Manufacturing's Continuous Failure to Launch

Manufacturing’s Continuous Failure to Launch

The Ethiopian manufacturing sector is still far from being an engine of growth and economic transformation despite potential and assurances from various actors to the contrary. It plays a marginal role in employment creation, exports, and output. It is also short of stimulating domestic linkages and is dominated by small firms, resource-based industries, low-value and technology products, and weak inter-sectoral linkages.

Ever since 1945, when strategic planning for industrialization first begun, successive administrations have been unable to oversee the take-off of the nascent manufacturing sector. Notwithstanding micro-level problems, legacy issues including foreign currency shortages, electrical power interruptions, and sectoral linkages still linger. But now, adding salt to the wound is the current administration’s tinkering with tariff privileges for factories. Selome Getachew reviews the issue with input from Bamlak Fekadu.

Adopting what the government called the Homegrown Economic Reform agenda aiming to advance a largely agrarian low-income country into an industrialized lower-middle-income one by 2030, Ethiopia is striving to structurally transform the economy by encouraging industries alongside the implementation of other strategies. Development of the manufacturing sector is identified as a path towards the structural transformation of the economy and the creation of jobs for the growing population.

The availability of a daily laborer for just USD2 per day and a monthly salary expense of USD100 to 150 for a skilled fresh graduate is too good to ignore for the manufacturing industry. The government has also claimed priority to private manufacturing support. The Investment Board of the Ethiopian Investment Commission (EIC) is under the chairmanship of the Prime Minister himself. These are few of the signals of how the sector is too good for the government to ignore.

Despite efforts in the past decade to develop the manufacturing sector through various initiatives including the grooming of factories in industrial parks, notable investment promotion works, and fiscal incentives to investors, it remains underdeveloped and diminishing. Data by the National Bank of Ethiopia (NBE) and Ministry of Industry (MoI) show that the sector only had a contribution of 5.1Pct of GDP in 2020/21, showing a decline of almost 2Pct from the previous fiscal year. Further, even with high expectations for the sector’s capacity to reduce forex shortages, only 11Pct of Ethiopia’s total exports in fiscal year 2020/21—USD390 million—were attributed to manufactured goods. The highest contribution to exports was in 2011 with 12.8Pct. When looking at impact towards employment, MoI recently stated that manufacturing’s share of total national employment is 5Pct, with plans to reach 15Pct by 2030.

The sector has not been able to live up to expectations owing to macro and micro limitations. Limited productivity and product diversification, shortage of inputs and forex, high cost of finance, electricity and logistics constraints, and deficient industrial relations have been hindering it.

Now, as if problems weren’t already amassed, a negative sentiment is developing among industrial players about a governmental backtrack on tax privileges for manufacturers. This relates to the second schedule tariff application.

The current Ministry of Finance (MoF), commenced the implementation of its directive on second schedule tariffs in 2016. It had introduced more than a hundred product ranges identified for value addition under 20 categories for different industrial products. A year-long study by the current Ministry of Revenues, MoF, and MoI was done for the purpose.

Adopted as Directive No. 45/2008 by MoF, the second schedule was primarily intended to support the manufacturing sector by encouraging those that undertake certain amounts of value addition within the country as per evaluations by MoI.

The very nature of this incentive package was to give raw material import duty privileges with substantive deductions according to the level of value addition by the local manufacturer. Importers who did not engage in value addition paid higher tariffs. The scheme, however, did not last long and the government replaced it with a new tax module introduced in 2019.

The replacement seems to have left many frustrated. It changed the expected value addition from one that was universally applied into one with a more flexible industry-specific approach, ranging from 5 to 41Pct. But the value addition requirement itself is still under debate at MoF, adding further woes. The majority of industries have no capacity to reach 35Pct percent of value addition, which was required. Most of them fall within the 19 to 21Pct bracket.

The evaluation process to certification to use the second schedule is still ambiguous and open to criticism. A big loophole was present that illicitly benefited non-manufacturers claiming to be so.

“Having imported light fixtures with our own brand for 12 years, we decided to erect a manufacturing plant for the same product taking into consideration the government’s claim of special attention to the manufacturing sector,” an operations director of an electrical equipment producing company told EBR. “We opened our factory and assembly line three years ago but the government is not walking any of the talking.”

Erecting a manufacturing plant on 2,000 square meters of the compound’s 7,000 and employing more than 150 workers is a serious backing to the economy. The company was first given a tariff privilege under the second schedule scheme overseen by MoF, MoI, and the corresponding sectoral governmental development institute of that specific product—the Metal Industry Development Institute (MIDI) in this case. Certificates were issued for manufacturers which got them discounts to regular customs tariffs.

In spite of shouldering overhead costs like employee salary, taxes, and benefits as well as rent and utilities expenses in an under-developed and difficult sector, only a 10Pct privilege is given relative to the first schedule import tariffs which is imposed on importers of finished goods. “We were forced to stop the assembly line since we couldn’t be competitive with our pricing in the market,” said the operations director.

Complaints go all around, and so does the blame. Governmental bodies continuously question the sincere and proper implementation of the directive as it has been proven to be open for abuse. Manufacturers, on the other hand, blame the narrow variance between the first and second schedules for a given material. The first schedule includes import tariffs at basic rates whereas the second schedule involves special privileges and discounts for manufacturers.

There was a strong argument between the Ethiopian Customs Commission (ECC) and MoF to revert to only utilizing the first schedule by using the Harmonized System (HS) Codes—the globally standardized numerical method of classifying traded products by their nature and level of production—and rate them accordingly. ECC took more favorably to this option as it’s the entity taking the brunt of the blame for execution failures for a difficult-to-implement system crafted by MoI and MoF, ie the second schedule.

“While we had the second schedule certificate, things were more or less smooth at least on the taxation process, even though we were suffering from foreign currency allocation,” added the operations director.

Sisay Negera, General Manager of the pioneering ZY Spare Parts, shares the challenges of the light fixtures manufacturer. The company makes automotive spare parts including air and oil filters, shock absorbers, and clutch disk lining for all types of vehicles including heavy cargo trucks. Now, the company seems to be in hot water following the lifting of the second schedule. “On top of the already heavy burden of the forex crunch, the removal of the tax discounts has taken away all the privileges the company used to entertain,“ said Sisay. “The customs billing system for raw material imports is exaggerated and almost the same as the finished material. It seems like the database system fetched the wrong trade maps and HR Codes,” he told EBR.

Esubalew Birhan is Director of the Electronic Department of MIDI—the institute tasked with policy formulation and development of Ethiopian metals and engineering industries. Additionally, the institution helps investors by providing support in technology selection, negotiation, erection, and project commissioning. Esubalew shares the idea of the extra burden on manufacturing caused by the lifting of the tariff privilege.

“The cancellation of the second schedule scheme, coupled with the foreign currency shortage, resulted in the downsizing of manufacturing industries to the extent of shutting down of plants,” Esubalew told EBR.

Of course, the manufacturing sector incentive package has been abused by many. Some, especially electronics assemblers, used their tariffs and duty-free privileges to ‘hit and run’ the market. But the fault of few should not lead to the punishing of all industrialists. Assessment, investigation, and report validation should be done by the respective institutions and MoI, according to Esubalew. “The action taken was more of burning the hut to smoke out the rat.”

In other cases, privileges for investors create their own obstacles towards fair competition, especially regarding capital goods. “The tax-free importation of machinery creates an uncompetitive marketplace for electro-mechanical companies that import some parts and motors at significantly high taxes” says Ato Michael Mehari, Owner of MKL Metal Engineering. His company has supplied more than 120 coffee processing machines to coffee washing and dry hulling enterprises.

The issue around taxation and duty privileges is just one in a sea of problems for the manufacturing sector. The nation, of course, is still yet to address the elephant in the room—foreign exchange shortages. Towards this, the manufacturing sector is still a victim even though it has always been believed to be a solution-holder. Local industrialists face major constraints in importing raw materials, spare parts, and machinery as well as employing foreign talent. “Despite being manufacturers, in the past year, we only accessed foreign currency just one time each from CBE and a private bank,” said an owner and general manager of a transformer builder whose name is withheld upon request. “We are not being privileged in the way the government is claiming.”

Both the high demand for imported goods and weak export performance due to various factors put stress on the county’s balance of payment. Ethiopian industrialists still operate in an agrarian economy where the majority of exports is raw agricultural produce. So, the unfavorable terms of trade for primary commodities puts a dent on the hoped-for manufacturing boon.

A further issue revolves around suppliers’ credit. The government has been working to amend the corresponding directive which had been ignoring local manufacturers’ access to raw materials on credit. NBE had only allowed foreign investors to tap into this privilege with guarantees from local banks. The directive had excluded local manufacturers involved in similar investment sectors and capacity, thus creating an unfair playing field to the point of being referred to as the ‘Apartheid Law’ by local manufacturers.

In a recent press conference, Eyob Tekalgn, State Minister of Finance, said the directive has been revised again aiming to include Ethiopian manufacturers in the scheme. “We have undertaken a correction on the directive that is now in the draft stage and will be ratified by NBE’s board of directors for implementation,” he explained. Eyob is member of the board which is led by the seasoned former minister and ambassador to the United States, Girma Birru. When that time arrives, Ethiopian investors are expected to be just as equally privileged as are Foreign Direct Investments (FDIs) through suppliers’ credit so long as they’re exporters.

Eyob detailed that as per the revised directive, local manufacturers will benefit from being able to import raw materials and spare parts on a credit scheme to be paid in six months by their banks. According to the latest MoF report that evaluated the first six months of fiscal year 2021/22’s public sector debt, suppliers’ credit stock took up USD1.62 billion—5.45Pct of the total external debt.

Thus far, local manufacturers are expected to await access to foreign currency under letters of credit (LC) for their imports of spare parts and raw materials—a process notorious for taking several months to a year. However, as per special NBE go-aheads, foreign industrialists directly access huge sums of foreign currency without delay from banks that receive the instruction from the central bank. Yet, there are claims from the private sector that FDIs are engaged in the illegal currency market to suck-out their dividends illegally.

Manufacturing does not only face challenges emanating from tax, duty, and financial sector issues. Weak supply chain integration—and the undue importation of raw materials and other locally available inputs—leaves manufacturing companies at the mercy of banks for access to foreign currency. The gap between the agriculture and manufacturing sectors forces the country to rely on costly imported inputs for its infant industries.

A number of measures were put in place under the Growth and Transformation Plan (GTP) II—a comprehensive economic strategy covering the years between 2015 and 2020. To that effect, the Agricultural Inputs Supply Enterprise was established with a mandate to purchase inputs for manufacturers from both local and foreign sources. It stocks strategically important raw materials to sustainably supply factories.

But agricultural produce is not the only input required. Metals and chemicals are critical inputs of which Ethiopia has thus far been relying on imports for. This has compromised possible domestic industrial linkage, resulting in little value addition. One major area of focus during GTP II was the metallurgy and petrochemical industries; Ethiopia has prospects of developing its own iron ore production with the purpose of supporting its industrial development strategy.

Issues with utilities, especially power shortages and interruption, feature heavily in the list of major constraints for the development of the manufacturing sector in Ethiopia. Shortages occur due to the mismatch between growing demand and limited supply of electric energy while interruptions arise upon the deficiency of efficient and dependable transmission and distribution lines.

Africa’s largest dam, the Grand Ethiopian Renaissance Dam (GERD), recently began generating its first 375 megawatts of energy with the second turbine of equal capacity to come online in the next three months. This might be of help in easing shortage burdens but the issue of distributing the electricity to manufacturers needs more attention.

The history of Ethiopia’s strategic planning for industrialization dates back to 1945 even though formal development planning was drafted in 1957 with the major objective of laying the foundation for an economic take-off. The first five-year development plan of Emperor Haile Selassie’s administration focused on infrastructure, human capital development, and resource mobilization.

The second five-year development plan, which commenced in 1963, was part of a development plan which targeted a doubling of national income in 20 years. The plan gave priority to industry, particularly agricultural processing, mining, and power generation. Following the development plan and direct follow-up of the imperial government, the manufacturing sector grew at an annual average rate of 16Pct.

The active interventions of the government in commercial agriculture during the third strategic period that began in 1968 gave more emphasis to the agricultural sector in order to fill the gap in raw materials and domestic demand for industrial outputs that emerged from the 2nd planning period.

However, flourishing industries hit a road block by the ensuing Derg regime which implemented a nationalization of major agricultural industrial capabilities, forced quota deliveries, and collectivization as demanded by socialist dogma and ideology resulting in a drastic drop in GDP per capita at a rate of 1.4Pct per annum beginning in 1973.

Efforts were then made to restore the market economy in the country after the Ethiopian People’s Revolutionary Democratic Front’s (EPRDF) government took power in 1991. This government, with its GTP I and II, set a high bar for the manufacturing sector. Despite the aspirations of previous and current administrations, manufacturing has fallen short every time.

Efforts put forth do bear fruit but not satisfactorily for many. During last fiscal year, 242 domestically- and foreign-owned investment projects commenced operations with an investment capital of over ETB12 billion. Yet, whether it is power or forex shortage, access to finance or favorable tax relief for manufacturers, there always has been a stumbling block slowing down the growth of manufacturing in Ethiopia. EBR

10th Year • Apr 2022 • No. 106

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