individual loans from 33% for up to 2 years, 1/ but thereturn is much lower if held for longer time periods. Moreover, two otheraspects of the mechanism also favor short-term operations, namely: (i) therelatively small resources of the funds and (ii) the fact that no intermediarycan use more than 5% of the resources of any individual fund. In the circum-stances, intermediaries are bound to opt for the short-term operations whichoffer greater return.

3.10 Two of the eight funds of the Fondos Financieros are aimed atassisting small-scale and artisan industries, namely the Fondo FinancieroIndustrial and the USAID Technical and Credit Assistance to Small IndustryProgram. The former has worked relatively well; during 1975, the EcuadorianGovernment increased its resources from S/. 200 million to S/. 400 million.The latter has not worked too well because of administrative complexitiesand at the end of December 1975 was up for renegotiations and/or an exten-sion of the closing date.

3.11 Two complaints have been most frequently heard about these funds.First, that the personal and real guarantees required by the financial in-termediaries are often beyond the capability of the small borrowers. Inview of the fact that commercial banks participate in the mechanism, consi-deration should be given to establishing a guarantee fund in the CentralBank so that small borrowers are not unduly by-passed. Second, that thereis a lack of easily accessible and practical technical assistance. InNovember, 1975 the Minister of Industry announced the creation of the NationalCenter for the Promotion of Small and Artisan Industry (CENAPIA) which, amongother things, will supervise the use of the funds of the Fondos Financierosmechanism and provide techncial assistance in the areas of accounting, indus-trial engineering, and product design and marketing. 2/

The Commercial Banks

3.12 There are 20 national and four foreign commercial banks operatingin Ecuador (May 1976). As of December 31, 1974, their combined liabilitiesstood at S/. 22,904 million, classified as follows: 3/

1/ Intermediary's own resources: 20%, yielding 9%; plus a spread of 6%on 80% of the loan, yield:

(.20 x .09) + (.80 x .06) = 33%.20

2/ Measures to assist small-scale industries are discussed in Chapter IV.

3/ The data refers to the 18 national and four foreign commercial banksoperating at that date.

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Amount(in million Sucres) % of Total

Deposits 12,239 54Bonds 2,738 12Letters of Credit 3,469 15Other Obligations 3,039 13Equity 1,419 6

Source: Banco Central del Ecuador, 1974-No. XLVIII-560.

3.13 The liabilities of the commerical banks are somewhat concentrated,with about 55% in only five of the national banks and another 23% in theforeign banks. Ownership is also fairly concentrated, although only one bank -

albeit one of the largest - is still family-owned.

3.14 The volume of credit extended by the commercial banks in the period1970-1974 according to main sectors is given below. Recent measures of commer-cial portfolio ceiling and directed investment are expected to change thetraditional mix of beneficiaries. The source does not indicate the contentof the "other" category which has shown considerable growth; this may includehowever, construction activities.

Commercial Banking System - Volume of Credit(in million Sucres)

Year Commerce Agriculture Industry Other Total

1970 5,573 841 1,134 506 8,0541971 6,521 749 1,266 544 9,0791972 7,097 1,035 1,631 778 10,5421973 8,610 1,103 2,215 960 12,8881974 10,018 1,123 2,913 1,614 15,668

Source: Banco Central

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Banco Nacional de Fomento

3.15 As of December 31, 1974, the total liabilities of Banco Nacionalde Fomento (BNF) stood at S/. 6,904 million, as follows:

Amount(in million sucres) % of Total

Deposits 1,868 27Borrowings 2,963 43Other 441 6

Equity 1,632 24

Source: Banco Central del Ecuador, 1974-No. XLVIII-560.

3.16 Banco Nacional de Fomento receives deposits and in this sensediffers most clearly from the other development banks. Also striking is the

fact that its debt/equity ratio was only 3.2:1 at the end of 1974. This lowleverage may reflect market conditions and the instruments at Banco deFomento's disposition, as well as the lack of aggressivity in attracting de-

posits.

3.17 For BNF, volume of credit extended in the period 1970-1974 isshown below. The salient feature of this table is the accelerated growthwhich took place in the last two years. The volume of credit to small-scaleand artisan industries has, however, represented a small percentage of itsoperations. One major reason given for this is Banco de Fomento's requirementthat it should have first ranking as a creditor. Accepting this conditionvirtually bars a borrower from obtaining credit elsewhere. If BNF is tofulfill its development role, it should accept pari passu ranking. Theproblem of personal guarantees mentioned above aTso applies to Banco Nacionalde Fomento.

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Banco Nacional de Fomento-Volume of Credit(in million Sucres)

Year Commerce Agriculture Industry Other Total

1970 27 543 104 4 6781971 37 593 127 6 7631972 66 587 150 5 8081973 143 1,136 222 7 1,5081974 346 2,776 503 16 3,640

Source: Banco Central del Ecuador.

3.18 Primarily oriented toward aiding agriculture, BNF has more than50 branches throughout the country but only 15 deal with industry. In aneffort to improve its capacity for aiding small enterprises, it is nowreceiving assistance from the Inter-American Development Bank. This programincludes technical assistance to borrowers through special centers jointlyorganized by BNF and other government agencies such as SECAP and CENDES.

CV-CFN

3.19 The Comision de Valores - Corporacion Nacional de Fomento (CV-CFN)was originally established to regulate the securities market but in 1964 itsresponsibilities were expanded to include long-term financing. It receivesfunds directly from the Government, issues bonds in the local market andborrows from bilateral and multilateral aid agencies; it has received WorldBank funds through two credits and a third is now in the appraisal stage. Inconnection with its international borrowing, in the 1960's the foreign exchangeconstraint represented a major obstacle to industrial growth and the mobiliza-tion of those resources was a major purpose of the corporation. 1/

1/ CV-CFN and COFIEC (see next section) have shared in two World Bankloans designed to promote the development of financial intermediaries.The first in 1971 (721-EC) was for $8 million, divided equally betweenthe two agencies. The second in 1973 (930-EC) was for $20 million, ofwhich $8 million was used by CV-CFN and $12 million by COFIEC. In addi-tion, CV-CFN was the intermediary for a tuna fishing development loan(555-EC) with the Government of Ecuador, being responsible for sub-lending for boats and other fishing equipment. Detailed discussion ofthe functions and objectives of both institutions are to be found inthe appraisal reports for these loans.

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3.20 CV-CFN mainly invests in and lends to large and medium-sized in-dustry; additionally, it administers the Fondo de Promocion de Exportacion,maintains rediscount facilities for loans to small industry, and financespre-investment studies. At the end of 1974, CV-CFN's portfolio consistedof 23% equity investments and 77% loans.

3.21 CV-CFN's industrial loans are for periods of up to 12 years forfixed assets and 5 years for permanent working capital. They cover up to70% of the cost of new projects and up to 100% of expansions; the beneficiary,however, must provide guarantees equivalent to 142% or 125% of the value ofthe loan depending on whether these are mortgages on land and buildings orliens on machinery, equipment and inventory. Strict enforcement of this re-quirement is bound to discourage many potentially worthwhile entrepreneurs.It is felt that the good quality of its appraisals, should permit relaxingthese guarantee requirements. This comment also applies to COFIEC.

CV-CFN: Volume of Credit(in million Sucres)

Year Commerce Agriculture /a Manufacturing Other Total

1970 12 2 131 -- 1451971 35 45 265 65 /b 4101972 9 2 291 -- 3021973 26 4 333 -- 3631974 143 5 1118 -- 1266

Source: CV-CFN 1973 and 1974 Annual Reports. This does not include eitherthe financing through FOPEX or the rediscounting facilities.

/a Includes fishing.

/b This covers one operation in the public utility sector.

3.22 At the end of 1974, CV-CFN's total resources amounted to S/.2,302 million, consisting of 39% equity, 34% foreign borrowings from institu-tional sources, 9% from the Ecuador Social Security Institute, 7% from itsown 5-year domestic bonds, and 11% from miscellaneous sources. Most strikingis CV-CFN's low debt/equity ratio of barely 1.6:1. With growing demand forinvestment funds, the Corporation has undertaken to expand its operations andhas played an important role in the growth in industrial financing. On theone hand, it has begun to enter the foreign guarantee market. To obtainadditional local currency resources, it has recently begun to issue 8%,10-year, income tax-free bonds in the local market, with the standing offer

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of repurchase at sight and at par. At first these bonds were selling almostexclusively "privately" among a small group of long-time investors (mainlyinsurance companies). In the hope of developing a broader market, CV-CFN hasnow begun, with some success, to offer them through its representative on theSecurity Exchanges. These bonds are in effect short-term instruments and thequantity issued by CV-CFN should be monitored closely. However, in a countrylike Ecuador, this a very important step in developing a market for long-terminstruments. In other countries in similar stages of development, it hastaken some time before any long-term instruments (other than real-estatemortgage bonds) became firmly established in the local money markets.But, it is hoped that the Ecuadorian public will quickly become used to thesetype of long-term instruments and will look for such alternatives to supple-ment the traditional savings accounts; there is some evidence of small-saverinterest in these instruments.

3.23 Among its other activities, CV-CFN finances 90% of the cost ofpre-investment studies at 8% for up to 10 years with varying grace periods,using its own funds and any other resource which may be obtained from otherinstitutions, local or foreign. At the end of 1974, some S/. 11 million ofCV-CFN's capital was earmarked for this type of operation. In addition, itexpected to receive S/.1 million from Fondo Nacional de Preinversion (FONAPRE)in the latter part of 1975. During 1974, less than S/. 2 million was usedto finance pre-investment studies.

3.24 Fondo de Promocion de Exportaciones (FOPEX) lends for "non-tradi-tional" exports. 1/ Its loans are for up to two years at 8%, rediscounted inthe Central Bank at 4%. At the end of 1974, the total assets of the Fundamounted to S/. 74 million, and were insufficient to meet financing require-ments. An additional S/. 100 million has been requested from the Governmentbut has not yet been allocated. Because of the scarcity of available funds,terms have in effect been reduced to one year or less. During 1974, a totalof 76 operations with a value of V/. 309 million were financed.

3.25 Rediscount operations for small industry have been made by CV-CFNat 5% to commercial banks and 3% to Banco Nacional de Fomento. At the endof 1974, it held rediscounted receivables worth S/. 51 million, equivalentto about 3% of its loan portfolio. During 1974 a total of S/. 30 millionwas rediscounted. These facilities appear to constitute a duplication ofthe Fondos Financieros mechanism, which offers 3% rediscount facilities tocommercial and development banks alike, and might be consolidated with thoseof the Central Bank.

1/ For this purpose, petroleum, bananas, coffee and cocoa in grain, andsugar are considered traditional exports.

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3.26 In connection with financing of small industries, CV-CFN has beencharged with undertaking a feasibility study for the establishment of aspecial financial intermediary for these types of enterprises. While the

equity composition of this entity has not yet been defined, the Governmenthas already pledged to contribute funds to its creation.

COFIEC

3.27 The private development finance corporation - Compania FinancieraEcuatoriana de Desarollo (COFIEC) - was created in 1966 and, like its publiccounterpart, one of its principal functions in its initial stages, was tochannel foreign exchange resources to private sector investment. Among itsoriginal shareholders was the IFC. 1/

3.28 COFIEC also mainly invests in and lends to large and medium-sizedindustry, but it has been more flexible than CV-CFN as to size and type ofprojects financed and up to now has been more heavily involved in foreignguarantee operations. Its portfolio at the end of 1974 amounted toS/. 1,248 million, with equity investments representing a mere 2%, projectloans 49%, and combined short-term operations, mostly guarantees and lettersof credit, 49%.

3.29 At the end of 1974, COFIEC's total resources amounted to SI. 1,325million and its total debt to equity was about 8:1. 2/ In spite of this highleverage, COFIEC has raised relatively little money in the domestic market.Almost from the start it has been hard-pressed to increase its equity. In theEcuadorian context, COFIEC has been relatively profitable, e.g., about 15% in1973 and 1974, and its shares should be attractive to the many industrialistswho sooner or later will have an expansion to finance and to foreign bankswho wish to strengthen their relationship with local banks. Still, it hasnot been easy to raise the additional capital needed to maintain its rela-tively fast growth. Enforcement of resolution 24 of the Andean Pact restrictsthe participation of foreign investors in financial institutions, althoughrecently the Ecuadorian Government has ruled that retained earnings on behalfof foreign shareholders could be reinvested provided their percentage ofownership did not increase. COFIEC has primarily issued stock dividends

1/ In addition, COFIEC has shared in two World Bank loans for assistingthe development of financial intermediaries (see previous section onCV-CFN). Also COFIEC has made use of the Fondo Financiero mechanismestablished under the Bank's loan for livestock development, 222-EC.

'N(See Annex II).

2/ This includes letters of credit. Under IBRD Loan 930-EC, COFIEC'sdebt/equity ratio, excluding letters of credit, must not exceed 7:1.

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and has thus eliminated a number of potential shareholders who look for a cashdividend. The growth of its equity base has been as follows:

Paid-in Capital

End of year (million sucres)

1966 19.61967 36.01968 45.o1969 57.11970 64.01971 65.41972 72.01973 90.01974 120.0

At the end of 1975, the Board of Directors voted to increase the equity baseto 200 million sucres. It is clear that one of the major factors which hasrestrained this growth has been discriminatory treatment of dividend income,mentioned earlier.

3.30 The structure of COFIEC lending is as follows:

COFIEC - Volume of Credit(in Million Sucres)

Year Manufacturing Agriculture /a Construction Others Total

1966 47.8 /b /b 10.0 57.81967 111.3 5.8 11.1 12.9 141.01968 137.6 29.8 3.3 47.6 218.31969 209.0 55.4 48.3 57.7 370.41970 198.5 38.4 49.4 72.5 358.91971 229.0 30.5 63.7 121.3 444.41972 366.7 44.5 108.8 113.4 633.41973 439.1 51.5 202.7 137.2 830.51974 752.1 99.6 268.9 184.9 1,305.5

Source: COFIEC/a Includes livestock and fishing./b Included under "others".

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Other Non-Bank, Financial Intermediaries

3.31 Five new privately-owned non-bank financial intermediaries inQuito, Guayaquil and Cuenca, are being set up and should start operationssometime in 1976. Additionally, as noted earlier, one possibly mixed-capitalsmall-industry-oriented development bank is being set up at the initiativeof the Government which has already announced it would participate withan equity investment of S/. 50 million. It has been suggested that thisnew bank might acquire the industrial portfolio of Banco Nacional de Fomentoand take over that portion of the rediscounting of small industry loanswhich CV-CFN currently undertakes.

Fondo Nacional de Desarrollo

3.32 Although kept in an account of the Central Bank, the resources ofthe Fondo Nacional de Desarrollo (FONADE) are not administered by the CentralBank. Allocation of available funds is made by an inter-ministerial com-mission. The resources of FONADE come from that portion of the Government'stax receipts on oil exports in excess of US$7.42 per barrel. By the end of1974, the fund had been given S/. 3,342 million and had disbursed S/. 2,313million. In order of importance, S/. 536 million was allocated for the con-struction of the state petroleum refinery, S/. 505 million for emergencyworks, S/. 502 million for project financing at Banco Nacional de Fomento,S/. 250 million for project financing at CV-CFN, S/. 200 million for discount-ing purposes at the Central Bank under the Fondos Financieros' mechanism andthe remaining S/. 320 million for projects of various ministries and otherdevelopment agencies. Of the S/. 835 million received by FONADE in the firstfive months of 1975, about S/. 532 million went to the state petroleum re-finery, S/. 156 million was used to finance the import of grain and heifers,S/. 50 million was transferred to FONAPRE and the remaining S/. 97 millionwent to finance projects of various ministries.

Fondo Nacional de Preinversion

3.33 Fondo Nacional de Preinversion (FONAPRE) was created in the middleof 1974 for the purpose of financing preinvestment studies for priorityprojects, public and private, within the priorities established by theNational Planning Board. Its resources to date amount to about S/. 300million of which the Government and FONADE contributed S/. 200 million andthe remaining S/. 100 million was obtained from IDB in December 1974. At theend of 1974, FONAPRE had approved S/. 171 million of credit for 8 of the 24requests it had then received. FONAPRE does not carry out studies althoughit approves and sometimes helps in the preparation of their terms of reference.In the future, it intends to reach the private sectors through the developmentbanks and two loan agreements have been signed to this effect with CV-CFN (S/.1 million) and COFIEC (S/. 5 million).

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The Security Exchanges

3.34 There are security exchanges in both Quito and Guayaquil, but theyhandle a negligible volume of industrial securities. On a typical day theQuito Exchange will handle a volume of securities of between S/. 5 and S/. 10million and Guayaquil usually less. The bulk of the transactions coversGovernment and mortgage bonds. During 1975, only four companies other thanCV-CFN and COFIEC had outstanding bonds and only eight companies had beenauthorized to have their stock quoted on the exchanges.

The Unsupervised Market

3.35 There seems to be a consensus among public officials and bankrepresentatives that the unsupervised market has been very small. However,the decision to freeze the commercial portfolio of the commercial banks atthe May 1975 level may have created conditions favorable to the developmentof such a market. One method used is where a commercial bank acts as brokerand guarantor for private placements with its commercial and industrial cus-tomers. For this service, the bank collects a fee of up to 4% depending onthe risk involved. There is evidence that such transactions have been goingon, although bankers are not eager to discuss them.

Measures Affecting the Flow of Resources to Industry

3.36 The principal monetary instruments which directly or indirectlyaffect the flow of resources to industry are legal reserve requirements,minimum capital requirements, portfolio ceilings, directed investments,open market operations, advance import deposit requirements, and interestand rediscount rates. These are presented in the following paragraphs.

3.37 Legal Reserve Requirements. All banks 1/ and savings and loanassociations are subject to minimum reserve requirements on deposits andother specified liabilities. Previously, these requirements could be ful-filled by deposits in the Central Bank and by bonds of CV-CFN. The amountheld in these bonds could be up to half of the total. Since June 1973,however, they can only be fulfilled with deposits in the Central Bank. Whenthe legal reserve requirements exceed 25% of a bank's total sight deposits, theCentral Bank pays interest on the excess (only up to 30%).

1/ Includes the Commercial Banks, the Banco Nacional de Fomento, theHousing Bank, Cooperations Bank and all Savings and Loan Associations,but excludes CV-CFN and COFIEC.

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3.38 The prevailing requirements (October 1975) for private commercialbanks are 35% for sight deposits,I/ 20% for time and savings deposits, and35% for all foreign currency deposits. When foreign currency deposits areheld by foreign-owned banks, the reserve requirement is 50%. For the BancoNacional de Fomento, the Ecuadorian Housing Bank and the savings and loanassociations (whose capital does not exceed S/. 100 million) all deposits aresubject to a 10% reserve requirement. The reserve requirement for savingsand loan associations whose capital exceeds S/. 100 million is 15%. The onlyexception is time deposits with the Ecuadorian Housing Bank, which aresubject to an 8% reserve requirement. Sight deposits at the Cooperative Bankhave a 32% reserve requirement but saving and time deposits only 10%. As ofJanuary 1973, the interest paid on commercial banks' reserve deposits wasfixed at 8%. At the end of May 1975, the level of excess reserves was about4% of the minimum required.

3.39 Minimum Capital Requirements. All banks may be subject to minimumcapital and reserve requirements with respect to loans, investments, and otheroperations. The prevailing requirements refer to: (a) guarantees and accept-ances on foreign loans, which cannot exceed five times the paid capital and re--serves of the bank's commercial section; (b) first trust mortgage loans whichare allowed up to 20% of their savings department paid capital and reserves;(c) loans secured by real estate, which cannot exceed 50% of paid capital andreserves of their commercial department; (d) mortgage bonds which can be issuedup to 20 times the paid capital and reserves of their mortgage department; and(e) investments in acceptances and guarantees on local currencv, which cannotexceed 100% of paid capital and reserves of their commercial department. Underspecial circumstances, the Superintendency of Banks may authorize an increaseof this limit up to 150%.

3.40 The minimum capital regulations were changed in October 1973 bvDecree 1146 which doubled capital requirements for commercial, savings, andmortgage banks. The new minimum capital requirements in Quito and Guayaquilare: for commercial banks S/. 20 million; for savings, and mortgage banksS/. 6 million; in all other cities minimum capital requirements are SI. 10million and S/. 4 million, respectively. In addition, Decree 1146 greatlyincreased the lending capacity of the commercial banks and of other types ofbanks having a commercial credit section by more than halving the requiredratio between paid-in capital plus reserves and the liabilities to the public,i.e. from 15% to 6.7%.

Portfolio Ceilings

3.41 The Monetary Board uses ceilings on bank credit as a tool to controlmonetary expansion. Until recently, a ceiling on credit expansion of 3% per

1/ In May 1976, this was reduced to 32%.

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quarter (12% per annum) was in force. Previously, banks that exceeded theseexpansion limits could not have recourse to the Central Bank for advances orrediscounts until their portfolios were reduced to the permitted limits.Subsequently, this prohibition was substituted for a fine. In June 1975, as astrong anti-inflationary measure, the Monetary Board froze the credit ceilingat the levels reached on 'lay 31, 1975, with the exception of productive creditfor firms classified under the Fishing and Industrial Promotion Laws. Withthe freezing of the commercial portfolio of the commercial banks, many businessesmay have been left without adequate means to finance the continuously increas-ing value of wholesale and dealer inventories, and may have had to resort tothe unsupervised market.l/

Directed Investments

3.42 To assist certain sectors, in particular the small entrepreneurs,farmers and artisans, the local and foreign commercial banks are required toinvest 20% and 25% respectively of their portfolio in loans which qualifyunder the Fondos Financieros mechanism (see earlier section). Banks whichfail to reach the prescribed levels must make up the difference by purchas-ing 4% Government Development Bonds, a rather unattractive alternative.Effective January 1975, another measure obliges the banks to relend a minimumof 80% of their deposits in the provinces where they originate. In 1974,about 80% of the banks' deposits had originated in the Quito/Guayaquil areaswhereas 87.6% of their portfolio covered loans to Quito/Guayaquil accounts.

3.43 Open Market Operations. In October 1972, the Monetary Boardauthorized the Central Bank to issue short-term bonds with the objectiveof developing the mechanism of open market operations to help in regulatingthe overall liquidity of the system. These "stabilization bonds" are for90 and 180 days, bear no interest, but sell at a discount. In April 1973,the Mlonetary Board prohibited the acquisition of Central Bank stabilizationbonds by the Government and other public agencies, by private institutionsof a social character, and by banks and other financial companies which werelegally compelled to keep their deposits at the Central Bank. The objectiveof this measure was to assure the absorption of these bonds by the privatesector, rather than resulting in a mere change in the composition of CentralBank liabilities. The amount in circulation has declined steadily from thepeak figure of S/. 420 million in October 1973 to only S/. 195 million inAugust 1975 as a consequence of the Government's decision to reduce theiryield by reducing the amount of discount at the time of sales.

i/ In April and July 1976, modifications in these ceilings were intro-duced to provide some additional liquidity to the financial system.

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3.44 Advance Import Deposit Requirements. The Monetary Board can requireimporters to place a stipulated amount in deposits with the Central Bank as acondition for the granting of an import license. From March 1961 up toFebruary 1973, advance import deposits had been required and variations inthe requirements had been frequently utilized as an instrument of balanceof payments and monetary management. On February 26, 1973, all prior importdeposits were eliminated. However, Regulation 788 of September 11, 1975re-introduced import deposit requirements for certain goods. (See ChapterII).

3.45 Interest and Rediscount Rates. The legal maximum rate of interestis 12%. Within this limit, the Monetary Board has the power to set interestand rediscount rates for all types of loans and deposits. The present interestand rediscount rate structure established by Monetary Board Resolution 755 ofJanuary 1975 represents the first change since 1970. Since 1972, banks alsohave been empowered to charge commissions on their credit transactions; thesehave ranged from 1% per quarter for guarantees to one half of 1% for lettersof credit.

3.46 Annex 2 presents a comparison of the rates which existed before andafter January 1975. The maximum lending rate for large industrial and forcommercial credit regardless of the life of the loan has remained unchangedat 12% while the corresponding rediscount rate has increased from 8% to 10%,and the rediscount and the interest rates for agricultural, livestock,artisanal and small-scale industrial credit have gone down 1% or 2%. Insofaras banks operate with Central Bank funds through rediscounts, the new set ofinterest and rediscount rates increased the margins earned by credit insti-tutions on their loans to agriculture and small industry (which reflects theirhigher risk and slower turnover), and reduced the margin on commercial loans.

3.47 With the inflation rates in 1973 and 1974 of between 15% and20%, the legal maximum rate of interest of 12% and the effective rates of14-16% - after adding allowable commissions - were negative in real terms. Sowere the 8% and 9% rates charged by Banco de Fomento and the 9% charged underthe Fondos Financieros mechanism. However, progress was made in curbinginflation during 1975, and by the end of June 1976 it is estimated to havedropped to about a 9% annual rate.

3.48 In general, an interest and rediscount rate structure should provide(i) a margin sufficient to enable the intermediaries to recover reasonablecosts and to obtain a return on equity high enough to avoid erosion of theircapital; and (ii) a compensation sufficient for the intermediaries to attractsavings. While it is almost impossible to assess the reasonableness of theoperating costs of the financial intermediaries, at the level of inflationprevailing in 1974, their combined return on equity was too low to avoiderosion of their capital. These returns were about 13% for commercial banks,almost nil for Banco Nacional de Fomento, 7% for CV-CFN and 15% for COFIEC.

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It is of course too early to tell how they fared during 1975, or will fare in1976, with considerably reduced levels of inflation and the application ofthe new rate structure.

3.49 The question of the adequacy of interest rates to attract re-sources to the financial intermediaries is a complex issue. In order tosimplify the discussions it is convenient to distinguish between shortand long-term resources. In the domestic market substantial short-termresources have been mobilized by the commercial banks through savings de-posits and, to a lesser degree, term deposits. During the-period of highinflation in 1973/74, savings deposits, although earning only 6%, continuedto grow (from December 1972 to December 1974 by about 50%). It would appearthat the bulk of these deposits reflect essentially liquid balances heldin relatively small deposits; in the absence of more liquid instruments insmall denominations, 1/ these deposits can be expected to continue to growmore or less proportional to genetal income growth.

3.50 The institutions which until now have been primarily concernedwith mobilizing long-term resources for project financing are COFIEC andCV-CFN. As pointed out in the earlier discussion of CV-CFN, with itsready access to government funds, including the recent contribution fromFONADE, it has recorded relatively low debt/equity ratios; (at the end of1974, it was only 1.6:1) and could well afford to incur more debt. Recentoperations suggest much more aggressive policies in that direction.

3.51 The case of COFIEC is much more difficult. Discrimination againstdividend income has limited its capacity to expand its equity base whilethe interest rate ceiling has forced it to move towards a high proportionof short-term operations, such as the foreign exchange guarantees, whichcan earn adequate profits. Particularly with the recent reduction in infla-tion rates, it appears likely that only a moderate increase in the effectiveinterest rate (including commissions) for long-term lending would permit itin turn to offer long-term bonds to the public with a sufficient spread to beprofitable.2/ With its present debt/equity ratio, however, unless there is anincrease in its equity base, COFIEC can only incur that debt by cutting downsome of its short-term operations (largely the foreign guarantees).

1/ However, see the above discussion of CV-CFN's recent liquid bond issues.

2/ In July 1976, the Government was studying a new rate structure to in-troduce a commission to increase the return of Commercial banks, BNFand the non-bank financial intermediaries on their medium and long-term loans to the productive sectors of the economy.

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3.52 In summary, given its stage of development, Ecuador has developeda relatively sophisticated financial structure which has played a role inthe recent industrial expansion. Nevertheless, important adjustments andmodifications are required to permit it to contribute to accelerated develop-ment in the future which is both desirable and possible. The earlier dis-cussion has concentrated on only a few limited aspects of the problems ofcreating an appropriate capital market. The institutions dealt with providea relatively important portion of new investment requirements of industry,but probably well under half. The growth of modern industry requires thepari passu development of a modern capital market. Thus the problems facedby these institutions reflect the policy issues which the Government mustface in one way or another if it is to mobilize financial resources andeffectively use the resources of the private sector.

3.53 Although complete data are not available, it appears that financialintermediaries currently play a minor role in providing long-term capital forindustry. As a rough measure, the data in para 1.24 indicate total importsof capital equipment for industry in 1973 of $75 million, including replace-ment parts. Normally, for countries such as Ecuador which import virtuallyall their capital goods requirements, these items account for 50 to 60% oftotal industrial investment costs, suggesting gross industrial investmentof the order of $150 million in that year. Data on long-term lending to in-dustry by COFIEC, CV-CFN and BNF (given in earlier sections of this chapter)indicate that some $30 million was provided by these intermediaries in 1973.

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CHAPTER IV

PROSPECTS FOR FUTURE INDUSTRIAL GROWTH

A. GENERAL SECTORAL STRATEGY

4.1 For a country the size of Ecuador and with its relative resourceendowments, substantial increases in per capita incomes can only be achievedthrough adequate expansion of exports, of a magnitude which in all probabi-lity would increase the relative share of the latter in GDP. 1/ There areobvious limits to the country's petroleum resources particularly in the lightof the current uncertainty on the extent of proven and probable resources.Horeover, growing internal consumption will over time reduce exportablesupplies. Thus, maintenance of a dynamic, growing economy requires theassurance that, as it becomes necessary to curtail exports based on thoseresources, there will have been developed other export possibilities whichcan at least in part take up that slack. This suggests the need to developindustrial activities which are export oriented.

4.2 A second critical consideration is the need to develop industrieswhich will provide widest possible employment opportunities so as to achievethe objective to improve income distribution. The direct effects of thepetroleum sector development on employment are extremely limited; utilizingthe funds made available from petroleum exports in financing constructionprojects has currently been the major indirect source of employment generation.The rate of employment absorption in industry (now estimated at about 10% ofthe annual increment to the labor force) is unlikely to rise in the nextdecade as much as necessary to become the principal source of new jobs. Thus,it is urgent to focus industrial investment on activities which have links toother sectors of the economy where additional employment opportunities can begenerated. There exist excellent possibilities for expansion in outputof agricultural products (including forest and fish and shellfish), particu-larly of items which can be subjected to additional processing and whichhave favorable world market prospects. Given the overall employment genera-tion from this orientation, highest priority should be given to pursuingthis approach.

1/ While econometric models have not defined precisely the relationshipbetween the ratio of exports to GDP and per capita incomes at differentpopulation levels, it is abundantly clear from examination of existingdata, as well as from any logical consideration of the price of autarchy,that smaller countries must have high trade levels to achieve highincomes. Examples are found in countries such as Belgium, Denmark andFinland with populations of 5-10 million where exports represent 30 toas much as 50% of GDP.

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4.3 In connection with the measures required to obtain further expansionof the industrial sector, it is important to recall the need for continuedefforts at improving the physical infrastructure (see Chapter I). In parti-cular, major efforts will be required to ensure an adequate supply of man-agerial and technical skills (see para. 1.25).

B. POSSIBILITIES FOR MAJOR SUBSECTORS

4.4 In the 1973-1977 Development Plan, the target annual growth rate of

the industrial sector for the quinquennium was set at 10.1%. During eachof the first three years of this period, the actual expansion achieved hasbeen slightly over 11%. It was earlier noted that most of this favorableperformance has been due to fuller utilization of existing capacity. Whilethere is indication of considerable new production capability, both in termsof expansions of plant and new enterprises, much of this has yet to come onstream.

4.5 Thus, providing overall demand can be maintained, prospects arefor sustained growth of the sector in the next few years. Much of thenew capacity, however, is domestic-market oriented, indicating the needfor special efforts to identify and promote the creation of industrialactivities for export. In the rest of this section, some principal areasof potential growth are examined, first from the point of view of exportpossibilities, then considering domestic demand.

4.6 With an excellent agricultural resource base, much of which iscurrently either underutilized or unutilized, there is need to focus attentionon agro-industrial development oriented in particular towards exportableproducts. Among the possibilities which have been identified are expansion ofsugar refining (increasing yields both at the plantation and refinery levels,as well as bringing into cultivation land not currently commercially culti-vated), fish products, and fruits and vegetables for processing (including

both dehydration and canning). A major project is now being examined forproducing banana flour for animal food for export to Western Europe, based ontraditional banana varieties grown in the northern coastal regions; this areahad previously been the main source of this product but the introduction ofnew types more suitable for current transport methods and the development ofthe ports in the southern part of the country had resulted in a shift inlocation of the major export plantations.

4.7 Agro-industrial products which offer excellent employment andinvestment opportunities are expected to experience increased local demandas a result of the growth in domestic incomes and consumption. Aside from

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the export-oriented items cited above which can also be expected to havesubstantial local marketing opportunities, there exist possibilities forsubstantial increases in dairy and meat production. A number of slaughter-houses and dairy plants are currently under construction while others arein the pipelines of the financial corporations awaiting allocation offoreign exchange or completion of feasibility studies. Other proposalsrelatively advanced for financing include canning of tomato and citrusproducts and animal foodstuffs.

4.8 There are also a number of non-food agro-industrial productswhich have excellent possibilities, including for export. The country cur-rently exports castor seeds and proposals have been made to establishrefining facilities for further processing of this item. A widely usedchemical, sorbitol, is a derivative of corn; studies have been made examin-ing viability for its production in the Sierra region. A.loreover, Ecuadorhas been given special concessions by its Andean Pact partner countriesfor this product.

4.9 In a related field, known forestry resources are adequate topermit considerable expansion of wood products industries; several newmills for sawnwood and plywood for construction purposes are being builtor have recently begun operation. A study to determine possibilities forindustrial exploitation of the forest resources in the Northwest (Cayapas) wasrecently undertaken with UNDP financing and supervised by the Bank; analysiswas made of alternative schemes and a recommendation was made to proceed withan integrated pulping-sawmill complex. But at present the project's sponsors(a mixed enterprise involving CV-CFN and the private sector) have chosen toimplement the proposal in extended stages and, in the first phase, adding aplywood mill to the original proposal. There remain some areas of the countrywhere only limited data are available on the extent of forestry resources andstudies are now being planned for examining exploitation potential. Givencurrent domestic demand, particularly for packing materials for bananas,expansion in output of these products would go largely towards import substi-tution. However, world market conditions continue to favor some export ofhigh quality plywoods.

4.10 The development of petrochemical and related products, based oncrude petroleum and natural gas resources, present vastly complex technical,financial and economic problems: the various technical routes (and con-sequent difference in product streams), the extremely high capital costsfor these facilities and the limitations of the local (and even Andean)market implying the need to export to third areas in one form or other asubstantial portion of final output. Basic decisions have been taken andconstruction is underway for the Esmeraldas petroleum refinery (55,000bbls/day), producing primarily fuels, and a system of pipelines for trans-porting refined products to consuming centers within the country.

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4.11 In addition, a joint venture has been formed for the developmentof a fertilizer complex in the Guayas area based on dry natural gas which*has been found in that province; preliminary planning for this project isnow underway. A substantial proportion of this output would be for export.

4.12 Under consideration are an additional refinery for 100,000 bbls/dayfor petrochemical production and an integrated basic steel plant of 400,000tons/year, utilizing natural gas and electric power, but requiring importedores; 1/ the latter would be primarily for domestic consumption. Variousunits within the Government are examining these possibilities, including theState Petroleum Exploration Corporation (CEPE), the Armed Forces IndustrialDepartment (DINE) and the Ministry of Industries.

4.13 A critical element in these decisions is the assignment to Ecuadorof a series of products within the petrochemical industry programing of theAndean Group. Under the recent decision, 16 products or groups have beenassigned to Ecuador although only one on an exclusive basis. Presentestimates are that as much as 70% of the target production of these itemsfor the country would have to be exported to third countries.

4.14 While these projects will, when completed, clearly change thestructure of Ecuadorian industry, their complexity means that many yearswill be required before that is achieved. Of the investment mentionedin the previous paragraphs, only the Esmeraldas refinery, due to initiateoperations in early 1977, can be expected to be on stream before the endof the decade.

4.15 The decisions relating to petroleum refining (whether for fuelsor petrochemical processing) have been made more complex with the emerginguncertainty on the extent of the available reserves. This has pointed upthe need for further testing and exploration which the Government haspartially resumed. Another key policy aspect, however, is the low domesticpricing for and low taxes imposed on gasoline and fuels which have resultedin an extremely rapid growth rate of consumption now estimated at 11% per year.Gasoline prices for consumers in Ecuador are currently among the lowest inthe world and, in terms of foreign exchange earnings foregone, represent anexcessive burden to the economy. 2/

1/ As noted in Chapter I there are some indications of ferrous ore depositsin the Andes but more intensive exploration is required to ascertainthe extent of these deposits as well as economic feasibility ofexploitation.

2/ If, as is likely, the domestic price elasticity of demand forgasoline is less than one, the present policy also represents asubstantial loss in net revenue for the Government.

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4.16 With the growth in incomes and investment, a number of import-substitution industries have now become economically viable productionopportunities. These include a wide range of consumer goods. However, amongthe most important are those associated with construction, not only forresidential purposes but also for commercial, industrial and public worksuse. These include cement, glass, ceramics (including sanitary ware),structural steels and hardware. Some expansion of these items is alreadyunderway, particularly the major cement plant at Cotopaxi in the publicsector which is being jointly financed by IDB and the Canadian Government.But others in the private sector are slow in implementation, in part due tothe difficulties in obtaining capital.

4.17 At the same time, the expansion of the industrial base willprovide opportunities for some backward integration which has not yet beenpossible. This is the case for some industrial chemicals, metal products(e.g. gas cylinders and small boilers) and simple items from the mechanicalengineering industries such as diesel engines, small transformers andelectric motors.

4.18 The availability of petroleum and natural gas resources, evenif there is some uncertainty over their extent, presents an important oppor-tunity to Ecuador to accelerate its overall economic growth in the longerrun. Generating both foreign exchange and public revenue, these two re-sources can serve as the basis for fundamental investment decisions andcareful consideration of the various alternative uses are required to achievemaximum benefits. In the case of petroleum, with the current level of provedreserves less than earlier anticipated and with installed refinery capacityto reach a total of some 100,000 bbls/day by 1977, 1/ questions arise as tothe viability of implementing the proposal for an additional 100,000 bbls/dayrefinery for petrochemical production which could not be on stream before theearly 1980's. Should oil extraction continue at the current rate, leavingaside the target of doubling the rate by the end of this decade, the reservesmight not be able to support further refinery expansion.

4.19 Nevertheless, even if further reserves are proven, an additionalconsideration which must be analyzed is the net foreign exchange earningsfrom. exporting petrochemicals as compared to continued export of the crudeand the possible alternative uses of investment funds for other export-oriented industries; allowance would have to be made for servicing the loansrequired to finance the costs of refinery construction, a high proportion ofwhich would represent imported equipment.

1/ In addition to the 55,000 bbls/day refinery at Esmeraldas now underconstruction, there are four smaller older plants totalling 44,000bbls/day capacity.

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4.20 In the case of dry natural gas, the situation is somewhat differentin that its export either unprocessed (as LNG) or in the form of a refinedproduct (e.g. ammonia) requires substantial investment. Even in thisinstance, however, the final use of the gas should aim to maximize itsvalue; thus the proposal to construct a direct reduction steel mill, in whichthe gas would be essentially used as energy must be evaluated against alter-native uses of that resource. 1/

4.21 It may be expected that a significant portion of the capitalfor these plants (except for the domestic-market oriented steel mill) wouldbe provided from external sources, particularly from the potential marketsor consumers, and consequently there would be no alternative possible usein Ecuador for these funds. However, some domestic capital and local manage-rial resources would also be required. The question, therefore, ariseswhether such funds could not have higher social and economic returns, throughdirect employment generation and consequent impact on income distribution, ifthey were applied to export oriented agro-industries, in particular theinfrastructure investment necessary to stimulate those activities; this isespecially so since the backward and forward links from most of the invest-ment for petroleum refining and petrochemical development are limited in thecase of Ecuador. From a practical point of view, what is required is a blendof investment, utilizing the non-renewable hydrocarbon resources to assure ahigh flow of export earnings in their lifetime and developing new sources ofemployment and export earnings among the currently underutilized agriculturaland related resources.

C. REGIONAL DISPARITIES

4.22 The marked differences in resources endowment described earlierbetween the coastal plains and the eastern Andean slopes on the one hand, andthe Andean mountain regions on the other, require approaches adapted to thosedifferences if a reasonably balanced growth objective is to be reached. Thecoastal plains offer possibilities of additional labor intensive agro-indus-trial development with excellent export potential; this type of developmenton the eastern slopes may also be possible although not for a number of yearsin view of the needs for colonization and further infrastructure development.In connection with the latter point, petroleum exploitation in the last fewyears has brought with it relatively substantial road and transport develop-ment, helping to open up these areas.

4.23 Further growth of the Andean mountain region cannot follow thispath, except in some exceptionally large fertile valleys such as those

1/ Moreover, these types of mills concurrently use large quantitiesof electric energy which also must be cheap, i.e. have littlealternative use.

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near Quito and Ambato. For the most part land resources will permit onthe one hand small intensive cultivation of high value vegetable crops,and, on the other, dairy development; these items will be primarily for localconsumption, although some possibilities for exports (e.g. processed garlicand onions) do appear to exist. To provide additional income generatingopportunities, use must be made of the highly developed manual dexterityfound in these areas through the development of skill-intensive industries;while a start has been made in this direction, particularly in the Cuencaarea (e.g. watch-making, starting with assembly but gradually increasinglocal production of parts), there is need for accelerating efforts andimplementing projects which have existed as plans for many years, especiallya number of labor intensive industries assigned to Ecuador within the AndeanGroup.

D. The Special Problems of Small-Scale and Artisan Industry

4.24 As pointed out in Chapter II, an elaborate set of policies andinstitutions have been developed to promote the growth of small and artisanindustries. Justification for this attention has derived from several con-siderations:

(1) in view of market size and, in particular, of the fragmentationof the market due to transport problems, it is felt that suchindustries are best suited to meet demand;

(2) these types of industries are generally less capital intensiveand more labor-using;

(3) small industries are the "training grounds" for entrepreneurialskills required for larger, more complex enterprises.

(4) the rich, artistic tradition of the Ecuadorians.

4.25 The expanded incentive law for small industries adopted in 1973and the general improvement in economic perspectives have led to a rapidexpansion in the number of enterprises applying for these benefits. In1973, 131 new enterprises were classified to receive benefits under thelaw, involving investment estimated at 128 million sucres; in 1974 therewere 217 enterprises with investment of 289 million sucres. The revisionin August 1975 raising the size limit to 5 million sucres invested inmachinery and equipment has apparently brought a further increase in newapplications.

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4.26 The experience gained in recent years has pointed to a number ofshortcomings in this approach. The apparently overly generous nature of thetax exonerations granted and the implications for public sector financialmobilization have already been noted in Chapter II dealing with the generalproblem of fiscal incentives. One result of the current system of permanenttax exonerations for small industry has been to discourage the expansionof individual enterprises; once they pass the legal limit they lose thatbenefit. At best, it has encouraged a diversification of output of a givenenterprise which permits it to be legally fragmented into two or more unitsso as not to lose the tax-free status.

4.27. To avoid weakening the tax base and to avoid disincentives tosmall industry growth, tax exonerations should be extended for a fixedtime period (four to five years) on a contractual basis to a qualifiedapplicant which would retain that benefit independent of its growth duringthe term of the contract.

4.28 Among other measures which can be taken to assist in the develop-ment of these enterprises is an expanded program of technical assistance.With the participation of UNDP/UNIDO, CENDES is currently operating ageneral technical assistance effort while within the Ministry of Industrythere was created in November 1975, a National Center for Promotion ofSmall and Artisan Industry (CENAPIA) which inter alia will be responsiblefor providing assistance to these units. Details of the functioning,organization and budget resources of the latter are not yet availablebut this Center has absorbed the functions of a special unit which hadbeen previously operating within the Ministry with apparently littleimpact. With the definition of small industry now expanded to enterpriseswith up to $200,000 equivalent in machinery and equipment and given therelative importance of these enterprises in the total number of factories,there appears to be little practical reason for this division of labor.Exceptions would arise in the case of artisan workshops, which are definedin a separate law and have special assistance programs.

4.29 Since the first development plan issued in 1963, considerableemphasis has been given to the establishment of industrial estates asa tool for helping in the development of smaller enterprises. Implemen-tation of the proposal has proven extremely difficult, however, andit has only been in the last year 1/ that construction began on a site atCuenca, representing the first phase (18 hectares) of a 65 hectare proj-ect. While lack of financial resources has played a major role in theslow progress achieved until the present, shortage of experienced person-nel for the management of this type of undertaking has also been critical.

1/ In the mid-1960's, two small industrial parks were constructed in thecities of Tulcan and Ibarra, 2.5 and 0.5 hectares respectively;these have apparently attracted mainly artisan workshops.

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4.30 With a view to accelerate the growth of these projects by stimu-lating investment in their construction, a law for the promotion of indus-trial parks was promulgated in November 1975, providing tax and otherbenefits for industrial park corporations and for shareholders. It isanticipated that these enterprises will be of mixed ownership, includingin the public sector CENDES and possibly the regional autonomous develop-ment corporations in the areas concerned. Excluded from benefits, however,are industrial parks established in the provinces of Pichincha (Quito) andGuayas (Guayaquil).

4.31 Nevertheless, some private groups are proceeding with site devel-opment, of limited size, in those two areas, where recent growth, both ofindustry and commerce, has caused numerous problems. In the case ofGuayaquil, the rapid expansion of economic activity has resulted in majortransport and communication difficulties for existing industrial enterprisesand the provincial association of small industrialists has attempted tointerest the Government in a relocation plan to move these firms to an indus-trial park outside the present city limits as part of an urban redevelopmenteffort.

4.32 In this connection, it is not expected that the parks to be con-structed will impose size limitations on clients other than those necessaryto ensure reasonably diverse occupation of space available. While industrialparks are not specifically restricted to small industries, in the situationof the country it can be expected to attract primarily such enterprises.

E. PROGRESS AND PROSPECTS UNDER THE ANDEAN PACT

4.33 Exports to Andean Pact countries 1/ benefit under various arrange-ments. As of January 1, 1971, exports of a heterogeneous group of 37 productsfrom both Bolivia and Ecuador were freed of all tariff and quantitativerestrictions by the other partner countries. NPC tabulations for theseitems indicate an increase in Ecuadorian exports from $0.5 million in1970 to $17.4 million in 1974. A substantial share of this trade hasbeen in items such as fish, cocoa and other food products, amounting to$11.6 million in 1974. At the same time, however, non-traditional exportshave also risen sharply, in the case of domestic appliances to more than$3 million in 1974, representing about 80% of the total of exports ofthese items in that year.

1/ Bolivia, Chile, Colombia and Peru through Dec. 31, 1973; Venezuelaentered on January 1, 1974.

- 55 -

4.34 Much of this trade came from enterprises which had been in exist-ence before the concessions were granted. Efforts to promote projectsto produce items on the free list which are currently not produced in thecountry have had limited success. However, some plants are now under con-struction, to produce such items as tire valves, welding equipment andelectro-mechanical tools; arrangements for establishing others have notyet been finalized (e.g. sorbitol and some other chemicals).

4.35 Within the regional agreement for metal-mechanical industries,approved in 1973, there has similarly been slow implementation of projectsfor items assigned to Ecuador and only two installations are now actuallyoperating. Of special interest is a highly labor-intensive plant assembl-ing watches in Cuenca, with a development plan to increase gradually localcontent. Projects for other items within this agreement, such as centri-fuges, small hydraulic presses, measuring instruments and dairy equipmentare still in the promotion stage.

4.36 Agreement has also been reached recently on a regional petro-chemical program, with a broad assignment of products to the participatingcountries. 1/ The Government is currently considering measures to implementthese proposals and it is considering to seek a series of joint ventureswith foreign technical partners for that purpose. As regards a proposedprogram for the automotive industries presented by the Andean Group Commis-sion, the participating governments have not yet reached agreement.

4.37 Practically all of the projects designed to take advantage ofthese concessions which are now in construction or operation have requiredsubstantial inputs of foreign technical know-how. In a few cases, non-Ecuadorian partners have been firms from other Andean Pact countries (primarilyColombia and Peru) which have similar product lines or are the principalconsumers of the items concerned. As noted earlier, the shortage of managerialand technical skills in the country remains a major constraint to furtherindustrial growth. The efforts to attract foreign technical partners whichare essential to adequate development of these industries may be encounteringdifficulties as a result of uncertainty over Andean Pact decisions regulatingforeign investment.

1/ See para. 4.13.

ANNEX 1

Page 1

AGRO-T'DUJSTPIAL OPPOPIUNITIES

1. (;!:NERA1L CH4ARACTIRISTICS OF AGRICULTURE

Ecuador, with a total land area of about 284,000 square kilometers,including the Galapagos Islands, is divided into three distinct regions bythe Andes crossing the country from north to south; the fertile Pacificcoastal plane (the Costa); the highland region (Sierra); and the easterntropical lands of the Anazon River Basin (Oriente). Soil fertility variesgreatly, ranging-from rich soils on the Costa to eroded hillsides in theAndes.

Rainfall varies widely; in the Costa region the rainy season isfrom D)ecember through May, and annual precipitation varies from 12 to 150inches 'jitlh sharp differences among districts. In the Sierra, rainfalloccurs mostly between October and May and varies from 15 to 50 inches. InOriente, annual rainfall is more than 120 inches distributed over the entire

year.

The Ecuadorian economy is essentially agricultural based. IWiththe exception of wheat, oilseeds and a moderate amount of temperate-climatefru.ts, the domestic agricultural output supplies the food needs of thecountry; before the development of the petroleum resourcs, this sector wasthe nain source of foreign exchange through exports of bananas, cocoa beansand products, sugar and coffee (See Table 1). In the last 10 years, itsannual rate of growth has been 3.7%, below the rate of growth of CUP and, asa, consequence, its share in total product has declined from 35" in 1965 to

247' in 1974. 1/

1/ 'o .r ces for the two -e.i's ,re n.it conrletely comparable and probably; tr-atic the decline.

ANNEX 1Page 2

'The nost recent estimates of Land use (1973) are as follows:

Percent of

MiLlion Total [lartialha. Area Areas

lotal Land and Inland Water 28.4 100Area not used for agriculture 7.6 27foal Area used for Agriculture 20.8 73

Forests 14.8 52Permanent Pastures 2.2 8Arable Lanid 3.8 13 100

Irrigated 0.5 2 13N.ot irrigated 3.3 11 87

Total Area harvested 1.8 6 lonIrrigated (0.2 1 11.Not irrigated 1.6 5 89

A considerable portion of the irrigated land is not currently cultivated andthere is clearly scope for increasing arable land under cultivation.

The Costa produces banana, coffee, cocoa beans, sugar, rice,tropical fruits, cotton, tobacco, soy and palm seeds, livestock products,hard fibers, citrus and tobacco. This region has the 59.7% of the nationalcultivated area and 34.9% of the pastures. The prevailing farm size is fromnedium to big.

The Sierra produces corn, potatoes, vegetables, fruits, wheat,dairy and livestock products. This region has 36.9% of the nationalcultivated area and 20.4% of the pastures. The prevailing farm size isfrom small to medium, many of them at subsistence production level.

The opening of the Oriente region is associated with recentpetroleum exploration and a number of colonization schemes are now in execu--;on. However, because of its previous remoteness, there is insufficientIKnowledge of its real agricultural possibilities.

ANNEX 1Page 3

Main crops and livestocks

The areas harvested in 1973 with the main crops and their average

yiJ?1ds are as follows:

Average YieldsArea Production Yields For South America

Thousand ha. M. Ton Ton/ha. Tons/ha.

/I /IRice, paddy 85,000 134,000 1.58 1.7Wheat 46,000 45,000 0.98 1.2Corn 265,000 254,000 0.96 1.4Barley 93,000 79,000 0.85 -Beans 66,000 32,000 0.48 -Potatoes 44,000 539,000 12.25 5.9Yuca 54,000 741,000 13.72 13.2All Bananas 197,000 3,650,000 18.53 15.4Citrus 13,000 152,000 11.69 11.8African Palm 9,000 13,000 1.44 -Soy Bean 1,000 1,500 1.50Abaca 7,000 7,000 1.00 -Cotton 23,000 20,000 0.87 0.8Cocoa bean 213,000 62,000 0.29 0.3Coffee 227,000 52,000 0.23 0.5Sugar cane 89,000 5,477,000 61.50 45.9Pastures 2,314,000

/ 1 Yields for Ecuador are for 1973 and yields from S.A. are average for1961-69. Source: FAO.

Ecuador has about 2.5 million head of cattle of which one-third arefor milk production and two-thirds for meat. From the 800,000 head of milk-producing cattle (mainly Holstein, Brown Swiss and their inbreeding with"criollos"), only 400,000 are estimated to be in production.

Forest resources

One half of Ecuador's area is covered with forests, one of thecountry's valuable natural resources. Tropical forests cover most of thenorthern and eastern regions. There are some coniferous species in thesouthern areas on the western slopes of the Andes which are now beings urveyed.

ANNEX 1Page 4

The total production of roundwood has averaged 5 mil)-ion cubicmeters yearly. Almost 60% of this total has been used as fuel. Theremainder has been used for sawnwood, plywood and board. t4ost of the landis exploited through concession. Forest land is poorly managed, cuttingselected trees with commercial value and leaving the rest without any carefor the young trees; there is need for strengthening forest managementservices.

Fisheries

Rich fishing grounds abound off the coast of Ecuador, includingthe Galapagos Islands. The production of fish and shellfish was nearly110,000 tons in 1972. Of this tonnage 9,000 tons were shrimps and 99,000tons of fish that were sold fresh and used for canning and fish meal. Themain varieties of fish caught off the Ecuadorian coast are sardines, tunaand mackerel, all valuable species for industrialization.

II. AGRO-INDUSTRIAL FACILITIES

A. Current Situation

The 1973 Industrial Survey contains data on 316 agro-industrialplants with a total permanent employment of 20,352 persons, processingproducts based on agricultural raw materials (Table 3). This tabulationincludes only plants with seven or more employees.

Seasonal and field employment created by agro-industries is diffi-cult to calculate because it varies from one product to another. Estimatesgive relations ranging from 4 to 15 time direct employment depending on theindustry. This would mean indirect employment from 80,000 to 300,000 people.The total output value and added value of agro-industries are US$304,692,000and US$95,824,000 (Table 3). In relation to the totals of the industrialsector the percentages are 46.1% for output and 38.6% for added value (SeeTable 3).

Principal products

(a) Sugar

There are 3 mills with capacities for processing over 5,000 tons ofcane per day and five others with less than 1,000 tons capacity. The threelarger plants have heen werking at over 80% of their installed capacity. In

ANNEX 1

Page 5

1973 total production reached 246,000 tons of sugar of which 27% (66,000 tons)were exported. The high value added reflects the integrated nature of theseoperations.

(b) Edible Oil

The factories are currently operating at an average of 55% oftheir installed capacity. The country has to import 62% of crude oilrequirements (30,000 tons/year of the equivalent in seeds) to meet thedomestic market requirements.

(c) Wlood, pulp and paper

Sawmills are not integrated installations and only 40% of thestanding tree is used, the remainder being left in the woods; sawdust isdiscarded. The production of Kraft pulp from bagasse in one plant is usedby the same manufacturer to produce liner paper. The output of this machineis around 12,000 tons/year, used mainly for multiwall sugar bags. 1/ Ecuadoris currently importing some 100,000 tons of cardboard only for banana boxes,and by the end of this decade its requirements for this use alone is expectedto amount to 150,000 tons/year.

(d) Canned and frozen fish, shellfish and fish meal

In 1972, 46,000 tons of sea products were consumed in Ecuador;3,000 tons of shrimps and 6,000 tons of tuna were exported frozen. Cannedsardines and tuna were also exported, amounting to the 17% of the value ofthe fisheries' exports. Fishmeal is a recent development and only limitedproduction is currently undertaken.

(e) Banana flour

There is one plant producing banana flour with a capacity of nearly10,000 tons a year. The product is used as animal fodder, having a proteincontent between 50-55%. Small amounts have been exported to Europe.

1/ This plant also uses cardboard scrap obtained from banana boxmanufacturing.

ANNEX 1Page 6

(f) Cocoa derivatives

There are six plants obtaining cocoa derivatives. The installedcapacity exceeds the actual production of cocoa beans. Industry is exportingsemi-finished products such as cocoa liquor, cocoa butter and cocoa powder.

J. Problems in expansion of agro-industries

Marketing

With the exception of farms owned by the processors (e.g. sugar)or those involved in the traditional export-oriented activities (e.g. bananasand cocoa) a general weakness of agriculture lies in inadequate marketingof the different crops. Most agro-industrial companies do not establishany contractual relationship with farmers regarding prices or quantitiesto be purchased. In addition, these enterprises as a rule do not giveany sort of technical assistance to their suppliers. Moreover, producersare reluctant to join in cooperatives and similar organizations, that couldhelp to solve marketing problems.

Another factor is the lack of cold storage and the small capacityof grain silos and warehouses presented by the country. This weaknesscreates a problem in the flow of the main supplies to the existing agro-industries. Similarly, the lack of sufficient and properly maintainedroads throughout the country forces the industries to use only the rawmaterials available within a relatively small radius, especially if theirinputs are perishable.

Current price policies 1/

The price of most agricultural products are set by the Superinten-dencia de Precios, an independent body; in most cases these are designedto keep prices low to consumers and, as a consequence, have often discouragedexpansion of production. One example is sugar; at the time of the mission'svisit the internal price was set at US$5.45 per 100 lbs., about a third ofthe prevailing pr,ice in the world market. The domestic price was recentlyraised to US$8.80 per 100 lbs. but still well below world market pricesat that time.

1/ See also the discussion in Chapter II of the text of the report.

ANNEX 1Page 7

Since total production exceeds local demand, the Government estimates theavailable exportable surplus and fixes an export quota for each enterprise, inproportion to its share in total output in the previous year. There islittle incentive for any firm to expand output for export since that incrementwould be shared by all producers. One effect of this system is to encouragethe use of sugar in the manufacture of products which are not subject toprice control.

Similarly, prices of construction plywood have been fixed and arewell below export prices. In spite of the obvious difficulties in transportof these items, there nevertheless appears to have developed a substantialcontraband trade with neighboring countries.

In the case of milk, domestic prices are also set at relatively lowlevels discouraging output expansion. Recently, dairies were forced to importlarge quantities of relatively low-priced dry milk powder in order to increasetheir output for sale in local markets.

On the other hand, prices for certain non-traditional agricultureitems have been set above world market levels. In the case of oil seeds,for example, these have been set relatively high but, at the same time, theceiling on the processed oil has been fixed at a low level. As a consequence,processors favor importing either seeds or crude oils.

Current promotional efforts

The country has an experienced agricultural research organizationin INIAP (Instituto de Investigacion Agropecuario). With its programs, theInstitute covers most of the main crops of the country, including the rawmaterials for agro-industries. However, the results of research and acquiredforeign technology do not reach the farmer. The Agriculture Ministry istrying to organize an extension service for this purpose.

Sector studies and individual projects are prepared in theirdifferent stages by the Ministry of Agriculture, the regional organizations,CENDES and CV-CFN, the latter also having the possibility of promoting andfinancing projects,. FONAPRE, another official agency, also financesfeasibility studies. The number of agencies involved in studying andpromoting new projects appears to be excessive and results in an ineffi-cient use of qualified human resources which are scarce in the country.The agencies mentioned above need to arrange a better division of labor.

ANNEX 1Page 8

The Government, through the Ministry of Agriculture, has estab-lished lists of priorities for agricultural products. First priorityhas been given to: rice, corn, oilseeds, wheat, barley, bananas, beans,coffee, cocoa, cotton and sugarcane; industries based on these items willhave full support from the Ministry's services.

III. POTENTIAL PROJECTS AND LINES OF DEVELOPMENT

A. Existing Pipeline

With relatively underutilized cultivable land resources and withgrowth in domestic incomes, there has been considerable interest in the devel-opment of a number of agro-industries primarily oriented toward the internalmarket. These have included slaughterhouses and tanneries, dairies, smallfruit and vegetable canning installations (and, indirectly connected to thisproblem, cold storage facilities), as well as some industrial items such ascorn starch and processed wood. There are also some proposals for export-oriented items such as fish canning, castor bean processing and citrusprocessing.

The two long-term financial intermediaries, CV-CFN and COFIEC,already have in their pipeline a relatively large number of small plants(or expansions of existing plants) in these categories.

Percentage ofTotal Projects Agro-industries agro-industry

Amount US$ Amount US$No. millions No. millions No. Amount

COFIEC 39 14.5 9 4.5 23.1 31.0

CV-CFN 14 17.7 8 5.9 57.1 33.3

B. Product lines for further development

In the following paragraphs, brief descriptions are provided o,various agro-industrial possibilities which are either in the formt of proj-ects presented to the financial intermediaries fnr implementation or existonly as general proposals or pre-feasibilitv studies. Emphasis is givento those products which have export potentiaL.

ANNEX 1Page 9

Livestock

Cattle raising for beef production is primarily located in theCosta but there are programs to expand this activity in the newly openedareas of the Oriente. Existing slaughterhouses and meat packing facilitiesare limited and a limited number of new slaughterhouse projects have beenproposed; some of these are in the pipeplines of the financial intermediaries.The industry is at present essentially domestic-market oriented.

Processed meat exports to the Andean Group benefit from thespecial liberalization program extended to both Bolivia and Ecuador.This trade has grown relatively quickly but is still small in actualvalue; there is substantial trade with Peru in live animals, however.Prospects for further growth in processed meat trade with the Andeanarea appear good; there also appear to be excellent prospects for theseexports to other neighboring countries, particularly in the Caribbean.

Dairy production is concentrated in the Sierra. As in thecase of meat products, Ecuador has benefited from the special liberaliza-tion of trade in these items within the Andean Group and has increasedsubstantially cheese exports in recent years. As noted earlier in thisannex, the main problem in expanding dairy output has been the relativelylow fixed price set on milk.

Processed Fruits and Vegetables

Many citrus and tropical fruits (e.g. pineapple and babaco) arebeing cultivated in the Coastal areas; lack of cold storage facilities isone of the major factors limiting processing for export. A foreign firmhas begun construction of a vegetable and fruit canning plant in Esmeraldasprovince with output primarily for export. Substantial expansion of thistype of activity appears possible but a major effort would be requiredto organize production of appropriate types for processing and to phasecultivation to permit efficient use of processing facilities. Proposalsfor pineapple, orange and tomato canning have been presented to the finan-cial intermediaries.

Vegetable processing in the Sierras also offers excellent possi-bilities. Preliminary studies have already been undertaken of dehydrationof onion and garlic, high value crops for export which can provide importantnew income sources for farmers in these areas; no firm project proposal hasbeen prepared, however.

ANNEX 1Page 10

Fisheries

Some preliminary FAO estimates of the potential annual fish catchindicate possibilities of more than doubling the actual production, particularly

of tuna and sardines the processing of which can generate considerable employ-ment. 1/ There is need to pursue these studies to determine investment poten-tial. In the meantime, however, a number of projects have been presented to

the financial intermediaries which would involve export-oriented processing

plants for sardines in particular.

Sugar

While policy problems discussed above have tended to constrain sugar

expansion, there is substantial scope for increasing output. IFC has recently

joined with other lenders to finance an expansion of the San Carlos complex,the largest in the country, involving both modernization and new capacity.The recent increase in the domestic price has been instrumental in making the

project financially viable.

In addition, under the auspices of the regional organization of

Esmeraldas province, a private company is being formed to set up a largescale sugar refinery using land now largely under pasture. Foreign financing

is being sought for this project. In the case of the activities of the

regional organization in the Guayas (CEDEGE), a number of its irrigation and

cultivation expansion schemes anticipate sugar cane as a likely crop for

cultivation but these are still in the planning stages. Appropriate price

policy, however, is critical to financial viability of these ventures.

Banana flour

CENDES has undertaken a study of large scale installation to

produce banana flour for export as animal foodstuff. The project is of

special interest as it can offer employment to over 10,000 people (includ-ing farm workers). Moreover, it uses as raw material a well known crop

and could le'ad to development of an area which has had limited growth recently.The province of Esmeraldas (in the northwest area of the country) had been the

principal banana growing area but the crop was subject to infestation; moreover,the development of the ports in the southern areas of the country in the late

1950's and 1960's and the introduction of new varieties made it more economical

to grow bananas for export in the southern area closer to those facilities.

1/ Fishmeal production, on the other hand, is highly capital intensive.

ANNEX IPage 11

At the present time, the only alternative use of the banana growingland in the province is as cattle pasture. Further development of bananacultivation for human consumption is limited by external market conditions.However, the production problems in the fishmeal industry may providebanana flour the opportunity of having a good market. Moreover in the longer-run with general prospects for increasing meat production, further expansionof demand for animal foodstuffs can be expected. A comparison of the pro-duction value per hectare between cattle and bananas for meal hasbeen calculated under the following assumptions:

(a) Banana-meal present price: US$250/ton;

(b) Relation of raw material to meal: 5 to 1;

(c) Price of bananas to the farmer calculated as 10%of selling price of the flour (same relation usedfor fish meal);

(d) Yield of bananas: 20 ton/ha;

(e) Animals per ha.: 1;

(f) Extraction per year: 30% over the cattle stock;

(g) Price of meat: US$1,200 per ton;

(h) Weight per animal, slaughtered: 400 Kg.

Product Yearly pro- Price per ton Gross income perduction - US$ ha. - US$

Ton/ha.

Banana 20 25 1/ 500

Beef 0.120 1200 144

This calculation does not include the investment cost. Production can beobtained from cattle on the third year and in bananas the same year of plan-tation.

1/ Bananas for human consumption sell at about $100/ton, ex-plantation.

ANNEX iPage 12

While this calculation only refers to gross revenue and does not

include costs, it does suggest a substantially more favorable return tobanana cultivation. MIoreover, employment generation is much larger in this

type of activity than in cattle growing.

However, before further exploratory work on the project can beundertaken, it will be necessary to continue with experimentation on the

technical processes to maximize extraction of the edible portion of thebaniana (in particular, protein content).

Forest Product Development

The recent growth of construction activity, as noted in the main

text, had led to substantial expansion in wood industries supplying itemsfor that purpose such as sawnwood and plywood. Additional projects for con-struction items based on forestry resources are also in the pipelines of

the financial intermediaries, including pressed wood boards and wood for

furniture.

The largest project proposals in this area, however, are designedto substitute local production for a major portion of the imported paper andboard materials required for banana boxes. As noted earlier, the country

currently imports almost 100,000 tons/year of these items and expects torequire some 150,000 tons by 1980. With UNDP financing and the Bank as

executing agency, a study examining industrial exploitation of forest resour-ces in Esmeraldas province (Cayapas) has been prepared; the raw material wouldbe the local relatively long-fibered hardwood species. The main recommendation

of the study is for the construction of a sawmill operation (190,000cubic meters/year) with a pulping facility and paper machine to provide

50,000 tons/year of corrugating medium; total capital costs were estimatedat $57 million at prices prevailing in the first quarter of 1974. At alater stage, facilities would be added to produce 115,000 tons/year oflinerboard. 1/ Further testings of the wood for pulping characteristicswere also recommended, particularly to determine suitability for the liner-board production.

At the same time, pre-feasibility studies have been undertaken byother government agencies of a proposal to produce 55,000 tons/year of pulp

1/ There would be no requirement for imported pulp for corrugated mediumbut it would still be necessary to import long-fiber chemical pulp(some 35 to 50%) to mix with the local pulp if linerboard were to bemanufactured locally. At a later date, however, long-fiber pulp couldbe made from plantation pine.

ANNEX 1

Page 13

from bagasse which, combined with imported long-fibered pulp, would be usedto produce 44,000 tons/year of corrugating medium and 66,000 tons/year oflinerboard. Total capital costs were estimated at $37 million, presumablyin 1973 prices.

The company organized to implement the Cayapas project, a mixedventure including the private sector and CV-CFN, has recently decided toimplement the recommendations of the feasibility study in stages. The firststage will include the sawmill operation plus a plywood mill; at a laterstage, the corrugated medium plant will be added.

Given the current market for this product, the potential foreignexchange savings, and the employment benefits which could occur from theCayapas project, (both direct employment in the mill [around 1,000 forthe plant including only corrugating medium] as well as indirect employmentin forest management and logging) there is need to accelerate implementationIt is likely that the difficulties in mobilizing equity capital as a resultof discriminatory tax treatment (examined in the main text of this report)may be a factor favoring the staged approach of the promoting company.

In addition, the possible competition from the bagasse project,which would most likely be located nearer the banana box manufacturer inGuayas, may tend to defer quick implementation. In these circumstances,it would be prudent for the agencies involved to consider other possiblepaper uses for bagasse pulp, (e.g. industrial and tissue papers). It mustalso'be noted that a project of the size contemplated would have hugerequirements for bagasse which would raise serious logistic problems;moreover given the real cost of energy, the actual bagasse surplus (i.e.available for uses other than for fuel) may be below those requirements.

Other Non-food Products

Considerable attention is being given to the production of castoroil, from processing of castor seeds, 1/ which has wide industrial usesand can form the basis for relatively large chemical complexes. A smallproject for this processing has been proposed for submission to the finan-cial agencies; it is believed that this would be both for exports and

1/ The country now exports substantial quantities of the seed with noadditional processing.

ANNEX 1Page 14

domestic markets to cover current needs for the oil (mainly soap productsand related items). The Guayas regional organization has, however, beenstudying a major complex based on castor seeds to produce substantialquantities of castor oil for use in plastics manufacturing and other indus-trial chemicals. This type of project has been under consideration for anumber of years but it has not been possible to implement it. There may besubstantial export potential for this product as it can compete with somepetrochemical-based products where prices have been rising recently. Inaddition, the pressed cake after oil extraction has use as either ferti-

lizer or as aninal feed (providing a toxic residue is first removed).

There are also some important industrial chemicals derived fromcorn which have been of interest. One corn-based product, sorbitol, has beenassigned to Ecuador in the first stage of trade liberalization of the Andean

Group; this item has wide industrial use including as a humidifying agent inpackaged foods as well as in the manufacture of plastics. CENDES has preparedsome pre-feasibility studies relating to this product but has not as yet beenable to bring it to the point of financing. Another corn-based productwhich is of interest is starch, with substantial use in the manufacture ofadhesives (e.g. for use in the assembly of banana cartons) as well as intextile finishing; in this case also it has not been possible to move thevarious project proposals to the implementing stage.

ANNEX 2Page 1

FINANCIAL SYSTEM

INTEREST AND REDISCOUNT RATES AS OF JULY 1975(annual rates in percent)

Before SinceJan. 75 Jan. 75

A. CREDIT RATES CHARGED BY CENTRAL BANK

1. Discount rate 8 8

2. Rediscount and other lending rates:

a. To Commercial BanksAgricultural, fisheries and artisan

credits (redisc.) 8 6Industrial credits (redisc.) 8 7Commercial credits (redisc.) 8 10Special advances 5 7Advances to cover reserve require-ments 10 12

b. To National Development Bank (BNF) andCooperative Banks

Rediscounts and advances:Agricultural, fisheries and artisan

credits 1/ 4 3Small-scale industry 2/ 7 3Commercial credits 8 10

c. To Public Sector Finance CorporationIndustrial rediscounts and advances - 7Rediscounts FOPEX 3/ 4

d. To Private Sector Finance Corporation

Rediscounts and advances 9 8

e. To Financial Institutions throughFondos Financieros

General rediscounts 3Rediscounts under Livestock Develop-ment Program 4/ - 7

f. To Private IndividualsDirect credits and discounts 12 12

1/ Including rediscounts of credits to Empresa Nacional de Almacenamiento vComercialization (ENAC).

2/ Regulation 755 of January 1975 set this rate at 4%; however, regulation781 of July 1975 set it at 3% and extended it to Commercial Banks.

3/ Fondo de Promocion de Exportaciones.4/ Including private Financieras.

ANNEX 2Page 2

Before SinceJan. 75 Jan. 75

A. CREDIT RATES CHARGED BY CENTRAL BANK

g. To Private Individuals throughFondos Financieros

Agricultural, fisheries, artisans - 7Industry for purchase of agricultural

raw materials 7Other industrial credit - 8Advances for future exports 6 6Reliquidation after export failure 12 12

h. To Public SectorCentral Government 3 3Others 5 5

1/CHARGED BY COMMERCIAL BANKS

Maximum rate on credits 12 12Maximum rate overdrafts 8 8CV-CFN through FOPEX 8 (max.)CV-CFN on rediscount of credits to

small-scale and artisan industries:Commercial Banks 5BNF 3

CHARGED BY NATIONAL DEVELOPMENT BANKAND COOPERATIVE BANKS

Agricultural credit (max.) 8 9Small-scale and artisan industries

(max.) 10 9Commercial credits (max.) 12 12ENAC _ 4

2/CHARGED UNDER FONDOS FINANCIEROS

Credits under Livestock DevelopmentProgram 3/ 12

Other lending operations 9

1, Inclutding private Financieras.2 Cominercial and Developnmo-t Banks have access to this mechanism.X Lor credits of more than B/. 625,n00 (222-EC).

ANNEX 2

Page 3

Before SinceJan. 75 Jan. 75

B. DEPOSIT RATES

Pass book savingsCommercial Banks 6 6Savings and Mortgage Banks 7 7

Deposits with Commercial Banks

a) 31-180 days, maximum interest 7 7b) 181-360 days, maximum interest 8 8c) Over 360 days, maximum interest 9 9

Deposits with Savings and Mortgage Banks

a) 31-180 days, maximum interest 8 8b) 181-360 days, maximum interest 9 9c) Over 360 days, maximum interest 10 10

Cedulas Hipotecarias, Government Bonds andother securities issued by stock companies 12 12

ANNEX 2Page 4

B F 0 N D 0 S F I N A N C I E R 0 S

i. The Fondos Financieros mechanism covers eight funds, six with localand two with foreign resources. The resources, purpose and special featuresof these funds are as follows:

a) Fondo Financiero Agricola

Resources: S/. 1,000 million

Purpose: Short, semi-permanent and long-cycle crops as wellas fertilizers., pesticides and herbicides.

b) Fondo Financiero Ganadero

Resources: S/. 180 million

Purpose: Acquisition, feeding and slaughtering of cattle, hogssheep and goats; acquisition and feeding of meat andegg producig poultry; feeds for the above; mineralsalts and veterinary products; seeds, expansion andimprovement of grazing land; and fertilizer, pesticidesand herbicides.

c) Fondo Financiero Agricola y Ganadero - Activos Fijos

Resources: Special fund of the Federal Government

Purpose: Territorial improvement; rural construction andinstallations; agricultural machinery and equipment;storage and other input distribution establishments;extension of services to improve productivity;acquisition of milk and meat reproduction cattle;and acquisition of feeder cattle.

d) Fondo Financiero Industrial

Resources: S/. 400 million

Purpose: Working capital for up to S/. 4 million;Fixed assets for up to S/. 5 million.

Borrower: Local industry and artisans with fixed assetsnot in excess of S/. 5 million, excluding landand buildings.

Excluded: Soft drinks, alcoholic beverages, drugs,cosmetics, deodorants and similar products.

ANNEX 2Page 5

e) Fondo Financiero Pesquero

Resources: S/. 120 million

Purpose: Working capital and fixed assets up to S/. 5 million.

Borrower: Individual, company or corporation with fixed assetsnot in excess of S/. 5 million, excluding land andbuildings.

f) Fondo Financiero Turistico

Resources: S/. 100 million

Purpose: Working capital and fixed assets for touristicestablishments, hotels and restaurants up toS/. 5 million.

Borrower: Individuals or companies registered under theTourist Development Law, whose fixed assetsare not over S/. 2.5 million.

g) Fondo Financiero-AID Loans 518-L-032, 033, 034

(i) Agricultural Enterpise Promotion Program.

Resources: US$ 2.75 million

Purpose: Working capital, fixed assets and marketing forup to S/. 3 million for individuals and companiesand S/. 250,000 per member for cooperatives.

Terms: Up to 10 years, including up to 3 years of grace.

(ii) Agricultural Development and Diversification Program.

Resources: US$5.96 million

Purpose: Oleagenous, crops and cocoa production; marketingup to S/. 1.5 million for individuals andcompanies and S/. 300,000 per member forcooperatives.

Terms: Up to 10 years, including up to 3 years of grace.

(iii) Technical and Credit Assistance to Small Industry Program.

Resources: US$4 million

ANNEX 2Page 6

Purpose: Working capital and fixed assets of small industry,i.e. with fixed assets not in excess of S/. 5 million,excluding land and building. Each credit limited toS/. 750,000.

Terms: Working capital up to 2 years, including 6 monthsof grace; fixed assets up to 6-7 years, includingup to 2 years of grace.

h) Fondo Financiero - IBRD Loan 222-EC

Resources: US$8 million

Free-Limit: S/. 2.5 million

Purpose: Credit for meat cattle up to 12 years, includingup to 5 years of grace; credit for milk cattleup to 9 years, including up to 3 years of grace.

2. The funds are used by the Central Bank to rediscount 80% of thevalue of eligible loans at 3%, except under IBRD loan 222-EC where for loansabove S/. 625,000 the rediscount rate is 7%. The loans are made at amaximum of 9% (IBRD loan 222-EC, at 12%) for maximum possible terms whichvary according to the nature of the project, as follows:

- short-cycle crops - up to 360 days

- semi-permanent crops - up to 5 years

- long-cycle crops - up to 10 years

- inputs, fattening and slaughtering of livestockand poultry - up to 2 years

- working capital 1/ for artisan activity,small industry, fisheries and touristicservices - up to 2 years

- construction and acquisition of fixed assets -up to 7 years.

1/ Working capital includes any element of cost which finds its way intoinventory; it does not include accounts receivable.

STATISTICAL APPENDIX

Table 1 t ECUtADOR: ODP BY ECONCHIC ACTIVITIES - 1970-74

1970 1971 1972 1973 1974

(Millions of suores at 1970 prices)

Agriculture -8,804 9,001 9,037 9,261 9,450Mining 449 643 1,668 3,645 3,329Manufacturing 5,713 6,204 6,657 7,176 8,012Flectrioir, gas & water 418 441 459 466 479ConstrUCtion 1,387 1,998 1,565 1,790 1,957TrEde 3,2341 3,,457 3,555 41,099 5,634Trasnsport & storAge 2,Q91 2,110 2,320 2,614 2,720services 8,012 7,965 8,802 9,522 10,725

GDP at factor cost jo,108 3,3X822 34,063 38,573 42,306

As percent of GDP)

Agriculture 29.3 28.3 26.5 24.0 22.3Mining 1.5 2.0 4.9 9.4 7.9Manufacturing 19.0 19.5 19.5 18.6 18.9Electricity, gas & water 1.4 1.4 1.3 1.2 1.2Construction 4.6 6.3 4.6 4.7 4.6Trade 10.7 10.9 10.4 10.6 13.3Transport & storage 6.9 6.6 6.8 6.8 6.4Services 26.6 25.0 25.9 j247.7 2g4

TOTAL 100.0 100.0 100.0 100.0 100.0

Source: Ban _ataff e8t1_tmles, taken from Ecuador: Eoonomic Memorandum,Report No. 1033-EC, February 12, 1976.

STATISTICAL APPENDIX

TABLE 2: ECUADOR - STRUCTURE OF INDUSTRIAL VALUEADDED 1970, 1972, 1974(as percent of total)

Industrial Branches 1970 1972 1974

31 Food, beverages and tobacco 44.8 37.8 40.432 Textiles and clothing 13.3 16.5 15.833 -Wood and wood products (incl furniture) 3.1 3.6 3.434 Paper and printing 9.2 7.9 7.535 Chemicals and products 15.6 17.5 16.8

36 Non-metallic minerals 5.4 5.8 5.637 Basic metals 0.5 1.7 1.638 Metal products amd machinery 7.3 8.5 8.139 Other manufactured products 0.5 0.7 0.8

Total 100.0 100.0 100.0

Source: Mission estimates based on data from Indastrial Censuses and CentralBank; details may not add to totals due to rounding.

Table 3 : ECITADORz FACTCRY MANIFAC¶I¶1RIWG:

VALUE ADDED, EMPLOYMENT AND PROaTCTIVITY, 1973

BY INIUSTRIAL BRANCHES

Value Addedper employed

Employment Value Added person(number of % (millions % (thousands % of

Industrial Branch persons) of total of sucres) of total of sucres) average

Food 15,604 26.5 1,717 27.7 110 104.8Beverages 3,118 5.3 558 9.0 179 170.5Tobacco 334 o.6 72 1.2 216 205.7Textiles 12,355 21.0 938 15.1 76 72.4Clothing 1,075 1.8 41 0.7 38 36.2Leather 765 1.3 41 0.7 54 51.4Fhoes 172 0.3 5 0.1 29 27.6Wood and cork 2,924 5.0 149 2.4 51 48.6Furniture 1,271 2.2 73 1.2 57 54.3Paper 2,060 3.5 278 4.5 135 128.6Printing 2,595 4.4 229 3.7 88 83.8Chemicals 3,544 6.o 468 7.5 132 125.7Petroleum refining 838 1.4 201 3.2 240 228.6Bubber 744 1.3 135 2.2 181 172.4Plastics 1,726 2.9 214 3.5 124 118.1Ceramic products 261 0.4 15 0.2 57 54.3Glass 387 0.7 45 0.7 116 110.4Other nonmetallic minerals 2,517 4.3 284 4.6 113 1C7.6Iron and steel 378 o.6 116 1.9 307 292.4.Basic metals (non-iron) 4 - - - loo 95.2Metal products 2,807 4.8 275 4.4 98 93.3Mlfachinery (non-electric) 162 0.3 5 0.1 31 29.5Electric machinery 1,767 3.0 250 4.0 141 134.3Transport material 555 0.9 35 0.6 63 60.0Scientific machinery 149 0.3 11 0.2 74 70.5Other industries 828 1.4 50 0.8 60 57.1

TOTAL 58,940 100.0 6,202 100.0 105 100.0El)

source: Industrial Census, 1973Differences due to rounding.

jT 26iI iCAL APEIJNDL.

Table 4 : ECTTADOB: TYPORT DEPEN'DENCE OF INTSTRY, 1973

*%!1j.)lons of sucres)

DoiXaestic % Imported % Total

TOTAL MANUIFACTURE 4,711 51.4 4,448 48.6 9,159 100.0

Food Processing 2,889 79.1 764 20.9 3,653 1 OC.OBeverages 283 69.4 125 30.6 4C8 100.OTobacco 15 23.8 48 76.2 63 100.0Textiles 503 47.5 552 52.5 1,055 100.0Clothing 28 57.1 21 42.9 49 100.OLeather products 50 61 .4 20 28.6 70 100.oShoes 8 88.9 1 11.1 9 1 0C.0wlood 113 93.4 8 6.6 121 1 GO.CFurniture 33 78.6 9 21.4 42 1i0.oPaper 34 4.5 730 95.5 76L 1CC.CPrinting 3 1.8 160 98.2 163 1 0.CChemicals 199 30.7 449 69.3 648 1 CC.OPetroleum refining 2Q• 54.2 214 45.8 541 100-o. 0Rubber products and

plast,ics 33 8.7 346 91.3 379 10C.0Ceramics and glass 7 41.2 10 58.8 17 1CC.0Other nonmetallic minerals 102 63.0 6o 37-. 16;2 100.0Basic metals 24 8.5 2 57 91.5 281 100.0lMetal products 84 12.2 605 87.8 689 10C0.COther industries 8 9.0 34 81.0 42 100.0

Table 5 ECUADOR: INCENTIVE LEBISLATION - PRINCIPAL FEATURES - 1975

Special Category Category A* w Zone 1 Zone 2 * Zone 1 Zone 2

Existing Existing

I Tax exonerations 100% 100% 100% - 100% 100%(except income tax 5 initial 10 initial 10 initial 5 initial 5 initialand sales tax) years years years years years

II Exonerations of importcustoms for new 100% 100% 100% 1o0% 100%1rnachinery, auxiliaryequipment and parts

11rJ Fxonerations of 80% 90% 100% up to up to up toimport duties on 5 initial 5 initial 5 initial 65% 75% 85%raw materials years; up to years; up to years; up to

70% after 80% after 90% after6th year 6th year 6th year

IV Exoneration of taxon transfers of 100% 100% 1CO% 100% 1001% 100%real estate

V Tax deduction fornew investment

(a) fixed capital 50% 75% 100% 50% 75% 100%

(b) nev equity - 50% 100% - 50% 1 00%

a/ Reflecting changes introduced in November 1973;b/ Benefits given prior to November 1973, in effect for Pichincha, Guayas and Galapoges; zone 1 includes

Imbabura, Cotopaxi, Tungurahua, Chimborazo, Esmeraldas, Manabi, El Oro; Zone 2 includes Las demas Provincias,excepto Pichincha, Guayas, Galapagos.

Sourcet CENDES.

TAbL% 6: SIIAlE U( JAi'WF'f'U I,j i4P0icTS, 1970-1974

Values Percentage Coinposition(in million U; dollars fob) (as a purcei)t of total exporti)

1970 1971 1972 1973 1'974 a 1,( 1971 1972 1973 1571h a!

l'ot,al manuf'actured products 18.6 .347 8 .4I 106.4 29 j!4.It 10.6 9.1 10.1

.2u-gai 8.0 13.2 13.2 12.5 42.6 4.2 6.6 4.0 2.l4 4. 1l-i<l asses 0.7 o.6 0.3 1.6 2.1 0.4 0.3 0.1 0.3 0.2Cocoa products 2.6 4.5 6.5 8.8 22.7 1.4 2.3 2.0 1.7 2.2ScauoOd pioducts 1.5 3.6 3.1 6.1 11.8 0.8 1.8 1.0 1.1 1.1Electric domnestic appliances - 0.2 o.6 0.6 3.3 - 0.1 0.2 0.1 0.4Lvtraw hats 1.3 6.8 2.0 2.8 5.0 0.7 0.4 o.6 0.5 0.5Textiles - 0.2 0.5 2.4 1.9 - 0.1 0.2 0.5 0.2Leather and plastic manuf. - - - 0.9 2.0 - - - 0.2 0.2Chemicals and pharmaceuticals 1.5 1.9 2.1 4.2 14.5 6.8 1.0 o.6 0.7 0.4Other manufactured products 3.0 3.8 6.3 8.5 10.2 1.6 1.9 1.9 1.6 1.0

'l'otal basic and other products 171.3 17().4 291.6 483.6 943.9 0.2 85.6 89.l4 90-S 89-9

of which: petroleum 0.3 1.2 59.5 282.1 614.6 - o.6 18.2 53.0 58'5

TOTAL ;PORT'fS 189.9 199.1 326.3 532.0 3,050.3 100.0 100.0 100.0 100.0 100.0

Source: Banco (entral de Ecuador.

a/ 1974 data refer to export licenses issued: data will be replaced with actualexports when latter are available. W4hile it appears that these licensesoverstate the amount of trade, the distribution is likely to be more or less -3tih same. ,

Table 7 : ECIJADOR: DISTRIIITTION OF 1'ACTORY ESTABLISHMENTS BY SIZE - 1973

Establishments Employment Output Value Added

Value of Outnut Number of Percent Number of Percent Value of Percent Value Percent

[miTlion sucres) Establishments of total Employees of total Production* of total Added* of total

Less than 0.5 232 19.8 1,887 3.2 73.3 0.5 35.6 0.6Petween 0.5 and 0.99 154 13.1 1,759 3.0 114.4 0.7 56.0 0.9

Between 1.0 and 4.99 373 31.8 8,595 14.6 902.8 5.5 399.0 6.4

Between 5.0 and 9.99 138 11.8 6,697 11.3 979.1 5.9 411.7 6.6

Petween 10.0 and 19.99 105 8.9 7,410 12.6 1,457.1 8.8 606.8 9.8

Between 20.0 and 29.99 48 4.1 4,660 7.9 1,2314.5 7.5 451.2 7.3

Petween 30.0 and 39.99 30 2.5 4,450 7.5 1,C12.0 6.1 l445.1 7.2

Between 40.0 and 49.99 20 1.7 3,222 5.5 900.5 5.4 314.6 5.1

50.0 and more 74 6.3 20,260 34.4 9,852.3 59.6 3,482.2 56.1

TOTAL 1,1714 100.0 58,940 100.0 16,526.0 100.0 6,202.0 100.0.

* 1Yillions of sucres

,source: Industrial Census, 1973.Differences due to rounding.

En

*-3

STATISTICAL APENDU

Table 8 : BADOR: STRUCTURE OF flIPORTS 1967-1974

(Millions of $ - c.i.f.)

1967 1968 1969 1970 1971 1972 1973 1974

Con ar non*=bles 20.4 23.3 23.6 2 24.6 C 37.6 74.93.4 4~~-.2 32 ~19 17.7 79.7

Peverages & tobacco 2.7 3.1 1.3 0.9 3.3 2.7 4.0 17.3Pharmaeutical 10.8 12.2 14.8 14.6 14.9 17.1 20.0 30.8Clothing & taxtlle. 0.9 0.7 0.7 0.8 0.5 0.4 o.6 0.8Other 2.6 2.8 2.6 2.4 2.7 5.0 8.0 6.1

Conm er dur * lee12.6 13.7 11.3 13.9 12.6 16.2 26.5 4MousEhold aypfilee -T2.2 2.7 2.3 2. 0 3.1Te

Other personal goods 0.9 1.0 0.9 1.3 2.2 1.7 2.4 4.5varrditlre 1.4 1.4 0.9 1.2 1.1 1.3 1.9 3.2'achinery 5.0 5.4 4.7 4.8 4.5 6.4 9.3 19.3

Private vehicles 3.1 3.8 2.1 4.2 3.4 4.7 9.7 1.2

Fuels and lubricants 20.8 9.3 15.9 17.2 27.7 10.6 11.2 16Wuels TT 7; S- o4Lubricants 2.9 1.7 1.9 2.0 2.1 2.1 2.8 6.3

Paw materiala for agricultura 3-8 4.3 4.7 5.6 3.7 4.6 5.7 61.0Food for animals TT00 T T00srCther 3.7 4.2 4.6 5.5 3.6 4.5 5.7 60.9

Paw materials for industry 75.8 1C1.3 96.1 115.1 118.2 1;05.6 149.3 3i6.2Fo 0 3 0 9 1. 737 -M 5

Other agricultural products 23.5 40.7 37.2 40.2 36.4 22.5 30.9 51.CMining procucts 23.0 28.2 26.0 30.5 37.0 32.5 45.7 119.2Chemicals 16.3 20.3 22.7 33.4 33.7 32.7 47.2 94.9

Construction Materials 11.8 24.4 13.1 15.4 36.7 24.5 18.7 65.8

Capital goods for agriculture 4.6 6.6 6.1 7.5 6.7 4.4 5.7 16.7Machinery & tools 1r -*7- 2.0 9*275 T. 2.0 2.7 15.1Other equipments 0.4 0.5 0.4 0.4 0.5 0.5 0.3 -Tractors & transport equipment 2.3 4.1 3.7 4.3 4.4 1.9 2.8 1.6

Capital oods for industry 40.5 41.4 37.2 __42.9 63.1 76 84.0 2.6Ofrice equipment - 5.1 S-7 7-51;I22.1Tools 1.4 1.5 1.6 2.1 3.5 2.4 3.3 6.9PartB for industrial machinery 5.3 3.9 5.4 6.1 4.5 5.8 7.9 21.5Cther equipment 25.3 26.9 21.2 25.8 44.7 48.7 53.3 167.6Other 3.5 3.5 4.3 4.3 4.9 9.9 8.1 21.5

Transport eauipment 22.7 29.6 3 32.6 44.6 45.0 -2 132 3

Polling equipment 11.7 16.0 18.8 18.7 29.0 24.0 34.4 75.1Other 0.1 0.1 0.2 0.2 0.1 2.7 3.1 0.4

Various 0.3 0.2 0.6 0.5 0.2 1.0 0.3 2.3_

TOTAL 213.4 2 240.9 273.0 3 318.6 37.3

source: Central Bank. (differences due to ounding)