CONTENTS -- Abstract -- Acknowledgments -- Abbreviations and Acronyms -- Executive Summary -- Fiscal Policy Faces Historical and Structural Constraints -- Fiscal Trends and Challenges -- Pro-Poor Expenditure and the Room for Additional Fiscal Space -- Public Expenditure Management (PEM) and Other Institutional Issues -- Conclusions and Policy Recommendations -- A Selection of Key Policy Recommendations -- 1. Fiscal Policy in a Dollarized Economy -- The Ecuadorian Economy: Some Historical Background -- The Role of Fiscal Policy in a Dollarized Framework -- Structural Constraints on Fiscal Policy -- 2. Fiscal Trends and Challenges -- The Volatility of Fiscal Variables -- Fiscal Performance Before and After Dollarization -- The Challenge of Revenue Management -- Fragmented Tax Structure -- Tax Exemptions and the Erosion of the Tax Base -- Earmarking: The Undermining of Budget Flexibility -- Expenditure Trends -- The Fiscal Transparency, Stabilization and Responsbility Law -- Stabilization Funds -- Fine-Tuning Fiscal Rules -- Issues in Debt Sustainability -- Exercise 1. Fiscal Sustainability under a Sudden Drop in the Price of Oil, Surge in Interest Rate, or Capital Outflows -- Exercise 2. Fiscal Sustainability under Tax Revenue Volatility -- Policy Recommendations -- 3. Pro-Poor Expenditures and the Fiscal Space -- Is Social Expenditure Enough for Poverty Reduction? -- Is Social and Basic Infrastructure Expenditure Pro-Poor? -- Main Social Programs -- Subsidies in Basic Infrastructure Services -- How Much Fiscal Space Is Available for a Poverty Reduction Strategy -- Reversing Current Expenditure -- Making an Optimal Selection of Public Investment -- Assessing Defense Spending -- How Much Off-Budget Fiscal Space Can Be Found for a Poverty Reduction Strategy -- Freezing or Reducing Budget Earmarking -- Reducing Tax Expenditure.

Making Transparent and Intergrating Off-Budget Public Investment -- Towards a Results-Oriented Budget:Attaining the Millennium Development Goals -- Policy Recommendations -- To Shift Public Expenditures Toward a Pro-Poor Focus -- To Re-Target Public Subsidies -- Trade-Offs Between In-and Off-Budget Fiscal Space -- To Reach Selected MDGs -- 4. Performance of Public Expenditure Management -- The PEM Process and its Recent Performance -- Budget Management Review in the Central Government -- Budget Formulation -- Execution -- Budget Management Review in Social Programs and Subnational Governments -- Social Programs -- Provincial and Municipal Governments -- Budget Transparency,Accountability, and Participation -- Are There Sufficient Conditions for a Multiyear Budgeting Framework in Ecuador? -- Policy Recommendations -- APPENDIX A. An Estimation of the Potential Output And the Structural Fiscal Balance in Ecuador -- APPENDIX B. Summary of the Budget Process -- APPENDIX C. Major Budgetary Issues in Priority Social Programs -- APPENDIX D. Budgetary Framework of Decentralization in Ecuador -- APPENDIX E. Budgetary Framework of Decentralization in Ecuador -- STATISTICAL APPENDIX -- BIBLIOGRAPHY -- LIST OF TABLES -- ES.1 Potential Sources of Fiscal Space and Estimated Annual Impact -- 2.1 Volatility of NFPS Variables,1993-2003 -- 2.2 Ecuador: Actual and Structural Fiscal Balance, Fiscal Stance and Fiscal Impulse -- 2.3 Total Revenue of the Non-Financial Public Sector and Central Government -- 2.4 The Structure of the Tax System -- 2.5 Selected Tax Administration Indicators, 2001-03 -- 2.6 "Optimal "Fund vs FEIREP Flows for Debt Reduction -- 2.7 Evaluation of Compliance with the Fiscal Rules -- 3.1 Ecuador:Social Expenditure of Central Government as a Percentage of GDP -- 3.2 Pro-Poor and Non Pro-Poor Social Expenditures.

3.3 Social Expenditure and Energy Subsidies, by Income Quintile -- 3.4 Basic Services Subsidies by Expenditure Quintile -- 3.5 Rigidity of the Central Government Budget, 2001-04 -- 3.6 Ecuador: Personnel Involved in Defense and Security -- 3.7 Estimated Tax Expenditures of the Internal VAT Exemptions -- 3.8 Progress by Ecuador in Meeting the Millennium Development Goals -- 3.9 Estimated Fiscal Cost of Attaining Key MDGs and Social Targets -- 3.10 Potential Sources of Fiscal Space -- 4.1 Basic Elements of Public Expenditure Management: The "Three-level Analysis " -- 4.2 Allocation of Public Spending by Tiers -- 4.3 Review of Ecuador's Public Expenditure Management and Benchmarks -- 4.4 Ranking of Ecuador's PEM in Relation to Peru, Bolivia, and HIPC Indicators -- 4.5 Sources of Government Financing -- 4.6 Budgetary Assumptions and Actuals -- 4.7 Level of Budget Execution of Sector Expenditures -- 4.8 Changes in the Budget Share between Executed and Approved -- 4.9 Forms of Local Participation within Selected Priority Social Programs -- 4.10 Budget of Priority Social Programs Grouped by Social Sector -- 4.11 Budget Approved and Executed for Priority Social Programs -- 4.12 Budget Execution and Tracking Survey of Transactional Delays within PSPs -- 4.13 Positive Qualifications per Country -- LIST OF FIGURES -- ES.1 Oil Prices, Growth, and the Fiscal Deficit -- ES.2 Debt Sustainability under the Fiscal Rule -- ES.3 Incidence of Social Expenditure and Energy Subsidies, 1999 -- 1.1 Total Public Sector Net Work -- 2.1 Non-Financial Public Sector Balances -- 2.2 Tax and Non-Tax Revenue of the Central Government and Important Tax Reform Efforts 1964-2004 -- 2.3 Total and Primary Expenditures -- 2.4 Trends in NFPS and Central Government Expenditures -- 2.5 Public Expenditure by Selected Functions -- 2.6 Composition of Wages by Selected Sectors.

2.7 Institutional Composition of Public Fixed Investment -- 2.8 "Optimal" and Actual Stabilization Accumulation Scenarios -- 2.9 Base Case for Debt Sustainability -- 3.1 Incidence of Social Expenditure and Energy Subsidies -- 3.2 Telephone Penetration by Household Income Quintile -- 3.3 Rigid Compared to Flexible Public Expenditure -- 3.4 Military Expenditure,1998-2001 -- 3.5 Decomposition of Budget and Off-Budget Financing Sources -- 3.6 Chile: Fondo Concursable -- 4.1 Changes in Shareof NFPS Expenditures, by Government Tier -- 4.2 Emergency Decrees -- 4.3 Stock of Arrears -- 4.4 Budget Execution of Social Programs -- 4.5 Seasonal Patterns in Budget for Social Programs -- 4.6 Planned Compared to Executed Transfers of the 15-Percent Law, 1997-2003 -- 4.7 Transfers and Payments of the 15-Percent Law to Municipalities -- 4.8 Transfers of the 15-Percent Law and the New Subnational Budget Cycle -- 4.9 LAC Index of Budgetary Transparency -- 4.10 Revenue Base for the 15-Percent Law with/without Oil Revenue -- LIST OF BOXES -- 1.1 The Costs and Benefits of Dollarization -- 1.2 Ecuador's Political Economy -- 2.1 The Civil Service and the Wage Unification Law: A Step in the Right Direction -- 2.2 Ecuador's Oil Funds -- 2.3 The Base Case Scenario -- 3.1 Teacher Absenteeism in Primary Schools -- 3.2 Household Expenditures on Water: The Case of Machala, El Oro -- 3.3 Main Conclusions of the World Bank Ecuador Poverty Assessment -- 3.4 The Chilean Competitive (Concursable ) Fund for Public Programs -- 4.1 The Six Stages of a Comprehensive Multiyear Budgeting Framework -- 4.2 Main Recommendations of the IMF-ROSC -- 4.3 Ecuador-Institutionalizing a Virtual Poverty Fund: A Look at Best-Practice in Uganda -- LIST OF ANNEX TABLES -- A.1 Structural Fiscal Balance -- C.1 Budget Execution at BDH, by Financing Source -- C.2 Budget Execution at PAI, by Financing Source.

C.3 Budget Execution at LMG, by Financing Source -- C.4 Budget Execution at PRADEC, by Financing Source -- C.5 Budget Execution at PAE, by Financing Source -- D.1 Current and Capital Spending of Municipalities and Provincial Councils -- D.2 Priorities of Subnational Investment Spending -- D.3 Capital Spending of Municipalities and Provincial Councils in the Health and Education Sectors -- D.4 Administration of Schools, Teachers, and Students in The Education Sector, School Year 2000-01 -- D.5 Public Spending in Health Sector -- E.1 Subsidy Distribution by Consumption Deciles -- E.2 Distribution of the Cooking-Gas Subsidy by Ethnic Group. -- E.3 Effect of Various Reform Scenarios for the Cooking-Gas Subsidy -- LIST OF ANNEX FIGURES -- A.1 Actual and Potential GDP -- A.2 Primary Balance -- B.1 Flow of Budgetary Funds -- C.1 Organization of the BDH Operating in 14 Provinces -- C.2 Organization of PAI Operating Nationwide -- C.3 Organization of LMG Operating in 40 Municipios -- C.4 Organization of PRADEC Operating in 443 Juntas Parroquiales -- C.5 Organization of PAE Operating in the Coast and Sierra -- D.1 Intergovernmental Transfers, 1996-2003 -- D.2 Sources of Revenue for Transfers to Subnational Governments -- D.3 Own Revenue and Expenditures per Level of Government and Veritcal Fiscal Imbalances,1997 and 2002 -- E.1 Distribution of the Gas Subsidy Retargeted with SelBen.