Risk drivers and outlook

  • One of Africa’s fastest-growing countries, mainly driven by public investments
  • New prime minister is trying to push through important but difficult reforms
  • Regular foreign exchange shortages are an important hurdle for the economy
  • Large public investments and low tax revenues are pushing public debt to an elevated level
  • External debt is high vis-à-vis export revenues due to the narrow export base
  • Country is vulnerable to droughts, ethnic tensions and low coffee prices

Facts & figures

Pros

  • Ethiopia has abundant agricultural, mineral and hydrological resources
  • Government is willing to reform
  • One of the fastest-growing countries in the region

Cons

  • Elevated external debt vis-à-vis current account receipts
  • Regularly reported foreign exchange shortages
  • Ethnic tensions

Chief of state

  • President Sahle-Work Zewde (since 25 October 2018)

Head of government

  • Prime Minister Abiy Ahmed (since 2 April 2018)

Population

  • 109.2 million

GDP (2018/2019)

  • 80,279 million USD

GNP per capita

  • USD 790 (low income)

Country risk assessment

Oldest independent country in Africa marked with ethnic tensions

Ethiopia is Africa’s oldest independent country. After a victory over the Italians in 1896 in Adwa, its independence was recognised by the major European powers. Ethiopia served as a symbol of African independence throughout the continent’s colonial period. Indeed, unlike other sub-Saharan countries, it has never been colonised, apart from a brief occupation by Mussolini’s Italy (1935-1941).

Ethiopia was a monarchy that ended only in 1974. The political system under the last monarch, Haile Selassie, was essentially a feudal system in which land was considered the property of the monarch and associated feudal lords. Periodic famine, exploitation of the peasantry, land issues, lack of political freedom and severe droughts led to widespread protests and strikes. Consequently, the monarchy lost control and, in the wake of a coup by the army, the imperial regime was changed into a military regime that adopted socialism as its ideology. Nonetheless, drought and civil conflict left Ethiopia in a state of turmoil in the following years. Only in 1991, when a coalition of the Tigray People’s Liberation Front (TPLF) and the People’s Revolutionary Democratic Front (EPRDF) took over, did the country enjoy a degree of political stability. The constitution of 1995 reorganised the country into nine regional states based on ethnic identity and language boundaries. The rhetoric of self-determination for Ethiopia’s nations within a federal state raised expectations among various groups, some of which were vying for autonomy. That being said, Ethiopia remains a complicated multi-ethnic federation with more than 80 ethno-linguistic groups. Ethnic tensions around territorial disputes regularly fuel violent unrest. The many interethnic conflicts of the past years have even led to the biggest displacement crisis in a nation. These ongoing ethnic tensions largely explain the elevated political violence risk of Ethiopia (5/7).

A new wind blowing through Addis Ababa?

To date the EPRDF coalition is the country’s dominant party, with an integrated structure that links top-level leaders to village-level cadres. Since 1991, the party has been in tight control of the political process and political space (notably through alleged harassment, imprisonment and exile of opposition as well as voting irregularities). The EPRDF coalition comprises four ethno-linguistic member parties. Historically, the most influential member was the Tigrayan TPLF. The Tigrayans only make up an estimated 6% of the population but they hold strong control over the Ethiopian politics, economy and military. In 2018, however, a significant shift occurred within the coalition, when an Oromo was selected as prime minister – being the majority party, the EPRDF has the power to select the prime minister. After the former prime minister resigned over the apparent failure to address grievances that had motivated anti-government protests since 2015, the EPRDF elected an Oromo, Ahmed Abiy. The Oromo are the largest ethnic group, representing 35% of Ethiopia’s population, yet Abiy is the first Oromo prime minister.

Abiy promised sweeping political and economic reforms. He loosened the grip of state security, invited political and armed opposition groups to return from exile, freed thousands of political prisoners and allowed much greater freedom of the press. Furthermore, he ended the 18-year ‘No peace, no war’ stalemate with Eritrea, significantly reducing the risk of conflict with the neighbouring country. Abiy was able to perform sweeping reforms as the prime minister has executive powers in Ethiopia and as economic policy largely originates from the Prime Minister’s office. Nevertheless, Abiy faces important challenges, as demonstrated by a coup attempt in Amhara State in June 2019. Furthermore, while his changes have made him popular in general, they have also unleashed a wave of unrest and regional ultranationalism that had previously been suppressed by the security forces. In addition, Tigrayans have the impression that the prime minister is biased against them as he is purging corruption (allegedly against them). Even though ethnic identity has long been an important factor in Ethiopian politics, its salience has intensified in recent years. What is more, it is likely to become even more polarising ahead of the 2019 (local) and 2020 (legislative) elections. That being said, it is unclear if these elections will go ahead as scheduled due to ethnic tensions and a delayed census.

Fastest-growing country in the region

Since 2000, Ethiopia has been one of the fastest-growing economies in Africa, after decades of stagnation. Indeed, before 2000, the average real GDP growth rate was 2.8% (between 1992 and 2000). However, between 2000 and 2019, real GDP growth has been on average a high 9.1%. In the past two decades, economic growth has been mainly driven by public sector investments in infrastructure. As shown on graph 1, since the beginning of the Ethiopian fiscal year 2018/19, which started in July 2018, real GDP growth has been slowing down – though it remains strong, at 7.7%. The main reasons are the political headwinds and the slowdown in infrastructure investments. In the medium term, economic growth is expected to decline slightly to around 7%, which is still a high level. Nonetheless, droughts remain a downside risk. They have become more severe and recurrent in the last years while the country relies on rain-fed agriculture (coffee, tea, spices…). Furthermore, a significant worsening of the political turmoil would also have a negative impact on economic growth.

Moderate business environment risk

Despite the strong growth performance, the systemic commercial risk rating is moderate (category B). On the downside, the business environment is rather difficult in Ethiopia. Though the Ease of Doing Business indicator improved in 2019 vis-à-vis 2018, Ethiopia is still well below the sub-Saharan regional average, ranking 159th out of 189 countries. Additionally, corruption is rather widespread. Furthermore, the Ethiopian birr is devaluating mildly. The Ethiopian birr exchange regime is de facto a crawling peg against the US dollar. The National Bank of Ethiopia kept the Ethiopian birr relatively stable vis-à-vis the USD in the past. As a result, while in 2015 the majority of sub-Saharan economies experienced severe exchange rate depreciation due to a strengthening US dollar, the birr depreciated very little. However, this monetary policy took its toll as it led to declining foreign exchange reserves, reported foreign exchange shortages and an increasing gap between the official and parallel markets. In October 2017, the authorities responded by devaluating the birr (by 13% vis-à-vis the USD); nonetheless, a policy of gradual depreciation with respect to the USD can also be expected in the coming months to years, as the birr remains overvalued. Lastly, inflation stands at a high level, estimated at around 15% in June 2019. Since 2017, the country has been suffering from double-digit inflation, as the devaluated currency puts upward pressure on prices. Nevertheless, inflation is expected to come down in the coming years due to the expected tighter monetary policy of the National Bank of Ethiopia.

Large public investments and low tax revenues are pushing public debt to an elevated level

Since 2012/2013, Ethiopia is recording significant public deficits. The deficits are the result of the low tax-to-GDP ratio – mainly due to the lack of efficiency of the domestic tax system – as well as of the heavy infrastructure investments made by the government. The public deficits have been pushing up the public debt. In July 2018, the public debt was estimated at 61.1% of GDP, an elevated level, coming from 42.2% of GDP in July 2012. More alarmingly, public debt was estimated at almost 500% of the public revenues in July 2018, which is a very high level, coming from around 300% in July 2012. Nonetheless, it is expected that the public debt has peaked and will gradually decline in the coming years to roughly 54% of GDP in 2023/2024. The government announced in July 2018 that it would not commence working on new mega projects. It focuses instead on completing the already launched projects that have been delayed. Moreover, new projects will not be allowed to rely on non-concessional financing and ongoing projects will largely shift to concessional financing. Additionally, tax revenues are expected to gradually increase thanks to a comprehensive Tax Transformation Programme implemented by the authorities. That being said, public interest payments are expected to increase in the coming years, even though they remain at quite a low level. The reason is that grace periods on non-concessional debt acquired in the past expire. As a result, the fiscal deficit is expected to decrease but should remain significant in the coming years despite fiscal consolidation efforts. Moreover, public expenditure might increase in the run-up to the elections.

The external balance is vulnerable to droughts, high oil prices and an overvalued currency

The country had been recording wide current account deficits since 2011/2012. On the import side, energy imports and capital goods (for construction) dominate. On the export side, private transfers play a key role, as they account for around 45% of the current account receipts in 2017/2018. It is likely that a big part of the transfers comes from the US, as a large part of the Ethiopian diaspora resides there. Furthermore, (air) transportation (which accounts for almost 21% of current account receipts in 2016/2017) and soft commodities (especially coffee, which accounts for roughly 8% of current account receipts in 2015/2016) are large sources of export revenues. Lastly, donor assistance is also an important source of export revenue. Despite the impressive real GDP growth rate, Ethiopia is still among the lowest-income countries in the world. It is therefore no surprise that Ethiopia is one of the largest aid-recipient countries in the world.

The trade balance significantly worsened in 2014/2015, as Ethiopia lost competitiveness because of its strong currency in comparison to regional trading partners. Consequentially, the devaluation of the Ethiopian birr in October 2017 led to an improvement of the current account balance as of 2017/2018. In 2018/2019, the IMF estimated the current account deficit at -6% of GDP, a slight improvement in comparison with 2017/2018, when the current account deficit stood at -6.5% of GDP. The main driver is the significant drop in public sector imports, while exports rose, driven by (air) transportation and manufacturing exports, despite the fall in coffee prices and the rise in oil prices. In the coming years, the current account deficit is expected to gradually narrow to -3.4% of GDP in 2023/2024. Firstly, the government is committed to constraining spending into infrastructure. Secondly, the country is investing in exports that will diversify export products (see below). Lastly, the intention of the government to join the African Continental Free Trade Agreement and accelerating progress on WTO accession would also improve access to foreign markets and support exports. Downside risks are a potential increase of oil prices, delays in the completion of export-supporting infrastructure, low prices for soft commodities, droughts, intensification of trade tensions between the US and China (affecting the Chinese economic growth and potentially the world economy) and lower private transfers.

Current account deficits are being financed by FDI and external debt

Current accounts deficits are being financed by foreign direct investment (FDI) and external debt. FDI has increased significantly in the past decade but remains limited. In the coming years, FDI inflows are expected to increase, as Ethiopia is gradually opening up to foreign investors (e.g. in the previously blocked sectors, such as telecoms and energy). Debt issuance has been the most important source of financing. External debt has been on the rise since Ethiopia has benefited from debt cancellation in 2006 under the Heavily Indebted Poor Countries (HIPC) initiative. China is an important lender to Ethiopia but the government has also already tapped the financial markets. In 2014, the country debuted in the financial markets with a USD 1 billion sovereign bond denominated in euro, which matures in 2024. Despite rising external debt, external debt vis-à-vis GDP is quite moderate as it is estimated at around 35% in July 2019. However, compared to current account receipts, external debt stands at an elevated level of almost 200% in July 2019. That being said, the external debt to current account receipts ratio should improve. Firstly, stronger export growth is expected as a result of multiple export-oriented infrastructure projects that should come on stream. Secondly, Ethiopia seems to have slowed the external debt build-up ever since the IMF flagged the country as being at a high risk of debt distress in 2017. The main risk for the medium- to long-term risk classification (in category 6/7) remains whether the infrastructure projects will be able to generate enough export receipts. Furthermore, despite its pledge to aim for concessional loans, the government might tap international capital markets again. Hence another important risk, that is, a potential rise of external debt service.

Diversification efforts will help the country in the long term

The country has increased its diversification efforts, as the government is concerned about the relatively low export revenues. Firstly, Ethiopia is striving to become a leader in light manufacturing in Africa. The government prefers diversifying into the soft manufacturing sector since it provides higher employability levels compared with traditional capital-intensive industry sectors. As Ethiopia is the second most populous country in Africa, after Nigeria, and as almost 70% of the population is young, creating jobs is important for governmental and political stability. However, as manufacture exports only account for 3% of total current account revenues, Ethiopia still has a long way to go. Moreover, small and medium-sized enterprises still struggle in accessing the credit they require for expansion. Secondly, hydroelectricity exports are likely to grow. In 2011, the construction of the Grand Ethiopian Renaissance Dam (GERD) started. When the dam is completed, it will be the largest hydroelectrical power plant in Africa and the 7th largest in the world. The dam is expected to both meet the growing domestic demand and generate significant earnings from electricity exports to neighbouring countries. The construction of the dam on the Blue Nile river and concerns over Nile water allocations have caused several conflicts with downstream countries, such as Egypt and Sudan, but these conflicts are not expected to escalate or derail the finalisation of the construction of the dam. Thirdly, in 2015 Ethiopia announced plans to export natural gas to China. Ethiopia found extensive gas deposits in its eastern Ogaden Basin back in the 1970s. It was envisaged that the production would start last year. However, conflicts between the government and rebel movements in the Ogaden Basin have delayed these plans. The Ethiopian government forecasts that the production will begin in 2020 and will create significant export revenues. Lastly, the country possesses the largest total livestock herds in Africa. Today, the export potential of meat and dairy is not fully exploited but, in the long term, the sector can generate export revenues.

Liquidity under pressure

Ethiopia’s external liquidity has been under pressure in the past years. Firstly, the short-term debt is rising – albeit from a low level – due to infrastructure developments. Secondly, wide current account balances weigh on the already limited foreign exchange reserves (standing at less than two months of import cover in January 2019). Lastly, the dependence on primary commodity exports makes the country prone to global price movements that cause volatility in foreign exchange earnings. As a result, foreign currency shortages are regularly being reported. In light of these events, since 2017, Credendo’s short-term risk classification of Ethiopia has been 6/7, the second worst risk category.

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com