Responding to Ethiopia’s Macroeconomic Achilles' Heel

Feb 19 , 2022.

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It must have been exasperating for the policy kingpins in Prime Minister Abiy Ahmed (PhD) Administration to see the International Monetary Fund (IMF) skip Ethiopia - perhaps for the first time - from its annual economic outlook for global growth. This puts Ethiopia in the league of a few countries such as Lebanon, Yemen and Afghanistan deemed too volatile, either due to macroeconomic headwinds or political turmoil, for forecasts to be made.

To their consolations, there has not been such bad news since. According to the World Bank, Ethiopia will likely grow by around 6.5pc next year. Fitch Ratings, which affirmed long-term sustainability at risk of default, shares a similar outlook, with a projection for growth to recover to 5.2pc in this fiscal year and six percent in the next. The exception is Cepheus Capital, a domestic equity firm known for its Panglossian view of Ethiopia’s economy. It sees growth almost flatlining this year.

On average, however, these outlooks seem exceptionally optimistic, considering everything the country has been through in the past two years, from COVID-19 to inflation and a devastating civil war in the north and a raging insurgency in the south-west. Add to this a political firestorm brewing in the east in recent weeks. It could reflect growth momentum built over the past decade sprinkled with reform efforts in the digital and telecom sectors. Still, this does not mean that the worst is over for Ethiopia’s economy. The ills are not yet in the middle pages of the book.

Inflation is likely to haunt consumers and domestic creditors, seeing the purchasing power of the Birr decline. The erosion of the Birr against major currencies continues unabated. The cost of reconstructing war-damaged public infrastructure and rehabilitating a massive population dislocated due to wars and drought is staring the treasury right in the face. Most alarming, perhaps, should be a crisis on the external debt front.

Ethiopia’s public debt ratio to the GDP is around 60pc. This should not be considered too high; it had reached 139pc during the military-Marxist regime in the 1980s. Neighbouring countries have much higher ratios, such as Sudan, 180pc, and Kenya, around 63pc. In aggregate, though, Ethiopia’s is the second-highest indebted economy in Africa, next to Angola. The devil is in the detail. External debt is estimated to reach 33pc of GDP by the end of this fiscal year, which is the part of the debt that has to be paid back in foreign currencies. With the value of the Birr depreciating by the days and the likely move by western central banks to adjust interest rates, the cost of servicing the foreign debt will no doubt become a burden.

Sufficient inflow of foreign currency has never been the strength of the economy. Although that level of external debt should not be a concern for a country with around 100 billion dollars in GDP, it is not the case for Ethiopia. An external debt level that should be healthy has turned into a live grenade waiting to explode. Take, for instance, Egypt. It has over three times Ethiopia’s GDP but boasts around 13 times the foreign exchange reserves.

Nonetheless, Messieurs Ahmed Shedie and Eyob Tekalegn (PhD), minister and state minister for Finance, may not have to worry about for the remainder of this year. As Fitch suggests, the central bank does seem to have the resources to get past this fiscal year. External reserves are estimated to have increased to 3.5 billion dollars, probably due to IMF's allocations from the Special Drawing Rights (SDR), enough to service about 1.9 billion dollars in non-domestic servicing costs this year. But it will have come at high costs, leaving only enough forex reserves to pay for 1.3 months of imports, which is alarmingly low.

Ask any of the banks' chiefs in town; the frustration over their inability to fulfil commitments in letters of credit is evident in their faces. After all, they are compelled to surrender two-thirds of the forex they labour to generate to the central bank. The injustice in this knee-jerk policy Governor Yinager Dessie (PhD) imposed on the market is deeply felt by the banks, and their clients lined up to import merchandise desperately demanded in the local market.

Scraping by will not be enough. It will be a disaster if policymakers on the economic front decide to be shortsighted. The Administration could claw its way out of default this and the next fiscal years. But a subsequent couple of years will also be deciding factors predicting whether the country will manage to pay back its largest maturing commercial debt, the billion-dollar Eurobond. Default on this will mean staining the country's credit rating for decades to come. A country that defaults is not just one that could not pay back its debt. It is also one willing to default on its creditors, which sends a chilling message.

The impending external debt crisis needs to be the primary macroeconomic priority going forward as it determines how much resources the Administration can commit to paying for domestic needs. Encouraging efforts are being undertaken, such as the Liability & Asset Management Corporation, an ER for the sick debts accrued by state-owned enterprises (SOEs). It has already soaked up some of their obligations and paid off about 34 billion Br.

It is a creative way of de-risking state enterprises essential to their respective industries, but it only goes so far. Public enterprises bloated with debt, such as the former Metals & Engineering Corporation (MetEC), the Ethiopian Electric Utility (EEU) and the Ethiopian Sugar Corporation, mainly owe to the Commercial Bank of Ethiopia (CBE). The Corporation’s mandate is concerned with domestic debt, not with the bigger worries of external debt. The other state enterprises, such as Ethiopian Airlines, are not in that great a bind, given they generate sufficient foreign currency to service their respective debt. With the promising prospect of exporting electricity, the EEU can also turn the tide in generating forex to pay its way out of external debt.

Sovereign external debt, though, will remain concerning. The Administration needs to look elsewhere for meaningful ways of addressing the problem. Beefing up the foreign currency reserve is the most obvious way forward. It can start by ensuring that a state of war does not continue. This will make a world of difference.

Countries are coming out of the COVID-19 pandemic. Ethiopia needs to grab this opportunity by removing the other significant obstacle – a state of war – scaring away potential tourism revenues and foreign direct investments (FDI). The latter is critical, especially in the telecom sector. Liberalisation and privatisation plans have been stuck following Safaricom Ethiopia’s entry into the telecom market because the political situation became precarious. Ending militarised conflicts and accelerating telecom sector reforms will significantly improve the foreign reserve position.

Getting a deal under the G20 Common Framework may also help, but it should be approached carefully. The Framework seeks to restructure the country’s external debt, potentially including the amount owed to private creditors. This is alarming to credit rating agencies that see “comparable treatment for private-sector creditors consistent with a default event,” at least under Fitch's criteria. Ironically, a favourable outcome under the Common Framework treatment could be the very thing that throws the country’s credit rating over the edge.

Unless clarity is received during the Common Framework process that private creditors will not be affected, the debt treatment could be more trouble than it is worth. The Administration should only take this risk after exhausting domestic economic and political reforms it can take at home. In the absence of achieving political stability through negotiated settlements, all these will be vain.

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PUBLISHED ON Feb 19,2022 [ VOL 22 , NO 1138]

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