Over the past two decades, deposits mobilized by commercial banks have skyrocketed more than 300 times, thanks to the massive expansion strategies that they have adopted. Such growth does not, however, mean a boost in financial inclusion. About three-fourths of the Ethiopian population remains unbanked. To make matters worse, the rise in the cost of living, which has forced the real interest rate to remain in the below zero territory, is already discouraging both the banked and unbanked population from depositing their money in banks, especially in urban areas. As a result, the contribution of saving towards the economy remains low, and is further exacerbated by the inflationary pressure that is eating the disposable incomes of citizens. EBR’s Kiya Ali explores.
Around 14 years ago, Rukia Omer decided to return to Ethiopia after working for nine years as a maid in Saudi Arabia. Like many Ethiopian returnees from abroad who usually find themselves in a state of confusion, Rukia was unsure of which sector to invest her hard-earned money. Soon, she realized that the only sector that could enable her make easy money was the buying of property.
Immediately thereafter, she contacted brokers and bought an unfinished house built on 105sqm of land around Summit, located on the outskirts of the city, where there are numerous unfinished residential blocks. Even though the area did not have sufficient transport and water infrastructure when she bought the house for ETB80,000, she did not second-guess her decision.
Years have passed by now and Rukia is very gratified by her decision. “Had I saved my money in a bank, I would have gained a very insignificant amount. I would have been unable to buy anything of value now. I made the right decision by spending the money on property, whose value grows every day,” says Rukia, who is now married. Such experiences are not uncommon.
With the ever-rising value of properties, like vehicles and houses, people tend to shy away from saving their money in banks. This is especially true for the middle-income earning segment of the Ethiopian society. Even though savings have shown a significant growth in terms of value over the past two decades, a large portion of which is contributed by the state and private sectors, it is still insignificant compared to the whole population.
“It is no wonder that the majority of Ethiopians are less encouraged to save, considering the rate at which the cost of living increases. Now, it seems like a large portion of the banked population saves just for the sake of safety, instead of for the purpose of reinvesting or earning interest,” says Asfaw Alemu, President of Dashen Bank.
Why Ethiopians don’t save?
Saving is an important aspect of the economy. Efforts to increase the GDP and thus accelerate economic growth partly rely on saving. Ethiopia’s gross domestic saving to GDP ratio has, however, declined by two percentage points to 22.2Pct during the past fiscal year. This signals that the growth in deposits across banks is undermined by the drop in the desire of citizens to bank their money. While this is lower than the 27.4Pct target set for the fiscal year of the second edition of the Growth and Transformation Plan (GTP II), the share of domestic savings to GDP showed only a five percent increase over the past two decades. But the ratio is still higher than the sub-Saharan average of 15Pct.
Despite the modest improvement over the past two decades, the recent rate of saving is very low by Ethiopia’s own standard and is even worse relative to other developing countries, like Kenya, whose banked population ratio is two times higher than Ethiopia’s. As saving remains low compared to the total population, it has made the economy largely dependent on external financing sources, exposed to international shocks and defaulting.
Weak saving performance means insufficient resources to finance investment necessities. Gross capital formation (investment) to GDP ratio has only increased by three percentage points to 35.2Pct over the past two decades. This results from lower savings as well as lagging necessary reforms required for a favorable investment climate for the private sector. Even though the contribution of saving to the economy has shown a very modest growth over the past two decades, deposits mobilized by commercial banks show a drastic growth during the same period.
Since the beginning of the century, deposits by commercial banks have skyrocketed from three billion birr to ETB900 billion as of the end of the last fiscal year, driven by aggressive branch expansions and several national saving programs. This does not, however, guarantee that savings are rising as more than three-fourths of the adult population is still unbanked and its growth has recently been slowing down.
Bank of Abyssinia is amongst the commercial banks that has experienced a decline in the growth of its deposits by more than half. Though it has mobilized more than ETB32.15 billion so far, the Bank attributes the decline to the growing competition amongst commercial banks. “All of us [commercial banks] employ almost the same strategy and have very similar products, instead of introducing new ones targeting the unbanked population,” says Estibel Tamiru, acting Corporate Communications Manager of Abyssinia. “There is a tendency to follow each other which fails to change the saving habits in the country.”
It is not only Abyssinia that is being challenged by the drop in depositors. The growth in demand deposit of all commercial banks has fallen three-fold to just 11.4Pct, while the change in time and saving deposit has dwindled by four percentage points to 17.8Pct and 27.4Pct, respectively. The decline in the growth rate of saving implies that the number of people who are interested in saving is waning. While this on its own partly shows that citizens’ attitude towards saving is at its worst shape, experts say the problem is far from what is being reported by the central bank. This is portrayed by the fact that saving accounts are opened by default and not current accounts.
In many other countries, the default initial type is a current account and saving accounts are opened only upon request—the reverse presides in Ethiopia. “This is relevant because the “increase in savings” being reported could just be money that has entered the system for a short duration only to be taken out in a day or two,” says Ayele Gelan (PhD), an Economist. “If incomings keep growing faster than outgoings, these flows of funds can create a sizable pool of money, giving rise to the wrong interpretation that savings have increased.”
Above all, bearing the real interest rate in mind, it is obvious why saving is not a lucrative endeavor in Ethiopia where inflation has peaked to 20Pct last month—the highest for seven and half years. The rising cost of living means citizens end up with ever-decreasing disposable income, while those with better earnings choose to purchase fixed assets, understanding the disadvantage of saving their money at commercial banks.
Further, numerous companies are beginning to understand that saving their money even at higher than normal interest rates—as much as 13Pct—is not a worthwhile option to consider. This is mostly due to the negative interest rates seen over the past decade. Even after the government increased the minimum interest rate after devaluing the Birr by 15Pct almost two years ago, the value remains in the negative territory.
During the past fiscal year, real interest rate on savings averaged negative 8.8Pct, and negative 8.7Pct for timed deposits. It is inflationary pressures, which has been in the double-digits for the past two and half years, that is hard-pressing the real interest rate to remain negative. The annual inflation rate in Ethiopia dropped to 19.5Pct in December 2019 after a seven-year high of 20.8Pct in November.
Inflation is particularly severe on food items, hitting a seven-and-half year high of 23Pct in December. This further squeezes the disposable income of citizens, thereby adversely affecting savings and making the mobilization of deposits tiresome for commercial banks. “In an atmosphere of economic slowdown and galloping inflation, mobilizing additional deposits will be difficult for banks,” Abdulmenan Mohammed, a financial expert says.
While the major reason for the inflationary pressures is supply-side issues including hoarding as asserted by the government, political instability has its own contribution. This is portrayed by the annual inflation rate registered in Tigray state reaching 23Pct during the past fiscal year, the highest amongst all regional states in Ethiopia. Keeping in mind that the lowest inflation rate in 2017/18 was registered in Tigray, the latest report is clear evidence the region is facing a problem like no other. This is notwithstanding the fact that inflationary pressures in Tigray are also partly due to the capital flight from Addis Ababa to Mekelle and the surge in Eritrean migrants in the region.
Experts say the political instability and the sour relationship between the federal and regional governments has a similar contribution. “Apart from the usual problem faced across regions in Ethiopia, Tigray has exceptionally registered the biggest inflation rate because of the influx of many new residents from different areas who have increased the demand for goods,” said Mueze Hadush, an economist at Mekelle University. Despite the growth in demand, supply is being hampered because of the political instability in neighboring regions and the blockade of the main road connecting Tigray to suppliers in Amhara and other regions.”
But inflationary pressures are not reflected only on the price of goods. Discouraged by negative returns, depositors have responded by refraining from putting their money in banks. “It is better to invest the money, instead of saving it in banks because the interest rate adds nothing but losses,” Tigabu Haile, CEO and cofounder of Eshi Express states. “In fact, the benefit of investment is double or triple than saving.”
On the other hand, for Muluneh Aboya, Vice President of Credit Management at the Commercial Bank of Ethiopia (CBE), the impact of interest rates on savings is insignificant for the majority of Ethiopians for two reasons. First is that there are limited investment options in the country and the second is that people save for safety and emergency, maybe to cover their future medical expenses, according to him. The Governor of the National Bank of Ethiopia (NBE), Yinager Dessie, agrees.
“The majority of Ethiopians have no choice but to put their money in banks because they don’t have enough savings to invest. So, interest rates do not really affect saving habits as receiving an annual seven percent for their deposits is better than nothing,” he said. But the reality, according to some studies, differs from such conclusions. It is non-financial savings that is preferred by a large chunk of the banked population, although majority of them are not able to do so.
Non-financial household savings, a common trend throughout Ethiopia, consists of other forms of ownership such as land, house, livestock, cereals, and harvests. “Putting money on assets like livestock and grains is extremely desirable, even though these are not usually called ‘savings,’ but rather ‘investments,’” Ayele says. “The moment cash is spent on a dairy cow, for instance, the money is considered to be transferred to a non-financial asset, which is to say capital. A dairy cow is capital, pretty much like a building or any other tangible asset.”
Abdulmenan believes non-financial household saving is a wiser decision for farmers rather than saving in banks. “Keeping money in the form of grains or livestock is much better than depositing in banks during high inflation times, as real interest rates become negative. “This hampers financial development, reduces savings, increases lending rates, and encourages consumption,” he noted. “High inflation is taxing savers; it penalizes the savers and rewards borrowers. This discourages citizens from saving and prompts individuals with high financial savings to shift their money to real assets, further driving up the prices of properties,” Abdulmenan comments.
Ayele agrees. “A good proportion of the Ethiopian youth in the Middle East do take this as their first option. Others are severely constrained by the frequency of travel back home so their money gets eaten up by inflation,” he said. “Yet banks thrive, declaring 30Pct and 40Pct dividends by literally robbing society: paying 7% to savers and receiving 15-18Pct from borrowers. Such rules do not exist anywhere.”
Many savers in Ethiopian Banks, however, are not sophisticated enough to watch out for trends in inflation, interest rates, and the gap between the two, according to Ayele. He cited the case of ever-increasing hundreds of thousands of Ethiopians working and living in the Middle East. “They do not have other options but to keep their hard earned income converted into birr and deposited in a bank account opened in their name or that of a close relative,” he adds. “They do not know that the money they deposit in Ethiopian banks will keep dwindling year after year due to inflation, and the real money value they get when they return home is only a fraction of the amount they have been accumulating over the years.”
On the other hand, another problem in the mobilization of savings concerns the microfinance sector. Many save with microfinance institutions (MFI) with the motive of securing a loan. But the many loopholes existing in credit management lead to defaulting, creating indebted societies in rural parts of the country. Such realities force MFIs to be dependent on their respective regional governments, as their non-performing loans skyrocket. “We have encountered many farmers unable to service their loans. This, in turn, discourages new savers and borrowers who fear similar outcomes,” says Debebe Argaw, SME Financial Service Specialist at Farm Africa.
An economic system must be able to produce capital in order to satisfy the wants and needs of its people. To do so, people must be willing and able to save; in turn providing others with a chance to produce. When people save, more funds will be available to others. To make this a reality, the Ethiopian financial sector has been striving to expand its accessibility. Commercial banks opened 807 new branches in 2018/19 alone, increasing the total number of branches to 5,564. Though branch expansion is costly, banks still use it as the primary instrument of savings mobilization. Even NBE encourages it. “The trend will continue,” Misganaw Habeta, a financial expert with 23 years of experience says. The lack of required technological infrastructures and national ID cards has forced commercial banks to employ branch expansion as a prime strategy.
However, despite the strategies adopted by the banks, the issue is more of an economic one than of marketing. People prioritize present and not future consumption. “The talk of a saving culture is rooted in the ignorance of basic economic fundamentals, like the so-called paradox of thrift which is one of the fundamental elements in the fallacy of composition in economics. What is desirable at individual or household levels is not desirable at societal levels,” Ayele says. He says that the government always encourages people to spend more, so that there will be enough demand for goods and services. “Demand is the engine of growth. Trumpeting thrift means discouraging consumption, and hence negatively affecting economic growth. Our policy makers do not understand the existence of such paradoxes,” Ayele explains.
For Abdulemenan, on the other hand, the priority should be taming inflationary pressures. “To increase the size of real saving rates, inflation has to be monitored. The recent surge of inflation is caused by political instability and uncertainty. So, ensuring political stability and clearing uncertainty will bring inflation down,” he declares. “The long-term solution is increasing supply and solving logistical issues. Bringing inflation down and making real interest rates positive will encourage people to save more.”
Mueze recommends that the government produce basic goods to distribute on a quota basis to help increase supply until stabilization. “From a fiscal policy point of view, the government should reduce its expenditure with caution and without affecting strategic areas of investment,” he noted. He added: “by using monetary policy tools, reducing the amount of lending from the World Bank and IMF, increasing the lending interest rates for local investors without affecting investment, and selling bonds to collect the money that is circulating in the economy are important tasks in controlling inflationary pressures.
Be that as it may, strengthening the independence of NBE from government interference is another solution proposed by Jean-Pierre Chauffour and Muluneh Ayalew Gobezie as seen on the World Bank’s policy research working paper dubbed “Exiting Financial Repression: the Case of Ethiopia to Control Inflation”. There is ample empirical evidence that central bank independence brings about lower inflation, ensuring a more stable environment for economic growth and jobs creation, the study says.
More independent central banks reduce the possibility of governmental interference towards monetizing their debts or to discretionarily channeling resources to other public sector entities. The government should consider amending the NBE Establishment Proclamation to strengthen NBE’s institutional, managerial, and operational independence from the government, according to the study.EBR
9th Year • Feb.16 – Mar.15 2020 • No. 83