Ethiopia’s Economy in Code Blue

The nation’s economy has reached a point where the economic fundamentals cannot be sustained without a major intervention. A starting point that could have a significant impact would be privatisation of major state enterprises, writes Ermias Amelga, an economist and a businessman engaged in manufacturing, commercial banking, investment banking and real estate. He is a frequent writer and speaker on development economics and development strategy in Ethiopia and Africa.

While the entire nation has been distracted and preoccupied with the political crisis, the economy has deteriorated to the point of collapse. The classic symptoms of an out of equilibrium and a deteriorating economy – acute and chronic foreign exchange shortages, high and accelerating inflation and declining economic activity – are all visible.

The shortage of foreign exchange, in particular, has reached a point where it is choking the economy to death. This economic crisis threatens to derail and reverse the dramatic economic growth and development achieved over the last 15 years.

The crisis is the culmination of an extended period of structurally unbalanced and distorted economic policy. The imbalances have reached a tipping point where economic activity across all sectors of the economy has ground to a virtual halt. At the same time, inflation in the economy has re-emerged at an alarming and accelerating rate.

The economic term for this worst-case scenario of combination of recession and inflation is stagflation. It is the most problematic of economic conditions to manage and resolve, because the policy prescriptions to address one exacerbates the other, thereby driving an economy into a circular recessionary cycle difficult to break.

We have reached a point where the current economic policies simply do not work. Updated economic strategies and policies are necessary to address the many structural weaknesses and imbalances in the economy that are the cause of the current crisis.

The core problems are the Growth & Transformation Plans (GTPs), which are sustained by large foreign and domestic debts. The success of a debt-fueled strategy is contingent on its sustainability.

Sustainability is, in turn, contingent on the many large-scale investment projects undertaken, generating returns on a timely basis to service the debt and maintain acceptable levels of debt to keep borrowing and investing.

Furthermore, the economic transformation of the economy into an export-oriented manufacturing economy that can generate adequate supplies of foreign exchange to service the debt is a must.

Unfortunately, this structural transformation has failed to emerge in Ethiopia. The large sums of money borrowed by the State and invested not only in critical hard and soft infrastructure but also in such state-affiliated entities as the Metals & Engineering Corporation (MetEC), the Ethiopian Sugar Corporation and industrial parks, have failed to generate the required returns to maintain the economy’s debt sustaining capacity.

We need to look no further than the debt-fuelled booms and busts witnessed in Latin America in the 1970s and ‘80s to understand what has happened and why.

It took Latin American countries decades to recover. Argentina is still making headlines with its recurring financial crisis spreading over 50 years and still counting. Bailouts without the appropriate policy reforms simply do not work over the long run.

Eliminating the foreign exchange crises through regime liberalisation is a must before anything else. It is the core problem paralysing the economy. Nothing will change or work until and unless the foreign exchange crisis is fully addressed.

Efforts to contain these pressures through price controls, rationing, and import restrictions have depressed the economy, reduced fiscal revenue, and caused external trade to shift to the informal sector. Attempts to fix the nominal exchange rate through administrative means will continue to result in chronic and crippling foreign exchange shortages.

What the economy needs immediately is a massive infusion of non-debt foreign exchange financing to kick-start economic activity combined with the set of policy measures and strategy recalibration. As much as 50 billion dollars or more of new foreign currency earnings, support or savings can be achieved over the next five years with a set of new policies and actions.

The most recent and relevant example of successful foreign exchange liberalisation in Africa occurred in August 2016 in Egypt. The nation reached an agreement with the International Monetary Fund to obtain a 12 billion dollar loan to support the three-year economic reform program.

The liberalisation of the exchange rate in November 2016 had an immediate positive impact on the Egyptian economy and sparked the recovery. The black market premium was substantially eliminated, the price of the dollar fell and Egypt’s reserve of hard currency rose.

The country’s foreign reserves rose by about 18 billion dollars in 14 months to 37 billion dollars at the end of December 2017. Foreign exchange shortages were eliminated and the economy was revitalized.

Can Ethiopia Replicate the Egyptian Experience?

We first need to look at what would be required, which is a hard currency war chest of approximately six billion dollars to absorb the initial currency demand surge from multiple sources that will accompany the liberalisation of the foreign exchange regime.

Privatisation, even partially, of some of Ethiopia’s largest state-owned enterprises could generate this financing and more. The funding required to address the foreign exchange crisis, resuscitate the economy and re-launch it on a self-sustaining growth trajectory, along with the appropriate policy reforms indicated, is approximately four billion dollars in a year. It would be two billion dollars in the second year. Even the partial privatization of just Ethio telecom would be adequate to cover these amounts.

Privatisation will not just solve the GTPs’ financing problem, a worthy enough accomplishment in itself, but would also help address three chronic macroeconomic problems. Inflation, the suffocating foreign exchange crisis and the unduly tight squeeze on credit to the private sector.

In the context of huge financing needed to fulfil the plans under the GTPs, privatization represents an excellent means of cashing out on the accumulated net worth of Ethiopia’s state enterprises. Indeed, there is arguably no more justifiable use of this accumulated net worth than spending it on the GTP that the government itself believes is worthy of supreme sacrifice from all corners of society.

Corrective policy measures are urgently needed to restore economic activity and balance. The economy needs a large, non-debt, foreign currency infusion and a liberalisation of the exchange rate regime to a managed float. This requires a war chest of six billion dollars after which market forces will balance supply and demand of foreign exchange.

Fortunately, in Ethiopia’s case, there is a viable path out of this mess. Privatisation – even if only partially, of a few large state-owned enterprises can finance all of the GTP objectives. The benefits of privatisation extend well beyond just providing funds for the GTPs. Two other significant advantages of privatisation are as important, if not more so than getting funding for GTPs.

First and foremost, privatization will, if done rightly, offer a cure for inflation. Inflation in Ethiopia has been linked heavily to a financing problem. More broadly, with government divesting its holdings in key areas of the economy, there would be a healthy re-balancing of ratios such as private investment-to-GDP and private manufacturing-to-GDP. This means a more competitive and more efficient economy with higher productivity.

In addition, it is desirable to have not one but two strong engines, both private and public, driving Ethiopia‘s economy and privatisation by attracting foreign investment, know how, and dynamism in key GTP supported sectors can play a major part in making this possible.

The newest thinking on the developmental state model, aims to bringing structural change back to the core of development strategies, and it emphasises the important roles for the market and the state in the process of promoting economic development.

It prescribes that the market should be the basic mechanism for resource allocation, but that government must play an active role in coordinating investments for industrial upgrading and diversification.

The New Structuralist Economics or Development Economics 3.0 is the third wave of development thinking that Ethiopia needs to adopt as its core development strategy. It is simply a learning and experience-based upgrade and extension of the developmental state model that Ethiopia has been following.

It would take six months to resolve the foreign exchange crisis.

The first step is securing the required six billion dollar war chest to absorb the initial currency demand surge from multiple sources that will accompany the liberalisation of the foreign exchange regime. This can be secured within six months through a non-debt commercial bridge financing tied to the privatisation of Ethio telecom.

This ought to be followed by signing into place a managed float of the Birr. Voilà, problem solved!

By Ermias Amelga
Ermias Amelga, an economist and a businessman engaged in manufacturing, commercial banking, investment banking and real estate.

Published on Sep 08,2018 [ Vol 19 ,No 958]



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