We held a client call with Melesse Tashu, Senior Macroeconomic Advisor to the Governor of the National Bank of Ethiopia (NBE), and summarise our key takeaways below. We thank Mr. Tashu for his time and contributions to this note.
Ethiopia has registered strong economic growth over the past decade and a half, averaging c8-10% per year. Covid has impacted key sectors like hospitality, air transport, and textile and leather manufacturing, but the overall impact has not been that bad and preliminary estimates put 2019/20 growth (ending June 2020) at 6% versus an initial 9% projection.
Key exports including coffee and flowers have performed surprisingly well, with overall exports rising 12% yoy in the year through June. While private transfers fell c13% yoy in 2019/20, they have also recovered in the past two months. As a result, the current account deficit actually narrowed in 2019/20 despite a drop in private transfers and tourism revenue, and reserves were down only slightly on the year to cUS$3.1bn and have since rebounded to US$3.3bn (albeit still low relative to imports, at 2.1 months using IMF import forecasts).
On the fiscal front, the 2019/20 deficit is estimated to have been broadly unchanged at 2.5-2.6% of GDP, with taxes actually rising 17.6% on the year despite the Covid-induced slowdown and bucking the recent trend of revenue under-collection. In addition, public sector external debt actually declined from 28.2% in the previous year to 26.6% of GDP. Despite increased social spending, the deficit is likely to remain broadly unchanged this year too, owing to conservative projections.
Lastly, on the monetary policy front inflation has continued to surprise to the upside, ending 2019/20 at 21.6% on the back of a series of shocks. Inflation slowed to 18.7% yoy in September, but it remains elevated. The NBE plans to gradually unwind its post-Covid liquidity injections to the banking sector this year to keep inflation on its present downward trajectory.
Although the macro outlook has generally surprised on the upside post-Covid, past growth has been driven mainly by public investment and there is a need to shift to a more private sector-driven growth model. To this end, the government has embarked on a three-pronged reform program focused on macro, structural and sector-specific reforms.
First, the NBE plans to modernise its monetary policy framework over the next two years by introducing a benchmark interest rate and other market-based liquidity management tools. Currently, the NBE targets base money but will transition gradually to a hybrid model of base money and interest rate targeting.
The NBE also plans to introduce a market-driven exchange rate regime in the next two years to address Ethiopia’s significant FX imbalances. Currently, there is a 24% gap between the official and parallel rate, which is down from c35% last year. The NBE hopes to reduce the spread to an insignificant level before introducing a managed float, which will facilitate the transition to a market-clearing exchange rate system alongside full current account convertibility.
Financial market liberalisation is another key pillar of Ethiopia’s reforms, including the launch of a domestic stock market. The NBE hopes to send draft regulations to the Council of Ministers shortly, with an eye to launching in early 2021, after the creation of the necessary regulatory bodies. In late 2019, the government also liberalised the T-bill market and repealed the regulation that mandates commercial banks to purchase securities issued by the NBE, the proceedings of which was channelled to the Development Bank of Ethiopia for lending to priority private sector projects.
The government has also embarked on a privatisation agenda, focused for now on the telecom and sugar sectors. Telecom licensing will likely be concluded in tH1 21 with partial privatisation of state-owned Ethiotelecom to follow. Removing barriers to foreign participation in the banking sector has not yet been addressed due to regulatory shortcomings, but a long-term financial sector roadmap is being developed by the NBE and will address this issue.
While this is an encouraging start, Ethiopia still has a number of highly indebted state-owned enterprises (SOEs) that the government has concluded cannot service the entirety of their debt. To resolve this problem, the government will take over a portion of SOE debt via a newly created asset management company, which will be financed with privatisation proceeds and is unlikely to need direct budget allocations in the near term. This will help ensure the solvency of the state-owned Commercial Bank of Ethiopia without a major cost to the government.
These reform efforts, alongside the commencement of power generation from the Grand Ethiopian Renaissance Dam by June 2021, will help promote Ethiopia’s post-Covid recovery. In the near-term, Ethiopia’s balance of payments remains fully funded with the support of the IMF and World Bank, and there are no plans to ask for further IMF funding at this time. Meanwhile, the Ministry of Finance is in the process of hashing out potential relief from bilateral creditors under the auspices of the debt service suspension initiative (DSSI), potentially providing a further cushion.
Overall, Ethiopia has been remarkably resilient in the face of the Covid shock and most major economic indicators have performed better than expected. Indeed, the IMF’s recently released WEO projections anticipate a return to 8-9% growth from 2022 onwards, a stabilisation of inflation in single digits, continually low budget deficits of 2-3.5% of GDP, a firm downward debt trajectory and a low current account deficit of 3-4.5% of GDP over the medium-term.
As we have previously written (here), Ethiopia is on the cusp of an important transition from a state to a private sector-driven growth model. Failure to do so will lead to a loss of growth momentum and push debt to unsustainable levels. However, the government’s ambitious reform agenda leaves us hopeful that it will be able to manage the transition and maintain its position as one of the star performers in the emerging and frontier universe.