Ethiopia: A Way Out of Debt Distress

The most talked economic performance of Ethiopia is evidently happening with considerably increasing domestic and external vulnerabilities. The economic grew by 8.7pc in 2014/15, supported by the booming manufacturing and construction sectors. However, inflation has been on the rise to disgracefully and almost literally offset what has been built.

External vulnerabilities have also increased as exports of goods and services slowed significantly, while imports continued growing fast. A sharp widening of the current account deficit (to an estimated 12.8pc of GDP) was largely countered by robust capital inflows, with a 50pc increase in foreign direct investment (FDI) and a much higher public borrowing from abroad.
At the same time, public enterprises continued to borrow heavily to finance their accelerated investment plans. In 2014/15, their financing needs increased to 7.4pc of GDP, while public and publicly-guaranteed debt reached an estimated 50pc.

Ethiopia’s foreign debt is high and it is rising, with China becoming Ethiopia’s third biggest lender (11pc of new loans) behind the World Bank (34.3pc) and IMF (11.5pc).

The economy is at the mercy of these debts. Moreover, it seems certain that debt will rise further in the next couple of years. This has again become an issue for financial markets, ratings agencies and policymakers alike. The consequences for the economy are severe, sharply lowering the value of the Ethiopian Birr.

The rise of the debt stock is going unnoticed since the economy is growing, but the recent drought crisis has become a huge problem. Increasing debt constraints access to credit and foreign exchange.

The overvalued exchange rate, as well as other competitive challenges has moderated public investment, leaving only a gradual increase in private investment. The present value of assets, calculated on discounted value of their real outflows, are much lower than our total debt obligations.
Monetary policy, anchored on base money growth, is geared toward maintaining inflation in single digits. The public debt-to-GDP ratio is expected to increase, reflecting large financing needs associated with implementation of the second Growth & Transformation Plan (GTP II). Balancing the macroeconomy needs policies to strengthen buffers and foster private-sector participation in the economy.

The unstable nature of our economy impedes the debt repayment process, challenging forecasts of what is to come. Structurally, the economy does not have muscles that could serve as smart fixes in the time of crisis. There is hope that potential shocks may not actually occur but with apparently no adequate mitigating strategies economically.

Low vibrancy of the private sector is another discouraging factor for the economy’s capability in increasing debt-to-GDP ratio. In response, the government remains intact and influential. It continues to push for mega projects, financed by local and external financing.

Fiscal policy has been prudent and appropriately pro-poor. However, with tax revenue below potential, there is a need for broadening the tax base with a great precaution not to discourage either foreign or domestic investing. Equally important is improving revenue administration to mobilize more resources for needed development spending, since servicing a debt may demand an increase in tax to raise resources.

Indeed, the expectation of higher tax may discourage investment and this in turn could lead to debt overhang. There are numerous concerns over the acceleration of public sector borrowing with attendant risks of external debt distress and private sector crowding-out.

At the heart of this lies seemingly careless selection and implementation of public projects with injudicious use of non-concessional external financing. Opacity in the state-owned enterprises, with a marginalized private sector, also plays its part in the puzzle.

More broadly, the policy framework of the National Bank of Ethiopia (NBE), which has a tight monetary stance and weak liquidity management, is not modern.

Inability to phase out the central bank’s direct advances to the government, while inflation is on the up, is a paradox. This is not to mention the overvalued exchange rate of Birr. There seems to be almost no flexibility in the monetary space.

For now, national debt and deficit worries seem to have taken a back seat. Yet, it remains a potential problem for Ethiopia. This is because it leaves Ethiopia vulnerable to the whims of foreign investors – those funding the debt. If, for whatever reason, they decide to stop lending to Australia – or if the interest rate they demand starts to rise – the Ethiopia economy is in trouble.

Further steps to secure positive real interest rates and greater financial deepening remain key to bolstering domestic savings and investment.
To increase credit to the private sector, phasing out the requirement for banks to channel resources to the national development bank, which may distort financial intermediation, is vital. Moreover, the importance of maintaining an adequate regulatory and supervisory framework to support financial development must be pointed out.

More decisive action must be taken to strengthen the business climate and enhance external competitiveness, softening export activity. Greater exchange rate flexibility, less burdensome regulation, and easier private sector access to credit and foreign exchange would be steps in the right direction. Opening some strategic sectors to foreign investment could also improve the provision of critical services.
By Hibamo Tagesse
Hibamo Tagesse Is an Economist.