Yohannes Ayalew Birru (PhD) is Deputy Director General and Head of Macroeconomic and Financial Policy Studies Cluster, at the Policy Studies Institute in Ethiopia. Between June and November 2018, he served as Executive Director of the Ethiopian Economic Policy and Research Institute.
Yohannes also served at the National Bank of Ethiopia for about 27 years, of which he served as the Vice Governor and Chief Economist of the National Bank of Ethiopia, a position he held for about nine years between 2009 and 2018. In total, Yohannes has 30 years of cumulative experience in the areas of finance, macroeconomic policy and economic growth. He holds a PhD in Economics from the University of Sussex, United Kingdom. EBR’s Ashenafi Endale spoke to him about the problems in the financial sector.
How deep is the impact of COVID-19? Do you think sufficient measures have been taken?
The impact of COVID-19 on the Ethiopian economy can be analyzed from external and domestic perspectives. Economic slowdown in our major trading countries like the USA, Europe, China, Japan and Saudi Arabia reduced demand for Ethiopia’s products. Lockdowns also hampered export, tourism and air transport. However, Ethiopia has been presented with an opportunity to export more agricultural commodities like coffee because major coffee exporters such as Brazil have been highly affected by COVID-19. There has been less change in demand for agricultural commodities.
Government Policies should target supporting highly affected domestic sectors such as industries and hotels. Tax reliefs, suspending prudential policies of banks and availing loanable funds through the National Bank of Ethiopia (NBE) are good measures the Ethiopian government is taking. Contraband and smuggling of commodities such as gold and livestock also diminish during the lockdown, which is another factor that helps increase official export. We will benefit from the export of goods but the export of services might be detrimental, although Ethiopian airlines is doing good.
What will be the long-term impact of unproductive financial injections being made by the government?
COVID-19 is an extra-ordinary situation and the government cannot just watch while businesses close. Service sector has been the fastest growing sector but it is stuck now because the demand side is nil. Businesses in this sector need financial injection to pay salaries, administrative cost and utilities. If the government does nothing, businesses lay workers off. That could spell macro and micro effects on the economy. Unemployment causes decline in aggregate demand. The country will have to establish new companies post-COVID-19, if the existing companies close now. Lay off can also bring social unrest.
Assuming COVID-19 will last not more than a year, targeted intervention by the government is very important. The government is currently making injections, which businesses cannot even pay because they are not making any profit. If COVID-19 lingers for more than a year, businesses must shift to other lines of service. However, we do not think COVID-19 will stay for more than a year. The long term impact will be determined by the measures taken and not taken by the government.
The parliament just approved highly expansive budget for next year. The preamble states an 8.5Pct GDP growth rate is expected next year and inflation will be single digit. Are the budget and forecast realistic?
Budget is prepared based on assumptions. For GDP to grow 8.5Pct, the government needs money to achieve that growth in each sector. The higher budget is natural.
But the National Planning and Development Commission recently forecasted GDP growth for next year at 6cpt, although IMF forecasted 3Pct growth.
The most important issue is not the budget expansion, but the budget deficit expansion. Non-inflationary sources will be used to fill the deficits. It is achievable as long as the government works hard. Ethiopia’s tax to GDP ratio is the least in sub-Saharan Africa; therefore, there is room to increase revenue and fill the deficit.
Banks are complaining of liquidity problems. What is the problem in the domestic financing system?
Liquidity is a cyclical thing. The money supply grows steadily. Its components, saving and deposit, are increasing, which reflects increasing economic activities and saving. Money is increasing but liquidity is not the same as money. Liquidity is part of money which banks have at their disposal to lend. When banks have over 5Pct of their reserve, it is over-liquid. Liquidity problem happens when it is below 3Pct. Between July and December, it is tax season; so, money moves from banks to government coffers. This is also the time when banks give huge pre-shipment loan for coffee collectors, suppliers and exporters. Banks face liquidity problem during this season. But liquidity problem does not mean banks are in trouble. Banks are in trouble only when Non Performing Loan (NPL) is high.
In advanced countries, there are instruments to handle liquidity problem. Banks borrow from other banks or sectors that have surplus liquidity. Ethiopia’s financial sector is less modern; so, only the central bank can intervene in liquidity problem. Banks are liquid between March and July. The cycle has been there for the last nine years.
The Ethiopian Bankers’ Association (EBA) disclosed recently there is ETB113 billion outside the banking system and recommended currency replacement to mop it up. How did the ETB113 billion end up outside banks and is it practical to replace currency now?
Reserve money has been growing at a faster rate of between 15Pct and 20Pct annually for the last decade. Sometimes, it goes down due to NBE’s moping up actions. Reserve money grows because of inflation and growing transactions. So, ETB113 billion would not surprise me. It is in line with the growing economic activity. More money is needed based on the inflation, economic growth and transaction demand. Therefore, the huge money outside banks is neither exceptional nor abnormal.
More than ten new banks are under formation. What will be the impact on the industry, economy, saving, and reducing the huge money outside banks?
Ethiopia is one of the most under banked countries. Banking and access to finance improved only after the first GTP was launched but it is still not enough. Branches increased from 800 to 4,000 since 2010. There is still a lot of room for new banks. Access to finance is very low; so, we need more branches.
Monetization of the economy will be determined by the number of people using banks. More money is needed when division of labor diversifies. Money is needed to separate the selling and buying activities. When you are self-employed, you do not need money because you are selling and buying your own labor. But when you hire other people, you need money. In Ethiopia, labor is not fully productive; therefore, the monetization is low. In developed countries, everything is bought. The commoditization of labor boosts industries and productivity. The need for liquidity continues until the economy is fully monetized.
The number of banks we have is insignificant. Banks are measured by their capital size, saving and investment, not number. The total investment our 15 banks made is less than one European bank. Even by African standards, no Ethiopian bank is listed in the top 20. Ethiopia is the second largest population in Africa. It is sixth in GDP size. But in terms of bank capital size, only two banks are in the top 100 banks in Africa. We want banks to grow in size and efficiency, not in number. It is good for banks to merge and create big banks.
Will Ethiopia maintain its bank protection policy and close the banking industry for foreign investment for long?
Banks are joining the industry because the industry is the most profitable sector in the economy, with 40Pct average profit annually. If you invest in banks, you get back your investment in less than three years. If you invest in production sectors like manufacturing or mining, it takes a minimum of ten years to return your investment. So people leave the sector only when it is no more profitable. It is profitable because it is paying good and attracting the best labor. But since the service sector is not generating foreign currency, it creates macro-imbalance. The government needs to make other sectors more attractive and re-allocate resources from the service sector towards manufacturing and agriculture. Currently, more resource is going to the banking industry.
If foreign banks came to Ethiopia, they would bring capital, sophisticated technology and efficient management system. They employ few people but pay higher salary. They market their services and all these things would lead to a decline in the profit of domestic banks from the current 40Pct to less than 20Pct. Then the size of domestic banks shrinks. That would prompt local banks to sell their shares to foreigners, since they offer higher price. Finally, the industry would be dominated by foreigners. This is what happened in African countries. Ethiopia’s banking sector is similar to the brewery industry. Even local breweries preferred to sell shares to foreigners. Ethiopian banks are more vulnerable. Foreign banks are willing to pay more per share. Ethiopia’s financial sector should be opened up step by step. The first step would be opening it up for the diaspora. The diaspora would bring its expertise and exposure. Once the domestic banks grow to the size of South African or Kenyan banks, opening them up to foreigners would be viable and it would make them efficient to carry the enlarging economy. There is no question as to whether foreign banks have to come. The question is the timing.
Experts say the profit of banks is higher in Ethiopia because banks disburse loan interest as dividend before the loan is collected. What is your take on that?
The accounting system of banks is based on accrual system. They lend but collection is scheduled. Loan is different from industrial product. In banks, the loan goes to the economy, enters transaction, generates profit, and returns back to the lender on schedule. NPL is less than 5Pct in Ethiopia, which is very normal. This means banks are collecting over 95Pct of their loans. Even the defaults can be recovered through foreclosures, recovery and other mechanisms. NPL is regulated by NBE’s prudential and supervision policies.
Why did Ethiopia not change its exchange regime to solve the foreign currency problem?
Foreign exchange shortage is outcome of the economic structure that has more import and less export. If the less export is not offset by other sources like remittance and FDI, then shortage continues. If export does not improve, that means structural problem, and the market is inward oriented than outward. You are consuming most of what you produce. This means you are investing by borrowing, by using FDI or remittance, or your investment is declining.
Banks are abusing privileges as they take advantage of the foreign currency shortage. Banks collect bribe to give the scarce foreign currency for businesses that pay bribe, despite the ‘first come, first served’ principle introduced by NBE. The system banks are using cannot be detected by the NBE, unless police or other security intelligence is involved.
The solution is increasing foreign currency besides taking administrative measures on misbehaving banks. Export incentives also need to be re-evaluated.
The kind of development strategy we have determines the exchange rate model. If the government is involved in addressing market failures and developing infrastructure, there is continuous foreign exchange demand. The government would buy foreign currency to import capital goods, even if exchange rate depreciates. The private sector would not buy foreign currency, if they incurred loss because of the price.
Considering the NBE takes 70Pct of the foreign currency exporters generate, is the government developing projects at the expense of the private sector?
Since demand is high, exchange rate will continue depreciating faster. If the expensive foreign currency is still profitable for the private sector, exchange rate will continue depreciating. The demand is higher than supply.
China and South Korea did not allow foreign currency to be determined by the market. It has to be a managed regime. The Kenyans adopted a floating system because they already liberalized their economy to the private sector. If the Kenyan government wanted to invest in electricity or other infrastructure, they would borrow or sell sovereign bond. They cannot do it from the domestic source.
Ethiopia is different because we are doing every investment, including the Grand Ethiopian Renaissance Dam (GERD), from domestic source. The foreign exchange regime must match the development model. Ethiopia cannot leave the exchange rate regime to the market because the market is unstable and that does not allow the government to invest in projects.
We cannot also control and fix the exchange rate whenever we feel like growing faster. Investment raises import and needs more export. The exchange rate regime must be attractive for investment and export. So, macroeconomic balance is critical. We need a workable and competitive exchange rate regime that depreciates at normal rate. The depreciation must also not trigger inflation. But growth and macroeconomic stability must be attained. Competitive exchange rate is created only when the official market and black market are unified. But now we only have a competitive black market, which is attracting money and spurring the informal economy. The official market is handling only the official sectors and markets. Due to the competitive parallel market, textile, over 50Pct of livestock, grain, coffee, gold and others are being smuggled out of the country. The informal economy cannot be formalized without unifying the parallel and official exchange rates.
The amount of operational FDI in Ethiopia is very low when compared to the official FDI inflow reported by the Ethiopian Investment Commission (EIC) and the NBE. How does the reporting flaw happen? How do you evaluate the FDI inflow?
FDI increases when companies in some countries are unable to make more profit there and want to move to other countries. They might shift to other markets due to unfavorable policy or the structure of that economy. For instance, textile and leather companies move from China to Ethiopia because China’s policy currently focuses more on high value products. Light industries lost their competitive advantages at home. They come to Ethiopia calculating higher advantage, not because Ethiopia is the only destination. They compare whether they should go to Kenya, Egypt or Ethiopia. Ethiopia is among the top five fastest growing economies globally. Ethiopia has been growing fast for the last seventeen years. Governmental policies towards infrastructure, education and health are also indicators of FDI inflow.
If infrastructure is growing, the economy becomes more efficient and the private sector gets more positive externalities. Investment in infrastructure, cheaper labor, and electricity maximize Private sector profit. The incentives provided by the Ethiopian government and the prospect of a growing population and market size are also another advantage for FDI. Growth in investment shows growth in economy, investment profit and demand.
Ethiopia’s FDI increased from USD400 million some years back to around USD5 billion currently. This is actual investment, not registered or attracted. This is confirmed by the NBE, not by the EIC.
But the NBE’s operational FDI report which puts average FDI inflows for the last five years at USD3 billion is way below the national FDI inflow reports.
The right report is NBE’s balance of payment report, which is also reported by the IMF.
So, did the USD3 billion actually enter Ethiopia annually?
Yes. It is the actual, not the potential. This is the figure in operational FDI. It could not be recorded in the NBE balance of payment, if it did not actually enter Ethiopia and become operational. Balance of payment only records foreign currency flows which happened in Ethiopia. Import is what entered the system, and export is what left your border. The balance record must fit to the foreign exchange reserve. EIC reports what is subscribed or registered as FDI. But NBE reports what is actually invested, crossing the border.
Can any ideological difference happen under COVID-19, because governments are deploying similar approaches? How do you evaluate the Homegrown Economic Reform?
COVID-19 is an emergency and a special situation. Under emergency situations, all policies and ideological models are suspended. All countries in the world, irrespective of political ideologies, economic models, philosophies and strategies, take similar measures. Ethiopia has also suspended some policies like the prudential requirements of the NBE, exempted taxes, availed more funds, and supported businesses to retain labor. These policies are similar across the world.
The quantitative easing of helicopter money in USA and Europe is also part of encouraging demand and consumption under COVID-19. Such quantitative easing cannot work in Ethiopia because we do not have that much money. The demand and supply declined equally; so, the injections must keep the equilibrium. This is considered an emergency because COVID-19 is assumed to be a short term problem, only for one year. So, you do not need to change your ideology or philosophy. But some policies must be suspended to allow flexibility until COVID-19 leaves.
The Homegrown program is devised to address problems we have been facing such as macro-economic imbalance; low export and high import, and boosting productivity. It is a transitional strategy to solve existing problems shortly and transform to long term strategy in the future. The ten years perspective plan is a transitional strategy to bring the economy to its balance and set off faster growth.
Most of the targets of the homegrown program have been recommended over the last decade, mainly by the World Bank and the IMF. Moreover, it emphasizes privatization. What makes it Homegrown?
It is devised by the Ethiopian government to solve economic problems. But the finance can be from somewhere else. Financiers might negotiate. But if the share of financiers is less than 20Pct, it is still ‘Homegrown.’
Privatization is already happening in the economy. Some industries were established by the state but they are better now in the hands of the private sector. The government needs to invest the resource in other areas. If productivity is not the issue, foreign currency might be the reason for privatization. China did the same. Privatization is normal, if it is studied and step by step. Ideologically driven privatization happened in Russia and Eastern Europe. When USSR crumbled, Russia sold every business it had. They faced critical problems then. The buyers became today’s Russian oligarchs. Such privatizations are not driven by the economic dictates.
Is institutional reform part of the homegrown reform? Many experts argue the NBE should be reformed first to reforms the financial sector.
True, the efficiency of the central bank determines the performance of the economy. Macroeconomic, exchange rate, inflation stability, banks’ health, affluent transaction and money supply are also crucial jobs. Quality manpower, technology, efficient and flexible management are also required. Reform is critical to strengthen the central bank, boost its organizational function, and efficiently conduct its businesses.
Ethiopia is a unique country in terms of resource, culture and mind setup. The policy we design and adopt must take that into account. If proper policy that fits the uniqueness is devised, Ethiopia can grow fast for the next three decades at an average rate of 10Pct. We must be able to avoid inconsistencies in policy, strategies and utilization of potential. EBR
9th Year • August 1 – 15 2020 • No. 89