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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