VII. INVESTMENT CLIMATE - Openness to Foreign Investment The Ecuadorian government welcomes foreign investment, and the trend in recent years has been toward substantial liberalization in investment regulations. As a member of the Andean Pact, Ecuador's foreign investment policy is governed largely by the parameters of Andean Pact Decisions 291 and 292 of May 1991. In early 1993, the Duran Ballen government issued a new set of implementing regulations which further liberalized the investment regime. While some foreign investors have faced bureaucratic hurdles in recent years, especially in the areas of taxation and employment permits, the current government is strongly committed to attracting foreign investment and breaking bureaucratic barriers. Under the January 1993 regulations, foreign investors with up to 100 percent equity are accorded exactly the same rights of entry as Ecuadorian private investors in nearly all sectors. By eliminating prior authorization requirements, there is no screening of foreign investment. Foreign investment is allowed without previous authorization in virtually all sectors of the Ecuadorian economy which are open to domestic private investment. Remittances of 100 percent of profits and capital are permitted. Foreign investors must register the level of their investments with the Central Bank for statistical purposes. No previous authorization is required for technology contracts including licensees or franchises. There is no limit on the amount of royalties which may be remitted. The only requirement is that all technology contracts be registered with the Ministry of Industries. Given the absence of prior approval requirements, there is no discrimination against foreign investors at the time the investment is made. The regulations lifted the prior limitation of 49 percent of equity for foreign investments in the financial sector and eliminated prior authorization requirements for foreign companies investing in public services. The Capital Markets Law enacted in May 1993 also eliminated discriminatory tax treatment for foreign investors. Previously, foreign investors paid an additional 11 percent tax on remitted profits in addition to the 25 percent corporate income tax. Foreign investors may participate in government financed research programs. Visa and residence requirements do not inhibit foreign investment. Although the 1993 Modernization of the State Law makes it somewhat easier to privatize state enterprises, foreign investors, and often domestic investors as well, still operate with limitations in certain sectors of the economy: o Petroleum: All subsurface resources belong to the state. In recent years, foreign oil companies have engaged in exploration and development activities under risk-service contracts with Petroecuador, the state oil company. The reforms to the Hydrocarbons Law enacted in November 1993 introduced a new production-sharing contract that will give foreign investors the right to share in finds. The new law facilitates the conclusion of a build-operate-transfer arrangement with a private group to build a second oil pipeline. The reforms also opened up domestic distribution, refining and transport activities to private companies, including foreign ones. o Mining: Under a mining law passed in 1991, the mining sector is fully open to foreign investment, with individual concession arrangements to be worked out with the Ministry of Energy and Mines. The Mining Law prohibits foreign investors from obtaining mining rights in zones adjacent to international boundaries, without the permission of the President and the approval of the Armed Forces. o Fishing: The fishing law restricts foreign investment in domestic fishing operations to 49 percent of equity, with exceptions permitted with appeal to the National Fishery Development Council. o Electricity: Article 46 of the Constitution reserves electric power generation for the state. The current Electrification Law notes that the state controls generation, transmission, distribution, and commercialization of electric energy, but can enter into service contracts with private sector entities to provide such services. The largest electricity distribution company, which serves the city of Guayaquil, is in private hands. The government plans to introduce new electricity legislation in 1994 to open up the sector to more private sector investment, including foreign, in power generation and distribution. o Telecommunications: Article 46 of the Constitution also reserves the telecommunications sector for the State, but the Telecommunications Law notes that the State can authorize other companies to establish or exploit telecommunications installations. Two private groups with foreign participation were granted concessions in 1993 to develop cellular telephone systems. New telecommunications legislation is being prepared to privatize the sector on a concession basis and foreign groups will be allowed to participate. o Media: The Law of Radio and Television prohibits branches of foreign companies from operating radio and television stations, but places no similar restrictions on companies that are locally incorporated. o Strategic Sectors: Article 46 of the Ecuadorian constitution reserves for the public sector other "strategic enterprises" determined by individual law. These are understood to include only national security industries. In some cases, the military is a joint venture partner with private industry. Several industrial development laws providing tax incentives to invest outside of Quito and Guayaquil are due to expire at the end of 1994, and the government does not intend to renew them. The Agrarian Development Law enacted in June 1994 provides a 50 percent income tax credit for investment outside Quito and Guayaquil in industrial transformation of agricultural products. - Conversion and Transfer Policies Foreign investors are free to remit 100 percent of net profits through the free exchange market without restriction. They may also repatriate the proceeds of liquidation of their investment through the free exchange market. Foreign investors can use the free exchange market to convert their inward investment flows. There is no rationing of foreign exchange, as the exchange market operates through commercial banks at freely determined rates. There are no limitations on outflows of funds for profit remittances, debt service, capital gains, returns on intellectual property, or imported inputs. - Expropriation and Compensation Expropriation is provided for in Ecuadorian law with appropriate compensation. In infrequent cases of expropriations, the individual has the right to petition a judge to establish the appropriate price for expropriated holdings. The Agrarian Development Law enacted in June 1994 restricts the grounds for expropriation of agricultural land and will dismantle the separate legal system for land reform cases. The extent to which investors and lenders receive prompt, adequate and effective compensation is largely related to the particular judicial process underway. However, the treatment is identical legally for both foreign and domestic investors. Under Ecuador's as yet unratified bilateral investment treaty with the United States, expropriation can only be carried out for a public purpose, in a nondiscriminatory manner, and upon payment of prompt, adequate and effective compensation. - Dispute Settlement A cumbersome legal system and complex land reform legislation have made it somewhat difficult to enforce property and concession rights in the mining and agricultural sectors. However, the current government is committed to improved respect for property rights in both agriculture and mining. Some local and foreign mining companies have had their concessions occupied by informal miners, who have subsequently negotiated for a share of the respective concessions. A number of foreign and local investors have had agricultural land seized by squatter groups over the years. In the past, squatter claims in the agriculture sector have often been subsequently legally recognized by the Agrarian Reform Institute (IERAC), with only minimal, if any, compensation being paid. The new agrarian law makes legalization of such seizures much more difficult and guarantees cash payment of the market value of expropriated property. In the petroleum sector, a major U.S. investor has had an extensive, longstanding dispute for tax claims dating back to 1980. Despite lengthy negotiations with several different governments, the dispute has not yet been resolved. Furthermore, company officials have been prevented by the courts from leaving Ecuador due to pending claims against the company by former employees. In the past there have been cases in which Ecuadorians involved in business disputes with foreigners have been able to arrange for foreigners to be jailed pending resolution of the dispute. Finally, a major U.S. investor in the electricity sector in Guayaquil had his investment "intervened" by the government for four years, an action impeded the remittance of profits and was not provided for in the terms of the company's valid concession contract. Although decisions of an arbitration panel convened by the two parties were not implemented, the issue was resolved in January 1993 when the U.S. owner sold his shares to a group of Ecuadorian investors. However, the new owners have been unable to negotiate a new contract with the government or lift the intervention. The new U.S.-Ecuadorian bilateral investment treaty provides for international arbitration of future disputes at the investor's option. Ecuador is a member of the International Center for the Settlement of Investment Disputes (ICSID). - Performance Requirements and Incentives There are no performance requirements associated with foreign investment in Ecuador. Nor are there any requirements that investors localize equity ownership by transferring shares to Ecuadorians over time. Under the 1993 investment regulations, any previous commitments under prior Andean Pact decision to localize ownership are no longer binding. - Right to Private Ownership and Establishment All foreign and domestic private entities can own business enterprises and engage in almost all forms of business activity. Private entities can compete freely with the public sector in most areas. While the constitution still provides for a monopoly for the public sector in the areas of telecommunications, electricity, and other "strategic" sectors, it also provides that such rights may be derogated to the private sector by subsequent legislation or executive decree. Foreign and private firms enjoy equal access in bidding for purchase of state-owned firms or long-term concession contracts. - Protection of Property Rights As a member of the Andean Pact, Ecuador's intellectual property rights (IPR) regime is dictated by Decisions 344, 345, and 351 under the Cartagena Accord of the Andean Pact. The decisions were implemented in Ecuador in December 1993 and provide improved minimum protection for patents, trademarks, and copyrights, although not to the standard of the intellectual property provisions of the Uruguay Round of the General Agreement on Tariffs and Trade. In addition, the Ecuadorian government signed a bilateral IPR agreement with the United States in October 1993 and is seeking Ecuadorian congressional ratification. Additional legislation may be necessary to harmonize Ecuador's IPR regime with the provisions of the bilateral agreement. The agreement is based on the IPR provisions of the North American Free Trade Agreement. Ecuador has observer status in the World Intellectual Property Organization. Decision 344 extends patent protection for 20 years from date of filing. Patenting of pharmaceutical products is permitted except for those products on the World Health Organization's list of essential drugs. Compulsory licensing and working requirements for patents have been made more limited. In infringement cases, the burden of proof lies with the alleged infringer. In contrast to Decision 344 itself, Ecuador's implementing regulations provides pipeline protection for products under development. Decision 344 provides protection for industrial designs, except for those related to clothing, for eight year terms. It also extends protection to industrial secrets and denomination of origin. Semiconductor chip layouts are not specifically protected, but it may be possible to register layouts under the Copyright Law or the industrial designs provision of Decision 344. Decision 345 provides protection for development of new plant varieties and biotechnology products. Trademark registration is permitted for renewable 10 year periods. Registration may be cancelled if the mark is not used in the Andean region for a period of three years. Decision 344 strengthens protection for well-known trademarks. In the past such marks have on occasion have been registered by individuals other than their legitimate owners. Trademarks can be subject to compulsory licensing and a trademark registration cannot be voluntarily surrendered without consent of licensees. Decision 351 supplements the 1976 Copyright Law providing protection for printed and recorded works for the life of the author plus 50 years. Computer programs are protected, albeit as a type of work distinct from literary works. Ecuador's Copyright Law has been changed to cover software and satellite signals. Efforts to improve the efficiency of the National Directorate of Industrial Property has led to a reduction in the backlog for registration of patents and trademarks. In spite of a 1992 law increasing penalties for copyright infringement, pirating of recorded material and software programs is common. - Regulatory System: Laws and Procedures The regulatory system in Ecuador economy has not been specifically geared toward fostering competition. There is a fair degree of industrial concentration and no anti-trust laws. The Superintendent of Banks regulates financial and insurance institutions, while the Superintendent of Companies regulates all other firms and, via the National Securities Council, the stock markets. - Efficient Capital Markets and Portfolio Investments Until recently, Ecuadorian capital markets were relatively underdeveloped. Activity on the Guayaquil and Quito stock exchanges was light and largely limited to trading in short term commercial paper, bank obligations, and government debt. Most large industrial groups remain privately held, and are financed largely through debt. Most stock transactions are done in the over-the-counter market. The Capital Markets Law enacted in May 1993 set up a modern regulatory structure, open up trading on the stock market to additional firms, including banks, and encourages the development of mutual funds. The new law, sales of government-owned shares in a few private companies, and increasing interest in Ecuador on the part of emerging market investment funds have stimulated the development of Ecuador's equity markets. Trading volume increased by two thirds in dollar terms during 1993 to reach USD 255 million, out of a market capitalization of some USD 600 million. Most of the stock trades, however, have involved shares of just five companies, leading to substantial run-ups in share prices as demand outpaced supply. More sales of government holdings, public offerings by major Ecuadorian firms, and privatization of the Social Security Institute pension funds are needed to deepen the market. Bank credit is generally allocated on market terms, though there is some concentration of domestic credit toward the major economic groups. Foreign investors are able to borrow competitively on the local market, in either local currency or dollars. The private sector has access primarily to short-term bank credit. Recent financial legislation provides for the use of "units of constant value" (UVC) as a means of facilitating medium-term credit in an inflationary economy. Since 1990, the government has phased out virtually all subsidized credits, which previously had been a key element of the country's development strategy. International auditors audit the books of most major companies in Ecuador, including large state-owned entities, under standards established by the Superintendency of Companies. - Political Violence Ecuador is a functioning democracy that is almost entirely free of the type of political violence that afflicts many of its neighbors. Students, labor unions, and indigenous groups regularly stage protests against government policies that can lead to confrontations with security forces. The only active guerrilla organization, "Red Sun," surrendered to authorities in June 1994. Kidnappings by criminals is becoming more of a problem. Land disputes can sometimes lead to violence. - Bilateral Investment Agreements Ecuador has bilateral investment protection agreements in place with Germany and Switzerland. A bilateral investment treaty signed with the United States in August 1993 guarantees national treatment, unrestricted remittances and transfers, prompt, adequate and effective compensation for expropriations, and international arbitration of disputes. The Ecuadorian congress is expected to ratify the treaty in 1994. Since last year, similar agreements have been signed with the United Kingdom, China, Argentina, Chile, Paraguay, and El Salvador. The Ministry of Foreign Affairs has also finished negotiations for investment agreements with Spain and France. Negotiations are underway or have been proposed with Japan, South Korea, Taiwan, Malaysia, Colombia, Peru, Bolivia, Panama, Costa Rica, Netherlands, Norway, Poland, Romania, Russia, the Czech Republic, and Canada. - OPIC and Other Investment Insurance Programs Ecuador has had an updated investment guarantee agreement with the Overseas Private Investment Corporation (OPIC) since 1986. Ecuador has signed and ratified the Multilateral Investment Guarantee Agreement (MIGA). - Labor Skilled and semi-skilled labor is generally available in Ecuador, and there is a surplus of professionals in such fields as law, medicine, and architecture. Some investors have had difficulties attracting trained financial professionals and engineers, who tend to require additional training to reach international standards. There have been relatively few high technology investments in Ecuador, though some foreign firms are conducting agricultural research here. There is practically no post-graduate education in Ecuador, and trained scientists and researchers are nearly all foreign-trained. Labor-management relations are generally adequate in most private sector companies. Local law allows for unionization of any company with more than 30 employees, and many private firms are unionized. Labor laws are enforced by the Ministry of Labor. Cumbersome labor regulations and expensive procedures for worker dismissals tend to inhibit investment. The GOE adheres to the ILO convention protecting worker rights. - Foreign Trade Zones and Free Ports Ecuador passed a foreign trade zone law in 1991, which exempts foreign investments in such zones from any current or future restrictions on capital repatriations. To date, only one foreign trade zone has been legally constituted, in Esmeraldas, but this has not yet begun to function. A maquila (in-bond processing) law has been in effect since 1990, but only a few firms in the textile and fish processing sectors make use of it. - Capital Outflow Policy Ecuadorians are free to export capital through the free market, and there are substantial Ecuadorian financial holdings in the United States and in other offshore banking centers. A number of Ecuadorian banks also have modest investments in banks in Miami. There are no incentives for outward investment, and no export credit arrangements. - Foreign Direct Investment Statistics Foreign direct investment (DFI) flows into Ecuador have been increasing in recent years, but remain extremely modest, with 1993 inflows of USD 115 million representing less than 1 percent of GDP. Western Europe accounted for 42 percent of recorded DFI in 1993. Investment coming from various "off-shore" locations, such as Panama, Bahamas, Liechtenstein, and Bermuda, accounted for 39 percent of DFI in 1993. The U.S. accounted for 11 percent of DFI, while Latin America accounted for 6 percent. Data covering the first four months of 1994 indicate that Ecuador could experience an increase in DFI flow on the order of 50 percent this year to reach nearly USD 180 million. So far this year, most DFI has come from "off-shore" sources, with U.S. investors are eclipsing Western Europeans to contribute 28 percent of DFI inflows. Table: Annual Direct Foreign Investment by Country of Origin ----------------------------------------------------------------- Year Amount Percentage Percentage (Millions of USD) Increase of GDP ------------------------------------------------------------------ 1989 80 0.0 0.9 1990 82 2.5 0.8 1991 85 3.6 0.8 1992 95 11.7 0.8 USA 9.1 - - Panama 7.7 - - Bahamas 7.2 - - Venezuela 3.4 - - Switzerland 3.2 - - Britain 2.6 - - 1993 115 21.1 0.8 Panama 23.2 201.6 - Switzerland 19.7 516.8 - USA 10.3 23.3 - Germany 4.6 205.2 - Bahamas 4.5 38.0 - Netherlands 4.3 117.1 - ------------------------------------------------------------------ Sources: Annual figures are from the Central Bank Monthly Statistical Information. Country figures are from based on registration information complied by the Central Bank. These figures do not capture the substantial volume of effective foreign direct investment in the petroleum sector, which is undertaken through risk-service contracts reimbursed through the proceeds of future oil liftings. There are no statistics currently available on foreign direct investment flows by industry or stocks by either industry or country of origin. - Major Foreign Investors The largest foreign investors in Ecuador are petroleum companies engaged in exploration and production in the Amazon basin, including Maxus Energy Consortium, Occidental Energy Corporation, ARCO, and Oryx Energy from the U.S. and Elf Aquitaine from France. There are also several U.S. oil services firms active in Ecuador. AGIP (Italy) markets liquified petroleum gas (LPG). Newmont Gold Corp. (U.S.), Gold Fields (South Africa), and RTZ (U.K.) have investments in the mining sector. Morton (U.S.) has been producing salt with a local partner. American firms active in the manufacturing sector include General Motors, which holds a minority interest in two automobile assembly plants, Owens-Illinois (glass containers), Phelps Dodge (copper and aluminum conductors), Philip Morris (cigarettes), Borden (chemicals), Texaco (lubricants and steel containers), Eveready Battery (batteries), and Fuller (paints). General Tire (U.S./Germany) manufactures tires, Holderbank (Switzerland) produces cement, Akzo (Netherlands) makes fibers and textiles, and Eternit (Colombia) fabricates construction materials. There are several American companies manufacturing pharmaceuticals in Ecuador, including Schering Plough, Bristol Myers Squibb, Merck, Upjohn, American Cyanamid, McKesson, Whitehall, and Sterling Wynthrop. U.S. firms Colgate Palmolive, Dial and Johnsonwax produce manufacture toiletries and cleaning products. Grupo Santodomingo (Colombia) owns the major breweries. Nestle (Switzerland) and Nabisco (U.S.) are leading food product makers, while a number of other foreign firms have invested in processing facilities for non-traditional vegetables and fruits. Continental Grain (U.S.) mills flour and, along with several other U.S. firms, is a major investor in shrimp farming. Standard Fruit/Dole (U.S.) is involved in banana marketing. Citibank (U.S.), Lloyd's Bank (U.K.), and Algemene Bank (Netherlands) have commercial banking operations in Ecuador.