IMF Deal Supports Ethiopia's Liquidity, Policy Framework


Thursday, December 26, 2019 10:33AM / by Fitch Ratings / Header Image Credit:  Your Story             


Ethiopia's IMF agreement will support external liquidity and the country's macro-economic policy framework, and underscores the Ethiopian authorities' desire to transition to a more open, market-based economic model, Fitch Ratings says. However, political instability and the associated economic risks remain relevant to Ethiopia's 'B'/Negative sovereign rating.


If the staff-level agreement on a three-year USD2.9 billion programme, announced on 11 December, is approved by the executive board, IMF disbursements and funding from other institutions, including the World Bank, would mitigate external financing constraints stemming from low foreign-exchange reserves (two months of current external payments). Pressure on external debt sustainability has increased due to low reserves, an overvalued exchange rate, persistent current account deficits and rising external debt repayments especially for state-owned enterprises (SOEs).


The IMF announcement set out the programme's broad aims to develop a more flexible exchange-rate regime, facilitate reforms to monetary policy and the banking sector, support fiscal measures to boost domestic budget revenue (only 11%-12% of GDP) and improve SOE governance. We believe the programme will bolster Ethiopia's policy framework, but the economic impact will depend on its final provisions and the government's ability to implement these as part of its overall reform efforts.


A more flexible exchange rate could help address chronic foreign-currency shortages, but it presents various challenges and durable gains to external finances will also depend on other fiscal, structural and monetary reforms. Exchange-rate reform will likely imply greater depreciation of the Ethiopian birr (the parallel exchange rate is 20%-25% weaker than the official rate, even as the authorities oversee a depreciation of about 6% a year). This would push up public debt, as half of government and SOE debt is in foreign currency, and could result in yet higher inflation, which reached 15.1% yoy in November (12 month moving average).


In addition, the value of the exchange rate is only one factor driving external competitiveness and the size of the current account deficit. A host of structural issues, including export regulations, bureaucracy, infrastructure and trade logistics affect competitiveness for Ethiopia, while fiscal policy is a key determinant of import levels.


The agreement marks another step in the efforts of Prime Minister Abiy Ahmed to open up Ethiopia's economy to foreign participation. Over the medium term, the government plans to partially liberalise some major SOEs and tender public-private partnership projects. For example, the government has announced its intention to sell a minority stake in state telecoms monopoly Ethio Telecom, as well as issuing two new telecoms licences, although there is no firm timeline.


The programme could boost Ethiopia's attractiveness for FDI (which is underpinned by its large domestic market and low labour and energy production costs), but other structural constraints that may take time to address will be important considerations for investors, as will political stability.


Ethiopia has experienced a rise in regional and ethnic violence, more volatile relations between some of the political groups that have held power together since 1991, and high-profile assassinations. Political unrest has had economic impacts, such as disruption from displacement of people and higher inflation, and may weigh further on tax collection and FDI.


The prospects for continued political instability and the potential for meaningful economic spillovers were the key drivers of our sovereign outlook revision to Negative on 1 October. Parliamentary elections are planned for mid-2020 and a smooth election process will be a key test of political stability.


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