Is Ethiopia Insolvent? Or Just Illiquid?

Mar 11 , 2023.

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Ethiopia is rapidly emerging as one of China's top African debtors, second only to Angola, which owes the second largest economy in the world 42.6 billion dollars. Although Ethiopia owes only a little over one-third of Angola's debt to China, it is significant considering the size of its economy.

Zambia and Kenya are other African countries with large debts to China, and Zambia is one of the three African countries that have asked creditors for debt restructuring. Its officials have signed a memorandum of understanding after nearly a year's wait, while Chad and Ethiopia are on the dock to reach this stage.

Despite the widespread perception that Ethiopia is on the brink of insolvency and at risk of defaulting on its loans, the authorities in charge of its debt affairs, Messrs. Mamo Mehiretu and Eyob Tekalegn (PhD), governor of the central bank and state minister for Finance, respectively, may believe that the country's economy is simply facing a short-term liquidity crunch.

Indeed, Ethiopia's external debt has remained relatively unalarming over the years, accounting for only one-third of its GDP of over 90 billion dollars. Multilateral lenders are the largest creditors, accounting for 42.5pc of total external debt. Bilateral creditors such as China account for 39.1pc, while commercial creditors take the balance.

China co-chairs with France the creditors' committee set up to examine Ethiopia's application under the G20 framework agreement, which would help it avoid defaults. However, the multilateral creditors, such as the Africa Development Bank (AfDB) and the World Bank, want a commitment guarantee from China before agreeing to debt relief or restructuring. It is an indispensable prerequisite for the International Monetary Fund (IMF) to resume its billions of dollars program to bail out Ethiopia`s debt-ridden economy.

Chinese authorities appear reluctant to grant this commitment, perhaps fearing the full transparency expected in the negotiations and unwilling to share Ethiopia's considerable debt relief burden. They want the multilateral and private creditors to foot the bill from what comes of the talks under the framework deal. A series of visits by Messrs. Mamo and Eyob to Paris and Beijing has brought no meaningful results.

However, international credit rating agencies, from Standard & Poor (S&P) to Moody's and Fitch, have downgraded Ethiopia to "C". They cite several factors for their low rating, including heightened political instability, low foreign exchange reserves, and a growing annual debt servicing exceeding two billion dollars this year.

The burden of servicing the debt will not get any lighter in the coming period. The maturity period for Ethiopia's one-billion-dollar euro bond will arrive in December 2024, representing one-tenth of the total bonds African countries issued, maturing next year. Ethiopian authorities will be compelled to ask for reprofiling of this debt or pay it in full before its due date. Either way, it will be a "damn if you do and damn if you don`t" situation for the authorities.

To make matters worse, the administration of Prime Minister Abiy Ahmed domestically owes significant amounts of money, fueling inflation through massive borrowing from the central bank.

Government bonds and treasury notes are the two instruments the administration uses to pay for its domestic debt. The federal government-issued bonds accounted for 15.38pc of the total domestic debt outstanding last year, while treasury notes accounted for 9.28pc (147.6 billion Br). Treasury bills also contributed to the domestic debt structure with a share of 19.8pc.

This makes domestic debt's share of the outstanding public debt significant, with 58.25pc of the total debt as of September 2022, while 41.7pc is owed by the state-owned enterprises (SOEs). The National Bank of Ethiopia (NBE) holds the largest share of domestic debt among the institutional holders, with 21.1pc of the nearly 1.6 trillion Br in total domestic debt. This amount equals (at the current exchange rate) the 27 billion dollars in total external debt stock Ethiopia holds.

Macroeconomic policymakers have chosen to rely heavily on domestic borrowing to finance the federal government's expenditures.

Ethiopia's economy has faced a series of challenges since 2018, including high inflation, growing budget deficits paid by domestic borrowing, and volatile growth in GDP. These trends should concern policymakers, notably as domestic debt outstanding has steadily risen over the past few years. It increased from 773.5 billion Br in 2017/18 to 1.59 trillion Br last year, representing a 106pc increase in just four years.

This growth was primarily driven by the rise in government bonds, which grew from 36.6 billion Br in 2017/18 to 244.7 billion Br last year. The central bank and the state-owned Commercial Bank of Ethiopia (CBE) were the primary holders of government bonds, with non-interest-bearing bonds being the most common type. The share of state-owned enterprises’ debt also increased from 411.7 billion Br in 2017/18 to 664.3 billion Br as of September last year, representing a 61pc rise over five years.

The federal government's increasing reliance on domestic borrowing has led to concerns about the sustainability of the country's debt. A high level of domestic debt could limit Ethiopia's ability to invest in infrastructure and social services like health and education, leading to slower growth. While the budget allocation towards education and health has increased over the years, the share of the budget for these social services remains relatively low compared to defence.

However, Ethiopia's economic challenges are not solely the result of domestic debt. The COVID-19 pandemic, civil war, and political instability have also significantly affected the country's slow growth rate in recent years. Inflation has been persistent in an economic environment of stagnant or slow growth, increasing from 13.8pc in 2018 to 33.6pc in January this year. The high inflation rate has been driven by factors such as the loss of the value of the Birr against major currencies, rising oil prices, and increased government spending, particularly on defence. It has significantly impacted consumers' purchasing power and made it challenging for businesses to plan.

External and domestic public debts have been on the rise in tandem, although external borrowing has seen a higher rate of increase than domestic public debt. While external borrowing can provide access to much-needed capital, it also exposes the country to risks such as currency fluctuations, changes in interest rates, and repayment obligations.

Policymakers must carefully manage the federal government's debt portfolio to ensure sustainable economic growth. One starting point could be re-examining the budget allocation for defence, which has remained consistently high over the years, indicating that the government prioritizes national security. However, the overriding objective should promote macroeconomic stability, a crucial prerequisite for sustained economic growth.

Central Bank Governor Mamo could prioritize a policy objective of pursuing price stability and lower inflation targets through sound monetary policies. Meanwhile, Ahmed Shedie, the minister of Finance, can ensure fiscal discipline, a vital element in restraining off-budget expenditures that have become rampant. Ultimately, policymakers must balance the need for investment in infrastructure and social services with the need for fiscal responsibility to ensure Ethiopia's long-term economic health.

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PUBLISHED ON Mar 11,2023 [ VOL 23 , NO 1193]

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