Public Information Notice: IMF Concludes Article IV Consultation with Ethiopia
August 16, 1999
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On July 27, 1999, the Executive Board concluded the Article IV consultation with Ethiopia.1
Since the conclusion of the last Article IV consultation in November 1997, Ethiopia has continued to pursue prudent macroeconomic policies and implement important structural reforms. The government's economic reform program has been supported since October 1996 by a three-year ESAF arrangement, and the second annual arrangement thereunder was approved by the Executive Board in October 1998.
Except for the floor on net foreign assets of the banking system, all other quantitative targets under the 1998/99 program (fiscal year ended July 7) have been met to date. Economic performance in the recent past has been affected by irregular and at times insufficient rainfall, a sharp drop in the terms of trade, and the outbreak of a border conflict with Eritrea in May 1998. Inflation has remained in the low single digits, and real GDP is expected to grow by 6.7 percent in 1998/99 (after a small contraction in 1997/98), buoyed by a strong performance of the major crop season, although the initial official forecast for even more rapid growth was scaled down owing to a slowdown in nonfarm activities and the onset of drought in early 1999 during the minor harvest season. The external current account deficit, which was to have narrowed slightly to 8.2 percent of GDP in 1998/99, is expected to widen to around 9.5 percent due to a sharp drop in world prices of coffee (the main source of foreign exchange receipts), and higher-than-expected military and food imports. Together with a shortfall in official loans and grants, this will likely lead to a loss in net foreign assets of the banking system in 1998/99, such that at the end of the year, gross official foreign reserves would be equivalent to 2.8 months of imports of goods and nonfactor services-only slightly higher than a year ago.
The staff now projects a general government cash deficit, excluding grants, of 6½ percent of GDP, versus 6 percent in the program. Total public spending is expected to be slightly higher than programmed, with an excess in defense outlays accompanied by a shortfall in capital spending that reflects implementation constraints and delays in foreign assistance, rather than discretionary cuts. Despite the spending pressures created by the war, the government has managed by-and-large to protect core spending for the health and education sectors. A shortfall in domestic tax receipts associated with the terms-of-trade loss and the slowdown in economic activity in recent months has been largely offset by extraordinary nontax receipts.During the last two years, progress has been made in implementing a wide range of structural reforms, including a further reduction in the average import tariff, modifications to the investment code allowing foreign participation in the telecommunications and power sectors, enactment of a foreclosure law, unification of several taxes on coffee exports, and administrative improvements at the Federal Inland Revenue Authority and the Customs Office. Restrictions on payments and transfers for all current international transactions (except for holiday travel) and the foreign exchange surrender requirement were eliminated in August 1998, with the latter being replaced by a 90 percent conversion requirement (the conversion period was extended from 3 to 4 weeks).
Reforms of the financial sector and modifications to the exchange system also continued, albeit at a slower pace than envisaged. In January 1998, the government decontrolled bank lending rates and introduced a floor on the deposit rate (currently 6 percent). A framework for the conduct of interbank money and foreign exchange markets was established in September 1998, but no money market transactions have taken place to date. The external audit of the state-owned Commercial Bank of Ethiopia by a foreign auditing firm selected in late 1998 has been delayed, but is now expected to start in August 1999.
Executive Board Assessment
Executive Directors commended Ethiopia's remarkable progress in improving macroeconomic stability and implementing structural reforms over the past two years, despite the shocks created by heavy terms of trade losses, adverse weather conditions, and the war with Eritrea.
Directors recognized that the authorities would continue to face formidable challenges, in view of the country's very low per capita income and limited institutional capacity. They regretted the heavy human and economic costs brought about by the war and were, therefore, encouraged by the recent initiatives aimed at securing peace. Directors hoped for a prompt settlement of the conflict with Eritrea, and noted that this would remove the major economic and financial uncertainties that the conflict had created.
Directors welcomed the authorities' resolve in adhering to the 1998/99 program supported by the second annual ESAF arrangement, evidenced by compliance with most program benchmarks and performance criteria, and implementation of the bulk of envisaged reforms. They noted the economic rebound and the maintenance of low inflation in 1998/99, but expressed concern about the weakening in the external accounts and the large deviations in the composition of public expenditure due to additional military spending. These developments pose risks to the achievement of Ethiopia's growth and poverty alleviation objectives, and more generally undermine the reform process.
The main challenge facing the authorities now is to strengthen fiscal discipline, notwithstanding the current spending pressures and the unfavorable external environment, so as to preserve the hard-won gains in macroeconomic stabilization. Directors saw the need for a strong effort to bolster domestic tax collections in order to contain the fiscal deficit to a level that can be financed largely by concessional foreign resources. Such revenue mobilization would require implementing new tax measures, strengthening tax administration, and broadening the tax base in order to offset revenue losses from trade reform and reduce the dependence on extraordinary nontax receipts.
Directors welcomed the government's efforts to protect social outlays despite the spending pressures created by the war and the shortfall in foreign resources. Nevertheless, they considered that sustained efforts were required in this regard, noting that Ethiopia's social indicators ranked very low even in comparison with neighboring countries. Directors added that the World Bank's recent public expenditure review (PER) had provided useful recommendations for enhancing the design and implementation of strategic sectoral development programs. The PER had also underscored the importance of securing the necessary concessional external resources to finance these programs and generating the required domestic counterpart resources through a greater tax effort.
Directors emphasized the need to enhance the soundness of the financial system and increase competition. In this light, several Directors encouraged the government to consider early entry of foreign banks so as to increase competition and upgrade the quality and range of financial services in Ethiopia. Directors also encouraged the National Bank of Ethiopia to build on its efforts to strengthen financial system supervision and regulation.
Directors welcomed the elimination of most restrictions on payments and transfers for current international transactions, and encouraged the authorities to remove the remaining restrictions.
Directors also supported the initiatives to improve public sector operations, divest public enterprises, liberalize the investment code, and promote exports. At the same time, they advocated further reforms to increase the role of markets and private activity as a means of accelerating growth and improving living standards.
Directors welcomed the authorities' efforts to upgrade and expand the statistical database, but urged them to resume full and timely reporting of all available data to the Fund in order to facilitate staff monitoring of Ethiopia's economic performance.
To build on the recent gains and provide a framework for ensuring macroeconomic stability in the future, Directors strongly encouraged the authorities to resume an intensive dialogue with the Fund-including on the recently approved budget for 1999/2000-as well as with other donors. They emphasized that maintenance of a solid track record-particularly regarding sound macroeconomic policies and social and development spending-was critical toward bringing Ethiopia to its HIPC Initiative decision point. Directors also stressed that efforts to strengthen all aspects of policy transparency, including financing of military spending, would also serve to enhance donor confidence.