## _cr15326

## Source details

**Canonical URL:** [_cr15326](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15326.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15326.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15326.pdf.json)

---

### INTRODUCTION — Overview and Objectives
- The Fund is increasingly concerned with how income inequality affects growth and macroeconomic stability; many fast-developing countries experienced rising income gaps over the last decade.
- Empirical finding cited: raising income inequality by 1 percentage point (through increasing the income share of the top 20 percent) reduces GDP growth on average by 0.08 percentage point; a similar decline in income inequality (by increasing the income share of the bottom 20 percent) has been associated with on average 0.38 percentage point higher growth.
- Objective of the paper:
  - Review the evolution of inequality in Ethiopia, compare with regional peers, and discuss the role of macroeconomic policies and structural factors.
  - Quantify the distributional impact of a set of selected growth-enhancing policy measures, including long-standing IMF recommendations, using a tailored dynamic general equilibrium model.
- Data sources referenced: “Household Income, Consumption and Expenditure Survey for 2010/11” (HICES 2010/11) and World Bank “Ethiopia: Poverty Assessment 2014”.

### EQUITABLE GROWTH AND POVERTY REDUCTION IN ETHIOPIA
- Growth and poverty trends:
  - Real GDP increased on average by 10.8 percent per year during 2004-2013.
  - The share of the population living below the poverty line halved between 1995 and 2010, from 60.5 percent down to 29.6 percent.
  - Poverty line defined as percentage of the population living on less than $1.25 per day, purchasing power parity adjusted.
  - Ethiopia’s poverty reduction performance is noted to be comparable to Senegal despite Senegal having twice as large GDP per capita.
- Regional and sectoral observations:
  - Discrepancies in poverty among regions have narrowed; public infrastructure investment attributed to improved market access and incomes in previously remote areas.
  - Food price shocks remain the biggest threat to Ethiopia’s poorest households despite expanded government programs.
- Poverty measurement nuances:
  - Incidence, depth (poverty gap), and severity (squared poverty gap) reported; reductions in incidence did not always translate to commensurate reductions in depth and severity.
- Inequality and vulnerability:
  - National Gini coefficient reported as 30.
  - Rural consumption distribution is very equal; land consolidation regulations contribute to low farm size variation and low rural Gini.
  - Urban inequality: after a decline between 2004 and 2010 (by 6.2 percentage points), recent developments indicate widening income gaps in cities.
  - Rising skill premia for higher education and changing household characteristics identified as drivers of increasing urban income disparities.
  - The most vulnerable households benefit less from growth than higher income deciles.
  - Overall vulnerability to food price shocks has increased almost tenfold despite expanded government policy efforts.

### IMPACT OF FISCAL AND SOCIAL POLICIES ON INCOME DISTRIBUTION
- Role of fiscal policy:
  - Fiscal instruments (income taxes and transfers) can reduce inequality of disposable incomes directly; in-kind benefits (education, health, housing) can affect inequality of market incomes via future earnings, health, and ability to work.
  - Fiscal policy in Ethiopia has an overall positive distributional impact on income inequality, but efficacy could be improved.
- Revenue policy specifics and priorities:
  - Ethiopia faces typical developing-country tax challenges: low tax-to-GDP ratio, heavy reliance on trade taxes, and generous tax exemptions and expenditures.
  - Recent improvements in tax administration allowed catch-up with some peers (e.g., Tanzania and Uganda), but performance still lags targets and regional averages for low-income countries.
  - Policy priorities: reduction of excessive tax exemptions and tax holidays; policies promoting private sector development to broaden the tax base.
- Direct taxes and incidence:
  - Direct taxes (personal income and business income) are progressive but account for a relatively small portion of overall tax revenue.
  - Analysis shows 67 percent of personal income taxes is paid by the top 20 percent of the population.
  - Lack of revisions to tax brackets for a decade and a relatively low threshold of the first tax bracket imply Ethiopia levies more taxes on the lowest income households compared to other countries.
- Agriculture and taxation:
  - Agriculture contributes less than 1 percent to total tax revenue despite the economy’s agricultural predominance.
  - Land fees and agricultural taxes are decided by regional governments and are levied according to land size and fertility; current land fees are regressive as they vary only with land size.
  - Recommendation: better define and capture commercial agriculture in the tax net to broaden the base.
- Expenditure priorities and pro-poor spending:
  - Government pro-poor strategy focuses on five areas: education, health, agriculture, access to water/sanitation, and roads.
  - Over the last five years, spending on those five areas accounted for 70 percent of total expenditure.
  - Within pro-poor spending, education and roads comprise the highest shares: 25 percent and 20 percent respectively.
  - Heavy investment in roads: total road length increased by 30 percent and access to all-weather roads expanded.
- Subsidy reform recommendation:
  - Electricity subsidy estimated cost: Birr 1.5 bn, equivalent to 2.6 percent of general government spending.
  - Because largest benefits accrue to relatively better-off households, recommendation is to replace electricity subsidies with direct transfers to improve targeting, efficiency, and transparency.
- Productive Safety Net Program (PSNP):
  - Introduced in 2005; targets more than 8 million beneficiaries (9 percent of total population), primarily in famine-prone areas.
  - PSNP integrates cash transfers with public-work employment; it is the second largest protection program in Africa and critical for poverty reduction.
  - Recommendation: use PSNP experience to inform urban-targeted programs given expected rural-to-urban migration under structural transformation.

### FINANCIAL INCLUSION — Structure, Gaps, and Constraints
- Financial system structure and access:
  - Access to finance is primarily through the banking sector and microfinance institutions (MFIs).
  - There are 18 commercial banks and one state-owned development institution (Development Bank of Ethiopia).
  - The sector is highly concentrated: the largest, state-owned commercial bank comprises about 70 percent of total assets.
  - Bank branches have increased four-fold since 2010.
  - More than a third of branches is located in Addis Ababa, while almost 80 percent of the population lives in rural areas.
  - Population per bank branch: 35,957 as of March 2015.
- Microfinance and coverage:
  - National Bank of Ethiopia (NBE) developed a prudential regulatory framework for microfinance in 1996; Microfinance Proclamation 40/1996 opened the possibility for deposit-taking MFIs.
  - As of March 2015, there were only 24 MFIs providing financial services.
  - MFI penetration: less than 4 percent of the population being served.
  - SACCOs remain small by international standards; coverage is insignificant relative to the size of the unbanked population.
- Financial depth and credit metrics:
  - Ethiopia’s broad money to GDP accounts for 75 percent of the regional average.
  - Private sector credit to GDP is only 25 percent of the regional average.
  - Bank penetration (total assets to GDP) in Ethiopia: 42 percent of GDP versus close to 60 percent in SSA; this ratio has declined over the last 12 years (by 41 percent), while in the region this ratio has increased by almost 50 percent.
  - Credit to the private sector increased from 8.2 percent of GDP (2003) to 9.4 percent of GDP in 2015.
  - In Sub-Saharan Africa (SSA), credit to the private sector grew fivefold over 2003–14, with an annual increase of 16 percent.
- Constraints on credit allocation and pricing:
  - Majority of credit is channeled to state-owned enterprises, limiting private sector access to formal credit.
  - Limited financial credit products (e.g., lack of availability of personal loans) and high cost and lengthy procedures to seize collateral hinder credit market development.
  - Negative real interest rates are present, distorting pricing, eroding incentives to save, and hampering financial intermediation.
  - Since 2011, private banks are required to invest the equivalent of 27 percent of their new loans in NBE bonds; proceeds are used to finance the DBE.

### Policy recommendations on financial sector reform and mobilizing savings
- Reform financial sector policies that constrain availability of credit to the private sector; eliminate policies constraining credit availability.
- Promote mobile banking and electronic financial services; the rapid development of M-Pesa in Kenya cited as a model.
- Promote capital market development as an alternative to bank credit for financing.
- Encourage MFIs and SACCOs to increase outreach to the poor by opening them up to institutions willing to provide capital and ensuring an appropriate regulatory environment.
- Promote financial instruments tailored to the needs and preferences of rural savers to mobilize private savings.
- Mobilizing private savings may require legislative changes and incentives to improve availability and return on existing instruments and introduce new instruments.

### MODEL-BASED ANALYSIS — Scope, Calibration, and Scenarios
- Model characteristics:
  - Dynamic stochastic general equilibrium model of a small open economy with multiple sectors and heterogeneous households.
  - Baseline calibration notes:
    - Agriculture: 43 percent share in GDP; almost 80 percent of workforce; accounts for 90 percent of goods exports and a third of total exports.
    - Baseline year (2011) model moments: agricultural sector accounts for 41 percent of GDP; tax incentives to exporters are approximately 2.8 percent of GDP; tax revenues are 13 percent of GDP.
  - Three consumption goods: domestically produced food, imported food, and non-food goods.
  - Four household types: rural, urban, government employees, entrepreneurs; continuum of households with idiosyncratic risk.
  - Only financial assets: one-period bonds; in baseline only urban households have access.
- Policy scenarios analyzed:
  - Reform the DBE's funding policy by eliminating the "27 percent investment requirement".
  - Streamline tax incentives for exporters in a revenue-neutral way (tax incentives estimated to reduce tax revenue by 2.8 percent of GDP per year).
  - Complementary equitable growth policies:
    - Double the size of the PSNP from 1 percent of GDP to 2 percent of GDP.
    - Deepen access to financial services: additional 25 percent of the rural population gains access to financial services; reduction in the risk premium in loans to all borrowers from 15 percent to 5 percent.
    - Foster rural-to-urban migration: 2.7 percent of the rural population migrates to urban areas, expanding labor supply to modern sectors by 19 percent.

### QUANTITATIVE RESULTS AND DISTRIBUTIONAL IMPLICATIONS
- Macroeconomic and investment effects:
  - Removing the DBE funding implicit tax increases the return on private sector capital and raises private investment by 3 percent.
  - Manufacturing and services share of GDP rises from 54% to 63%; agriculture falls from 46% to 37% after economic reforms.
- Sectoral and household impacts:
  - Manufacturing (more capital intensive) receives the largest stimulus, increasing labor productivity and labor demand; wages increase.
  - Urban sector average welfare improves; reforms benefit urban households more than rural households in the short run.
  - Traditional exports sector faces higher wages and demands less labor and less agricultural goods; farmers switch from commodity exports to domestic food production.
  - Increased domestic food supply more than offsets higher demand from urban sector; price of agricultural goods falls, lowering welfare of rural households.
  - In the short run inequality increases, though poverty falls and the poorest in rural areas would enjoy higher consumption than before.
- Policy-specific distributional effects (from simulations):
  - Cash transfers (targeted to the rural poor):
    - Reduce inequality, measured by the Gini coefficient.
    - Reduce the proportion of households below the poverty line.
    - Can be financed from the increased economic activity that results from fostering private investment and from streamlining tax incentives.
    - Targeting the rural poor is pertinent when the price of agricultural goods is negatively affected by the proposed reform.
  - Financial deepening (especially in rural areas):
    - Reduces consumption inequality and supports economic growth.
    - Facilitates saving by rural households, allowing consumption smoothing over time.
    - Strongest effect for households that wanted to save but lacked access to financial services.
    - Lowers risk premia, freeing up resources for private investment similar to reductions in implicit taxes.
    - Estimated effects: helps to boost private investment growth (by 1 percentage point per year), and output (by 0.3 percentage point per year).
  - Rural-to-urban migration:
    - Contributes to equalization of labor returns in urban and rural areas.
    - Facilitates structural transformation by supplying inexpensive labor to manufacturing and services.
    - Estimated effects: increases private investment growth (by 1 percentage point per year), and output (by 0.5 percentage point per year).
  - Combined effects:
    - In simulations, increasing cash transfers reduces both the Gini coefficient and the proportion of households below the poverty line.
    - Financial inclusion and migration both contribute to narrowing consumption inequality, particularly benefiting rural deciles.

### MODEL MECHANISMS, ASSUMPTIONS, AND ROBUSTNESS NOTES
- Occupations and production:
  - Agricultural workers produce food for consumption or sale.
  - Entrepreneurs produce a non-food item using capital and labor; non-food good used for consumption or converted into capital.
  - An agricultural export product (e.g., coffee) is produced by entrepreneurs using the domestic food product as input.
- Financial intermediation and taxation:
  - Financial intermediation converts non-food goods into capital and allows workers to save and borrow.
  - Government imposes a tax on financial intermediation: if households save at real rate r, borrowers face interest rate r+߬௦; to increase capital stock by ܫ, entrepreneurs pay ሺ1൅߬௦ܫሻ.
  - Fiscal policy parameters include a tax on entrepreneurs’ capital income, a tax on private and public sector workers’ wage earnings, and sector specific and means-tested transfers.
- Household behavior and shocks:
  - Households live forever, are forward looking, face idiosyncratic productivity shocks, and decide consumption versus saving and allocation across goods.
  - Only private and public sector workers and a given fraction of agricultural workers have access to finance; remaining farmers can neither save nor borrow.
  - Idiosyncratic shocks: no aggregate uncertainty; distribution of shocks across households within each sector remains constant.
- Equilibrium/steady state:
  - Markets for domestically produced goods, credit, and labor clear; prices of imported food and agricultural exports are exogenously given; aggregate variables and prices are constant over time.

### EMPIRICAL REGRESSION EVIDENCE ON FINANCIAL INCLUSION (Appendix I)
- Regression approach follows Allen et al. (2013); uses 2013 data from Sub-Saharan African countries (some observations omitted for data gaps).
- Reported coefficients (dependent variables: log(Depositors per 1000) and log(Borrowers per 1000)):
  - log(GDP per capita): 0.286 and -0.317
  - Oil-rich: -0.937 and -0.022
  - Rule of law: 0.260 and 0.349
  - Political stability: 0.453 and 0.693
  - Population density: 0.000 and -0.002
  - Rural-: -0.012 and -0.001
  - Inflation: 0.055 and 0.015
  - Internet per hundred: 0.031 and 0.059
  - Mobile cellular subscriptions: 0.000 and 0.000
  - Public credit bureau coverage: 0.033 (reported in table)
  - Private credit bureau coverage: 0.020 (reported in table)
  - Constant: 3.763 and 5.231
  - Number of observations: 3429
  - Adjusted R-squared: 0.77 and 0.75
- Note: bold-typed coefficients indicate statistical significance at the 5-percent level (as reported in the table).

### POLICY IMPLICATIONS AND CONCLUSIONS
- To sustain inclusive growth, growth-promoting reforms that generate macroeconomic gains need accompanying policies to address distributional costs and protect those who may lose out.
- Key policy design principles:
  - Assess policy impacts using a framework that combines macro-structural understanding with micro-level income and consumption distribution.
  - Strengthen fiscal instruments (tax administration, reduce exemptions, adjust brackets) to increase redistributive capacity while promoting private-sector-led growth.
  - Replace poorly targeted subsidies (e.g., electricity) with better-targeted direct transfers to improve equity and efficiency.
  - Deepen financial access, especially in rural areas, through supportive regulation, MFIs/SACCOs outreach, mobile/electronic banking, and instruments suited to rural savers.
  - Use targeted cash transfers (e.g., expanded PSNP) to protect vulnerable rural households during structural transformation and agricultural price adjustments.
  - Facilitate rural-to-urban migration as part of structural transformation while designing policies to share benefits across households.
- Overall finding: a well-designed package combining DBE funding reform, streamlined tax incentives, expanded targeted transfers, financial deepening, and managed migration can raise efficiency and protect equitable growth objectives, particularly for the rural poor.

*Source: _cr15326 - INTRODUCTION (September 4, 2015), IMF staff.*

### INTRODUCTION  ________________________________________________________________________ 3

### INTRODUCTION

### Overview and Objectives
- The Fund is increasingly concerned with how income inequality affects growth and macroeconomic stability, noting that many fast-developing countries experienced rising income gaps over the last decade.
- Empirical finding cited: raising income inequality by 1 percentage point (through increasing the income share of the top 20 percent) reduces GDP growth on average by 0.08 percentage point; a similar decline in income inequality (by increasing the income share of the bottom 20 percent) has been associated with on average 0.38 percentage point higher growth.
- Objective of the paper:
  - Review the evolution of inequality in Ethiopia, compare with regional peers, and discuss the role of macroeconomic policies and structural factors.
  - Quantify the distributional impact of a set of selected growth-enhancing policy measures, including long-standing IMF recommendations, using a tailored dynamic general equilibrium model.

### Key contextual points
- Ethiopia selected as a pilot case for the Fund’s project to operationalize its work on inequality because equitable growth is deemed macro-critical.
- Data sources referenced: “Household Income, Consumption and Expenditure Survey for 2010/11” (HICES 2010/11) and World Bank “Ethiopia: Poverty Assessment 2014”.

---

### EQUITABLE GROWTH AND POVERTY REDUCTION IN ETHIOPIA

- Real GDP increased on average by 10.8 percent per year during 2004-2013.
- Ethiopia’s growth exceeded regional peers and other developing and emerging market countries.
- The share of the population living below the poverty line halved between 1995 and 2010, from 60.5 percent down to 29.6 percent.
- Poverty measurement:
  - Poverty line defined as percentage of the population living on less than $1.25 per day, purchasing power parity adjusted.
- Ethiopia’s poverty reduction performance is noted to be comparable to Senegal despite Senegal having twice as large GDP per capita.
- Regional disparities:
  - Discrepancies in poverty among regions have narrowed; public infrastructure investment attributed to improved market access and incomes in previously remote areas.
- Food insecurity:
  - Despite expansions in government programs to combat food insecurity, food price shocks remain the biggest threat to Ethiopia’s poorest households.
- Poverty metrics:
  - Incidence, depth (poverty gap), and severity (squared poverty gap) reported; reductions in incidence did not always translate to commensurate reductions in depth and severity.
- Inequality:
  - National Gini coefficient reported as 30.
  - Rural consumption distribution is very equal; land consolidation regulations contribute to low farm size variation and low rural Gini.
  - Urban inequality: after a decline between 2004 and 2010 (by 6.2 percentage points), recent developments indicate widening income gaps in cities.
  - Rising skill premia for higher education and changing household characteristics identified as drivers of increasing urban income disparities.
- Vulnerability:
  - The most vulnerable households benefit less from growth than higher income deciles.
  - Overall vulnerability to food price shocks has increased almost tenfold despite expanded government policy efforts.

---

### IMPACT OF FISCAL AND SOCIAL POLICIES ON INCOME DISTRIBUTION

- Fiscal policy as redistributive tool:
  - Fiscal instruments (income taxes and transfers) can reduce inequality of disposable incomes directly; in-kind benefits (education, health, housing) can affect inequality of market incomes via future earnings, health, and ability to work.
- General assessment:
  - Fiscal policy in Ethiopia has an overall positive distributional impact on income inequality, but efficacy could be improved.
  - Recommendations include strengthening tax collection, eliminating tax exemptions, revising tax brackets upwards, replacing indirect subsidies (particularly on electricity) with direct transfers, and leveraging the Productive Safety Net Program (PSNP) experience to address urban unemployment.
- Revenue policy specifics:
  - Ethiopia faces typical developing-country tax challenges: low tax-to-GDP ratio, heavy reliance on trade taxes, and generous tax exemptions and expenditures.
  - Recent improvements in tax administration allowed Ethiopia to catch up with some peers (e.g., Tanzania and Uganda), but performance still lags targets and regional averages for low-income countries.
  - Policy priorities: reduction of excessive tax exemptions and tax holidays; policies promoting private sector development to broaden the tax base.
- Direct taxes:
  - Direct taxes (personal income and business income) are progressive but account for a relatively small portion of overall tax revenue, limiting redistributive impact.
  - Analysis shows 67 percent of personal income taxes is paid by the top 20 percent of the population.
  - Lack of revisions to tax brackets for a decade and a relatively low threshold of the first tax bracket imply Ethiopia levies more taxes on the lowest income households compared to other countries.
- Agricultural taxation:
  - Agriculture contributes less than 1 percent to total tax revenue despite the economy’s agricultural predominance.
  - Land fees and agricultural taxes are decided by regional governments and are levied according to land size and fertility; current land fees are regressive as they vary only with land size.
  - Recommendation: better define and capture commercial agriculture in the tax net to broaden the base.
- Expenditure and social policies:
  - Government pro-poor strategy focuses on five areas: education, health, agriculture, access to water/sanitation, and roads.
  - Over the last five years, spending on those five areas accounted for 70 percent of total expenditure.
  - Within pro-poor spending, education and roads comprise the highest shares: 25 percent and 20 percent respectively.
  - Heavy investment in roads: total road length increased by 30 percent and access to all-weather roads expanded.
- Subsidy reform:
  - Electricity subsidy estimated cost: Birr 1.5 bn, equivalent to 2.6 percent of general government spending.
  - Because largest benefits accrue to relatively better-off households, recommendation is to replace electricity subsidies with direct transfers to improve targeting, efficiency, and transparency.
- Productive Safety Net Program (PSNP):
  - Introduced in 2005; targets more than 8 million beneficiaries (9 percent of total population), primarily in famine-prone areas.
  - PSNP integrates cash transfers with public-work employment; it is the second largest protection program in Africa and critical for poverty reduction.
  - With expected rural-to-urban migration under structural transformation, PSNP experience should inform urban-targeted programs.

---

### FINANCIAL INCLUSION

- Literature and empirical evidence:
  - Financial development is associated with positive impacts on economic growth and more equitable distribution of growth benefits.
  - Cross-country finding: the Gini coefficient falls more rapidly in countries with more developed financial intermediaries (Back, Demirguc-Kunt, Levine, 2007).
  - India-specific finding: output increased and poverty declined with greater access to finance (Burgess and Pande, 2005).
- Benefits of financial development:
  - Channels capital to more productive sectors, increases resources available for investment.
  - Reduces cash and barter transactions, limits cost of remitting funds, and allows smoothing of income and consumption over time.
  - Insurance services reduce vulnerability to shocks for households and firms.
  - Some studies indicate greater financial inclusion reduces inequality directly by easing credit constraints.

*Source: _cr15326 - INTRODUCTION (September 4, 2015), IMF staff.*

### 18.      Financial development in Ethiopia should focus particularly on rural areas where the

### Financial development in Ethiopia should focus particularly on rural areas where the

### Financial system structure and access
- Access to finance is primarily through the banking sector and microfinance institutions (MFIs).
- There are 18 commercial banks and one state-owned development institution (Development Bank of Ethiopia).
- The sector is highly concentrated: the largest, state-owned commercial bank comprises about 70 percent of total assets.
- Bank branches have increased four-fold since 2010.
- More than a third of branches is located in Addis Ababa, while almost 80 percent of the population lives in rural areas.
- Population per bank branch: 35,957 as of March 2015.

### Microfinance, SACCOs, and financial inclusion gaps
- National Bank of Ethiopia (NBE) developed a prudential regulatory framework for microfinance in 1996; Microfinance Proclamation 40/1996 opened the possibility for deposit-taking MFIs.
- As of March 2015, there were only 24 MFIs providing financial services.
- MFI penetration: less than 4 percent of the population being served.
- SACCOs remain small by international standards; coverage is insignificant relative to the size of the unbanked population.
- Ethiopia’s broad money to GDP accounts for 75 percent of the regional average.
- Private sector credit to GDP is only 25 percent of the regional average.
- Bank penetration (total assets to GDP) in Ethiopia: 42 percent of GDP versus close to 60 percent in SSA; this ratio has declined over the last 12 years (by 41 percent), while in the region this ratio has increased by almost 50 percent.
- Credit to the private sector increased from 8.2 percent of GDP (2003) to 9.4 percent of GDP in 2015.
- In Sub-Saharan Africa (SSA), credit to the private sector grew fivefold over 2003–14, with an annual increase of 16 percent.

### Constraints on credit allocation and pricing
- Majority of credit is channeled to state-owned enterprises, limiting private sector access to formal credit.
- Limited financial credit products (e.g., lack of availability of personal loans) and high cost and lengthy procedures to seize collateral hinder credit market development.
- Negative real interest rates are present, distorting pricing, eroding incentives to save, and hampering financial intermediation.
- Since 2011, private banks are required to invest the equivalent of 27 percent of their new loans in NBE bonds; proceeds are used to finance the DBE (see paragraph 30).

### Policy recommendations on financial sector reform
- Reform financial sector policies that constrain availability of credit to the private sector; eliminate policies constraining credit availability.
- Promote mobile banking and electronic financial services; the rapid development of M-Pesa in Kenya cited as a model.
- Promote capital market development as an alternative to bank credit for financing.
- Encourage MFIs and SACCOs to increase outreach to the poor by opening them up to institutions willing to provide capital and ensuring an appropriate regulatory environment.
- Promote financial instruments tailored to the needs and preferences of rural savers to mobilize private savings.

### Mobilizing private savings
- Mobilizing private savings may require legislative changes and incentives to improve availability and return on existing instruments and introduce new instruments.
- Easy access to convenient and safe saving instruments can raise savings significantly.
- Promotion of financial instruments suited to rural savers is vital for generating and mobilizing savings among the rural population.

### Model-based analysis: scope and calibration
- The study uses a dynamic general equilibrium model calibrated to Ethiopian economy features:
  - Agriculture: 43 percent share in GDP; almost 80 percent of workforce; accounts for 90 percent of goods exports and a third of total exports.
  - Baseline year (2011) model moments: agricultural sector accounts for 41 percent of GDP; tax incentives to exporters are approximately 2.8 percent of GDP; tax revenues are 13 percent of GDP.
- Model structure highlights:
  - Small open economy with three consumption goods: domestically produced food, imported food, and non-food goods.
  - Four household types: rural, urban, government employees, entrepreneurs; continuum of households with idiosyncratic risk.
  - Three goods produced: domestic food (rural households), non-food items (urban households or entrepreneurs), traditional exports (entrepreneurs).
  - Only financial assets: one-period bonds; in baseline only urban households have access.

### Policy scenarios analyzed in the model
- Reforms assessed:
  - Reform the DBE's funding policy by eliminating the "27 percent investment requirement".
  - Streamline tax incentives for exporters in a revenue-neutral way (tax incentives estimated to reduce tax revenue by 2.8 percent of GDP per year).
- Equitable growth complementary policies:
  - Double the size of the PSNP from 1 percent of GDP to 2 percent of GDP.
  - Deepen access to financial services: additional 25 percent of the rural population gains access to financial services; reduction in the risk premium in loans to all borrowers from 15 percent to 5 percent.
  - Foster rural-to-urban migration: 2.7 percent of the rural population migrates to urban areas, expanding labor supply to modern sectors by 19 percent.

### Quantitative results and distributional implications
- Removing the DBE funding implicit tax increases the return on private sector capital and raises private investment by 3 percent.
- Structural transformation effects:
  - Manufacturing (more capital intensive) receives the largest stimulus; manufacturing acquires more capital, increasing labor productivity and labor demand; wages increase.
  - Urban sector average welfare improves; reforms benefit urban households more than rural households in the short run.
- Impact on rural households:
  - Traditional exports sector faces higher wages and demands less labor and less agricultural goods; farmers switch from commodity exports to domestic food production.
  - Increased domestic food supply more than offsets higher demand from urban sector; price of agricultural goods falls, lowering welfare of rural households.
  - In the short run inequality increases, though poverty falls and the poorest in rural areas would enjoy higher consumption than before.

*Source: IMF staff report content provided in the supplied PDF chapter.*

### 37.      The proposed reform alone generates macroeconomic growth, but has a distributional

### _cr15326 - 37.      The proposed reform alone generates macroeconomic growth, but has a distributional

### Macroeconomic and distributional effects
- The proposed reform generates macroeconomic growth but has a distributional cost in terms of inequality and poverty.
- To sustain inclusive growth the reform needs accompanying policies that address those who may lose out by redistributing the benefits across all agents in the economy.
- Structural change in the simulations (share of GDP):
  - Before economic reforms: Manufacturing and Services 54%, Agriculture 46%
  - After economic reforms: Manufacturing and Services 63%, Agriculture 37%

### Policy measures evaluated
- Three policies considered to offset distributional costs:
  - (i) cash transfers (expansion of the PSNP)
  - (ii) rural-urban migration
  - (iii) financial sector deepening

### Findings from simulations and quantitative impacts
- Cash transfers (targeted to the rural poor)
  - Reduce inequality, measured by the Gini coefficient.
  - Reduce the proportion of households below the poverty line.
  - Can be financed from the increased economic activity that results from fostering private investment and from streamlining tax incentives.
  - Targeting the rural poor is pertinent when the price of agricultural goods is negatively affected by the proposed reform.
- Financial deepening (especially in rural areas)
  - Reduces consumption inequality and supports economic growth.
  - Facilitates saving by rural households, allowing consumption smoothing over time.
  - Strongest effect for households that wanted to save but lacked access to financial services.
  - Lowers risk premia (via a better regulatory environment that allows banks to monitor and enforce contracts more efficiently), freeing up resources for private investment similar to reductions in implicit taxes.
  - Estimated effects: helps to boost private investment growth (by 1 percentage point per year), and output (by 0.3 percentage point per year).
- Rural-to-urban migration
  - Contributes to equalization of labor returns in urban and rural areas.
  - Facilitates structural transformation by supplying inexpensive labor to manufacturing and services.
  - Estimated effects: increases private investment growth (by 1 percentage point per year), and output (by 0.5 percentage point per year).
- Distributional outcomes in model
  - In the simulation, increasing cash transfers reduces both the Gini coefficient and the proportion of households below the poverty line.
  - Financial inclusion and migration both contribute to narrowing consumption inequality, particularly benefiting rural deciles.

### Model structure, mechanisms, and calibration notes
- Model type: dynamic stochastic general equilibrium model of a small open economy with multiple sectors and heterogeneous households.
- Occupations (four types): Agricultural workers (rural); Entrepreneurs (urban); Public sector workers (urban); Private sector workers (urban).
- Key production and consumption features:
  - Agricultural workers produce food for consumption or sale.
  - Entrepreneurs produce a non-food item using capital and labor; non-food good used for consumption or converted into capital.
  - An agricultural export product (e.g., coffee) is produced by entrepreneurs using the domestic food product as input.
- Financial intermediation roles:
  - Convert non-food goods into capital.
  - Allow workers to save and borrow.
  - Government imposes a tax on financial intermediation: if households save at real rate r, borrowers face interest rate r+߬௦; to increase capital stock by ܫ, entrepreneurs pay ሺ1൅߬௦ܫሻ.
- Fiscal policy parameters include:
  - A tax on entrepreneurs’ capital income
  - A tax on private and public sector workers’ wage earnings
  - Sector specific and means-tested transfers
- Household features:
  - Households live forever, are forward looking, face idiosyncratic productivity shocks, and decide consumption versus saving and allocation across domestically produced food, imported food, and non-food item.
  - Only private and public sector workers and a given fraction of agricultural workers have access to finance; remaining farmers can neither save nor borrow.
- Idiosyncratic shocks: no aggregate uncertainty; distribution of shocks across households within each sector remains constant.
- Equilibrium/steady state: markets for domestically produced goods, credit, and labor clear; prices of imported food and agricultural exports are exogenously given; aggregate variables and prices are constant over time.

### Empirical/regression evidence on financial inclusion potential (Appendix I)
- Regression approach follows Allen et al. (2013); uses 2013 data from Sub-Saharan African countries (some observations omitted for data gaps).
- Reported coefficients (dependent variables: log(Depositors per 1000) and log(Borrowers per 1000)):
  - log(GDP per capita): 0.286 and -0.317
  - Oil-rich: -0.937 and -0.022
  - Rule of law: 0.260 and 0.349
  - Political stability: 0.453 and 0.693
  - Population density: 0.000 and -0.002
  - Rural-: -0.012 and -0.001
  - Inflation: 0.055 and 0.015
  - Internet per hundred: 0.031 and 0.059
  - Mobile cellular subscriptions: 0.000 and 0.000
  - Public credit bureau coverage: 0.033 (reported in table)
  - Private credit bureau coverage: 0.020 (reported in table)
  - Constant: 3.763 and 5.231
  - Number of observations: 3429
  - Adjusted R-squared: 0.77 and 0.75
- Note in table: bold-typed coefficients indicate statistical significance at the 5-percent level.

### Policy implications and conclusions
- Assessing the impact of growth-promoting policies that address inequality requires:
  - An in-depth understanding of the economy’s structure and channels of policy transmission.
  - Accounting for the micro-level distribution of income and consumption and their connections to the macroeconomic and policy framework.
  - Considering the depth, access, and efficiency of the financial sector.
  - Evaluating effects of structural reforms and policies on different sectors and households and potential tradeoffs with other objectives.
- The illustrative model scenarios show that a well-designed set of policies can increase efficiency and protect equitable growth objectives, particularly for the rural poor.

*THE FEDERAL DEMOCRATIC REPUBLIC OF ETHIOPIA    INTERNATIONAL MONETARY FUND*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15326.pdf_