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Cablegate: Goe Responds to Increasing Inflation

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

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