However, the budget is expected to become constrained again in 2025
Multinationals operating in Ecuador should prepare for a temporary hike in their tax obligations in 2024. Additionally, they should anticipate a potential dip in demand as a result of the VAT increase to 15% over the next two years. The potential IMF loan approval could further boost aggregate demand in the future despite the country’s fiscal restrictions.
Overview
Since the pandemic began, Ecuador has faced a liquidity crisis that has severely limited public investment across various sectors. Following the recent approval of tax and fiscal reforms by Ecuador’s National Assembly, in the aftermath of the tragic events on January 9, President Daniel Noboa’s government appears to have partially eased these budget constraints. This shift enables a limited fiscal expansion, allowing for increased funding to be allocated to healthcare, education, security, and fuel subsidies.
- Ecuador’s current administration began amid a significant liquidity challenge, facing a shortfall that left USD 738.9 million in delayed payments. To address this, an advanced tax collection strategy was adopted as part of the Economic Efficiency Law enacted in December, targeting large taxpayers with an income withholding mechanism capable of drawing up to 10% of taxable income. This initiative is expected to contribute USD 326 million in revenue for 2024.
- March 9 marked the introduction of a pivotal tax reform known as “The Law to Confront Armed Conflict,” which aimed to fund expanded security spending in the wake of a security crisis. This legislation increased the VAT from 12% to 13%, with a planned escalation to 15% over the next two years. It also introduced additional tax burdens, including a 3.25% tax on companies’ EBITDA for 2022, a 25% tax on banks and cooperatives’ profits for 2023, and an escalation in the currency exit tax from 3.5% to 5%. The cumulative effect of these measures is a projected increase in total tax collection to USD 17.2 billion, equivalent to 19.2% of the GDP.
- Furthermore, the government is actively seeking a USD 3 billion loan from the IMF’s structural adjustment facility, which could entail short-term public expenditure adjustments as per the IMF’s likely conditions.
Government Spending Trajectory
- The increase in revenue is set to drive a substantial expansion in government spending, with capital expenditure and investments expected to receive a boost of USD 3.5 billion. This represents 87.5% of the additional tax revenue, of which a substantial portion, approximately 76%, is allocated to health and education initiatives.
- Fuel subsidies, a contentious but vital aspect of public spending, are anticipated to rise by USD 426 million, a 16% YOY increase, totaling USD 3 billion for 2024. Such subsidies play a crucial role in maintaining economic stability and consumer spending capacity, especially in the transportation and logistics sectors.
- In contrast, spending on security is slated for a relatively minor increase of USD 214 million, totaling USD 3.5 billion—a 6.48% YOY increase. This modest augmentation comes as a surprise given the new law aimed at confronting armed conflict and suggests a strategic prioritization of long-term investment in health and education over immediate security spending. However, given the ongoing delays in payments on broader public administration, it is doubtful that any further increase in security funding will be sanctioned this year.
Our View
We anticipate that Ecuador will steer clear of a liquidity crisis in 2024. However, the temporary nature of many of the newly enacted taxes suggests that tax revenues may decline in 2025 as these special measures start to phase out, which could lead to further constraints in the budget the next year.
The incremental increase in VAT to 15% over the next two years could potentially restrain consumption growth, which is currently expected to be a modest 0.7% YOY in 2024. Additionally, the extraordinary taxes on large corporations and banks may dampen domestic investment, which is projected to grow by 1.3% YOY in the same period.
If the IMF loan is sanctioned, Ecuador would secure an additional USD 3 billion in funding and the opportunity to roll over its current debt with international institutions for the coming years. This increase in funds, together with the deferral of interest payments, would provide Ecuador with a more flexible fiscal outlook in the near future. Nonetheless, in exchange for this funding, the IMF is requesting that the Ecuadorian government adopt austerity measures aimed at improving the country’s financial risk profile in the short to medium term.
Finally, the recent breakdown in diplomatic relations with the Mexican government, triggered by Quito’s police raid on the Mexican embassy—which had granted political asylum to a former Ecuadorian vice president—is not expected to influence the ongoing IMF loan negotiations, set to resume between April 17 and April 19.
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