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Inside the FDI Smokescreen

For over half a decade, Ethiopia has been crowned as one of the preferred destinations for foreign direct investment (FDI). Just three years ago, the country was ranked second in Africa. FDI remains a highly politicized concept and contrasts to the reality on the ground. Actual FDI capital inflow represents a small portion of the reported figures of FDI into the country. Even then, both are now in their worst shape, largely because of the political instability in the country and bureaucratic hurdles, among others. EBR’s Ashenafi Endale investigates.

Owned by Turkish investors, BMET Cables opened a factory seven years ago, hoping to benefit from the growing demand for different types of cables in Ethiopia. Enthralled by the opportunity existing in the Horn of African country praised for its double-digit economic growth over the past decade, the Turkish company did not hesitate to invest USD2.5 billion.

Nonetheless, the reality differed from the expectation of the company’s management. “At first, we were ready to invest billions of dollars in different phases, but we have invested only USD150 million thus far, largely because of raw material shortages and bureaucratic hurdles, among other issues,” says Moges Feyera, General Manager of BMET.

No doubt, the experience of BMET is evidence showing how hard investing in Ethiopia is, which is ranked 159th among 190 economies in terms of ease of doing business, according to the latest annual World Bank ratings. But it is also a clear indication that FDI in Ethiopia does not always involve flows of financial capital and, in most cases, it is much lower than the amount reported by Ethiopian authorities.

With Ethiopia being labeled as one of the top recipients of FDI in east Africa and beyond, there was a tendency to consider reported amounts of foreign investment as if it entails cross-border capital flows. As FDI remains as one of the most ambiguous and least understood concepts in Ethiopia, the gap between financial pledges made by foreign investors and actual investment remains wide. Between 2013/14 and 2017/18, Ethiopia has attracted USD3.6 billion yearly and on average, but only USD563 million has translated towards operations, according to NBE reports.

But when looking at just the past fiscal year, Ethiopia managed to attract foreign direct investment of three billion dollars but the actual amount invested by the foreign companies was just USD40 million. By the same token, total foreign-owned investments that went operational in the first half of the current financial year was just ETB119 million, 2.6Pct of the attracted FDI during the same period, according to National Bank of Ethiopia (NBE). The report of declining FDI does not seem to surprise Ethiopian officials as everyone is occupied with domestic political issues.

“Ethiopia has never attracted yearly FDI below three billion dollars over the past five years,” argues Mekonen Hailu, Communications Director of the Ethiopian Investment Commission (EIC). However, he did not deny the wide gap between the attracted nominal FDI and real FDI translated into operational projects on the ground.

What is FDI to Ethiopia?
Commonly, FDI is referred to as capital inflows to host countries. But the reality is multifarious and the concept is a lot more controversial. The International Monetary Fund (IMF) defines it as a cross-border investment in which a resident in one economy (the direct investor) acquires a lasting interest in an enterprise in another economy. Lasting interest means having an effective voice (10Pct or more shares in most cases) and requires a long-term relationship between the direct investor and the direct investment enterprise, according to the IMF.

Accrued value of transactions should be considered while computing FDI inflows, the Fund says. This, in other words, means FDI transactions should be recorded at a time when economic value is created or transferred, but this does not necessarily coincide with the liquid proceeds and payments generated. FDI flow per Ethiopia’s context, on the other hand, can be categorized into three levels.

The first is the interest stage, where investors come to test the water. In this regard, the number of foreign investment delegates visiting Ethiopia has almost doubled to 1,200 in 2018/19 compared to the previous fiscal year, according to the Ministry of Foreign Affairs (MoFA). “We are recently receiving frequent and an incredibly high number of delegates from all over the world. This is the result of favorable investment potential in the fastest growing economy of Ethiopia and efforts undertaken by our embassies,” Ambassador Dewano Kedir, State Minister of MoFA, affirmed to EBR.

The number of visitors is increasing as Ethiopia is gaining acceptance among international lenders, like IMF, according to Alemayehu Geda (PhD.), seasoned economist at Addis Ababa University (AAU). It is the positive impact from IMF, World Bank (WB), and western countries accepting the ongoing reform and efforts in improving ease of doing business in Ethiopia, Alemayehu asserts. “Acceptance among western nations and institutions has a big influence on investor’s decision,” he says.

However, the rate of translating such increasing visitors’ interest into real materialized investment on the ground has contrarily decreased. “There might be four or five top officials making good efforts in attracting FDI. However, almost all of the government structure behind the ministerial levels does not have in-depth knowledge of handling investment on the ground. They lack real data, capacity, knowledge, and flexibility to respond ahead of challenges,” said a government insider EBR spoke to. “FDI managers, including the self-sufficient Chinese, spend over 50pct of their managerial time handling bad bureaucracy. The problem is worse with regards to customs, accessing land and finance, foreign currency, and corruption.”

Despite the presence of such problems, however, the fact that investment in Ethiopia starts from scratch and almost all sectors offer more than 50Pct in profits is still making Ethiopia attractive in the eyes of foreign investors, according to Alemayehu. “For instance, the real estate sector gifts more than 100Pct in profits, telecom 66Pct, bank 40Pct, manufacturing 35Pct, and SME 27Pct. This is excluding the incentive packages government provides, according to research that I have been a part of,” said Alemayehu.

Be that as it may, the second level of FDI, according to the government, is registering and taking an investment permit. Investors register their rough-estimate capital proposal that they want to invest, which could later materialize or not.

Although this should have been recorded as ‘attracted’ FDI, NBE reports it as foreign currency revenues secured by the country, irrespective of the actual capital inflow to the country. To make things worse, some foreign investors deposit the foreign currency, except the initial investment that they are required to present in US dollars, in offshore accounts of corrupt officials, taking the equivalent in ETB, according to insiders. While this mechanism has trended particularly with Chinese investors, it serves as evidence that being operational does not necessarily mean that the country is getting the forex.

Another level of FDI inflow per Ethiopia’s context involves the transformation of investment into operation and starting production or service.

The investment permit is transferred into a trade license, at this stage. Only true investors reach this stage after passing all the hustles, taking a year or several more. For instance, record high projects worth close to one billion dollars became operational in 2017/18, exactly a year after Ethiopia attracted a record high FDI of USD4.17 billion. The acquisition of National Tobacco Enterprise by Japan Tobacco International to the tune of USD1.2 billion and significant injection by the Moroccan fertilizer company OCP ballooned Ethiopia’s FDI during this time.

Declining FDI Inflow: Another Worrying Development
The rate of FDI attraction and transformation into operation has started showing declining acceleration following the escalation of conflicts and political uncertainty in Ethiopia, which reached a turning point when a rather peaceful power transition took place in April 2018. To substantiate this, of the total ETB25.8 billion investments that went operational in 2017/18, 76Pct were in Addis Ababa, largely owning to its comparatively better peace and stability compared to the regional states. This indicates how deeply conscious foreign investors are to safety concerns in every corner of Ethiopia.

There was hope that FDI would improve after Prime Minister Abiy Ahmed (PhD.) took power almost two years ago. Contrary to widespread assertions, however, it declined even after the implementation of different reforms targeting improving the business climate and opening-up of the economy, including the privatization of giant state-owned enterprises and liberalization of key sectors. There are two main reasons scaring away FDI attraction and implementation in Ethiopia. They can be categorized under push and pull factors, or internal and external factors.

Among the push factors are the deteriorating political instability and worsening of the country’s doing business index. The number of new factories that went operational declined in Ethiopia particularly after a substantial number of factories and flower farms were burned down during the political turmoil between 2016 and 2018. As the looting and burning of factories has continued during the last two years (albeit showing a decline), observers say investors will need to get reassurance from the government in guaranteeing peace and security, understand the interests of host communities, and introduce reliable investment insurance mechanisms.

Since 2017/18, permanent jobs created by FDIs have fallen by almost 10-fold to just 9,939 in the past fiscal year. To make things worse, in the first half of the current financial year, the number of jobs created by foreign investors reached a mere 614. “Investment is almost impossible under current circumstances. Regional towns once attractive for both FDI and tourists have currently turned lawless and unstable, due to political unrests and the transition the country is undergoing. The population is witnessing the cost of unrest through piling unemployment. It is a self-inflicted loss,” said a developmental economy Lecturer at AAU University.

Alemayehu, the Economist, also believes that the relationship between conflict and FDI in Ethiopia is strong. “FDI has a strong and direct relationship with conflict, in countries like Ethiopia, where much of the FDI goes to manufacturing—a long-term investment requiring strictly predictable and sustainable peace and security,” he says.

Samuel Efrem, an external investment expert, agrees. “Investment is highly sensitive to conflict and instability. The investment facilitation mechanism and government’s command and procedure structure has also been destabilized since the change in government of April 2018,” Samuel says. “Only top officials at the Ethiopian Investment Commission and Ministry of Foreign Affairs may be doing better. Other institutions and regions have no capacity and manpower to receive and implement the attracted FDI.”

The fact that there is a huge gap in skills is also well understood by regional governments, the majority of which are introducing economic reforms targeting at improving the business climate, with the latest being Oromia state.

“Most of the investment projects in our region failed to become operational due to the failure of officials in making minor decisions that assure investors, alongside the difficulties in accessing power, foreign currency, raw material, infrastructure, and efficient services. Currently, we are trying to solve the problem of each failed investment project in the region,” said Degu Setegn (PhD.), Economic Advisor to the President of Oromia state, where some 341 investment projects have failed to become operational after reaching the pre-implementation stage.

Even Shimelis Abdisa, President of Oromia, recently admitted this. “What we have been doing has been complicating problems, instead of coming up with solutions,” said Shimelis, while launching an economic model, named ‘big fast result’, prepared based on experiences of Malaysia, India and South Africa, at Elily Hotel last month. “The new model will solve investors’ problems. We are also keen to identify challenges facing existing investors and intervene accordingly, thereby improving the investment climate in our region.”

Another factor for the drop in FDI is the nature of the attracted investors. Insiders say most of the FDI that arrives in Ethiopia looks to reap large profits in a short timeframe by employing shortcuts and exploiting loopholes, rather than investing in long-term productive facilities. For instance, a foreign company wanting to invest in Ethiopia could secure up to 70Pct of the project’s value in loans from the Development Bank of Ethiopia (DBE) as per Ethiopia’s financing scheme, though this has recently been amended and reduced. However, the investor can disappear after taking the loan, while others import second-hand machinery and factory equipment with low value and pocket the rest.

Using the loopholes existing in the country as an opportunity, owners of Saygin Dima, Selen Dawa, and ELSE textile factories, among others, abandoned their factory and fled the country without settling billions of Birr in loans taken from DBE, whose non-performing loan reached as high as ETB16 billion at the end of the last fiscal year. “Foreign investors profit a minimum of 25Pct and a maximum of 70Pct from such frauds,” an insider told EBR. “This trend, which only balloons the figure of FDI flow into Ethiopia, is costing the nation, rather than benefiting. The damage is even higher when investment incentives like duty free, land allotment, and tax holidays are included.

On the other hand, genuine investors, even after becoming operational, face discouraging problems in accessing raw material, power, logistics, and quality manpower. The average capacity utilization in manufacturing stands at 55Pct, reaching as low as 20Pct in some subsectors.

“We are utilizing 17Pct of our production capacity as a result of a shortage of raw materials,” says Moges, Chief of BMET Cables. “For instance, about 95Pct of ethio telecom’s demand for cables is satisfied by imports while we supply the rest. But we could have satisfied the entirety, even at significantly lower prices than what telecom spends, had we secured sufficient forex.”

With such realities being common, Ethiopia’s government is focused on attracting big and capable international producers and brands especially since two years ago, which resulted in strong attention from manufacturers like H&M, and even Volkswagen and Toyota. However, big companies are starting to shift their attention towards Kenya, following the unpredictable environment in Ethiopia, according to some analysts.

However, Zemedeneh, a renowned investor and advisor, strongly argues this not to be true. “Ethiopia has been attracting FDI more than Kenya by five-fold for the last five years. Big international companies still have strong interest in Ethiopia. Investors interested in sectors like finance, retail, and service—closed to foreigners in Ethiopia—might prefer Kenya,” said Zemedeneh.

Mekonen, EIC’s Spokesperson, says Ethiopia is still the most viable FDI destination in east Africa. “FDI is not diverting from Ethiopia even in these times. The Ethiopian government is still highly committed, the macro-economy is stable, there is infrastructure, peace, stability, and the economy is still the fastest growing,” he says, while recommending joint ventures as the ideal scheme for Ethiopia. “Such investments are more protected by the domestic partner and the community, while the foreign partner contributes by bringing in capital and technology.”

Some 560 joint venture investment projects are registered in Ethiopia over the last six years. To further increase the number, the new Ethiopian investment proclamation, legislated just last month, introduced new incentives for joint ventures. The proclamation lowered the required minimum capital for joint ventures in engineering, architecture, and technical firms down to USD50,000 from USD200,000. The requirement has been reduced by as much as USD100,000 in other sectors, while it is still USD200,000 for solely foreign-owned FDIs.

The introduction of the new proclamation was necessitated to accommodate new sectors that are going to be fully and partially liberalized in the months ahead, and also improve FDI inflow into Ethiopia, according to Mekonen. “Currently, companies that have been under the ownership of the government, including sugar, logistics, and telecom firms, are under the pre-privatization process, hoping to boost foreign currency generation for the Ethiopian government.”

The new proclamation will also allow investors to access foreign currency from abroad after getting the consent of NBE and the opening of a foreign account. This was not explicitly stated in previous proclamations. However, the newly adopted proclamation again overlooked equity investment and angel investment flows.

However, despite such important omissions, Mekonen says Ethiopia’s government has a lasting solution to put any FDI worries to rest. “Industrial parks (IPs), which fulfills everything, has become the best manufacturing place, attracting a lot of FDI into Ethiopia.”

For instance, EIC welcomed its first foreign company inside Kilinto Industrial Park, the first pharmaceutical IP in the country, on February 7, 2020. Africure, an India-based company producing tablets, capsules, and other medical outputs joined Kilinto, with a capital of USD10 million. Kilinto, the eighth to become operational of close to 15 industrial parks under construction, houses 21 companies.

Trends show developing countries are becoming the last resort for global production, especially since the 2008 economic crisis. An active workforce, abundant resources, cheap land, and industrial parks (especially) keep attracting FDI to Ethiopia, and the continent, whether the path is furnished or bumpy. This is particularly ideal for Chinese investors, who have dominated FDI flow into Ethiopia. UNCTAD’s report also anticipates that Africa will remain a reliable FDI destination, though its portion is insignificant, since it is starting from scratch.

FDI to Africa in 2019 increased by 11Pct to USD46 billion, despite the 13pct downward trend globally, to USD1.3 trillion. Out of the slice, USD9 billion went to east Africa, of which Ethiopia leads by attracting USD2.5 billion, forecasted to double by the end of this year. Nonetheless, despite the optimism, Alemayehu argues unexpected foreign currency inflow will benefit Ethiopia only if it arrives in the investment areas it has prioritized. “It brings no difference if it is invested in areas prioritized by the foreigners themselves.” EBR

9th Year • Mar.16 – Apr.15 2020 • No. 84

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