Like the rest of the world but perhaps more than most, the Coronavirus poses an unprecedented existential challenge to Ethiopia. If current projections of the spread of the pandemic hold, the country will see the gains from recent rapid growth, now totally wiped out, the poverty level more than doubled, its economy shattered, export revenues drastically reduced, its external debt servicing shooting to an unsustainable and dangerous level, its social and political order enormously tested and even threatened, and its population decimated by death, illness, hunger and famine. Ethiopia may or may not survive the pandemic, although its past assures us, it will. But it will not be the country we now know, much less the future we may have hoped for.Thus, we need to do our best and at most possible effort to stop the spread of the virus by any means necessary.
The potential damage and urgency of the looming pandemic and its economic shock call neither for high-flown theory nor for empirical sophistication. What is needed is quick analytical insight using available data in order to inform the Ethiopian government and the public at large of the likely magnitude of the resulting economic problems and to stimulate debate about the possible and feasible policy options that can minimize the impact.
Given the nature of our livelihood, the analysis assumes and recommends that full-lockdown is impossible in Ethiopia. Hence, the focus of this analysis is on the possible impact of COVID-19 under a partial lock-down condition and various scenarios.
I have envisaged three scenarios. The first, best-case scenario assumes that the current shock will last for the 1st quarter of the new fiscal year 2020/21 (i.e. July to September 2020/21) only and the economy will go back to normal then. The second-case scenario assumes that the economic shock will continue into the 2nd quarter (October to December) and subsides thereafter. This, in my view, is most likely to happen.
The third and worst-case scenario assumes this shock will last up to the 3rd Quarter (January to March 2021). In all three cases, the effect of COVID is compared to what would have been without COVID by taking the average annual value of major macroeconomic variables in the last three years to be the base run (the business as usual scenario), or, the benchmark of the economic situation of the country without the effect of COVID.
II. GDP and Sectoral Growth Effects
The economic impact of the COVID-19 pandemic is staggering. The pandemic is estimated to reduce GDP by 11.1Pct in 2020/21 fiscal year. This shock will be felt most in the industrial sector, which is projected to contract by 17Pct. The service sector will decline by 15.6Pct. The agricultural sector is expected to be the least affected as it is projected to decline by only 1.6Pct.
The government projects a growth figure of nine percent for the fiscal year 2019/20 or a GDP of ETB2.04 trillion. With such figure, the economy would fall by 11Pct means the GDP of the country will face a ETB227 billion decline. In the event of the best-case scenario, the effect being limited just to the first quarter of the new fiscal year, and hence a 5.6 percent decline in GDP, this loss becomes ETB114 billion.
The external sector is especially vulnerable, and this will have a significant impact on the national economy. The sector’s vulnerability comes from the effect of COVID-19 on global commodity prices and the volume of exports and imports as well as from the disruption of the supply chain with our major trading partners especially China and Europe.
Thus, we project in our scenario that exports will decline by about 16.2Pct. Imports also are projected to decline by about 12Pct in our scenario. The latter is apparently a positive development from the point of view of the balance of trade deficit. For instance, our fuel import bill will decline by at least 30Pct. However, the negative side of the story is that this may lead to shortage of essential goods that include food supply in the market, a rise in prices and a disruption especially of industrial production.
The decline in exports will have a significant negative impact on external debt servicing, which is now almost two billion dollars (two-third of our merchandise exports) and has been growing by 24.4Pct annually in the last three years. The COVID-19 effect will raise this figure from the current level of 26Pct to 38Pct of exports of goods and services. This underscores the need to re-schedule or cancel servicing debt as it will be virtually impossible to pay and may lead to the country defaulting to its creditors anyway.
The trade balance and balance of payment problems of the country is generally structural. Unless there is a fundamental change in export capability – which is very unlikely – the country will continue to be extremely dependent on external finance (aid, borrowing, remittance) for years to come. The COVID-19 impact will accentuate this dependency and aggravate the foreign exchange problem if such capital flows are not forthcoming.
Proposed Policy Directions for the Real Sectors
A strong focus on the agricultural sector with the aim of increasing food production to an unprecedented level is a key policy imperative. Increased effort on the agricultural front would not only greatly reduce the contraction in GDP, but also minimize the potential deficit in food supply and export revenues.
Creating a food bank to withstand the likely food shortages across regional capitals and Addis Ababa as a complementary political and policy intervention deserves special consideration. Boosting food production and food imports is also crucially important to ensure macroeconomic stability, especially during such a defying moment. My recent empirical analysis on inflation in Ethiopia shows that a 10Pct rise in domestic food production would lead to a significant 26Pct reduction of general prices. The converse is also generally true.
Although this policy brief stresses the imperative of giving particular attention to the agricultural sector, another albeit counter-intuitive recommendation is the adoption of a policy of minimizing the rural-urban linkage so as to shield the rural population from the transmission of the disease from urban areas, while at same time maintaining the flow of goods and services between the two sectors. This would call for unconventional measures such as limiting points of contact and marketing venues, extensive testing and use of masks and mandatory social distancing. Provision of marketing services through neighborhood cooperatives or other creative approaches could also be important and viable options.
In order to abate the negative income and poverty effect of the pandemic, it may well be necessary to allow the continued operation of some major sectors of the economy, especially the construction and some service sectors. This may be done using different shift schedules in order to preserve social distancing. COVID-19 related health services could also be provided on sites. A complementary policy would be to consider a strategic shift to import substitution and the production of basic goods wherever there are opportunities for doing so.
The various intended and unintended consequences of the economic dislocation and other concomitant changes in production and production processes will have adjustment costs for firms and workers. Government must envisage and design various kinds of supportive measures to keep firms going and minimizing the economic and financial cost of the crisis. Among such measures is the provision of credit for a renewable three months period or so. These, coupled with other measures, need to be preceded and supported by intensive consultations between the government, industrial leaders and other stakeholders.
The use of the renaissance dam financing type bond selling scheme for COVID purpose (call it COVID-bond) for a limited period is worth considering. This is because the effect of financing the spending related to COVID-19 could be enormous for the government and may lead to sever macroeconomic instability.
III. The Socio-Economic Impact
Poverty: Using the official poverty line of Birr 20 per adult per day, it is estimated that 22 percent, about 26 million of the estimated 108 million population of the country, live below this poverty line. With an international poverty line of Birr 40 per day (that is USD1.25 a day), or about Birr 1,200 per month, some 73Pct or about 79 million of our people are below poverty line.
On the average, the COVID-19 economic impact is estimated to increase the number of poor people by about 28 million. Even using the official poverty line, the pandemic will more than double the poverty rate from 22 to 48Pct of the population. These figures show the gravity of the problem that we are going to face.
Jobs and Vulnerable Groups: Since the government will not retrench workers during this time, the 1.8 million public sector workers are the better protected occupational group. They may cost the government about ETB5.7 billion per month for a full-lockdown period. With partial lockdown this would decline by half.
On the other hand, about 1.5 million workers in the private sector could be vulnerable if their private sector employers couldn’t run their businesses during the partial lock-down period (and after). The government may need to finance fully or share the cost of keeping these workers on their jobs.
In addition to this, there are also 3.1 million self-employed workers. These are the second group of workers that are vulnerable to the economic impact of COVID-19 and partial lock-down measures. The third vulnerable group includes those in small and micro enterprises. These three groups have a combined figure of about five million workers. With full lockdown all these people could be vulnerable.
With partial lock-down and partial running of the economy, this may decline by half or to 2.5 million workers. The estimated job loss and, hence, the corresponding income loss of these vulnerable paid employed people under the average scenarios envisaged in this study could be about ETB2.5 billion per month.
Proposed Policy Directions to Address the Social Consequences
The first measure that could be considered to minimize the socio-economic effect of the pandemic is to keep at least half the work force running the economy so that these people are earning a living and supporting the other half for a three – month period until the economic effect of the virus subsides.
For those in the informal sector that depend on their daily labour and lead a hand-to-mouth life, the likely occurrence of unemployment, hunger and starvation is a real threat and more deadly than the virus itself especially if the lock-down persists for more than a month. It could also lead to migration back to rural areas, worsen the breakdown of social cohesion and law and order and could be a health threat to rural areas.
There is a clear trade-off between dying from the virus and dying from hunger and starvation. The government may therefore need to significantly tilt its policy towards avoiding hunger and starvation and preventing the potential breakdown of law and order, while doing its best to contain the virus.
Prime Minister Abiy Ahmed (PhD) and Addis Ababa’s Mayor Takele Uma are doing a great job in sensitizing the public on the health issues and mobilizing resources for the extremely vulnerable. What they now have to do is to make this excellent initiative more systematic and orderly, and not ad hoc as has been the case so far.
It also needs to be done on a bigger scale and should be accompanied with a plan for its financing by the Federal and Regional States and Neighborhood indigenous institutions, at least for the coming three months. It is important to deploy our social capital (churches, mosques, neighborhood networks) to squarely address this challenge. As regards to employees and employers in the private sector, although the government has advised private businesses not to dismiss their workers, it has not come up yet on how to support the business owners to do that for long. This is particularly difficult for small business owners. Two policy directions may be worth considering:
(i) Helping businesses run their operations on the basis of a shift system and encouraging them to shift to essential goods production or to import substitution if this is feasible
(ii) Share or fully finance the financial burden of holding onto the work force during the lockdown period. This is important to mitigate business bankruptcy and failures. With an estimated average monthly salary of about ETB3,000 per month in urban areas, the cost ofkeeping 1.5 million workers on the job may amount to about Birr 4.5 billion per month – as a wage bill. Again, how to share this cost should be a matter for consultation amongst business owners, workers and government.
For the self-employed in micro and small enterprises, however, rent freezing is the first and most important policy initiative. This is because the rentals cost of business premises/shops is the most significant cost to the self-employed. The government could guarantee the payment of rents during the partial lockdown period on behalf of small business owners through bonds payable to the owners of the premises. The implementation of this policy idea requires detailed and concrete assessment by the Ministries of Trade, Labour and Social Affairs.
The social policy directions proposed above need an efficient and effective system of administration. From this perspective, the following points are worth considering:
(A) Re-routing or strengthening existing administrative systems is preferable to setting up new institutions
(B) At this point in time, food and other essential transfer is much better than cash transfer as markets may breakdown and prices rise; and
(C) Prime Minister Abiy’s idea of people sharing their meal and rent cancelation is a great idea worth pursuing, although it needs to be done systematically for it to be effective. Neighborhood-based programmes using indigenous institutions as well as media-based sensitization programmes are key complementary approaches for this initiative to continue on a sustainable basis.
Macroeconomic and Financing Issues
The public spending analysis in this study assumes that capital expenditure will be halted at least for the current fiscal year or until the effect of the virus subsides. To the extent possible, this should be the policy direction of the government. If not, non-monetization financing of it is criticall for macroeconomic stability.
The most notable public spending (fiscal policy) response of the government so far includes the Birr 300 million allocated to bolster the health sector, the ETB15 billion liquidity injected to the private banking sector, and the ETB51.2 billion (USD1.6 billion) the government is currently planning to spend on the economy to abate COVID-19’s economic effect. This planned spending (some already done) adds up to ETB66.5 billion. If the recently parliament approved supplementary budget of Birr 28 billion is not part of the above planned spending, the total government additional spending will jump to ETB94.5 billion.
To avoid significant macroeconomic instability, I recommend the supplementary budget of ETB28 billion to be reckoned as part of the USD1.6 billion the government is planning to allocate for spending as a policy response to the pandemic. In addition, I will also recommend the freeze on capital expenditure unless it has significant sunk-cost and labour displacing effect or could be financed in non-monetized way. The analysis here is based on these two key assumptions.
If these assumptions are violated, the presumed possible macroeconomic instability condition would be much more severe than is painted here. With my recommendation about the capital and supplementary budget above accepted, the effect of COVID is to increase total public expenditure by 17.4Pct compared to the base run situation (the recurrent expenditure will increase by 30Pct). In addition, the possible shrinking of the economy will also reduce the total government revenue, including grant, by 16Pct, whereas taxes and non-tax revenues are expected to decline by 18.8Pct and 7.7Pct, respectively.
The combined effect of a rise in public expenditure (ETB66.5 billion, 17.4Pct increase) and a fall in revenue (ETB50.5 billion, 16Pct reduction) is to bolster public deficit by ETB117.1 billion and hence the need to get this amount of money just to have a fiscal posture that we had before COVID (or maintain the status quo). If the supplementary budget is not part of the USD1.6 billion COVID response money, the money needed just to maintain the fiscal posture that we had before the virus will jump to Birr 145 billion. It has to be noted that this doesn’t include the financial assistance to the private sector operators as well as to the vulnerable workers noted above. In addition, this is assuming that the government will freeze public capital expenditure during this period.
The combined effect of this hike in public expenditure and a decline in public revenue is to put unprecedented pressure on public deficit and strong pressure on monetization of this deficit. From macroeconomic stability (low inflation, stable exchange rate, sustainable deficit& debt level and low unemployment) point of view, financing this deficit is a major challenge for the government. Given the already high inflation of about 22Pct now and food inflation of about 25 percent, macroeconomic instability that includes further high inflation (in particular food inflation) is a real possibility that may emerge as part of the economic shock and policy response related to the COVID effect. This calls for cautious and prudent macro policy.
Proposed Macroeconomic and Financing Policy Directions
Full monetization (financing it by borrowing from the National Bank, which basically means money printing) of this increase in deficit is problematic because its inflationary consequences could be overwhelming. This hurts the poor and the vulnerable workers disproportionally and depreciation of the Birr, which is contrary to the policy objective of protecting the welfare of the population. Such policy needs to be avoided.
For instance, a pressure of borrowing from the National Bank to finance the ETB117.1 billion additional budget needed just to maintain the status quo through full monetization(this is equivalent to 11 percentage points increase the broad money supply) could lead to about 20 percent rise on general price level, which is already very high, as noted. A better policy alternative to financing such deficit without major macroeconomic instability is to pursue a mix of heterodox policies that includes:
1. Expenditure switching: this means the government needs to revisit and revise its book and postpone and switch some of the less urgent items in the current budget, and shift the resources to fund the COVID related programs.
2. Avoid any devaluation (no matter how high the parallel market rate premium is) until the effect of the virus subsides as it exacerbates inflation. My updated inflation model shows that, if we devalue the Birr from the current level of Birr 32 per USD to, say, 35.20 (a 10 percent devaluation), the price level will increase from its current level by about 24Pct(and this without any compensatory positive effect by way of increasing exports or reducing imports – two important justifications that are generally given for such a policy).
3. External financing is important as long as a good part of the money (if we manage to get it)canbe used to import food and related essentials and/or boost domestic production of food and such essential consumer goods. Increase in food supply iskey for financing the COVID instigated public spending within a non-inflationary macroeconomic environment. Non-inflationary environment is also key to avoid pressure on exchange rate depreciation, which may lead to a “depreciationinflation” cycle. In addition, inflation and devaluation will also increase the Birr value of the already approved budget, fuelling inflation further. This may lead to runaway inflation that is also a recipe for political crisis. Hence, the non-inflationary financing policy advocated here, apart from protecting the poor, has additionalbenefit of maintaining macroeconomic and social stability.
4. The external financing, if obtained, needs to be accompanied by a monetary policy of sterilization (i.e., reducing total credit by the equal amount of external assets obtained) for more effectiveness. The latter seems difficult at this trying time if there are no non-essential or non-urgent credit provisions in our current plan that we could easily halt. However, it has to be tried.
In conclusion, it is imperative to note that the Ethiopian economy is going to face an enormous shock. There is no room for complacency, incompetence or uninformed decisions. The consequences of such actions could be devastating especially at this extraordinary time. Decisions must be guided by evidence, knowledge and good judgment. The challenge we are facing is so great and the potential consequences so catastrophic that we need an exceptional and bold politico-economic approach to rise to the challenge and avoid the precipice. This means above all the political determination to run the economy with the attitude, conviction and commitment akin to “an economic state of emergency”. It is important for Ethiopians, the government and opposition political parties to put aside their differences and unite as one people, one country, and one nation – in this sense it is also an opportunity to forge our unity.
9th Year • May.16 – Jun.15 2020 • No. 86