IMF Survey: For Sustained Growth, Ethiopia Needs to Promote Remonetization

IMF News, June 22, 2010

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Ethiopia made progress in restoring economic stability in 2009 while maintaining strong growth.
Short-term priority: arrest a demonetization trend and promote financial deepening to support sustained growth.
IMF 2010 Article IV discussions emphasized adjusting policies to reverse demonetization and reduce vulnerability to shocks.

Findings:
- Consumer price inflation peaked at 64 percent in July 2008 and declined sharply to single digits by mid-2009.
- International reserves fell to 1 month of imports at end-October 2008 and recovered to just over 2 months of imports at end-2009.
- Ethiopia’s real GDP growth is estimated to have eased to 7 percent in 2009/10 from near double-digit growth recorded in 2008/09.
- Following policy adjustments, excess liquidity in the banking system declined; bank credit to the private sector grew but was constrained by credit ceilings.
Policy response:
- Late 2008 policy package included substantial fiscal and monetary adjustments and elimination of fuel subsidies, with measures to protect vulnerable groups.
- IMF support: initial low access disbursement under the Exogenous Shocks Facility (ESF) in February 2009, followed by a 14-month ESF arrangement under the high access component in August 2009.
- First review of the government’s program was completed on June 11, allowing Ethiopia to draw $58.7 million.

Core recommendation: urgently reform monetary and financial policy to remonetize the economy and foster financial deepening.
Specific policy prescriptions:
- Raise nominal interest rates on government securities in conjunction with active liquidity management by the central bank.
- Ensure nominal interest rates are at least as high as the inflation rate.
- Achieve positive real interest rates to support macroeconomic stability and financial system development.
- Tighten control on the printing of money by the central bank to keep inflation low.
- Lift credit controls (credit ceilings) on financial institutions once excess liquidity is mopped up.
- Move toward an independent and active monetary policy focused on achieving low inflation.
Rationale:
- Monetization and financial deepening are engines of growth and development.
- Removal of credit ceilings is needed for monetization and financial deepening to take root.
- Fiscal support is required to relieve domestic financing pressures on central bank financing.

Fiscal measures:
- Prudent budget management has led to stronger revenue collection and constrained expenditure in the first half of 2009/10; domestic financing repayment occurred.
- For 2009/10 as a whole, the deficit will be reduced and domestic financing will be half the original program target.
- A stepped-up tax collection effort is being introduced to sustain stronger revenue efforts.
Financial sector supervision:
- Enhance supervision, especially given the large number of new private bank entrants, to ensure financial stability.
Supporting structural measures:
- Tax reform strategy to raise government revenue from low levels.
- More active liquidity management policy.
- Enhanced monitoring of public enterprise financing.
- Strengthening of national account statistics.
- Over time, implement productivity-enhancing structural policies including financial sector competitiveness and improvements in the business climate.

Exchange rate and external policy:
- The exchange rate was devalued twice: 9 percent in July 2009 and 5 percent at end-January 2010 vis-à-vis the U.S. dollar, on top of a modest ongoing crawl depreciation.
- These actions, combined with the sharp fall in inflation, brought the real effective exchange rate broadly back into equilibrium and improved external competitiveness.
- Further recommended steps: liberalization of the exchange regime, unification of the official and parallel foreign exchange markets, further accumulation of external reserves, and lower import tariffs.
External borrowing and debt sustainability:
- An updated debt sustainability analysis shows Ethiopia is in the low risk range of public external debt distress, providing room for more external borrowing.
- External borrowing, especially on commercial terms, needs to be carefully managed and directed to projects that demonstrate a high rate of return.
Medium-term growth drivers:
- Sustained high export growth and import substitution will require vigorous implementation of productivity-enhancing structural policies.

IMF Survey: For Sustained Growth, Ethiopia Needs to Promote Remonetization — By Paul Mathieu, IMF African Department, June 22, 2010.