## sipea2025107

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---

### Taxation Powers of the Federal and Regional Governments

- Main characteristics of intergovernmental relations
  - Fiscal decentralization process started three decades ago; the National Constitution was approved in December 1994.
  - Federal structure evolution:
    - Initial setup: nine states; expanded over time to twelve; most recent change in 2023 with three new regions formed from the previously Southern Nations, Nationalities, and Peoples’ Region (SNNPR).
    - Two largest cities, Addis Ababa and Dire Dawa, are under federal government jurisdiction.
  - Revenue assignment:
    - Revenues categorized as federal, state, or joint.
    - Federal government has exclusive right to tax international trade.
    - Domestic indirect taxes (VAT and excise) are split according to joint revenue sharing formulas.
    - Regional governments collect direct taxes (including PIT) and certain royalties and fees.
    - For taxes not mentioned explicitly, the Constitution requires a two-thirds majority vote of the joint session of the House of the Federation and the House of Peoples’ Representatives to establish revenue assignment (mechanism applies to property and motor vehicle circulation taxes envisaged under the National Medium-Term Revenue Strategy).
  - Expenditure responsibilities:
    - Federal: national defense, national infrastructure (air, rail, major roads, post, telecom), formulating country’s overall economic and social development.
    - Regional: basic education and health, tailored to local needs.
  - Degree of decentralization:
    - Ethiopia is relatively decentralized compared to Sub-Saharan African countries; only Nigeria and South Africa have subnational spending accounting for half or more of general government spending.
    - In East African comparators (Kenya, Rwanda, Tanzania, Uganda) subnational spending about 15–20 percent of general government spending.
  - Trends in vertical balance:
    - Regions’ share of total public expenditure increased from about 35 percent in mid-1990’s to around 55 percent in the last decade.
    - The regional block (general purpose) grant has shrunk relative to the federal government’s resource envelope.
  - Legislative reforms:
    - Proclamation 1250/2021 introduced: limit on revisions of the grant formula to once in five years (with possibility of data updates); creation of the House of Federation Secretariat as an independent technical body to design grant and joint revenue sharing formula recommendations and to implement monitoring and evaluation activities.
    - Status of implementation and technical capabilities of the autonomous body remain unclear.

- Revenue: recent developments and reform considerations
  - Joint revenue sharing reforms:
    - Joint revenue sharing formula revised eight times.
    - Federal government’s share of joint revenues declined from 70 percent in 2010/10 to 45 percent by 2023/24.
    - The FY2020/21 formula revision: increased regions’ share from 30 to 50 percent for VAT, and from 40 to 75 for royalties.
    - FY2020/21 committed 50 percent of income taxes to regional states where businesses operate, leaving tax assignment of the two federal cities unchanged.
  - Tax administration design trade-offs:
    - Need to balance minimizing administration and compliance costs with fiscal sovereignty of states.
    - Central taxation favours inter-regional equalization when tax bases are unequally distributed; regional autonomy allows dynamic regions to reap economic success.
  - Direct taxes (personal income tax and progressivity constraints):
    - Decentralized progressive income taxation constrains scope for promoting interregional equity.
    - Ethiopia uses a schedular income tax system where salary, rental income, self-employment incomes taxed under separate schedules and possibly by different governments.
    - Example: a federal government employee’s salary taxed by federal government while rental income taxed by the region.
    - As total income is not aggregated across jurisdictions, taxpayers may avoid higher rate bands; division of taxing rights plus schedular system limits progressivity.
    - Introducing progressive unified income at regional level could be feasible but requires complex implementation, centralized tax filing or enhanced information sharing, and safeguards to protect regions from presumptive tax revenue loss.
    - Employment income tax and unincorporated business income tax account for almost 90 percent of regions’ direct tax revenues.
    - Possible measures: allow regions flexibility to apply a surtax to turnover tax revenues (e.g., 10 percent); consider surcharges on excises.
  - Indirect taxes (VAT and turnover tax):
    - Nationwide uniform VAT rate: 15 percent.
    - 2024 VAT Proclamation: widens tax base to include services, removes various VAT exemptions, modernizes administration.
    - Division of administration:
      - VAT administered at federal level; Ministry of Revenue or Customs Commission can delegate Regional and City Administration Revenue Bureaus to assess and collect VAT on its behalf.
      - Delegation could introduce uneven application; requires coordination and information flow (e.g., validation of VAT refunds and input tax credits).
    - Legal form of businesses affects revenue assignment:
      - Regional governments entitled to revenue from unincorporated businesses; revenues from incorporated businesses treated as joint and subject to sharing.
      - Small businesses (“category C” taxpayers) subject to turnover tax (VAT counterpart below VAT registration threshold); turnover taxes assigned to region.
      - Division of tax base remains dependent on legal form of establishment.
      - The 2024 VAT Proclamation raised mandatory VAT registration annual turnover threshold from 1 to 2 million birr but allowed voluntary registration otherwise (Article 13).
      - If not periodically adjusted for inflation, VAT registration thresholds could drift, moving more businesses into VAT’s joint revenue pool.
    - VAT based on origin principle: VAT remitted to region where seller is registered rather than where consumer is located; large corporations headquartered in Addis Ababa remitting VAT away from poorer regions can cause fiscal transfers from poorer to wealthier regions or to federal government.
    - Expansion of e-commerce and remote services subject to VAT implies potential growth of imbalances; periodic public debate on centralized vs local taxation and block grant effectiveness will remain important.
  - Property tax reforms:
    - Almost all tax revenues sourced in Addis Ababa and Dire Dawa are channeled to the federal government, with property tax and municipal fees being the main own revenue source for the cities.
    - The two cities expected to be at the forefront of property tax reform and reform of presumptive tax (belongs to local authorities) offers revenue mobilization opportunity.
  - Natural resource taxation:
    - Ethiopia does not earn significant revenues from high value extractive mining operations but gold has become the most significant mined commodity; other materials and fertilizers are under consideration.
    - Typically resource-rich regions benefit from portions of tax potential beyond local costs; consideration relevant for Ethiopia if extractive activity expands.

- Regional grant framework
  - Purpose and forms:
    - General purpose grants (GPGs) intended to fill vertical fiscal gaps and advance equalization across regions to deliver comparable levels of essential public services.
    - Unconditional budget grants complemented by targeted regional grants for capital investment supporting SDG priorities (relatively small compared to general pool); used recently for agro-industrial parks and small-scale irrigation infrastructure.
    - Other sizable specific purpose transfers include urban and rural Productive Safety Net Programs (PSNP).
  - Institutional responsibilities:
    - Size of GPG pool formulated by the Ministry of Finance; allocation criteria responsibility rests with the House of Federation.
    - Size of the grant pool set as part of the annual federal budget cycle and subject to parliamentary approval.
    - In practice, regions have limited direct input on pool size and grant amounts.
  - Allocation formula:
    - Formula modified eight times over three decades; current formula last modified in 2017.
    - Current formula pillars:
      - (i) difference in regional tax revenue (income, turnover, VAT),
      - (ii) regional government expenditure (primary and secondary education, agriculture and rural development, rural roads),
      - (iii) a sub-pool set at one percent of the total pool to support catch-up of four least developed regions (Benishangul-Gumuz, Afar, Gambela, Somali).
    - FY2024/25 work plan foresees revision of regional state budget allocation formula based on empirical data.
    - No rule or procedural trigger guides periodicity of formula revisions; lack of timely regional data and limited technical capacity are main constraints.
    - Formula not yet established for the three new regions previously SNNPR.
  - Challenges and considerations:
    - Decline in size of grant pool has weakened equalization; pool size set by Ministry of Finance often independently of gap-filling objective.
    - Constrained fiscal space and decline in tax-to-GDP ratio of the federal government have contributed to pool shrinking, risking regions’ essential public service delivery and interregional equity.
    - Fiscal gaps formula components are complex and data intensive, reducing transparency and raising fairness questions.
    - Considerations for medium term:
      - Equalization principles imply sharing taxes collected from states with higher revenue potential with less endowed regions; current fiscal capacity calculations are based primarily on actual revenue collection rather than potential tax base and administration capacity.
      - Near-term revenue reforms disproportionately benefit tax bases assigned to federal government (customs, VAT, income taxes from SOEs and firms headquartered in Addis Ababa), while expenditure pressures remain with regions (developmental and poverty-reducing mandates).
      - Federally financed programs (PSNP, rural development capital spending, SDG grants) can help narrow gaps, but setting block grant size should consider absolute fiscal gaps and equitable sharing of federal revenue windfalls.
      - The small sub-pool for the four less developed regions could decline further and may need reconsideration.
      - Increased concurrent revenue shares incentivize regional revenue mobilization; overcoming regional revenue administration weakness requires federal support.
      - Regular, data-driven grant formula updates can help attain fiscal equalization.
      - Simplicity, objectivity, and transparency of grant allocations are critical given the political sensitivity of large horizontal and vertical fiscal gaps; outdated statistics penalize faster urbanizing regions.

### Analysis of recent regional fiscal accounts and socio-economic indicators

- Findings on budget grants, regional fiscal capacity, and multidimensional poverty
  - Multidimensional poverty indicator (MPI) used: World Bank Ethiopia Poverty and Equity Assessment, 2024; ranges from 0 to 1, with higher value representing a higher level of deprivation. Computation based on Global MPI methodology by Alkire et al. (2021).
  - Evidence from FY2023/24 regional government budget execution combined with MPI (2021) indicates:
    - Positive correlation between a region’s dependence on general-purpose grants and that region’s MPI (first panel). Regions with higher MPIs tend to have greater shares of their budget expenditure covered by general-purpose grants.
    - Nationwide multidimensional poverty declined between 2016 and 2021, reflecting increased access to public services such as water and electricity, improved housing quality, and ownership of durable assets in rural areas—areas primarily within regional policy mandates.
    - Federal budget grants have been effective at reducing interregional fiscal gaps that stem from socio-economic expenditure needs.
    - Negative correlation between per capita spending on recurrent social services (education, health) and multidimensional poverty outcomes (second panel) indicates federal general-purpose grants do not fully offset the impact of regional disparities in fiscal capacity on multidimensional poverty.
    - Regions with higher MPIs collect less own revenue per capita (third panel), but there is no clear statistical link between the per capita amount of the general-purpose grant and region’s own revenue or the degree of severity of multidimensional poverty (last panel).
  - Data sources: Ministry of Finance, Ethiopian Statistical Service, World Bank, and IMF staff calculations.

- Macroeconomic implications and institutional gaps
  - The federal government’s macroeconomic stabilization function should be strengthened; the fiscal stance is set through the federal budget.
  - General-purpose grant pool, set in the context of the annual budget cycle, provides a mechanism to harmonize macroeconomic stabilization policy across federal and regional budgets but has been subject to strong budget constraints at the national level.
  - Strengthening federal and regional budgetary frameworks and rebuilding fiscal space are needed to support macro-stabilization of public finances.
  - Recent macro-fiscal TA policy recommendations emphasize:
    - Modernizing forecasting techniques.
    - Improving institutional coordination.
    - Strengthening links between medium-term fiscal frameworks (MFF) and the annual budgets.
    - Producing further information from the MFF to inform budget preparation, including impacts of budget decisions on debt and other sustainability indicators.

- Policy coordination, public investment, and shock response
  - Policy coordination between the federal government and regional governments is necessary to ensure effective economic governance and development; the federal government should encourage and support common best practices replicable at regional level.
  - Improving coordination of investment plans across government entities would help ensure public infrastructure is delivered in the right areas with appropriate funding.
  - Policy recommendations of the 2024 Public Investment Management Assessment (PIMA) and Climate PIMA report call for:
    - Better investment and budgetary resource planning.
    - Project implementation monitoring.
    - Systematic disclosure.
    - Improving alignment of regional frameworks with federal climate priorities.
  - Insurance against regional macroeconomic shocks primarily operates through federal safety net programs; other channels are limited:
    - General-purpose grant formula is linked to revenue and expenditure norms, with 3-year averaging limiting responsiveness of grant shares to temporary shocks.
    - Regional grant allocation shares are unaffected by temporary revenue shocks; market borrowing is precluded.
    - Effective regional shock response is provided through federal shock response facilities: PSNP and programs administered by the Disaster Risk Management Commission to address localized shocks (e.g., drought, livestock disease outbreaks).
    - Curtailment of overseas development assistance would disproportionately affect regions with large humanitarian and disaster risk expenditure requirements and would increase the value of a stronger framework to manage regional macroeconomic shocks.
    - Setting up an adequately funded national disaster risk management fund, as envisaged by the authorities, could strengthen response to natural disasters and humanitarian crises and channel available international resources transparently.
    - Strengthening interregional stabilization and resilience could be achieved by broadening geographic reach of safety nets, enhancing focus on livelihoods, improving efficiency through e-payments and digitalization, establishing a National Social Registry, and producing timely regional data to inform periodic updates of regional grant shares.

- Fiscal responsibility and regional borrowing
  - Reinforcing the fiscal responsibility framework by maintaining tight control over regional borrowing should continue.
  - Regional governments are legally empowered to borrow domestically subject to federal terms and conditions, but there has been no regional borrowing except for Addis Ababa. Constraints include scarce financial system capacity, potentially high risks, and federal control via approval requirements.
  - Legislative safeguards have precluded budget or project financing by regions; the only possibility for regions to borrow provided by law is for projects requiring a feasibility study showing capacity to repay and approval by the Ministry of Finance. External borrowing by regions is not permitted. NBE or commercial banks are not permitted to lend to regional governments.
  - Recommendation: Continue tight control over regional borrowing until revenue mobilization capacity and fiscal space are rebuilt and domestic debt market preconditions are established.

- Key statistics and exact references from the chapter
  - FY2023/24: regional government budget execution data used in analysis.
  - MPI years referenced: 2016 and 2021 (national decline in multidimensional poverty between these years).
  - Grant formula characteristic: 3-year averaging limits responsiveness of grant shares to temporary shocks.
  - Institutional programs named: PSNP; Disaster Risk Management Commission; National Social Registry (recommended).
  - Assessments referenced: 2024 World Bank Poverty Assessment; 2024 Public Investment Management Assessment (PIMA) and Climate PIMA report; recent macro-fiscal TA.

*Source: sipea2025107 — 1. Taxation Powers of the Federal and Regional Governments; June 16, 2025. Chapter 17, sipea2025107 (IMF staff analysis and calculations).*

### 1. Taxation Powers of the Federal and Regional Governments ___________________________ 13

### 1. Taxation Powers of the Federal and Regional Governments

### A. Main characteristics of intergovernmental relations
- The process of fiscal decentralization in Ethiopia started three decades ago; the National Constitution was approved in December 1994.
- Federal structure evolution:
  - Initial setup: nine states; expanded over time to twelve; most recent change in 2023 with three new regions formed from the previously Southern Nations, Nationalities, and Peoples’ Region (SNNPR).
  - Two largest cities, Addis Ababa and Dire Dawa, are under federal government jurisdiction.
- Revenue assignment:
  - Revenues categorized as federal, state, or joint.
  - Federal government has exclusive right to tax international trade.
  - Domestic indirect taxes (VAT and excise) are split according to joint revenue sharing formulas.
  - Regional governments collect direct taxes (including PIT) and certain royalties and fees.
  - For taxes not mentioned explicitly, the Constitution requires a two-thirds majority vote of the joint session of the House of the Federation and the House of Peoples’ Representatives to establish revenue assignment (mechanism applies to property and motor vehicle circulation taxes envisaged under the National Medium-Term Revenue Strategy).
- Expenditure responsibilities:
  - Federal: national defense, national infrastructure (air, rail, major roads, post, telecom), formulating country’s overall economic and social development.
  - Regional: basic education and health, tailored to local needs.
- Degree of decentralization:
  - Ethiopia is relatively decentralized compared to Sub-Saharan African countries; only Nigeria and South Africa have subnational spending accounting for half or more of general government spending.
  - In East African comparators (Kenya, Rwanda, Tanzania, Uganda) subnational spending about 15–20 percent of general government spending.
- Trends in vertical balance:
  - Regions’ share of total public expenditure increased from about 35 percent in mid-1990’s to around 55 percent in the last decade.
  - The regional block (general purpose) grant has shrunk relative to the federal government’s resource envelope.
- Legislative reforms:
  - Proclamation 1250/2021 introduced: limit on revisions of the grant formula to once in five years (with possibility of data updates); creation of the House of Federation Secretariat as an independent technical body to design grant and joint revenue sharing formula recommendations and to implement monitoring and evaluation activities.
  - Status of implementation and technical capabilities of the autonomous body remain unclear.

### B. Revenue: recent developments and reform considerations
- Joint revenue sharing reforms:
  - Joint revenue sharing formula revised eight times.
  - Federal government’s share of joint revenues declined from 70 percent in 2010/10 to 45 percent by 2023/24.
  - The FY2020/21 formula revision: increased regions’ share from 30 to 50 percent for VAT, and from 40 to 75 for royalties.
  - FY2020/21 committed 50 percent of income taxes to regional states where businesses operate, leaving tax assignment of the two federal cities unchanged.
- Tax administration design trade-offs:
  - Need to balance minimizing administration and compliance costs with fiscal sovereignty of states.
  - Central taxation favours inter-regional equalization when tax bases are unequally distributed; regional autonomy allows dynamic regions to reap economic success.
- Direct taxes (personal income tax and progressivity constraints):
  - Decentralized progressive income taxation constrains scope for promoting interregional equity.
  - Ethiopia uses a schedular income tax system where salary, rental income, self-employment incomes taxed under separate schedules and possibly by different governments.
  - Example: a federal government employee’s salary taxed by federal government while rental income taxed by the region.
  - As total income is not aggregated across jurisdictions, taxpayers may avoid higher rate bands; division of taxing rights plus schedular system limits progressivity.
  - Introducing progressive unified income at regional level could be feasible but requires complex implementation, centralized tax filing or enhanced information sharing, and safeguards to protect regions from presumptive tax revenue loss.
  - Employment income tax and unincorporated business income tax account for almost 90 percent of regions’ direct tax revenues.
  - Possible measures: allow regions flexibility to apply a surtax to turnover tax revenues (e.g., 10 percent); consider surcharges on excises.
- Indirect taxes (VAT and turnover tax):
  - Nationwide uniform VAT rate: 15 percent.
  - 2024 VAT Proclamation: widens tax base to include services, removes various VAT exemptions, modernizes administration.
  - Division of administration:
    - VAT administered at federal level; Ministry of Revenue or Customs Commission can delegate Regional and City Administration Revenue Bureaus to assess and collect VAT on its behalf.
    - Delegation could introduce uneven application; requires coordination and information flow (e.g., validation of VAT refunds and input tax credits).
  - Legal form of businesses affects revenue assignment:
    - Regional governments entitled to revenue from unincorporated businesses; revenues from incorporated businesses treated as joint and subject to sharing.
    - Small businesses (“category C” taxpayers) subject to turnover tax (VAT counterpart below VAT registration threshold); turnover taxes assigned to region.
    - Division of tax base remains dependent on legal form of establishment.
    - The 2024 VAT Proclamation raised mandatory VAT registration annual turnover threshold from 1 to 2 million birr but allowed voluntary registration otherwise (Article 13).
    - If not periodically adjusted for inflation, VAT registration thresholds could drift, moving more businesses into VAT’s joint revenue pool.
  - VAT based on origin principle: VAT remitted to region where seller is registered rather than where consumer is located; large corporations headquartered in Addis Ababa remitting VAT away from poorer regions can cause fiscal transfers from poorer to wealthier regions or to federal government.
  - Expansion of e-commerce and remote services subject to VAT implies potential growth of imbalances; periodic public debate on centralized vs local taxation and block grant effectiveness will remain important.
- Property tax reforms:
  - Almost all tax revenues sourced in Addis Ababa and Dire Dawa are channeled to the federal government, with property tax and municipal fees being the main own revenue source for the cities.
  - The two cities expected to be at the forefront of property tax reform and reform of presumptive tax (belongs to local authorities) offers revenue mobilization opportunity.
- Natural resource taxation:
  - Ethiopia does not earn significant revenues from high value extractive mining operations but gold has become the most significant mined commodity; other materials and fertilizers are under consideration.
  - Typically resource-rich regions benefit from portions of tax potential beyond local costs; consideration relevant for Ethiopia if extractive activity expands.

### C. Regional grant framework
- Purpose and forms:
  - General purpose grants (GPGs) intended to fill vertical fiscal gaps and advance equalization across regions to deliver comparable levels of essential public services.
  - Unconditional budget grants complemented by targeted regional grants for capital investment supporting SDG priorities (relatively small compared to general pool); used recently for agro-industrial parks and small-scale irrigation infrastructure.
  - Other sizable specific purpose transfers include urban and rural Productive Safety Net Programs (PSNP).
- Institutional responsibilities:
  - Size of GPG pool formulated by the Ministry of Finance; allocation criteria responsibility rests with the House of Federation.
  - Size of the grant pool set as part of the annual federal budget cycle and subject to parliamentary approval.
  - In practice, regions have limited direct input on pool size and grant amounts.
- Allocation formula:
  - Formula modified eight times over three decades; current formula last modified in 2017.
  - Current formula pillars:
    - (i) difference in regional tax revenue (income, turnover, VAT),
    - (ii) regional government expenditure (primary and secondary education, agriculture and rural development, rural roads),
    - (iii) a sub-pool set at one percent of the total pool to support catch-up of four least developed regions (Benishangul-Gumuz, Afar, Gambela, Somali).
  - FY2024/25 work plan foresees revision of regional state budget allocation formula based on empirical data.
  - No rule or procedural trigger guides periodicity of formula revisions; lack of timely regional data and limited technical capacity are main constraints.
  - Formula not yet established for the three new regions previously SNNPR.
- Challenges and considerations:
  - Decline in size of grant pool has weakened equalization; pool size set by Ministry of Finance often independently of gap-filling objective.
  - Constrained fiscal space and decline in tax-to-GDP ratio of the federal government have contributed to pool shrinking, risking regions’ essential public service delivery and interregional equity.
  - Fiscal gaps formula components are complex and data intensive, reducing transparency and raising fairness questions.
  - Considerations for medium term:
    - Equalization principles imply sharing taxes collected from states with higher revenue potential with less endowed regions; current fiscal capacity calculations are based primarily on actual revenue collection rather than potential tax base and administration capacity.
    - Near-term revenue reforms disproportionately benefit tax bases assigned to federal government (customs, VAT, income taxes from SOEs and firms headquartered in Addis Ababa), while expenditure pressures remain with regions (developmental and poverty-reducing mandates).
    - Federally financed programs (PSNP, rural development capital spending, SDG grants) can help narrow gaps, but setting block grant size should consider absolute fiscal gaps and equitable sharing of federal revenue windfalls.
    - The small sub-pool for the four less developed regions could decline further and may need reconsideration.
    - Increased concurrent revenue shares incentivize regional revenue mobilization; overcoming regional revenue administration weakness requires federal support.
    - Regular, data-driven grant formula updates can help attain fiscal equalization.
    - Simplicity, objectivity, and transparency of grant allocations are critical given the political sensitivity of large horizontal and vertical fiscal gaps; outdated statistics penalize faster urbanizing regions.

*Source: sipea2025107 — 1. Taxation Powers of the Federal and Regional Governments; June 16, 2025.*

### 17.      Analysis of recent regional fiscal accounts and socio-economic indicators confirms that

### 17.      Analysis of recent regional fiscal accounts and socio-economic indicators confirms that 

### Findings on budget grants, regional fiscal capacity, and multidimensional poverty
- Multidimensional poverty indicator (MPI) used: World Bank Ethiopia Poverty and Equity Assessment, 2024; ranges from 0 to 1, with higher value representing a higher level of deprivation. Computation based on Global MPI methodology by Alkire et al. (2021).
- Evidence from FY2023/24 regional government budget execution combined with MPI (2021) indicates:
  - Positive correlation between a region’s dependence on general-purpose grants and that region’s MPI (first panel). Regions with higher MPIs tend to have greater shares of their budget expenditure covered by general-purpose grants.
  - Nationwide multidimensional poverty declined between 2016 and 2021, reflecting increased access to public services such as water and electricity, improved housing quality, and ownership of durable assets in rural areas—areas primarily within regional policy mandates.
  - Federal budget grants have been effective at reducing interregional fiscal gaps that stem from socio-economic expenditure needs.
  - Negative correlation between per capita spending on recurrent social services (education, health) and multidimensional poverty outcomes (second panel) indicates federal general-purpose grants do not fully offset the impact of regional disparities in fiscal capacity on multidimensional poverty.
  - Regions with higher MPIs collect less own revenue per capita (third panel), but there is no clear statistical link between the per capita amount of the general-purpose grant and region’s own revenue or the degree of severity of multidimensional poverty (last panel).
- Data sources: Ministry of Finance, Ethiopian Statistical Service, World Bank, and IMF staff calculations.

### Macroeconomic implications and institutional gaps
- The federal government’s macroeconomic stabilization function should be strengthened; the fiscal stance is set through the federal budget.
- General-purpose grant pool, set in the context of the annual budget cycle, provides a mechanism to harmonize macroeconomic stabilization policy across federal and regional budgets but has been subject to strong budget constraints at the national level.
- Strengthening federal and regional budgetary frameworks and rebuilding fiscal space are needed to support macro-stabilization of public finances.
- Recent macro-fiscal TA policy recommendations emphasize:
  - Modernizing forecasting techniques.
  - Improving institutional coordination.
  - Strengthening links between medium-term fiscal frameworks (MFF) and the annual budgets.
  - Producing further information from the MFF to inform budget preparation, including impacts of budget decisions on debt and other sustainability indicators.

### Policy coordination, public investment, and shock response
- Policy coordination between the federal government and regional governments is necessary to ensure effective economic governance and development; the federal government should encourage and support common best practices replicable at regional level.
- Improving coordination of investment plans across government entities would help ensure public infrastructure is delivered in the right areas with appropriate funding.
- Policy recommendations of the 2024 Public Investment Management Assessment (PIMA) and Climate PIMA report call for:
  - Better investment and budgetary resource planning.
  - Project implementation monitoring.
  - Systematic disclosure.
  - Improving alignment of regional frameworks with federal climate priorities.
- Insurance against regional macroeconomic shocks primarily operates through federal safety net programs; other channels are limited:
  - General-purpose grant formula is linked to revenue and expenditure norms, with 3-year averaging limiting responsiveness of grant shares to temporary shocks.
  - Regional grant allocation shares are unaffected by temporary revenue shocks; market borrowing is precluded.
  - Effective regional shock response is provided through federal shock response facilities: PSNP and programs administered by the Disaster Risk Management Commission to address localized shocks (e.g., drought, livestock disease outbreaks).
  - Curtailment of overseas development assistance would disproportionately affect regions with large humanitarian and disaster risk expenditure requirements and would increase the value of a stronger framework to manage regional macroeconomic shocks.
  - Setting up an adequately funded national disaster risk management fund, as envisaged by the authorities, could strengthen response to natural disasters and humanitarian crises and channel available international resources transparently.
  - Strengthening interregional stabilization and resilience could be achieved by broadening geographic reach of safety nets, enhancing focus on livelihoods, improving efficiency through e-payments and digitalization, establishing a National Social Registry, and producing timely regional data to inform periodic updates of regional grant shares.

### Fiscal responsibility and regional borrowing
- Reinforcing the fiscal responsibility framework by maintaining tight control over regional borrowing should continue.
- Regional governments are legally empowered to borrow domestically subject to federal terms and conditions, but there has been no regional borrowing except for Addis Ababa. Constraints include scarce financial system capacity, potentially high risks, and federal control via approval requirements.
- Legislative safeguards have precluded budget or project financing by regions; the only possibility for regions to borrow provided by law is for projects requiring a feasibility study showing capacity to repay and approval by the Ministry of Finance. External borrowing by regions is not permitted. NBE or commercial banks are not permitted to lend to regional governments.
- Recommendation: Continue tight control over regional borrowing until revenue mobilization capacity and fiscal space are rebuilt and domestic debt market preconditions are established.

### Key statistics and exact references from the chapter
- FY2023/24: regional government budget execution data used in analysis.
- MPI years referenced: 2016 and 2021 (national decline in multidimensional poverty between these years).
- Grant formula characteristic: 3-year averaging limits responsiveness of grant shares to temporary shocks.
- Institutional programs named: PSNP; Disaster Risk Management Commission; National Social Registry (recommended).
- Assessments referenced: 2024 World Bank Poverty Assessment; 2024 Public Investment Management Assessment (PIMA) and Climate PIMA report; recent macro-fiscal TA.

*Source: Chapter 17, sipea2025107 (IMF staff analysis and calculations).*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025107.pdf_