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The Federal Democratic Republic of Ethiopia: Staff Report for the 2013 Article IV Consultation

Author(s):
International Monetary Fund. African Dept.
Published Date:
October 2013
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Background

1. During the last decade, Ethiopia has made strides in economic and social development. Robust economic growth averaging more than 7 percent since 2001/02 and social assistance—that now reaches more than 8 million beneficiaries in about 1.5 million households—have resulted in a several-fold rise in real per capita GDP (Figure 1) and a dramatic drop in the national poverty rate (from 60.5 percent in 2005 to 30.7 percent in 2011).2 In addition to the dramatic decline in the incidence of poverty over the last decade, nonmonetary dimensions of well-being have also improved, including in the rural areas. Based on the Human Development Index (HDI), Ethiopia has been successful in translating economic growth into higher living standards for its citizens and has outperformed many sub-Saharan African countries and a number of non-African countries (indicated by Ethiopia’s higher actual HDI than that predicted by a cross-country correlation between the HDI and per capita gross national income (Figure 2)).3

Figure 1.Ethiopia: Real GDP per Capita

(Birr)

Sources: Ethiopian authorities; and IMF staff calculations.

Figure 2.Ethiopia: Growth and Living Standards

Sources: UN and IMF staff calculations.

2. Income distribution in the country is relatively even. Among Sub-Saharan African countries, Ethiopia is one of the most egalitarian with a Gini coefficient of 33.6 (Figure 3) and it has consistently maintained this distribution in the last ten years. With a large population and more than 80 percent of it in rural areas, Ethiopia stands out among comparable African countries regarding relatively even income distribution, although there are likely differences between rural and urban populations.

Figure 3.Ethiopia: Income Distribution in Sub-Sahara Africa: Gini Coefficient

(Kernel distribution of SSA countries’ index)

Sources: World Bank World Development Indicators.

3. Economic growth has helped to reduce unemployment particularly in urban areas. While overall unemployment rate stands at about 25 percent, urban unemployment rate declined from 22.9 percent in 2004 to 17.5 percent in 2012 (Figure 4). In urban areas, both female and male unemployment declined and the large gap between the two groups has narrowed for the two years of available and comparable data (2009 and 2010). Unemployment rate remains particularly high among young females, with almost one third of them unable to find a job in the urban areas.

Figure 4.Ethiopia: Urban Unemployment Rate

(Percent of labor force, urban areas)

Sources: ILO and Ethiopian Central Statistical Agency.

4. A public sector-led growth strategy centered on high public investment has been instrumental in delivering these results. The strategy, which calls for substantial external financing and state mobilization of domestic resources, has provided an important impetus to growth. Combined with pro-poor spending that has averaged more than 12 percent of GDP over the past decade, this has helped improve living standards. Following the passing of Prime Minister Meles in August 2012, the new Prime Minister Hailemariam has reaffirmed the state-led model and the public investment plan embodied in the GTP. Developments in the first two years (2010/11–2011/12) of the GTP suggest that the required external financing is not materializing, and the investment drive in the priority projects through directed domestic credit is squeezing the availability of credit and foreign exchange for the rest of the economy.

5. The recommendations from the 2012 Article IV consultation have only been partially implemented. The authorities brought inflation down to single digits. While, owing to the decline in inflation, the extent to which real interest rates were negative have been reduced, positive real interest rates are yet to be realized and liquidity management at the National Bank of Ethiopia (NBE) remains to be improved. Similarly, progress has been slow on structural reforms to allow proper functioning of financial markets; to liberalize the foreign exchange or improve the business climate. Much emphasis continue to be put by the authorities on improving physical infrastructure such as roads, railway, and electricity supply, which they believe would help improve business climate. The 2013 Article IV discussions touched upon these recommendations, which remain valid.

Recent Developments and Outlook

A. Recent Economic and Policy Developments

6. Recent macroeconomic developments are encouraging, with a significant deceleration in inflation and continued robust economic growth (Figures 5, 6, and 7). Despite significant decline in coffee prices and supply bottlenecks growth remains robust, supported by better agricultural output and construction and other services activities.4 Inflation declined from the peak of 40 percent in July 2011 to around 7 percent in June 2013, lower than initially projected by staff. This has significantly eased the extent to which real interest rates were negative, reducing the severity of the distortionary effect on financial intermediation. Pressures resulting in foreign exchange shortages in the wake of the passing away of Prime Minister Meles, have eased, although the spread between the official and parallel markets is yet to be eliminated.

Figure 5.Ethiopia: Comparative Growth and Inflation Performance

Sources: Ethiopian authorities and IMF staff estimates.

Figure 6.Ethiopia: Recent Economic Developments

Sources: Ethiopian authorities and IMF staff estimates.

Figure 7.Ethiopia: International Comparison: External Vulnerability

Source: IMF World Economic Outlook.

7. Fiscal policy at the general government level remains prudent with cautious execution of the government budget. 5 Overall revenue-to-GDP ratio is estimated to fall from 14.0 percent in 2011/12 to 13.2 percent in 2012/13. Reflecting the strong pro-poor focus, the ratio of poverty-reducing expenditure to GDP is being maintained and non-priority expenditure will likely be compressed in 2012/13. Staff estimates the government budget deficit, including grants, to be 2.8 percent of GDP.

8. However, public enterprises continue to expand their investment activities. Net credit expansion (through loans and corporate bonds) from the Commercial Bank of Ethiopia (CBE) to public enterprises (in the 10 months up to April, 2013) alone accounted for 3 percent of GDP. In addition, they borrowed from the Development Bank of Ethiopia (DBE) and through bond issuance for the construction of Renaissance Dam, which is proceeding as planned. The dam is estimated by the authorities to cost 10 percent of 2012/13 GDP and is intended to be entirely financed domestically.

9. An accurate overall fiscal stance for the consolidated public sector (including public enterprises) is difficult to gauge, although it would seem considerably more expansionary. While appropriately consolidated data on the overall public sector finances were not available, external financing of public enterprises in 2012/13 was 2.3 percent of GDP and the monetary survey indicates additional domestic financing of public enterprises from the banking sector of 4.3 percent of GDP in 2012/13, not taking into account non-bank financing of the Renaissance Dam. This implies overall public sector (including public enterprises) borrowing of at least 9.4 percent of GDP in 2012/13.

10. Although the monetary stance remains generally tight to keep inflation in single digits, recent developments point to some relaxation. Base money contracted by 4 percent in 2011/12, achieved by not extending any new NBE credit to the government and foreign exchange sales. Annual base money growth at end-May 2013 stood at 18 percent (compared to one percent contraction for end-May 2012) and the authorities adjusted only slightly the base money target for the year at 13 percent from 12.2 percent. The pickup reflects an increase in net domestic credit, net foreign assets, and in other items net. Achieving the 13 percent target implies a very tight monetary policy for the remainder of the fiscal year. The reserve requirement ratio has been further lowered recently (March 2013) from 10 percent to 5 percent, following an earlier (January 2012) lowering by 5 percentage points, and NBE sterilized the resulting liquidity injection through the sale of certificate deposits, reflecting lack of clarity in monetary policy decision-making. Broad money growth remains somewhat high and stood at 28 percent in 2012/13.

11. The external current account deficit widened slightly to US$3 billion in 2012/13 from US$2.8 billion in 2011/12, reflecting a weaker trade balance, although it improved as a ratio of GDP from 6.6 percent to 6.4 percent. Export performance suffered from a decline in prices and weak external demand conditions, growing only 3.2 percent (in nominal terms), while continued infrastructure and industrial investment and higher fuel importation contributed to an increase in imports by 6.3 percent. Transfers brought in a net inflow of around US$5 billion due to a surge in net private transfers that more than offset a decline in official transfers. Increased loan disbursements to the central government and public enterprises yielded a capital account surplus of US$3.4 billion. The resulting surplus on the overall balance of payments was less than US$0.2 billion (0.4 percent of GDP) compared to a deficit of US$1.1 billion (2.5 percent of GDP) in 2011/12. The NBE’s gross international reserves slightly declined to US$2.2 billion (1.8 months of imports) at the end of 2012/13 from US$2.3 (1.9 months of imports) at the end of 2011/12.

12. Foreign exchange supply came under pressure in the first half of 2012/13. The passing of Prime Minister Meles created uncertainty and excess demand in the foreign exchange market which was also reflected in a widening of the premium in the parallel market. Since its previous peak in October 2008, the Real Effective Exchange Rate (REER) reached the highest level in November 2012, indicating an erosion of competitiveness gains from previous devaluations which may also be a factor in the recent trade performance. This has started to turn around with the recent decline in inflation, although the REER may still be significantly overvalued based on the IMF’s Consultative Group on Exchange Rate methodology (Annex II).

B. Medium Term Outlook and Risks

13. Outlook. Inflation has been brought down to about 7 percent at end-2012/13 and is projected to remain in single digit over the medium-term.6 The current account deficit as a percentage of GDP is projected to slightly improve over the medium-term, as exports recover after declining in 2012/13. Moderate recovery in external demand and ongoing efforts to improve productivity, increase value-added, and diversification of the export base (covering, for example, agricultural and agro-industrial, horticultural, livestock, light manufactures, and electricity exports) are expected to support export growth. Overall economic growth is projected to remain robust in 2013/14 and beyond but fall short of the highly ambitious GTP target. Constraints on external financing for public investment, uncertain external demand, and a cumbersome business environment are the factors underpinning the growth shortfall. Reflecting continued uncertain global environment and unchanged policies, the projected growth rate tapers-off over the medium-term falling further short of the ambitious GTP target.

14. Risks. Key risks to the outlook include (i) a continuation of limited financing for infrastructure investment in the GTP; (ii) re-emergence of severe foreign exchange shortages; (iii) significant growth slowdown in the major emerging market countries; and (iv) weather-related shocks, particularly a possible drought returning to the Horn of Africa (Table 1).

Table 1.Ethiopia: Risk Assessment Matrix1
Source of RisksRelative

Likelihood
Impact if RealizedPolicy response
Financial stress in the euro area reemerges (triggered by stalled or incomplete delivery of national and euro area policy commitments).MediumThe impact of such a stress would include falling commodity prices and higher risk aversion. Specifically, it would reduce demand for Ethiopian exports and lower coffee prices, and also result in shortfalls of aid flows, lower remittances, and limited financing for infrastructure investment in the GTP.Restrain fiscal policy while shielding low-income and vulnerable households, in particular appropriate pacing of public enterprises and infrastructure investment.
Deeper than expected slowdown in Emerging Markets (EMs) (reflecting lower than anticipated potential growth).MediumA deeper than expected slowdown in EMs would lead to commodity price decline with a negative impact on Ethiopian exports. It would result in severe shortfalls of financing (especially from China), and a decline in remittances. The financing of the GTP would be jeopardized with significantly lower growth.Restrain fiscal policy while shielding low-income and vulnerable households, in particular appropriate pacing of public enterprises and infrastructure investment.
Sharp slowdown in growth in China (buildup of excess capacity eventually resulting in large financial losses).MediumFDI from China, which has been rising rapidly across sectors, could decrease, slowing development of newly emerging export sectors, like textile and leather manufacturing. Major infrastructure investments, particularly in power, telecom, and roads, may not be fully financed, delaying the implementation of the GTP.Appropriate pacing of public enterprises and infrastructure investment.
Strain on the state-owned Commercial Bank of Ethiopia resulting from increased domestic financing of GTP.MediumGiven the systemic importance of CBE (70 percent of total banking sector assets), it would slow down the entire Ethiopian economy, resulting in significant deceleration of medium-term growth and a buildup of further vulnerabilities on both domestic and external fronts.Greater role for private banks (including opening up to foreign banks). Strengthen banking supervision capacity at NBE and rigorously apply the limit of 25 percent of capital for loans to related parties and the limit of 15 percent of capital for a single borrower.
Lack of sufficient financing for GTP.HighLower growth.Appropriate pacing of public enterprises and infrastructure investment.
A worsening of the foreign exchange shortage.HighDifficulties in financing imports with negative impacts on growth. Rapid devaluation, leading to higher inflation and larger fiscal deficitGreater flexibility in the exchange rate management. Buildup of foreign reserves to 3 months of import cover.
The return of drought to the Horn of Africa.MediumHigher food prices, leading to an increase in inflation and lower growth.Shielding poor households and tight monetary policy, minimizing second round effects.
Global oil shock triggered by geopolitical events (driving oil prices to US$140 per barrel).LowA global oil shock triggered by geopolitical events (driving oil prices to US$140 per barrel) would not only worsen trade and current account balances, it would also put pressure on inflation and slow growth.Maintain full pass-through into domestic prices to contain fiscal impact, while minimizing impact on the poor through well targeted subsidies.
Non-oil commodity price increases.LowNon-oil commodity price fluctuations affect both export price (coffee) and import price (wheat) in Ethiopia. The negative impact from the import price increases is likely to be offset by the benefit of export price increases.Build policy buffers as a contingent plan by increasing international reserves coverage.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.

Promoting Inclulsive Growth and Reducing Vulnerabilities

15. Ethiopia has been able to translate its broad-based economic growth into significant poverty reduction. Both rural and urban areas have experienced significant increases in per capita consumption between 1995 and 2011. Improvements in nonmonetary measures, such as primary schooling and life expectancy have been particularly impressive (Table 7). However, further efforts are needed, to identify and address the needs of those in severe and chronic poverty and to significantly reduce malnutrition. In addition, to sustain the gains in poverty reduction, improving access to factor and product markets for the bulk of the population would be important.

16. The government’s objective is to become a middle-income country by 2025. The GTP envisages achieving an average economic growth target of 11.2 percent over 2010/11–2014/15 and realizing the MDGs. Among the key pillars are raising agricultural productivity and scaling-up infrastructure and human capital development. The authorities seek to realize their ambitious development objectives through proactive public policies with heavy state involvement in infrastructure and industrial investments. Although the required financing for the GTP has not been fully spelled out, the expansion of domestic credit to public entities has constrained the availability of credit and foreign exchange for the private sector. Policies thus need to be adapted for an appropriate balance between the public and private sectors to enhance the resiliency of the country’s developmental model.

17. On the basis of a continuation of current policies, a deceleration of medium-term growth is expected, pointing to the need for policy adjustments. The baseline projections assume the continuation of current policies, including constraints on private banking activities, directed lending with artificially low real interest rates and allocation of foreign exchange to priority public investment projects. Some of these policies undermine the authorities’ growth objectives and have contributed to the recent foreign exchange shortages, especially for the private sector. Domestic financing is unlikely to meet the requirements of the GTP and prospective external inflows are insufficient to fill the gap. Absent mid-course policy correction, in particular strengthening private sector leverage in the economy, the government’s 11 percent growth target is likely to be elusive. Based on a domestic financing which is less compared to full financing of the GTP, staff projects growth in the 7–7.5 percent range over the medium term (Table 2).7

Table 2.Ethiopia: Selected Economic and Financial Indicators, 2009/10–2017/181
2009/102010/112011/122012/132013/142014/152015/162016/172017/18
Act.Act.Act.Prel.Proj.Proj.Proj.Proj.Proj.
(Annual percentage change)
National income and prices
GDP at constant prices (at factor cost)210.611.48.57.08.08.59.09.59.5
GDP deflator1.620.034.211.37.17.36.05.96.1
Consumer prices (period average)2.818.134.113.56.76.56.06.06.0
Consumer prices (end period)7.338.120.77.47.06.06.06.06.0
External sector
Exports (U.S. dollars, f.o.b.)38.437.114.83.215.917.118.718.618.6
Imports (U.S. dollars, c.i.f.)7.0−0.234.06.39.211.47.07.07.0
Export volume10.58.9−0.414.016.314.820.120.118.0
Import volume14.1−3.825.96.810.613.18.27.57.0
Terms of trade (deterioration –)38.323.58.2−10.30.93.9−0.3−1.00.6
Nominal effective exchange rate (end of period)−13.4−26.52.8
Real effective exchange rate (end of period)−9.7−2.320.9
(Percent of beginning-period stock of broad money, unless otherwise indicated)
Money and credit
Net foreign assets9.629.1−12.72.23.22.95.98.210.1
Net domestic assets (including other items net)14.710.143.026.419.319.614.211.89.4
Claims on the government1.7−2.9−7.03.24.43.32.72.62.5
Claims on public enterprises6.825.128.520.28.510.412.612.713.6
Claims on private sector10.59.813.24.48.09.812.115.420.9
Broad money24.339.230.328.522.522.520.120.019.5
Base money (annual percentage change)6.540.7−3.613.215.816.615.515.916.2
Velocity (GDP/broad money)3.643.493.903.623.423.253.133.022.94
(Percent of GDP, unless otherwise indicated)
Financial balances
Gross domestic savings5.212.816.515.915.315.416.817.818.6
Public savings4.54.35.74.96.77.27.57.77.9
Private savings0.68.510.811.08.68.29.310.110.7
Gross domestic investment23.627.234.632.631.531.531.831.831.5
Public investment14.919.626.524.318.717.315.915.014.6
Private investment8.77.58.18.312.814.215.916.816.9
Resource gap−18.4−14.4−18.1−16.7−16.2−16.1−15.0−14.0−12.9
External current account balance, including official transfers−4.1−0.7−6.6−6.4−6.0−6.2−5.1−4.1−3.0
Saving-investment (government)−4.0−9.5−16.8−16.6−8.7−7.0−5.4−4.4−3.8
Gross Fixed Capital Formation10.910.19.77.710.010.310.510.610.8
Saving-investment (private)9.817.218.418.415.614.815.716.116.4
External current account balance, excluding official transfers20.322.918.216.117.618.219.119.920.7
Government finances
Revenue14.213.714.013.213.914.715.715.916.1
Tax revenue11.411.711.611.412.112.913.914.114.3
Nontax revenue2.82.02.31.81.81.81.81.81.8
External grants3.33.31.72.01.61.61.41.31.2
Expenditure and net lending18.818.516.918.017.417.818.718.719.0
Fiscal balance, excluding grants (cash basis)−4.6−4.9−2.9−4.8−3.5−3.1−3.0−2.8−2.9
Fiscal balance, including grants (cash basis)−1.3−1.6−1.2−2.8−1.9−1.5−1.6−1.5−1.7
Total financing (including residuals)1.31.61.22.81.91.51.61.51.7
External financing1.11.50.91.33.02.72.62.32.4
Domestic financing (not including privatization)0.50.00.51.51.61.41.41.31.4
Public debt 339.437.832.838.635.036.136.434.933.9
Domestic debt21.115.614.919.714.614.813.912.211.3
External debt (including to the IMF)18.322.217.918.920.521.322.522.822.6
Overall balance of payments (in millions of U.S. dollars)6851446−1067−27544840193814622018
Gross official reserves (in millions of U.S. dollars)1,9793,0442,2622,2182,4662,8473,7345,1407,101
(months of imports of goods and nonfactor services of following year)2.42.71.91.81.71.92.33.03.6
GDP at current market prices (billions of birr)379.2506.1736.6877.51,016.51,185.01,369.01,587.11,844.3
Sources: Ethiopian authorities and IMF staff estimates and projections.

Data pertain to Ethiopian fiscal year from July 8 to July 7.

GDP statistics in Ethiopia are subject to significant weaknesses. Applying plausible factor productivities would suggest that the annual GDP growth rate could be off by as much as 3 percentage points in recent years.

Including debt of major public enterprises.

Sources: Ethiopian authorities and IMF staff estimates and projections.

Data pertain to Ethiopian fiscal year from July 8 to July 7.

GDP statistics in Ethiopia are subject to significant weaknesses. Applying plausible factor productivities would suggest that the annual GDP growth rate could be off by as much as 3 percentage points in recent years.

Including debt of major public enterprises.

18. Policy discussions focused on sustaining robust and inclusive growth and structural transformation while maintaining macroeconomic and financial stability and mitigating vulnerabilities. Key recommendations include (i) rationalizing and appropriately pacing public sector investment, especially for state-owned enterprises, (ii) keeping inflation under control, eliminating exchange rate overvaluation, and restoring reserve adequacy; (iii) strengthening financial deepening and inclusiveness, bringing real interest rates to positive levels, and enhancing access to finance for farmers and small and medium enterprises; and (iv) increasing the scope for the private sector’s role in the economy (Table 1). The implementation of these recommendations would facilitate financial development that should enable less distortionary financing of the GTP that is consistent with debt sustainability.

19. Staff has developed an alternative scenario that targets stronger growth while safeguarding macroeconomic stability and reducing vulnerabilities and that is consistent with the policies mentioned above (Table 6). Under staff’s alternative (adjustment) scenario, the growth rate is projected to rise to 9.5 percent in 2016–17 and inflation is targeted to decline further to 6 percent by 2014–15, as positive real interest rates expand the deposit base, the exchange rate is kept competitive, private sector access to credit from the banking system increases.

C. Fiscal Policy: Stance and Inclusion

Fiscal stance

20. The fiscal stance embodied in 2013/14 general government budget submitted to parliament recently is appropriately restrained (Tables 3a and 3b). However, despite the government’s revenue mobilization efforts, the revenue-to-GDP ratio is projected to fall from 13.2 percent in 2012/13 to 12.9 percent in 2013/14. Reflecting the ongoing efforts to improve tax administration, the tax-to-GDP ratio is projected to rise but nontax revenue is slated to fall on account of lower dividends from state-owned enterprises. The authorities are relying on administrative improvements to increase revenue substantially. Staff encouraged the authorities to consider the revenue potential of reducing tax expenditure and tax incentives and improved tax collection, along the lines identified by IMF FAD technical assistance.8

Table 3a.Ethiopia: General Government Operations, 2009/10–2017/18
2009/102010/112011/122012/132013/142014/152015/162016/172017/18
Act.Act.Act.Est.Proj.Proj.Proj.Proj.Proj.
Total revenue and grants66,23785,611115,659133,296145,612175,539202,286233,683269,690
Revenue53,86169,120102,864115,808129,804156,603182,804212,798247,757
Tax revenue43,31558,98185,74099,838118,092142,892166,956194,501226,586
Direct taxes14,90319,55028,85834,65340,59248,90557,28967,02678,609
Indirect taxes28,41239,43156,88265,18677,50093,988109,668127,476147,978
Domestic indirect taxes10,72715,70523,32627,96433,39640,80547,80155,92565,589
Import duties and taxes17,68523,72633,55637,22044,10353,18261,86671,54982,387
Nontax revenue10,54610,13917,12415,97011,71213,71115,84818,29721,171
Grants12,37616,49112,79517,48815,80818,93619,48220,88521,934
Emergency assistance (food and nonfood aid)6313380000000
Program grants 16,8169,6334,7064,6084,0224,7085,4426,2837,270
Project grants4,9306,5218,08912,88011,78614,22814,04014,60214,664
Total expenditure and net lending (cash basis) 271,33593,831124,417157,987176,511207,714237,252270,908313,230
Recurrent expenditure232,01240,53551,44560,55570,25182,97195,636110,335127,789
Defense spending4,0004,7506,4866,5007,5008,5008,5008,5008,500
Poverty-reducing expenditure 314,75018,99524,99429,77534,22440,06446,30853,46361,862
Interest payments1,5871,9132,2303,1534,2425,9787,96910,43513,531
Domestic interest and charges1,2201,3001,3881,7842,5894,0645,9418,29611,320
External interest payments43686138421,3691,6531,9152,0282,1392,210
Emergency assistance (food and other emergency aid)6313380000000
Other recurrent expenditure11,04414,53917,73521,12824,28528,42932,86037,93743,897
Capital expenditure39,32253,29772,97197,432106,261124,743141,615160,573185,441
Central treasury29,94738,34057,43976,57883,43899,405116,293134,504159,131
External project grants4,9306,5218,08912,88011,78614,22814,04014,60214,664
External project loans4,4468,4367,4437,97311,03711,11011,28211,46711,646
Of which: poverty-reducing expenditure332,70443,38362,57474,65186,079100,689117,289136,021157,746
Overall balance
Including grants−5,097−8,220−8,758−24,690−30,899−32,175−34,965−37,225−43,540
Excluding grants−17,473−24,712−21,553−42,178−46,707−51,111−54,447−58,110−65,474
Financing6,5869,50613,08724,69046,93448,80553,76157,65669,723
Net external financing4,1317,7986,53011,68230,89932,17534,96537,22543,540
Gross borrowing4,4468,4367,44313,01116,47916,82017,88219,08620,462
Project loans4,4468,4367,4437,97311,03711,11011,28211,46711,646
Protection of Basic Services (PBS)0005,0375,4425,7106,5997,6198,816
Amortization4−315−638−1,063−1,329−1,614−1,275−1,712−2,292−3,106
Total net domestic financing1,7582513,79313,00816,03416,63018,79520,43126,183
Privatization6971,4582,764000000
Memorandum items:
Poverty-reducing expenditure47,45362,37987,568104,425120,302140,753163,597189,484219,608
Primary fiscal balance, including grants−3,510−6,308−6,528−21,538−26,657−26,197−26,996−26,790−30,009
Domestic fiscal balance, including grants−7,099−8,804−5,178−19,956−22,231−23,858−27,097−29,902−36,953
Gross domestic government debt53,00953,26057,05370,06186,095102,725121,521141,952168,135
Sources: Ethiopian authorities; and IMF staff estimates and projections. The Ethiopian fiscal year ends July 7.

Including the disbursements under the PBS operations starting from 2005/06.

Excluding special programs (demobilization and reconstruction).

Poverty-reducing spending is defined to include total spending on health, education, agriculture, roads, and food security.

External interest and amortization are presented after HIPC debt relief from the World Bank and African Development Bank.

Sources: Ethiopian authorities; and IMF staff estimates and projections. The Ethiopian fiscal year ends July 7.

Including the disbursements under the PBS operations starting from 2005/06.

Excluding special programs (demobilization and reconstruction).

Poverty-reducing spending is defined to include total spending on health, education, agriculture, roads, and food security.

External interest and amortization are presented after HIPC debt relief from the World Bank and African Development Bank.

Table 3b.Ethiopia: General Government Operations, 2009/10–2017/18(Percent of GDP)
2009/102010/112011/122012/132013/142014/152015/162016/172017/18
Act.Act.Act.Est.Proj.Proj.Proj.Proj.Proj.
Total revenue and grants17.516.915.715.214.414.914.814.814.8
Revenue14.213.714.013.212.913.313.413.513.6
Tax revenue11.411.711.611.411.712.112.212.312.4
Direct taxes3.93.93.93.94.04.14.24.34.3
Indirect taxes7.57.87.77.47.78.08.08.18.1
Domestic indirect taxes2.83.13.23.23.33.53.53.53.6
Import duties and taxes4.74.74.64.24.44.54.54.54.5
Nontax revenue2.82.02.31.81.21.21.21.21.2
Grants3.33.31.72.01.61.61.41.31.2
Emergency assistance (food and nonfood aid)0.20.10.00.00.00.00.00.00.0
Program grants11.81.90.60.50.40.40.40.40.4
Project grants1.31.31.11.51.21.21.00.90.8
Total expenditure and net lending (cash basis)218.818.516.918.017.517.617.417.217.2
Recurrent expenditure28.48.07.06.97.07.07.07.07.0
Defense spending1.10.90.90.70.70.70.60.50.5
Poverty-reducing expenditure 33.93.83.43.43.43.43.43.43.4
Interest payments0.40.40.30.40.40.50.60.70.7
Domestic interest and charges0.30.30.20.20.30.30.40.50.6
External interest payments 40.10.10.10.20.20.20.10.10.1
Emergency assistance (food and other emergency aid)0.20.10.00.00.00.00.00.00.0
Other recurrent expenditure2.92.92.42.42.42.42.42.42.4
Capital expenditure10.410.59.911.110.510.610.410.210.2
Central treasury7.97.67.88.78.38.48.58.58.7
External project grants1.31.31.11.51.21.21.00.90.8
External project loans1.21.71.00.91.10.90.80.70.6
Of which: poverty-reducing expenditure 38.68.68.58.58.58.58.68.68.7
Overall balance
Including grants−1.3−1.6−1.2−2.8−3.1−2.7−2.6−2.4−2.4
Excluding grants−4.6−4.9−2.9−4.8−4.6−4.3−4.0−3.7−3.6
Financing1.71.91.82.84.74.13.93.73.8
Net external financing1.11.50.91.33.12.72.62.42.4
Gross borrowing1.21.71.01.51.61.41.31.21.1
Project loans1.21.71.00.91.10.90.80.70.6
Protection of Basic Services (PBS)0.00.00.00.60.50.50.50.50.5
Amortization4−0.1−0.1−0.1−0.2−0.2−0.1−0.1−0.1−0.2
Total net domestic financing0.50.00.51.51.61.41.41.31.4
Privatization0.20.30.40.00.00.00.00.00.0
Memorandum items:
Poverty-reducing expenditure12.512.311.911.911.911.912.012.012.0
Primary fiscal balance, including grants−0.9−1.2−0.9−2.5−2.6−2.2−2.0−1.7−1.6
Domestic fiscal balance, including grants−1.9−1.7−0.7−2.3−2.2−2.0−2.0−1.9−2.0
Gross domestic government debt14.010.57.78.08.58.78.99.09.2
Sources: Ethiopian authorities; and IMF staff estimates and projections. The Ethiopian fiscal year ends July 7.

Including the disbursements under the PBS operations starting from 2005/06.

Excluding special programs (demobilization and reconstruction).

Poverty-reducing spending is defined to include total spending on health, education, agriculture, roads, and food security.

External interest and amortization are presented after HIPC debt relief from the World Bank and African Development Bank.

Sources: Ethiopian authorities; and IMF staff estimates and projections. The Ethiopian fiscal year ends July 7.

Including the disbursements under the PBS operations starting from 2005/06.

Excluding special programs (demobilization and reconstruction).

Poverty-reducing spending is defined to include total spending on health, education, agriculture, roads, and food security.

External interest and amortization are presented after HIPC debt relief from the World Bank and African Development Bank.

21. The budgetary focus on pro-poor spending has been impressive and the 2013/14 budget aims to strengthen this further (Box 1). To maintain the ratio of poverty-reducing expenditure to GDP, its share in the total expenditure will need to rise as federal government support to regional governments for MDGs wanes as projects receiving this allocation approach completion by 2014/15, the target year for the MDGs (for a discussion of pro-poor spending see also the accompanying Selected Issues Paper).

22. Public financial management (PFM) reforms are yielding significant improvements in the budgetary processes. Program-based budgeting is in the second year of full implementation and cash management reform, with the aim of reducing idle cash in the various government accounts and improving the quality of fiscal reporting, is progressing well. Staff stresses the need to maintain the momentum in these areas. The IMF’s Fiscal Affairs Department is prepared to provide continued technical assistance as requested by the authorities.

Public sector debt

23. The pace of accumulation of overall public sector debt deserves close attention. A rapid growth of credit to public enterprises to finance major investments in dams, factories, and housing construction continues to drive this buildup. The net worth of the government is thus heavily exposed to the direct borrowing by these enterprises and contingent liabilities stemming from such lending by CBE and DBE. Staff stresses the need for comprehensive and timely information on the financial position of public enterprises as part of the enhancement to the medium-term debt strategy.

24. Debt sustainability analysis continues to show that Ethiopia remains at a low risk of external debt distress. It is predicated on a conservative disbursement profile that is considerably lower than the requirements for the full implementation of the GTP. Staff encourages the authorities as in the 2012 Article IV consultation to seek concessional external financing and reconsider the pacing of the investments if scaled-up external financing on manageable terms is not forthcoming and authorities intend to maintain their low risk of external debt distress.

25. Domestic debt is rising and vulnerabilities will continue to increase as large public investments draw financing from domestic sources. Beyond a certain limit, such financing could be destabilizing and/or inflationary, suggesting that careful consideration should be given to the sustainability of the overall financing envisaged in the GTP. Consideration should be given to developing a comprehensive debt management strategy covering total public debt, including the debt of public enterprises, to improve public fiscal management and monitoring of the total fiscal stance.

Fiscal policy and inclusiveness

26. The tax structure of Ethiopia with its heavy reliance on indirect taxes suggests scope for making it more equitable even though income tax brackets appear somewhat progressive. Staff could not estimate the incidence of taxes for various income cohorts due to data constraints. However, tax revenue in Ethiopia derives largely from international transactions—on average 4.8 percent of GDP in 1999/00–2011/12, compared with regional comparators’ average of 1.4 percent—suggesting a relatively regressive revenue structure. Income taxes, which are considered more progressive than indirect taxes, averaged 3.7 percent of GDP in the same period against the regional comparators’ average of 4.8 percent of GDP. On the other hand, domestic taxes on goods and services stand only at 2.4 percent of GDP as opposed to 7.2 percent of GDP for regional comparators’ average. There is an apparent potential to raise more revenue from income tax and domestic taxes on goods and services to support growth promoting and social expenditure. Income tax revenue could be boosted by ensuring adequate tax collection from public enterprises and by broadening the tax base through promoting the private sector.

Text Table 1.Tax-to-GDP ration(Average over the period 1999/2000–2011/2013)
IncomeGoods &

Services
Internation

Trade
Ethiopia3.702.424.82
Kenya7.538.501.89
Tanzania3.548.501.89
Uganda3.306.891.13
Regional comparators’ average4.797.211.38
Sources: National authorities and IMF staff calculations.
Sources: National authorities and IMF staff calculations.

27. The authorities’ focus on pro-poor capital expenditure has resulted in improvements in human capital and physical infrastructure. Strong investment-led economic growth has also delivered improvements in the employment conditions in the urban areas, but youth and female unemployment are still high and bringing them down remain a challenge. While the poor have generally benefited from strong economic growth the benefits have not been realized by poorest to the same extent. Thus, more focused efforts would be needed to lift up the poorest of the poor.

Box 1.Ethiopia: The Budgetary Focus on Pro-poor Spending

Despite the tight resource constraint, the government has been successfully maintaining public investment and pro-poor spending in line with GDP (Box Figure 1). While the expenditure-to-GDP ratio has declined from the peak of 27.3 percent in 2002/03 to 16.9 percent in 2011/12 (partly reflecting an exceptionally high emergency food assistance in 2002/03), pro-poor expenditure have been maintained, averaging 12.4 percent of GDP over the 10 year period.1 The key to achieve this outcome has been the prioritization through the budgetary processes, and the strong pro-poor focus that has been instrumental in Ethiopia’s progress toward the MDGs.

Box Figure 1.Ethiopia: General Government Expenditure by type, 2000/01–2011/12

(in percent of GDP)

Within pro-poor spending, recurrent expenditure has been restrained and more emphasis has been given to capital expenditure. The restraining of recurrent spending has taken place across all the sectors, with notable decline in the ratios of current spending-to-GDP in the education and health sectors, reflecting public sector wage restraint during the episode of high inflation.

The rise in pro-poor capital expenditure has been concentrated mostly in the road sector. This heavy investment in roads has paid off as the total road length has increased by a third (from about 36 thousand kilometers to about 49 thousand during the Plan for Accelerated and Sustained Development to End Poverty (PASDEP) period), the road conditions have improved (with the proportion of roads assessed as being in good condition having increased from 64 percent to 81 percent during the PASDEP period), and the access to all-weather roads has improved.

1 Pro-poor expenditure in the official definition consists of education, health, agriculture, natural resources (water), and roads.

Authorities’ views

28. The authorities expect their revenue mobilization efforts through administrative improvements to deliver substantial revenue increases (some 4 percent of GDP by 2014/15). They concurred with staff on the desirability of increasing the share of direct taxes over the medium term and on the need to review tax expenditures and exemptions. They indicated that all public enterprises were subject to corporate income taxes. They also noted the difficulty of identifying the appropriate investment-friendly exemptions and stressed that continued technical assistance from the Fund and other development partners was necessary to support their efforts.

D. Monetary Policy

29. The NBE seeks to control inflation through targeting base money and intervenes in credit allocation to ensure that broad money is consistent with government’s inflation, growth and employment objectives. Although inflation has been brought down to single digits, the risks remain on the upside, especially considering the downward stickiness of nonfood inflation and the successive reductions of reserve requirements. To the extent that directed credit allows access to finance across selected industries and geographical areas, it could contribute to financial inclusion. However, significant segments of the economy, especially in rural areas, remain constrained by lack of access to credit. The conduct of monetary policy suffers from rigidity in interest rates and inflexible instruments to achieve monetary objectives. Changes in reserve and other requirements and foreign exchange sales are used for liquidity management and for achieving other developmental objectives.

30. The NBE’s monetary policy stance has contributed to the decline in inflation. Inflation has come down to single digits with beneficial effects for the general population and especially for the poor. Base money increased by 13 percent in 2012/13 (Table 4). In addition to the slowdown in global food and fuel price inflation, this has been instrumental in the recent decline in inflation to 7.4 percent in June. Limited resort to NBE financing of the government and mopping of liquidity through sales of foreign exchange also helped in this regard, although this is at the expense of building foreign exchange reserve buffer.

Table 4.Ethiopia: Monetary Survey and Central Bank Accounts, 2009/10–2017/181
2009/102010/112011/122012/132013/142014/152015/162016/172017/18
Act.Act.Act.AuthEst.AuthProj.Proj.Proj.Proj.Proj.
(Millions of birr)
Monetary survey
Net foreign assets27,90558,15739,78843,86343,86357,79352,62359,49867,52176,25385,596
Central bank15,89535,63721,25421,19721,19728,12527,19334,06842,09150,82360,166
Commercial banks12,01022,52018,53322,66622,66629,66825,43025,43025,43025,43025,430
Net domestic assets76,21286,735149,051198,850198,850254,773243,458295,805357,066429,006515,662
Domestic credit105,407138,696189,080240,994241,464301,131289,816351,001422,219503,056596,779
Claims on government (net)234,69531,65521,57127,02727,52737,02738,72049,91962,43675,61994,510
Claims on nongovernment70,712107,041167,510213,966213,936264,104251,096301,082359,783427,437502,269
Public enterprises31,43657,61398,897137,004163,311201,844248,392303,649365,207
Private sector39,27649,42868,61376,93387,78599,238111,391123,788137,062
Other items (net)−29,195−51,961−40,030−42,144−42,614−46,358−46,358−55,196−65,152−74,050−81,117
Broad money104,117144,892188,838242,713242,713312,566296,081355,303424,587505,258601,257
Money51,98575,76394,280118,912141,444173,210209,172251,433300,306
Currency outside banks23,95032,76838,53745,43245,43253,15650,83458,51165,88475,43887,282
Demand deposits28,03442,99655,74373,48090,610114,699143,288175,995213,023
Quasi money52,13369,12994,558123,801154,637182,093215,415253,825300,952
Savings deposits48,19664,40582,489115,490144,306169,590200,303235,717279,299
Time deposits3,9374,72412,0708,31110,33212,50315,11218,10821,653
Central bank
Net foreign assets15,89535,63721,25421,19721,19757,79327,19334,06842,09150,82360,166
Foreign assets26,80551,51740,10140,98640,98628,12546,98253,40660,28067,63675,506
Foreign liabilities10,91015,88018,84719,79019,79048,90419,79019,33918,19016,81315,340
Net domestic assets32,77432,83244,71853,45553,48560,42158,60866,40674,05883,33195,051
Domestic credit36,42148,64757,84670,34670,84685,34685,846100,846115,346128,346140,346
Government (net)36,42142,39745,34453,84454,34462,84463,34475,34487,34499,344111,344
Other items (net)−3,647−15,815−13,128−16,892−17,362−24,925−27,238−34,440−41,288−45,015−45,295
Base money48,67068,46965,97374,65174,68188,54685,801100,474116,149134,154155,217
Currency outside banks23,95032,76838,53753,89445,43263,05650,83458,51165,88475,43887,282
Commercial bank reserves24,71935,70127,43520,75729,24925,49034,96741,96350,26558,71667,935
Cash in vault4,9776,6937,2487,4358,5389,82711,77113,75015,909
Reserve deposit19,74229,00820,18721,81426,42832,13638,49444,96552,025
(Annual percentage change, unless otherwise indicated)
Monetary survey
Net foreign assets40.4108.4−31.610.210.231.820.013.113.512.912.3
Net domestic assets19.313.871.833.422.421.520.720.120.2
Domestic credit17.731.636.327.527.725.020.021.120.319.118.6
Claims on government (net)4.1−8.8−31.92527.63740.728.925.121.125.0
Claims on nongovernment25.751.456.52827.72317.419.919.518.817.5
Public enterprises22.083.371.738.519.223.623.122.220.3
Private sector28.925.838.812.114.113.012.211.110.7
Broad money24.339.230.328.128.528.822.020.019.519.019.0
Money20.645.724.426.118.922.520.820.219.4
Quasi money28.232.636.830.924.917.818.317.818.6
Memorandum items:
Base money growth6.540.7−3.61313.21914.917.115.615.515.7
Excess reserve deposit (billions of birr)3,8387,0333,72211,23413,45016,58119,84322,75925,611
Percent of deposits4.26.62.35.35.25.35.55.35.0
Money multiplier (broad money/reserve money)2.142.122.863.253.453.543.663.773.87
Velocity (GDP/broad money)3.643.493.903.623.413.323.213.123.03
Currency-deposit ratio0.2990.2920.2560.2300.2070.1970.1840.1760.170
Gross official foreign reserves (millions of U.S. dollars)1,9793,0442,2622,2182,5182,8183,1183,4183,718
Birr per U.S. dollar (end of period)13.5416.9117.7718.63
Nominal GDP (millions of birr)379,219506,079736,612877,5121,008,6331,180,7571,364,7781,575,6581,823,183
Sources: National Bank of Ethiopia; and IMF staff estimates and projections.

Year ending July 7. Including commercial bank claims and liabilities to Eritrea. The columns for the authorities reflect NBE’s estimates and targets for end-June.

Claims on the general government by the banking system less deposits of the general government with the banking system.

Sources: National Bank of Ethiopia; and IMF staff estimates and projections.

Year ending July 7. Including commercial bank claims and liabilities to Eritrea. The columns for the authorities reflect NBE’s estimates and targets for end-June.

Claims on the general government by the banking system less deposits of the general government with the banking system.

31. Monetary policy implementation and liquidity management would be greatly enhanced by the use of indirect monetary policy instruments and allowing for price discovery. At present, the NBE uses changes in reserve requirement and foreign exchange sales as the main tools and has also deployed offsetting deposit requirements for liquidity management, and for achieving other developmental objectives. While the reserve requirement ratio has been lowered recently (March 2013) for a second time from 10 percent to 5 percent, the NBE simultaneously sterilized the associated excess reserves through the issuance of the NBE’s certificate of deposits. To preserve the gains on inflation monetary policy will need to remain vigilant, taking into account the effect of changes in reserve requirement on the money multiplier and the growth of broad money. Going forward, monetary policy implementation would need to take into account the renewed NBE financing of the government’s budget deficit and changing money demand conditions. In the context of relatively low levels of foreign exchange reserves, monetary operations with market priced Treasury or NBE bills can provide the NBE with greater flexibility in liquidity management.

32. Activating the Treasury bills market would be important for the development of the money market. It could also improve the monetary transmission mechanism, allow for establishing a short-term risk-free yield curve, encourage banks to more actively manage their own liquidity positions and allocate risks. Treasury bill market remains also a precondition for establishing a market for longer-term instruments, such as Treasury bonds. Technical assistance from the Fund could be helpful in this regard.

33. Proper coordination and consistency between monetary and exchange rate policies are critical for further financial market development and orderly conditions in the foreign exchange market. The foreign exchange market developments in the first half of 2012/13 and the premium in the parallel market suggest considerable scope for improving the functioning of the NBE’s foreign exchange sale mechanism and the interbank market. Greater flexibility in exchange rate and presence of NBE in the foreign exchange market whenever necessary can be helpful in preventing excessive volatility and disorderly conditions in the market. Exchange rate flexibility is also essential for the competitiveness of the traded goods sector which staff considers critical for the realization of the authorities’ growth objectives. For NBE to effectively play its role in this regard, staff welcomes its objective of raising its foreign exchange reserve target to US$2.5 billion (about 1.9 months of imports) by the end of 2013/14 and further to the equivalent of 3 months of imports over the longer term as a move in the right direction. However, staff would prefer a faster buildup of foreign exchange reserves—which would be facilitated by an increased use of domestic securities (rather than foreign exchange sale) for liquidity management—to 3 months of import cover (Table 6).

Table 5.Ethiopia: Balance of Payments, 2009/10–2017/181
2009/102010/112011/122012/132013/142014/152015/162016/172017/18
Act.Act.Act.Est.Proj.Proj.Proj.Proj.Proj.
(Millions of U.S. dollars, unless otherwise indicated)
Current account balance−1,193−211−2,800−3,037−2,849−3,283−3,426−3,612−3,613
(Percent of GDP)−4.1−0.7−6.6−6.4−5.7−6.0−5.8−5.6−5.2
Current account balance, excl. official transfers−3,099−2,071−4,588−4,519−4,690−5,257−5572−5932−6132
(Percent of GDP)−10.5−6.6−10.8−9.5−9.3−9.5−9.4−9.2−8.8
Trade balance−6,265−5,506−7,908−8,500−8,899−9,690−10,228−10,660−10,952
Exports of goods2,0042,7473,1533,2543,7404,3064,9595,7096,601
Imports of goods−8,269−8,253−11,061−11,754−12,640−13,995−15,187−16,369−17,553
Services (net)5137581715818441,0091,1751,2581,348
Exports2,0442,5862,8112,9053,3403,6924,0474,3314,636
Imports−1,531−1,828−2,639−2,323−2,497−2,683−2,871−3,073−3,289
Income (net)−55−70−96−132−198−259−330−410−477
Private transfers (net)2,7082,7473,2463,5323,5633,6833,8113,8793,949
Official transfers (net)1,9061,8611,7881,4811,8411,9732,1452,3202,519
Capital account balance2,1762,9892,2433,4063,3483,6043,7773,9683,969
Foreign direct investment (net)9561,2431,0721,1791,3991,6892,0302,3792,654
Other investment (net)21,0401,7471,1712,2271,9501,9151,7471,5891,315
Official long-term loans1,0441,9031,2921,7041,3941,2741,189966799
Disbursements1,1272,0731,6052,0951,8071,8501,8611,7401,710
Amortization−83−170−313−390−413−576−672−774911
Monetary Authority1800000000
Errors and omissions−298−1,332−510−18000000
Overall balance6851,446−1,067189500321350356356
Financing−685−1,4461,067−189−500−321−350−356−356
Central bank (net; increase -)−323−1,00278243−300−321−350−356−356
Reserves (increase -)−398−1,06578243−300−300−300−300−300
Liabilities (increase +)7562000−21−50−56−56
Commercial banks (net; increase -)−361−444285−232−2000000
(Annual percentage change, unless otherwise indicated)
Memorandum items:
Exports of goods38.437.114.83.214.915.115.215.115.6
Export volume index10.58.9−0.414.015.312.816.616.615.1
Imports of goods7.0−0.234.06.37.510.78.57.87.2
Import volume index14.1−3.825.96.88.912.49.78.37.3
Services exports5.726.58.73.315.010.59.67.07.0
Services imports1.119.444.4−12.07.57.57.07.07.0
Exports of goods and services (percent of GDP)13.817.014.013.014.014.515.115.616.2
Imports of goods and services (percent of GDP)−33.3−32.1−32.2−29.7−30.0−30.2−30.3−30.3−30.0
Gross official reserves (millions U.S. dollars)1,9793,0442,2622,2182,5182,8183,1183,4183,718
(Months of following year imports of goods and services)2.42.71.91.81.81.91.92.02.0
Terms of trade index38.323.58.2−10.30.93.9−0.3−1.00.6
GDP (millions of U.S. dollars)29,39631,40042,51647,33550,39855,13959,56364,26769,498
Sources: Ethiopian authorities and IMF staff estimates and projections.

Data pertain to Ethiopian fiscal year from July 8 to July 7.

For 2008/09 and 2009/10, other investment (net) includes a correction for the timing difference between entry of ETC imports and corresponding loan disbursements.

Sources: Ethiopian authorities and IMF staff estimates and projections.

Data pertain to Ethiopian fiscal year from July 8 to July 7.

For 2008/09 and 2009/10, other investment (net) includes a correction for the timing difference between entry of ETC imports and corresponding loan disbursements.

Table 6.Ethiopia: Alternative Scenario: Selected Economic and Financial Indicators, 2009/10–2017/181
2009/102010/112011/122012/132013/142014/152015/162016/172017/18
Act.Act.Act.Prel.Proj.Proj.Proj.Proj.Proj.
(Annual percentage change)
National income and prices
GDP at constant prices (at factor cost)210.611.48.57.07.57.57.07.07.0
GDP deflator1.620.034.211.36.98.98.07.98.1
Consumer prices (period average)2.818.134.113.57.38.08.08.08.0
Consumer prices (end period)7.338.120.77.48.08.08.08.08.0
External sector
Exports (U.S. dollars, f.o.b.)38.437.114.83.214.915.115.215.115.6
Imports (U.S. dollars, c.i.f.)7.0−0.234.06.37.510.78.57.87.2
Export volume10.58.9−0.414.015.312.816.616.615.1
Import volume14.1−3.825.96.88.912.49.78.37.3
Terms of trade (deterioration -)38.323.58.2−10.30.93.9−0.3−1.00.6
Nominal effective exchange rate (end of period)−13.4−26.52.8
Real effective exchange rate (end of period)−9.7−2.320.9
(Percent of beginning-period stock of broad money, unless otherwise indicated)
Money and credit
Net foreign assets9.629.1−12.72.23.62.32.32.11.8
Net domestic assets (including other items net)14.710.143.026.418.417.717.216.917.2
Claims on the government1.7−2.9−7.03.24.63.83.53.13.7
Claims on public enterprises6.825.128.520.210.813.013.113.012.2
Claims on private sector10.59.813.24.44.53.93.42.92.6
Broad money24.339.230.328.522.020.019.519.019.0
Base money (annual percentage change)6.540.7−3.613.214.917.115.615.515.7
Velocity (GDP/broad money)3.643.493.903.623.413.323.213.123.03
(Percent of GDP, unless otherwise indicated)
Financial balances
Gross domestic savings5.212.816.515.911.313.714.114.615.5
Public savings4.54.35.74.94.65.15.35.55.7
Private savings0.68.510.811.06.68.68.89.19.8
Gross domestic investment23.627.234.632.627.229.429.329.329.3
Public investment14.919.626.524.318.820.920.720.620.5
Private investment8.77.58.18.38.48.58.68.78.8
Resource gap−18.4−14.4−18.1−16.7−16.0−15.7−15.2−14.6−13.8
External current account balance, including official transfers−4.1−0.7−6.6−6.4−5.7−6.0−5.8−5.6−5.2
Government finances
Revenue14.213.714.013.212.913.313.413.513.6
Tax revenue11.411.711.611.411.712.112.212.312.4
Nontax revenue2.82.02.31.81.21.21.21.21.2
External grants3.33.31.72.01.61.61.41.31.2
Expenditure and net lending18.818.516.918.017.517.617.417.217.2
Fiscal balance, excluding grants (cash basis)−4.6−4.9−2.9−4.8−4.6−4.3−4.0−3.7−3.6
Fiscal balance, including grants (cash basis)−1.3−1.6−1.2−2.8−3.1−2.7−2.6−2.4−2.4
Total financing (including residuals)1.31.61.22.83.12.72.62.42.4
External financing1.11.50.91.33.12.72.62.42.4
Domestic financing (not including privatization)0.50.00.51.51.61.41.41.31.4
Public debt339.437.832.838.641.743.746.348.049.0
Domestic debt21.115.614.919.721.022.323.825.126.2
External debt (including to the IMF)18.322.217.918.920.721.422.522.922.9
Overall balance of payments (in m illions of U.S. dollars)6851446−1067189500321350356356
Gross official reserves (in millions of U.S. dollars)1,9793,0442,2622,2182,5182,8183,1183,4183,718
(months of imports of goods and nonfactor services of following year)2.42.71.91.81.81.91.92.02.0
GDP at current market prices (billions of birr)379.2506.1736.6877.51,008.61,180.81,364.81,575.71,823.2
Sources: Ethiopian authorities and IMF staff estimates and projections.

Data pertain to Ethiopian fiscal year from July 8 to July 7.

Historical GDP statistics are official data and are subject to significant weaknesses. Applying plausible factor productivities would suggest that the annual GDP growth rate could be off by as much as 3 percentage points in recent years.

Including debt of major public enterprises.

Sources: Ethiopian authorities and IMF staff estimates and projections.

Data pertain to Ethiopian fiscal year from July 8 to July 7.

Historical GDP statistics are official data and are subject to significant weaknesses. Applying plausible factor productivities would suggest that the annual GDP growth rate could be off by as much as 3 percentage points in recent years.

Including debt of major public enterprises.

Authorities’ views

34. The authorities agreed on a restrained monetary stance to sustain single digit inflation but were more circumspect about any policy response to international food and fuel prices shocks. They noted that low nominal interest rates were necessary to finance public investment but agreed on the need to have positive or near zero real interest rates. They were also open to considering flexible pricing of securities for the conduct of monetary policy but indicated that this would be dependent on sustaining single-digit inflation for some time. They indicated that renewed NBE financing of the budget is consistent with the demand for base money and in the event that money demand conditions changed, direct instruments will be used. They also stressed that foreign exchange market pressures in the first half of 2012/13 reflected the uncertainty and a speculative element in the wake of Prime-Minister Meles’ passing away.

E. Financial Sector Policy and Inclusion

35. Access to finance in Ethiopia is mainly through the banking sector and to some extent the microfinance institutions; capital markets are yet to be developed. The country’s banking sector comprises one state-owned development bank and 18 commercial banks—including two state-owned, with one dominant, CBE, with assets representing about 70 percent of the sector total—as of May 2013. The remaining 17 commercial banks, mainly private, together account for the remainder. Out of a population of nearly 90 million, only 7.1 million have deposit accounts, i.e., less than 8 percent of Ethiopians have a banking account. The proportion of borrowers is even smaller (a mere 112,793). Access to finance in rural areas is limited, with only 31 microfinance institutions (MFIs) as of end-June 2012, providing financial services to 2.9 million clients. Fifteen insurance companies exist with each insurance branch serving on average a population of 335,000. The industry is not sufficiently developed to mobilize significant contractual savings.

36. Broadening financial inclusion could have a significant payoff in terms of economic growth. The limited reach of the financial sector constrains the opportunities for small entrepreneurs and savings instruments for the poor, subjecting them to vulnerabilities in the event of shocks. The structure and regulation of Ethiopia’s financial system contribute to these limitations. The authorities’ development strategy relies heavily on directed lending to public enterprises mainly by the CBE.

37. Commercial banks continue to be subject to the April 2011 directive requiring them to hold 27 percent of new loan disbursements in low-yield NBE bills. The proceeds of these bonds are transferred to the state-owned Development Bank of Ethiopia (DBE) which, according to the stated policy is supposed to on-lend them to government targeted private sector activities. However, an analysis of DBE balance sheet reveals that more than half of the proceeds are used to buy T-bills. This, combined with the policy of directed lending mainly to public enterprises in an environment of negative real interest rates, results in a significant transfer of resources from creditors (savers) to borrowers, especially the public sector.

38. The banking sector remains highly profitable despite a slowdown in overall credit extension to the economy. Overall credit to the nongovernment sector grew by 22 percent over the first 10 months of the fiscal year 2012/13 compared to 50 percent over the same period last year in the context of higher inflation. Of this, 79 percent was allocated to the public enterprises and the rest to the private sector. The authorities indicate that the composition of very short-term fast rolling-over borrowing of the public and private sectors was more even. Driven by aggressive expansion of the number of branches by banks, demand deposits increased by 16 percent while time and saving deposits increased by 22 percent over the same period. Owing to increased lending rates and net interest margins, profitability in the banking sector remains strong with return on assets of 3.1 percent and return on capital of 47 percent as of March 2013.

39. The NBE directive requiring banks to hold NBE bills equivalent to 27 percent of their lending has been distortionary and has triggered unnecessary portfolio adjustment by banks. Since the directive initially did not discriminate short-term from long-term loans, private banks adjusted their portfolios toward long-term loans to avoid high NBE-bills purchase due to higher turnover of short-term loans. They also raised fees and commissions to make up for lower returns on NBE bills holding. The subsequent amendment to the NBE directive also requires banks’ short-term loans to be at least 40 percent of total loans at any given time.

40. Staff reiterated the 2012 Article IV recommendation and suggested phasing out the 27 percent NBE bills holding requirement. The directive was introduced to provide funding to DBE for lending to priority projects. This modality is indirect and it would be better if DBE funds itself through bond issuance, supported by appropriate credit enhancements, including attractive pricing, as needed. In the interim, proceeds from this requirement transferred to the DBE and not yet committed could be used to increase credit for small scale entrepreneurs to promote financial inclusion. Purchase of T-bills by DBE from these proceeds should be substantially reduced and limited to the DBE’s day-to-day liquidity management requirements. In addition, the recent amendment of the NBE directive requiring banks to hold 40 percent of total loans in short-term loans should be withdrawn.

41. Although available financial soundness indicators (Table 8) do not point to immediate risks, the systemic importance of the CBE and the concentration of large exposures to single entities warrant strict supervision of compliance by the NBE. On the whole, the banking sector seems sound with aggregate CAR at 14.6 percent and system-wide NPL ratio at 2.4 percent as of March 2013. The NBE is strengthening its oversight of the financial sector through risk based supervision. NBE regulations set a limit of 25 percent of capital for loans to related parties and a limit of 15 percent of capital for a single borrower. These limits should be rigorously applied to the borrowings of public enterprises where they currently do not apply. The DBE should also be subject to similar oversight and supervision. Going forward, allowing greater role for private banks (including opening up to foreign banks) could reduce the systemic importance of CBE and the associated vulnerabilities (Table 1).

Table 7.Ethiopia: Millennium Development Goals
199019952000200520062007200820102011
Goal 1: Eradicate extreme poverty and hunger
Employment to population ratio, 15+, total (%)767575808080808079
Employment to population ratio, ages 15-24, total (%)707070737373727171
GDP per person employed (constant 1990 PPP $)1,3031,1891,2961,4411,5571,6881,8182,0012,087
Income share held by lowest 20%7998
Malnutrition prevalence, weight for age (% of children under 5)423529
Poverty gap at $1.25 a day (PPP) (%)2116108
Poverty headcount ratio at $1.25 a day (PPP) (% of population)61563931
Vulnerable employment, total (% of total employment)91919152
Goal 2: Achieve universal primary education
Literacy rate, youth female (% of females ages 15-24)283947
Literacy rate, youth male (% of males ages 15-24)39615863
Persistence to last grade of primary, total (% of cohort)616158403841
Primary completion rate, total (% of relevant age group)231523434748526258
Total enrollment, primary (% net)36.630.955818795102102106
Goal 3: Promote gender equality and empower women
Proportion of seats held by women in national parliaments (%)22212222222828
Ratio of female to male tertiary enrollment (%)222528323235444343
Ratio of female to male primary enrollment (%)655965838688899191
Ratio of female to male secondary enrollment (%)757966606367728287
Share of women employed in the nonagricultural sector (% of total nonagricultural employment)41444742
Goal 4: Reduce child mortality
Immunization, measles (% of children ages 12-23 months)383833384142505657
Mortality rate, infant (per 1,000 live births)1119887776562595452
Mortality rate, under-5 (per 1,000)18416114112210196908277
Goal 5: Improve maternal health
Adolescent fertility rate (births per 1,000 women ages 15-19)112103827772685853
Births attended by skilled health staff (% of total)6610
Contraceptive prevalence (% of women ages 15-49)5381529
Maternal mortality ratio (modeled estimate, per 100,000 live births)950880700510470350
Pregnant women receiving prenatal care (%)272843
Unmet need for contraception (% of married women ages 15-49)353426
Goal 6: Combat HIV/AIDS, malaria, and other diseases
Children with fever receiving antimalarial drugs (% of children under age 5 with fever)3310
Condom use, population ages 15-24, female (% of females ages 15-24)223
Condom use, population ages 15-24, male (% of males ages 15-24)201825
Incidence of tuberculosis (per 100,000 people)173182235276324308293269258
Prevalence of HIV, female (% ages 15-24)20
Prevalence of HIV, male (% ages 15-24)10
Prevalence of HIV, total (% of population ages 15-49)221
Tuberculosis case detection rate (all forms)1102559615054616972
Goal 7: Ensure environmental sustainability
CO2 emissions (kg per PPP $ of GDP)000000
CO2 emissions (metric tons per capita)000000
Forest area (% of land area)141413131312
Improved sanitation facilities (% of population with access)3491416171821
Improved water source (% of population with access)1420293739414244
Marine protected areas (% of total surface area)
Goal 8: Develop a global partnership for development
Net ODA received per capita (current US$)211510262733424242
Internet users (per 100 people)000000011
Mobile cellular subscriptions (per 100 people)0001122817
Telephone lines (per 100 people)000111111
Other
Fertility rate, total (births per woman)776655544
GNI per capita, Atlas method (current US$)250150130160190230280360370
GNI, Atlas method (current US$) (billions)1288121418223031
Gross capital formation (% of GDP)131820232423202526
Life expectancy at birth, total (years)474952555657575959
Literacy rate, adult total (% of people ages 15 and above)27363630
Population, total (millions)485766757779818385
Trade (% of GDP)142536515045424749
Source: 2013 World Development Indicators database
Source: 2013 World Development Indicators database
Table 8.Ethiopia: Financial Soundness Indicators of the Commercial Banking Sector, 2008–12(In percent, unless otherwise indicated)
Jun-08Jun-09Jun-10Jun-11Jun-12Mar-13
Capital adequacy
Regulatory capital to risk-weighted assets18.918.718.718.113.414.6
Regulatory Tier I capital to risk-weighted assets18.918.718.718.113.414.6
Capital (net worth) to assets10.19.69.17.86.76.6
Asset quality and composition
NPLs to gross loans6.86.03.52.11.42.4
NPLs net of provision to capital5.67.30.7−3.8−5.61.5
Spread between highest and lowest interbank rate
Earning and profitability 1
ROA2.93.24.03.04.13.1
ROE (total capital) 227.731.542.231.534.246.7
ROE (core capital) 329.834.046.434.955.8
Gross interest income to total income 454.957.160.154.454.7
Interest margin to gross income 546.150.638.740.045.0
Noninterest expenses to gross income36.627.828.028.726.6
Personnel expenses to noninterest expenses40.650.546.051.142.3
Trading and fee income to gross income53.949.461.352.055.0
Spread between reference loan and deposit rates7.07.46.46.46.4
Liquidity
Liquid assets to total assets31.530.832.732.720.619.7
Liquid assets to short term liabilities41.940.442.743.426.725.4
Total (non-interbank) loans to customer deposit 687.282.080.181.994.096.7
FX liabilities to total liabilities
Source: Ethiopian authorities.

Earning ratios indicated for March 2013 is provisional.

The average capital used to calculate the ROE includes retained earnings, profits and loss.

The average capital used to calculate the ROE excludes retained earnings profits and loss.

Total income comprises gross interest income and gross non-interest income.

Gross income comprises net interest income and total non-interest income.

Customer deposit includes time, current and saving deposits and total loans include bonds.

Source: Ethiopian authorities.

Earning ratios indicated for March 2013 is provisional.

The average capital used to calculate the ROE includes retained earnings, profits and loss.

The average capital used to calculate the ROE excludes retained earnings profits and loss.

Total income comprises gross interest income and gross non-interest income.

Gross income comprises net interest income and total non-interest income.

Customer deposit includes time, current and saving deposits and total loans include bonds.

42. Promoting financial inclusion is an essential requirement for pro-poor development. Staff supports the efforts the authorities are already devoting in this area. Among the promising avenues are seeking greater technology based penetration in rural areas to promote access to financial services; allowing banks to operate microfinance institutions with funding for on-lending purposes from international financial institutions eager to increase access in rural areas in low income countries, thereby giving time for domestic intermediation efforts to be created; and forging partnerships with international organizations with experience in rural and microfinance.

Authorities’ views

43. The authorities do not share staff concerns about the financial sector. They disagreed with staff assessment of the impact of the 27 percent NBE bill requirement arguing that private banks remain highly profitable. They disagreed that private banks are raising fees and commissions to make up for lower returns on NBE bills holding. The authorities indicated that NBE was vigilant in taking actions to mitigate any risks that would emerge. They had adopted risk-based supervision and assigned a desk officer to each bank and were holding monthly prudential meeting with banks as well as conducting quarterly credit and liquidity risk stress testing. In addition, implementation of World Bank financial sector capacity building recommendations was ongoing. The authorities acknowledged the CBE’s systemic importance and were confident in their close supervision of the bank. They considered an assessment such as under the FSAP premature until the capacity building exercise being undertaken was completed. While they would welcome technical assistance and knowledge sharing partnerships with international organizations with respect to rural and microfinance institutions, they saw risks in allowing IFIs to provide funding to MFIs.

F. External Policy

44. External competiveness has eroded and foreign exchange reserves cushion remains modest considering that foreign exchange sales are used to sterilize liquidity. Improved competitiveness—as a result of exchange rate adjustments in 2009–10—had fully given way by end-2011/129, with the exchange rate currently estimated to be overvalued by 10–14 percent (Annex II). In the absence of an active Treasury bill market, foreign exchange reserves have been the primary monetary policy tool to affect liquidity. Gross official reserves have declined since early-2012 and are currently at about 1.8 months of imports (Table 5)—compared to the reserve adequacy assessment, which points to the need for a much higher (6.8 months) cushion (Annex III). Going forward the real appreciation needs to be reversed in order to reduce vulnerabilities and restore competitiveness and foreign exchange reserves need to be replenished.

45. The NBE is targeting annual increases of US$300 million in gross international reserves over the medium term. This would maintain reserves at around 2 months of imports. Together with the expected replenishment of foreign exchange reserves of commercial banks, the target implies achieving an overall balance of payments surplus of 1 percent of GDP in 2013/14. The authorities expect to achieve this outcome through appropriate monetary and foreign exchange policies.

However, given the lack of monetary instruments for sterilization and the overvalued exchange rate, this could be challenging.

Authorities’ views

46. The authorities were of the view that in the context of their de jure managed float regime, the exchange rate was allowed to adjust to maintain competitiveness but it was very difficult to pin this down precisely and determine magnitude of the over- or under-valuation.

Key Structural Reforms for Promoting Inclusive Growth

47. There is a pressing need for policies to translate positive growth outcomes into stronger employment gains and further reduction in poverty and set off a dynamic, virtuous cycle of self sustaining and broad-based growth. Thus far, the informal agricultural and trade sectors have been the main drivers of growth. The authorities see economic diversification and increased competitiveness as vital to creating more formal sector jobs and achieving strong inclusive growth. Their strategy of quickly addressing major infrastructure gaps (mainly in power and transportation) is a major step toward achieving their objectives. The GTP envisioned the structural transformation of the country, with the public housing scheme, roads, railroads, hydro-electric generation plants, sugar factories and other projects transforming the national labor market. Technical and vocational training for construction workers is provided and the program Competence of Excellence has certified more than 400,000 individuals. However, availability and high turnover of qualified workers constitutes a major challenge for the execution of the projects included in the GTP. Staff emphasized that achieving these objectives would require correcting structural bottlenecks, strengthening financial intermediation, leveraging more the private sector, and reducing the costs of doing business.

48. Promoting financial deepening and inclusion in the country’s development model is crucial, as borrowing by the public sector risks crowding out the private sector in a context of limited savings. As in many developing economies, domestic savings in Ethiopia are low. Small and medium enterprises (SMEs) have very limited access to bank credit or other financial services. Over the first 10 months of 2012/13, 79 percent of total loans issued by the banking sector were allocated to the big public enterprises, with only 21 percent going to the private sector. Not surprisingly, in various business climate surveys, access to finance has been identified as one of the key obstacles to doing business. Enhancing access to credit (especially for agriculture and SMEs) will require efforts in many areas, including the elimination of the 27 percent NBE bill directive; training for entrepreneurs in the preparation of adequate business plans; improving credit reporting systems; and strengthening enforcement of lenders’ rights over collateral. Developing nonbank sources of financing such as contractual savings through promoting insurance companies and pension schemes should be considered to boost domestic savings. An assessment, such as under the FSAP, could provide a comprehensive diagnostic of the financial sector.

49. Promoting the private sector’s role in the country’s development model is vital. While Ethiopia has so far pursued a state-led development strategy, it may be approaching the limits of this strategy in engendering broad-based growth. A number of key sectors, especially manufacturing, are lagging behind and the scope seems wide for private sector involvement, while retaining control in some strategic sectors. In particular, opening up the telecommunication sector, sugar industry, and transport sector to private sector (including foreign investors) could attract new investments, improve efficiency and delivery of services, and increase public revenues.

50. Transforming agriculture with the aim of improving its productivity is the linchpin of the reform program. Transforming agriculture—which employs more than 50 percent of the labor force—from a subsistence into a commercial sector with value-chain linkages to manufacturing holds a great potential for reducing poverty. The authorities’ strategy involves better use of the land inputs and labor with growing needs of qualified and better remunerated workers; an agricultural credit insurance scheme; and the setting up of the Agricultural Transformation Agency (ATA) to help poor farmers improve their production technology. Staff welcomes these developments, which are contributing to productivity improvements.

51. Addressing the external competiveness issue is critical (Box 2). In the context of an overvalued exchange rate (10–14 percent), deteriorating terms of trade, and limited foreign exchange reserves, the authorities intend, going forward, to implement foreign exchange policy with a view of containing inflationary pressures. This policy—together with measures aimed at lowering domestic transportation costs, streamlining customs clearance procedures, putting in place needed infrastructure, and enhanced access to credit—should over time address the competitiveness problem. Staff’s analysis indicates that bringing more flexibility in the exchange rate to eliminate its overvaluation would better support the country’s economic development (Annex II).

Box 2.Ethiopia: Export Competitiveness and Diversification

Strengthening export competitiveness is critical to the success of authorities’ development strategy. In 2012/13, Ethiopia’s exports of goods and services amounted to the equivalent of some 13 percent of GDP, about the average over the past two decades. The commodity-heavy export structure is subject to developments in international markets and has tended to vary significantly over the years—ranging from 9 to 17 percent of GDP—without demonstrating a clear trend.

While exchange rate flexibility is critical, addressing structural factors are also important for improving productivity and performance of export industries. The cost of transporting goods to markets is high, but improved transportation links are expected to significantly lower these costs. Several major road projects are under way along with a railroad from Addis Ababa and Djibouti. Together with streamlined customs clearance and other government procedures, the authorities aim at increasing gradually farm-gate prices relative to export prices (farm-gate prices currently constitute only 60 percent of export prices), thereby improving the incentives for exports.

Ongoing and planned non-government investments—including in cold storage facilities and increased airline capacity—augur well for export diversification. The labor intensive cut flowers industry has the competitive advantage of low wages in Ethiopia which, in conjunction with a widening of export markets, should boost the nascent industry’s exports. The development of Ethiopia’s ample hydro-electric potential should also contribute to improved diversification of the export sector. Electricity exports to Kenya are expected to commence in 2014/15 and once the Renaissance Dam has been completed, electricity export is expected to increase further.

Ethiopia: Non-coffee Exports(US $, millions)
(US $, millions)
Sources: Ethiopian Authorities.

Labor-intensive manufacturing hold considerable potential for further export diversification. FDI into leather manufacturing and textile production indicate areas where Ethiopia seems to have a comparative advantage. Public sector investments in electricity and transport infrastructure would provide the necessary support for a scaling up of additional FDI into these and other manufacturing sectors. Their success will also depend on a competitive exchange rate.

52. Reforming the current tax structure with its heavy reliance on indirect taxes with the aim of making it more equitable will further support inclusion. Staff and authorities concurred that further technical assistances from the Fund’s Fiscal Department will be helpful in this regard.

Other Issues

53. Data provided to the Fund are adequate for surveillance, albeit with notable shortcomings and delays. Although GDP statistics in Ethiopia are subject to significant weaknesses, the national accounts compilation methodology improved considerably in 2011/12 and the authorities are continuing efforts to further strengthen their statistics. Staff has stressed the need to further improve national accounts data and offered technical assistance. Substantial information gaps on the health of the financial sector remain as the mission did not have access to detailed banks’ balance sheet data in order to undertake a banking sector diagnostic. In addition, fiscal and BOP statistics require improvements. For example, comprehensive public sector data, including on public enterprises, are still lacking and would be desirable for a proper assessment of public sector finances.

54. Ethiopia has yet to move to Article VIII status and maintains several exchange restrictions on payments and transfers for current international transactions that are not consistent with Article VIII.10 A unification of the official and parallel exchange markets would free up significant efficiency gains. Staff enquired about the terms of the 2006 China EXIM Bank Framework agreement with Ethiopia. The authorities indicated that the agreement is consistent with Ethiopia’s commitments under the IMF’s Articles of Agreement.

55. WTO accession negotiations are ongoing. Since the submission of the Memorandum of Foreign Trade Regime in 2006, four rounds of Working Party meetings have taken place. The authorities intended to join the WTO within the current development plan period, i.e., before end-2014/15, but this timetable may be stretched. Outstanding issues relate to domestic market access, including non-financial and financial services, state trading regime, and customs valuation practices.

56. Ethiopia’s anti-money laundering and combating the financing of terrorism (AML/CFT) regime is not in conformance with international standards. In consequence, Ethiopia continues to be listed by the Financial Action Task Force (FATF) as among the jurisdictions with strategic AML/CFT deficiencies that have not made sufficient progress in addressing them. The authorities explained the delay in addressing the FATF requirements by their interest in also ensuring compliance of their legal framework with the new FATF standard. In order to avoid further scrutiny by the FATF and possible counter-measures, Ethiopia should continue to work on addressing the long standing strategic deficiencies highlighted by the FATF, particularly in the areas of terrorist asset freezing and sanctions. In the meantime progress is being made in part owing to training provided by bilateral donors. Further technical assistance has been requested from the World Bank.

Staff Appraisal

57. Ethiopia’s public sector led developmental strategy has delivered robust growth and rising standards of living. Staff commends the authorities for their prudent macroeconomic management and the realization of robust growth and impressive progress in poverty reduction. Restrained fiscal and monetary policies have been instrumental in reducing inflation to single digits.

58. A restrained overall fiscal stance is essential for macroeconomic stability and sustaining growth. While the budgetary stance at the general government level has been restrained, staff urges the authorities to carefully monitor the operations of the overall public sector (including public enterprises) to properly calibrate the fiscal stance. Concentrating data collection on federal and regional governments, as currently is the case, provides only a partial view and fiscal policy would benefit from a more complete picture, including public enterprises, of the overall fiscal stance.

59. Staff applauds the authorities for their achievements and urges them to continue and strengthen the policies for inclusive growth. The poverty reduction strategies have achieved important results and the government’s focus on pro-poor expenditure has been paying off in terms of improved social indicators. The authorities should continue the momentum of revenue administration reforms and staff welcomes the ongoing reforms in public financial management to achieve the GTP fiscal objectives. Introducing measures to mobilize more revenue from income taxes and domestic taxes on goods and services equitably should be considered. Authorities should also consider adopting the FAD TA recommendations on rationalizing tax incentives and tax expenditures. Staff advises the authorities to strengthen the policies for inclusive growth, especially by making the tax system more progressive and maintaining and possibly expanding pro-poor spending as more revenues are mobilized.

60. Preserving these gains and mitigating vulnerabilities and risks in order to achieve the objectives embodied in the GTP would require continued cautious policy stance as well as private sector involvement. Ethiopia’s public sector led developmental strategy is now at crossroads. There is a need to carefully consider the balance between the public and private sectors in the economy. In light of the large financing need in the GTP, staff urges the authorities to reduce and streamline the role of public enterprises in the economy. Development of a strong and vibrant private sector is essential to sustain growth and attain middle income status. This would mean fostering competition in areas where public enterprises enjoy monopolies, gradually withdrawing from areas where they displace and crowd-out the private sector, and fully corporatizing and orienting outward through foreign partnerships those that remain. In particular, foreign direct investment should also be encouraged for example in trade logistics and communications sectors.

61. The transformational power of the private sector could be further harnessed to generate employment and sustain development. Opportunities for the private sector are an important dimension of inclusion. With its strong investment and trade capabilities, the sector could be a strong engine for creating employment opportunities for the youth. The authorities should thus strengthen competitiveness by improving the business climate and enhancing public private dialogue to better understand the needs of the private sector and create a supportive policy environment. They should also work with the World Bank—in particular its private sector arm, the International Finance Corporation—to incubate entrepreneurship for SMEs, youth, and women. They should increase vocational schools to address skills mismatch and support job creation for youth.

62. NBE needs to continue its focus on keeping inflation in single digits, as the risks are on the upside considering the still high nonfood inflation and potential of shocks to food prices. Staff suggests a cautious stance of monetary policy that keeps base money growth consistent with preserving the gains on inflation and achieving robust economic growth. Monetary policy will need to remain vigilant to increasing resource pressures and changes in broad monetary conditions taking into account the aggressive deposit mobilization by banks. It would also need to be supported by proper pacing of public enterprises’ investment and a reconsideration of the renewed NBE financing of the government budget deficit.

63. Staff urges the authorities to improve the efficiency and flexibility of NBE instruments, including through flexibility of nominal interest rates and development of market-based liquidity management. Avoiding the use of reserve requirements as the main monetary policy instrument and focus on developing indirect instruments to achieve the monetary targets should be considered. Flexibility would be needed to make T-bills an effective instrument for liquidity management. Staff underscores that, with inflation in the single digit, the timing is right for bringing flexibility in interest rates to increase domestic saving and to support inclusive growth. Raising interest rates should encourage saving which is important for scaling up investment, which in turn is vital for sustaining growth and broader inclusion.11

64. More broadly, introducing policy measures to support higher domestic savings should be explored. Consideration could be given to developing nonbank sources of financing such as contractual savings—e.g., (i) providing incentives for the emergence of more insurance companies; and (ii) strengthening pension schemes and other long-term savings instruments. Introducing mobile banking to increase access to finance is also vital to support inclusive growth.

65. Phasing out the forced 27 percent holding of NBE bills by commercial banks would help promote financial deepening and facilitate the GTP financing. The impact of this policy measure has been to crowd out private sector credit even if commercial banks are currently enjoying high profitability from higher non-interest income and interest rate spreads which is further squeezing out the private sector. Its phasing out would help realize the objectives of GTP in a much more sustainable manner. In the interim, at a minimum, the proceeds from this requirement that are transferred to the DBE should be used to increase credit for small scale entrepreneurs to promote financial inclusion. Purchase of T-bills by DBE from these proceeds should be discontinued.

66. Strengthening capacity at the NBE for supervision and formulation of financial policies to promote inclusion for all segments of the economy is crucial. This also encompasses banking supervision capacity to enable regular inspection of all banks and improve the quality of the analysis of banks’ soundness.

67. Staff supports the authorities’ objective of building foreign exchange reserves, while encouraging them to bring some flexibility in the exchange rate. Accumulation of foreign reserves initially to at least three months of imports would be desirable. Allowing more market-based movement of exchange rate with a view toward enhancing competitiveness and eliminating the spread between the parallel and official foreign exchange markets would be helpful. Using foreign reserves to manage liquidity in the context of a rigid (and overvalued) exchange rate risks external stability. In addition, better coordination of monetary and exchange rate policies with a view toward strengthening external competiveness on a lasting basis would be welfare improving.

68. Staff underscores the need for continued improvements in data quality. There are significant financial sector data gaps and fiscal and BOP statistics require improvements. Comprehensive public sector data, including on public enterprises, data would be desirable for a proper assessment of public sector finances.

69. Staff recommends that the next Article IV consultation with Ethiopia be held on the 12-month consultation cycle. This is in accordance with the decision on consultation cycles, Decision No. 14747-(10/96) (9/28/2010).

Annex I. National Accounts Statistics Issues

1. Ethiopia’s official national account statistics suffer from significant weaknesses. An IMF Statistics Department (STA) mission in March 2010 identified major compilation and estimation deficiencies and suggested corrective actions. The authorities developed a national accounts improvement and capacity building action plan which they have been implementing.

2. During the 2012 Article IV consultation, it was agreed that completion of a new benchmark GDP for 2010/11 and implementation of the improved methodologies being supported by East AFRITAC (AFE) would help improve official statistics. Since then, with the help of AFE, the authorities have made methodological improvements and published the 2011/12 national accounts based on the new benchmark which show a real GDP growth rate of 8½ percent, significantly lower than in recent years, reflecting in part lower growth in agricultural output.

3. The authorities need to continue to improve national account statistics and related capacity. In consultation with STA, the mission decided to use the official historical figures with a notation regarding data weaknesses and possible overestimation of GDP growth rates. This approach is consistent with the general practice of reporting official historical data in other countries with national account data deficiencies. Staff will continue to have its own projections, but at the end of the fiscal year will adopt official statistics based on the national accounts outturns with the appropriate caveat. Authorities expressed their disagreement about putting a caveat on their statistics. Staff stressed the need to continue to improve national accounts data and the readiness of the Fund to offer further technical assistance.

Annex II. Exchange Rate Assessment

1. The assessment of the exchange rate in Ethiopia for the fiscal year 2012/13, based on the IMF’s CGER methodology, suggested an overvaluation of the real effective exchange rate in the range of 10 to 14 percent, depending on the method applied. The estimated misalignment has slightly narrowed since the 2012 Article IV consultation. The standard CGER methods are (i) the macroeconomic balance approach, (ii) the equilibrium REER approach, and (iii) the external sustainability approach.

2. The macroeconomic balance approach indicates an overvaluation of 10 percent, because a REER depreciation of that proportion would align the current account with its equilibrium level. The current account is expected to sustain a large but reducing deficit in the medium term. With an estimated current account deficit of 6.4 percent of GDP in 2012/13, the deficit is expected to shrink to 5.2 percent of GDP in the next five years. The norm current account balance is also negative (4.5 percent), supported in part by the large inflow of remittances and international development aid that is expected to continue in the medium term. Large level of imports is forecasted in the medium term, mostly on petroleum products and heavy construction equipment. A 10 percent depreciation of the REER is necessary to close the current account gap.

3. The equilibrium real exchange rate approach shows an overvaluation of about 10 percent from the equilibrium REER derived from the medium-term macroeconomic fundamentals. This result is predicated on highly volatile terms of trade, a stable level of remittances, and government expenditure partially financed by large external transfers.

4. The external sustainability approach suggests an overvaluation of the REER of about 14 percent. This approach calculates the current account balance that stabilizes the net foreign asset (NFA) position at a sustainable level. Nominal GDP growth is estimated at 14.9 percent, and the underling current account deficit of 5.8 would result in a long-run NFA position of -41.6 percent of GDP. To sustain the NFA position at -24 percent (average of last five years), the current account deficit should be 3.1 percent of GDP, implying a depreciation of 13 percent in the REER.

Figure II.1.Ethiopia: Exchange Rate Assessment

Sources: Ethiopian authorities and IMF staff calculations.

Annex III. Reserve Adequacy Assessment

1. Ethiopia is a low-income country with an agricultural commodity export oriented sector and a high dependency on imported fuel and capital goods. The economy is exposed to potential terms-of-trade shocks and has a limited capacity to absorb them, given chronically low reserve coverage.

2. In addition, Ethiopia receives a large volume of private transfers from Ethiopians leaving abroad. These remittances averaged about US$3 billion in the last three years, an amount close to the value of total exports during the same period. The large trade deficit is also partially offset with important official transfers that reached US$1.7 billion in 2011/12.

3. From September 2011 to May 2012, international reserves contracted by more than US$1.5 billion as the government sold reserves in an attempt to control domestic liquidity. Since then, reserves appear to be growing again.

4. The reserve coverage has remained low in months of imports. By June 2013 reserves could sustain only about two months of prospective imports. Given the relatively high level of imports expected in the coming years, further accumulation of reserves is needed to improve the coverage and have some buffer to respond to possible deterioration of the terms of trade.

5. Reserves have stabilized in percent of broad money just above the 20 percent threshold. Although there are no large capital flows in Ethiopia, low reserves in the context of a pegged exchange rate could add to the evidence of an inadequate reserves level.

6. Reserve adequacy assessment based on Dabla-Norris and others (2011)1 shows that for a country with a fixed exchange rate regime and assuming the cost of holding foreign reserves is set at 5 percent (mid-point in the range of the marginal product of capital in low-income countries), the optimal reserve coverage would be the equivalent of 6.8 months of imports. The model evaluates various shocks in external demand, terms of trade, FDI, and aid flows for different cost levels of holding reserves. Remittances are not explicitly included in the calculation of the cost-benefit analysis, but a large and sustained inflow of foreign resources to Ethiopian households could imply lower reserve coverage for a given cost of holding those reserves.

Figure III.1.Ethiopia: Reserves

Sources: Ethiopian authorities and IMF staff calculations.

1Historical GDP statistics are official data and are subject to significant weaknesses. Applying plausible factor productivities would suggest that the annual GDP growth rate prior to 2011/12 could be overestimated by as much as 3 percentage points (Annex 1).
2Based on the international standard of US$1.25 a day, purchasing-power-parity adjusted (World Bank’s World Development Indicators, August 2013.).
3A forthcoming Selected Issues Paper, “Translating Economic Growth into Higher Living Standards: Inclusive Growth in Ethiopia,” provides an in-depth analysis of inclusive growth in Ethiopia.
4GDP statistics in Ethiopia are subject to significant weaknesses. Applying plausible factor productivities would suggest that the annual GDP growth rate could be off by as much as 3 percentage points in recent years. In the past two years, staff used its own estimates showing lower GDP growth. The methodology improved considerably in 2011/12 and the authorities are continuing efforts to further strengthen national accounts statistics. Staff has thus reverted to using official statistics, but has stressed the need to further improve national accounts data and offered technical assistance (see Annex I).
5Excluding public enterprises.
6Taking into account developments on the ground, in particular better than anticipated inflation at the end of the fiscal year 2012/13 and less severe negative real interest rates, staff has adjusted its projections, notably on broad money.
7Domestic financing and prospective external inflows amount roughly to two third of full financing of the GTP.
8Since 2012 FAD undertook a series of TA missions, recommending rationalization of tax incentives and tax expenditures. Staff alternative scenario suggests that annual tax revenue gain ranges from 0.4 percent to 2 percent of GDP over the next five years.
9The de facto exchange rate regime is crawling peg to the U.S. dollar and the de jure regime is managed floating. Adjustments to the peg took place in July 2009 (9.0 percent), January 2010 (4.8 percent), and September 2010 (16.7 percent).
10See Informational Annex.
11According to the Commission on Growth and Development (2008), for growth to be inclusive it is critical that it is sustainable (see also the October 2011 Regional Economic Outlook: Sub-Saharan Africa).
1Based on Dabla-Norris, Kim, and Shirono, 2011, “Optimal Precautionary Reserves for Low-Income Countries: A Cost-Benefit Analysis,” IMF Working Paper 11/249.

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