The potential cessation of crude oil production in Yasuní-ITT has raised concerns about the impact on government income and the measures that would be needed to offset the loss.

Currently, the oil exploitation in Yasuní generates approximately $1.2 billion annually for the state. As the government prepares for a popular consultation on August 20, 2023, to determine the fate of this oil reserve, various options are being discussed to compensate for the potential loss of revenue.

President Guillermo Lasso has warned that if oil production in Yasuní-ITT stops, society will face a challenging debate on reducing expenses in critical areas such as health, education, security, or eliminating certain subsidies.

Increase in VAT and cuts in subsidies

Minister of Economy and Finance, Pablo Arosemena, suggested that the income side could be compensated by raising the value added tax (VAT) by two points, from 12% to 14%.

But to understand the scale of the necessary adjustments, experts point out that both subsidies and taxes would need to be addressed. Jaime Carrera, from the Fiscal Policy Observatory, explains that each VAT point represents around $500 million. Therefore, to compensate for the annual $1.2 billion loss, a VAT increase to 15% would be required.

Regarding subsidies, this year’s fuel subsidies are projected to amount to approximately $5.0 billion. To recover $1.2 billion, subsidies would need to be reduced by at least 25%. However, it is important to note that some subsidies, particularly those for domestic gas usage, cannot be easily touched. The largest subsidy is in diesel and gasoline.

Fuel prices for extra gasoline and diesel have remained fixed at $2.40 and $1.75 per gallon, respectively, since October 2021, with only minor downward adjustments due to protests in 2022. The targeting and reduction of subsidies were part of the agreements reached between the government and indigenous groups during dialogue sessions. However, no concrete solution was found, leaving the issue unresolved.

Pablo Arosemena highlights the need to reconsider current spending habits. For example, he suggests that the cost of supplying all medicines in the public hospital network is equivalent to the income generated from Yasuní.

Jaime Carrera emphasizes the severity of the situation and the implications of the popular consultation on Yasuní. Compensating for the lost income requires sustainable sources of revenue. Even with compensation, the fiscal deficit would remain high, posing challenges for financing and debt payments.

Carrera estimates that the deficit in 2023 will reach around $5.0 billion. If the $1.2 billion from Yasuní is not received the following year, the deficit would rise to $6.2 billion. While compensating for the Yasuní deficit through a higher VAT increase would address the income shortfall, the overall deficit would remain the same. It is crucial for the country to grasp the gravity of the fiscal issue and its potential impact on dollarization, investments, and country risk.

Most don’t understand the impact

Carrera warns that failure to exploit Yasuní and adequately compensate for the loss would have significant repercussions on public accounts, investment inflow, and ultimately, the stability of dollarization. Understanding these implications is not solely the responsibility of the government but also of the Ecuadorian society. Failing to comprehend the functioning of public accounts and the costs associated with not exploiting Yasuní would hinder the country’s progress.

He warns of a great repercussion on public accounts, on the message that the country sends to investors, the increase in country risk, and if fiscal weakness deepens further, and even dollarization would be put at risk. “Investments are not coming, there is no work, growth is slowing, there are more poor people, that is the complete picture,” comments Carrera.

As Ecuador faces this critical decision, it is essential to weigh the potential consequences comprehensively. The government, along with all sectors of society, must work together to find the best path forward for the country, considering the fiscal implications, economic stability, and long-term development goals.