Promise and peril in Ethiopia
Capital markets key to sustaining country's essential reforms
by Ben Robinson in London
Wed 3 Oct 2018
In October 2017 the central bank of Ethiopia increased interest rates by 200 basis points to stem capital outflows. At the same time, the government devalued the birr by 15% in an attempt to boost exports, narrow the large current account deficit and gain some much-needed foreign currency. In the end it was not enough to quell public resentment; in April, Hailemariam Desalegn resigned as prime minister of Africa's second most populous country.
His successor, Abiy Ahmed, has embarked on a widespread programme of economic and political reform. This places Ethiopia among a handful of African countries, including South Africa, Zimbabwe and Angola, that have recently rid themselves of incumbent leaders in pursuit of better governance and accountability.
So far, Ethiopia has gone further and faster than the rest in revising its fortunes. Abiy has signed a peace accord with neighbouring Eritrea, marking an end to decades of hostility. The government has announced a large-scale privatisation scheme to attract foreign investment to the country's aviation, energy and telecommunications industries, among others. Reforms to the dominant power of the security services are intended to improve governance across all areas of public life. Zimbabwe, by contrast, has made a shakier start under the new regime. Elections in July were marred by violence and accusations of fraud, while senior members of the previous regime have stayed in key posts.
The difficulties facing reformers in Addis Ababa remain substantial. A violent flare-up in the ethnically Somali east of the country in August underscores tensions in Ethiopia's diverse population. The Tigrayan and Amhara minorities feel threatened by some reforms undertaken by Abiy, the first prime minister from the majority Oromo group. In June, Abiy was targeted by a grenade attack, reputedly made by some members of the intelligence services.
Ethiopia also faces a difficult external environment. The peace agreement with Eritrea is far from assured, with the country's dictator, Isaias Afwerki, an unreliable partner. Landlocked Ethiopia relies on ports in Somalia, Djibouti and (after the peace deal) Eritrea. This makes trade expensive – sending goods by road from Addis Ababa to Djibouti costs more than shipping them from Djibouti to east Asia – and vulnerable to political developments. A rising dollar and risks of an escalating global trade war don't help.
Adding to these difficulties, Chinese investment, at around $15bn over the last decade, has fallen drastically. An agreement with the United Arab Emirates to provide $3bn in loans and investment helps a little. But with government debt at 60% of GDP and imports outweighing exports by a factor of four-to-one (both legacies of the previous government's debt-fuelled investment programme, not all of it well-spent), this is insufficient to ease the foreign currency shortage.
With a reformist leader and a peace agreement with its neighbour, Ethiopia is well placed to make the necessary changes to strengthen its economy. The population is large and young, the economy grew by more than 10% per year on average between 2005-16, income per capita rose fourfold in the same period, and it has a nascent but significant manufacturing sector.
Given its persistent current account deficit and the drying up of external financial flows, the government must find capital from new sources. Ethiopia's growth rate, underpinned over the last decade by considerable public spending, is unsustainable and has fallen recently. Private sector investment is necessary to maintain growth and attract foreign capital.
To aid this process, the country needs to develop a local capital market. Ethiopia is the largest emerging economy without a domestic securities exchange (beyond one for commodities). As the government seeks to reduce the state's role in the economy, a domestic bourse will prove essential. However, capital market development has not been a focus of Abiy's reforms, which may create obstacles for the government's wider proposals.
Easing the country's foreign exchange shortage and tackling its large debt burden will be vital to ensuring reform efforts are kept on track and not disrupted by social unrest or economic volatility. The promise – and the peril – facing this large and important country make it a key one to watch.
Ben Robinson is Deputy Head of Research at OMFIF. On Thursday 11 October in Bali, OMFIF is launching the second edition of the Absa Africa Financial Markets Index alongside the International Monetary Fund-World Bank Group meetings. The index is a premier indicator of the attractiveness of Africa’s capital markets, for use by investors and asset managers around the world.
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