Radar | Aug 21,2021
Dec 25 , 2021
By Christian Tesfaye
In the field of development, there are certain pillars economists like to focus on as a foundation to building wealth. Many of them are obvious. There is infrastructure to make the transport of goods, people and information smooth; a modicum of political stability to keep supply chains open and make it possible for long-term planning; robust regulatory capacity, to create a flexible doing business environment; education and health, to build up a highly skilled labour force; and energy production, to power economic activity. My favourite is the financialisation of an economy.
Countries generally witness economic development that is parallel to the health and stability of their financial sectors. For the world's advanced industrial economies, financialisation, especially after the Reagan-Thatcher era, has a negative connotation as it led to the overwhelming influence of institutional players such as banks and hedge funds on healthy economies. This is not far from the truth. It was evident by the late 2010s that unregulated financial markets could morph into purely profit-making institutions uninterested in creating - and sometimes even betting against - economic value.
But at the heart of it, the finance sector is perhaps the most effective way of building wealth in any economy. The same is true for Ethiopia, one of the least financialised countries in the world. Around a quarter of a century ago, we did not even have private banks – ironically, we did half a century ago. There are now 19 banks, most of them private and gradually becoming competitive against the state goliath, Commercial Bank of Ethiopia (CBE).
Around a quarter of the adult population is considered financialised, which is very low. Worse yet, it is probably even lower since banks are concentrated in urban areas and have a highly overlapping range of customers (I have five accounts at different banks). Although the government is trying to address this issue, customers complete information is not gathered, and this probably will not matter since the national ID programme is in its infancy.
The state of the insurance industry is even worse. By that, I mean far less advanced by even Ethiopia’s banking industry standards. The capital of the insurance industry in an economy of 100 billion dollars in annual gross domestic product (GDP) was about a quarter of a billion dollars by the last fiscal year.
We see two things here. One is that Ethiopia’s financial sector is unprecedentedly under-developed. The other is that it offers a massive potential to capitalise on the gaps. It is one of the indicators of how far the economy can go if there are not that many distractions.
The main contribution of finance to the economy is pooling together wealth in the form of short-term loans to redistribute it for long-term loans. The latter is the basis for development since investments (into a business by entrepreneurs, into infrastructure by governments or into consumption by parents to pay for their kids' education) will take time to pay off. There needs to be something sufficiently capitalised to lend to such risky endeavours at relatively low interest.
It does not always have to be banks or microfinance institutions. Something that has never been practised in Ethiopia – except a brief experiment at the end of Emperor Haile Selassie’s reign - is capital markets.
One is under establishment at the moment. It will not likely be that complex – that is, no such things as derivatives – since financial literacy is not that developed in Ethiopia. But it will be a game-changer as an investment option for people with disposable incomes, especially that section of the population currently speculating and inflating Addis Abeba’s housing market, and a source of funding (in the form of bonds or shares) for businesses.
PUBLISHED ON Dec 25,2021 [ VOL 22 , NO 1130]
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