## _cr13309

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---

### INTRODUCTION — Framing and caveats
- Purpose: review the extent to which growth in Ethiopia has translated into higher living standards, identify key bottlenecks, and highlight main areas for policy action.
- Caveats:
  - Analysis constrained by limited, timely and detailed data on employment, household expenditure, income distribution, and other socio-economic indicators; national accounts and household expenditures are subject to important weaknesses.
  - Definition of inclusive growth: growth that is high, sustained, broad-based across sectors, inclusive of a large part of the country’s labor force, and which results in equality of opportunity and sizeable increases in income and living standards of the majority of the population.
- National strategy overview:
  - PASDEP implemented during 2005/06–2009/10.
  - Growth and Transformation Plan (GTP) spanning 2010/11–2014/15; longer term target is to become a middle-income country by 2020–25.
  - Economic structure: “developmental state” with proactive public sector leadership and widespread state ownership.

### A. Reviewing Key Outcomes — Growth and Poverty
- Poverty and human development:
  - Proportion living below US$1.25/day PPP: 60.5 percent in 1995; 30.7 percent in 2011.
  - Sub‑Saharan Africa comparison: decline from about 60 percent in 1996 to 48 percent in 2010.
  - Cross‑country analysis: Ethiopia’s actual HDI improvement slightly exceeds the fitted HDI predicted by GNI growth.
  - Gini coefficient: 33.6 percent (consistent over the last ten years).
- Human capital and household consumption:
  - National literacy rate: 37.6 percent in 2004/05; 48.3 percent in 2010/11.
  - Education attainment: share of household heads completing Grade 6 rose nationally and across segments.
  - Consumption changes:
    - All households above the first income quintile experienced significant increases in consumption; the lowest quintile benefited less.
    - Urban poor households increased consumption expenditures by more than 25 percent from 2004 to 2010.
    - Rural consumption improved for all income segments, more pronounced for middle to upper quintiles.
- Labor market and employment (urban):
  - Labor participation rate: 59.7 percent in May 2009; 62.5 percent in March 2012.
  - Female labor participation: strong increase in 2012.
  - Unemployment rate: 20.4 percent in May 2009; 17.5 percent in March 2012.
  - Total employment increase: 26 percent over 2009–2012; 11 percent in 2012 alone.
  - Share of informal employment sharply declined in 2012 for male and female workers.
  - Memorandum:
    - Urban population: 14,011,269
    - Urban population aged 10 and above: 11,110,653
    - Labor force: 6,944,691
    - Employment at firms (excluding subsistence farmers and domestic paid workers): 5,152,260
- Labor income and vulnerability:
  - Share of wages and salaries rose in all but the 1st quintile; share of agricultural production rose in the 1st and 2nd quintiles — worse‑off households rely more on own agricultural production and remain vulnerable.
- Remaining exclusion:
  - More than 30 percent of the population still lives under the US$1.25/day PPP poverty line.
  - Share of economically active population excluded from participation in income‑earning economic activity: around 25 percent.

### B. Inclusive Public Policy — Fiscal focus and social spending
- Fiscal stance and equity:
  - Fiscal policy emphasized promoting growth and equity through pro‑poor spending.
  - Heavy reliance on indirect taxes; regressive bias suggests scope to increase the share of direct taxes.
  - Income tax brackets are progressive; changes must consider implications for inclusive economic growth.
  - Ethiopia behind peers in revenue mobilization; greater efforts could support higher growth‑promoting and social expenditure.
- Public spending composition:
  - Public investment (capital expenditure) average over last 10 years: 10 percent of GDP.
  - Pro‑poor spending average over last 10 years: 12.4 percent of GDP.
  - Pro‑poor expenditure defined as spending on education, health, agriculture, natural resources, and roads.
  - Prioritization through budgetary processes underpinned pro‑poor focus contributing to MDG progress.

### Shift in pro‑poor spending composition (recurrent to capital)
- Trend:
  - Gradual shift from recurrent expenditure to capital expenditure within pro‑poor spending; recurrent spending has declined across‑the‑board.
  - Decline in current spending‑to‑GDP ratios in education and health likely reflects erosion of real wages owing to high inflation rather than fewer workers.
  - Rise in pro‑poor capital spending concentrated mostly in the roads sector.
- Road investment outcomes during PASDEP:
  - Total road length increased from about 36 thousand kilometers to about 49 thousand (an increase by a third).
  - Proportion of roads in good condition: 64 percent increasing to 81 percent.
  - Access to all‑weather roads improved.
- Productive Safety Net Program (PSNP):
  - Integrates public works with transfers to labor‑constrained households.
  - Eligibility/transfer rule example: eligible households must work for five days to receive the transfers for one person.
  - Transfers mix food and cash; balance based on multiple factors.
  - Scale and impact:
    - Program started in 2005 with about 4.5 million beneficiaries.
    - Program now has about 8 million beneficiaries in about 1.5 million households.
    - Described as the second largest social protection program in Africa and crucial for poverty reduction.

### Monetary and financial policy alignment with developmental goals
- Monetary policy:
  - Monetary expansion accommodated growing economy needs with credit allocation supporting some priority, labor‑intensive sectors.
  - Authorities implemented a tight monetary policy targeting base money growth consistent with single digit inflation to protect the poor.
- Financial policies and credit allocation:
  - Real interest rates have remained negative and only recently approached zero.
  - Dominant state‑owned financial institutions (Commercial Bank of Ethiopia (CBE) and Development Bank of Ethiopia (DBE)) have directed credit toward public spending priorities.
  - Directed credit may have broadened inclusion but likely distorted credit allocation and constrained private sector availability; significant segments, particularly rural areas, remain credit‑constrained.

### Financial inclusion: banking sector, MFIs, and SACCOs
- Banking sector (as of September 2012):
  - Composed of 18 commercial banks and one state owned development bank.
  - The 18 commercial banks include 2 state‑owned banks, with one representing about 70 percent of all commercial banks’ assets.
  - Commercial bank branches: 1,257; more than a third located in Addis Ababa.
  - Population per bank branch: 63, 644.
  - Deposit accounts: 7.1 million (suggesting less than 8 percent of Ethiopians have a bank account given population of nearly 90 million).
  - Number of borrowers: 112, 793 as of September 2012.
- Microfinance institutions (MFIs):
  - Microfinance Proclamation 40/1996 opened possibility for deposit‑taking MFIs.
  - As of end‑June 2012, 31 MFIs providing financial services to 2.9 million clients.
- Savings and Credit Cooperatives (SACCOs):
  - Urban SACCOs: work‑based cooperatives of mainly low‑income segments; key role in urban poverty alleviation.
  - Rural SACCOs: small grassroots-based and semi‑formal with about 50 to 200 members; growing but coverage insignificant relative to unbanked population.

### Inclusion of the private sector and governance constraints
- Public sector dominance limits private sector contribution in finance, communications, and trade logistics where state‑owned enterprises hold monopolies or advantages.
- Policy implications:
  - Need a different balance between public and private sectors to allow broader access to factor and product markets.
  - Public sector involvement in productive activities and credit allocation may need to be circumscribed to avoid crowding out the private sector.
  - Recommendations to harness private sector:
    - Foster greater competition.
    - Encourage foreign direct investment.
    - Gradually withdraw the public sector from areas where private sector could lead.
    - Create supportive business environment through public‑private dialogue.

### Challenges for growth and inclusiveness — composition, informality, and employment
- Growth sustainability:
  - High growth since 2004 is relatively recent compared with cases of sustained inclusive growth spanning about three decades; growth exhibited volatility around 2002–03 before resuming in 2004.
- Composition of growth (sector shares in total GDP, current prices in percent):
  - Services: 40.3 (2000/11); 40.2 (2005/06); 41.9 (2011/12)
  - Agriculture: 41.6; 43.4; 45.1
  - Mining: 0.6; 1.4; 1.6
  - Manufacturing: 5.7; 4.5; 3.6
  - Construction: 4.5; 5.7; 4.0
  - Utilities: 2.2; 1.9; 1.1
  - Forestry: 6.0; 4.5; 3.6
- Implication: composition insufficiently broad‑based for rapid structural transformation; rising services share (likely urban concentrated) raises questions on employment, income distribution, and inclusion.
- Doing Business and governance indicators:
  - Doing Business ranking: 102 (out of 178) to 111 (out of 183) over 2008–2012; 2013 ranking: 127 out of 185.
  - Governance indicators (re‑scaled 0–5, World Bank Institute Governance Indicators, 2011):
    - Ethiopia: Corruption Control 2.6; Rule of Law 2.6; Regulatory Quality 2.3; Government Effectiveness 2.9
    - Sub‑Saharan Africa averages shown: Corruption Control 2.7; Rule of Law 2.6; Regulatory Quality 2.7; Government Effectiveness 2.6
- Informal economy:
  - Estimated at about 38.6 percent of GDP.
  - Comparators: SSA average 38.4 percent; all low‑income countries 38 percent.
  - Low registration of informal units leaves most outside government policies (labor, taxation); institutional weaknesses and high registration costs incentivize informality.
- Employment challenges and demographics:
  - Young population (under age 24) represents 65 percent of total population.
  - Increasing labor force participation rates generate about 1.2 million new job seekers each year, corresponding to about 3.2 percent annual growth in the labor force.
  - Skills mismatch from education system inadequately responsive to sector needs, causing high unemployment and under‑employment, especially among youth.
  - Need to develop labor‑intensive industries (tourism, garments‑textiles) to create employment.
  - Access to finance constraint: credit institutions reach only a small proportion of the population.

### Domestic Savings, Financial Deepening, and Policy Actions
- Savings mobilization and financial sector structure:
  - Time deposits: 12.5 billion (1.6 percent) were time deposits; 68 percent of these deposits collected by state‑owned banks and 32 percent by private banks.
  - MFIs collected birr 5.4 billion (about 1 percent of GDP) in saving over the same period.
  - Insurance sector (as of June 30, 2012):
    - 15 insurance companies; 243 branches; total capital birr 1.2 billion.
    - 129 branches (53 percent) located in Addis Ababa.
    - Return on equity (RoE): 35 percent.
    - Return on assets (RoA): 8 percent.
    - Insurance branch to population ratio: 334,608.
  - Mobile and banking access:
    - About 17 million cell phone users and 7.1 million bank accounts.
    - Ethio Telecom projection: number of cell phone users expected to reach 40 million in the next three years.
  - POESA performance: in its first year POESA collected more than 800 million birr.
- Financial market features limiting retail participation:
  - Minimum denomination for bonds: birr 2 million.
  - Bond market: two years maturity and absence of a secondary market make markets illiquid and unattractive.
  - T‑bill market constraints for individual savers:
    - Relatively large denominations: birr 5000.
    - Uncertainty of winning a tender.
    - Negative real rate of return.
  - Market participants in T‑bill, government bond and corporate bond markets mainly banks and institutional funds (insurance companies, pension funds).
- Quantitative assessment: investment‑saving gap (Percent of GDP)
  - Domestic financing gap averaged about 9.4 percent of GDP in 1990–2000 and widened to about 17 percent in 2006–12.
  - SSA average gap: about 6 percent.
  - Table 5 key figures (Percent of GDP):
    - Periods: 1990–2000; 2006/07; 2007/08; 2008/09; 2009/10; 2010/11; 2011/12
    - Gross domestic saving: 5.0; 8.7; 5.2; 5.7; 5.2; 8.8; 13.9
    - Gross domestic investment: 14.4; 22.1; 22.4; 22.7; 24.7; 25.5; 32.3
    - Resource gap: -9.4; -13.5; -17.1; -17.0; -19.5; -16.7; -18.4
- Policy actions recommended to boost savings and financial inclusion:
  - Broad structural and growth‑promoting actions:
    - Provide incentives for emergence of activities creating jobs for high‑ and low‑skilled workers.
    - Undertake deep reforms to create a business‑friendly environment, strengthen the regulatory framework, and promote access to financing.
    - Introduce structural improvements to alleviate credit constraints and trade‑related restrictions.
    - Provide opportunities for the private sector to leverage large public investment.
  - Fiscal policy and revenue mobilization:
    - Strengthen tax revenue mobilization; current tax revenue to GDP ratio about 12 percent in Ethiopia versus about 16 percent in sub‑Saharan Africa and above 25 percent in emerging markets.
  - Increasing private savings through instruments and legislation:
    - Combine legislation and incentives to improve availability and returns on existing financial instruments and introduce new instruments.
  - Banking and MFIs:
    - Encourage banks and MFIs to increase outreach by opening sectors to institutions willing to participate and providing an appropriate regulatory environment.
    - Promote financial instruments suited to rural savers.
  - Mobile banking:
    - Enact legislative and regulatory provisions to introduce mobile banking, including allowing entry of non‑bank mobile money providers (including mobile network operators).
    - Leverage existing mobile infrastructure and engagements (e.g., BelCash and M‑Birr) to expand financial inclusion.
  - Insurance companies and pensions:
    - Enact legislation to incentivize more insurance companies and increase coverage to mobilize contractual savings for long‑term lending.
    - Enact legislation to increase coverage of pension or provident funds to support greater savings mobilization.

*Source: Ethiopian authorities and IMF staff calculations.*

### INTRODUCTION ___________________________________________________________________________________ 4

### INTRODUCTION

### Framing and caveats
- The paper reviews the extent to which growth in Ethiopia has translated into higher living standards, identifies key bottlenecks, and highlights main areas for policy action.
- Two caveats:
  - Analysis constrained by limited, timely and detailed data on employment, household expenditure, income distribution, and other socio-economic indicators; national accounts and household expenditures are subject to important weaknesses.
  - Inclusive growth is defined here as growth that is high, sustained, broad-based across sectors, inclusive of a large part of the country’s labor force, and which results in equality of opportunity and sizeable increases in income and living standards of the majority of the population.

### National strategy overview
- Key national plans:
  - Plan for Accelerated and Sustained Development to End Poverty (PASDEP), implemented during 2005/06–2009/10.
  - Growth and Transformation Plan (GTP), spanning 2010/11–2014/15, aimed at sustaining high and broad-based economic growth and achieving MDG targets by 2015; longer term target is to become a middle-income country by 2020–25.
- Economic structure: emphasis on a “developmental state” with a proactive public sector leading development and a private sector oriented to support development goals; public sector is deeply involved and state ownership is widespread.

### A. Reviewing Key Outcomes — Growth and Poverty
- Real outcomes:
  - Proportion living below US$1.25/day PPP fell from 60.5 percent in 1995 to 30.7 percent in 2011.
  - For comparison, sub-Saharan Africa estimates show a decline from about 60 percent in 1996 to 48 percent in 2010.
- Growth-to-living-standards translation:
  - Cross-country analysis (annual change in HDI vs annual change in per capita GNI) shows Ethiopia’s actual HDI improvement slightly exceeds the fitted HDI predicted by GNI growth.
- Income distribution:
  - Gini coefficient reported as 33.6 percent (most egalitarian among many sub-Saharan African countries and consistently maintained over the last ten years).
- Human capital and household consumption:
  - National literacy rate rose from 37.6 percent in 2004/05 to 48.3 percent in 2010/11; improvements spanned males/females and urban/rural areas.
  - Education attainment (share of household heads completing Grade 6) rose nationally and across segments.
  - All households above the first income quintile experienced significant increases in consumption; the lowest quintile benefited less.
  - Urban poor households increased consumption expenditures by more than 25 percent from 2004 to 2010.
  - Rural consumption improved for all income segments, more pronounced for middle to upper quintiles.
- Labor market and employment (urban):
  - Labor participation rate rose from 59.7 percent in May 2009 to 62.5 percent in March 2012.
  - Female labor participation showed a strong increase in 2012.
  - Unemployment rate declined from 20.4 percent to 17.5 percent over the same period.
  - Declines in female and youth unemployment contributed to the overall decline.
  - Share of informal employment sharply declined in 2012 for male and female workers.
  - Total employment increased by 26 percent over 2009–2012 and by 11 percent in 2012 alone.
  - Urban population (memorandum): 14,011,269; urban population aged 10 and above: 11,110,653; labor force: 6,944,691.
  - Employment at firms (memorandum) reported as 5,152,260 (excluding subsistence farmers and domestic paid workers).
- Labor income and vulnerability:
  - Share of wages and salaries rose in all but the 1st quintile; share of agricultural production rose in the 1st and 2nd quintiles.
  - This suggests worse-off households rely more on own agricultural production and remain vulnerable.
- Remaining poverty and exclusion:
  - More than 30 percent of the population still lives under the US$1.25/day PPP poverty line.
  - Share of economically active population excluded from participation in income-earning economic activity is around 25 percent.

### B. Inclusive Public Policy — Fiscal focus and social spending
- Authorities’ emphasis:
  - Fiscal policy has sought to promote both growth and equity through pro-poor spending.
- Revenue composition and equity:
  - Heavy reliance on indirect taxes, which tend to be regressive, suggests scope for making revenue more equitable by increasing the share of direct taxes.
  - Income tax brackets within direct taxes are progressive, but changes to the overall tax regime must consider implications for inclusive economic growth.
  - Ethiopia remains behind peers in revenue mobilization; greater efforts could support higher growth-promoting and social expenditure.
- Public spending composition and priorities:
  - Public investment (capital expenditure) and pro-poor spending with respect to GDP have been kept at relatively constant averages of 10 and 12.4 percent respectively over the last 10 years.
  - Pro-poor expenditure is defined as spending on education, health, agriculture, natural resources, and roads.
  - Prioritization through budgetary processes underpinned the strong pro-poor focus that contributed to progress toward the MDGs.

*Source: INTRODUCTION, August 29, 2013, THE FEDERAL DEMOCRATIC REPUBLIC OF ETHIOPIA, INTERNATIONAL MONETARY FUND*

### 14.      Within pro-poor spending, there has been a gradual shift from recurrent to capital

### 14.      Within pro-poor spending, there has been a gradual shift from recurrent to capital

### Shift in pro‑poor spending composition
- Gradual shift from recurrent expenditure to capital expenditure within pro‑poor spending; recurrent spending has declined across-the-board.
- Decline in current spending-to-GDP ratios in education and health likely reflects an erosion of real wages owing to high inflation rather than a reduction in the number of workers.
- Rise in pro‑poor capital spending concentrated mostly in the roads sector.
- Road investment outcomes during the PASDEP period:
  - Total road length increased by a third (from about 36 thousand kilometers to about 49 thousand).
  - Proportion of roads assessed as being in good condition increased from 64 percent to 81 percent.
  - Access to all-weather roads improved.

### Productive Safety Net Program (PSNP)
- PSNP integrates income and employment through public works with transfers to labor-constrained households.
- Typical eligibility and transfer rules:
  - Eligible households must work for five days to receive the transfers for one person.
  - Transfers are a combination of food and cash; balancing of food and cash payments is based on multiple factors.
- Scale and impact:
  - Program started in 2005 with about 4.5 million beneficiaries.
  - Program now has about 8 million beneficiaries in about 1.5 million households.
  - PSNP is described as the second largest social protection program in Africa and has been crucial for poverty reduction.

### Monetary and financial policy alignment with developmental goals
- Monetary policy:
  - Monetary expansion sought to accommodate needs of a growing economy with credit allocation supporting some priority, labor‑intensive sectors.
  - Authorities implemented a tight monetary policy targeting base money growth consistent with single digit inflation to protect the poor from inflation’s deleterious effects.
- Financial policies and credit allocation:
  - Real interest rates have remained negative and only recently approached zero, artificially keeping the cost of development expenditures low.
  - Dominant state‑owned financial institutions—the Commercial Bank of Ethiopia (CBE) and the Development Bank of Ethiopia (DBE)—have directed credit toward public spending priorities.
  - Directed credit may have contributed to broader inclusion but likely distorted credit allocation.
  - Absorption of credit by the public sector has constrained availability to the private sector; significant segments, particularly in rural areas, remain constrained by lack of access to credit.

### Financial inclusion: banking sector, MFIs, and SACCOs
- Banking sector (as of September 2012):
  - Composed of 18 commercial banks and one state owned development bank.
  - The 18 commercial banks include 2 state‑owned banks, with one representing about 70 percent of all commercial banks’ assets.
  - Commercial bank branches numbered 1,257, with more than a third located in Addis Ababa.
  - Population per bank branch was 63, 644.
  - Despite population of nearly 90 million, there are only 7.1 million deposit accounts (suggesting less than 8 percent of Ethiopians have a bank account).
  - Number of borrowers was 112, 793 as of September 2012.
- Microfinance institutions (MFIs):
  - Focus on pro‑poor finance emerged in 1994; Microfinance Proclamation 40/1996 opened possibility for deposit‑taking MFIs.
  - As of end‑June 2012, only 31 MFIs were providing financial services to 2.9 million clients.
  - These numbers are small relative to a country where about 80 million people have no bank account.
- Savings and Credit Cooperatives (SACCOs):
  - Urban SACCOs are primarily work‑based cooperatives comprising mainly low‑income population segments; they play a key role in urban poverty alleviation.
  - Rural SACCOs are small grassroots-based and semi-formal with about 50 to 200 members; they are growing but coverage remains insignificant relative to the unbanked population.

### Inclusion of the private sector
- Public sector dominance has limited the private sector’s contribution to growth in areas such as finance, communications, and trade logistics where state‑owned enterprises enjoy monopolies or advantages.
- Policy implications:
  - For enduring inclusion and poverty reduction, a different balance between public and private sectors is needed to allow broader access to factor and product markets.
  - Public sector involvement in productive activities and credit allocation may need to be circumscribed; investment profile should be consistent with sustainable financing and avoidance of crowding out the private sector.
  - Recommendations to harness private sector:
    - Foster greater competition.
    - Encourage foreign direct investment.
    - Gradually withdraw the public sector from areas where private sector could lead.
    - Create a supportive business environment through public‑private dialogue to better understand private sector needs.

### Challenges for growth and inclusiveness — Growth sustainability
- High growth since 2004 is relatively recent compared with cases of sustained inclusive growth which span about three decades.
- Growth exhibited volatility around 2002–03 before resuming in 2004.

### Composition of growth
- Growth dominated by services and agriculture.
- Sector shares in total GDP (current prices in percent):
  - Services sector: 40.3 (2000/11), 40.2 (2005/06), 41.9 (2011/12)
  - Agriculture: 41.6, 43.4, 45.1
  - Mining: 0.6, 1.4, 1.6
  - Manufacturing: 5.7, 4.5, 3.6
  - Construction: 4.5, 5.7, 4.0
  - Utilities: 2.2, 1.9, 1.1
  - Forestry: 6.0, 4.5, 3.6
- Implication: composition appears insufficiently broad‑based to bring rapid structural transformation; rising share of services (likely urban concentrated) raises questions on employment, income distribution, and inclusion.

### Business climate, governance, and transparency
- Doing Business rankings:
  - Ethiopia’s ranking declined from 102 (out of 178) to 111 (out of 183) over 2008–2012.
  - In 2013 ranking declined further to 127 out of 185 countries.
- Governance indicators (re-scaled to range between 0 and 5; computed from World Bank Institute Governance Indicators, 2011):
  - Regional averages (sample shown) and Ethiopia:
    - Western Hemisphere: Corruption Control 3.4; Rule of Law 3.3; Regulatory Quality 3.4; Government Effectiveness 3.4
    - Asia and Pacific: 3.3; 3.3; 3.3; 3.4
    - Middle East and central Asia: 2.8; 2.8; 2.8; 2.9
    - Europe: 3.9; 4.0; 4.1; 4.0
    - Sub‑Saharan Africa: 2.7; 2.6; 2.7; 2.6
    - Ethiopia: 2.6; 2.6; 2.3; 2.9
    - Low Income Countries: 2.4; 2.3; 2.4; 2.3
- Ethiopia compares favorably with SSA average on government effectiveness and is at par on rule of law, but unfavorably on corruption control and regulatory quality.

### Informal economy
- Informal economy estimated at about 38.6 percent of GDP compared with averages:
  - SSA average: 38.4 percent
  - All low‑income countries: 38 percent
- Low registration of informal units leaves most outside government policies (labor, taxation); weaknesses in institutional framework, regulatory quality, and rule of law incentivize informality; high costs of registration also contribute.

### Employment challenges
- Labor market pressures likely to continue owing to:
  - Demographic dynamics:
    - Young population (under age 24) represents 65 percent of total population.
    - Increasing labor force participation rates lead on average to 1.2 million new job seekers each year, corresponding to about 3.2 percent annual growth in the labor force.
  - Skills mismatch from an education system inadequately responsive to sector needs, leading to high unemployment and under‑employment, especially among youth.
  - Lack of job opportunities in labor‑intensive sectors; limited agricultural growth complicates prospects for new job seekers.
- Need to develop labor‑intensive industries such as tourism and garments‑textiles to create employment opportunities.
- Access to finance constraint:
  - Credit‑providing institutions reach only a small proportion of the population, constraining creation of productive employment, inclusive growth, and poverty reduction.

### Need for resource mobilization
- Sustaining high rates of growth over the long term requires substantial physical capital accumulation and reliance on savings.
- With external financing constraints, domestic savings must finance aggregate investment; accessible, diversified, and safe saving instruments are important.
- Current saving instruments in Ethiopia include deposits in banks or MFIs, pension/provident funds, insurance, T‑bills, government bonds, and corporate bonds.
- Banking sector deposits (as of June 30, 2012):
  - Total deposits: birr 187.3 billion (25 percent of GDP)
  - Demand deposits: birr 92.2 billion (12.5 percent of GDP)
  - Savings deposits: birr 82.5 billion (11 percent of GDP)

*Source: _cr13309 - 14.      Within pro-poor spending, there has been a gradual shift from recurrent to capital*

### 12.5 billion (1.6 percent) were time deposits. 68 percent of these deposits were collected by state-

### Domestic Savings, Financial Deepening, and Policy Actions

### Current saving mobilization and financial sector structure
- Time deposits: 12.5 billion (1.6 percent) were time deposits. 68 percent of these deposits were collected by state-owned banks and 32 percent by private banks.
- MFIs: Over the same period, MFIs collected birr 5.4 billion (about 1 percent of GDP) in saving.
- Pensions and insurance: As of June 30, 2012, there were 15 insurance companies, with 243 branches and total capital of birr 1.2 billion. Out of the 243 branches, 129 (53 percent) are located in Addis Ababa.
- Insurance sector performance (as of June 30, 2012): return on equity (RoE) of 35 percent and return on assets (RoA) of 8 percent. Insurance branch to population ratio stood at 334,608.
- Mobile and banking access: Ethiopia has about 17 million cell phone users and 7.1 million bank accounts. According to Ethio Telecom, the number of cell phone users is expected to reach 40 million in the next three years.
- POESA performance: In its first year of operation, POESA was able to collect more than 800 million birr.

### Financial markets and constraints on retail participation
- Bond market features limiting retail access:
  - Minimum denomination for bonds: birr 2 million.
  - Two years maturity and absence of a secondary market make bond markets illiquid and unattractive because investors have to hold the bonds until maturity.
- T-bill market constraints for individual savers:
  - Relatively large denominations: birr 5000.
  - Uncertainty of being able to win in a tender.
  - Negative real rate of return.
- Market participants: Participants in T-bill, government bond and corporate bond markets are mainly banks and other institutional funds such as insurance companies or pension funds.

### Quantitative assessment: investment-saving gap
- Domestic savings shortfall and financing gap:
  - Domestic financing gap averaged about 9.4 percent of GDP in 1990–2000 and widened to about 17 percent in 2006–12.
  - In sub-Saharan Africa, this gap on average is about 6 percent.
- Table 5. Ethiopia: Investment-Domestic Saving Gap (Percent of GDP)
  - Periods: 1990–2000; 2006/07; 2007/08; 2008/09; 2009/10; 2010/11; 2011/12
  - Gross domestic saving: 5.0; 8.7; 5.2; 5.7; 5.2; 8.8; 13.9
  - Gross domestic investment: 14.4; 22.1; 22.4; 22.7; 24.7; 25.5; 32.3
  - Resource gap: -9.4; -13.5; -17.1; -17.0; -19.5; -16.7; -18.4

### Policy actions recommended to boost savings and financial inclusion
- Broad structural and growth-promoting actions:
  - Provide incentives for the emergence of a wide range of activities capable of creating jobs for high-skilled and low-skilled workers.
  - Undertake deep reforms to create a business-friendly environment, in particular by strengthening the regulatory framework and promoting access to financing.
  - Introduce structural improvements to alleviate credit constraints and trade-related restrictions.
  - Provide opportunities for the private sector to leverage the large public investment.
- Fiscal policy and revenue mobilization:
  - Strengthen tax revenue mobilization efforts; current tax revenue to GDP ratio is about 12 percent in Ethiopia, compared with about 16 percent in sub-Saharan Africa and above 25 percent in emerging markets.
- Increasing private savings through instruments and legislation:
  - Combine legislation and incentives to improve availability and returns on existing financial instruments and to introduce new instruments.
- Banking and MFIs:
  - Encourage banks and particularly MFIs to increase outreach by opening up the banking and MFI sectors to institutions willing to participate and by providing an appropriate regulatory environment.
  - Promote financial instruments suited to rural savers to mobilize savings from populations lacking access to financial instruments.
- Mobile banking:
  - Enact appropriate legislative and regulatory provisions to introduce mobile banking, including allowing entry of non-bank mobile money providers, including mobile network operators (MNOs).
  - Leverage existing mobile infrastructure and engagements (e.g., with BelCash and M-Birr) to expand financial inclusion and reach the currently financially excluded.
- Insurance companies and pensions:
  - Enact legislation to incentivize the emergence of more insurance companies and increase coverage to mobilize contractual savings for long-term lending.
  - Enact legislation to increase coverage of pension or provident funds to support greater savings mobilization, building on expansion potential indicated by employment and coverage figures.

*Source: Ethiopian authorities and IMF staff calculations.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13309.pdf_