The Ethiopian government has embarked on fiscal consolidation effectively since FY2022/23 but more strictly after it embraced the IMF’s 48-month stabilization program in July 2024. So, after reaching a 20-year peak of 4.2% of GDP during wartime in FY2021/22, the overall budget deficit plummeted to just 1.2% by FY2024/25 – a fiscal contraction averaging, roughly, 1% of GDP per year. Over the same period, the primary deficit (excluding interest payments) declined from its recent peak of 3.5% to a mere 0.5% of GDP. The fiscal program envisages running an overall deficit of around 2% and a primary deficit of 0.5% of GDP throughout. The fiscal consolidation is driven by tax revenue, while maintaining “spending restraint.”

Here, then, arises a natural question: Is this a sensible policy move for Ethiopia?   

First some background: Longing for the ideal of a balanced government budget largely comes from macroeconomic models that assume a full -or near-full- employment economy. In practice, however, a budget deficit is not necessarily a bad thing, depending on the state of the economy under consideration. It is considered excessive only if its financing results in inordinate inflation and/or burdensome public debt. As a rule of thumb, budget deficits less than 5% of GDP per year are said to be little cause for concern. But multilateral institutions such as the IMF have traditionally pressured countries to balance their budgets, even when this makes little sense. For what it’s worth, the countries who call the shots in these institutions – the supposed paragons of “putting one’s house in order” – rarely achieve a balanced budget. In fact, they often make fiscal policy based not on rational criteria but on political realism.   

Now, has there really been a clear case for reining in Ethiopia’s budget deficits, other than the standard admonition from the IMF? Well, data from, um, the IMF show that the budget deficits themselves have been anything but excessive, averaging 2.4% of GDP overall and 1.9% of GDP in primary terms during 2009/10-2023/24, albeit with slight upward trends. These deficits have typically been financed by domestic borrowing from the banking system, direct advances from the National Bank of Ethiopia and external loans. However, it would be implausible to blame – as some commentators do – budget deficits and their monetary financing (aka printing money) for the high inflation observed in those years, given the very high rate of unemployment in our economy. Indeed, the inflation story contains both domestic determinants (e.g., internal conflicts, drought, currency devaluation, administered-price increases) and external shocks (e.g., the Covid-19 pandemic, Russia-Ukraine war). Nor did budget deficits result in a very large and upward-trending public debt-GDP ratio, which averaged 46.9% in 2009/10-2023/24. Domestic public debt – almost invariably incurred at negative real interest rates – averaged 22.7% and external public debt – mostly on concessional terms with an average interest rate of 1.5% – averaged 24.2% of GDP.

Could deficit reduction be better justified as stabilization policy? True, it is fiscal policy rather than monetary policy that can lay claim to doing the stabilization job in Ethiopia. But the problem is, our economy has been giving conflicting signals by combining high inflation with excessive unemployment. Should the government pursue fiscal contraction to tame inflation or fiscal expansion to reduce unemployment? It is a tough choice to make, one that demands care not to make drastic moves in either direction.

Nonetheless, the government has made a hard turn toward balancing its budget, seemingly disregarding stabilization concerns. Yet the contractionary fiscal stance hinders unemployment reduction both directly by limiting the number of jobs created and indirectly by depressing consumption and investment demand, which in turn limits economic growth and employment. Moreover, even if it does reduce the inflation rate, it also raises many prices by withdrawing subsidies and raising taxes, compounding our affordability woes. So perhaps it would be better to try to bring inflation down gradually with, say, judicious supply-side interventions.

We also know that following fiscal discipline to the letter is neither necessary nor sufficient for a country to achieve, or even sustain, real growth. Remember, our own EPRDF era economy grew, at least by official records, at an average per capita rate of 7.6% during the period 2004-17, when the regime was posing as a “developmental state” but certainly not as a fiscal idealist. True, Ethiopia still failed to achieve structural transformation (be it in production, employment or exports) and the much-trumpeted middle-income status, or to significantly reduce unemployment. But that economy’s dynamism was mainly constrained by low-quality human capital, investment project misidentification and mismanagement, inadequate industrial promotion, misjudging the role of the private sector, state capture (or crony capitalism), poor governance, and supremacy of flawed political ends – not by fiscal imprudence. 

Now, this is not to say that there was no room for improvement in the management of public finances and liabilities. For example, domestic financing via public enterprises, coupled with financial repression, constrained private sector access to credit, especially in periods of banking liquidity shortages. And servicing an externally held public debt lately became burdensome due to some short-sighted contracting of non-concessional loans, which was amplified by inadequate foreign exchange earnings and in the immediate aftermath of counter-insurgency in Tigray. None of this called for fiscal austerity by hook or crook, however.

Regardless, our fiscal consolidation is in full swing, primarily based on tax revenue mobilization, which has come to mean not only broadening the tax base, but increasing marginal rates – and there are quite a few head-scratchers. New taxes either introduced or in the pipeline include: value-added tax (VAT, 15%) on electricity, water, edible oil and (God forbid) fuel; a 15% tax on “income” from digital content uploaded to YouTube, social media and so on; a minimum bottom-line tax equal to 2.5% of turnover, regardless of your actual loss or profit; property tax, even if you don’t actually own the property; and an inheritance and donation tax. There is even talk about subjecting street vendors to taxation! Meanwhile, tax rates have increased from a minimum of 10 to 15% on labor, rental and individual business incomes; from 2 to 3% on withholding income from domestic supply of goods/services; from 5 to 10% on interest income from savings deposits; and from 10 to 15% on dividends. Even more perplexing, businesses must now pay their annual tax before they know it, quarterly as per 25% of the previous year’s tax payment.

Pursuing fiscal prudence as an objective, rather than as a policy tool, predictably opens the door for conflicts with other policy objectives. On the revenue side, for instance, how do you rationalize doubling the tax rate on interest earned on savings deposits, when the latter is already pitiful and you also want to mobilize domestic private savings? And subjecting micro mobile phone and digital transactions to more taxation – coupled with the latest 5% addition to service charges for all digital banking and telecom services, apparently to establish an emergency response fund – magnifies transaction costs for low-income users and can thus retard digitization and financial inclusion. Making frequent and ad hoc changes to tax policy, by creating uncertainty, also has a non-trivial disincentive effect on business investment and risk-taking, imposing a drag on growth and job creation. On the expenditure side, austerity is likely to constrain the fiscal space for “poverty-reducing” spending that was already declining as a share of GDP for eight years prior to Ethiopia entering the IMF agreement. Cuts in capital outlay, itself on a downward trend as a share of GDP for the past 20 years, dampen productive capacity and future growth. And squeezing subsidies for, say, fertilizers and improved seeds can have a negative impact on agricultural productivity and output. 

In fact, bringing tax increases to the forefront of fiscal policy runs the risk of backfiring even in its stated goals. Ironically, it can actually encourage fiscal profligacy. Taxing income at high rates can severely distort incentives. Burdensome taxation motivates taxpayers, who are already voicing so many complaints against the taxman, to escape taxes, leading to tax revenue losses for the government beyond the short run. It can also promote flight of capital to lower-tax jurisdictions – worsening one of the very problems fiscal discipline is supposed to address.

To be clear, the authorities are not wrong for seeking to expand their resource base for providing public goods and services. But they had better take a wider and longer view of raising tax revenue than they currently seem to. In general, they should focus more on achieving inclusive, broad-based and diversified growth, which will normally increase tax receipts and can further improve their fiscal position. So, for example, to expand the tax base over time, offer enforceable and secure property rights to increase private investment and entrepreneurship, and make sure it is inexpensive to also stimulate formalization of business. Additionally, ensure prevalence of rule of law, free movement of people, goods and services, and political stability across the country to spur greater investment. To encourage tax compliance, reduce – not raise – tax rates and improve tax administration through, among other things, greater digitization (already underway). And why not close loopholes and strengthen tax enforcement to fight tax avoidance by the rich?

In a nutshell, while “fiscal discipline” always sounds an honorable policy stance, empirical examination of Ethiopia’s budget deficits and related macro variables does not imply an urgent need for its restoration. All the same, rapid and extensive consolidation has become the fiscal order of the day over the past two years or so. Particularly worrisome is the way in which tax revenue, coupled with cuts in essential spending, is driving the fiscal consolidation, jeopardizing consumer welfare, private investment and employment. Even though the authorities are for now only too happy to experience a leap in their budgetary position, they ignore or downplay the negative collateral effects at the economy’s peril, if not their own.

Matias Assefa is a local economic commentator and analyst who write on Ethiopia’s economic policy landscape, March 3, 2026

DISCLAIMER