Zero Hour

Ethiopia’s Economic Slowdown Takes A Toll

Ethiopia been praised by the global community for its outstanding economic performances for decades. Although the country has registered one of the highest economic growth rates in Africa, the economy has been slowing down in recent years. In December 2018, the International Monetary Fund announced that Ethiopia’s economic growth dipped to 7.7 pct in 2017/18, due to political uncertainty and severe foreign exchange shortages. Now, Ethiopia’s economy seems to be at a crossroads. While the decline of exports, a rise in prices, a drop in construction activities and the disruption of main trade routes signal that the economy is indeed slowing down, experts are worried that decreasing state involvement, coupled with the drop in government spending, will make the problem worse, as EBR’s Samson Berhane reports.

For the past three years, business has been difficult for Tilahun Altaye, a businessman who owns a coffee roasting company, and a construction machinery rental business. Like many people, his business has suffered a lot due to unrest that began in the state of Oromia and spread throughout the country.

But when Prime Minister Abiy Ahmed (PhD) came to power, Tilahun was very optimistic that his problems would quickly become history. However, those hopes have not been realized. “My revenues have dropped considerably, while the confidence of my partners, who supply coffee to my company, is lower than ever,” he says.

Even during the turmoil, Tilahun used to buys 300 quintals of coffee every year, and most of the machines he had at his rental company were leased out to customers. “Now, I only buy a third of my previous amount of coffee, and most of the machines are idle,” he explains.

Of course, Tilahun is not the only businessperson challenged by the drop in trade activities. Many traders, in Addis Ababa and other parts of the country, are now feeling the pinch of the business slowdown. The state of the biggest open trade centre, Merkato, shows the severity of the problem.

It has been a few months since bored sellers, unoccupied warehouses and deserted shops have become the new face of Merkato. The situation is no different in other parts of the city. While these unfortunate realities are still a source of concern, the measures undertaken by the government have shown no results yet.

Genesis of the Economic Miracle
Ethiopia’s seemingly miraculous economic growth in the past decade has been the result of demand-side economics; a growth path developed by the renowned economist John Maynard Keynes as a response to the Great Depression in the 1930s. Keynes maintains that the primary factor driving economic activity is the demand for goods and services, so he stresses boosting this demand by investing more. If the private sector is unwilling to invest, the government should step in and stimulate demand for goods and services.

The EPRDF-led government acted accordingly by adopting an expansionary economic policy, which emphasized increasing public expenditure and money supply. As a result, the broad money supply increased in an unprecedented manner especially in the last ten years. Between 2007/08 and 2017/18, it grew by a whopping 987Pct from ETB68.1 billion to ETB740.6 billion, according to the latest annual report of the National Bank of Ethiopia (NBE). Credit to the government, both for central and public entities, accounts for the majority. By the end of the past fiscal year, for instance, claims on the central government reached ETB102 billion while claims on public entities were ETB683 billion.

The result has been astounding. Ethiopia, a country that was the third-poorest in the world 20 years ago, became one of the fastest growing in the world. In fact, it registered 10Pct growth on average in the last decade. Ethiopia’s incredible economic rise, however, has recently started to diminish.

The Big Bang
It started with the political violence that erupted in late 2015 and early 2016. The violence evolved into a larger ethnicity-based conflict and political turmoil, which forced the government to declare states of emergency twice in the past three years. Meanwhile, the unrest deterred economic activity, including trade, manufacturing and even tourism.

In December, 2018, the International Monetary Fund announced that Ethiopia’s economic growth dipped to 7.7Pct in 2017/18 due to political uncertainty and severe foreign exchange shortages, as well as reduced government public expenditure aimed at tackling the growing current account deficit and indebtedness.
Even the Ethiopian government was not bold enough to deny the effects of the unrest on the economy. The NBE, in its latest annual report, indicated that in 2017/18, the economy registered 7.7Pct growth in 2017/18, slower than the 10.9Pct recorded the previous year.

Although the political turmoil and unrest started to die down after Abiy came to power, economic activities, particularly trade, have continued to slow down. Yonas Feleke, a wholesaler of textile products, is amongst those who have suffered in this regard, saying, “Although there has been a shortage of supplies, we have not adjusted prices even though there are enough reasons to do so. We did not want to lose our customers by increasing price, even though the possibility of finding the product for the price that we are selling for now is so low. It is a decision made out of despair.”

He isn’t the only one. Recent difficulties have made many businesses desperate to sell their products to cope with rising costs of living and shop rents. Other than retailers and wholesalers, importers and exporters are amongst those affected by the business slowdown.

Firms engaged in the construction sector are amongst the latest to experience this. In fact, many have been forced to temporarily quit or postpone projects, including the Ethiopian Roads Authority, as stated in its half-year report presented before Parliament on January 24, 2019. The Authority, which usually achieves more than 80Pct of its targets, was not able to replicate its previous success.

The property market has also not escaped the downturn. Many people are selling their property for lower prices, according to industry insiders. “They are uncertain about the future, and for those who are eager to sell their properties, it is becoming a bit tiresome to find buyers,” says a broker around the CMC area, who spoke to EBR on condition of anonymity.

Fueling Factors
The large current account deficits the country has shown since the late 1990s have been getting worse in recent years, and have exacerbated the economic slowdown. In the past financial year, export earnings reached USD2.8 billion in Ethiopia, showing a 2.3Pct decline from the export revenue the previous year, according to NBE.

In fact, export earnings have been stagnating around three billion dollars for the past seven years. On the other hand, the country’s total merchandise imports almost doubled, reaching USD15.8 billion in 2017/18. As a result, the current account deficit climbed by 134.5Pct since 2010/11, to USD12.4 billion in 2017/18.

The situation was aggravated by the failure of the country to pay external debts, borrowed to bring about growth and productivity improvements in the manufacturing sector and infrastructure development. Although the country, which is trapped in a quagmire of mega projects, relied on external debt to implement projects from railway networks, cross-country roads and industrial parks, to multiple sugar as well as fertilizer factories, most of the projects have been unable to earn foreign currency because of delays.

While Ethiopia’s external debt stock increased by 140Pct from USD10 billion in 2010 to USD24 billion in September 2017, which is 40Pct of the gross domestic product (GDP), according to the Public Sector Debt Statistical Bulletin published by the Ministry of Finance and Economic Development in September 2018, these projects are incurring costs for the country due to interest payments, let alone exporting goods as promised.

The gap between the export and import bills created a foreign currency shortage that has always been a headache to the country. For a country like Ethiopia whose consumption and local production is highly dependent on imports, the instability of the foreign currency market has had a big impact on the economy by constraining growth rate.

The current fiscal year seems no different. While the demand for foreign currency remain unchanged, export earnings stood at 1.2 billion dollars, declining by 10Pct during the first half of this fiscal year compared with last year figure. The international market is one factor behind the decline in major export items, including sesame.

Earlier this year, when India announced that its sesame production would decline by between 30 and 35Pct, exporters in Ethiopia hoped to reap huge profits. Many businesses, which were optimistic that prices would rise because of the decline in productivity of the leading sesame producer, spent huge amounts of money to buy the crop from farmers and suppliers, far higher than the recommended international price.

While the average price of a ton of sesame is traded for ETB1,875 in the international market, it was being traded for an average ETB4,000 on the floor of the Ethiopian Commodity Exchange, according to sources. But international buyers, most of whom were from China, were not willing to do the same. They actually turned to West African countries, such as Nigeria and Burkina Faso, which registered a significant rise in sesame production this year, while Ethiopia faced a drop in export proceeds from sesame as data obtained from the Ministry of Trade and Industry shows.

Exporters of coffee encountered much the same situation, although for different reasons. The volume of exported coffee fell 28,000 tons short of the target set to achieved over the past six months, meaning it met only 70Pct of targets. Compared to the same period of the previous fiscal year, the volume showed a four percent decrease, whereas earnings from coffee exports declined by 12.5Pct.

The decline in international prices was the major reason for the decline, according to the Ethiopian Coffee and Tea Authority. To be specific, the price of coffee on the international market declined by nine percent to 24Pct on average over the past six months.

The U-Turn
The economic slowdown didn’t seem to surprise the Prime Minister and his administration. In fact, Abiy clearly indicated the root causes of the decline while speaking to Members of the Parliament (MPs) in February 2019. “Government spending and public investments have been hugely cut back,” he told MPs. “This is because we can’t afford to increase our debt.”

In fact, it was right after Abiy’s appointment that the administration decided to cut public spending and slash government expenses, defying trends that have been unchanged for two decades. Many mega industrial undertakings and power infrastructure projects, which were under suspicion of mismanagement were temporarily suspended, while those under construction by state contractors were transferred to private ones.

Tassew Woldehanna, a professor of economics at Addis Ababa University with over three decades of experience, has been observing the diminishing role of the government in the economy. “As the state invests less compared to its previous engagement, and because government spending in the macro economy has declined, the aggregate demand has decreased and economic activities are apparently at a standstill. If not, they are heading downwards,” he argues.

Sources at the NBE also affirm this sentiment. “The reduction in the state’s role is affecting the economy,” says a senior official of the central bank. “But it must be noted that the problem is not with the dominant role of the state in the economy. Rather, the economic slowdown is related to the inefficiency of the state.”

Considering the massive government spending cuts, it is not surprising to see a slowdown in some sectors, according to Abiy. “For instance, those engaged in the construction sector, such as in the rebar and cement businesses are affected because the government was the main buyer. But this does not mean that the whole economy is at a standstill.”

For Alemayehu Geda (PhD), a renowned macroeconomist, the economic slowdown is not as inevitable. “The measures undertaken by the new administration to destroy networks of contrabandists and tackle the underground economy is a reason for the economic slowdown. The crackdown on corruption creates uncertainty in the underground economy, whose livelihood would likely be impacted by the measures. This has pushed those with higher influences on the economy to reduce their activities, and resulted in economic slowdown.” As a result, Alemayehu thinks that there should be mechanisms to replace those with a big influence as a short term solution for the economic slowdown.

Hope or Despair
Abiy didn’t deny the dark path the economy was headed down before he came to power. “A huge macroeconomic imbalance was seen in our assessment after the reform,” he told MPs. “Not only was the economy heading into stagflation, if unchecked, it could lead to recession or even depression.”

Economists define stagflation as a situation in which the inflation rate and unemployment remains steadily high while economic growth rate slows. Coined by Iain Macleod, the then- spokesman on economic issues for the United Kingdom’s Conservative Party, stagflation signals the arrival of the worst case scenario in both fronts: not just high inflation on one side and economic stagnation on the other, but both of them combined.

Globally, there are different views explaining why stagflation occurs. The supply theory stresses that stagflation is created by significant supply side disruptions, such as a sudden shortage of key commodities or capital required to produce goods and services, on top of factors like policy change. After supply shocks occur, the economy will first try to maintain momentum while consumers start paying higher prices. If supplies don’t respond to the price increment, inflation climbs while real output drops, which creates stagflation. Monetarists, on the other hand argues that stagflation is created by changes in aggregate demand.

While those in favor of supply theory and monetarists differ, they tend to agree on the impact changes in money supply can bring. According to Keynesian economists, if the government cuts spending and public investment while the economy is thriving, it only cause an insignificant fall in real GDP. However, if the government cuts spending when the economy is in stress and declining, there will be a significant real GDP drop, which could lead to recession.

Yet, Abiy seems optimistic. “The performances of commercial banks indicate that the economy is healthy. Deposit mobilization and credit disbursement is growing at a fast pace. This shows that normal economic transactions have been very health in the past six months.”

“Three out of seven industrial parks have already been finalized while the rest will be finalized this year. Some of the sugar factories have also been finalized,” Abiy told MPs. “On the other hand, the World Bank estimates 8.8-9Pct economic growth this year. We also managed to reduce year-on-year inflation to 10.3Pct from the average 14Pct in the past 15 years by cutting back public driven investment.”

Alemayehu, however, stresses that the dominant role of the government in the economy should be replaced by the private sector in a step by step manner. “If the government persists in cutting spending and investment, the economic slowdown might get even worse in the near future.”

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8th Year • Jan.16 – Feb.15 2019 • No. 70