a. Agriculture

The agricultural sector--including principally agriculture and livestock, but, to a marginal degree, the forestry, fishing, and hunting sub-sectors--is by far the most important sector in the Ethiopian economy, constituting more than 50 percent of GDP (1993/94), and employing more than 80 percent of the labor force (Appendix Table II).

b. Manufacturing

The manufacturing sector in Ethiopia is comprised of light manufacturing products such as construction materials, metal and chemical products, and basic consumer goods such as food, beverages, and textiles. The sector is mainly dominated by about 150 public enterprises (PE), which contribute more than 95 percent of the sector’s value added. The production of PEs is mostly concentrated in the food and beverages (50 percent) and textiles industries (15.3 percent); in addition, tobacco (12.4 percent), leather and leather products (6 percent), rubber, plastic, and cement (5.5 percent) are also important subsectors. ^2/ Private sector manufacturing activity, although on a much smaller scale, follows a similar pattern. Of about 150 private sector firms, most are involved in bakery products, textiles, footwear, and furniture production.

During 1989/90-1991/92, manufacturing was adversely affected by the escalation of the civil war; shortages of raw materials, foreign exchange, and fuel; and the frequent breakdowns arising from obsolete machinery and power failures. As a result, the share of the manufacturing sector in GDP declined steadily, from around 5.7 percent in 1989/90 to 2.2 percent in 1991/92. In 1992/93, the sector’s share increased to 3.8 percent, owing to a sharp rebound following the elimination of some of these constraints (mainly the greater availability of foreign exchange). The average capacity utilization rate of the Pes climbed to almost 70 percent, from rates as low as 20 percent in many industries at the end of 1991/92. In 1993/94, the sector’s share increased further to 4.5 percent, though this was in part due to the contraction in agricultural production.

In the short term at least, the sustainability of the recovery in the manufacturing sector is likely to be influenced by the rapidity with which the private sector responds to market incentives as well as by the capacity of the PEs to adapt to the more competitive market environment that has been recently introduced in the economy. With respect to the latter, as a result of the Public Enterprise Proclamation enacted in August 1992, PEs elect their own management boards, assume autonomy in their pricing and production decisions, and are no longer supervised by the Ministry of Industry. ^1/ The economic policy reforms that took place during 1992/93, most notably the liberalization of prices, the devaluation of the exchange rate, and the dismantling of the state distribution network, ^2/ have created an unusual economic environment for PEs. Although most PEs succeeded in increasing output from unusually repressed levels and in improving their financial viability, the change in the cost structures following these reform measures made direct adherence by the PEs to the former cost-plus pricing principle difficult, partly because of low demand at the new, much higher prices.

In certain sectors, the need for restructuring is particularly pronounced. For instance, the textile sector currently suffers from serious overstocking, owing to a combination of supply and demand problems that have been developing over years, and which became acute during the transition to a market economy. On the demand side, changing tastes as well as competitive prices offered by private sector firms--most importantly by contraband trade from neighboring countries and increased sales of secondhand clothing--have resulted in a serious disruption in sales. Production, on the other hand, has been continuing, owing to the temporary availability of cotton supplies, and the concern to keep firms operating, given their sizable work forces. The tobacco industry is faced with similar problems arising from weak demand. Obsolete machinery is a major problem in many sectors, most notably in the food industry.

c. Energy

Ethiopia is excessively dependent on traditional fuels consisting mainly of wood, agricultural residues, and animal waste. Only about 6 percent of Ethiopia’s energy needs is met from modern energy sources such as petroleum and electricity. As a result, deforestation, with its adverse impact on soil productivity, has been an extremely serious problem.

Power generated by hydroelectric plants supplies most of Ethiopia’s electricity needs (over 95 percent), with total installed electricity capacity at about 370 megawatts. Ethiopia’s rich hydroelectric potential, with 40 river basins, remains almost completely untapped. Greater effort is being made to develop such energy sources. The construction of a new hydroelectric plant (rated at 180 megawatts) was supposed to start in 1992 as a result of an agreement with North Korea. The agreement, however, is currently being renegotiated; four other hydroelectric projects are under study. After almost complete stagnation between 1988/89 and 1991/92, electricity production increased by 11 percent in 1992/93 and 8.5 percent in 1993/94, reaching 1.3 billion kilowatt-hours (Appendix Table XIX). Although only 2 percent of the hydroelectric potential has been exploited, the country has excess capacity at the present rate of consumption. Thus the Ethiopian authorities have been looking into the possibility of marketing electricity to neighboring countries and progress has been made in the construction of transmission lines for the export of electricity.

Ethiopia imports crude oil (mainly from Saudi Arabia) for processing at the Assab petroleum refinery, which is now owned by Eritrea. Ethiopia has a contract with the Eritrean Government for processing the crude oil imported by Ethiopia; the contract is renewed every year. Petroleum products refined at Assab are considered “Ethiopian output” and are either shipped to Ethiopia or sold to Eritrea as an export; about 20 percent of the products refined at Assab are sold in the Eritrean market, the remainder is used in Ethiopia. Transactions are settled in birr, and the prices are revised every quarter based on international market prices. Additional petroleum products are imported from outside (and paid for in convertible currencies), and principally include kerosene, gasoline, and gas oil.

Recently, important steps have been taken to develop new energy sources for Ethiopia, while reducing dependence on forests and the import of petroleum products. Financed under a World Bank loan, a project has been initiated to develop the natural gas deposits situated in the Ogaden region. The Calub gas reserves, estimated at about 2.7 trillion cubic feet (in two reservoirs of 0.7 and 2.0 trillion cubic feet), are significant, with the upper layer (0.7 trillion cubic feet) also estimated to contain substantial associated liquids (LPG, gasoline, kerosene, and diesel/gas oil). The project’s contribution is expected to reach approximately 70,000 tons of oil equivalent per year (or about 8 percent of the current consumption of petroleum and electricity), providing energy sources for urban consumption amounting to about 400,000 tons/year of fuelwood (about 18 percent of current urban consumption).

d. Mining

Mining and quarrying are relatively unimportant in Ethiopia, contributing less than 1 percent of GDP. However, based on the findings of geological surveys, it is estimated that there is substantial potential for expansion. The Ethiopian Mineral Resource Corporation (EMRC) is responsible for the overall management of Ethiopia’s mineral resources (except for marble) from the early stages of exploration through production and exporting; private sector involvement is encouraged to tap the sector’s potential.

Gold, Ethiopia’s most important natural resource, is concentrated in the Legedenbi area (500 kilometers south of Addis Ababa in the Sidamo region). Average annual production is about 3 tons, which is fully sold to the National Bank of Ethiopia (NBE) for export. A project financed jointly by the AfDB is expected to increase annual production capacity to about 4.8-5 tons by the year 1996, assuming that private sector involvement increases. In addition to primary gold (produced by modern techniques), small-scale production takes place in the same region. Production from such sources is estimated to be around 500 kilograms. Tantalite production is about 30 tons per annum, and is principally produced at a pilot plant, also located around Legedenbi. The production potential at this particular reserve is up to 200 tons, but output has been limited by the competitiveness of the international markets.

Potash deposits exist around the very northern tip of Ethiopia by the Eritrean border (close to the Red Sea). Soda ash is produced for local consumption only, for use in the production of glass, bottles, detergents, etc.; current production is about 20,000 tons. If access to world markets could be ensured, production could be raised to 1 million tons. Salt is produced in very small quantities in a localized manner; large quantities are mostly imported from Eritrea. A reserve is being built in the Afar region in the north-east, which is expected to produce about 300-400 million tons of salt. There is an iron ore deposit in the western part of Ethiopia. Although it is not expected to be very rich, the Government is undertaking a feasibility study. Marble is handled by Natural Mining Company, a private enterprise. West Wolega, East Hararge, and Tigray have particularly rich marble deposits.

e. Building and construction

The construction sector was particularly repressed in the last years of the previous government, declining by a cumulative 56 percent during 1988/89-1991/92; this largely reflected shortages in construction materials as well as the overall decline in economic activity. As a result, the sector’s share in GDP declined from 3.9 percent in 1988/89 to 2.1 percent in 1991/92. In 1992/93, along with the overall recovery in economic activity, the sector rebounded by about 17 percent. This strong performance continued in 1993/94, with the sector’s share reaching 2.9 percent of GDP after another year of strong growth (10 percent). However, the share of GDP has remained lower than in the pre-1989/90 period.

f. Transportation

The most common form of transportation in Ethiopia is road transport, accounting for more than 90 percent of all inter-urban freight and passenger movement. The jointly owned single track Ethiopia-Djibouti railway line, although in poor condition, handles most of the remaining load. Civil aviation is not yet very important, although Ethiopian Airlines is considered to have established a highly profitable network of international and domestic routes. Given the rural nature of the economy, nonmotorized transport is also significant in areas where roads have not been constructed.

Ethiopia’s road density is among the lowest in Africa, with an estimated 15.2 kilometers of road per 1,000 square kilometers. The main road network extends radially from Addis Ababa with few interconnecting links; large areas of the country have no linkage to regional and economic centers. The public road network in Ethiopia consists of less than 20,000 kilometers of main and rural roads. Of the main roads, approximately 3,500 kilometers are paved and roughly 8,000 kilometers are graveled. It is estimated that about 65 percent of these roads are in poor condition, with the deterioration in road conditions having intensified over the last decade because of a lack of maintenance.

In December 1992, central control of road transport operations was abolished and the trucking industry was deregulated. Specifically, zonal transport offices (Ketenas), established according to the Proclamation of 1976 to control and regulate commercial road transport operations, were closed. State control of freight rates was removed, and the centralized system of route and cargo assignment to private operators was liberalized. Although the state-owned Ethiopian Freight Transport Corporation (EFTC) is still the largest single trucking operation in Ethiopia in terms of its massive infrastructure (cargo reservation and maintenance facilities as well as load capacity), private sector participation has been increasing. By the end of 1993, in addition to 4,000 trucks that operated in association with EFTC, six private companies, with a capacity of about 1,450 trucks, have been established.

After having risen by about 30-40 percent following deregulation, freight rates subsequently declined to levels lower than those prevailing in the pre-deregulation period, which is partly due to the increase in the supply of trucks, depressed demand, and to some extent, competition from unlicensed operators. Rates appear to vary depending on routes; this is attributable to a number of factors, some of which are associated with problems encountered by the trucking industry, including poor road conditions, the aging fleet and high vehicle operating costs, and an imbalance in the freight cargo load between inbound and outbound routes.

With the independence of Eritrea (with its ports of Assab and Massawa), Ethiopia is now a land-locked country. Assab is the principal port for imports to and exports from Ethiopia. Imports of dry, bulk, and oil cargoes enter through Assab, while other goods, particularly food aid, enter through Djibouti. In addition, smaller quantities enter through Massawa for the northern regions. The government-owned Ethiopian Shipping Lines Corporation is the major shipping company servicing Assab; it owns 11 vessels, with a combined denarius weight (DWT) of 80,000 tons.

a. Overview

In 1988/89, owing to favorable economic growth and the strong controls associated with a centrally planned economy, revenue performance was good, with a revenue to GDP ratio of 23.1 percent, almost two thirds of which was from tax revenue. In the following two years, however, the revenue performance worsened progressively, largely because of the intensifying political crisis. By 1991/92, the revenue-to-GDP ratio had fallen to the very low level of 10.7 percent of GDP. The drop in nontax revenue was particularly strong (from 9.1 percent of GDP in 1988/89 to 2.9 percent in 1991/92), mainly reflecting a sharp deterioration in the profitability of public enterprises (with a dramatic decline in capacity utilization rates), and the inability of the Government to command profit remittances as in the past. During the past two years, the revenue-to-GDP ratio rose considerably, to 11.9 percent in 1992/93, and an estimated 13.6 percent in 1993/94. At the same time, a significant change occurred in the tax and nontax revenue structure with the change from a centrally planned to a market economy. Receipts from external grants also rose sharply during the past two years. Largely, this reflected receipts from donors associated with the World Bank-organized Emergency Recovery and Rehabilitation Program (ERRP), as well as grants provided by the European Union (EU), including the STABEX scheme and structural adjustment support.

b. Tax revenue

Tax revenue rose from a very low level of 7.8 percent of GDP in 1991/92 to 8.2 percent of GDP in 1992/93, and an estimated 10.7 percent of GDP in 1993/94, reflecting not only the economic recovery, but also the implementation of important tax and tariff policy reforms and successful efforts to strengthen the institutional capacity of the tax and customs administration. The composition of tax revenue during the whole period changed substantially; most notably, the share of direct tax revenue in total revenue declined from more than 40 percent in 1988/89 to about 31 percent in 1993/94; and the share of import duties and taxes rose substantially from 15 percent to 41 percent during the same period. In addition, export tax revenue declined from about 6.9 percent to 1.7 percent in the period 1988/89-1993/94.

The business profit tax and profit transfers from the public enterprise sector were the most important revenue instruments during the time of the previous government. These tax bases effectively collapsed at the end of the 1980s with the deteriorating performance of public enterprises and parastatals. Revenue from these sources reached its lowest level in absolute terms during the years 1991/92 and 1992/93, reflecting the aftereffects of both the economic and political crisis and the transition to a new Government. For the TGE, restoring tax revenue levels and revising the tax system in a way commensurate with the systemic change from a centrally planned economy to a market-oriented system were important tasks and formed an integral part of the economic reform program.

Specifically, prior to 1991/92, Ethiopia’s tax system was integral to the needs of a command economy; the tax system was very complex, it had a narrow base, and tax rates were set at punitively high levels. Tax assessment and collection methods were administratively cumbersome, although carried out under the discipline connected with a centrally planned economy. Tax reforms undertaken during 1992/93 and 1993/94 have focused on changing this system toward one that is consistent with a market economy, i.e., a liberalized economy with a rapidly growing private sector. These reforms have included a reduction of the maximum rate of the personal income tax and the rationalization of the large number of sales and excise taxes into a simpler system with fewer tax rates, and more services made subject to the sales tax. In a bid to broaden the tax base and make the tax system more equitable, the taxation of rental incomes was introduced. All export taxes other than on coffee were abolished. With the devaluation of the birr, the Government also sought to significantly reduce tariff rates. In addition, it eliminated the higher sales tax rate on imports, incorporating the differential rate into the new tariff structure (see below).

In the context of its regionalization policy, the TGE in 1992/93 delegated some tax collection tasks to the Regions, including the agricultural income tax and land-use fee, the profit and sales taxes on small-scale traders, and the personal income tax from regional government employees and enterprises owned by the Regions (see section II.4 below). Also, the TGE began to strengthen the tax and customs administration. In May 1994, steps were initiated to establish an autonomous Revenue Authority, comprising both the Inland Revenue Administration (IRA) and the Customs Administration.

Concerning specific taxes, after falling to a low level in 1991/92, revenue from the personal income tax increased slightly during 1992/93 and 1993/94 (see Appendix Table XXIV). The personal income tax is levied on the wages and salaries of civil servants and public enterprise employees. This tax was reformed in October 1992; the maximum tax rate was lowered from 85 percent to 50 percent, and the number of brackets was reduced from 17 to 10. However, this reform left the incidence for most low-income wage earners largely unchanged. Also, at the same time, substantial salary and wage increases took place in the public sector, which more than offset the negative impact of the reduction of the maximum tax rate on revenue.

With regard to the business profit tax, in 1993/94, a strong increase in revenue was achieved, reflecting the beginning of the recovery process in the economy during 1992/93; revenue from this tax rose by 43.7 percent compared with the previous year. ^1/ However, this was still lower than the level of receipts collected in 1988/89 and 1989/90. Taking into account the substantial improvements in capacity utilization and production output in both the public and private nonagricultural sectors, the buoyancy of the business profit tax during 1993/94 was lower than expected. Further improvements in revenue performance from this tax were hampered by tax evasion in the face of high tax rates, cumbersome collection methods, and the weak institutional capacity of the IRA and the Regional Finance Bureaus.

Other forms of income taxes yielded only limited revenues during the period under consideration. The rental income tax, which was introduced in July 1993, did not produce any noteworthy revenue in 1993/94, owing to delays in the preparation of directives by the Ministry of Finance for the collection of this tax by the Regional Finance Bureaus. General administrative weaknesses in the Regional Administrations also hampered revenue collections. Agricultural income tax and rural land-use fee receipts recovered considerably during 1992/93 and 1993/94, but were still limited by various factors. First, and most importantly, the land-use fee is uniform across the country and does not take into account the considerable variation in land quality and differences in cash-crop growing potentials; substantial revenue from the commercial farming sector is thereby forgone. ^2/ Second, the agricultural land tax, which has a maximum tax rate of 89 percent (but a flat rate of 50 percent for all incorporated commercial farms), has proven to be impractical from the perspective of the tax administration; collections appear mostly confined to the minimum tax of Br 10 per farmer. Third, although revenue from the agricultural income tax is largely collected in agricultural surplus areas (e.g., Oromia, Amhara), drought and production shortfalls in large parts of the country during 1993/94 made it impossible to increase revenue collection from this tax further.

Revenue from domestic sales and excise taxes also recovered during the past two fiscal years. After falling by almost 30 percent in 1991/92, receipts rose by 32 percent in 1992/93 and by another 13 percent in 1993/94. However, the increase in revenue in 1993/94 was much lower than expected, considering that the tax reforms introduced in August 1993 resulted in a broader tax base for the sales tax on services, and that higher exfactory prices prevailed for a large number of products. In part, the shortfall may be explained by an increase in arrears of about Br 50 million in sales and excise taxes from public enterprises in the textile, beverages, and tobacco sectors. These enterprises produced large stocks that they were unable to sell because of strong competition from smuggled imports (such as secondhand clothing, alcohol, and cigarettes), and noncompetitive output prices that reflected high production costs and the structural problems of the enterprises concerned.

Revenue from customs duties and taxes rose substantially in 1992/93 and 1993/94, reflecting both higher imports (especially from franco valuta imports subject to high tariff rates) and the impact of the October 1992 devaluation, which had a major effect on the value of imports in local currency terms, particularly during 1993/94. ^1/ Revenue from import duties and taxes rose by about 70 percent in 1992/93 and again by about 72 percent in 1993/94. The tariff reforms that the Government introduced in August 1993 also contributed to this outcome--despite a substantial reduction of the maximum tariff rate (from 230 percent to 80 percent) and a reduction in the average nominal tariff rate from 34 to 29 percent. ^2/ In addition, the Government has begun to restructure and strengthen the Customs Administration, involving both external technical assistance and the hiring of an external company charged with preshipment inspection. However, revenue was forgone as a result of the smuggling of goods, especially second-hand clothing, cigarettes, and alcohol via Djibouti and other neighboring countries. Recent protocols signed between the Government and neighboring countries (including Djibouti and Eritrea) should improve the exchange of information and result in a reduction of smuggling.

Not surprisingly, revenue from export taxes fell considerably from 1988/89 until 1991/92. In 1992/93, the Ethiopian Government abolished all export taxes, except for coffee, in a bid to promote the expansion and diversification of exports. ^1/ Owing to the recovery in the Ethiopian coffee sector, the devaluation of the birr, and rising world market prices for coffee since mid-1993, revenue from export taxes increased ‘Substantially during 1993/94.

During the past fiscal year, the Government made progress in its efforts to collect tax and customs arrears, although sales tax arrears from public enterprises have built up as mentioned above. At the end of fiscal year 1993/94, total tax and customs arrears amounted to about Br 640 million and Br 150 million, respectively, most of which had been incurred by public enterprises and parastatals prior to 1991/92. Involving the Supervising Authority for Public Enterprises, the IRA and the Customs Administration have started to negotiate repayment schedules, and agreements have been reached with a number of public enterprises and parastatals, including the Telecommunications Authority, the Ethiopian Shipping Lines Corporation, and some 15 other public enterprises from various sectors (e.g., grinding mills, printing press companies, and woodworking factories).

c. Nontax revenue

Nontax revenue is principally derived from public enterprise and parastatal receipts, consisting of capital charges, residual surplus, interest payments, and from 1993/94 onward, state dividends. ^2/ After having reached a historically high level of 9.1 percent of GDP in 1988/89, nontax revenue plummeted by two thirds until 1991/92, with the ratio to GDP declining to about 3.0 percent in 1990/91 and 1991/92 (see Table 2). The decline reflected the sharp drop in payments received from the public enterprise sector, resulting from the deterioration in financial performance and the inability of the Government to command profit transfers from these enterprises.

Table 2.

Ethiopia: Summary of Government Finance, 1988/89–1993/94

Source: Ministry of Finance; and staff estimates.

^1/Adjusted for extrabudgetary outlays financed from commercial external borrowing before 1991/92.

Table 2.

Ethiopia: Summary of Government Finance, 1988/89–1993/94

Fiscal year ending July 7				1988/89	1989/90	1990/91	1991/92	1992/93	1993/94
				Actual		Preliminary			Prel. est.
				(In millions of birr)
Total revenue and grants				4,698.2	3,544.0	3,179.0	2,640.9	4,158.7	5566.0
	Revenue			3,899.2	3,142.6	2,703.7	2,183.9	3,091.6	3,752.4
		Tax revenue		2,371.1	2,159.2	2,114.0	1,591.0	2,1353	2,955.1
		Nontax revenue		1,528.1	983.4	589.7	592.9	956.3	797.3
	Grants			799.0	401.4	4753	457.0	1067.1	1,813.6
Expenditure				6,032.5	5,785.2	4,943.5	4,141.6	6,028.5	8,2573
	Current expenditure			3,843.0	4,164.7	3,726.4	3,205.2	3,878.1	5,182.3
	Capital expenditure			2,189.5	1,620.5	1,217.1	936.4	2,150.4	3,075.0
Overall balance (commitment basis)				1,334.3	–2,341.2	–1,764.5	–1,500.7	–1,869.8	–2,691.3
	Excluding grants			–2,133.3	–2,642.6	–2,239.8	–1,957.7	–2,936.9	–4,504.9
Change in arrears on interest				--	44.1	81.4	80.9	--	--
Rescheduling of interest due				--	--	--	--	11.2	31.7
Overall balance (cash)				–1,334.3	–2,197.1	–1,683.1	–1,419.8	–1,858.6	–2,659.6
	Excluding grants			–2,133.3	–2,598.5	–2,158.4	–1,876.8	–2,952.7	–4,473.2
Financing				1,334.3	2,197.1	1,683.1	1,419.8	1,858.6	2,659.6
	External (net)			601.6	495.9	341.1	249.3	1,025.6	1,971.6
		Gross borrowing		748.8	552.7	400.6	300.1	1,111.9	2,082.6
			Capital budget	748.8	552.7	400.6	300.1	892.5	905.5
			Untied counterpart/cash	--	--	--	--	219.4	1,177.1
		Debt relief		--	--	--	--	356.7	434.1
		Amortization paid		147.2	56.8	59.5	50.8	443.0	545.1
			Scheduled repayment	147.2	388.3	392.3	473.4	443.0	545.1
			Arrears increase	--	–331.5	–332.8	–422.6	--	--
			Clearance of past arrears	--	--	--	--	--	--
	Domestic			732.7	1,701.2	1,342.0	1,1705	833.0	688.0
		Banking system		718.4	1,724.2	1,2222	1,159.0	833.0	516.4
		Other and residual		143	–23.0	119.8	115	0.0	171.6
Memorandum: Defense expenditure 1/				1,725.2	2,119.3	1,845.3	628.1	697.0	645.5
				(In percent of GDP)
Total revenue and grants				27.8	19.8	16.0	13.0	16.0	20.2
	Revenue			23.1	17.6	13.6	10.7	11.9	13.6
		Tax revenue		14.1	12.1	10.7	7.8	8.2	10.7
		Nontax revenue		9.1	5.5	3.0	2.9	3.7	2.9
	Grants			4.7	2.2	2.4	1.2	4.1	6.6
Expenditure				35.8	32.4	24.9	203	23.2	29.9
	Current expenditure			22.8	23.3	18.8	15.7	14.9	18.8
	Capital expenditure			13.0	9.1	6.1	4.6	8.3	11.1
Overall balance (cash)				–7.9	–12.3	–8.5	–7.0	–7.1	–9.6
	Before grants (cash)			–12.6	–14.5	–10.9	–9.2	–11.2	–16.2
Financing				7.9	12.3	8.5	7.0	7.1	9.6
	External (net)			3.6	2.8	1.7	1.2	3.9	7.1
	Domestic			4.3	9.5	6.8	5.7	3.2	2.5
		Banking system		4.3	9.6	6.2	5.7	3.2	1.9

Source: Ministry of Finance; and staff estimates.

^1/Adjusted for extrabudgetary outlays financed from commercial external borrowing before 1991/92.

View Table

Table 2.

Ethiopia: Summary of Government Finance, 1988/89–1993/94

Fiscal year ending July 7				1988/89	1989/90	1990/91	1991/92	1992/93	1993/94
				Actual		Preliminary			Prel. est.
				(In millions of birr)
Total revenue and grants				4,698.2	3,544.0	3,179.0	2,640.9	4,158.7	5566.0
	Revenue			3,899.2	3,142.6	2,703.7	2,183.9	3,091.6	3,752.4
		Tax revenue		2,371.1	2,159.2	2,114.0	1,591.0	2,1353	2,955.1
		Nontax revenue		1,528.1	983.4	589.7	592.9	956.3	797.3
	Grants			799.0	401.4	4753	457.0	1067.1	1,813.6
Expenditure				6,032.5	5,785.2	4,943.5	4,141.6	6,028.5	8,2573
	Current expenditure			3,843.0	4,164.7	3,726.4	3,205.2	3,878.1	5,182.3
	Capital expenditure			2,189.5	1,620.5	1,217.1	936.4	2,150.4	3,075.0
Overall balance (commitment basis)				1,334.3	–2,341.2	–1,764.5	–1,500.7	–1,869.8	–2,691.3
	Excluding grants			–2,133.3	–2,642.6	–2,239.8	–1,957.7	–2,936.9	–4,504.9
Change in arrears on interest				--	44.1	81.4	80.9	--	--
Rescheduling of interest due				--	--	--	--	11.2	31.7
Overall balance (cash)				–1,334.3	–2,197.1	–1,683.1	–1,419.8	–1,858.6	–2,659.6
	Excluding grants			–2,133.3	–2,598.5	–2,158.4	–1,876.8	–2,952.7	–4,473.2
Financing				1,334.3	2,197.1	1,683.1	1,419.8	1,858.6	2,659.6
	External (net)			601.6	495.9	341.1	249.3	1,025.6	1,971.6
		Gross borrowing		748.8	552.7	400.6	300.1	1,111.9	2,082.6
			Capital budget	748.8	552.7	400.6	300.1	892.5	905.5
			Untied counterpart/cash	--	--	--	--	219.4	1,177.1
		Debt relief		--	--	--	--	356.7	434.1
		Amortization paid		147.2	56.8	59.5	50.8	443.0	545.1
			Scheduled repayment	147.2	388.3	392.3	473.4	443.0	545.1
			Arrears increase	--	–331.5	–332.8	–422.6	--	--
			Clearance of past arrears	--	--	--	--	--	--
	Domestic			732.7	1,701.2	1,342.0	1,1705	833.0	688.0
		Banking system		718.4	1,724.2	1,2222	1,159.0	833.0	516.4
		Other and residual		143	–23.0	119.8	115	0.0	171.6
Memorandum: Defense expenditure 1/				1,725.2	2,119.3	1,845.3	628.1	697.0	645.5
				(In percent of GDP)
Total revenue and grants				27.8	19.8	16.0	13.0	16.0	20.2
	Revenue			23.1	17.6	13.6	10.7	11.9	13.6
		Tax revenue		14.1	12.1	10.7	7.8	8.2	10.7
		Nontax revenue		9.1	5.5	3.0	2.9	3.7	2.9
	Grants			4.7	2.2	2.4	1.2	4.1	6.6
Expenditure				35.8	32.4	24.9	203	23.2	29.9
	Current expenditure			22.8	23.3	18.8	15.7	14.9	18.8
	Capital expenditure			13.0	9.1	6.1	4.6	8.3	11.1
Overall balance (cash)				–7.9	–12.3	–8.5	–7.0	–7.1	–9.6
	Before grants (cash)			–12.6	–14.5	–10.9	–9.2	–11.2	–16.2
Financing				7.9	12.3	8.5	7.0	7.1	9.6
	External (net)			3.6	2.8	1.7	1.2	3.9	7.1
	Domestic			4.3	9.5	6.8	5.7	3.2	2.5
		Banking system		4.3	9.6	6.2	5.7	3.2	1.9

Source: Ministry of Finance; and staff estimates.

^1/Adjusted for extrabudgetary outlays financed from commercial external borrowing before 1991/92.

During the past two fiscal years, the ratio of nontax revenue to GDP remained relatively low. However, sizable profit transfers were derived from a number of public enterprises and parastatals, including the Commercial Bank of Ethiopia, the Telecommunications Authority, the Ethiopian Shipping Lines, the National Bonded Warehouse, the Petroleum Corporation, and the Agency for the Administration of Rented Houses. Also, profits remitted from the NBE increased substantially, to Br 90 million in 1992/93 and Br 151 million in 1993/94. A one-time boost in nontax revenue was recorded in 1992/93 through a grant payment from Israel associated with the earlier emigration of the Felashas (see Appendix Table XXIV).

In 1992/93, the Government initiated a process of restructuring in the public enterprise and parastatal sector. Proclamation No. 25/1992 was issued, through which about 160 of the total of more than 200 public enterprises and parastatals were given an autonomous status. According to this law, these state enterprises and parastatals are now formally under a Supervising Authority within the Prime Minister’s Office, but have autonomy in terms of wages and staffing policy, price policy, and investment and financing decisions (see also Section 1.7). While all other public enterprises and parastatals continue to pay capital charges, residual surplus and interest payments, those enterprises covered by Proclamation No. 25/1992 began to pay state dividends in 1993/94. The Government has devised a schedule, according to which those enterprises to be divested in the short term pay a higher state dividend (up to 90 percent of net profits) than those that will be retained under government ownership over the medium to long term (which will pay up to 50 percent of net profits). At the end of 1993/94, outstanding arrears from public enterprises and parastatals amounted to about Br 200 million, mostly from the period prior to 1991/92.

d. External grants

External grants plummeted from about Br 800 million (4.7 percent of GDP) in 1988/89 to about Br 460 million (2.2 percent of GDP) in 1991/92 as donors significantly curtailed their support of the previous government. During 1992/93 and 1993/94, the flow of external grants increased again, reflecting (i) the realization of counterpart funds from the sale of imported goods and foreign exchange associated with the ERRP; (ii) counterpart funds realized through the EU’s STABEX scheme; and (iii) donors’ recognition of the economic reform efforts of the TGE. In 1992/93 and 1993/94, Ethiopia received grants in kind and untied cash and counterpart funds amounting to 4.1 percent of GDP and an estimated 6.6 percent of GDP, respectively.

After having played only a very minor role before, counterpart funds generated from external grants and loans have become increasingly important for financing expenditures in the Government’s budget over the past three years. In 1993/94, total counterpart funds amounted to 3.6 percent of GDP and financed 14.4 percent of expenditures (see Appendix Table XXIX). However, in 1993/94, the generation of counterpart funds was below expectations, reflecting both lower aid flows than anticipated and the accumulation of arrears, mostly from the Agricultural Inputs Supply Corporation (AISCO) for the payment of fertilizer received under loans and commodity grants.

In April 1993, supported by the Fund and the World Bank, the Government concluded an agreement with a number of donors with regard to the budgeting and management of counterpart funds. Six donors have signed this Memorandum of Understanding on Counterpart Funds to date. ^1/ The agreement involves arrangements for the collection of counterpart funds in pooled accounts and the general principles to be followed in the utilization of counterpart funds, the most important of which is that counterpart funds should not be used to finance extra budgetary expenditures. In financing outlays from the pooled counterpart funds accounts, the Government agreed to adhere to a number of important principles, including transparency, verifiability, and cost-effectiveness. A Counterpart Funds Administration Unit (CPFAU) was subsequently established within the Ministry of Finance to monitor the application of the memorandum and any other matter relating to the collection and utilization of counterpart funds. With technical assistance provided by the European Union, the Ministry of Finance has begun to strengthen the capacity and authority of this unit in the management of counterpart funds.

a. Current expenditures

In line with the priorities of its economic reform policy agenda, the TGE in 1992/93 began to restructure current outlays in terms of the functional structure of the budget. Current spending on general services (including organs of state, judiciary, defense, public order, and security) and productive activities in economic sectors (e.g., industry, mining, and commerce) was contained; conversely, current outlays for basic economic infrastructure (e.g., roads) and social sectors (health, education, community services) were increased substantially. For example, current outlays for education and health, which had fallen to the low level of 2.8 percent in 1990/91, rose to 3.4 percent of GDP by 1993/94. In contrast, military spending, which had averaged 9.7 percent of GDP in the period 1988/89-1990/91, was cut back to 2.7 percent of GDP in 1992/93, and to 2.3 percent of GDP in 1993/94 (see Appendix Table XXV).

There was also a shift in the structure of the current budget when classified on an economic basis. Prior to 1992/93, the public sector wage bill was severely repressed, with a cap imposed on salary increases for all civil servants earning above Br 600 per month. Almost 80 percent of all employees in the civil service received salaries below Br 400 per month, while an estimated 40 percent of civil servants had salaries below the poverty line; this number appears to have risen to between 50 percent and 70 percent through 1992. ^1/ In October 1992, when the Ethiopian birr was devalued, the Government adjusted public sector wages to address this problem and to compensate for the expected cost of living increases associated with the devaluation. The minimum wage was raised by 110 percent, from Br 50 to Br 105 per month; percentage increases were substantially lower for higher salary grades. ^2/ Also, the general salary cap was abandoned. Despite the salary adjustment, in 1993/94, about two thirds of all civil servants still received salaries below Br 400 per month. Moreover, the October 1992 adjustment resulted in a further compression of civil service salaries; remuneration levels for high-ranking Government officials remain significantly below those of counterparts in the private sector.

The total wage bill increased from 5.8 percent of GDP in 1992/93 to 7.1 percent of GDP in 1993/94 (see Appendix Table XXVI), mainly reflecting the full impact of the October 1992 salary adjustment. Also, in 1993/94, costs associated with the regionalization policy contributed to the increase; in the context of rationalizing central government ministries and strengthening the regional administration employees, some 4,000 staff were transferred from the Central Government to the Regions (for details see Section II.4 on regionalization). However, this development masks the fact that the wage bill for military personnel was significantly reduced during the past two years.

Since 1991/92, the Government has not increased the total number of civil servants, and the automatic hiring of university and college graduates has been abolished. At the end of fiscal year 1993/94, the Government employed about 242,000 civil servants, including Central Government and Regional Administrations. In September 1993, the Government published a document on retrenchment policy, which provides guidelines and principles on the implementation of the planned retrenchment from both the civil service and the public enterprise and parastatal sector, including compensation programs and packages that will be made available.

Prior to 1991/92, outlays on materials and supply for operations and maintenance (excluding the military) had been allowed to deteriorate dramatically. Over the past two fiscal years, while outlays on materials for military purposes declined strongly, progress was made in terms of increasing materials and supply expenditures in other sectors. In 1993/94, total expenditures for materials rose slightly to 3.3 percent of GDP, although there was still an imbalance between spending on wages and expenditures for materials.

Outlays for grants and contributions comprise payments to international organizations, grants to individuals (e.g., scholarships), and grant contributions to various government institutions. Prior to 1991/92, general price subsidies for agricultural products (especially food grain), which were untargeted and heavily biased toward the urban population, featured prominently in the budget. ^1/ These subsidies were abolished in fiscal year 1992/93 except for a modest coffee price subsidy. In the following year, the coffee price subsidy was fully terminated, while a subsidy on fertilizer was introduced. This subsidy, which was targeted at about Br 50 million during 1993/94, was designed as a temporary measure to promote fertilizer usage among small-scale farmers and to increase agricultural production. ^2/ In 1993/94, higher-than-expected expenditures for drought relief were incurred through the Relief and Rehabilitation Commission (RRC). Pension payments rose modestly in 1992/93 and somewhat more rapidly in 1993/94, owing to the larger number of civil servants who took early retirement.

During the period 1989/90-1991/92, the Ethiopian Government began to accumulate external interest arrears, amounting to about Br 210 million. Through an agreement reached with Paris Club creditors in December 1992, the TGE was able to reschedule a substantial part of its foreign debt, including arrears (see Chapter VI.5). Consequently, the authorities were able to keep external interest payments at a relatively low level in 1992/93 and 1993/94 (0.5 percent and 0.6 percent of GDP, respectively). In contrast, domestic interest payments increased substantially during the past two fiscal years--from an average of 1.1 percent of GDP for the period 1988/89-1991/92 to 1.6 percent of GDP in 1992/93 and 2.8 percent of GDP in 1993/94. This reflects that a substantial part of the Government’s internal debt, totaling about Br 10 billion, and taken up mostly by the previous government at low interest rates (2-5 percent), has had to be serviced at the market interest rate of 12 percent since October 1992.

Expenditures directly linked to external assistance, and mainly in the form of grants in kind (including technical assistance), were relatively low until 1991/92, but rose strongly during 1992/93 and 1993/94. In part, this reflected high levels of food aid as well as a substantial USAID commodity grant to assist in the rehabilitation of the textile industry.

In 1992/93, the Government began to design social safety net measures for retrenched civil servants and employees from the public enterprise and parastatal sector as well as other groups adversely affected by the country’s political transition and economic reform program, including ex-servicemen of the previous government’s army, refugees and returnees, and other impoverished groups in the rural and urban areas. A steering committee was given responsibility for developing the Government’s policy in this area and supervising the implementation of safety net measures. The following elements are part of the Government’s safety net program: (i) public works programs for the unemployed, especially in the urban areas; (ii) agricultural production subsidies for ex-servicemen, refugees, returnees, and poor farmers; (iii) special projects for elderly people, the disabled, orphans and widows; and (iv) severance payments and other programs for retrenched civil servants and workers from public enterprises and parastatals.

During 1992/93 and 1993/94, the Government spent Br 37 million and about Br 50 million, respectively, on social safety net measures. However, the implementation of these measures occurred at a considerably slower pace than anticipated because of delays in the finalization of the safety net policy as well as in the preparation of guidelines and mechanisms for program implementation at the regional level. The generally weak administrative set-up in a number of Regions, and their general inexperience with implementing safety net programs, were also contributing factors.

Compensation payments to retrenched workers from the public enterprise and parastatal sector have been the most important safety net measures over the past two years. Severance payments and other compensation packages were made available for up to 20,000 workers who were laid off from the Ethiopian Building Construction Authority, the Maritime Transport Authority, and other public enterprises and parastatals, including state farms. Apart from providing severance payments, the Government has also begun to design a number of programs and projects specifically geared to this target group within the context of its retrenchment policy, including a revolving fund to provide credits for retrenched workers who want to start their own businesses.

b. Capital expenditures

Capital expenditures, which had been relatively large through the late 1980s, were sharply eroded in the last few years of the previous government. Capital outlays fell to 6.1 percent of GDP in 1990/91, and further, to 4.6 percent of GDP in 1991/92 (see Table 2), as the new Government sorted out its investment priorities and as the disruptions to government administration from the years of civil war were addressed. During the following two fiscal years, capital expenditures recovered to 8.3 percent and 11.1 percent of GDP, respectively, reflecting the new Government’s commitment to rehabilitate existing infrastructure and initiate new development projects as well as its reassertion of control over the central government ministries. During the past two years, this policy was supported by increasing external financing of capital projects; total external financing of capital projects increased from about Br 300 million in 1991/92 to about Br 900 million in each of the following two years (see Appendix Table XXVIII).

The implementation rate of the capital budget gradually improved from well below 70 percent in previous years to 71 percent in 1992/93, and an estimated 87 percent in 1993/94. Much of the emphasis during the early years of the new Government was on the completion of long-outstanding projects, rather than on the introduction of new projects. Even through 1993/94, much of the outstanding project portfolio is still in need of completion. During 1993/94, the Government embarked on a detailed assessment of its strategies in the different sectors. Together with the World Bank, the Government also engaged in a detailed Public Expenditure Review (PER), which played an important role in the formulation of the 1994/95 budget.

Within the capital budget, substantial expenditure restructuring took place during the past two years, with the focus shifting away from investments in general and economic services sectors, and toward projects in the infrastructure and social services areas. The share of investments in mining, industry, and commerce in the total capital budget fell from more than 25 percent in the years 1989/90 and 1990/91 to 14.8 percent in 1992/93 and 13.2 percent in 1993/94 (see Appendix Table XXVII). In contrast, the share of social services rose from 6 percent in 1991/92 to 12.5 percent in 1992/93 and 18.9 percent in 1993/94. Also, government capital spending on infrastructure (especially roads) increased considerably over the past two years. Within sectors, the TGE also began to shift its capital spending priorities; in 1992/93 and 1993/94, more emphasis was put on primary education and primary health care in the social sectors. In the agricultural sector, substantially less was spent on investments in state farms, while projects focusing on small-scale farmers received more attention.

a. Overview

In 1992, the TGE initiated a far-reaching regionalization policy through Proclamation No. 7/1992, which established 14 administrative regions and granted the right to establish self-governments by a “nation, nationality, or people” within prescribed areas. ^1/ This policy represented an important departure from the strong tendency of centralizing government administration under previous regimes, and an important step toward the establishment of fiscal federalism and the development of a democratic political system. In June 1992, elections for Regional Councils were held in most of the country, forming the basis for establishing Regional Governments. At present, owing to the merger of four Regions into one, there are 10 official Regions. ^2/

Proclamation No. 41/1993, which became effective in January 1993, established the respective powers and duties of Central and Regional Governments. It provided the legal basis for the establishment of 20 ministries and four commissions at the central government level, and outlined the powers and duties of these ministries and commissions, including the responsibility of giving assistance and advice to the Regional Administrations. Also, according to this Proclamation, each Regional Government was allowed to establish, as necessary, up to 20 regional bureaus, following very similar sectoral divisions as applied for the establishment of central government ministries. The Proclamation further outlined the powers and functions of these bureaus.

An administrative base is already in existence in a number of Regions, since the previous government had maintained 30 administrative regional centers. In a few Regions--notably Tigray, Amhara, Oromia, and Addis Ababa--the administrative capacity has traditionally been strong. Shortly after having initiated its regionalization policy, the TGE began to transfer staff from the Central Government to the Regions; by January 1994, about 4,000 professional staff had been redeployed to the Regions. There have also been movements of personnel between Regions. Substantially larger transfers are envisaged during 1994/95 within the context of the restructuring and civil service reform of the Central Government. This will address the recognized shortage of skilled personnel in many of the Regions. In 1993/94, the Government also began a program to strengthen Regional Administrations with support from UNDP.

b. Tax policy and revenues

Overall tax policies are set by the Central Government, but the Regions have substantial scope for designing and implementing their own tax instruments. Proclamation No. 33/1992, which became effective in October 1992, defined the division of revenue-sharing responsibilities between the Central Government and the Regional Administrations. Revenue instruments are categorized as regional, joint, and central instruments.

Regional revenue instruments include the rural land use fee and agricultural income tax; the profit tax and sales tax on individual traders; the profit tax, sales tax, and personal income tax from enterprises owned by Regions; the personal income tax from regional government employees; the rental income tax on property belonging to the Regions; the tax on income from water transportation; royalty and rent of land from other than large-scale mining activities; and charges and fees for licenses and services rendered by the Regional Governments. Revenue sharing applies to the profit tax, personal income tax, and sales tax from jointly owned enterprises; profit tax, sales tax, and personal income tax for incorporated businesses; all taxes on large-scale mining, petroleum, and gas operations; and forest royalties. The Central Government collects revenue from levies on imports and exports, the personal income tax on central government employees and international organizations, the profit tax on enterprises owned by the Central Government, the rental income tax for houses in the possession of the Central Government, taxes on lotteries, and fees and service charges on services provided by the Central Government. According to current practice, the Central Government collects revenue from the profit tax, sales tax and personal income tax on businesses operating across regional boundaries (e.g., transport companies) and other large-scale incorporated private enterprises, as well as the income tax, royalty and rents from large-scale mining activities.

c. Budget preparation and implementation in 1993/94

According to Proclamation No. 41/1993, each Region should prepare and implement its own current and capital budget proposals; regional budgets are then included in the overall consolidated budget of the Central Government. ^1/ This process was initiated for the first time for 1993/94, and it appeared to operate relatively smoothly, although only about half of the Regions were able to prepare their budgets independently. In the other Regions, the Ministries of Finance and Economic Development and Planning had to provide assistance to the Regional Finance Bureaus in forecasting revenues and budgeting current and capital expenditures. However, much progress has been made in the meantime; reportedly, most Regions were able to prepare the 1994/95 budgets without central government assistance.

In the budget preparation process for 1993/94, revenue forecasts were subject to a high degree of uncertainty with regard to the capacity of individual regions to collect revenue from the tax and nontax instruments legally assigned to them. Given the distribution of responsibilities for revenue collection and the existing ownership structure of public enterprises and parastatals, only about 20 percent of all revenue (Br 806 million) was expected to be collected by the Regions, while the Central Government would collect about 80 percent in the 1993/94 budget. There were also large differences in revenue shares of individual Regions; Afar, Oromia, and Addis Ababa accounted for about three fourths of the total revenue to be collected by Regions, while three Regions (Afar, Benshangul, Gambella) accounted for less than 1 percent each in the Regions’ revenue share (see Table 3).

Table 3.

Ethiopia: Distribution of Revenues, Expenditures and Central Government Grants, 1993/94 ^1/

Sources: Ministry of Finance; and staff estimates.

^1/Budget data.

^2/Block grants received from the Central Government.

^3/World Bank data.

^4/Southern Ethiopian Peoples’ Administrative Region (former Regions 7, 8, 9, 10 and 11).

^5/The extremely high expenditure per capita figure shown for Gambella Region may be the result of an underestimated population size.

Table 3.

Ethiopia: Distribution of Revenues, Expenditures and Central Government Grants, 1993/94 ^1/

		Revenues	Grants 2/	Expenditures	Population 3/	Expenditure per capita	Grants as a ratio of expenditure
		(In millions of birr)			(In millions)	(In birr)	(In percent)
Tigray (Region 1)		57.4	222.5	279.9	3.5	80.1	79.5
Afar (Region 2)		7.7	106.0	113.7	1.0	115.9	93.2
Amhara (Region 3)		113.4	583.7	697.0	13.3	52.5	83.7
Oromia (Region 4)		185.7	696.4	882.1	16.9	52.1	78.9
Somali (Region 5)		31.1	106.2	137.3	2.4	56.2	77.4
Benshangul (Region 6)		4.6	81.0	85.6	0.9	99.8	94.7
SEPA 4/		82.9	388.7	471.7	11.1	42.7	82.4
Gambella (Region 12)		2.6	62.5	65.1	0.1	451.8 5/	96.0
Harar (Region 13)		18.9	6.5	25.4	0.2	163.7	25.6
Addis Ababa (Region 14)		278.3	78.9	357.2	2.1	167.2	22.1
Dire Dawa		23.8	5.7	29.6	0.5	56.6	19.4
	Total	806.3	2338.2	3144.5	52.0	60.5	74.4

Sources: Ministry of Finance; and staff estimates.

^1/Budget data.

^2/Block grants received from the Central Government.

^3/World Bank data.

^4/Southern Ethiopian Peoples’ Administrative Region (former Regions 7, 8, 9, 10 and 11).

^5/The extremely high expenditure per capita figure shown for Gambella Region may be the result of an underestimated population size.

View Table

Table 3.

Ethiopia: Distribution of Revenues, Expenditures and Central Government Grants, 1993/94 ^1/

		Revenues	Grants 2/	Expenditures	Population 3/	Expenditure per capita	Grants as a ratio of expenditure
		(In millions of birr)			(In millions)	(In birr)	(In percent)
Tigray (Region 1)		57.4	222.5	279.9	3.5	80.1	79.5
Afar (Region 2)		7.7	106.0	113.7	1.0	115.9	93.2
Amhara (Region 3)		113.4	583.7	697.0	13.3	52.5	83.7
Oromia (Region 4)		185.7	696.4	882.1	16.9	52.1	78.9
Somali (Region 5)		31.1	106.2	137.3	2.4	56.2	77.4
Benshangul (Region 6)		4.6	81.0	85.6	0.9	99.8	94.7
SEPA 4/		82.9	388.7	471.7	11.1	42.7	82.4
Gambella (Region 12)		2.6	62.5	65.1	0.1	451.8 5/	96.0
Harar (Region 13)		18.9	6.5	25.4	0.2	163.7	25.6
Addis Ababa (Region 14)		278.3	78.9	357.2	2.1	167.2	22.1
Dire Dawa		23.8	5.7	29.6	0.5	56.6	19.4
	Total	806.3	2338.2	3144.5	52.0	60.5	74.4

Sources: Ministry of Finance; and staff estimates.

^1/Budget data.

^2/Block grants received from the Central Government.

^3/World Bank data.

^4/Southern Ethiopian Peoples’ Administrative Region (former Regions 7, 8, 9, 10 and 11).

^5/The extremely high expenditure per capita figure shown for Gambella Region may be the result of an underestimated population size.

Very preliminary data on the outcome of the 1993/94 budget suggest that on average, the collection of revenue by the Regions has been somewhat lower than anticipated. In general, both the budget data and the preliminary outcome of 1993/94 mask the fact that relatively large tax bases in a number of Regions, especially Oromia and Addis Ababa, have so far remained unexploited to a significant extent, notably the commercial sector in agriculture, the large numbers of unincorporated businesses in the industrial sector, and self-employed professionals in the services sectors. However, since Proclamation No. 33/1992 has become effective, Regional Administrations now have a strong incentive to improve their own tax and nontax instruments and intensify assessment and collection efforts on the group of taxes for which the revenue wholly accrues to the Regions.

The Regions are expected to finance about 25 percent of their total expenditure with own revenues, the other 75 percent being financed through block grants from the Central Government. These grants appear to have been allocated in a way that reflected the Regions’ own revenue potential as well as economic and development policy priorities and such criteria as population density. For example, taking into consideration its large revenue base, Addis Ababa (Region 14) was only allocated a relatively small grant from the Central Government, whereas those Regions with a very narrow own revenue base were expected to receive very substantial grants from the Central Government (Table 3).

On the expenditure side of the 1993/94 budget, the Regions were expected to be responsible for about 38 percent of total outlays, with roughly the same shares in the current and capital budgets, 38 percent and 37 percent, respectively. However, the Regions’ shares in individual sectors varied greatly, with the highest shares in health (85 percent) education (81 percent), and agriculture and natural resources (60 percent).

The analysis above (Sections II. 3 and II.4) has shown, that the implementation of budgeted expenditures during 1993/94 was hampered by the weak administrative capacity in the Regions. This was particularly so with regard to the execution of some programs under the current budget, notably social safety net measures. More importantly, capital budget implementationat the regional level was generally more difficult than originally envisaged. Until late into 1993/94, capital budget spending at the regional level was very slow and capital outlays were ultimately concentrated at the end of the fiscal year. It also appeared that in a number of Regions, capital budget implementation ratios were considerably below the level achieved by the Central Government.

d. Domestic and foreign financing

In 1993/94, the Regional Administrations depended on their own revenue and transfers from the Central Government to finance their operations; preliminary data suggest that Regions did not borrow from the domestic banking system. Although domestic bank borrowing by Regions is allowed de jure, de facto this has not yet happened. The Central Government has indicated its strong determination to contain domestic bank borrowing by the Regions. With regard to foreign financing (and external grants). The Central Government has full control over the negotiation and spending of foreign funds; moreover, the management of foreign currency is also reserved for the Central Government. Nevertheless, in 1993/94, the Central and Regional Governments have begun to develop a policy that will allow Regions a greater degree of autonomy to negotiate external grant assistance programs with donors.

a. Exports

Ethiopia’s main exports are coffee, gold, leather and leather products, chat, petroleum products, sugar and molasses, textiles, pulses, and fruits and vegetables (Appendix Table XXXII). Among these categories, coffee is by far the most important export good, constituting on average (1989/90-1993/94) about half of Ethiopia’s export value. Coffee exports were affected by low world coffee prices during the 1989/90-1991/92 period, as well as by restrictions in the domestic market and by an increasingly overvalued exchange rate. Increases in world coffee prices, devaluation, and domestic market reform stimulated coffee exports, particularly through official channels, during 1992/93 and 1993/94.

Since Ethiopia’s share in the world market is currently under 2 percent, receipts from coffee exports have been heavily influenced by exogenous developments in the world coffee market. Specifically, coffee prices declined sharply from 1988 to 1992, when they stood at their lowest levels in 20 years. Coffee prices only began to strengthen in 1993, especially during the second half of the year; price increases continued through the remainder of 1993/94. The main reasons for the rise in prices during 1993 were reductions in world stocks, as world production fell short of consumption, and the implementation of an export retention scheme by the major coffee-producing countries.

Ethiopian coffee also came under increased competition in the world market, especially for the high-end varieties for which it had been highly competitive. Reduced demand in some of Ethiopia’s principal markets for high-quality varieties of coffee (viz., Japan, Western Europe, and Saudi Arabia), together with the emergence of new suppliers of competing high-end varieties (such as Yemen), led to downward pressure on prices for some of Ethiopia’s high-quality coffee varieties such as Harar coffee.

Domestic market factors have gradually facilitated a strengthening in volume. The market was heavily regulated during 1989/90-1991/92, with the sector subject to marketing controls, restrictions on entry into the unwashed coffee export sector, the monopoly position of the government-owned ECMC regarding exports of washed coffee, and the overvaluation of the exchange rate. These factors reduced producer incentives and encouraged smuggling. ^1/ As a result, the volume of coffee exports dropped during 1990/91 and 1991/92.

However, the coffee market was substantially reformed during 1992/93 and 1993/94. The October 1992 devaluation substantially increased incentives for export. The export licensing system was streamlined and minimum capital requirements were eliminated for exporters in December 1992, lowering the cost of exporting coffee and opening up access to the coffee export market to a wider range of private traders. The reduction of coffee export taxes in August 1993 also improved incentives for coffee exporters. Importantly, the ECMC was split into separate domestic and export enterprises in November 1993, placing private exporters on an equal footing with the new ECEE. These reforms have improved incentives for exporting through official channels and for improving the quality of coffee by, for instance, improving harvesting and storage methods and by bringing more coffee beans to washing stations. ^2/ Many washing machines were destroyed during the change of government in May 1991 and these are now being rebuilt. As a result of these domestic market reforms, export volume nearly doubled during 1992/93.

With the recent strengthening of international coffee prices since summer 1993, Ethiopia’s coffee exports increased during 1993/94. However, the increase in export volume was less than expected, owing to the time needed for trees planted (following the change of government) to bear fruit, the diversion of coffee into the domestic market (as strong local demand boosted domestic prices above export prices), reduced government shipments in the months following reorganization of the former ECMC, and the roughly half-year lag between world coffee price increases and the pass-through into shipments for export.

Leather and leather products (hides and skins) are Ethiopia’s principal manufactured exports. In value terms, the share of hides and skins exports have fluctuated between 14 percent and 18 percent of total exports during the period, with 1992/93 exports at the lower end of this range, owing to a sharp drop in export prices (corrected for devaluation) during 1992/93. Starting from a high base in 1989/90, exports of hides and skins declined in terms of both value and volume during 1990/91 and 1991/92 because the sector suffered from an increasingly overvalued exchange rate, excessive regulation, and the effects of the war. During 1992/93, supply increased owing to devaluation, liberalization of domestic assembly activities, and integration of previous war zones into the national economy; this led to an increase in export volume and, correcting for devaluation, a decrease in export prices. Overall, export value increased substantially during 1992/93. The export volume continued to increase significantly during 1993/94 and this was accompanied by higher prices.

Exports of chat increased dramatically during the period, more than tripling in value terms from 1990/91 to 1992/93. This trend reflects the liberalization of the domestic market for chat, which was government controlled.

Petroleum products exports (surplus residues from the refining process of crude petroleum from the oil refinery at Assab, Eritrea) have followed the general trend in exports, dropping from 1990/91 to 1991/92 and then rising in 1992/93. The growth in export volume during 1992/93 (38 percent) was more than double that in export unit value, reflecting the increasing capacity utilization of the refinery at Assab.

In general, the volume of exports of pulses, oilseeds, oilseed cake, sugar and molasses, and fruits and vegetables has been affected by weather conditions and by changing foreign demand. Additionally, the export volume of each of these commodities fell very substantially during 1991/92, given the displacement of farmers as a result of the civil war. The loss in volume was especially significant for pulses, sugar, and molasses, given their historical importance in total export value. While there is substantial scope for increased exports of these commodities, developments during 1993/94 suggest that the potential for growth in these exports lies in the future. Gold exports in Ethiopia’s balance of payments consist of purchases of gold by the NBE from the Ethiopian Mineral Resources Development Corporation; an offsetting debit entry is contained in the capital account under short-term capital (net).

b. Imports

By end-use category, Ethiopia’s main imports consist of semifinished goods, crude petroleum and petroleum products, transport and industrial capital goods, and durable and nondurable consumer goods (Appendix XXXV). Other imports include raw materials and agricultural capital goods. Total imports (valued in birr) fell during 1991/92 and rose during 1992/93. Most of the increase in the birr value of imports during 1992/93 may be attributed to the 142 percent increase in the birr/U.S. dollar official rate (from Br 2.07 = US$1 to Br 5.0 = US$1) in October 1992; the average exchange rate for imports in 1992/93 depreciated by about 66 percent, while the birr value of total imports (excluding aircraft) increased by 97 percent. Most of the remaining increase in total imports can be accounted for by increased imports of crude petroleum, which expanded once an agreement had been reached with Eritrea on the terms for Ethiopia’s use of the Assab refinery. Imports of raw materials and capital goods were weaker than expected during 1992/93, principally because of delays in the implementation of projects under the ERRP.

The growth of imports during 1993/94 reflected the pickup of disbursements under the ERRP. Imports of cereals and other items, which had been expected to surge, reflecting the needs of those adversely affected by the erratic weather conditions of 1993, were held to normal levels, principally because of delays in the provision of drought relief supplies by donors, together with constraints at the port of Assab and in the making of deliveries to the interior of Ethiopia.

c. Terms of trade

Ethiopia’s terms of trade deteriorated modestly during 1990/91 and then recovered during 1991/92 (Appendix Table XXXVI). In 1992/93, Ethiopia experienced a terms of trade deterioration of over 20 percent, which was the largely to decreases in the export unit values of coffee, leather, and leather products associated with a weakening in world market prices. The terms of trade appear to have improved markedly in 1993/94, owing to stronger world prices for Ethiopia’s key exports; in the case of coffee, the rebound in world prices began in mid-summer 1993.

d. Direction of trade

During the period 1988-92, Ethiopia’s major trading partners were the European Union (EU), the United States, Japan, Saudi Arabia, Sweden, and the former Soviet Union (FSU) (Appendix Tables XXXIX and XL). During the period 1989-91, the share of imports from the EU averaged 41 percent of total imports (including commodity aid); the share fell to 35 percent during 1992. The share of Eastern European countries had been about 20 percent of total imports during 1989-90 (with the FSU by far the most important supplier), but fell to 3 percent in 1991 and 1 percent in 1992, as trade with the FSU dropped precipitously. Imports from the United States were steady at 5 percent of total imports except for 1991, when they rose to 13 percent. Japanese imports were fairly steady during the period at about 7 percent of total imports. Imports from Saudi Arabia, which had averaged 2 percent of total imports during 1989-1990, increased substantially to 10 percent during 1991 and 17 percent during 1992. Within Africa, imports from Djibouti more than doubled in birr terms during 1992, principally because of blockages at the port of Assab.

During the same period, Ethiopia’s exports to the EU averaged about 45 percent of its total exports. After having decreased to 39 percent in 1990, the EU’s share increased to 52 percent in 1991 and then dropped to 40 percent in 1992. There was a notable drop in exports to Germany, especially during 1992, owing to decreased demand for high-quality Harar coffee. Exports to the United Kingdom increased strongly in 1992. Exports to Eastern European countries amounted to 11 percent of total exports in 1989, falling to 5 percent in 1990, 1 percent in 1991, and 0.2 percent in 1992; this reflected a steady decline in purchases by the FSU during the period, which had been the largest export buyer in the group of Eastern European countries. The share of exports to the United States declined steadily over the period (from 15 percent in 1989 to 4 percent in 1992), while Japan’s share in total exports increased from 11 percent in 1989 to 23 percent in 1991, falling slightly to 22 percent in 1992. Saudi Arabia increased its share of total Ethiopian exports substantially, from an average of 8 percent during 1989-91 to 20 percent in 1992, owing to exports of coffee, live animals for religious ceremonies, and other agricultural products such as flour.

a. Overview

During 1988/89-1990/91, the annual growth rate of broad money increased from 8.9 percent in 1988/89 to 18.6 percent in 1990/91 (Appendix Table XLIX). The rapid growth in net domestic assets (NDA) was the major factor affecting the money supply; NDA movements mainly reflected variations in domestic credit to the Government, which depended on central bank financing for its budget deficits. In contrast, net foreign assets, which had once reached Br 576.4 million (US$ 278.5 million) at end-June 1986, fell sharply and became negative in 1989/90 before rising to Br 270.7 million in 1990/91. Interest rates were unchanged during the period.

From its inception, the TGE sought to adopt disciplined fiscal and monetary policies; as a result, broad money growth declined to 13.3 percent in 1991/92, and 14.0 percent in 1993/94; broad money growth increased to 16.2 percent in 1992/93, but this was a year when the currency was devaluated 58.6 percent in U.S. dollar terms. Compared with pre-TGE periods, the principal factor affecting the money supply shifted to movements in net foreign assets, reflecting the 1992 devaluation and the mounting inflows of foreign aid from the international community (Appendix Table L). In the meantime, the growth of net credit to the Government has slowed from its recent peak of 29.3 percent in 1989/90, declining to 10.6 percent in 1992/93, and further to 6.3 percent in 1993/94.

The velocity of circulation of broad money declined steadily during the period 1988/89-1991/92, from 2.97 in 1988/89 to 2.27 in 1991/92. It rose slightly to 2.49 in 1992/93, before declining again to 2.32 in 1993/94. ^2/ There was still an increase in velocity in the period 1991/92-1992/93, even when the change in birr currency notes in Eritrea during this period is excluded. The share of quasi-money (time and savings deposits of the CBE) in broad money decreased from 26.8 percent in 1988/89 to 22.8 percent in 1990/91, but subsequently increased to 26.5 percent in 1992/93 and 28.8 percent in 1993/94. It is likely that some of this increase reflected a movement of funds from non- interest-bearing narrow money to interest-earning deposits, given the large revision in the interest rate structure in October 1992.

Through the periods of the previous Government and the first year of the TGE (1991/92), overall domestic credit grew basically in line with developments in net credit to the Government. While domestic financing of the government deficit (including grants) rose from 4.3 percent of GDP in 1988/89 to 9.6 percent in 1989/90 and 6.2 percent in 1990/91, overall credit growth rose from 7.7 percent in 1988/89 to 17.1 percent in 1989/90, and then dropped to 11.9 percent in 1990/91. Domestic credit growth to the nongovernment sector, in sharp contrast, decelerated from 20.0 percent in 1987/88 to 1.2 percent in 1989/90 and turned negative, to minus 1.2 percent in 1990/91.

With the commencement of the structural adjustment efforts, the TGE began to reduce its deficit financing through the domestic banking system, with a small reduction in 1991/92 (to 5.7 percent of GDP), and more significant reductions in 1992/93 and 1993/94 (3.2 percent of GDP and 1.9 percent, respectively). Since 1992/93, the Government has attempted to ensure that overall domestic credit growth is consistent with the overall macroeconomic policy framework, rather than simply being driven by the pace of government credit expansion. Thus, the reduction in government credit expansion has been offset by an increase in credit to the nongovernment sectors (public enterprises, cooperatives, and private and individuals).

As briefly mentioned above, NFA became the major determinant of movements in broad money, as the TGE’s economic reform efforts gathered pace (including the impact of the devaluation) and as the inflow of foreign aid increased. During 1988/89-1990/91, the last three years of the pre-TGE period, NFA had contributed an annual average of 1.5 percent to broad money growth. Thereafter, NFA’s contribution increased from 12.9 percent in 1991/92 to 86.5 percent in 1992/93, and further to 132.8 percent in 1993/94.

It should be noted, however, that a literal interpretation of these figures would lead to an over estimation of the role of NFA, since some of the factors that explain this large contribution in the latter years had, in effective terms, no monetary consequences. Specifically, the effects of the devaluation, from 1992/93 onward, show up both as an increase in NFA as well as an offsetting increase in the valuation account component of “other items net” (OIN). Also, certain foreign-aid-related funds, which are of a “blocked nature,” were included in both NFA and OIN at the time that their ownership was transferred from the donor institution to the TGE (see below). ^1/

In effect, these NFA-related developments in OIN (in terms of the accounting of the monetary survey) simply result in offsetting developments in NDA, thus masking to some extent the TGE’s efforts to enhance credit to the nongovernment sectors. The NDA’s contribution in broad money developments declined as that of NFA increased and turned negative in 1993/94.

During the period 1988/89-1990/91, interest rates were effectively negative in real terms. In October 1992, the Government raised the overall level of interest rates, with a view to achieving positive real interest rates. The spread between deposit and lending rates was compressed somewhat, and the structure of rates was changed in order to eliminate all differentials by ownership and most of the differentials across sectors. Among sectors, agriculture, construction, and housing were treated preferentially by setting the lending rates slightly lower than for other sectors, in line with the Government’s development priorities.

c. Domestic liabilities of the monetary system

During 1989/90-1991/92, broad money grew at an annual average rate of 16.5 percent, which was substantially higher than the annual nominal GDP growth rate of 8.5 percent (Appendix Table XLIX). Despite the negative rate of interest on deposits (which averaged minus 9.7 percent based on the Addis Ababa Retail Price Index (AARPI) ^1/), quasi-money (interest-earning deposits) increased by an average of 12.3 percent, reflecting forced saving by the private sector owing to policies that restricted private expenditure. In 1992/93, the real interest rate on deposits increased to zero percent and, in 1993/94, to more than 5 percent; quasi-money increased by 28.5 percent and 24.2 percent, respectively, during these two years. The high growth in quasi-money was caused by a shift within households’ portfolios from real to financial assets, from non-interest -earning currency and demand deposits to interest-earning time and saving deposits. Between 1991/92 and 1993/94, the share of quasi-money in broad money increased from 23.9 percent to 28.8 percent.

Conversely, currency in circulation (cash), which increased 48.1 percent in 1990/91 as a share of broad money, declined steadily in importance, to 43.3 percent by 1993/94. The cash-dominant nature of the economy as well as the moderate response of cash demand to interest rate changes can be explained by several factors: (i) the primitive stage of development of payment systems such as time-consuming procedures for transferring and withdrawing money from the banks, the lack of networks, which makes it difficult for people to reach banks, and the high associated transactions costs of depositing funds at the banks; (ii) uncertainties regarding the political situation; (iii) a lack of information regarding banking services; and (iv) a lingering suspicion of banks in terms of their maintaining the confidentiality of an individual’s financial information vis-à-vis the Government.

Despite the ending of the discrimination in deposit rates, interest-earning deposits of public enterprises and cooperatives have shown little movement (Appendix Table LIII). During 1989/90-1991/92, savings and time deposits by public enterprises and cooperatives decreased from Br 23.9 million (0.7 percent of total deposits) at end-June 1989 to Br 19.5 million (0.4 percent) at end-June 1992, and then increased marginally to Br 28.1 million (0.4 percent) at end-March 1994. The latter increase can be explained partly by the growth of demand for liquid assets to cover the cost-push effect of devaluation, the elimination of budgetary support for certain enterprises, and the increased wage bill, which was financed from own resources.

In effect, as of March 1994, the private sector was virtually the sole depositor in interest-earning deposits, its share accounting for more than 99 percent of savings deposit and more than 96 percent of time deposits. The interest-rate responsiveness of short-term saving deposits was larger than that of time deposits in absolute terms, while the rate of change was smaller, owing to the difference in the size of both types of deposits (as of March 1994, private saving deposits stood at Br 2,753.0 million while time deposits were only Br 349.6 million). ^1/ The large magnitude of saving deposits is attributable to the low speculative demand for money of households rooted in low income levels.

d. Specialized banks

Loans constituted about 90 percent of the total assets of specialized banks and almost all of these loans were to the nongovernment sector. During 1989/90-1991/92, specialized banks’ lending to the nongovernment sector grew at an annual average rate of 5.4 percent; it grew 6.0 percent in 1992/93, and 7.6 percent as of end-December 1993. The AIDB has been the main vehicle for medium- and long-term lending and also deals with short-term lending to the agricultural sector. Agricultural credit, particularly to state farms, accounted for 76.2 percent of the AIDB’s total lending at end-December 1993, although most of those loans were nonperforming. The Housing and Savings Bank (HSB) extends loans for residential and commercial buildings to state enterprises, housing cooperatives, and private individuals. While the majority of loans in terms of the number of commitments are for residential buildings, the majority of loans in terms of loan amounts are for commercial buildings.

On the liability side of specialized banks’ balance sheets, as of end-December 1993, the major items were: borrowing from the NBE (57.0 percent of total liabilities), time and savings deposits (14.3 percent), and foreign loans--mainly from the IDA, African Development bank, and bilateral donors (7.9 percent). For the HSB, most time deposits were from the CBE, EIC and the PSSA, which carried a 1 percent interest rate.

a. Credit allocation

The NBE regulates and monitors loans provided by the banking system, and determines which activities are to be financed and under what conditions, particularly with regard to credit terms, maturities, and collateral. Each bank provides credit to the specific economic sectors in which the bank specializes, and all transactions that exceed certain amounts have to be reported to the NBE for approval ^1/. The CBE provides mostly short-term credits for working capital. The AIDB is the main source of credit for cooperatives and state farms in the agricultural sector and public and private enterprises in the other sectors. The HSB concentrates on activities related to building, including private dwellings.

Within the banking system, loans are, in principle, disbursed against physical collateral, such as vehicles or project plans (in the case of new projects). The formal collateral requirements of the banking system, viz., the ratio at the value of the collateral (estimated by the registered price of the collateralized good) to the amount to be borrowed, was revised in December 1992, when the ratio was reduced from 250 percent to 100 percent in the case of the CBE (the AIDB maintained its collateral requirement ratio of 125 percent). A joint working group (comprising of the NBE, CBE, and the Ministry of Industry (MOI)) has also been reviewing the formalities of the registration scheme and a possible broadening in the range of eligible forms of collateral (currently limited to only registered vehicles). Pending this review, agricultural machinery such as tractors, combines, and harvesters, which used to be rejected as collateral, have become acceptable as collateral as they have been registered by local regions. In addition, efforts have also been made to make the collateral requirements operationally more flexible for loans related to fertilizer imports, coffee exports, and transport vehicles (where no collateral is being required), and to differentiate the collateral policy according to customers’ credibility ratings.

In providing credit to the Government (through direct advances or the acquisition of Treasury bills and bonds), the recently issued Monetary and Banking Proclamation (Proclamation No. 84/1994, January 30, 1994) stipulates limits on the Government’s borrowing ability from the NBE and commercial banks based on the average annual ordinary revenue (AAOR) for the three preceding fiscal years for which accounts are available. Specifically, the outstanding stock of (i) direct advances (overdraft facility) from the NBE are not to exceed 15 percent of AAOR; (ii) treasury bills purchased by the NBE and other banks are not to exceed 25 percent of AAOR; and (iii) government bonds purchased by the NBE and other banks are not to exceed 50 percent of AAOR. ^1/ Regional governments are required to submit any request for bank financing to either the Ministry of Finance or the Ministry of Planning and Economic Developments, along with a feasibility study for any project requiring financing as well as the full regional budget and revenue forecast. Approval of the relevant ministries would be required, taking account of the overall financing constraints on the overall borrowing by the Government. Commercial banks are not allowed to extend direct advances or other credit facilities, whether directly or indirectly, to the Central Government and the Regions.

In the agricultural sector, loans were provided only to service and producers’ cooperatives and state farms in the pre-TGE period. Since 1991/92, the latter two institutions have either been dismantled or become insolvent. Newly organized cooperative societies (operating under a recently passed Proclamation) are able to receive deposits from and extend loans to their members. Nevertheless, a large majority of the rural population have little or no access to official credits, and are forced to rely on the curb market for loans. Despite wide recognition of the existence and importance of the informal market in the economy, relatively little is known about its working and structure.

Based on available information, two of the most important informal institutions are the iqqub and the iddir. The iqqub is a saving association based on pre-established homogeneous groups, where each member agrees to pay a small sum periodically into a common pool so that each member can, at a given point in time, borrow the full amount in the pool; when a loan is repaid, another member of the iqqub is then able to borrow (there is usually a specified sequencing of borrowers). Iqqub loans are lent at zero nominal interest rate. The iqqub is generally used for the purchase of consumer durables, payment of school fees, clothing, and the like. Depending on the size and location, some iqqqub have linkages with a bank. The iddir is a non-profit making institution based on solidarity, friendship, and mutual assistance among members. It runs an insurance program to meet emergency situations. The risks covered by iddirs include funeral expenses, financial assistance to families of the deceased, medical expenses, and losses due to fire or theft. Members have to pay certain amount to a common fund. Most of the common funds are deposited in a bank.

b. Reserve and liquidity requirements

The CBE is required to maintain, at the end of each week, ^1/ at least 5 percent of its total net deposit liabilities (defined as the sum of demand deposits, saving deposits, and time deposits, less uncleared checks paid and uncleared foreign effects) in a nonremunerated reserve account with the NBE and to hold liquidity (defined as the sum of cash, reserve deposits at the NBE, demand balances with other banks, and government securities maturing within 370 days) of at least 20 percent of their total net current deposits (defined as net deposits less deposits payable after 30 days of notice). ^2/ An NBE committee is currently working to establish a new ratio on the basis of Proclamation No. 84/1994. The CBE’s reserve and liquidity holdings at the NBE have consistently exceeded the legally required levels, owing both to the low levels of economic activity in the past and the binding effect of the credit ceiling recently imposed by the NBE in connection with the macroeconomic adjustment program. ^3/

c. Refinancing facilities

The NBE provides short- and long-term refinancing facilities to banks and other financial institutions. Owing to the considerable excess liquidity in these institutions, this refinancing facility has not been used since the mid-1970s for the CBE, while the bulk of the loans extended to the AIDB were converted to government bonds in March 1994 (see below).

d. Interest rates

In July 1986, the lending rates of the CBE and specialized banks were reduced in order to encourage investment. Rates were differentiated in order to favor certain sectors, including the state-owned enterprise sector. Time and savings rates were raised to encourage long-term deposits from small savers. These rates remained unchanged until October, 1992, when they were adjusted upward in order to realize positive real interest rates and eliminate differentials according to the type of ownership (Appendix Table LVIII). As of end-June 1994, sectoral differences in lending rates were narrowed but not fully liberalized, in order to make the changes more acceptable to the public and to provide some preferential borrowing rates for priority sectors.

Since October 1992, the lending rate to the Government from the financial sector has been 12 percent (revised upward from 3 percent) for short term loans and 13 percent (revised upward from 5 percent) for loans with maturity of more than over five years. Differentiation of rates by ownership ^1/ have been eliminated. In lending to other sectors of the economy, the preferential rates for housing construction, agriculture, exports, and imports of agricultural inputs (ranging from 4.5 to 7 percent) have been significantly reduced. As of end-June 1994, lending rates ranged between 10 percent and 14 percent according to sector. The term structure of lending rates to the nongovernment sector is slightly upward sloping, instead of being flat, as in the previous structure.

With regard to time deposits for individuals, savings and credit cooperatives, and self-help organizations, the term structure of interest rates is upward sloping, allowing greater returns to longer term deposits; interest rates on time deposits with a maturity of one year or longer range from 11.5 percent (revised from 6 percent) for one year to 12.0 percent (revised from 7.5 percent) for five years. Time deposits with a maturity of less than one year earn interest either 10.5 percent or 11.0 percent. Effective July 1989, savings deposits cannot be held by financial institutions and government-owned enterprises. Interest rates on savings deposits for individuals, savings and credit cooperatives, and private and self-help organizations have been revised upward to 10 (from 6) percent.

e. Payment system

Since there is only one commercial bank and neither a clearing house nor an interbank market exists in Ethiopia, the present payments system in Ethiopia is quite rudimentary. Intrabranch settlements are, in principle, conducted through branch accounts held at the head office of the CBE, except for some regional branches, which are given some autonomy to settle among branches in the same region. Money transfers are conducted by telegram, mail, or the issuance of draft (checks), followed by the sending of a credit summary as an official payment instruction in the case of the former two methods. A payment instruction is issued for all transactions (gross basis) and sent to the head office via mail, and the head office nets out the transactions and feeds them back to each branch with the results. The normal time lag between an actual transaction and its final settlement is about ten days. Interbank settlements (settlements among the CBE, HSB, and AIDB) are all conducted using the CBE account. The branches of the HSB and the AIDB open current accounts at one of the branches of the CBE and settle their transactions through certified payment order in the case of the Government or by cash payment orders (or drafts) in the case of the private sector. There are no cable transactions between the HSB and the AIDB. With respect to settlements between the CBE and the NBE, a reserve account held at the NBE is used, and both banks exchange daily a form of document that confirms the transactions that occurred during the previous day (i.e., a voucher system).

a. Restructuring and recapitalization of the AIDB

The AIDB was established to extend loans to the agricultural and industrial sectors. The AIDB drew its funds mainly by borrowing from the NBE, and loans were highly concentrated in the state farm sector with no collateral required. Owing to the serious operating inefficiencies of the state farms (and their consequent inability to repay loans), and the subsequent dissolution of many state farms since 1988/89, more than 90 percent of the AIDB’s loans to some 90 state farms (over Br 2 billion including principal and interest) were nonperforming. These losses destroyed the profitability of the AIDB and fully eroded its capital base.

To restructure the AIDB’s financial position, a proclamation was issued in December 1993, which allowed for the transfer of AIDB’s debt claims from the NBE’s books to those of the Government. A special interest-free Government bond with a maturity of ten years, with equal annual repayments ^1/, was issued in March 1994 by the Government in the amount of Br 1.3 billion to the NBE in exchange for the Government’s assuming the NBE’s claims on the AIDB. A similar, second special bond of Br 85 million was issued and exchanged for the AIDB’s remaining debt claims on state farm loans. In effect, combined with the drawdown of the NBE’s provisions for bad debt, the nonperforming loans for state farms financed by the NBE and AIDB’s own resources have thus been written off, and an independent trust fund established for the purpose of managing the sale or liquidation of state farms in default and for the application of proceeds to compensate the Government in its repayment of the special bonds.

With respect to the recapitalization of the AIDB, a proclamation is now awaiting gazetting, which will allow the AIDB to increase its capital to the level of Br 250 million (from a current loss position of negative Br 131.5 million). ^2/

b. New legislation

The Monetary and Banking Proclamation (No. 83/1994) was issued on January 30, 1994 and redefines the status, functions, and authority of the NBE under a free market economic environment. The legislation was formulated so as to provide for a stronger and more autonomous role for the NBE. The legislation states the NBE’s relations with the Government and other financial institutions through its supervision of credit, the setting of foreign exchange rates, and the framework of interest rate policy. The legislation stipulates that 20 percent of the net profit of the NBE is to be allocated to the General Reserve Fund, while 80 percent is to be credited to the account of the Ministry of Finance.

As noted above, the Proclamation “Licensing and Supervision of Banking Business” (No. 84/1994) was issued on January 31, 1994, and allows for the establishment and supervision of private domestic commercial banks (with equity participation limited to investors of Ethiopian nationality). It states the requirements for opening a commercial bank, including a minimum capital requirement ^2/ as well as the stipulation that banks can only be established on a limited share basis, ^3/ in order to protect a bank from the dangers that could arise from minority rule and decisions. The legislation also specifies that a minimum liquid assets position and reserve balance must be maintained and that the NBE is the sole organ allowed to issue a license to a financial institution. Upon receipt of an application for license, the NBE is required to decide on its acceptability within 90 days. No bank can pay dividends unless it has fully covered all of its capital expenses; at the end of each financial year, a bank is required to transfer at least 25 percent of its net profits to a Legal Reserve Account until the latter account reaches the required minimum capital amount. Subsequently, the NBE issued a directive in May 1994 that established criteria for the selection of the members of the Board of Directors of a private bank, fee rates, the content of application forms, and other relevant information that has to be submitted along with the application.

Finally, the “Licensing and Supervision of Insurance Business Proclamation” (No. 86/1994), which was issued on February 1, 1994, established the main requirements for establishing new insurance companies, including the minimum paid-up cash capital requirement (Br 3 million for the general insurance business, Br 4 million for the life (long-term) insurance business, and Br 7 million if both services are given). If an insurance company is established by a share company, each shareholder’s investment is limited to no more than 20 percent of the total equity. The law also specifies the requirements for the issuance of a license, the application for license, share registration, required capital, reserves, and solvency margin. This proclamation was followed by a Directive (No. SIB/1/94) in June 1994, which set the criteria for the selection of members of the Board of Directors of a proposed insurance company, as well as the fees, contents of the application form, and other relevant information that have to be submitted along with the application.