When More of Everything Leaves Less in the Bank

Dec 14 , 2024.

Ethiopia’s monetary policy has shifted conspicuously in recent years. Gone is the era of demand-side tinkering; under Governor Mamo Mihretu, the central bank is now guided by supply-side doctrines and an obsession with price stability. Yet while inflation-fighting measures have loomed large, the deposit interest rate, traditionally an instrument to encourage saving and temper currency volatility, has remained remarkably static.

Despite persistent economic strains, the reluctance to raise it is a telltale sign of the uneasy choices facing policymakers seeking growth and stability in an economy struggling under heavy public debt.

At first glance, Ethiopia seems to be experiencing an economic upswing. In Addis Abeba, towering cranes loom over new construction sites, highways loop across once-vacant tracts of land, and a fresh canopy of greenery decorates main avenues, a.k.a. corridor developments. Visitors cannot help but notice the city’s tidiness and the proliferation of polished facades. To the casual observer, these signs mirror a society on the move, buoyant and hopeful.

Yet beneath the sheen of progress lies an unsettling truth. Once on the upward trend, the national savings rate has begun to slide. This should be a worrying development for an economy that has long enjoyed a reputation as one of Africa’s rising stars. The economy appears to consume more than it sets aside, sapping its ability to generate robust, domestically sourced capital.

The erosion of savings is painfully evident in the resource balance, which has remained stubbornly negative. In the 2019/20 fiscal year, it was at a troubling minus 2.5pc of GDP. By the following year, it had slipped further to a negative 3.4pc. Two years ago, it improved slightly, but only to a negative 2.6pc. This persistent deficit is more than a statistical quirk. It signals that an economy applauded for growth fails to create surplus capital at home.

Although the country’s total output has risen, it consistently imports more than it exports. Households and businesses, for their part, are spending more of their incomes rather than building financial buffers. Vigorous consumption is not unexpected in a country of over 100 million, with a median age of around 19. Youthful societies tend to spend freely investing in homes, education, and consumer goods. But when such spending outstrips sustainable financing, it whittles away the very savings needed to secure a brighter future. The result is that more debt and external funding should be tapped, leaving the economy vulnerable to foreign currency shortages, global interest-rate swings, and fickle investor sentiment.

The consequences of the thinning savings base are readily visible. Without adequate domestic funds, infrastructure projects and industrial ambitions lean heavily on external credit lines. In recent years, efforts to secure foreign financing have collided with rising global borrowing costs and diminished foreign currency inflows. The declines in khat export revenues and global commodity price volatility have added to the strain.

Without a stout savings cushion, the push to build factories, roads, and power grids risks becoming a difficult balancing act. Ethiopia’s dream of evolving from an agrarian backwater into a manufacturing powerhouse rests on steady capital formation. If that capital must be begged from abroad, the project is more vulnerable to external shocks, and the economy becomes more beholden to forces beyond its control.

The diminishing savings pool is also a sign that the ambitious targets laid out by policymakers may rest on shaky ground. Rapid consumption growth might indicate better living standards today, but it leaves the country less equipped to invest in tomorrow’s hospitals, universities, and industry. A persistent savings shortfall hamstrings the long-term development agenda. Over time, it can entrench a cycle of dependence on foreign borrowing and persistent trade deficits, leaving little room for the economy to weather sudden shifts in the global marketplace.

These patterns should set alarm bells ringing.

Policymakers have a familiar toolkit at their disposal. Around the world, central banks often respond to inflation and currency erosions by raising deposit interest rates. Higher returns on deposits entice savers to keep funds in domestic banks, rather than chasing foreign currencies or alternative assets. The result, in theory, is a tighter money supply, reduced consumer demand, and alleviated pressure on foreign reserves. Currency stability, in turn, can reinforce the credibility of policymakers and shore up the economy’s defences against price shocks.

For Ethiopia, which has maintained a deposit rate of around seven percent in the face of loan rates that average 26pc, raising deposit rates might seem a sensible step. Improving the attractiveness of deposits could strengthen financial stability, deepen the capital pool available to the banking sector, and channel more credit towards ventures that boost productivity. Higher rates might draw money into time deposits, currently a meagre eight percent share of total deposits.

At the close of the third quarter of the 2023/24 fiscal year, total deposit liabilities grew by 16.3pc year-on-year, reaching 2.4 trillion Br. Of these, demand deposits were 31.4pc, and savings deposits 60.6pc. That growth might reflect a measure of public confidence in the banking system, but the dearth of time deposits hints at deeper reluctance. As long as inflation gnaws away at real returns, the appeal of tying up money in long-term deposits remains limited.

Governor Mamo’s caution is not entirely misplaced. He may fear that raising deposit rates would push up borrowing costs, making loans pricier and scaring off the investments the economy sorely needs. More expensive credit could discourage the entrepreneurial undertakings essential to growth and the structural transformation policymakers crave. Rather than ushering in a new era of productivity, higher deposit rates might lure savers to passively park their funds, robbing the economy of investments in factories, farms, and start-ups.

The uncomfortable truth is that higher deposit rates alone cannot overcome fundamental structural issues. If inflation remains stubborn, driven by supply-chain inefficiencies, poor infrastructure, and overly burdensome regulations, higher deposit rates are, at best, a palliative. Political instability is causing deadly militarised conflicts, as it is ongoing in the Amahara and Oromia regional states, and policy uncertainty saps investors' confidence. Under these conditions, even attractive domestic yields may fail to prevent capital flight.

Without tackling these underlying problems, attempts to stabilise the currency and contain inflation by tweaking rates may amount to pouring water into a leaky bucket.

Ethiopia's contemporary leaders aspire to join the ranks of middle-income countries in a decade or so. There are visible signs of progress manifested in the highways and manicured boulevards. Yet, beneath these, the capacity to save and invest, the bedrock of development, appears to be slipping away. The economy's vulnerability grows as external financing becomes costlier and less reliable. Reforms to boost tax revenues, improve deposit mobilisation, and spur productivity-enhancing investments have gained a new urgency. In the absence of addressing the shortfall in savings, which is vital to cushioning the economy against shocks, the economy remains volatile.

PUBLISHED ON Dec 14,2024 [ VOL 25 , NO 1285]

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