Striking a Delicate Balance: Ethiopia’s Sectoral Economic Growth, Sustainability

At the end of the 2008/09 fiscal year, for the first time in Ethiopian history, agriculture gave way to service as the biggest contributor to the nation’s Gross Domestic Product (GDP). Experts argue this was unhealthy because economic theories suggest a healthy structural transformation of a growing economy shifts focus from agriculture to industry and then to service. That was why the service sector’s extraordinary growth was like “putting the cart before the horse”. Accordingly the administration of the late Prime Minster Meles Zenawi took a series of policy measures to adjust the growing economic imbalance. Samson Hailu, EBR’s Research Editor, writes about the implications of these policy measures for the current business slowdown in the country.

When the long serving finance minister Sufian Ahemed sat in front of members of the parliament last June to present the nation’s annual macroeconomic performance, he focused on the government’s remarkable success in the industrial sector. The Minister told parliamentarians that the sector registered an average growth rate of 16.7Pct during the Growth and Transformation Plan’s (GTP) first three years. The government regarded this achievement as the foundation for the country’s quest to join the club of the lower ranking middle income countries in 2025, by increasing industry’s share of the Gross Domestic Product (GDP) to 27Pct.

Critics however argue that the industrial sector’s growth is happening at the expense of other vital parts of the economy. They point out that substantial financial resources are being reallocated from the long blossoming service industry and they fear that this may crowd that sector, which is helping to sustain the economy’s momentum, out. Judging from the rampant business slowdown observed in the past couple of years particularly in the service sector- in the wholesale and retail trade, real estate and banking sub sectors - the policy measures taken by the government to boost industrialization seems to be backfiring. Some experts have even been warning that the service sector is heading for a massive slowdown and near freeze.

Growth Rates of Economic Sectors (Pct)
  2007/08 2008/09 2009/10 2010/11 2011/12 2012/13
Agriculture 7.5 6.4 7.9 9 4.9 7.1
Industry 10.1 9.7 10.6 15 17.1 18.5
Service 16 14 13 12.5 10.6 9.9

 Prime Minister Hailemariam Desalegn, in his have been cash strapped. However, according to his explanation this was caused by a temporary holding back of liquid money in the economy, which came as a result of payment delays for many government projects. Instead of circulating in the economy, huge sums of money that should have been disbursed were accumulated in the vaults of the National Bank of Ethiopia (NBE). “However, all the payments owed by the government have been effective phase by phase which ultimately leads to the current relaxed business environment,” Hailemariam told journalists.

Despite the Prime Minister’s assurance many observers and critics still believe that businesses will continue to suffer. Although the government is saying it is injecting fresh money into the economy by paying for its large infrastructure projects, experts argue that the cash strapped economy was created by policies the government introduced in the financial sector, particularly with regard to the operation of private banks.

“Although the payment delay contributed to the problem, the government policy, which surrenders 27Pct of the total loans disbursed by private banks for NBE Bills, plays a much greater role, Tesfakiros Aklilu, a financial consultant who has been working with many private banks for the last 15 years explains to EBR.

This, according to the consultant, can be illustrated by the current massive slowdown observed in the service sector, which was making a fortune before the government implemented its new policy in 2011. Before 2011, most service oriented businesses were enjoying relatively better services such as eaiser access to loans from financial institutions operating in the country.

A picture of the long journey the service sector has undergone after the liberalization of the Ethiopian economy in 1993 can be painted by the experience of Essayas Fekru, 39, who has been engaged in the wholesale and retail business for the last 17 years. Essayas, who mostly imports and sells consumer goods, remembers the golden age of his business where accessing loans from banks was not an issue. “Business was pretty good three years ago, Essayas recalls. However, after 2011, things started to change to the extent that he could not access credit from any of the banks operating in the country. Aggravated by limited credit opportunities, businesses like Essayas owns, especially those located in urban areas like Addis Ababa, are becoming anxious about finding credit from banks to sustain and survive regardless of their size.

The Good Old Days

It was at the end of the 2008/09 fiscal year that the service sector—which covers wholesale and retail trade, real estate, hotels, transportation, communication, banking, health and education—started to dominate the economy in terms of its GDP contribution for the first time in Ethiopia’s history. Agriculture, on the other hand, ceased to be the economy’s largest player. At the time, the service sector’s contribution to the national economy reached 45.1Pct of the GDP while the contribution of agriculture shrunk to 43.2Pct.

Macroeconomic performance indicators demonstrate the mushrooming of easy- profit making businesses [in the service sector] over the past decade. According to the macroeconomic estimates prepared by the Ministry of Finance and Economic Development (MoFED), in 2008/09, the service sector grew by 14Pct while agricultural growth was limited to 9.9Pct. The service sector has also enjoyed a 12.7Pct average annual growth rate since 2003/04, while industries grew by just a single digit throughout this period.

For the government, however, the growth of the service sector at this extraordinary pace was like “the cart before the horse”. According to many economic theorists, there is limited real production involved in the service sector. They stress that the growth of the service sector results in a lot of spending with most of the money going to a few agricultural and industrial goods.

Despite its merits and disadvantages, this sectorial transformation is not consistent with the internationally recognized three-sector macroeconomic theory, which was developed by Alan Fisher, Colin Clark and Jean Fourastié in the 1930s.

This economic growth theory predicts that the centre of gravity in economic activities shifts, through inter-sectoral resource allocations by the market. As people have more discressionary income the economy transforms from agriculturally based to industrial and then to primarily relying on service industries, as average per capita income rises. However, this is not always the case. Some Asian countries like India and Indonesia have passed through similar sectorial shifts to Ethiopia. Some economists argue that Indonesia and India’s pattern of growth could be an alternative for underdeveloped economies that are still struggling to achieve high economic growth by developing their manufacturing sector. While the growth of the service sector could be left to the dynamics of globalization and technology, Ethiopia with its huge population and workforce needs to pursue high growth policies in its agriculture and manufacturing industries especially those with high labour absorption capacities, according to Nega Ejigu, a researcher at Bahir Dar University, Economic Research Centre. “This is why the Ethiopian government hopes to limit the growth of the service sector even though its success can increase the GDP,” he explains.

 Despite the arguments, many were astonished by the boom of service sector in Ethiopia that was relatively faster than the manufacturing sector. Motivated by a conducive business environment many private investments in the country were concentrated in the service sector. According to observers, private investors are attracted to service industries because of easy credit access and the lower risk. The financial sector in Ethiopia previously embraced only short term financing and the service sector is suitable for short – term loans. Investors were happy to engage in making easy money in the service sector which has a relatively lower risk due to the limited need for physical investment and equipment installation. As a result, most private banks were disbursing close to 60Pct of their loans for domestic trade services, imports and exports. The manufacturing sector, on the other hand, was scuffed from a lack of such finance schemes relative to other sectors since it requires relatively long-term financing.

Restoring Balance

The glamorous period of the service sector diminished as the government introduced more and more policy measures so as to uplift the stagnated industrial sector. When senior officials of the government sat on the drawing board to prepare the ambitious GTP, adjusting these sectorial imbalances was their focus of attention. Government officials pointed to lack of finance as one of the salient factors hampering industrialization. This forced the government to prioritize sectors according to its targets.

The first action the government took was to divert most of the financial resources under its channels to support large and medium scale industrial projects through the state owned Development Bank of Ethiopia (DBE) and Commercial Bank of Ethiopia (CBE). In the beginning of the 2010/11 fiscal year, the board of DBE approved its five-year strategic plan to give out 21.9 billion Birr, which is 67Pct of the 32.7 billion Birr approved to be disbursed until 2015, as loans to the manufacturing sector. The new strategic plan contradicted with DBE’s focus on agriculture and some selected sub sectors like hotels and tourism before 2010. Nevertheless, the new strategic plan, also gives some emphasis on agricultural projects by allocating 10.8 billion Birr. The service sector, however, was not included in the planned allocation of loans. The largest commercial bank in the country, CBE also followed DBE’s suit when allocating loans for the private sector.

Regardless of the different polices introduced to encourage investment in manufacturing by diverting financial resources from the service sector, the government had little luck limiting the growth of the service sector to the maximum of 8Pct as envisioned in the GTP. Instead, the service sector continued to enjoy a relatively higher growth rate than other sectors although at a decreasing rate. This called for additional policy measure to curb its growth. That was how a policy was introduced to hinder the activities of the flourishing private banks in the country. In the beginning of 2010/11 fiscal year, the government extended its arms in the operation of private banks by forcing all commercial banks except CBE to buy NBE Bills, amounting to 27Pct of the loans they disburse.

Unlike the first policy measure implemented through state owned banks, the impact of the second policy shook the core of the service sector, in which private banks have a major role. Since then the banking sector outlook has changed markedly. “Due to tightening policy measures, the growth of loan disbursement by private banks, especially short term loans slowed, a president of a private bank told EBR. In terms of deposit mobilization, the share of private banks also declined as the result of strong competitive pressures from the state owned, CBE. In fact CBE was very aggressive in its approach of expanding its reach and on average began opening branches every other day. This has significantly raised its market share, client base and deposit mobilizations. Industry observers call these aggressive measures of CBE a “mission to reclaim lost market position”

By the end of September 2013, 44.3Pct of the 76.3 billion Birr in deposits mobilized by all private banks were tied by NBE bills. This puts most banks under a liquidity crunch gradually and slowed down activities in the service sector, since there was little room for extending short term loans for businesses. Currently, most private banks are disbursing close to 40Pct of their total loan portfolio to finance domestic trade import and export. For the government, however, the liquidity problem observed in private banks comes from their limited capacity to reach the unbanked section of the society and mobilize enough deposits. “If you see state owned banks such as CBE, they are not affected because they manage to mobilize huge deposits, the Prime Minister said in his latest press conference. Stakeholders and experts, however, still point their fingers, for such imbalance, at the uneven playing field created by the policy measures the government took. Most senior managers of private banks EBR approached agree that the strong competitive pressures private banks are now facing from the fast-expanding state owned banks are created using state resources. CBE alone currently holds a 57Pct larger amount than the deposits mobilized by all private banks combined. Its branch network is also double the number of branches the private banks operate. Four years before, the condition was quite different.

The Future

Three and a half years since the launch of the GTP, all policy measures taken to boost the contribution of the industrial sector to the nation’s economy seems to be working although it comes with an opportunity cost of creating an inhospitable environment for services. At the end of the last fiscal year, the government achieved its dream of increasing the contribution of the industrial sector to 12.4Pct of the GDP from 10.7Pct three years before. On the other hand, the share of the service sector shrunk to 45.2Pct of GDP from 46.2Pct in 2010/11.

Service Sub - Sectors Growth Rates (Pct)
  2007/08 2008/09 2009/10 2010/11 2011/12 2012/13
Whole Sale &
Retail Trade
15.8 14.7 13.7 13 12.5 9.8
Real Estate 17.3 15.9 19.9 21.1 3.9 3.8
Financial
Intermediation
28.1 16.5 13.7 23.7 12.6 0.7

 Although there is no concrete research conducted on the issue, the preliminary assessment conducted by the Ethiopian Bankers’ Association in June 2011, reveals some of the effects such policy changes made on the growth of the service sector in general and financial sub sector in particular. The assessment indicates that the new requirement is creating an adverse effect on major sub sectors of the economy, such as international trade. It also projected that the lending interest rate of short-term loans will become more expensive in the future as banks try to conserve their liquidity, which would affect the entire business sector. Instead, industry players suggested to the government that loans that will be extended to finance export and import as well as merchandise loans should not be included in the calculation. They also warned that since a shortterm loan has a revolving nature the new policy will have a significant impact on most of the activities that lie under the service sector.

Close investigation of the country’s macroeconomic data reveals a much more disturbing picture of the service sector. Accordingly, its growth rate decreased to 9Pct last year from 12.5Pct three years ago. A couple of sub sectors under the service sector dominated by private investors, including wholesale and retail trade and banking as well as real estate companies were among the businesses hit by the policy change the most.

The latest macroeconomic data prepared by MoFED illustrates the alarming stages of businesses in the service sector. The wholesale and retail subsector growth has been decreasing gradually from 52.4Pct in 2008/09 to just 15Pct last year. The financial sub sector registered an even more alarming performance by exhibiting a 0.7Pct growth rate in 2012/13. This is despite the fact that the sub sector has been enjoying a twenty plus percent growth rate for the last nine years. The real estate sub sectorgrowth also stood at 9Pct last year, which was much lower than the 27Pct annual average growth rate it registered before 2010/11.

Many experts agree that the current conditions in the service sector created by policy measures can indicate the future of the sector. “Even businesses within the service sector that are not hit vastly such as hotels, restaurants, transport and communications will find themselves in a difficult position in the near future if the situation continues,” financial consultants explain. For the experts as well as industry players, the policy that is being implemented on private banks will have even a greater danger than simply affecting the financial sub sector. If the trend continues, they stress that it might erode the financial capacity of private banks which ultimately will make them irrelevant in the economy.

Searching for alternative means of financing industrial projects from international lenders, according to experts, could give the service sector some relief. Most financial experts also call for a more relaxed policy so as to create room for the business sector, which is still dominating the Ethiopian economy.

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