Abstract
The newly issued five-year second Growth and Transformation Plan (GTP II) envisages continued high growth and public infrastructure investment, while placing a greater emphasis on private sector development and foreign direct investment (FDI), competitiveness, and export-oriented industrialization. A major drought and deterioration of the external environment resulted in a 2015/16 growth slowdown to an estimated 6.5 percent. Stability-oriented macroeconomic policies and effective policy responses, including food imports, to mitigate the drought's social costs kept inflation low and the budget deficit on target. The current account, however, posted for a second year a deficit above 10 percent of GDP.
1. The Ethiopian authorities value the engagement with the Fund and thank staff for the constructive dialogue, during the 2016 Article IV mission, which continues to inform implementation of the country’s macroeconomic policy and development agenda. The authorities broadly agree with staff’s balanced assessment of the economic challenges and priorities for Ethiopia in the short and medium term.
2. The Ethiopian economy which is one of the fastest growing economies in Sub Saharan Africa has achieved tremendous social and economic gains with increasingly inclusive and employment-generating growth realized in recent years. The second Growth and Transformation Plan (GTP II), which was launched in October 2015 builds on this progress to guide the national development policy priorities for the next five years, 2015/16–2019/20. The key objective of the GTP II is to maintain rapid, sustainable and broad-based growth in a stable macroeconomic environment conducive for investment and international competitiveness. The plan envisions transforming the Ethiopian economy into lower middle income status by 2025.
Recent Economic Developments
3. In FY 2015/16, the economy continued to exhibit strong growth supported by prudent macroeconomic management and productivity-enhancing reforms. In this context, economic activity is estimated to have expanded by 6.5 percent mainly underpinned by growth in manufacturing, construction and service sectors. Economic momentum was, however, dampened by the negative impact of a weaker global environment and severe weather conditions which affected agriculture in some parts of the country.
4. This notwithstanding, the investments made to build resilience in agriculture over time, coupled with pragmatic and timely interventions by the authorities, minimized the impact of the El- Niño induced drought. The authorities have over the past two decades invested in improving agricultural practices, including through commercial farming, training, technology, irrigation schemes for smallholder farmers and infrastructure development. This has resulted in more resilient and interconnected communities and complemented government’s actions to mitigate the impact of the drought through provision of substantial resources and food aid with the help of the international community and regional states. These interventions were in addition to the ongoing Productive Safety Net Program (PSNP) successfully implemented in close collaboration with development partners.
5. Fiscal policy implementation has remained prudent, with expenditure and tax revenues broadly in line with the annual budget plan. The general government deficit estimated at 3 percent of GDP, is consistent with targeted levels for the fiscal year. Drought related expenditures were largely met by tapping into reserves accumulated in the oil stabilization fund. This ensured that there was no need to shift resources within the budget and pro-poor development activities were protected.
6. The authorities maintained a tight monetary policy stance in order to keep inflation within the National Bank of Ethiopia (NBE)’s target of single digit inflation. After peaking at 11.9 percent in September 2015, headline inflation receded to 5.9 percent in August 2016. Financial intermediation continues to advance, with a 25.2 percent increase in bank branch openings and a 19.3 percent annual growth of bank deposits as at the end of the fiscal year.
7. The current account deficit for 2015/16 was US$ 7.06 billion representing a decline from 12 percent of GDP in the preceding year to 10 percent. Notwithstanding the decline in commodity export earnings and increased imports of food, capital and intermediate goods, the increase in export volumes and the strong remittances had a moderating effect on the current account. In addition, Foreign Direct Investment (FDI) inflows, in response to the ongoing investment promotion initiatives, provided strong impetus to the financial account of the balance of payments.
Medium-Term Outlook and Policies
Fiscal Policy
8. The authorities remain committed to prudent fiscal policy and maintaining the deficit at less than 3 percent of GDP. The 2016/17 budget, in line with the GTP II priorities, continues to focus on attaining the key objectives under the Sustainable Development Goals (SDGs) which is one of the major ambitions of the authorities’ five-year plan. Expenditure to growthenhancing infrastructure and social developments largely remain a priority, with about twothirds of spending having a strong pro-poor focus.
9. Efforts in domestic resource mobilization are being enhanced to support development spending and maintain fiscal sustainability. Although tax revenues have steadily grown over time, the authorities are determined to achieve their medium term target of tax-to-GDP of over 17 percent. Efforts to strengthen tax administration and streamline tax policies to simplify procedures, update tax brackets as well as other measures to improve capacity, technology and tax compliance are being stepped up. The authorities are mindful of the financial implication of tax incentives and for this reason, they are mainly used to support export promotion, and are time-bound and performance-based to ensure their effectiveness.
10. Ethiopia’s risk of external debt distress remains moderate and my authorities are committed to maintaining debt at sustainable levels. In this regard, the authorities intend to refrain from any new non-concessional debt for the time being to the extent that it threatens debt sustainability. Moreover, a significant scale up of financing in the near term is not anticipated as most of the investments commenced in previous years and are expected to materialize in the near and medium term. The debt contracted by the Ethiopian authorities is directly associated with significant growth-enhancing public investments aimed at boosting export competitiveness and expected to generate high returns. The authorities are confident that critical infrastructure, like the energy projects, transportation and industrial parks some of which have already started operations will strengthen the country’s export and tax revenues. In addition, state owned enterprises are being managed in a manner that ensures they are self-sufficient. In this regard, a new ministry has been created with the mandate to streamline public enterprises and improve their governance and efficiency. Further to their efforts to boost domestic resource mobilization, the authorities are working on a regulatory framework for Public Private Partnerships (PPPs).
11. The authorities maintain a well-coordinated and centralized management of public funds including extra budgetary funds, which are all monitored and audited. In addition, reforms pertaining to the roll out of program budgeting and IFMIS as well as cash management in preparation for the development of a Single Treasury Account are progressing well. Capacity building and civil service reforms envisaged in the GTP II are expected to enhance institutional and human development at all administrative levels.
Monetary, Exchange Rate and Financial Sector Policies
12. Monetary policy is aimed at maintaining price and exchange rate stability so as to create a macroeconomic environment that is conducive for strong and sustained economic growth. Inflation is expected to remain in single digits in the medium term as reserve money stays in line with nominal GDP and government borrowing remains consistent with monetary policy objectives. The NBE is working on establishing a secondary market for government securities to effectively pursue indirect policy instruments in its monetary policy operations. To further strengthen its monetary policy framework, a forecasting team has been set up under the Economic Modeling and Statistical Analysis Directorate to improve liquidity monitoring and forecasting.
13. The exchange rate remained broadly stable in 2015/16 and the NBE assesses that any potential overvaluation of the birr against the US dollar in 2015/16 would be less than 10 percent. Against this background and recognizing the benefits of a flexible exchange rate, the NBE continues to pursue a gradual depreciation of the birr given the weak export responsiveness to real effective exchange rate movements but yet pronounced pass through into inflation. In addition, the authorities are working towards strengthening the foreign reserves buffer, with the NBE targeting 3 months of prospective imports.
14. The financial sector remains healthy characterized by an increase in banking, insurance and microfinance branches; expansion in savings as a result of the creation of new instruments; and an expansion of credit to the private sector. The NBE continues to promote greater access to finance and financial inclusion initiatives. New products such as electronic, mobile and agent banking services are being introduced and regulated by the NBE. With this rapid pace of expansion, the NBE will continue to strengthen its surveillance and monitoring tools to ensure that the sector remains sound and stable. In addition, the NBE will also closely monitor the Non-Performing Loans (NPLs) of the Development Bank of Ethiopia (DBE), notwithstanding their provisioning requirement in the NBE’s Asset Classification and Provisioning for Development Finance Institutions Directives to maintain 100 percent provisioning of NPLs.
Structural Reforms
15. Structural reforms continue with a focus on diversification of the economy, agricultural transformation and industrialization. In this regard, an export-led industrial development strategy has been developed to support a shift from reliance on traditional commodity to high value and diversified goods and services. In addition, government has developed a 10-year National Sustainable Tourism Master Plan with the objective of enhancing the contribution of tourism to economic development.
16. The authorities recognize the importance of private sector participation in the development process and are promoting an environment conducive for investment and private sector development. The government has developed industrial parks and clusters to boost FDI and private investment in key sectors. To this end, the Industrial Park Development Corporation (IPDC) has been set up with the responsibility of facilitating and removing bureaucratic bottlenecks that hinder production and capacity of both export and import substitution industries. In addition, efforts to increase access to credit through the DBE and improve the ease of doing business have been intensified. Moreover, increasing investments in various infrastructure development projects in power generation, telecom, transportation especially the Ethio-Djibouti railways and other logistical services are expected to reduce production costs and enhance overall productivity and competitiveness.
Statistics
17. With support from development partners including the Fund, the authorities have made progress in data compilation and dissemination. The quality of the national accounts and overall statistics continues to improve. Going forward, the authorities have a comprehensive plan to further strengthen the national statistics agency to improve its economic monitoring capacity. With respect to agricultural statistics, an assessment of the Agricultural Statistics System in Africa by the African Development Bank in 2014 concluded that Ethiopia emerges as the country best equipped to run an effective and efficient agricultural statistics system to produce timely, reliable and sustainable statistics.
Conclusion
18. The authorities remain committed to sustain efforts aimed at structurally transforming the economy to address emerging vulnerabilities and build resilience to exogenous shocks in pursuit of strong and inclusive growth. As part of the agricultural development strategy and the Climate Resilient Green Economy (CRGE) Strategy, measures to strengthen resilience of the agricultural sector to weather shocks are being scaled up. In addition, the increased focus on exports is in line with efforts to address some of the emerging macroeconomic imbalances and attendant risks as the authorities pursue their ambitious growth strategy. The authorities appreciate the Fund’s policy advice and technical assistance which remain vital as they proceed with implementation of their development agenda under the GTPII.