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.
1. The Ethiopian authorities are appreciative of the constructive engagement with the Fund over recent years. They thank staff for the frank and constructive dialogue during the 2015 Article IV mission, which will help inform implementation of their macroeconomic policy and development agenda. They remain committed to pursuing prudent macroeconomic policies and further deepening their structural reform agenda in support of their Growth and Transformation Plan (GTP).
2. Consistently strong economic growth over the past decade and a broadly stable macroeconomic environment has placed Ethiopia among the top performing economies in Sub-Saharan Africa. With broad-based expansion and increased diversification of the economy, growth has been rendered increasingly inclusive and employment-generating. Poverty has reduced significantly and the income gap narrowed substantially. Implementation of the authorities’ GTP is on course to deliver remarkable socio-economic gains, and the authorities are committed to mobilizing the required financing for sustainable development. The economic outlook continues to be greatly favorable, reflecting the country’s huge economic potential, prudent macroeconomic management, and productivity-enhancing reforms.
Recent economic developments
3. The Ethiopian economy continues on a strong growth trajectory, supported by the successful implementation of the GTP I, over the last five years. Real growth averaged 10.1 percent between FY2010/11 – FY2013/14 on account of favorable outturns in all key economic sectors, notably industry (20.0 percent), services (10.7 percent), and agriculture (6.6 percent). The growth momentum continued in FY2014/15, with real GDP estimated to have expanded by 8.7 percent.
4. Monetary policy has been geared towards achieving single digit inflation, with the National Bank of Ethiopia (NBE) appropriately calibrating its policy instruments to achieve this objective. Accordingly, reserve money growth has been kept in line with growth in nominal GDP and well within its annual target of 20 percent. However, to address short-term liquidity challenges during FY 2014/15, the NBE certificates of deposits held by the Commercial Bank of Ethiopia, which were issued in March 2013 following the lowering by NBE of the reserve requirement ratio, were redeemed. Moreover, the NBE extended short-term credit facility to several banks against NBE-bills. Inflationary pressures, exerted mainly by the higher food prices, drove inflation to low double digits, recording 11.8 percent in July 2015. The balance of payments came under immense pressures, reflecting a widening of the current account deficit. The exchange rate depreciated against the US dollar, though it appreciated markedly in real terms.
5. Fiscal policy implementation has remained prudent, with the authorities mobilizing most of the anticipated revenues and grants during FY2014/15. Tax collection increased in real terms with the tax-to-GDP ratio estimated at 12.9 percent. Budget execution kept in pace with the realized revenues, thus containing the deficit below the authorities’ target of 3 percent of GDP. To further strengthen execution, the authorities continued implementation of program-based budgeting and the rolling of the integrated financial management information system to all federal budgetary agencies.
Medium-term outlook and policies
6. The policy interventions over the medium term will be defined by the priorities set out in the authorities’ second Growth and Transformation Plan (GTP II) which aims to elevate the country to middle income status by 2025. Broadly speaking, policies will focus on attaining high and sustainable economic growth, within a stable macroeconomic environment. Continued scaling up of investment in critical infrastructure, with due consideration to debt sustainability, and enhanced delivery of basic social services, coupled with increasing private sector participation, will form an integral part of the strategy. To this end, the authorities will seek to achieve an average real GDP growth rate of 11 percent and address underlying macroeconomic imbalances to support their medium-term objective.
Fiscal policy
7. Implementation of the authorities’ fiscal program for FY2015/16 and over the medium term will largely focus on attaining the priorities identified in the Sustainable Development Goals (SDGs) which is a major ambition of the authorities’ five-year GTP. To this end, over 70 percent of the total federal government’s budget has been allocated to key priority areas, including education, agriculture, health, rural electrification and urban development. On the revenue front, the authorities will continue efforts to enhance domestic revenue mobilization through strengthening tax administration and streamlining tax policies. In this context, the Ethiopian Revenue and Customs Authority will vigorously pursue its reform program which seeks to, among other things, improve technical tax collection capacity and increase awareness against tax evasion and fraud. While mindful of the financial implications of tax incentives, which are mainly in the form of export promotion duty waivers, the authorities consider these schemes crucial to accelerating industrial growth and improving foreign exchange earnings needed for investment and development.
Debt sustainability
8. My authorities note the updated joint Debt Sustainability Analysis(DSA) undertaken by the Fund and World Bank staff which indicates that Ethiopia’s risk of external debt distress has increased from ‘low’ to ‘moderate’, though external debt remains sustainable. While acknowledging the downside risks to export growth including from uncertainties related to foreign demand, the authorities disagree with staffs’ overall assessment of an increased risk of external debt distress. They believe that the growth-enhancing benefits of the significant public investments primarily directed at critical infrastructure were not adequately taken into consideration. In this vein, the authorities underscore the fact that proceeds from the successful issuance of 1 billion in Eurobonds on international capital markets will go towards developing critical infrastructure, including industrial parks, and are confident that as all these projects come on stream, the country’s exports and tax revenues will be strengthened, thus eliminating any doubts about the Ethiopian government’s capacity and commitment to repay its external debt. Further, the authorities reiterate their view that the inclusion of the debts of Ethio Telecom in the DSA is unwarranted given that the enterprise does not generate contingent financial liabilities on the central government. They emphasize that it continues to be profitably operated and maintains audited financial accounts in line with international standards.
Monetary and exchange rate policies
9. Monetary policy will aim at maintaining price and exchange rate stability so as to create a macroeconomic environment that is conducive to rapid and sustained economic growth. To achieve these objectives, the NBE will, over the medium term, maintain a monetary targeting regime, with reserve money target set consistent with developments in the other key sectors. The NBE remains committed to containing inflationary pressures and considers the recent spike in inflation (year-on-year) to low double digits in July 2015 as driven by seasonal factors. An appropriate mix of monetary and fiscal policies will be employed going forward to keep inflation within single digits. In addition, the NBE’s direct financing of the government will be placed on a declining path over the medium term. Furthermore, the authorities are determined to ramp up efforts at managing domestic liquidity by adopting a robust liquidity forecasting and management framework and introducing indirect monetary instruments.
10. On the exchange rate, the authorities recognize the need for greater flexibility of the exchange rate, in terms of benefits as an absorber of exogenous shocks, in supporting external competitiveness, and in strengthening foreign exchange reserves. However, while sharing staff’s view that the birr may be overvalued in real terms, the authorities are inclined to pursue a path of gradual depreciation given the weak export responsiveness to real effective exchange rate movements but yet pronounced pass through into inflation.
Financial sector policies
11. The NBE will continue to strengthen its financial stability monitoring tools to preserve the stability and soundness of the banking system which is assessed to be liquid, adequately capitalized and profitable. To this end, the recently-adopted risk-based supervisory framework combined with regular on-site examination will be utilized to mitigate any emerging financial risks. To mobilize savings and promote greater access to finance, the authorities will continue to build on the recent initiatives to promote financial inclusion, including development of national financial education and consumer protection strategy and implementation framework. The expansion of bank branch networks and the development of more innovative savings instruments will remain policy priorities going forward. The authorities emphasize that the current funding mechanism of the Development Bank of Ethiopia (DBE) has served the economy well by providing much-needed long-term financial resources. Nonetheless, they undertake to continue exploring additional funding options that will further enhance the DBE’s lending capacity.
Structural reforms
12. The authorities are cognizant of the fact that attaining their goal of structurally transforming the economy and delivering equitable growth would require steadfast implementation of far-reaching structural reforms. To this end, they welcome the focus of the accompanying selected issues paper on poverty reduction and the macro-social impacts of policies on income distribution. The authorities intend to give due consideration to the policy recommendations when refining their pro-poor policy interventions, which already have proven to be effective and highly successful. Additionally, they are committed to enhancing the role of the private sector in the development process by providing greater access to credit and creating a favorable business climate. Finally, addressing the underlying impediments to increased external competiveness will remain at the center of the authorities’ policy strategy.
Conclusion
13. The Ethiopian authorities recognize the challenges of macroeconomic management in the midst of scaled up investments in infrastructure and social development and are committed to instituting appropriate measures to address emerging macroeconomic imbalances and mitigate potential downside risks to the growth outlook. They are determined to persevere with efforts at structurally transforming their economy through enhanced domestic resource mobilization, increased investment in infrastructure, and more broad-based, pro-poor growth. Finally, the authorities consider the Fund’s policy advice and technical assistance useful as they proceed with implementation of their development agenda.