The Federal Democratic Republic of Ethiopia
Request for a 14-Month Arrangement under the Exogenous Shocks Facility-Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Federal Democratic Republic of Ethiopia

Facing declining reserves and high inflation, Ethiopian authorities have implemented an effective macroeconomic adjustment package supported by the IMF under the rapid-access component of the Exogenous Shocks Facility. The global recession is putting renewed pressure on the external position, via weaker export receipts and remittances and slowing inward direct investment. Supporting structural measures focus on tax reform, the control of public enterprise borrowing, and the control of liquidity through indirect instruments.

Abstract

Facing declining reserves and high inflation, Ethiopian authorities have implemented an effective macroeconomic adjustment package supported by the IMF under the rapid-access component of the Exogenous Shocks Facility. The global recession is putting renewed pressure on the external position, via weaker export receipts and remittances and slowing inward direct investment. Supporting structural measures focus on tax reform, the control of public enterprise borrowing, and the control of liquidity through indirect instruments.

I. Background

1. Ethiopia has faced a turbulent external economic environment of late, as commodity price movements and, later, global recession produced a series of shocks to the balance of payments. Rapid import growth, fueled in part by public spending, created pressure on reserve levels even prior to the surge in world food and fuel prices in 2007–08. The price surge then helped push reserves down to some $0.9 billion (1.2 months of imports) by mid-2008, while also contributing to an exceptional jump in consumer price inflation.

2. Concerns about declining reserve levels and rising inflation led the authorities to implement a macroeconomic adjustment package from late-2008, focused on fiscal and monetary tightening and the elimination of fuel subsidies. The package of policy adjustments was supported by a drawing in February 2009 under the rapid access component (RAC) of the Exogenous Shocks Facility (ESF), with ESF access based on the balance of payments impact of the commodity price surge.

3. The track record of both policy implementation and performance under the adjustment program has been strong:

  • Key policy targets—zero domestic borrowing by the general government, limits on public enterprise borrowings, elimination of fuel subsidies, exchange rate adjustment—are expected to have been met, although effective monetary control remains a challenge (see Box 1).

  • Key policy objectives—bringing inflation down sharply and partially rebuilding reserves—have been achieved, with inflation in the 12 months to June declining to 3 percent, aided by falling food price levels, and foreign reserves, helped by increased donor assistance, ending the year at some $1.5 billion (1.8 months of import cover).

uA01fig01

With good harvests and declining world food prices, inflation is subsiding.

Citation: IMF Staff Country Reports 2009, 296; 10.5089/9781451812855.002.A001

uA01fig02

International reserves picked up modestly with donor aid.

Citation: IMF Staff Country Reports 2009, 296; 10.5089/9781451812855.002.A001

4. The authorities anticipate that real GDP increased by some 10 percent in FY 2008/09, down only marginally from the 11.6 percent recorded in 2007/08: agricultural output is expected to have risen by some 6 percent, industrial output by some 9 percent, and tertiary sector output by 15 percent. Staff believe that underlying growth was on the order of 7–8 percent, with the recorded growth in tertiary output (averaging 15 percent over the past three years) likely overstating the true expansion of such activity.1

II. The Near-Term Outlook

5. The global recession is constraining export growth and limiting key external resource inflows, but the impact of these pressures on aggregate output is modest given the central role of subsistence agriculture. The authorities expect GDP to grow by at least 9 percent in 2009/10, with agriculture and industry, aided by weather conditions and progress with key infrastructure projects, growing at 6.2 and 8.7 percent, respectively. Staff believe that the underlying expansion in GDP is more likely to be around 7 percent: the financial program described below has been constructed around this more cautious growth assumption.

6. Following the dramatic movements in price indices over the past two years, single-digit inflation looks to be achievable over the current (fiscal) year, although high food price volatility and stubborn non-food price inflation (15 percent as of June 2009) are significant risk factors. The links between CPI movements and macroeconomic aggregates have not been stable (IMF Country Report No. 08/264, July 31, 2008), so further volatility cannot be ruled out—although the buildup of grain reserves should help to limit speculative price surges.

7. The balance of payments outlook for 2009/10 is troubling, as global recession takes a toll on remittances, exports, and direct foreign investment, oil prices move upward again, and the exceptional assistance provided by donors during 2008/09 falls away.2 Staff estimates suggest that, absent policy changes, reserves would decline by some $250 million this year, reversing about one-half of the rebuilding of reserves achieved in 2008/09.

III. The Authorities’ Program

8. The authorities are framing their macroeconomic program for FY 2009/10 around the twin objectives of maintaining price stability and building a stronger reserve position (Table 1).3 They have been encouraged by the results achieved with the FY 2008/09 adjustment program, but see important trade-offs between the two objectives, intensified by their intention to meet spending needs squeezed in last year’s adjustment program and to press ahead with their investment program. They see the appropriate resolution of these trade-offs as involving a combination of some easing of the fiscal stance, continued tight limits on public enterprise borrowing, maintenance of a cautious monetary policy, and gradual real depreciation of the birr.

Table 1.

Ethiopia: Selected Economic and Financial Indicators, 2005/06–2010/11 1/

article image
Sources: Ethiopian authorities; and IMF staff estimates and projections.

Except for data on external sector which is based on July 1-June 30, data pertain to the period July 8-July 7.

Excluding aircraft and telecom purchases.

Including debt of major public enterprises.

After enhanced HIPC and MDRI relief.

9. The authorities’ program for FY 2009/10 is outlined in the attached Memorandum of Economic and Financial Policies (Attachment I of the Appendix) and summarized below. Key quantitative objectives are: a) GDP growth of at least 7 percent; b) 12-month consumer price inflation of not more than 10 percent; and c) raising international reserves, inclusive of the financial support requested here from the IMF, to some $1.85 billion, equivalent to 2.1 months of import coverage by end-2009/10.4 The authorities are seeking Fund financial support for this program in the form of an arrangement supported under the high-access component (HAC) of the ESF.

A. Policies for the Public Sector

10. A surge in public sector borrowing levels was an important factor in contributing to widening macroeconomic imbalances during 2005–08: the authorities’ policy framework of 2009/10 therefore envisages continued tight control of domestic borrowing levels, combined with careful scrutiny of external borrowing and its associated implications for debt sustainability (see below). Public sector domestic borrowing will be kept to 3 percent of GDP in 2009/10, up somewhat from the 2008/09 level, but considerably less than the levels of previous years (see Text Table 1).

Text Table 1.

Ethiopia: Public Sector Domestic Financing

(In percent of GDP)

article image
Note. ETC and EAL are not planning any domestic financing in coming years.

11. The general government budget for 2009/10 envisages some easing of the tight limits on public spending imposed last year (see Tables 2 and 3). Revenues should rise by some 0.5 percent of GDP, aided by the elimination of the temporary VAT exemption for foodstuffs and the delayed impact of the past high inflation on income taxes; domestically-funded capital outlays would rise while recurrent outlays are maintained under tight control. The authorities underscored that the budget was heavily pro-poor in its orientation and that the rise in Treasury-funded capital outlays would be focused on the provinces, benefiting mainly smaller population centers and the rural population. The budget deficit is set to rise from 2.3 percent to 3 percent of GDP, financed by a mix of external and domestic borrowing; if aid inflows, whether in the form of loans or grants, exceed budgetary projections, the authorities intend to reduce domestic borrowing levels.

Table 2.

Ethiopia: General Government Operations, 2005/06–2010/11

(Millions of birr)

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

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

Debt relief from the IMF under the MDRI is recorded in 2005/06. Withdrawal from the special account at the NBE is assumed to take place from FY2006/07 and FY2007/08.

Excluding special programs (demobilization and reconstruction).

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

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

Demobilization and reconstruction.

Table 3.

Ethiopia: General Government Operations, 2005/06–2010/11

(In percent of GDP)

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

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

Debt relief from the IMF under the MDRI is recorded in 2005/06. Withdrawal from the special account at the NBE is assumed to take place from FY2006/07 and FY2007/08.

Excluding special programs (demobilization and reconstruction).

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

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

Demobilization and reconstruction.

12. The gradual erosion of the tax-GDP ratio in recent years is placing significant constraints on the government’s ability to finance its spending objectives. The authorities attach central importance to boosting revenue collections and are set to receive, in the coming months, technical assistance from the Fund’s Fiscal Affairs Department in evaluating current tax policies and tax administration. They intend to use the outputs from these missions in developing a new tax strategy, and are committed to preparing a time-bound plan by the time of the first program review. Development of a tax reform strategy is a structural reform priority for the proposed arrangement.

13. Public enterprises play a key role in several sectors of the Ethiopian economy, notably the provision of infrastructure. Government policy is that enterprise pricing should be based on the principle of full cost-recovery: an exception to this policy, now eliminated, was the subsidy on petroleum products via the Oil Stabilization Fund in place through late-2008.5 Borrowing levels of public enterprises are now subject to regular scrutiny to evaluate their macroeconomic impact, via an interagency committee that reviews enterprise borrowing on a monthly basis. Large public enterprises submit annual investment and financing plans to the committee, which reviews plans and their implementation and, where warranted, brings proposed remedial policy actions to senior policy makers. The committee is working to extend coverage of its operations to all significant borrowing units and will soon issue a formal notification to that effect to all agencies. Effective working of this oversight mechanism is a structural reform priority for the proposed arrangement.

B. Monetary Policy

14. Monetary policy is to focus on achieving the inflation objective (see Table 4). The monetary program is framed around controlling broad money growth, with reserve money as the operational target. For 2009/10, money growth will be limited to 17 percent, equivalent in size to the combined increase in real economic activity and the (end-of-period) price level: given the public sector borrowing program and the foreign reserve targets, this would make room for real growth in credit to the private sector on the order of 6 percent. The policy settings for the first semester of FY 2009/10 have been calibrated tightly to help entrench single-digit inflation against a backdrop of exchange rate adjustment; the full-year targets will be reviewed at mid-fiscal year in light of the inflation experience in the coming months.

Table 4.

Ethiopia: Monetary Survey, 2005/06–2010/11 1/

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

Year ending July 7. Including commercial bank claims and liabilities to Eritrea.

Claims on general government (federal and regional governments and other public agencies) by the banking system less deposits of the general government with the banking system.

Table 5(a).

Ethiopia: Balance of Payments, 2006/07–2010/11 1/

(Millions of U.S. dollars, unless otherwise indicated)

article image
Sources: Ethiopian authorities, and IMF staff estimates and projections.

Data pertain to the period July 1-June 30.

The 2009/10 PBS II disbursed by the World Bank in June 2009 is reflected in the 2008/09 balances.

Table 5(b).

Ethiopia: Balance of Payments, 2006/07–2013/14 1/

(Millions of U.S. dollars, unless otherwise indicated)

article image
Sources: Ethiopian authorities, and IMF staff estimates and projections.

Data pertain to the period July 1-June 30.

The 2009/10 PBS II disbursed by the World Bank in June 2009 is reflected in the 2008/09 balances.

Foreign reserves from 09/10 onward include IMF disbursements from the HAC ESF and SDR allocation.

15. Limiting the pace of monetary growth to the programmed level will require effective control of reserve money (see Box 2). The authorities intend to make systematic use of the regular auctions of Treasury bills to control liquidity, setting sales volumes on the basis of what is needed to meet reserve money targets. Effective liquidity forecasting will entail close cooperation and regular information-sharing between the National Bank of Ethiopia (NBE) and the Ministry of Finance and Economic Development (MoFED). These changes represent a significant break from past practice, and will require that interest rates on Treasury bills adjust to allow the target sales volumes to be realized. The authorities noted that excess liquidity has been a recurrent problem for them, only partially addressed through adjustments in reserve requirements; they therefore expected to face initial challenges in achieving smooth operation of the proposed approach. Assistance in support of this reform agenda is to be obtained from the World Bank’s financial sector capacity-building project.

C. Exchange Rate Policy

16. Ethiopia has a tightly managed exchange rate, classified by staff as a de facto crawl-like arrangement; the authorities describe their exchange rate regime as a managed float with no pre-determined path for the exchange rate. The pace of depreciation has been modest, partly to anchor price expectations, but there have been occasional discrete jumps in the exchange rate aimed at restoring tradable sector competitiveness. The most recent such move was on July 10th, when the birr was allowed to depreciate by some 9 percent.

uA01fig03

Exchange Rates

(In Birr per 1 U.S. Dollar)

Citation: IMF Staff Country Reports 2009, 296; 10.5089/9781451812855.002.A001

uA01fig04

Real and Nominal Effective Exchange Rates

(Index, 2007=100)

Citation: IMF Staff Country Reports 2009, 296; 10.5089/9781451812855.002.A001

17. High inflation in the past two years has been accompanied by significant real exchange rate appreciation, measured either in terms of the full consumer price index or the non-food price index (which may better track wage and other input costs, and hence competitiveness). Measured against the benchmark of average levels in 2003–07, the real effective exchange rate (all products) had appreciated by some 35 percent as of June 2009, having fallen from more elevated levels during the first 6 months of 2009; the corresponding net real appreciation based only on non-food prices was some 15 percent.6

18. The authorities agreed with staff that the exchange rate was overvalued at its June 2009 level; they viewed a real level closer to that observed in 2007 as being broadly appropriate from a medium-term perspective. Price competitiveness needed to be improved, but they argued that this could be achieved only gradually: they ruled out rapid adjustment via a large step devaluation on the grounds that it would revive inflation, only recently brought under control. They saw a step adjustment on the scale of that implemented on July 10th as an important move towards correcting overvaluation. They underscored their commitment to achieving, over the medium-term, an appropriate level for the real exchange rate and would not hesitate to adjust the nominal exchange rate for this purpose, if needed. Staff emphasized the overarching importance of boosting Ethiopia’s production of tradable goods and services, arguing that some further real exchange depreciation would likely be needed over time to achieve this objective.

D. External Debt Issues

19. Ethiopia’s external debt levels are rising significantly as major public enterprises borrow externally to finance infrastructure investment. The stock of debt (in NPV terms) is set to rise from $1.3 billion at end-June 2008 to $6.0 billion by end-June 2011, with almost 70 percent of the increase accounted for by the state-owned electric power (EEPCo) and telecom (ETC) companies. Given infrastructure weaknesses, the case for large-scale investment in these sectors is compelling but the sizeable and rapid build-up of debt underscores the need to ensure that borrowed funds are being put to effective use, that a supportive business environment is being put in place to ensure full take-up of infrastructure outputs, and that public enterprise pricing policy will ensure the full recovery of costs needed to facilitate debt service in the future.

Text Table 2.

Ethiopia: NPV of External Public Debt

(In billions of U.S. Dollars)

article image

based on 2008 DSA

20. An updated external debt sustainability analysis (DSA) yields similar conclusions to the DSA conducted as part of the 2008 Article IV Consultation process: Ethiopia is at moderate risk of debt distress: debt burden indicators are projected to remain below the policy-dependent thresholds but one threshold (the NPV of debt-to-exports ratio) is breached under four stress tests. While the conclusions are similar to those of the 2008 DSA, the debt profile shows significantly higher levels for debt indicators in the 2009/12 period, reflecting a combination of a) faster-than-projected disbursements on existing loans to ETC; b) additional new borrowings by EEPCo; and c) weaker export performance over the near term in light of weak global demand. Debt sustainability hinges on reaping strong returns, in the form of expanded output of tradables, from the large infrastructure investments.

21. The authorities currently envisage contracting, either directly or by providing a government guarantee, a number of new loans in 2009/10. Some of the loans under discussion may be extended on non-concessional terms—including a possible loan to Ethiopian Shipping Lines for the purchase of new ships and some further borrowing by EEPCo for investment projects. The authorities have indicated that the amount of nonconcessional loans contracted will not exceed $500 million during the program period; they have agreed to discuss in advance with staff the contracting of any sizeable new loans within this ceiling.

22. The authorities emphasized their commitment to carefully overseeing the evolution of public external debt, including that incurred by public enterprises. They indicated that they will keep debt levels under close review and will make every effort to ensure that new borrowings are contracted at concessional terms and that large foreign-financed projects are subject to rigorous economic appraisal before being approved. The mechanisms utilized to scrutinize the investment and external borrowing program of the public enterprises will be a topic covered, in coordination with the World Bank, as part of the first program review.

IV. Program Issues

A. Access and Capacity to Repay the Fund

23. Ethiopia is facing a difficult external environment. With low reserves and pressure on the balance of payments, there is a strong case for provision of Fund financial support under the Exogenous Shocks Facility (ESF). But Ethiopia also faces deep-rooted economic challenges as it pursues its development strategy and, while supporting the ESF request, staff advises the authorities to develop a medium-term reform program focusing on more entrenched balance of payments difficulties.

24. Staff calculations of the effects of the changing global environment on the balance of payments in 2009/10 yield an estimated adverse impact in the range of $260–300 million (125–140 percent of quota) (see Box 3). The estimates are based on comparisons of projected outturns in 2009/10 (on unchanged policies and a constant real exchange rate) with the 2008/09 outcome. The authorities argued that these estimates underestimate the net impact of the global crisis on Ethiopia, suggesting that a more appropriate measure would be to compare projected levels in 2009/10 with the levels that would have prevailed in the counterfactual where the global recession had not taken place.7

25. Staff is proposing access under the arrangement in the amount of 115 percent of quota (SDR 133.7 million), to be disbursed in three disbursements. Given the difficult external environment and the low levels of international reserves, it is proposed that 55 percent of quota be made available on approval of the arrangement, with two ensuing disbursements of 30 percent of quota. Front-loaded drawings under the ESF would support a more comfortable international reserve position for 2009/10 and enhance the credibility, and hence feasibility, of the authorities’ macroeconomic program.8 In conjunction with the proposed SDR allocation (totaling SDR 117 million, inclusive of both the general and special allocations), the provision of Fund support along these lines would raise import cover to some 2.1 months by June 2010 and to near 2.5 months of imports by June 2011.

26. The proposed financing from the Fund would complement substantial inflows from donors to Ethiopia. Donor aid flows jumped to $2.4 billion (7.2 percent of GDP) in 2008/09, as donors provided exceptional assistance to Ethiopia in responding to commodity price shocks. Aid flows are set to rise slightly in 2009/10, and would be up some 46 percent on 2007/08 levels. Proposed Fund assistance under the ESF, inclusive of the initial RAC-ESF drawing, would amount to some $290 million, equivalent to some 6 percent of donor aid flows during 2008/09 and 2009/10.

27. Ethiopia has adequate capacity to repay the Fund (see Table 6). Notwithstanding the high growth in public enterprise borrowings cited above, the DSA indicates that the various debt thresholds are observed in the baseline scenario and Ethiopia’s debt to the Fund would remain at modest levels throughout the projection period. The proposed access of 115 percent of quota would amount to about ½ percent of GDP; with full disbursement under the arrangement, debt to the IMF would amount to 2 percent of total public debt in 2010/11. Access under the proposed arrangement would raise the ratio of the NPV of debt to exports by 4 percentage points at its peak (from 135 percent to 139 percent), and does not affect the rating of moderate debt distress recorded in the DSA. Future repayments to the Fund would be modest in relation to exports of goods and services, peaking at some 0.6 percent of exports in 2016.

Table 6.

Ethiopia: Indicators of Capacity to Repay the Fund, 2009–20

article image
Source: IMF staff projections.

Assuming three semi-annual disbursements starting in September 2009, with access of 55, 30, and 30 percent of quota, respectively.

Data pertain to the period July 1 to June 30.

B. Risks to the Program

28. The immediate risks to the program stem from the uncertain external environment and from Ethiopia’s dependence on rain-fed agriculture; the election cycle, with national elections slated for mid-2010, could also affect developments. Weaker exports, remittances, and inward investment would put pressure on reserves or the exchange rate, the latter threatening the inflation objective. Any significant erosion of donor support would undermine both the external payments and budgetary positions. Ethiopia’s narrow export base and dependence on agriculture leave it vulnerable to weather shocks; the authorities are confident that near-term output goals will be achieved but a significant agricultural supply shock cannot be ruled out. Over the medium-term, output diversification and technical progress in agriculture will be key to limiting vulnerabilities: in the near-term, the authorities will need to move flexibly, supported by donors, to handle further adverse shocks.

C. Program Monitoring and Conditionality

29. Program implementation and its economic results will be subject to two reviews based on end-December 2009 and end-2009/10 performance criteria (Table 7). The program will be monitored on the basis of (a) quantitative performance criteria and benchmarks, set out in Table I.1 of the attached MEFP and defined in the technical memorandum of understanding; and (b) structural benchmarks, as specified in Table I.2 of the MEFP. The first review would be scheduled for completion by March 2010.

Table 7.

Ethiopia: Reviews and Disbursements Under the 14-Month ESF Arrangement

(In millions of SDR)

article image
Source: IMF staff projections.
Table I.1.

Ethiopia. Quantitative Performance Criteria and Benchmarks 1/

(In millions of birr, unless otherwise indicated)

article image

Cumulative flow from the start of Ethiopia's fiscal year (July 8).

Adjusted upward/downward for 100 percent of any non-project external assistance that exceeds/falls short of programmed amounts, subject to specified caps.

Adjusted upward/downward for 100 percent of any non-project external assistance that falls short of/exceeds programmed amounts, subject to specified caps.

Excluding the Ethiopian Airlines.

This shall be a continuous performance criterion.

Table I.2.

Ethiopia: Structural Benchmarks

article image