The Federal Democratic Republic Of Ethiopia: Staff Report for the 2015 Article IV Consultation—Debt Sustainability Analysis
Author: International Monetary Fund. African Dept.
Publication Date:
30 Oct 2015
eISBN:
9781513560038
Language:
English
Keywords:
ISCR; CR; authority; deficit; authorities' GTP; debt indicator; debt sustainability; creating flow; outlook hinge; sustainability framework; Debt sustainability analysis; Global
Download PDF (3.2 MB)

This 2015 Article IV Consultation highlights that Ethiopia's recent macroeconomic performance has continued to be strong overall, although with some rising domestic and external vulnerabilities. Economic growth in 2014/15 was buoyant, supported by booming manufacturing and construction sectors. However, inflation has been on the rise, with domestic food prices pushing it above 10 percent. External vulnerabilities have also increased as exports of goods and services slowed significantly, while imports continued growing fast. In the medium term, the IMF staff forecast strong growth at 7.5-8 percent. Public investment is expected to moderate, while private investment is projected to increase only gradually.

Abstract

This 2015 Article IV Consultation highlights that Ethiopia's recent macroeconomic performance has continued to be strong overall, although with some rising domestic and external vulnerabilities. Economic growth in 2014/15 was buoyant, supported by booming manufacturing and construction sectors. However, inflation has been on the rise, with domestic food prices pushing it above 10 percent. External vulnerabilities have also increased as exports of goods and services slowed significantly, while imports continued growing fast. In the medium term, the IMF staff forecast strong growth at 7.5-8 percent. Public investment is expected to moderate, while private investment is projected to increase only gradually.

Ethiopia’s external debt remains sustainable, but the risk of external debt distress has increased from “low” to “moderate” due to weak export performance and higher than expected non-concessional borrowing, reflecting faster execution of the government’s investment program. Over the longer term, a recovery in exports and a moderation of non-concessional borrowing would improve external debt indicators. In assessing the risk of external debt distress, the DSA calls for the use of judgment, focusing in particular on capacity to repay. In this regard, the fact that external loans are being used primarily to finance growth-enhancing infrastructure helps reduce the risk of debt distress. However, uncertainties related to foreign demand and foreign financing for investment present downside risks to export growth. Total public sector debt (domestic and external) also remains sustainable, though vulnerable to risks. To enhance debt sustainability, it remains essential to promote the growth and diversification of exports. Ensuring an appropriate pace of public borrowing—especially from external, non-concessional sources—is also critical to ensure that public investment does not undermine debt sustainability. These findings highlight the importance of having a medium-term debt management strategy, and of increasing oversight of state-owned enterprises, which have been in the lead for major infrastructure projects and thus have contracted much of the external, non-concessional debt.

Background and Key Assumptions

1. Ethiopia’s large-scale public investment in infrastructure has been financed by significant borrowing, which has resulted in higher public debt. Ethiopia reached the completion point under the Heavily Indebted Poor Countries (HIPC) Initiative in 2004 and benefited from debt relief under the Multilateral Debt Relief Initiative (MDRI) in 2006.1 Public and publicly guaranteed (PPG) external debt2 fell in the years that followed, reaching a low of 18 percent of GDP in mid-2012.3 It rose to 23 percent of GDP by mid-2014 (and total public debt was 42 percent of GDP).

2. The Debt Sustainability Analysis (DSA) prepared in 2014 concluded that Ethiopia’s risk of external debt distress was “low”, though on the cusp of “moderate”. No indicative threshold was breached in the baseline. However, the indicator showing the ratio of the present value of debt to exports (PVDE) temporarily breached the 150 percent threshold under the most extreme shocks scenarios. 4 With other risk indicators far below their respective thresholds, Ethiopia was considered a borderline case, for which the use of the probability approach was warranted. This analysis indicated a very low probability of debt distress, which underpinned the final assessment that Ethiopia’s risk of external debt distress was “low”. Incorporating remittances to determine the risk of debt distress did not change the final assessment.

3. Since last year, there has been a significant increase in disbursements of non-concessional external loans. The government issued a US$1 billion Eurobond in December 2014 (which had not been anticipated in the 2014 DSA), and disbursement of commercial loans to state-owned enterprises (SOEs) accelerated. In total, SOEs borrowed $4.1 billion during 2013-15, broadly as expected in the 2014 DSA. As SOE commercial borrowing is expected to remain significant in the coming years, the grant element of total public borrowing will fall further. However, as the large-scale public investment program begins to wind down and associated external financing for public enterprises declines, the non-concessional share of external financing is expected to fall for total external debt (general government and SOEs). Other key assumptions include:

  • Non-concessional loan disbursements will average about US$1.7 billion per year in the next five years, and around US$750 million per year over the entire projection period (FY2015/16-FY2034/35).

  • The maturity on all new external loans will average 26 years, and 13-16 years for new non-concessional loans.

  • The interest rate on all new external loans will average 2.2 percent, and 3-5 percent on new non-concessional loans.

4. The accelerated disbursement of previously contracted commercial loans to state-owned enterprises reflects the ramping up of Ethiopia’s infrastructure development. Total non-concessional borrowing in 2014/15 is estimated at US$4 billion. The DSA projects such borrowing to average US$1.9 billion over the next two years. Major ongoing projects include the following:

  • Ethiopian Railway Corporation: Awash Woldia / Hara Gebeya Railway Projects, the Addis Ababa Light Railway. Commercial disbursements are projected at US$2 billion through 2016/17.

  • Ethio Telecom: purchased US$1.1 billion of equipment using commercial loans during 2014/15.

  • Power related projects (mostly in electricity transmission): disbursements for the Genale Dawa dam and the final phase of the Gilgel Gibe III dam could reach US$0.6 billion.

  • US$1 billion Eurobond and other loans to support development of industrial parks, the sugar industry, and power transmission infrastructure; also expansion of the road network and Bole International airport in Addis Ababa.

5. IDA has reduced Ethiopia’s ceiling for new non-concessional borrowing to US$750 million for 2015/16 and, in principle, for 2016/17. The ceiling was lowered in July 2015 (from the US$1 billion ceiling that had been in place for 2012/13-2014/15) in light of rising risks of external debt distress. The reduced ceiling was seen as striking a good balance between encouraging the authorities to focus on concessional financing for public investment, while leaving room to tap non-concessional financing sources. At the same time, IDA revoked the 5 percent volume cut introduced for FY15 given that the authorities contained new non-concessional borrowing within the IDA limit of US$1 billion. IDA will continue to support Ethiopia on regular credit term.

6. The medium-term macroeconomic outlook remains broadly unchanged compared to the assumptions used in the 2014 DSA, though the outlook for exports is somewhat weaker (Box 1). Real GDP growth is estimated at 8.7 percent in 2014/15 and projected at 8.1 percent in 2015/16, reflecting strong public infrastructure investment and favorable agricultural production. The projected long-run GDP growth rate is maintained at 6.5 percent. Compared to the 2014 DSA, the outlook for the level of exports is lower, reflecting underperformance in 2014/15. Exports of goods and services are projected to rebound in 2015/16—growing at 19.5 percent—and sustain healthy growth over the following years, reflecting improved product diversification (for example in light manufacturing, horticulture, and electricity). Export growth is expected to taper off to 8.3 percent in the longer run. This fairly optimistic outlook faces downside risks if structural reforms are not sufficiently ambitious to address Ethiopia’s considerable competitiveness challenges. The uncertain global outlook presents another downside risk to export growth. Weaker economic growth in Ethiopia’s major trading partners could depress exports, and tighter global financing conditions could weaken FDI growth.1 With respect to China, slower economic growth is a risk for Ethiopia. However, a rebalancing of China’s demand towards consumption could boost Ethiopia’s exports to China, which so far have been primarily vegetable products.

Ethiopia: Macroeconomic Assumptions for the Baseline Scenario

Real GDP growth is projected at 8.7 percent in 2014/15, 8.1 percent in 2015/16, and at 6.5 percent over the longer term. CPI Inflation is projected at 8.5 percent in the long run. The primary deficit of the public sector is projected to average 2.7 percent of GDP during the next five years, with better tax collection largely offsetting large public investment and current expenditures. An improvement in the fiscal balance is constrained by the slow pace of improvement in revenue as a share of GDP, reflecting a narrow tax base, significant tax exemptions and tax expenditures, and tax administration challenges. Also, as import growth slows, revenue from customs duties may also decline as a share of GDP.

The external current account deficit (before official transfers) is estimated at 14.7 percent of GDP in 2014/15. Improved export performance, a slowdown in capital imports and steady remittances will lead to a gradual decline of the deficit over the longer term. Economic transformation is expected to ameliorate the large external imbalances, with more dynamic and diversified exports and a phase down in the imports of capital goods.

Exports of goods and services are estimated to have declined by 5.9 percent in 2014/15. Exposure to volatile commodity prices—especially for gold and oilseeds—largely offset gains in export volumes. A recovery in traditional exports and the development of new exports could raise average growth to 16–17 percent over the next three years, and 11.3 percent in the long run. Investments in industrial parks and targeted sectors that receive government support are expected to contribute to export growth and diversification. Imports of goods and services are projected to slow down but increase well above GDP in the medium term as demand for imported capital goods is expected to remain strong during the second phase of the GTP. In the long run, imports are expected to grow in line with domestic output.

Remittances have played a key role in supporting the balance of payments and in 2014/15 are estimated at 7.4 percent of GDP. Economic stability in Ethiopia and solid growth in developed countries is expected to keep remittances rising in dollar terms but declining to 2.7 percent as a share of GDP by 2034/35.

Foreign direct investment is projected to increase from 3.6 percent of GDP in 2014/15 to 5.0 percent in the medium term, reflecting improved competitiveness and policies to attract foreign investment.

The exchange rate is expected to remain determined by the NBE’s crawl-like arrangement with the real effective exchange rate remaining constant over time. Export growth will be driven by FDI, domestic investment, competitiveness reforms, better infrastructure, and labor productivity gains.

7. The authorities requested that Ethio Telecom be excluded from the DSA. In their view, Ethio Telecom meets most of the conditions for exclusion of an SOE: it is run as a commercial entity, its external commercial loans are not guaranteed by the government, and audited financial statements indicate its profitability. While some audited reports for Ethio Telecom have now been made available to staff, they are only through 2012, and do not provide sufficient information to assess whether there may be remaining contingent liabilities that could pose risk for the government. The government expects to have more recent audited financial reports for Ethio Telecom available in the coming year. The 2015 DSA includes Ethio Telecom’s external debt (as was done in the 2014 DSA).

External Debt Sustainability Analysis

8. The 2015 DSA projects external debt to peak as a share of GDP in 2017/18. The present value (PV) of PPG external debt increases to 18.8 percent of GDP in 2014/15, and reaches 24.5 percent of GDP by 2017/18, reflecting the assumed sharp increase in disbursements to finance public investment projects. It would decline after that, falling below 10 percent of GDP in the long run.

9. Under the baseline scenario, the ratio of the present value of debt-to-exports (PVDE) breaches the indicative threshold (Table 1 and Figure 1). The PVDE ratio is estimated at 192 percent by end-June 2015. Despite the expected recovery in exports, it is projected to continue increasing, peaking at 220 percent in 2016/17. This would entail a baseline breach of 7 years, until 2020/21. All other debt indicators remain below their indicative thresholds in the baseline scenario. For the indicators related to debt service, the peaks in 2024/25 reflect the assumption that the Eurobond is repaid in full.

Table 1.

Ethiopia: Comparison of PPG External Debt Baseline Scenario, 2015–35

article image
Sources: Ethiopian authorities; IMF and World Bank staff estimates and projections.
Figure 1.
Figure 1.

Ethiopia: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2015–351

Citation: IMF Staff Country Reports 2015, 300; 10.5089/9781513560038.002.A003

Sources: Ethiopian authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. In figure b. it corresponds to a One-time depreciation shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock.

10. Looking at alternative scenarios, a terms-of-trade shock appears to present the largest risk to external debt sustainability. The breach of the indicative threshold for the PVDE ratio would last three more years, and extend to 2023/24. A depreciation shock would also have a significant impact, in particular on the debt service to revenue indicator (with a large share of imports exempt from customs duties, depreciation would not lead to as much of an increase in the birr value of customs duties than might otherwise be the case). As in the baseline, no other indicator breaches its indicative threshold in the alternative scenarios.

11. In assessing the risk of external debt distress, the DSA calls for the use of judgment, focusing in particular on capacity to repay. In the case of Ethiopia, external loans are being used primarily to finance infrastructure investment, which are expected to have growth pay-offs that will boost tax revenue and enhance debt repayment capacity. Large investments in energy, railroads, and roads will enhance competitiveness, boost export revenue, and promote economic diversification. While this is to some extent factored into the baseline growth projections, staff’s assumptions are fairly conservative in this regard. The DSA provides for additional tools to evaluate the risk of external debt distress. Results from this extended, judgment-based analysis indicated the following:

  • Probability approach. This approach assesses the evolution of the probability of debt distress over time, taking into account past economic performance. For Ethiopia, no indicator breaches the threshold in the baseline, and the breach of the threshold for the PVDE ratio in one shock scenario is short-lived (2 years) and less than 3 percentage points from the threshold (Figure 2). In the historical scenario, the debt indicators would be lower than under the baseline. This reflects persistently high real GDP growth in the recent past and the better export performance prior to the recent stagnation, which lowers the debt ratios in the first years of the forecast and increases them in the outer years.

  • Including remittances.1 In Ethiopia, strong and relatively stable remittances play an important role in bolstering external stability. When remittances are included in the DSA, the breach of the augmented indicator (namely the ratio of the PV of debt to exports of goods and services plus remittances) reaches a maximum value of 149.8 percent and lasts 5 years (Figure 3). Other indicators are well below the revised thresholds even under the most extreme shocks.

Figure 2.
Figure 2.

Ethiopia: Probability of Debt Distress of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2015–351

Citation: IMF Staff Country Reports 2015, 300; 10.5089/9781513560038.002.A003

Sources: Ethiopian authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. In figure b. it corresponds to a One-time depreciation shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock.
Figure 3.
Figure 3.

Ethiopia: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios (Including Remittances), 2015–351

Citation: IMF Staff Country Reports 2015, 300; 10.5089/9781513560038.002.A003

Sources: Ethiopian authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. In figure b. it corresponds to a one-time depreciation shock; in c. to anexports shock; in d. to a one-time depreciation shock; in e. to anexports shock and in figure f. to a one-time depreciation shock.

12. This augmented analysis indicates that Ethiopia has greater resilience to debt distress than suggested by the standard methodology. Supported by robust past economic performance, the path of debt and debt service indicate that only in the most extreme shock (to exports) would the PVDE probability ratio be pushed above its policy threshold. These results support the assessment of Ethiopia’s risk of external debt distress as “moderate”.

13. The increased risk of external debt distress calls for caution going forward regarding the pace of foreign borrowing. Projects should be assessed carefully to ensure that they meet stringent economic and/or social rate of return assessments, in particular if they are being financed on non-concessional terms. Priority should also be given to those projects with solid growth-enhancing effects. Policies that promote exports will also be essential to bolster Ethiopia’s foreign exchange earnings, which remains a weakness for the economy overall. A more competitive exchange rate, better access to credit for the private sector, and fewer structural bottlenecks would all help in this regard

Public Debt Sustainability Analysis

14. The projected path of total public sector debt-to-GDP has essentially remained the same as forecast in the 2014 DSA: rising in the coming years, and falling after that. This reflects large domestic and external borrowing by SOEs to finance infrastructure investment. As these projects reach completion, total public sector expenditure would revert to lower levels in the long run.

15. The PV of debt-to-GDP ratio remains below the threshold in the baseline. However, there is a five-year threshold breach under the most extreme shock (a one-time depreciation). This is explained largely by the fact that Ethiopia has increased its exposure to external commercial debt. The breach provides additional evidence of a heightened risk of public debt distress.

16. Debt stock related indicators are relatively flat and most extreme shocks do not alter significantly the results. All debt indicators show a mild increase in the medium term, before returning to levels similar to 2014/15. This result is predicated on the continuation of robust GDP growth, moderate public sector primary deficits, and—most crucially—low domestic interest rates (such that real interest rates remain mildly negative, as inflation is forecast at 8.5 percent in the long run).

17. Public sector debt would grow in the long run as a result of a permanent negative shock to GDP growth, but debt service-to-revenue could absorb this shock (Figure 4). The scenario that fixes the primary balance at its 2014/15 level shows a particularly sharp deterioration because of the unusually large primary deficit in that particular year, reflecting the high level of investment activity. The other two alternative scenarios (a shock to real GDP growth and primary balance at the historic average) show trajectories with no important changes in the debt ratios over the DSA horizon.

Figure 4.
Figure 4.

Ethiopia: Indicators of Public and Publicly Guaranteed Debt (Domestic and External) Under Alternative Scenarios, 2015–351

Citation: IMF Staff Country Reports 2015, 300; 10.5089/9781513560038.002.A003

Sources: Ethiopian authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. It corresponds to a one-time depreciation shock.2/ Revenuesare defined inclusive of grants.

18. The baseline scenario understates the public debt burden for the economy, because it is based on nominal interest rates on public sector borrowing remaining significantly below inflation. Like in the 2014 DSA, with inflation projected to remain at a single-digit level, under current policies interest rates on SOEs’ domestic borrowing would be negative in real terms. Ethiopia’s relatively benign public sector debt outlook hinges strongly on the continuation of these financing conditions. If the actual cost of borrowing were to rise above inflation, the debt indicators would worsen or fiscal adjustment would be required to maintain sustainability.

19. This assessment, with a moderate risk of debt distress, assumes the acceleration of external borrowing to achieve the investment required for the development plan. The ongoing large public investment projects rely heavily on domestic financing and would lead to a large accumulation of public debt. Without an appropriate balance in the financing and pacing of the public investment projects in the GTP, resources for the private sector could be squeezed. Monitoring the operations of the consolidated public sector, including contingent liabilities arising from financial transactions among public entities, is thus important.

Conclusion

20. Ethiopia’s risk of external debt distress has increased from “low” to “moderate”. This finding reflects the use of judgment in assessing the likely impact of Ethiopia’s external public borrowing on growth, and hence on its capacity to repay. The risk assessment remains vulnerable to further delays in the recovery of exports, a terms-of-trade shock, higher external borrowing, and deterioration in external borrowing conditions. The exposure to a terms-of-trade shock is reflected in a more protracted breach in the PV of debt-to-exports ratio under the most extreme shock. However, robust economic performance and a continued favorable outlook help to reduce the probability of debt distress.

21. Containing the risk of debt distress will depend critically on bolstering export performance. Addressing competitiveness concerns, facilitating greater access to credit and foreign exchange for the private sector, and continued macroeconomic stability will play important roles in promoting export growth and export diversification. A more competitive exchange rate would also reduce headwinds for exporters, and contribute to increased availability of foreign exchange to finance imports of critical capital and intermediate goods.

22. Ensuring that public sector borrowing is consistent with debt sustainability is also essential. The authorities need to monitor closely the debt levels and the terms of the new loans, especially those on commercial terms. A dedicated agency that monitors the financial positions of SOEs would increase transparency regarding their overall impact on public finances, and reduce fiscal risks. The authorities are also encouraged to increase non-debt sources of financing for GTP II. For example, private-public partnerships could bring in valuable equity financing while maintaining state control. The authorities should also ensure adequate concessionality of new external loans.

23. As advised in previous DSAs, the authorities are encouraged to systematically update their medium-term debt management strategy (including SOEs) and to start monitoring the overall debt (external and domestic) of the consolidated public sector. A joint work from the World Bank and the IMF in collaboration with UNCTAD on medium-term debt management strategy advised Ethiopia on the growing vulnerabilities derived from SOEs borrowing strategy, including substantial domestic borrowing from the state-dominated banking system.

24. The authorities disagreed with the DSA’s finding of an increased risk of external debt distress. In their view, this assessment does not accurately reflect the Ethiopian government’s capacity and commitment to repay its external debts, emphasizing that the financing is being used for growth-enhancing investments, which should bolster exports and tax revenue. They also noted that the deterioration in the debt indicators was due in large part to the very poor export performance in 2014/15, which they expected to reverse in the coming years. They also argued for the exclusion of Ethio Telecom from the DSA, noting that it is run on a commercial basis, is profitable, has audited financial accounts (though only through 2012), and borrows externally without a government guarantee. Staff noted that including SOEs was the norm for DSAs, and that Ethio Telecom did not yet meet the conditions required for exclusion (which include regular publication of audited financial accounts).

Table 2.

Ethiopia: External Debt Sustainability Framework, Baseline Scenario, 2012–351

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

Includes both public and private sector external debt.

Derived as [r - g - p(1+g)]/(1+g + p+gp) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 3.

Ethiopia: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2015–35

article image
article image
Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly a an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 4.

Ethiopia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2012–35

(percent of GDP, unless otherwise indicated)

article image
Sources: Country authorities; and staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Table 5.

Ethiopia: Sensitivity Analysis for Key Indicators of Public Debt, 2015–35

(percent)

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

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.