Ethiopia’s Thorny Quest for Public Investment Finance

Ethiopia’s sources of finance are thinning, calling into question the sustainability of the large government-financed GDP expansion of the last fifteen years. The recent decision of the US to impose economic sanctions on Ethiopia has only worsened the situation of Ethiopia’s external financial sources, already crippled with high debts.

In a bid to maintain the 10Pct average annual growth, government needs to invest 37Pct of GDP—very difficult to fulfill from only tax and FDIs weakened by conflict and COVID-19. Even the highly expected telecom license sale did not garner expected amounts.

New investments are critical to maintain the pace of growth and fulfill the demands of a fast-growing population and fend off soaring inflation and unemployment. Finalizing the megaprojects of the past decade needs further investment and starting new ones seams dreamy. EBR’s Ashenafi Endale navigates alternative venues left for development financing.

By mid-May 2021, Moody’s Investors Service (Moody’s), a US-based credit rating agency, downgraded Ethiopia’s credit worthiness for the third time on the heels of similar actions a few months back by Fitch as well as Standard & Poor’s (S&P). The three rating agencies are picked and paid by the Ethiopian government for their services.

The major factor for the downgrading is the massive accumulated external debt stock, especially of the last decade, now constituting a quarter of Ethiopia’s gross domestic product (GDP). As of December 2020, the nation’s total debt reached USD54.5 billion—a fourfold growth within a decade—with USD29 billion owed to external debtors and USD25.5 billion locally. Out of the total outstanding public debt, 57Pct is owed by the central government with the balance of 43Pct attributable to state-owned enterprises (SOEs). Particularly the government-guaranteed debt of Ethiopian Electric Power surpassed ETB500 billion. Sugar, railway, industrial parks, fertilizer complex, and many other projects stuck after consuming sums of debt, need additional finance to be finalized, become productive and service their debts.

Due to the deteriorating credit rating, it has become difficult for Ethiopia to access much-needed loans to finance development endeavors as well as mitigate the negative impacts of the COVID-19 pandemic. “Now, every foreign creditor is thinking twice before loaning to Ethiopia,” explains Kiflu Gedefe (PhD), Lead Researcher and Coordinator in the Trade Policy Research Center of the Policy Studies Institute (PSI). “Ethiopia is ineligible for further loans because the default probability is high.”

However, Eyob Tekalign (PhD), State Minister for Finance downplays the impact of Ethiopia’s deteriorating credit ranking. “The downgrading has no big impact apart from pushing creditors to slightly increase their lending interest rates. This increment only adds just a few thousand dollars to the total debt stock.”

Public debt has been the major source of financing public investment for the past decade. In a bid to sustain the 10Pct average annual growth, Ethiopia has been spending a huge chunk of money—equivalent to 36Pct of its GDP—towards public investments. Nevertheless, the ventures could not fully materialize to repay their debt. For instance, 14 sugar projects financed by borrowing from China have been stuck after consuming around USD4.6 billion. This is just the tip of the iceberg compared to the huge capital wasted on other public projects across various economic sectors. Most of the debt taken out starts maturing by 2023 and the high servicing period stretches to 2029 with no viable foreign currency source in sight to service obligations.

The dwindling window of access to external financial sources will have a massive impact on Ethiopia’s economy in the coming years. As such, the degree to which the country diversifies into other sources of investment capital will determine how Ethiopia surfs the storm of the coming years. Given the critical needs of job creation, stabilization of galloping inflation, settling of macro-economic distortions, and recovery from both political and pandemic-induced crises, Ethiopia needs other sources of finance.

“Ethiopia can no longer maintain huge public investments seen in the past. Government investment has been largely financed by borrowing and the country has now reached its debt limit,” tells Mehrteab Leul, Principal at Mehrteab Leul and Associates (MLA), a leading law firm specialized in consulting foreign companies in Ethiopia.

Amin Abdella (PhD), Head of the Trade and Industry Department at the Ethiopian Economics Association (EEA), stresses that the government’s assumption of investing in infrastructure helps attract more private investors is valid. “But in reality, debt distress and the failure of the projects coupled with low export earnings has diminished the country’s financial capacity moving forward.”

In light of such limitations, the government has begun employing Public Private Partnership (PPP) arrangements to bridge the financing gap—the prime shift from previously trending governmental investment models. The new scheme allows the private sector to mobilize capital and execute public projects.

Seventeen mega projects were prioritized and shortlisted to be built under the PPP scheme in the next five years, including a USD3.36 billion hydropower plant in Gambela Region. To date however, government has only managed to sign two solar power projects with private investors.

“The PPP program is currently stuck due to systemic problems which need further analysis and especially communication, awareness creation, and coordination between the government and the private sector,” says Teshome Tafesse (PhD), who was the state minister in charge of the then newly minted PPP department at the Ministry of Finance (MoF) in 2018. However, Teshome resigned a few months back and has returned as Lecturer at Assela University. “After shifting from public financing to PPP, the government faced a big problem. Contract negotiations with private investors were extremely tedious and complicated. Over 25,000 pages are negotiated and ratified for a single PPP project.”

“I believe this will be solved in time,” says Mehrteab, leading contract drafter and advisor to the government on issues relating to the PPP investment model.

Another option of finance—domestic resource mobilization—is incapable of satisfactorily financing public investments. Though government says tax revenues are significantly improving, business activities have slowed down following instability and the pandemic. The Addis Ababa Trade Bureau has recorded over 20,600 returned licenses by businesses over the past nine months declaring bankruptcy primarily owing to COVID-19. Yet, the Ministry of Revenues has announced a tax revenue surge of 13Pct to ETB191.4 billion from last year. This mixed picture does not guarantee domestic sources can replace beefy foreign creditors.

Improved savings can narrow the widening saving-investment gap in Ethiopia, according to Amin. “NBE’s measures in allowing interest-free banking are showing positive results. Many such banks are now forming and this will significantly increase saving rates.”

Kiflu argues that sustainable sources of finance come from savings and private investment. “When possible, government can raise funds from concessional loans and aid but that should not be the major source.”

When the Ethiopian Investment Commission disclosed its newly crafted investment regulations in 2020, officials were vowing that foreign investors would salivate for Ethiopia. Nonetheless, FDI inflow for the last nine months was USD2 billion, higher by 6.7Pct compared with the same period last year but down by 50Pct from the record-high FDI flow of 2017.

“Investors globally are currently in survival mode. No investor is aggressively working to expand their business. But this will improve once the pandemic is over,” argues Mehrteab, who also participated in the drafting of the new investment proclamation and regulation.

Another source of capital Ethiopia has not tapped into thus far is the stock market, where government has been dragging its feet regarding its establishment. “A share market can be started with few products and limited institutions,” Amin explains. “It can commence with banks as their financial reporting systems are sound. International brand hotels can follow suit on the listing.”

Though the National Bank of Ethiopia (NBE) initially claimed it will setup a stock market by 2020, this is yet to materialize. It is currently preparing to launch a bond market but it is unclear when it will start.

Mehrteab believes the ongoing privatization and liberalization will generate sufficient foreign currency stock to payoff overdue public debt and boost Ethiopia’s credit rating to access fresh loans. “Privatization will generate a large sum of capital for Ethiopia. Some ten sugar factories are up for sale alongside the partial sale of Ethio telecom and other projects,” explains the lawyer.

Some experts roughly estimate Ethiopia can raise a combined minimum of USD10 billion by selling or partially privatizing state owned enterprises.
However, Amin argues privatization will have adverse impacts on Ethiopia’s economy even though it can help in the short run by generating much-needed foreign currency. “The approach will have a devastating effect in the long run. Privatization is linked to national economic sovereignty. If Ethiopia transfers the telecom sector to foreign operators, it would just be shifting from a state monopoly to a corporate monopoly.”

Amin stresses Ethiopia should decide by itself on which sectors to open-up and which enterprises to sell shares in. “The deregulation and privatization push under the Washington consensus focuses on policy adjustments and structural transformation. It is Western pressure on developing countries,” argues Amin.

Other experts further argue that ongoing reforms and privatization in Ethiopia totally favors Western investors to the detriment of the Chinese, a reliable source of finance for Ethiopia’s economic progress since the 2000s. Half of Ethiopia’s USD29 billion in external debt is owed to China.

“Ethiopia has not excluded China from participating in the ongoing privatization process,” argues Eyob. “Ethiopia should not craft its policy to favor China just because they were our top investors before. Policy should be crafted to serve Ethiopia’s interests and should treat all countries openly and equally.”

Be that as it may, experts stress that revitalizing FDI and swiftly adopting digitization can be important avenues to bridge the gap in finance. For Amin, the magic bullet for Ethiopia is private investment. “Domestic investors should focus on import substitution while foreign investors should concentrate on export.”

Kiflu also agrees that private investment is the solution but expresses his reservations. “There is mounting instability across Ethiopia. Insecurity is the biggest inhibitor to both domestic and foreign investors. Stability needs to be restored in the country as soon as possible.”

He further stresses that the government can raise additional revenue by expanding the tax base rather than only overwhelming taxpayers already in the tax net. “The administration should focus on reducing tax evasion and illicit financial flows as well as tackling corruption.” EBR

9th Year • May 16 – Jun 15 2021 • No. 98