IMF recommends slowdown in growth to contain inflation to single digits

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The government policy of reducing inflation to single digits might be possible at the end of this fiscal year, says the International Monetary Fund (IMF). The government hopes to accomplish this by during this fiscal year as well. The IMF also said that Ethiopia is left with foreign reserve that can cover less than two months of the import bill of the country.

That releases negatives shocks to the economy, argues the representative.
“We support tightening of federal government monetary policy and fiscal policy. From the beginning of this fiscal year, the authorities have put in place base money hunger. That is a key monetary policy tool in this country. It is tight and consistent, in our view, to bring inflation down to single digits. Of course, shocks can happen in food prices. International food prices are on the rise again. It might have an impact on Ethiopia through time. We agree with the idea of putting policies in place that will bring inflation to single digits at the end of this Ethiopian year. That is what one should strive for and the government is doing,” said Jan Mikkelsen, IMF Resident Representative, while briefing journalists in his office about the content of the soon to be published IMF Article of Consultation for 2012 with Ethiopia.  
The IMF’s Resident Representative appreciates the public sector led development strategy of Ethiopia though he warns of the negative impact of the move on private sector.    
“We agree that the public sector led development strategy that Ethiopia is following has led to robust economic growth in Ethiopia for a number of years and has also led to poverty reduction. It carries positive results in terms of economic development. However, what we have seen in the past is that macroeconomic imbalances are reemerging in terms of high inflation, in particular, and appreciation of currency. Inflation causes very negative real interest rates and some real appreciation of real exchange rates,” he argues.
“Most of the discussion we had during IMF mission visit and the staff report we are going to publish recognizes some of the achievements and we are still discussing some of the policies that would focus on how to sustain growth but also readdress some of the vulnerabilities and risks that are in the future and what the policies, in our view, should be in place in order to sustain economic growth and lower inflation,” he adds.
The IMF and the government agree that inflation is still an issue. They agree that policies need to be put in place to bring down inflation below where it is now. Inflation is still around 20 percent. For the past five or six years, it has been difficult to bring inflation down below 20 percent. The deal is now to bring that inflation level to single digits.
“We also support the fiscal monetary policy that the government is putting in place for this year and some of the effort to restructure tax administration and collection. There is good progress. Though it is gradual, it is improving its performance.  On the expenditure side, in terms of public financial management and putting in place a budget system, budget reporting system, and budget control system. We have been looking in some of these issues although there is clearly some progress also in terms of improving those systems. Those systems are put in place in order to achieve the overall goals. This is very positive,” he argues. 
The government collected close to 71 billion birr gross tax revenue. In the last two years of the GTP, government tax revenue has increased in absolute terms from 43 billion in 2010/11 to over 70 billon birr. This represents a growth as a share of GDP from 11.5 percent to 13.8 percent. But, at 13.8 percent of the GDP, tax revenue still remains low compared to the sub – Saharan average of 18 percent.
“However, we still have a number of areas where we still see a number of vulnerabilities in the economic system that need to be addressed in the coming years in order to insure stable economic growth and development. One area is to pace the implementation of the GTP properly. That means to try to put in place the financing and the investment plans in accordance with the financing budget available. We feel that, it is important to do so in order to make sure that you maintain stability [low inflation]. High inflation will have repercussions on the balance of development. That means if you expand public investment very fast, it will have a negative effect on private sector,” he argued.
“That is crowding out the private sector. There is a risk in implementing the GTP by forcing significant investment very quickly; you may not be able to do it with low inflation; you may not able to continue growing very fast. That marginalizes the private sector which is the long term engine of growth. We need to rebalance a little bit. That is the general point we have made a number of times. I think this important to bear in mind in terms of government policies in the coming years,” he adds.
The National Bank of Ethiopia’s bill that compels private banks to buy government bonds which consumes 27 percent of the loan disbursement each bank gives out bearing only three percent interest as opposed to the five percent interest they give on deposits they mobilise is sighted as one example of crowding out private sector.
The introduction of the directive managed to suck out more than 11.5 billon birr from the private financial sector of the country according to reports. The directive was introduced in April 2011, ending a two-year long credit cap policy in the industry.
Despite tough measures imposed on the lending capacity of private banks by the financial sector regulating arm of the government, the banks remains profitable in the just concluded Ethiopian Fiscal Year. Fourteen private banks currently operating in the country amassed more than 3.5 billion birr gross profit. However, the cumulative gain of the 14 commercial banks is less than half of what the Ethiopian financial giant; Commercial Bank of Ethiopia (CBE) earned over same time period. CBE has earned record high gross profit amounting 7.9 billion birr in the 2011/12 budget year. The collective gain of the private banks represents 45 percent of the earning of CBE. 
Early in mid June, the IMF mission to Ethiopia predicated a single digit real economic growth for the last and this Ethiopian year. It also sees a decelerating inflation that eventually settles at single digits if tight monetary and fiscal policies are in place. The mission visited Addis Ababa from May 30 to June 13. 
“For 2011/12, the mission projects real GDP growth at 7 percent and end-year inflation at about 22 percent. A similar growth rate and single digits inflation are achievable in 2012/13 if implementation of tight monetary and fiscal policies is maintained,” said Michael Atingi-Ego, head of the mission back in June.
The World Bank (WB) estimates that the Ethiopian economy will experience 7.2 percent growth in 2012. Both the IMF and WB growth projections are lower than the government’s baseline projection of 11 percent in the governing economic plan of the country that dusks in 2015.
Meanwhile, the Ethiopian government is confident that the economy will continue to grow at double digits in last year and continue to do so in the years to come. Sufian Ahmed, Minister of Finance and Economic Development, reaffirmed MPs last June that the economy will continue to register double digit economic growth as it did in the past eight years while containing inflation at single digit by midyear.
“The Ethiopian economy continues to grow at a robust pace, poverty continues to fall, and inflation, while still high, has been declining. The expansion in economic activity has been supported by robust export growth and public enterprise investments. Tight monetary and fiscal policies have contributed to the deceleration of inflation, which also reflects declining international commodity prices. Monetary tightening, reflected in a contraction of base money, was achieved by terminating central bank financing of the budget and significant sales of foreign exchange. As a result of this foreign exchange intervention, gross official foreign reserves have declined to under two months of import coverage. The budget execution has been prudent, but increased domestic credits to public enterprises have been providing strong fiscal impulse,” adds the mission head.
Ethiopia’s year-on-year inflation increased a little over 20 percent in August from 20 percent in the previous month reported by Central Statistical Agency in its monthly inflation report published two weeks ago. 
Looking ahead, the mission advocates an ongoing fight against inflation. Raising interest rates immediately would enhance the activation of the Treasury bill market for liquidity management and monetary policy implementation. Higher interest rates will also support domestic savings mobilization efforts which are crucial for financing investment.  In addition, the policy of sterilizing central bank financing of budget deficit should remain in place. Such a financial policy sends a strong signal about government’s commitment to fight inflation argues the mission.
Ethiopian’s domestic saving has increased from 5.2 percent in 2010 to 8.8 percent in 2011 surpassing the annual target of 7.4 percent.
Access Capital’s Research Unit Mid-Year Macroeconomic review for July 2012 has put the aggregate size of Ethiopia’s economy, or nominal Growth Domestic Product (GDP) to about USD 41.1 billion based on the year-average exchange rate of 17.28 birr per dollar. This nominal GDP calculation reflects a starting (actual) GDP base of Birr 511 billion in the Fiscal Year 2010/11, boosted by real GDP growth of 11.1 percent and an estimated GDP deflator of 25 percent in the just completed fiscal year.