IMF Executive Board 2018 Article IV Consultation with Ethiopia

IMF Executive Board 2018 Article IV Consultation with Ethiopia
Photo credit: OCHA | Charlotte Cans

06 Dec 2018

Ethiopia has built on its strong track record of development over more than a decade.

Growth slowed in 2017/18, but remained high while the current account deficit continued to narrow, the IMF says in its recent report on the economic health of Ethiopia. The sub-Saharan country is embarking on its next phase of economic and social development – supported by reforms and powered by the private sector.

Over the last decade, high growth has led to a significant reduction in poverty and improved living standards for many Ethiopians.

The country’s large infrastructure investments are beginning to bear fruit and the provision of public services such as education and health has increased dramatically.

As a result, the population has enjoyed important welfare gains. For example, the number of maternal deaths per 100,000 live births fell radically from 1,080 in 1995 to 353 in 2015 and the proportion of people living in poverty fell from over 45 percent in 1995 to around 23 percent in 2015.

Recovering growth after a dip

In 2017/18, Ethiopia’s economic growth dipped to 7.7 percent due to reduced government public expenditure aimed at tackling the growing current account deficit and indebtedness. Political uncertainty and severe foreign exchange shortages also dampened growth.

As the political climate settles and investment recovers, growth is expected to recover to 8.5 percent this fiscal year, and the current account deficit should continue to narrow. In their report, IMF staff say they expect inflation – which currently exceeds the single-digit authorities’ target – to continue to fall due to an appropriately tight monetary policy.

Risks to medium-term outlook

Despite positive developments, the large external imbalances and the public debt burden are constraining future growth and pose risks to the medium-term outlook.

While debt is sustainable in the medium term, Ethiopia remains at high risk of debt distress. To mitigate those risks, restrained public sector borrowing – particularly on non-concessional loans – while protecting pro-poor spending programs, will be key, say IMF economists. At the same time, the government will need to mobilize tax revenues and raise exports to reduce vulnerabilities over the medium term.

Since his election, Prime Minister Abiy has created space for a more inclusive political dialogue and has taken steps to bring stability to the region. On the economic front, the new government has announced an ambitious reform program for the country aimed at opening the economy to private investment and competition to support sustainable growth.

Developing an open and inclusive economy

The new legal framework for public-private partnerships can play an important role in strengthening growth by promoting private sector development and the provision of public services, while reducing government costs, says the report. It also calls for privatization and removal of barriers to private investment in key sectors, which supports policy announcements by the government.

The government also wants to develop the domestic financial system. An important first step will be to introduce a market for government securities with market-determined interest rates. This will allow the central bank to reduce direct financing of the government and increase the effectiveness of monetary policy in maintaining low and stable inflation.

Reforms to support continued development

In their report, IMF staff encourage the authorities to review the strategy and financial model of the government’s development lending agency – the Development Bank of Ethiopia – which has seen lower-than-expected returns to its investments in recent years. A more flexible system for the exchange rate is also needed to increase foreign exchange reserves, improve external competitiveness, and increase the availability of foreign exchange. This would support the country’s continued development.

Analysis carried out jointly by IMF staff and UN Women finds that the government’s agenda of promoting gender equality could yield large economic benefits over time. Closing gender gaps in educational attainment, formal labor force participation rates, and access to quality land and other resources are key to realizing these benefits.

The new government has made progress in this area. They have appointed a gender balanced cabinet, while women have been placed in key decision-making positions, including the presidency and the head of the Supreme Court.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They noted that Ethiopia has maintained high and inclusive growth for more than a decade, achieving commendable progress in reducing poverty and improving living standards. However, the public sector led development strategy is reaching its limits, exacerbating external imbalances and raising public debt vulnerabilities. Directors commended the authorities for tightening macroeconomic policies to address these challenges. They welcomed the authorities’ ambitious reform program aimed at catalyzing private investment and driving sustainable growth as set out in the Growth and Transformation Plan II.

Directors underscored the need for fiscal consolidation and higher revenue, through tax policy and administrative measures, further prioritization of public projects, reductions in the borrowing requirements of state owned enterprises (SOEs) and phasing out of implicit subsidies. Rationalization of tax exemptions and excise reform would help in this regard. Further improvements in public financial management and SOE governance and transparency are also warranted.

Given the risks posed by the high debt burden, Directors called for strengthening public debt sustainability. They noted the efforts at reprofiling of non-concessional debt and welcomed the authorities’ intention to contract new debt at concessional terms. Directors commended the authorities for their plans to protect social and pro poor spending.

Directors noted that the tighter monetary stance announced by the National Bank of Ethiopia (NBE) for 2018/19 is warranted to bring inflation down to target. This stance should be supported by restrictive public-sector credit policies, including gradually phasing out central bank financing of the budget. Exchange rate flexibility would help strengthen competitiveness, reduce foreign exchange shortages and support reserve accumulation. Directors recommended the elimination of the remaining exchange restrictions on current transactions.

Directors noted that financial sector reforms would increase the effectiveness of monetary policy and support development goals. These reforms should include the development of a market for government securities with market determined interest rates. Until this market develops, NBE bills should be used solely to manage liquidity in the banking system and delinked from funding of the Development Bank of Ethiopia which needs to complete a comprehensive financial assessment. Directors noted that channeling the payment of taxes through banks could deepen financial intermediation, reduce opportunities for corruption and improve the business climate. Gradual opening of the financial sector to foreign investors could improve services and transfer technology and know how. Directors also noted that continued efforts are required to strengthen the AML/CFT framework.

Directors stressed that implementation of structural reforms is critical to promoting competitive markets and improving the investment climate to catalyze private investment. Privatizations, public private partnerships with adequate safeguards, and removal of obstacles to private investment could support renewed growth momentum while attracting foreign resources and know how. Directors underscored the importance of addressing data gaps and delays to improve the quality of statistics. They welcomed Ethiopia’s decision to join the African Continental Free Trade Agreement and looked forward to progress toward World Trade Organization membership. Directors also welcomed the joint analysis conducted with UN Women which shows that further reducing gender disparities would yield large economic benefits over time and commended the authorities’ efforts in this direction.

Source International Monetary Fund
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Date 06 Dec 2018
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