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Cablegate: Natural Disasters Increase Short-Term Inflation

VZCZCXYZ0020
PP RUEHWEB

DE RUEHQT #0267/01 0781321
ZNR UUUUU ZZH
P 181321Z MAR 08
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC PRIORITY 8636
INFO RUEHBO/AMEMBASSY BOGOTA 7446
RUEHCV/AMEMBASSY CARACAS 2953
RUEHLP/AMEMBASSY LA PAZ MAR LIMA 2489
RUEHGL/AMCONSUL GUAYAQUIL 3412

UNCLAS QUITO 000267

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EC
SUBJECT: Natural Disasters Increase Short-Term Inflation

REF: A) QUITO 225, B) Quito 55 C) 07 Quito 2659, D) Quito 36, E) 07
Quito 2114, F) 07 Quito 2095

1. Summary. Ecuador's inflation rose in the first two months of
2008 due in large part natural disasters, namely severe flooding and
a volcanic eruption. Additionally, rising global inflationary
pressure, particularly for food, contributed to Ecuador's
inflationary up-tick. However, Ecuador's medium- to long-term
inflation outlook appears stable, although salary increases and
rising government expenditure could generate inflationary pressure.
End Summary.

Short Term Inflation Rise Due to Local Disasters
--------------------------------------------- ---

2. (U) Inflation rose significantly in the first two months of 2008
compared to 2007. Inflation rose 1.14 percent in January 2008, the
highest monthly increase in five years. Inflation rose 0.94 percent
in February 2008 compared to 0.07 percent in February 2007.
Annualized inflation through January 2008 was 4.19 percent, compared
to 2.68 percent in the same period a year earlier.

3. (U) The eruptions of Tungurahua volcano in late January and early
February affected agricultural production and distribution in the
volcano's vicinity. Potato production was most significantly
affected, with prices rising 3.8 percent in February 2008.

4. (U) Mass flooding throughout Ecuador in February harmed
agricultural production, especially in coastal regions, and closed
many transportation routes, thus hindering distribution (reftel a).
This led to increased consumer prices nationwide. The largest
inflationary spikes were seen in food products and non-alcoholic
drinks. Prices in this group rose 0.52 percent in February 2008.
Products with the highest increase were: tomatoes, 13.9 percent;
fresh fish, 7.25 percent; and soft drinks, 3.8 percent.

5. (U) In addition to the weather and the volcanic eruption, two
policy factors also contributed to inflation. The minimum wage was
increased by 15% in late 2007 and was effective at the beginning of
2008. In addition, the government implemented extensive tax reforms
at the beginning of the year (reftels b and c), including raising
excise taxes on ostensibly luxury goods (including cigarettes,
make-up and cars), which led to price increases for those goods.

Rising Global Inflationary Pressure
-----------------------------------

6. (U) Increasing global prices for commodities coupled with
Ecuador's reliance on imported inputs have contributed to
inflationary pressure on both consumer and producer prices since the
middle of 2007. The biggest increases in February in this category
were whole chickens, 6.6 percent; and vegetable oil, 5.4 percent;
chicken prices are heavily influenced by the cost of imported feeds
and other inputs, while vegetable oil is imported. Producer prices
rose 1.89 percent in February 2008, raising the annual producer
prices inflation rate to 9.36 percent. With producer prices rising
faster than consumer prices, this trend could put additional
pressure on consumer prices.

7. (U) Rising petroleum prices have only a secondary impact on
inflation in Ecuador, for example in the cost of plastic packaging
material or international shipping costs. However, the domestic
prices of fuel products (gasoline, diesel, LPG) have been frozen for
several years. This policy, which predates the Correa
administration, has become increasingly expensive for the
government, which imports petroleum derivatives and subsidizes the
difference.

Long Term Inflation Outlook Appears Stable
------------------------------------------

7. (U) At 3.3 percent, Ecuador's 2007 year-end inflation was the
lowest in Latin America. In spite of the unexpected short term up
tick from natural disasters, Ecuadorian inflation in the beginning
of 2008 remained on par relative to its regional neighbors. In
February 2008, Ecuador's inflation rate of 0.94 percent was lower
than Colombia (1.51 percent) and equal to Peru (0.91 percent).

8. (U) The Central Bank of Ecuador predicts inflation to rise
between 2.9 and 3.7% in 2008. Five-year predictions from the
Economist Intelligence Unit predict Ecuadorian annual inflation
rates between 3.4 and 4.5 percent through 2012.

Comment
-------

11. (SBU) Since adopting the U.S. dollar in late 2000, inflation has
been a bright spot in the Ecuadorian economy. Inflation rates have
remained low both by regional and global standards. Although
Ecuador had the lowest inflation rate in 2007 in Latin America and
the medium- to long-term inflation outlook appears stable, risks
remain. One is that short-term inflationary pressures remain from
both the flooding and global price increases. It remains to be seen
whether the government will try to contain this inflationary
pressure through market intervention, as it has already done for
milk (price controls), flour (subsidies), and rice (export ban)
(reftels d-f).

12. (SBU) In the medium-term, continued government spending and
promises of more wage hikes in upcoming years could generate
additional inflationary pressure, although those pressures appear to
be contained for the time being because of Ecuador's sluggish
economic growth. Frozen fuel prices also represent suppressed
inflation, which will be a problem when and if the government ever
decides to adjust those prices.

JEWELL

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