VZCZCXYZ0001
RR RUEHWEB

DE RUEHQT #0557/01 1751350
ZNR UUUUU ZZH
R 231350Z JUN 08
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC 9050
INFO RUEHBO/AMEMBASSY BOGOTA 7622
RUEHCV/AMEMBASSY CARACAS 3083
RUEHLP/AMEMBASSY LA PAZ JUN LIMA 2670
RUEHGL/AMCONSUL GUAYAQUIL 3642
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS QUITO 000557 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR MEWENS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EAGR PGOV EC
SUBJECT: GOE RESPONDS TO INCREASING INFLATION 
 
REF: A: QUITO 267 
 
¶1. (SBU) Summary: Inflation has climbed dramatically in Ecuador in 
the past six months, largely due to natural disasters and 
international food and petroleum price increases, but also Ecuador's 
internal market structure.  A Finance Ministry official detailed 
several GOE programs to fight inflation, including tax breaks and 
subsidies for farmers.  However, a recent GOE price control and ban 
on exports of rice has created controversy among producers.  End 
Summary. 
 
¶2. (SBU) In Ecuador prices continue to rise, affecting every sector 
of the economy.  The Ministry of Finance and the Central Bank of 
Ecuador (CB) initially projected inflation rates for 2008 of close 
to 3%.  However, in May 2008 annual inflation hit 9.29%.  Econcouns 
and Econ Specialist met with Mateo Villalba, Advisor to the Under 
Secretary of Macroeconomic Consistency in the Ministry of Finance, 
who provided an analysis of the various factors contributing to 
inflation in Ecuador and details on GOE programs to address them. 
 
INFLATIONARY PRESSURES 
---------------------- 
 
¶3. (SBU) According to Villalba, rising inflation in Ecuador is due 
to four factors:  natural disasters, international food and 
petroleum price increases, growing domestic demand and nonresponsive 
local production, and the domestic market structure. 
 
¶4.  (SBU) Severe flooding that occurred in Ecuador in the spring and 
a volcanic eruption in 2007 (ref. a), as well as recent 
international price increases in food and raw materials, led to 
local price increases.  Another pressure point has been rising 
international petroleum prices, which has a direct effect on the 
prices of agricultural inputs like fertilizers.  To illustrate the 
rapid effect this has on consumer prices, Villalba said that a third 
of the final price of potatoes is attributable to inputs such as 
fertilizer.  (Note:  Ecuador has frozen the domestic price of fuel 
products since 2003, containing that source of inflationary pressure 
for the time being.) 
 
¶5.  (SBU) While the GOE has publicly blamed rising inflation on the 
shocks cited above, Villalba went on to explain additional domestic 
pressures.  One that he mentioned is rising demand and inflexible 
supply.  He noted that the government has increased the income of 
the poor by raising the minimum wage and the Human Development Bond 
(a targeted income transfer program).  A high portion of the poors' 
income is immediately spent on food, so this led to a sharp increase 
in food demand.  Conversely, food supply is inelastic due to the 
time required for crop planting and harvesting.  In addition, small 
producers, who are responsible for an important share of Ecuador's 
agricultural production and therefore its prices, are highly 
sensitive to the cost of inputs, which have been rising. 
 
¶6.  (SBU) Villalba also said that because of high inflation in the 
1990s, the Ecuadorian supply chain remains highly sensitive to price 
expectations.  He noted that this is particularly pronounced for 
small-scale food retailers, who will rapidly raise prices of 
existing stocks in anticipation of price increases for future 
supplies.  According to Villalba, 80% of Ecuadorians buy their food 
from small retailers, so this impact is substantial.  (Note:  food 
and non-alcoholic beverage prices contributed 59.4% to the latest 
increase in inflation.) 
 
PROGRAMS TO ADDRESS INFLATION 
----------------------------- 
 
¶7. (U) According to Villalba, the GOE has been taking steps to 
address the different factors contributing to inflation, with a mix 
of policies including price controls, tariff cuts, subsidies, and 
export bans.  The GOE agencies that have the lead in implementing 
anti-inflation policies are the Coordinating Ministry of Social 
Development and the Ministry of Agriculture, with financial support 
from the Ministry of Finance. 
 
¶8. (SBU) In order to minimize the effects of natural disasters, the 
GOE is improving infrastructure in affected areas by rebuilding 
roads and bridges, and extending and refinancing   agricultural 
producers' credits with the National Development Bank.  On June 13, 
President Correa announced a USD 256 million GOE plan to support 
agricultural producers.  He approved two decrees.  One will 
partially subsidize small producers for the purchase of agricultural 
inputs; the other waives the value added tax (VAT) for agricultural 
inputs.  Villalba noted that previously the GOE had attempted to 
support agriculture by directly providing subsidized inputs 
(fertilizer), but that program had not worked well, so this time 
around the GOE will allow agricultural producers to purchase inputs 
from their regular suppliers, and after presenting copies of their 
invoices they will receive the subsidy payment.  Villalba allowed 
that the GOE was still working out the details of how subsidies 
would be implemented. 
 
¶9. (SBU) There are three other fiscal measures that the GOE is 
contemplating in order to reduce costs for the agricultural sector 
in 2008 and 2009, Villalba explained.  One measure is to reduce the 
tax on electricity consumption by the agricultural and commercial 
sectors by 10%, and another is to exclude companies that import 
agricultural inputs from income taxes so that they can sell these 
inputs at lower prices.  The last measure is to exclude 
"unproductive land" from taxes (often, a portion of a farmer's land 
is "unproductive" either because it is being used for cattle grazing 
or because of insufficient funds for additional investment). 
 
¶10.  (SBU) Villalba commented that the GOE had considered further 
wage adjustments for the poor, but decided that this would increase 
domestic demand and put further upward pressure on prices. 
 
COMMENT: 
-------- 
 
¶11. (SBU) The GOE had previously used strong market interventions in 
an effort to slow inflation:  price controls for milk, a ban on rice 
exports, direct provision of subsidized inputs.  Those measures 
remain in place, but the latest round of measures show a greater 
willingness to work with the market using more moderate 
interventions.  These newest measures seem to have been crafted in 
part by first undertaking a relatively thorough analysis of the 
underlying factors of inflation, as outlined by Villalba, something 
we have not necessarily seen in other GOE policy exercises. 
 
JEWELL