Ethiopian Business Review

Cash Strapped: How the Credit Crunch is Affecting the Private Sector Featured

Abenomics is a recently coined word to re- fer to the massive planned spending by the new Japanese Prime Minister Shinzo Abe to relieve the country’s economy from more than two decades of stagnation. To start the economy going and achieve some level of growth, the plan envisages investing tens of billions of dollars on infrastructures, among other things. Even though it is still a challenge to do this in an era of austerity, the Japanese government can go with its plan, thanks to a variety of deficit financing mechanism and its sophisticated financial market.

This is what Ethiopia’s government is trying to implement, except the country’s infrastructure system is almost nil and have to be built from scratch with much more significance to the econ- omy-beyond being a mere stimulus package as in Japan. But unlike Japan, the government doesn’t have a variety of deficit financing mechanisms at its disposal. And the sources it chooses to finance its massive projects with brought huge amount of additional money in to circulation exacerbateing the inflationary pressure in the economy. The measures that the Business doing in Ethiopia continues to be an audacious venture due to highly unpredictable financial market government has been taking to correct this and curb the galloping inflation seem to back fire, once again. These measures that are being implemented at the expense of the private sector are tangling the financial sector in various problems: from the shortage of foreign currency to liquidity crunch. The situation is taking its toll on private investment in the country.

Business doing in Ethiopia continues to be an audacious venture due to highly unpredict- able financial market. Even though the National Bank of Ethiopia (NBE) is taking measures to correct this, the economy has a long way to go before enjoying some level of predictability that comes with scientific financial management.

Money supply and inflation in Ethiopia

In economics, the money supply or money stock is the total amount of monetary assets available in an economy at a specific time. There are several ways to define money, but standard measures usually include currency in circula- tion and demand deposits. The money supply is just the amount of money floating around the economy and available for spending. According to NBE’s monetary policy framework, the cur- rent target is to ensure that the money supply growth is in line with nominal GDP growth rate.

Liquidity is the amount of capital that is available for investment and spending. High liquidity means there is a lot of capital. Most of the time high liquidity spurs economic growth, even though it may sometimes create inflation- ary pressure.

For Ethiopia, evidences show that in the long- run, non-food inflation is caused by monetary growth, interest rates and inflation expectations. According to a research by African Development Bank, the main driver of short-run inflation in Ethiopia is a surge in money supply, accounting for 40 Pct. For Ethiopia, this means that achiev- ing fiscal balance and control of the money sup- ply are essential policy tools for stabilizing inflation over the longer term.

Components of broad money supply, in millions of Br as ended on June 30s
Source: National Bank of Ethiopia, Compiled by EBR
Particulars 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12
1.Narrow money supply 29,617.70 35,350.40 42,112.66 52,434.63 76,171.00 94,849.90
Currency outside banks 13,708.40 17,654.10 19,715.01 24,206.80 32,574.90 38,537.10
Demand deposits (net) 15,909.30 17,696.30 22,397.64 28,227.84 43,596.10 56,312.70
2.Quasy-money 27,034.20 32,831.80 40,397.09 51,997.77 69,206.00 94,548.90
Savings deposits 23,715.20 29,477.60 37,148.72 48,041.57 64,539.60 82,487.80
Time deposits 3,319.00 3,354.10 3,248.37 3,956.21 4,666.40 12,061.10
3.Broad money supply 56,651.90 68,182.10 82,509.75 104,432.40 145,377.00 189,398.80

Broad money supply growth was 35 pctat the end of March 2011, said the IMF, which had previously projected growth of 22 pctin money supply in the fiscal year. According to The Global Economy, an international economic research organization, the money supply growth in Ethiopia is higher when compared with other countries.

According to the table broad money supply almost quadrupled in a period of five years. And the narrow money supply, the most liquid section of the money supply, more than tripled in the same time.

This surge in money supply has put infla- tionary pressure on the economy. And it has eroded the purchasing power of the urban- ite especially that of the civil servant. Even though the government brought inflation down to 5.3 pctin August 2010 from a peak of 64.2 pct in July 2008, a 17.5 pct devaluation of the Ethiopian Br against major international currencies in September 2010 boosted import costs, pushing up inflation again.

According to African Development Bank, the inflation rate in Ethiopia was nearly 40 pct in October before leveling off to 35.9 in December 2011. Inflation has been building for some time, even before the onset of the current episode of high food prices driven by expansionary monetary policy. Credit to the public sector grew by more than 45 pct in 2011, triggered largely by the monetization of the fiscal deficit.

Annual average inflation rates, in pctage.
Source: Central Statistics Agency (CSA) and National Bank of Ethiopia
Compiled and Illustrated by EBR

As we can see from the graph the general inflation was above 20 pct on average for the last six years. To successfully jump out of this inflationary trap, the Ethiopian monetary authorities needed to tighten the stock of money in the country. Accordingly, the central bank has taken different measures to this effect. Different mechanisms that range from buy- ing the local currency with foreign exchange and restructuring of loan portfolios to bond purchase directives, were deployed to suck the money suffocating the economy.

These measures in combination with other factors have resulted in a slower rate of inflation.

Central banks any where in the world take several measures to curb in- flation, which sometimes may result in some unintended outcome like liquid- ity shortage and credit crunch, which seems to be the case now at this time in Ethiopia. A credit crunch is a reduction in the general availability of loans or credit.

A credit crunch generally involves a reduction in the availability of credit independent of a rise in official inter- est rates. In other words, a tight mon- etary policy could serve as an anchor for inflationary pressure in Ethiopia. However, economists agree the prob- lem of inflation in the Ethiopian context cannot be tackled without addressing the large budget deficit. Yet some signs of relief are being seen. Prices for com- modities continued to increase, but at a slower rate than they did in 2011/12. According to the February 2013 con- sumer price index, released by the Cen- tral Statistics Agency (CSA), the general inflation rate decreased to 10.3pc. But at what cost…?

...broad money supply almost quadrupled in a period of five years. And the narrow money supply, the most liquid section of the money supply, more than tripled in the same time

Credit access and the private sector

Habehsa Cement Share Company seems to be among the first causalities of the private sector in this unfortunate development in the financial sector. On September 30, 2011, Habesha Cement and The Development Bank of Ethiopia (DBE) signed a 1.52 billion Br financ- ing agreement. However, DBE has now withdrawn the offer on the grounds of inability to disburse funds. It has simi- larly pulled out of loan agreements with five other companies, according to local media reports.

In its directive that required banks to purchase bonds worth 27 pct of their loan disbursements, NBE designated the amount to be used to finance long term projects through DBE. This is not however realized as DBE fails to finance long term projects like cement produc- tion. Insiders link this to the absence of enough cash even in state owned banks. The limited amount of money available are used to finance public projects.

There is a visible lack of credit and liquidity shortage in the economy. A banker that EBR talked to blames the above directive and its consequent bond purchases for the liquidity shortage in the market. Mulugeta Ayalew public relations and network officer at Ethio- pian bankers association agrees with this, “the bond purchases have eroded the banks’ credit forwarding capacity; so they are not able to lend as much as they want.”

“Basically banking is buying and selling cash; However, there is not enough cash to sell at this time,” the banker says. “Even though the reduced reserve requirement is a positive thing,” referring to the recent NBE directive that slashes reserve requirements by half to five pct, “still more than 25pct of most private banks’ deposit is tied up in government bond and bill.”

This has made many private banks cash strapped. Thus, they advise their cus- tomers to postpone their loan requests. Public banks, like Commercial Bank of Ethiopia (CBE), where a large sum of the country’s de- posits are mobilized, and which are not required to bond purchases, are not forwarding loans to the private sector except for exporters. At the mo- ment, there is high demand for loans from exporters. Presently, projects, with amounts more than a single loan limit, are coming to private banks for finance. These kinds of projects were normally presented to public banks,” states a banker. Such developments show the changing dynamics in the financial sector in present day Ethiopia.

Annual average inflation rates, in pctage.
Source: Central Statistics Agency (CSA) and National Bank of Ethiopia
Compiled and Illustrated by EBR

As can be seen from the graph, loan The bond purchases have eroded the banks’ credit forwarding capacity, so they are not able to lend as much as they want advances from public banks have beendwarfing those of the private banks in recent years. As most of these loans are supplied to the public sector, the situation has put private investment at a disadvantage.

“The economic growth of the country was not all smooth and it is very hard to sustain the high rate of cash injection that the economy was enjoying, so the government may have felt the need to normalize the economy,” reflects Seid Nuru (PhD), macroeconomic head at Ethiopian Economic Association (EEA). “The service sector was the main growth engine of the private sector in the last couple of years; creating infla- tionary pressure and this may have led the government to restrict the amount of finance flowing to this- sector. Rather diverting resources to sectors it deems productive. Even though it continues to finance pub- lic investments on infrastructure and energy that may have the same effect on inflationary pressures,” the macro economist says.

More or less that is what happened. “We are practically rationing loans, favoring manufacturers and export- ers, while advising new projects, and projects from the hospitality and the service sector to postpone their re- quests,” says the banker. There is no interbank lending as such at this time as almost all banks are cash strapped. “In six months time, our bank has lent what it has planned for the whole year and more than 40 Pct of that of last year”, a senior manager in one of the private banks told EBR.

According to Awash Bank, total loans and advances markedly rose to Br 5.5 billion in 2011/12 from about Br 4 billion the previous year, partly reflecting the positive impact of the removal of credit ceiling by NBE and to some extent due to the growing credit demand in the country asso- ciated with economic growth. As a result, the Bank’s loan/deposit ratio improved to 60 Pctfrom 50 Pctthe previous financial year. But, this is not as good as it seems as substantial amount of the deposit is tied up in government bonds.

With a vision of facilitating the rapid economic development of the nation, with stable price and foreign exchange rate and healthy financial system, NBE was reestablished as per the amended proclamation in 2008. This made it accountable to the prime minister. In six months time our bank has lent what it has planned for the whole year and more than 40 pct of that of last year With this, the government redefined what it wants to accomplish and how to regulate the sector. Indus- try observers argue that this might have forced NBE to operate not as a conventional central bank, rather as an agency of the executive branch of the government, having a tilted focus on issues rather than executing it’s primary mandate, which is ensuring financial stability in the country.

Yet the macro economist elaborates this saying, “every central bank has its own assignment,” and tries to see NBE’s approach through this light. “Of course,” he added “this pragmatism should not open the door for a ‘blank check policy’ situation.” Yet, some analysts argue this lack of focus and independence as the main reason behind the various problems in the financial sector, including the present credit and liquidity shortage in the economy.

Remedies and priorities

Monetary policy strategy of a central bank depends on a number of factors that are unique and contextual to the country. Given the policy objective, any good strategy depends on the macroeconomic and the institutional structure of the economy. According to NBE’s policy frame work, monetary policy of central banks in a simplified analysis amounts to the determination of the “optimal” quantity of money or, in a dynamic sense the optimal rate of growth of the money stock. But, the bank seems a long-way from achieving this goal. It need capacity building and scientific financial management systems that will enable it to make accurate and long sighted decisions, rather than being in a knee jerk reactions mode all the time.

The banker proposes this to all banksreme and financial institutions in the country as well. He says, “most, if not all, banks are using traditional approach. The need for strategic and optimal fund management, that will make decisions regarding deposit mobilization, loan disbursement and other financial management aspects of the bank more advanced is ever evident.” In addition to this, the banker suggests aggressive

deposit mobilization as a solution in the short run. “CBE is working aggressively and in relative effectiveness, especially in deposit mobilization and it has acquired good qualities that we in the private banks envy. So we have to take lesson from CBE and work hard on deposit mobilization” the banker says, even though some bankers are disgruntled by the level of CBE’s aggressiveness. Recently, time deposits of different government institutions in private banks were moved to CBE accounts.

The bankers association agrees with the need for deposit mobilization, even though the institution embarrassingly doesn't have any strategic direction as to how its members should handle the situation. For a sector with all the massive capital and work force, its association is very dormant. Recently time deposits of different government institutions in private banks were moved to CBE accounts From the discussions we had with its staff, it seems like the association has no clear mission and direction. It doesn't even have the minimum data and information about the sector and its members. Rather, the association was busy defending the actions of the central bank rather than advocating the concerns of its members.

The issue finally boils down to prioritization. Economic policies are all about prioritization and allocation, al- locating the scarce resource to the most efficient sector. And there are two major sectors in the economy: the private and the public (government) sectors. And to whom precedence is given depends on the anchor ideology of the government and the level of development the economy finds itself in, among other things. Many economists and international organizations argue that actors in the private are more efficient than the public sector in using resources. Hence, they criticize governments for crowding out the private sector from the economy.

However, the developmental state begs to differ. In the early days of development, the private sector is in no position to make the required investments to take the economy out of its structural predicament, the late prime minister, Meles Zenawi, had reiterated on many occasions. Given limited resources at the developing nation’s disposal, the resources have to be directed towards most critical sectors that determine the country’s future trajectory; and that ac- cording to developmental state theory is big infrastructural projects and other public investments.

As the problem partly arises from issues regarding resource allocation and the umbrella policy framework, the solution may not be simple. But many observers agree that NBE must do something before the situation gets worse and ease some of the conditions. But for now finding enough finance for the growing demand for credit from the private sector will continue to be a real challenge for the financial sector.

Mikias Merhatsidk

EBR staff writter

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