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Ethiopia's growth challenged by a myriad of factors

10 December 2020 Alisa Strobel Eva Renon
  • IHS Markit has made a downward revision to our near-term forecast for Ethiopia's real GDP in November. The revision is on increased downside risks to our GDP forecast, including weak global demand and the armed conflict in Tigray, as well as a weak investment and non-coffee export growth performance during the first two quarters of 2020.
  • A prolonged duration and worsening of the armed conflict in Tigray, would increase government spending, widening the fiscal gap and acting as an additional drag on foreign-exchange (FX) inflows through lower export growth.
  • FX shortages will continue to challenge Ethiopia's economic reform momentum and business growth, while IHS Markit sees further fiscal consolidation going forward to align with the requirements of the International Monetary Fund (IMF) to obtain crucial support through the Fund's three-year Extended Credit Facility and Extended Fund Facility arrangement.

Duration of the armed conflict dictates scope of economic impact

Ethiopia's real GDP growth is expected to be 1.9% in 2020 and 2% in 2021 amid increased downside risk factors such as prolong weak global demand and foreign direct investment inflows (FDI). Additional spending needs on healthcare in 2020 amid the coronavirus disease 2019 (COVID-19) outbreak, as well as additional costs arising from Tigray's armed conflict, have created urgent fiscal and balance-of-payments needs, leading to a widening of the budget deficit.

FDI inflows fell by 9.7% during the first quarter of 2020 and 12.4% during the second quarter. The total number of industry investment projects and the total investment capital declined 96% and 55.7% respectively during the first quarter of 2020, with the construction sector showing the steepest drop. Although total export growth came in better than expected during the second quarter compared to the previous quarter, this was mainly due to stronger coffee exports, which grew 48.7% quarter on quarter, with the rest of export performance seeing a slowdown of 13.4 percentage points during the same quarter. Overall, FX levels reached ETB102,412.06 billion (USD2.67 billion) in the second quarter.

Total exports are expected to underperform during the second half of 2020 and into 2021 amid weak global demand. Tigray hosts some of Ethiopia's crucial oilseed industry, Ethiopia's second largest agricultural export after coffee, followed by the horticulture industry. The region plays also an important role in Ethiopia's agricultural-sector transition towards value addition and houses some industrial parks, whose output performance could be impacted by a worsening of the armed conflict.

Policy response

Despite significant diversification efforts, Ethiopia's export growth is expected to continue to lag in the near term. In an effort to stimulate export growth, the IMF has stated that Ethiopia needs to move, in the long run, towards a market-clearing exchange rate. However, such a move, including a short-term devaluation of the birr, would face strong political opposition to the resulting inflationary pressures, among other challenges. This suggests that such a policy is very unlikely to be considered before the scheduled June 2021 legislative elections.

A devaluation and a move towards a more liberal exchange-rate regime would help reduce real currency overvaluation and boost Ethiopia's export potential. However, such move would require caution to maintain stability of other macroeconomic fundamentals. We expect to see an ongoing tightening of monetary policy to bring inflation down as a result. We also expect to see tighter fiscal policy, with overall government expenditure to come down in 2021.

Further fiscal consolidation is aligned with the requirements of the IMF to obtain crucial support through the Fund's three-year Extended Credit Facility and Extended Fund Facility arrangement. External support will be crucial to Ethiopia's financing needs. Furthermore, in 2020, Ethiopia has enjoyed a steady influx of bilateral and multilateral support for its economic reforms and assistance to combat the COVID-19 virus outbreak, suggesting a strong government commitment to reverting to policies to ensure macroeconomic stability that is welcomed by the international community. Therefore, we expect to see reform momentum continuing in 2021; however, some implementation risks in the near term could lead to delays. We consider FX shortages to be one of the key implementation risks that could slow reform processes.

FX shortages are very likely to remain in the near to medium term. The FX scarcity has also been the main impediment to boosting FDI in non-agricultural sectors such as construction, manufacturing, and tourism. Therefore, we expect to see the government prioritise policies that support rapid FX generation. Furthermore, Ethiopia's government is very likely to increase the stake of the private sector in the telecommunications sector to bring in FX by mid-2021, but exclude a wider opening of the financial sector in the next year.

The government has approved privatising 40% of state-owned Ethio Telecom, which is expected to generate income through royalties, taxes, and dividends. Twelve companies have submitted bids and the two qualified bidders were due to be announced by end of November. Instead, on 27 November, Finance Minister Eyob Tekalgn announced the opening of the Official Request for Proposal for three months, which is due to close on 5 March 2021, so that the two qualified bidders would be able to start operating from April 2021. The delay in this announcement was reportedly due to disagreement between bidders and the government over whether the qualified companies would be authorised to provide mobile money services, which Prime Minister Abiy Ahmed opposed in September.

IHS Markit assesses that the government is likely to be more favourable to including mobile money services as part of the liberalisation of the telecom sector in the second half of 2021. In November, the central bank governor hinted at the partial opening up of the financial sector, which, in IHS Markit's view, is likely to be made very gradually, until local private banks build up their competitiveness. The minor use of mobile money services by the population (1%) makes it a mild step towards the liberalisation of the financial sector and it is unlikely to threaten local private banks.

Posted 10 December 2020 by Alisa Strobel, Senior Economist and

Eva Renon, Senior Country Risk Analyst, IHS Markit



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