US embassy cable - 05QUITO1734

C O N F I D E N T I A L SECTION 01 OF 02 QUITO 001734 
 
SIPDIS 
 
E.O. 12958: DECL: 07/22/2015 
TAGS: ECON, EFIN, PGOV, PREL, EC, Economy 
SUBJECT: MORE FINANCIAL PRESSURE ON ECUADOR 
 
Classified By: Charge d'Affaires Kevin Herbert Reasons 1.4 (b) & (d) 
 
1. (C) Summary.  Opting for the path of least resistance, 
President Palacio issued a partial veto of the bill to refund 
social security (IESS) reserve funds, but proposed to refund 
the reserve funds anyway.  The major immediate difference 
between the congressional bill and the Palacio proposal is 
that under his proposal the reserves will be refunded over 
six months versus the 0-90 days proposed in the bill.  His 
attempt to please everyone (business, and even Minister of 
Economy Correa, were urging a veto) places additional 
pressure on Ecuador,s already strained financing needs. 
Palacio has succeeded in temporarily averting strong public 
protests, but only by postponing more and greater (especially 
financing) pressures in the future.  End summary. 
 
Is Everybody Happy? 
------------------- 
 
2. (SBU) President Alfredo Palacio, in a nationally televised 
address to the nation the night of July 21, announced he was 
partially vetoing the congressional bill to refund social 
security (IESS) reserve funds to contributors.  While in the 
strictest sense it is a partial veto, Palacio actually 
proposed to do exactly what the bill called for, refund IESS 
reserve funds to contributors.  The major difference between 
the congressional bill and Palacio,s proposal is that, under 
the latter, reserve withdrawals would be phased in over a 
relatively longer 3-6 months instead 0-90 days in the 
original bill.  Congress has 30 days to override the veto 
with 67 out of 100 votes; otherwise, Palacio,s version 
becomes law.  Palacio called for an extraordinary session of 
congress (which is in recess) to convene next week. 
 
3. (C) Retirees, union members and others had threatened to 
take to the streets if Palacio vetoed the bill.  Seventy-five 
of the 100 congressional deputies voted in favor of the bill. 
 Business leaders and others, including Minister of Economy 
Rafael Correa, who understood more of what was at stake for 
the country, had urged Palacio to veto the bill.  In press 
reports July 22, Correa was still calling for a full veto of 
the bill.  Palacio, perhaps fearing the same fate of his 
predecessor Lucio Gutierrez who was ousted last April 20, 
elected to try to satisfy everyone, providing both a veto 
(partial) and the return of the reserves. 
 
4. (C) To further distract both the Congress and the public, 
Palacio threw in several additional proposals.  Among them 
are economic and political reforms, including proposed 
national referendum issues (septel). 
 
More Financial Pressures and Causes for Concern 
--------------------------------------------- -- 
 
5. (U) Instead of allowing contributors to immediately 
(within 90 days) withdraw their IESS reserve funds, Palacio 
proposes to make the funds available to contributors in 3 
phases.  In the first phase, contributors with $1000 or less 
in reserves can withdraw their funds within 90 days of 
September 1.  Those contributors with $1000-1500 would be 
able to make withdrawals in December and January.  Those 
contributors with over $1500 in social security reserve funds 
would have to wait until February 2006 to withdraw the funds. 
 Palacio claimed that the first phase alone would cover 91% 
of those eligible to withdraw funds from the reserve system. 
 
6. (U) Currently, the reserve fund holds $734 million, $384 
million of which is invested in government debt.  Thus, under 
the congressional or Palacio scenario, because both allow the 
complete withdrawal of reserves, the GOE could lose up to 
$384 million in financing.  (It is not clear how many people 
would actually elect to withdraw their funds.) However, the 
GOE was already considering an increase in IESS holdings of 
government debt.  The intended increase was to cover the 
prospects of low rollovers of previous debt, lower 
multilateral disbursements and promised higher capital 
spending.  Credit Suisse First Boston (CFSB) also notes that 
there are short-term liquidity problems.  The reserve fund 
only has $265 million in cash deposits, which would require 
the IESS to liquidate securities holdings to pay back the 
full $734 million to contributors.  CFSB adds that the GOE,s 
liquidity problems will be further challenged by domestic 
debt maturities in September ($261 million) and January 2006 
($195 million). 
 
7. (U) As part of the social security system reforms, Palacio 
proposed that future reserves be divided into two funds, only 
one from which the contributor could seek withdrawals.  He 
said that next week, during his called-for extraordinary 
session of Congress, he would send proposals for a series of 
reforms, e.g., the restructuring of the social security 
system, and the Deposit Guarantee Agency (AGD - roughly 
equivalent to the former U.S. Resolution Trust Agency). 
According to press reports, within 90 days of the passage of 
the new law, the Minister of Economy could acquire an &open 
bank8 under the AGD and transfer it to the IESS.  The AGD 
could use the proceeds to pay off the depositors of failed 
banks who have yet to recover their funds from banks taken 
over by the state in the 1999-2000 banking crisis. 
Palacio,s plan also proposes that the Minister of Economy 
would establish another bank for the benefit of IESS 
contributors, offering mortgages and loans to contributors. 
This proposal calls for much closer examination, given 
Minister of Economy Correa,s out-dated statist economic 
policies. 
Comment 
------- 
 
8. (C) The details of the extensive proposals from Palacio 
are still emerging, requiring more review and analysis before 
drawing definitive conclusions, which was probably one of 
Palacio,s goals in the first place.  He has given everyone 
almost exactly what was requested, but it is not clear how 
(or if) he can pay for it all, both economically and 
politically.  For now though, he has kept himself in office 
and caused enough confusion to send the Congress and public 
in enough different directions to prevent them from seizing 
any one issue that could unite them against him.  Sooner, 
rather than later though the financing bill will come due, 
which might make Venezuelan assistance overtures more 
enticing.  Also, much of Palacio,s proposed economic reforms 
seem to have come from Correa, which would imply that the 
prospects of his imminent departure from the cabinet are much 
less likely. 
 
9. (C) By avoiding the hard, but clearly best choice (a full 
veto of the IESS bill), Palacio appears to confirm early 
impressions of him.  He is more interested in keeping himself 
in office than taking controversial public stands that are in 
Ecuador,s best national interests. 
HERBERT