Walking on Tightrope of Economic Growth, Debt in a Post-War Landscape

Apr 9 , 2023.

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As the current fiscal year draws to a close, over 170 federal agency heads frequent the Ministry of Finance on King George VI St., jostling for their share of the federal budget. If past trends are any indication and factored for inflation and currency depreciation, it would not be surprising if the federal budget for the next fiscal year hit a record one trillion Birr.

Minister Ahmed Shedie and his deputies face the unenviable task of allocating resources to satisfy this demand and the goals of the 10-year economic development plans, set in motion four years ago. The plan envisions spending around 19 trillion Br (350 billion dollars at the current exchange rate), with 60pc earmarked for recurrent budgets.

Budget bills serve as indicators of the political agendas of ruling governments. Examining resource allocations allows for discerning their ideological leanings and the leaders' conviction. Historically, the Ethiopian federal government's budgets have strived for economic development and poverty alleviation. Labelled "pro-poor", they focused on improving the country's productive capacity and establishing a solid foundation for long-term growth.

The Revolutionary Democrats prioritised social services, investing in education, health, and public welfare. They sought to expand public infrastructure and promote economic development, leaving a commendable legacy.

However, their heirs, the Prosperitians, face different challenges, grappling with macroeconomic imbalances, budget deficits, negative balance of payments, and high debt servicing. Although it would be unfair to pin all blame on them, a closer examination of federal budgets reveals troubling trends.

Budget deficits have swelled, with a marked increase from the 2021-2022 fiscal year onwards, leading to high public debt and macroeconomic instability. This hampers Ethiopia's development trajectory. The country's heavy dependence on external grants and loans to fund a quarter of federal expenditures exposes the economy to the whims of international donors.

Ethiopia's plunge into a devastating civil war has strained relations with development partners. The conflict has claimed hundreds of thousands of lives, displaced millions, and weakened the economy. Reconstructing the damaged public infrastructure will likely cost tens of billions of dollars.

Following peace deals brokered in Pretoria and Nairobi, the next fiscal year's budget might see donors again opening their coffers. However, Minister Ahmed has urged federal agencies to rely on domestic revenue mobilisation rather than counting on loans and grants. It was advice made in wisdom, although not pragmatic.

While an uptick in domestic and tax revenues over the past few years seems promising, the proportion of revenue and grants to GDP has declined—Ethiopia's tax revenues as a percentage of GDP are not even half of the African average. Expanding the tax base should be a priority, and tax reforms should be implemented to include untapped sectors. A promising start would be the federal government's new drive to raise revenues from property owners, a tax not previously imposed.

Streamlining tax administration is another critical step. Investing in technology and building human capital would modernise tax administration, reducing collection costs and generating additional revenues. Efforts to improve tax compliance, reduce tax evasion and avoidance, and promote a culture of tax compliance through awareness campaigns and incentives would also contribute to revenue generation.

Diversifying revenue streams can shield the budget from economic fluctuations, protecting against sudden changes in global markets, commodity prices, or aid flows. Encouraging the private sector to increase exports could help mobilise additional resources.

Export revenues have been growing, though their share of the GDP leaves much to be desired. To boost export revenues, private sector investment can be promoted through risk-sharing mechanisms that balance public and private sector interests. Creating an enabling environment for private sector investments, reducing bureaucratic hurdles, and providing incentives for capital-intensive projects could encourage private sector participation.

Fostering an environment conducive to private sector growth and investment is essential. The private sector has the potential to drive economic growth, create jobs, and contribute to the country's development. Prosperitians should work towards removing barriers to capital and credit, streamlining regulations, and enhancing the ease of doing business.

A significant challenge in developing a prudent and efficient budget is the growing federal deficit, with problematic financing. The federal government's inclination to borrow from the central bank to pay for its 1.6 trillion Br domestic debt has fuelled inflation. The rising budget is primarily due to increased expenditures in various sectors such as education, health, water, agriculture, roads, and defence.

Recurrent expenditure, particularly defence and debt service, must be closely monitored and controlled to maintain fiscal discipline.

Defence spending has long been one of Ethiopia's largest budget components. In the two decades since 2001/02, defence expenditure accounted for an average of 4.4pc of total expenditures. Its share of GDP has fluctuated over the years, reaching 3.3pc in 2009/10 and dipping to 1.1pc in 2018-19. However, recent years have seen this positive trend reverse, with defence spending climbing back to 2.4pc.

With the civil war now over, opportunities to reduce defence spending should be seized. The mediation efforts that resolved the civil war in Tigray could be employed to quell the growing insurgency in the south and southwest of the country. Pacifying restive regions would not only cut defence spending but also help regain the confidence of development partners, encouraging them to resume capital expenditure assistance.

Although federal spending on capital investments has increased over the years, its proportion of total expenditure has declined. Minister Ahmed and his deputies have strong reasons to advocate for more budget allocation. They should promote capital investments in areas that bolster economic growth, generate employment, and improve infrastructure. The challenge lies in balancing public investment in infrastructure with high inflation.

Nevertheless, allocating resources to strategic public investments that stimulate economic growth, such as infrastructure projects, research and development, and innovation, is crucial. Focusing on high-impact capital projects that yield long-term benefits and drive economic growth will optimise capital expenditure.

These efforts may prove futile in an environment marred by fiscal indiscipline at the federal and regional levels. Building public trust and ensuring the efficient use of resources requires transparency and accountability in fund allocation and utilisation. It is essential to strengthen robust oversight institutions and mechanisms to monitor budget implementation and hold public officials accountable for their actions.

Formulating the budget bill within a medium-term fiscal framework allows for better alignment with the country's development objectives, macroeconomic stability, and debt sustainability. Aligning sector-specific strategies and budgets with the medium-term fiscal framework will ensure policy implementation and resource allocation consistency.

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PUBLISHED ON Apr 09,2023 [ VOL 24 , NO 1197]

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