The fiscal situation of the State has deteriorated because of increased spending and a drop in income, primarily due to lower oil production and the reduction of the Foreign Currency Outflow Tax (ISD).

Amidst political uncertainty following President Guillermo Lasso’s invocation of ‘cross death,’ and a harsh winter period, the State recorded revenues of $10.549 billion in the first half of 2023.

This marks a decrease of $1.095 billion or 9.4% compared to the same period in 2022.

Moreover, this is the lowest figure since 2021 when compared to the first half of previous years.

The decline in state revenue is concerning, particularly in a year when the current or incoming government will require increased spending to address a potential emergency caused by the El Niño phenomenon, explained Ángel Maridueña, an economics professor at the State University of Milagro.

Increased spending and no easy credit

In fact, the first half of 2023 already shows an increase in government expenses.

Investment spending, for instance, rose by 13% compared to the first quarter of 2022, amounting to a total of $2.191 billion. Additionally, interest expenses on debt grew by 43% and salary expenses, which constitute a significant portion of the budget, increased by 6.6%. Overall, public spending rose by $81 million compared to the first half of 2022.

Furthermore, Ecuador’s access to credit has become more challenging, according to José Hidalgo, director of the Development Studies Corporation (Cordes).

The fiscal situation’s deterioration has resulted in accumulated State arrears with social security, local governments, and State providers, further exacerbating the financial strain.

In response to this scenario, several presidential candidates are considering seeking liquidity from the Central Bank of Ecuador (BCE), which would potentially weaken dollarization. However, Hidalgo points out that borrowing money from the ECB is prohibited by law.

Given the circumstances, Hidalgo believes that both the current and incoming governments should take unpopular measures, such as targeting subsidies for low-octane gasoline or increasing taxes.

However, history has shown that such measures have led to national strikes, as witnessed in October 2019 and June 2022.

How the government got here

The decline in Budget income can be attributed to four primary factors.

Plummeting Oil Revenues

State oil revenues experienced the most significant decline, amounting to $815 million between January and June 2023, compared to $1.611 billion in the first half of 2022, representing a 49% annual drop.

The decline is attributable to multiple factors, including the lower price of a barrel of Ecuadorian oil, which stood at $64.04 between January and May 2023, falling below the $64.80 per barrel required by the State to finance its budget.

Additionally, the government has failed to achieve its goal of increasing oil production due to various challenges, such as the temporary suspension of operations of the OCP and SOTE pipelines in February 2023, the strike by Amazonian communities in March 2023, the void declaration of the tender to reactivate 100 closed oil wells in April 2023, and the inability of Petroecuador, the country’s largest oil company, to add new oil platforms to the ITT block.

Reduced Tax on the Exit of Foreign Currency (ISD)

The reduction of the ISD rate, one of the campaign promises of President Lasso’s administration, has led to a decline in State Budget income.

The ISD rate decreased from 5% in 2021 to 3.5% in 2023. As a result, ISD collection fell from $528 million in the first half of 2022 to $388 million in the same period this year.

The plan to further reduce the ISD rate to 2% by December 2023 now rests with the incoming President.

Decreased VAT Income

The cooling off of the economy is evident in the decline in private sector consumption, leading to a drop in VAT revenue, the country’s largest tax source.

VAT revenues in the Budget for the first half of 2023 amounted to $3.149 billion, representing a decrease of $49.8 million compared to the same period in 2022. The decline is primarily due to reduced income from VAT paid on imported products.

It is important to note that the gross tax collection reported by the Internal Revenue Service (SRI) has increased, but this is mainly due to returns, credit notes, and compensations that do not contribute to the state budget.

Overall, the State’s tax income in the first semester of 2023 fell by 2.5% compared to the same period in 2022.

Effects of Tax Reform

The first tax reform implemented by President Lasso’s government, effective from November 2021, introduced temporary taxes for individuals with high net worth or assets abroad.

The Tax for the Regularization of Assets Abroad generated $92 million for the State, while the temporary contribution for the post-Covid 2019 economic boost, a tax ranging from 1% to 1.5% for individuals with assets over $1 million, contributed $183 million.

These taxes were applied only in 2022.

To sum it all up, the State’s revenues have experienced a significant decline in the first half of 2023. Factors such as plummeting oil revenues, the reduction of the ISD rate, decreased VAT income, and the effects of tax reform have all contributed to this challenging fiscal situation.