In the absence of fundamental economic reforms, inertia in economic growth does not carry for too long. Even faster growth brings some negative impacts with it, writes Eyob Tesfaye (PhD), a macroeconomist, urging policymakers to pursue desperately needed reforms. The views reflected here are only his and do not represent any institution.
Over the past years, Ethiopia’s economy has been clocking up at an average annual growth rate of eight percent in a gross domestic product (GDP). It was driven mainly by massive investments in public infrastructure development, invigorated consumption and a remarkable upsurge in foreign direct investment (FDI).
No less was the hype growing fast, creating a sense of complacency in the political conclave of the top brass leadership. The over-inflated and excessive exuberance has the leadership miserably failing to recognize the looming danger – up until recently.
Amid the bustling business activities and raucous traffic of the Ethiopian capital, innumerable banners exhort citizens to celebrate the “rapid growth”. Visitors to the country are welcomed with the Ethiopia poised mantra, though what it was for is not clear.
While Ethiopia’s economic growth has been impressive, it was not devoid of stubbornly high inflation, continuous currency depreciation, widening trade deficit, dwindling forex reserve, ballooning external debt, and high youth unemployment. This may not be a story of gloom and doom but the shape of the economy has a lot of cracks, with sufficient reasons for concern.
All the macro imbalances put together the situation is a classic recipe for a hard landing. There is a general but misguided view that having achieved a growth rate of 10pc or above, the economy would never go down. The illusion of high growth and the misplaced confidence has resulted in callous disregard to macroeconomic fundamentals and economic reforms that are essential to sustain growth.
Growth inertia does not carry for too long in the absence of fundamental economic reforms. Ironically, faster growth also brings some negative impacts with it. As a country tries to shift from low income to a lower middle-income group of nations, institutional adaptation and reforms are critical to sustaining growth. Policies that trigger growth may not be necessary to keep the economic growth robust.
Despite the imminent macroeconomic pressure, there is a strong notion that the current economic malaise is nothing but technical and could resolve itself soon and everything gets back on track. It is a short-sighted view.
Now is a crucial turning point as the vulnerabilities of the economy has piled up. It demands an exigent action to address the imbalances and a tide of economic reforms that would also facilitate transformation. Slipping up on this will be tantamount to a costly and potentially irreversible squandering of opportunities.
The first order of business is to correct the macroeconomic imbalances due to forex drawdown, high inflation and mounting debt burden. Ethiopia’s balance of payments has been under severe pressure as evidenced by a massive but increasing current account deficit which stands at 8.1pc of GDP. The increase in the deficit is the consequences of high growth in imports. Exports are not helping either to narrow the gap, despite continued depreciation and devaluation of the currency.
The economy has managed to finance its deficit through sizeable external borrowing, increased capital inflows in the form of investments from overseas, and official development assistance. Whenever there is a drop in capital inflows, concurrently with growing debt repayment, currency devaluation is an expected outcome. It is among the most significant reasons that have forced the authorities to devalue the Birr against a basket of major currencies and introduce forex rationing.
The rate in the parallel market, on the other hand, is higher by 33pc than the official exchange rate, indicating the weakness of the economic fundamentals, such as high inflation and limited foreign exchange reserve. A current account deficit above a sustainable level is a clear testimony of a potential macroeconomic risk as it raises concern about the country’s ability to meet its external payment obligations and erodes the confidence of potential lenders and investors.
A sudden surge in the international price of oil and a global slowdown or a strong Dollar could erode the deficit further, exacerbating the macroeconomic risks.
Officials of the Administration may see the importance of taking a quick move and manage the volatility in capital inflows by alluring more foreign direct investment, seek ways to increase official development assistance, improve the inflow of remittances and control the ever-increasing capital flight. Accelerating the operationalisation of some of the sugar mills, whose completion of the constructions is long overdue, could support the generation of badly needed foreign currencies.
A rapid and sustained economic growth can also be realised if apparitions which haunt the economy are addressed. High on the ‘hit list’ should be the stubborn inflation, which could be triggered by a rapid pace of capital formation. It implies that demand is outpacing supply and the speed of growth is an unsustainable path.
Monetary policy is the first line of defence to guard against inflation. The contractionary monetary policy seeks to curb demand which in return restrains growth. Reduction in growth is an inevitable outcome of tight monetary policy. However, despite contractionary monetary policy actions, inflation in Ethiopia remains in the woods. The import of essential food items was not able to douse the inflationary fire in a sustained manner. It looks like the lid is already bubbling of the pot.
Since inflation is not only fueled by excess demand, supply constraints are the major factors that spark inflationary fire.
While it is essential to manage the dynamics of growth and inflation through monetary policy actions, it is imperative to take more aggressive supply-side measures that can lead to the heart of the problem. In the short run, the monetary policy stance should aim at a threshold level of inflation that is in the range of 10pc and 12pc. Expecting double-digit inflation should be seen as an unavoidable price to be paid to maintain double-digit growth.
On the fiscal front, a sustainable consolidation is essential, putting the quality of expenditure as a priority. The future course of the strategy is to curb on wasteful spending and cut back on embezzlement of funds, enhancing the efficiency of budget utilisation.
The narrow tax base and a limited pool of middle-class taxpayers is nowhere reflected more starkly than in the country’s low tax ratio to the GDP. Hovering around 12pc, Ethiopia’s tax to GDP ratio is well below the 20pc African average. More effort is required to widen the tax base, fight tax evasions and account for businesses operating beneath the tax radar.
Ethiopia in the past couple of years heavily relied on external debt to finance its overambitious development plans. Some of these are commercial loans with higher interest rates and shorter repayment terms. The mounting debt is steadily increasing the burden on the country’s economy. Ethiopian’s debt to GDP ratio is now standing at 56pc, according to a recent report released by the IMF. Adventurism both in policy and project implementations have contributed to both internal and external debt loads.
Most of Ethiopia’s loans are Dollar denominated and a strong dollar, which is now hovering over the world economy, could also further exacerbate the debt problem. Unsustainable debt, jointly with declining capital flows, has a power to stifle growth and keep the economy under water.
It would be advisable for the Administration to revamp its debt management strategy and usage of loans. The recent decision to curtail commercial loans is a step in the right direction.
The financial sector, too, plays a crucial role to achieve development objectives. It is essential to build on past achievements and bring in new financial products and tools that could broaden and deepen the financial markets.
A capital market that would attract large amounts of investment money and which can also augment capital provided through the banking system is an excellent way to broaden the market and increase liquidity resilience. A viable secondary market not only brings more depth to the financial sector but also facilitates efficient conduct of monetary policy.
Housing finance, increased finance to the SMEs, and access to finance to the underprivileged and underserved should be given priority as they are essential to improve the living standard and reduce poverty. This requires the Administration to rigorously assess the institutional capacity, governance and business practices of the banking industry.
While elite politics has been obsessed with a ‘double-digit’ growth rate, mass politics, however, is asking for inclusiveness and its deserved share of the growth benefits. It requires the generation of more jobs to address the rapidly rising unemployment. More focus should be given to the expansion of SMEs before the demographic opportunity turns into a demographic disaster.
Making governance more efficient, transparent and accountable will ensure growth benefits are not confined only to the well-heeled, connected and the corrupt. Reforms are nothing except removing the obstacle of growth. They are not easy to come by, especially when powerful elites have vested interests in the status quo. However, neither foot-dragging nor pretention would be helpful.
Without reforms, the economy would have stuck behind the faith of people will dissipate, and the country will remain the proverbial “country of future” full of vast potential but never coming close to grasp it.