IMF report: Inflation, fiscal deficit to hamper growth

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The International Monetary Fund (IMF) Article IV consultation report  released on Friday, states that Ethiopia’s overall economic growth is projected to remain robust in the 2013/14 budget year and beyond but will fall short of attaining the target of the highly ambitious Growth and Transformation Plan (GTP).
Lack of sufficient financing for the GTP and worsening of the foreign exchange shortage are mentioned as high risks for the year’s economic growth that will have an adverse impact on the growth, as well as difficulties in financing imports with negative impacts on growth such as rapid devaluation, leading to higher inflation and a larger fiscal deficit.
The IMF country report released on Friday October 18 indicated that the constraints on external financing for public investment, uncertain external demand and a cumbersome business environment are the factors underpinning the growth shortfall. Reflecting a continued uncertain global environment and unchanged policies, the projected growth rate tapers off over the medium term falling short of the ambitious GTP target, the report reads.
The government stressed that even though the GTP is ambitious, it will continue to move forward based on the plan. For instance, Ahmed Abtew, Minister of Industry, strongly asserted that the industry sector would meet the target set by the GTP, even though it has not yet met projections over the past three years.
To achieve the target in the past few months different government offices have been busy rearranging some structures and polices in the private sector and in government offices.
The IMF report also highlighted various accomplishments in the past fiscal year. It stated that inflation was brought down to about 7 percent at the end of 2012/13 budget year and is projected to remain in single digits over the medium-term. The current account deficit as a percentage of GDP is projected to slightly improve over the medium-term, as exports are expected to recover after declining in 2012/13.
Moderate recovery in external demand and ongoing efforts to improve productivity, increase value-added activities, and diversification of the export base (covering, for example, agricultural and agro-industrial, horticultural, livestock, light manufactures, and electricity exports) are all expected to support the export performance of the country.
Key risks to the outcome of the current year are included: a continuation of limited financing for infrastructure investment in the GTP, re-emergence of severe foreign exchange shortages, significant growth slowdown in the major emerging market countries, and weather-related shocks, particularly a possible drought returning to the Horn of Africa.
Appropriate pacing of public enterprises and infrastructure investment has been mentioned as a policy response by the monetary organization for lack of sufficient financing of the GTP. Greater flexibility in the exchange rate management and a buildup of foreign reserves to cover 3 months of imports has been indicated as policy response for the hard currency shortage.
According to the report, the external current account deficit widened slightly to USD 3 billion in 2012/13 from USD 2.8 billion in 2011/12, reflecting a weaker trade balance, although it improved as a ratio of GDP from 6.6 percent to 6.4 percent. Export performance suffered from a decline in prices and weak external demand conditions, growing only 3.2 percent (in nominal terms), while continued infrastructure and industrial investment and higher fuel importation contributed to an increase in imports by 6.3 percent.
According to the report increased loan disbursements to the central government and public enterprises yielded a capital account surplus of USD 3.4 billion. The resulting surplus in the overall balance of payments was less than USD 0.2 billion (0.4 percent of GDP) compared to a deficit of USD 1.1 billion (2.5 percent of GDP) in 2011/12. The National Bank of Ethiopia’s (NBE) gross international reserves declined slightly to USD 2.2 billion (1.8 months of imports) at the end of 2012/13 from USD 2.3 billion (1.9 months of imports) at the end of 2011/12, the IMF report stated.
However, public enterprises continue to expand their investment activities. Net credit expansion (through loans and corporate bonds) from the Commercial Bank of Ethiopia (CBE) to public enterprises (in the 10 months up to April, 2013) alone accounted for 3 percent of GDP. In addition, they borrowed from the Development Bank of Ethiopia (DBE) and through bond issuance for the construction of the Renaissance Dam, which is proceeding as planned. The authorities have estimated the dam’s cost to be10 percent of the 2012/13 GDP, which is intended to be entirely financed domestically.
The report stated that an accurate overall fiscal stance for the consolidated public sector (including public enterprises) is difficult to gauge, although it would seem considerably more expansionary.
While appropriately consolidated data on the overall public sector finances were not available, external financing of public enterprises in 2012/13 was 2.3 percent of GDP and the monetary survey indicated additional domestic financing of public enterprises from the banking sector of 4.3 percent of GDP in 2012/13, not taking into account non-bank financing of the Renaissance Dam. This implies overall public sector (including public enterprises) borrowing of at least 9.4 percent of GDP in 2012/13.
The passing of Prime Minister Meles Zenawi created uncertainty and excess demand in the foreign exchange market, which was also reflected in a widening of the premium in the parallel market. Since its previous peak in October 2008, the Real Effective Exchange Rate (REER) reached its highest level in November 2012, indicating an erosion of competitiveness gains from previous devaluations, which may also be a factor in the recent trade performance. This has started to turn around with the recent decline in inflation, although the REER may still be significantly overvalued based on the IMF’s Consultative Group on Exchange Rate methodology suggesting to devalue the Birr.
Overall revenue-to-GDP ratio is estimated to have fallen from 14 percent in 2011/12 to 13.2 percent in 2012/13. Reflecting the strong pro-poor focus, the ratio of poverty-reducing expenditure to GDP is being maintained and non-priority expenditure will likely be compressed in 2012/13. The government budget deficit, including grants, is estimated to be 2.8 percent of the GDP.
Executive Directors of IMF agreed that Ethiopia’s public-sector-led strategy needs to be recalibrated, with greater participation by the private sector to sustain robust and inclusive growth and mitigate vulnerabilities. They emphasized the importance of policies to maintain fiscal sustainability, preserve low inflation, rebuild external buffers, and improve financial intermediation and the business environment.
The Directors also welcomed the government’ prudent budgetary stance, but underscored the need to gain a fuller picture of public enterprises’ finances and to pace public investments appropriately.