Ethiopian Business Review

Brews Inflation, Exacerbates Balance  of Payment Problem

The budget deficit for 2019/20 fiscal year stood at ETB97.1 billion, twice the amount registered two years ago. Despite the escalating figure, the government claims it is under control since it accounts for only three percent of the gross domestic product (GDP).

Nevertheless, experts stress that the deficit goes as high as 17Pct of the GDP when the money borrowed by public institutions is included in the equation. As the budget deficit grows, there is a fear money supply would rise, which will ultimately lead to a rise in inflation, which has already reached 15.4Pct. The consequence will further exacerbate balance of payment problem, which is already at alarming stage. EBR’s Ashenafi Endale spoke with officials and experts to shed light on the matter.

Financing development endeavors has always been a contentious matter in Ethiopia as it requires balancing the adverse effects arising from the ever ballooning government expenditure. Since the government follows public lead investment growth model, budgeting strings clearly shows where the economy is heading to, leaving less for uncertainty.

As the government continues to employ expansionary fiscal policy, the construction of mega projects with billions of birr, year after year, public expenditure is indeed inflating at higher rates. While this has brought macroeconomic imbalances, it has also broadened the country’s budget deficit.

Of course, government revenues have never been on a par with expenditures in Ethiopia. In fact, it has become a tradition that annual budget of the country that the executive submits to the parliament for approval comes with huge deficit. However, 2019/20 fiscal year comes with the highest deficit the country has seen. While the budget approved stands at ETB386.9 billion for the year; the deficit goes to ETB97.1 billion, twice the amount registered three years ago. It also accounts for three percent of the gross domestic product (GDP), which is the second highest registered since 2006/07, a year it climbed to 3.7Pct.

The main reason for such widening deficit is none other than the unmatched growth rate of government revenues vis-à-vis expenditures. For the year 2019/20, the government has planned to collect ETB253 billion from tax and non-tax revenues. On the other hand, ETB36.8 billion is expected from external sources in the form of grant.

While the revenues plus grant will cover 75Pct of the expenditure, the government is expecting to fill the gap, which accounts for 10Pct of the budget, by external assistances (ETB40.3 billion). On the other hand, ETB56.8 billion will be borrowed from local sources to finance the gap.

However, some of these sources of income have proved to be unreliable especially in the era of US President, Donald Trump. In fact, the share of grants has been declining especially in the past seven years from 19Pct to six percent of the budget. Domestic revenues, especially income from tax, have also been falling.

Ahmed Shide, Minister of Finance, didn’t not deny the fact that tax revenues have been falling short of the targets especially in recent years. While addressing Members of the Parliament (MPs) last month; he said, “Although ETB235.7 billion was planned to be collected in the form of taxes in the first 10 months of the year, only 68Pct of the plan was achieved.” 

Tax constitutes the majority of domestic revenues. In the past fiscal year, 95Pct of the domestic revenues came in the form of tax. Between 2010/11 and 2014/15, the revenues collected as tax has been showing a modest growth with average annual rate of 21Pct. But since 2016/17, the average annual growth rate has subsided to six percent. When compared with the previous fiscal year, the revenues in 2019/20 is only hoped to increase by 7.6Pct. The tax-to-GDP ratio has also been dwindling since 2016/17, a year it reached its zenith with 12.7Pct. Currently, this figure stands at 10.7Pct, way below the average ratio of tax revenue to GDP for sub-Saharan Africa which stands at 16.8Pct in 2019, according to OECD Centre for Tax Policy and Administration

The same cannot be said for government expenditures. In 2010/11, government expenditures stood at ETB94 billion. This increased to ETB354 billion in 2017/18, growing by a whopping 23.8Pct annually, on average. The biggest increase is registered in recurrent budget, which showed a 27.9Pct rise during the same period while capital budget showed a 20.2Pct annual growth. Even between 2016/17 and 2018/19, government expenditure rose by 16Pct.

A closer look at the budget for 2019/20 reveals that public expenditures remained high while revenues fail to meet the target. The capital budget allocated for the fiscal year stood at ETB130.7 billion while recurrent expenditures stood at ETB109.5 billion. Large pie of the capital budget goes to infrastructure and pro-poor priorities, such as financing projects aimed at achieving sustainable development goals, poverty reduction, and bridging income inequality.

Zelalem Birhane, director of external communications at the National Planning Commission, says the budget is in line with projects planned in the second phase of the Growth and Transformation Plan (GTP). “Nothing new has been added to the ongoing projects. The revenues and expenditures are growing hand in hand.”

Of course, compared with the amount approved in the fiscal year, the budget for 2019/20 showed a 1.5Pct increase. But fiscal policy analysts warn that the government is likely to request parliament to approve supplementary budget in the middle of the year as it did during the previous fiscal year. This will further inflate the public expenditures as well as the budget deficit.

When the government approved budget for 2018/19 fiscal year, the deficit was ETB57 billion, but this has increased to ETB90 billion when ETB33 billion supplementary budget was approved three months before the end of the budget year. Bearing these in mind, with the rise in inflation, it is expected that the budget deficit is likely to increase even higher than ETB97.1 billion in 2019/20. 

The Finance Minister was confident while presenting the budget bill to MPs. “The deficit for the upcoming financial year is not bad,” he said. He added that the domestic credit will only be 1.8Pct of the deficit; and affirmed that there will be no inflationary pressure arising from the budget deficit.

Alemayehu Geda (PhD), professor of macroeconomics at Addis Ababa University, on the other hand, differs. He explains that the deficit is worrying in contrary to what the government claims. “Currently, the budget deficit stands at about 17Pct of the GDP, almost six times higher than what the government states,” he says. “Government intentionally excluded public sector deficits [credit taken by public institutions like the Ethiopian Electric Power] while calculating the figure. It is only by doing so that the government managed the deficit to stay around three percent of GDP.”

The quarterly report published by the national bank of Ethiopia (NBE) in April 2019 indicate that the outstanding credits taken by public institutions in the form of corporate bounds reached at ETB256 billion by the end of December 2018. Out of this, 87.6Pct of the loans is borrowed by Ethiopian Electric Power while the remaining goes to Ethiopian Railway Corporation.

The huge money borrowed by these public institutions helped the national debt level to mount. Ethiopia’s debt to GDP ratio now stands at 56Pct. Even though government financed many mega projects by borrowing money from local and external sources, the return on these investments remain very questionable. A case in point is the Ethio-Djibouti Railway project, which was constructed with USD4.2 billion loan from China. The Chinese-built 756 km electrified rail way connecting landlocked Ethiopia to Djibouti, a gate to more than 90Pct of the import and export commodities of the country, was supposed to boost up export revenues by substantially improving the logistic hurdles along the export corridor. However, Ethiopia’s export has kept its downward growth even after the railway has become operational.

However, some economists still advice government to keep its developmental state outlook. Alemayehu Geda is one of them. “To keep the type of economic growth Ethiopia has been witnessing over the last decade, the government should keep increasing public investment,” he said. “What is different today is, however, relying on external finance sources is no more possible as in the past. Thus, it is inevitable for government to start printing money and pumping into the economy soon.”

Amin Abdela (PhD), Head of Trade and Industry Department at the Ethiopian Economics Association, agrees. “The high time for external sources of finance is gone. The supply of money into the economy without [real output growth] will only worsen inflation.”

Monetary experts have been studying the correlation between the size of budget deficit, money supply and rate of inflation. Emeh, E. Onyinyechika, in his study entitled ‘Fiscal Policy Measures and its Implication on Economic Growth’, examined the determinants of fiscal deficits and found out that inflation, revenue instability (or slow growth of revenues) and increased government participation in the economy has been the major factors behind mounting budget deficits in developing countries.

On the other hand, Festus O. Egwaikhide, Professor of Economics at the University of Ibadan, Nigeria, who investigated the role of fiscal policy in developing countries with specific reference to Nigeria, indicates that the narrow revenue base that could not endure the burden of public expenditure ultimately leads to more money supply. When budget deficit is financed by borrowing, macroeconomic instability arise in the form of escalating public debt and high rate of inflation.

In Ethiopia, inflation already climbed to 16.5Pct, the highest since April 2018, according to Central Statistical Agency. “Considering the growth of the expenditures, the government is likely to need additional budget, which will worsen the deficit, says Alemayehu.

Yet, the worst macroeconomic instability will come in the form of balance of payment deficit, according to Alemayehu. “Budget deficit has direct implication on foreign trade imbalance, which is currently at alarming stage in Ethiopia.”

While the country’s annual export remain less than three million dollars for the past six years, import bills reached as high as USD18 billion currently, six times the export revenues. “Ethiopian government is looking for several solutions to increase access to hard currency since the economy has become import dependent. The hard currency pooled from remittance, export, foreign direct investment, aid and loan cannot cover the mounting import bill unless the economy becomes more productive.”

8th Year • July.16 - Aug.15 2019 • No. 76

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