IMF express concern over acceleration of public sector borrowing


The International Monetary Fund (IMF) executive board expressed concern over Ethiopia’s acceleration of public sector borrowing. In its Article IV consultation, the board stated that such borrowing exposes the nation to external debt distress and crowding-out by the private sector, but supported phasing out the requirement for banks to channel resources to the national development bank.
The final consultation document released on September 30, recommended that careful selection and implementation of public projects with judicious use of non-concessional external financing and greater use of public-private partnerships.
According to the Executive Board’s assessment, IMF directors commended the authorities’ macroeconomic management that has delivered robust GDP growth and poverty reduction. The Directors also noted that the outlook for Ethiopia remains broadly favorable but domestic and external vulnerabilities have increased. Accordingly, they encouraged the preservation of policies that safeguard macroeconomic stability, strengthen buffers, and foster private-sector participation in the economy.
The fiscal policy was notably prudent and appropriately pro-poor. “However, with tax revenue below potential, they recommended broadening the tax base and improving revenue administration to mobilize more resources needed for development spending,” according to the document. Ethiopia’s tax revenue compared with the GDP ratio stood at 12.9 percent, which is very low compared with regional performance. The government is currently looking to increase the tax to GDP ratio to 17 percent by the end of the current five-year Growth and Transformation Plan (GTP) that will end in 2020.
The assessment indicated that the exchange rate appears to be overvalued in real effective terms and encouraged authorities to allow greater exchange rate flexibility to facilitate external adjustment.
Further steps to secure positive real interest rates and greater financial deepening remain key to bolstering domestic savings and investment. “To increase credit to the private sector, Directors also supported phasing out the requirement for banks to channel resources to the national development bank, which may distort financial intermediation. They have also stressed the importance of maintaining an adequate regulatory and supervisory framework to support financial development,” as explained in the statement.
National Bank of Ethiopia (NBE) issued a directive forcing private banks to purchase treasury bonds that make up 27 percent of their disbursed loans. The purchase of bonds was put in place on April 6, 2011, on private banks after NBE announced lifting of the lending cap, which had been static since 2009.
More decisive action to strengthen the business climate and enhance external competitiveness is needed given the softening of export activity in the country. Greater exchange rate flexibility, less burdensome regulation, and easier private sector access to credit and foreign exchange would be steps in the right direction, the statement added.
IMF also emphasized that opening some strategic sectors to foreign investment could improve the provision of critical services.
Directors welcomed the authorities’ plans to establish an agency for the oversight of state-owned enterprises, which will strengthen the transparency of the public sector.
Despite a rise in domestic and external vulnerabilities, theIMF recognized that the overall strength of Ethiopia’s recent macroeconomic performance has continued. Economic growth in 2014/15 was buoyant (at an estimated 8.7 percent), supported by booming manufacturing and construction sectors. However, inflation has been on the rise, with domestic food prices pushing it above 10 percent.
According to the Ethiopian Statistical Agency’s monthly inflation report, the year-on-year overall inflation rate in the country stood at 11.60 percent in August 2015, as food inflation increased to 14.7 percent from 13.9 percent in the previous month.
The IMF statement stated external vulnerabilities have also increased as exports of goods and services slowed significantly, while imports continued growing fast.
A sharp widening of the current account deficit (to an estimates 12.8 percent of GDP) was largely offset by robust capital inflows, with a 50 percent increase in foreign direct investment and a much higher public borrowing from abroad. The general government deficit expanded only marginally (by 0.2 percentage point) to an estimated 2.8 percent of GDP.
It stated that public enterprises continued to borrow heavily to finance their accelerated investment plans. “As a result, their financing needs increased to 7.4 percent of GDP, while public and publicly-guaranteed debt reached an estimated 50 percent of GDP in June 2015,” it added.
The economic outlook remains favorable, reflecting the country’s significant potential, generally sound macroeconomic policies, and the government’s efforts to improve infrastructure and attract foreign direct investment. In the medium term, the IMF forecast strong growth at 7.5 – 8 percent.
Public investment is expected to moderate, while private investment is projected to increase only gradually, reflecting constraints on access to credit and foreign exchange, the overvalued exchange rate, as well as other competitiveness challenges.
The public debt-to-GDP ratio is expected to increase, reflecting large financing needs associated with implementation of the second Growth and Transformation Plan (GTP II).
According to the IMF report the public debt includes general government and state own enterprises excluding Ethiopian Airlines estimated to stand at 50.2 percent in the 2014/15 budget year compared with the GDP, which was 41.2 percent in 2013/14. The domestic debt coverage from the state percentage is 24.1, while the balance is external debt.
The IMF statement indicated that the past budget year the domestic saving has been 18.1 percent of the GDP, which was 19 percent a year ago. From the stated percentage the public saving stood at 4.9, while the balance is private saving. Contrary  to the IMF statement, the government report stated that the domestic saving has reached 22 percent of the GDP in the past fiscal year.
The government targeted to achieve a 29.6 percent domestic saving to GDP ratio to finance 41.3 percent of the country’s investment with local sources in the end of the GTP.
The gross domestic investment has shown growth compared with the 2013/14 fiscal year. According to the statement the gross domestic investment has stood at 40 percent, which was 36.8 percent a year ago.
Public investment is continuing on its leadership by the share of 22.4 percent for the past budget year, while the private sector investment is 17.6 percent of the GDP.
Directors emphasized the importance of timely and comprehensive data for effective policy design and evaluation. They called for continued improvements in Ethiopia’s statistical capacity, particularly as regards national accounts and financial sector statistics.
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies.
IMF staffs have visited Ethiopian and met officials before releasing the compiled assessment.