Analysis: Government pushes forward with second phase economic reform despite dismal outcomes of the first

A delegation led by Prime Minister Abiy Ahmed that included Finance Minister Ahmed Shide and the governor of the National Bank of Ethiopia, Mamo Mihretu, met with Kristalina Georgieva, managing director of the IMF, at the Paris Summit for New Global Financing Pact. Photo: PMO

Addis Abeba – The government is set to push forward with the second phase of its home-grown economic reform agenda, despite lackluster results from the initial phase implemented over the past three years. Prime Minister Abiy Ahmed (PhD) revealed during a briefing with parliament members on 06 July 2023, that the next phase of reforms will commence the following week. The objective of these reforms is to revive an economy impacted by both domestic and international conflicts.

The announcement comes two weeks after the conclusion of consultations with the executive committee of the Development Assistance Group (DAG). Led by Eyob Tekalign (PhD), State Minister for Finance, the consultations centered around economic reforms to be implemented in the next three years. The forthcoming macroeconomic reform will primarily focus on two aspects: halving the debt-to-GDP ratio and reducing inflation to below 30%. The previous reform agenda, initiated in 2019, aimed to maintain a stable macroeconomic environment, reduce debt vulnerabilities, and limit inflation to single digits. Yet, the current situation is far from the intended targets.

The other target of the first reform agenda was to uphold a stable exchange rate. However, achieving this in an environment with relatively high inflation remained challenging for the government. In recent years, the local currency, the birr, has experienced a consistent decline in value against major international currencies, particularly the US dollar. With the official rate currently at around 55 birr per dollar, the scarcity of hard currency has driven the black-market value of a dollar to surpass 110 birr. This substantial premium of over 100% marks a significant event in the nation’s economic history.

“If these reforms had been fully implemented, the current macroeconomic situation would be different.”

Tewodros Makonnen, country economist, IGC

The Prime Minister, however, noted that this is beyond the government’s control. The Reserve Bank’s decision to raise interest rates in the United States of America in order to tackle inflation led to the appreciation of the dollar in the global currency market, subsequently causing a significant depreciation of the local currency, the birr. According to the Troubled Currencies Project, which tracks exchange rates in black and spot markets, the Ethiopian birr has depreciated by nearly 40% against the US dollar since January 2022.

Tewodros Makonnen (PhD), a country economist at the International Growth Center (IGC) Ethiopia, argues that many of the tasks outlined in the reform agenda have remained incomplete due to the COVID-19 pandemic and internal conflicts in the country. “If these reforms had been fully implemented, the current macroeconomic situation would be different,” Tewodros remarks.

Over the past three years, Ethiopia has seen some improvements in its debt stress status, as measured by the debt-to-GDP ratio. In June 2021, the total nominal public sector debt, both external and domestic, accounted for about 51% of the GDP. By March 31, 2023, this figure had dropped to 38.8%. However, such progress was insufficient to change the country’s debt distress rating from high risk to moderate risk.

In early 2021, the government sought debt restructuring under the Group of 20’s Common Framework—a plan targeted at restructuring government debt in low-income countries. However, progress was hindered by a two-year civil war that erupted in November 2020, and ongoing discussions with development partners have yet to reach a conclusive outcome. Sources close to the matter have informed Addis Standard that the government is presently seeking approximately $3 billion in assistance from the IMF and the World Bank.

Julie Kozack, spokesperson for the IMF, emphasized two months ago the need for clear commitments from development partners and financing assurances from creditors under the G20 common framework to finance any program.

Addressing concerns about inflation, the prime minister acknowledged that it remains a significant issue for policymakers and the general public. He described it as “spreading like a pandemic,” despite the government’s extensive efforts to curb it. Three years ago, when the reform was launched, the administration aimed to bring inflation below the single-digit mark. However, the results have fallen short of this target, with some initial improvements observed.

During his most recent appearance before lawmakers, Prime Minister Abiy stressed that limiting the money supply will be a key priority for the government over the next three years (Photo: PMO/Facebook)

By tightening monetary policy, the current administration managed to decelerate annual average inflation to 12.6% in 2018/19 from 14.4% a year before. Unfortunately, since 2019, average annual inflation has surpassed the 20% mark, reaching a staggering 33.7% in 2021/22, with food inflation standing at 40.2%. Nonetheless, by May 2023, overall inflation had dropped to 30.8%, while food inflation had dropped to 28.5%.

Prime Minister Abiy emphasized that slowing down inflation has been challenging, given the current global environment of rising prices. The government has allocated close to 100 billion birr this year to subsidize fertilizer and fuel as part of efforts to stabilize inflation.

Limiting the money supply will be a key priority for the government over the next three years, aimed at tackling inflation. However, previous events cast doubt on this intention, as the present administration has predominantly depended on direct funding from the central bank to cover its mounting expenses. The Prime Minister emphasized that the 801-billion-birr budget, devised diligently using a conservative approach, considers the objectives outlined in the reform agenda. Notably, the budget for the upcoming year shows a mere two percent increase compared to the current year.

Limiting the money supply also means depending on financial resources mobilized from the economy, mainly in the form of taxes. In the last 11 months, 365 billion birr were collected in taxes, representing a 20% increase compared to the same period last year. However, the tax income collected falls short of its potential, with the tax-to-GDP ratio declining in recent years from 10.7% to 7.1% last year, well below the sub-Saharan African average of 16%. Abiy described this performance as “embarrassing.”

But the poor tax performance didn’t outdo the economic growth, according to Abiy, who asserted that it is growing “phenomenally.” To fully comprehend this, he emphasizes the importance of evaluating achievements on a global and regional scale. According to the IMF, global growth is estimated to decline from 3.4% in 2022 to 2.8% in 2023 before settling at 3.1% in 2024. Sub-Saharan Africa’s growth is also projected to sharply slow to 3.6% in 2022, before increasing to 3.7% in 2023 and rebounding to 4.2% in 2024. In light of this global trend, Ethiopia’s GDP growth, which is forecast to remain around six percent in the next two years, is unquestionably exceptional. However, this is not enough for the current administration. Abiy conveyed the government’s aim to reach an even higher annual growth rate of 7.1% this year while addressing legislators.

Some of his claims, such as the expectation of the industry sector growing by 8.2% this year, do not align with the reality on the ground. Over the past three years, many large and medium-scale manufacturing industries have either drastically reduced production or completely shut down, mostly due to a scarcity of raw materials caused by foreign currency shortages in the country and conflicts in different parts of Ethiopia, including Northern Ethiopia. In May 2022, Melaku Alebel, the Minister of Industry, reported that over 446 industries had halted operations. The government responded by launching a nationwide campaign called “Ethiopia Tamerit” (roughly translated as “Let Ethiopia Produce”), resulting in the revival of over 160 industries, according to the Prime Minister. The industry sector currently makes for 28% of the GDP. AS

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