On the Hook:

Is Ethiopia’s Public Debt Sustainable?

Neither be a lender nor a borrower, for money you lose both your friend [the borrower] and the money itself” has been one of the famous lines from William Shakespeare’s plays. That was many, many years ago. The game has changed now. Not only people, but countries, including the richest ones on earth, from the United States to Japan, from Australia to the UK, borrow a huge amount of money. They have even established institutions that specialize in lending money in massive amounts. Countries borrow money from these institutions and provide loans to one another. Ethiopia has been receiving loans for many years now. It receives them, both from multilateral agreements, such as loans from the World Bank and bilateral agreements from individual countries and private creditors. It also borrows money from internal sources. In the second half of the past century where loans have become quite common, Ethiopia has been using loans for both unnecessary expenditures such as to buy weapons and wage civil wars and recently to some very imperative achievements such as supporting citizens’ education, health, building infrastructures etc.
In the early 1990s Ethiopia had been in a debt distress. The country reached a point where it could not pay its debts and creditors weren’t willing to give any additional loans. This was the typical situation for many Sub-Saharan African countries at the time though.
With a debt relief schedule, the Heavily Indebted Poor Countries (HIPC) initiative given by the International Monetary Fund (IMF) and the World Bank, to countries with high levels of poverty and debt overhang, Ethiopia has been able to trim down its external debt. The World Bank only has cancelled about USD four billion the country has been indebted until 2004.
The country also received substantial debt relief from the Multilateral Debt Relief Initiative (MDRI) which provided 100 pct debt relief to a group of debt relief eligible, low-income countries from three multilateral institutions, the IMF, the International Development Association (IDA) of the World Bank, and the African Development Fund (AfDF). The initiative is intended to help these countries advance toward the United Nations’ Millennium Development Goals (MDGs), which are focused on halving poverty by 2015.

How Much and Where Do We Receive Loans
Having benefited from the debt reduction and relief of these initiatives and recording an impressive but controversial economic growth in the past decade, the country has been receiving an enormous amount of loans. According to data from the Ministry of Finance and Economic Development (MoFED), the country’s total public debt has now risen to USD16 billion. From this amount the external outstanding debt amounts more than USD10 billion. Though, some independent economists and critics don’t accept this number.
There are different kinds of loans which constitute the total outstanding public debt of a country. These are; the central government external debt, the government-guaranteed external debt, the non-guaranteed external debt, and the domestic debt.
In the Ethiopian public debt case the most important of all which accounts about 61pct (94pct ten years ago) of the total outstanding debt of the country is the central government’s external debt. It refers to all external loans contracted between external creditors and MoFED. Most of these loans that the central government receives from both bilateral and multilateral agreements are concessional loans with minimum interest rates and are extended on terms substantially and are considered as “more generous” than market loans.
“These loans are used to finance government projects and programs which are mainly related to achieving the MDGs” Tesfaye Alemu (PhD), director of Debt Management at MoFED told EBR. These concessional loans have a 35pct or above “grant element”, the percentage amount of the difference between the face value of the loan and the sum of the discounted future debt service payments to be made by the borrower which the borrower is relived from paying, according to Tesfaye.
The other two type of loans are the Government-guaranteed and non-guaranteed external debts, which different public enterprises borrow from external debtors in non-concessional agreements.
Public enterprises such as the Ethiopian Electric and Power Corporation (EEPCo), Sugar Corporation, Ethiopian Railways Corporation and Ethiopian Shipping Lines receive loans guaranteed by MoFED as well as the state owned bank, the Commercial Bank of Ethiopia (CBE). In government guaranteed loans the central government has contingent liability and is responsible to pay the debt if the responsible public enterprise fails to do so.
Other enterprises, mainly Ethiopian Airlines (EAL) and Ethio-Telecom, receive loans without government or government owned bank guarantees. These enterprises receive the loans without guarantees because of their trustworthiness sourced mainly from their reputations and ability to generate foreign currency and pay their debts.
Accordingly, the latter two types of loans have no direct relation with the national budget. But it has implication on the aggregate foreign exchange accumulation.
This is where the government’s theory and calculation of public debt faces a challenge from critics and independent economists.
A senior macro economist who has a PhD and worked as a top government official, now a consultant, doesn’t agree with the analysis and data the government provides.
“The government’s data on public debt is not valid and acceptable,” the economist told EBR. “If we want to know the exact figure of the country’s public debt and thus budget deficit we have to calculate all the debts received including debts of public enterprises in the off budget financing schemes,” he says.
Ethiopia’s public debt is therefore estimated to be around USD 27 billion not USD16 billion, according to him. Several public enterprises borrow a huge amount of money from both domestic banks and international creditors. The debt EEPCO has borrowed from local banks is estimated to be ETB 80 billion, the economist says as an instance.
The worst part is that these public enterprises borrow with short term loans and the grace period will end in the coming four or five years. Since these institutions are not capable of paying this much loans in the given period, it will create chaos for banks and the economy in general. The private sector will not be able to borrow money from banks to finance their investments. It will not be too long before the country experiences a debt trap, according to the economist. “It is inevitable,” he exclaims.

The Need for Loans
Developing countries such as Ethiopia’s domestic savings are too low to finance their development needs. They are unable to mobilize the required financial resources locally to finance different development programmes and projects the government plans to undertake.
The Ethiopian Government uses the loans received primarily for education, health, agriculture, rural roads and water and sanitation which will help to achieve the MDGs. Moreover, a deficit characterized international trade results in that, only foreign exchange earnings from the export of goods and services finance a small portion of their imports.
The non concessional loans borrowed by public enterprises with or without the guarantee of the central government are used for strategically important projects such as foreign currency earning projects, according to a senior official from MoFED.
“There is no doubt that foreign loans inject additional capital to the economy which is an important ingredient to enhance the country’s productive capacity,” says Fantahun Belew, a public policy and management consultant who has worked as head to Macro Economy Policy and Management Department at MoFED and Macro-Fiscal Advisor to the Ministry of Finance of Liberia, in an e-mail interview with EBR.
Thus borrowing from abroad enables developing countries to achieve their development objectives and import capital goods, including input and basic consumption goods which are not produced locally. As the result of this, Fantahun adds, “growth is likely to increase and allow for timely debt payment and promote economic development”.

The impact of loans and debt sustainability
It is not only development that comes with debts. “Foreign loans require financing of its principal and interest, thus its burden both on the national budget and foreign exchange is evident,” says Fantahun. Even under normal circumstances, external debt service encroaches the growth of the economy as a significant portion of government budget goes to debt financing according to him. Debt servicing shifts spending away from economic and social sectors, such as agriculture, roads, health and education. Moreover, while external debt is financed by hard currency it directly impinges on the country’s foreign exchange accumulation, he concludes.
A country is said to achieve debt sustainability when it can pay its loan obligations without requiring debt relief or accumulating more debts to pay off the original ones. It designates the country’s ability to meet its current and future debt-service obligations, without recourse to debt relief, rescheduling of debts, or the accumulation of arrears, and without unduly compromising growth.
According to the IMF debt sustainability indicators, a country’s debt shouldn’t exceed 40 Pct of its GDP where as its debt service shouldn’t exceed 20 and 30 Pct of its export earnings and government revenues respectively though the number may vary according to the economy of that particular country. Based on these indicators a country can be categorized as low risk, moderate, high risk and debt distress types.
According to Dr. Tesfaye who is in charge of the country’s debt sustainability office at MoFED, Ethiopia lies in the most comfortable category of the low risk ‘green’ cluster in both calculations from his office and the IMF 2013 debt sustainability report.
“The country being in this category implies it is in a good state to pay its debts and receive additional loans for different development activities,” he wraps up.
However, the independent economist disagrees; saying that the reports from the IMF and WB can’t be always taken for granted, simply because the government of Ethiopia doesn’t give appropriate data and the report depends on the strength of the leader of the mission to write the report.
“To gauge the country’s debt situation it is useful to evaluate the outstanding debt (debt accumulated over time) in a given period in view of the size of the economy, potential growth of the economy and the opportunity cost of debt service financing,” says Fantahun, who previously worked at MoFED.
The major sources of Ethiopian external loans from multilateral creditors are International Development Association (IDA) of the World Bank, African Development Fund (AfDF), International Monetary Fund (IMF), International Fund for Agricultural Development (IFAD), European Investment Bank (EIB) etc. Whereas the main bilateral creditors are China, India (Exim Bank) Kuwait Fund, Saudi Fund and Korea from the Non-Paris Club, Italy is the only country that provides loans to Ethiopia that is a member of the Paris Club bilateral creditors. The domestic loans come from selling government bond, treasury bills and direct advances.
Debts are financed and paid with foreign currency. This of course effects to FOREX supply and can be costly. The ratio of debt service to GDP and debt service to national revenue measure how much of our domestic output goes to simply paying off debts. The most common indicators of debt sustainability are the ratios of debt service to exports and debt service to government revenues. Countries that are considered to have sustainable debts have debt service-export ratios of 25 Pct and debt service-government revenue ratios of 35 Pct as thresholds. Ethiopia and its development partners successfully did reduce the country’s debt burden through the HIPC and Multilateral Debt relief. This allowed the government to take out fresh loans and bring the economy to a more debt sustainable level.
Fantahun, however is concerned that; “In recent years, although directs loans taken out by the central government remained low rising contingent liabilities may pose a concern”.
Ethiopia must be vigilant about managing debts and minimize the use of non-concessional loans. While external debt is financed by hard currency the need to augment export proceeds is highly demanding as the country’s debt financing mounts. Linking external borrowing with export promotion investments is one possible solution.
Foreign loans must be managed transparently, in an accountable, efficient and effective manner. They must be utilized cautiously to minimize the keeping the next generation on the hook with unsupportable debt. EBR

2nd Year • January 2014 • No 11