Private Bank Profits Don’t Represent the Health of the Economy

May 08, 2013

Arthur Phillips

Bloomberg’s Nathan Gill wrote a particularly one-sided article on Thursday, in which he states that “Ecuador’s bid to reduce poverty by taxing its banks is threatening to deepen the nation’s economic slump.”

“Slump” seems somewhat dire to describe the state of the Ecuadorian economy. In 2012 the economy grew by 5 percent, and it is projected to grow by 4.45 percent for 2013.

The report also offers no convincing evidence that Ecuador’s taxation of its banks is hurting the economy. 

The article specifically focuses on a set of reforms that took effect on January 1, including the elimination of banks’ tax deductions for reinvested profits and a 0.35 percent tax on assets held abroad. The reporter argues that a sharp drop in bank profits in the first quarter of this year was a result of the taxation. He then argues that an increase in the banks’ interest rates must also be due to the reforms:

Non-government banks, including Citigroup Inc (C).’s local unit, raised rates on corporate loans by an average 0.21 percentage point in the first quarter to 8.88 percent, the highest since November 2010, according to central bank data. That compares with a decline of 0.72 percentage point to 8.81 percent in Colombia and an increase of 0.01 percentage point to 5.79 percent for similar loans in Peru.

However, this causality is not at all clear.  It is more likely that this modest increase in interest rates is attributable to a recent uptick in inflation. Consumer prices increased at an annualized rate of 4.6 percent in the first quarter of this year, as compared to a rate of 0.2 percent in the last quarter of last year.

The reforms that increased taxes on the banks were reportedly enacted to pay for increasing cash subsidies for the country’s poor, and they were passed by congress in a 79-5 vote. Gill describes these changes as having been motivated by an election race that Correa was all but certain to win, rather than being the latest step in a determined and so-far successful process to transform a country that, like many in the hemisphere, has been historically plagued by inequality. It is perhaps worth noting that Ecuador has seen some of the region’s highest growth over the past few years. Furthermore, economic gains have been broadly shared and increased social spending has significantly improved the quality of life of a broad portion of the country’s citizens.

As CEPR’s recent report on Ecuador’s financial reforms describes, President Rafael Correa’s actions in recent years are a major reason why the government has raised revenue and consequently been able to pursue expansionary fiscal policy and increased social spending. The results of this policy regime have included the lowest unemployment rate on record, a near-halving of the poverty rate, and a doubling of education funding, among other gains.

Yet, from this article, one would be led to believe that new taxes on the financial sector have only led to lower bank profits, which are presented as a serious problem for the country’s macroeconomic outlook. Among Gill’s quoted sources are the CEO of Ecuador’s biggest brokerage firm, the director of a market research and consulting firm, and the president of the country’s Private Banking Association. Their views should come as no surprise, but they are not necessarily the full picture or even accurate.

The article (on the second page) also quotes Pedro Solines, Ecuador’s banking superintendent, as saying “Less profits for the banks, yes, but where does it go? To the people who receive the subsidy.” The quote continues with Solines saying, “If I receive the subsidy, I’m going to say that the impact is very good. If I run a shop where the person who receives the subsidy spends not $35 but $50, I’m going to say it’s good. If I’m a bank, I’m going to say I’m doing badly.”

Correa was re-elected on February 17, receiving 57 percent of the vote compared to his closest competitor’s 23 percent. 

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