Ethiopia's domestic debt has surged past the 1.2 trillion Br mark, triggering a contentious debate in the federal legislative house. During his nine-month report to Parliament last week, Finance Minister Ahmed Shide faced intense scrutiny from the Standing Committee for Planning, Budget & Finance, which called for attentive management of the mounting debt. Recent data covering a period from 2019/20 to the end of 2022/23 revealed a cautious yet unsurprising uptick in both external and domestic borrowing.

However, the federal government has curtailed direct borrowing from the National Bank of Ethiopia (NBE), seeking alternative financing methods to cover its budget deficit during times of austerity measures and face loan payment defaults to external creditors.

Ethiopia's public sector debt (including its external obligation) crept up slightly in the six months to December 31, reaching 64.3 billion dollars, a moderate 1.63pc increase. The rise represents 39.4pc of the country's nominal Gross Domestic Product (GDP), an essential indicator of the fiscal pressures it faces as the administration of Prime Minister Abiy Ahmed (PhD) struggles to manage a growing debt load.

“The economy is wrestling with the challenges of managing borrowing while maintaining growth momentum,” said a macroeconomist, speaking anonymously.

External debt increased modestly by 1.02pc, while domestic debt rose more pronouncedly by 2.12pc. Despite the escalation, Ethiopia's debt metrics remain within sustainable boundaries as defined for low-income countries. External debt comprises 17.5pc of GDP, comfortably below the cautionary threshold of 40pc.

An internal document from the Ministry of Finance attributed the debt’s sustainability to the government's “careful debt management strategy,” which it argued is supported by consistent economic expansion. The annual growth rate in GDP was 6.2pc last year, a percentage point lower than government authorities claimed. However, the rate of the economy’s expansion has continuously declined since the 2010s when the GDP was growing by double digits, fueled by massive public infrastructure investments mainly financed by external loans from China and multilateral financial institutions, ballooning public debt.

“The government’s debt strategy aligns with broader economic reforms under the Homegrown Economic Reform Program, aiming to enhance macroeconomic stability and encourage private sector involvement,” says the internal document.

Much of the funds procured through public debt has been allocated to infrastructure, energy, and transport sectors.

The composition of the public sector debt includes commitments by the federal government and those guaranteed for state-owned enterprises (SOEs), as well as non-guaranteed debts of public enterprises such as Ethiopian Airlines. A substantial proportion of the public debt is external loans, with major creditors including the World Bank’s International Development Association (IDA).

In 2021, the federal government established the Ethiopian Investment Holding (EIH), a sovereign wealth fund incorporated to manage state assets and generate revenue independently of traditional fiscal mechanisms. The move, along with the establishment of a Capital Market by mid-2021, marked a shift towards diversifying funding sources and reducing reliance on external debt. The federal government has also leveraged innovative financial instruments like Treasury Bills, which have seen an increase in yield, reflecting a rising cost of government borrowing.

“While this strategy expands the domestic debt portfolio, it also attempted to fulfil the dual purpose of financing government projects and cultivating a local investor base,” said a macroeconomist.

The Ministry's report attributed this shift to the Development Bank of Ethiopia (NBE) converting much of its debts to Treasury bills and bonds. Despite making 65 billion Br in payments to service domestic debts, this represented only 40pc of the nine-month target. It has sold 88 billion Br in treasury bills and bonds to cover its 139 billion Br budget deficit.

The Finance Minister attributed the growing reliance on Treasury bills and bonds, which have become mandatory for most commercial banks, to being a preferred choice for financing public debt. Despite these measures, debt servicing costs have reached 40.72 billion Br, with 65pc of this paid, reflecting a rising debt stock to GDP ratio of 40.2pc.

"Our biggest risk is high debt servicing compared to our exports," Ahmed told Parliament, stating the disproportionate burden on the economy.

He hopes that potential debt restructuring under the G-20 common framework mechanism could reduce these high servicing costs and bring debt distress to moderate levels within six years. A critical component of this strategy includes economic reforms, such as a medium-term tax strategy developed with the help of international financial institutions. The debt restructuring deal hinges on adopting an economic reform package prescribed by the International Monetary Fund (IMF), which includes fiscal consolidation, recalibrated balance of payments, tax reform, and addressing disparities between official and parallel foreign exchange rates.

Ahmed praised the interim debt suspension agreement of 1.44 billion dollars from China and ongoing negotiations for nearly half a billion dollars more as noteworthy achievements in managing the external debt burden, which stands at 28 billion dollars.

"The interim relief was a major milestone for our forex management," he said.

However, the negotiated debt service suspensions under the G20 Debt Service Suspension Initiative (DSSI), which provided essential fiscal breathing room, ended last year. New rounds of negotiations with private, bilateral, and multilateral creditors are ongoing, the latest being held in Washington, D.C., in April with the IMF. Neither side has reported a deal, though.

According to Julie Kozack, the IMF's communications director, a final deal has yet to be reported despite signals of "progress" in negotiations.

The federal government's direct borrowing from the central bank has reduced by 90 billion Br from last year to 57 billion Br. The Finance Minister disclosed a shift towards sustainable debt management, pointing to a 200 million dollars reduction from the 8.6 billion dollars owed by state-owned enterprises to external creditors.

Nonetheless, such a shift in policy gear did little to comfort legislators such as Desalegn Wedajo, chairperson of the Standing Committee. He was concerned with the long-term feasibility of shifting to domestic borrowing as a sustainable strategy to address the budget deficit, hitting a record high of four percent of the GDP.

"This could entail risks soon," Desalegn warned.