Gov’t Can’t Ensure Capital Inflow by Restricting Outflow

For a nation that is growing by above average levels – even by the admission of the Bretton Wood Institutions – the current macroeconomic paralysis is unprecedented. Ethiopia remains a nation that is recording one of the highest growth rates in the world while suffering from severe foreign currency shortage, double-digit inflation and a ballooning external debt.

A macroeconomic policy regime based on a statist’s worldview has come to a dead end. The state-sanctioned practice of distorting the credit market; printing of money to finance budget deficits; and an overvalued currency due to a negative balance of payments has put the economy in paralysis.

It is not surprising that Prime Minister Abiy Ahmed (PhD) appeared before parliament to defend the current fiscal year federal budget, and gave emphasis to the macroeconomic crisis. Although the budget is lower in dollar terms than previous years, policymakers have been worried that domestic revenues (68pc of the budget) would not be able to cover it. It is a concern informed by last year’s collection effort, which had recorded a projected shortfall of 50 billion Br.

Supply constraints and an inefficient tax administration regime have been highlighted as the culprits here. Just as dilapidating to the national economy has been capital outflow, which stands at an estimated one billion dollars annually.

Capital flight mostly has to do with the outflow of foreign currency from a country, given that it is the most accessible form of asset. It severely kneecaps the economic growth of an import-dependent nation such as Ethiopia. It makes infrastructure development and the expansion of the manufacturing sub-sector sluggish as foreign currency is needed to import capital goods.

There appears to be a consensus that high capital outflow is detrimental to an economy. Intervention methods on how to arrest it vary, however. The prevailing view amongst policymakers is that it should be stopped by restricting the movement of capital. They see the outflow as a problem on its own, not a symptom created by capital controls. They are trapped in an old restrictive policy regime designed to protect the domestic manufacturing sector by promoting import substitution through high tariff and strict foreign currency control regimes.

Prime Minister Abiy’s administration has not shown signs of straying away from its predecessors’ policies in opening up the nation’s capital account. His administration has not presented policy changes to encourage individuals and firms to keep their monies inside the country out of their own free will.

While capital controls remain intact, Abiy has emphasised working with overseas governments to uncover hidden accounts held by Ethiopians allegedly hoarding forex overseas. He has also pleaded with members of the private sector to stay away from the practice of stashing their cash in overseas accounts.

It is an ill-advised pronouncement and devoid of a logical base for why moving legitimately acquired assets out of the country is considered illegal, or how profitable it is for private businesses to bring capital into the country. Both are needless sacrifices that pay the price of the government’s inability to incentivise capital inflow and to ensure political and economic stability that will encourage businesses to reinvest here.

Capital flight mainly occurs when there is a high degree of political instability. Any government that is unable to guarantee the security and safety of its citizens and their properties loses the confidence of businesses. An environment where the rule of law has broken down and a precarious policy of unpredictability exists is anathema for capital to stay put in the country.

Restrictions in capital outflows may have contributed to the problem also. Foreign companies that have investments in the country are facing challenges given the inability to repatriate their profits. They are faced with high liquidity that leaves them in a tricky situation where they either have to reinvest here and take their chances with a historically precarious evaluation of the Birr against major currencies and high inflation. It discourages future investment inflow.

Capital flight is persistently tied to tight capital controls. It cannot be addressed by putting more restrictions on the nation’s capital account, or even toughening up border controls. It is often the case that if traders have the will, they will find a way to move their liquid assets out of a country. This is easier to accomplish in countries located in unstable regions.

Fewer controls on capital flows have been found to encourage inflow in the long-term, as was the case in India in the early 1990s, with the liberalisation of the current and capital accounts. Kenya is another example where the capital account is liberalised, and an exchange market is floated. Such are the necessary measures that allow a nation to become more financially integrated into the global economy and effectively reduce capital outflow. Net capital flows to India, for instance, increased from 7.1 billion dollars in 1991/92 to 108 billion dollars a decade and a half later.

Ethiopia should similarly roll back its legacy of draconian laws that stand against the free movement of capital and the right to own foreign currency. The central bank ought to allow Ethiopian citizens and firms to open foreign currency accounts here as well as open bank accounts abroad. Exporters should be allowed to retain the foreign currency they generate, as opposed to the 30pc they are currently allowed. And Ethiopian expats should have the right to keep their hard-earned foreign currencies without having to convert it to Birr.

Such liberalisation could give individuals and firms the level of confidence that enables them to move capital out of the country as effortlessly as they can bring it in.

The administration should recognise that citizens have the right to own one of the nation’s significant sources of wealth creation, foreign currency. The alternative, where the banks collect foreign currency and dole them out based on an arbitrary system, fails to reward meritocracy. In fact, the right bestowed upon banks to mobilise and apportion forex is one of the sources of corruption and favouritism in the market.

An ideal mechanism of ensuring that those who are most productive get the resource that they need is to allow them to keep the resources that they generate as they please.

However, the temporary risk in liberalising the nation’s capital account and introducing a floating forex market cannot be shrugged off. When the guardrails against moving capital freely are removed, there is nothing keeping individuals or firms from doing so except preferences.

The underlying reason for capital flight is not the removal of these guardrails or a plot on the part of the private sector to deny the nation of its resources. It is a failure of the government to ensure political stability, maintain a stable currency and low inflation, and to fend off severe external debt burden that is responsible for the capital flight.

The administration cannot have its cake and eat it, too. It cannot opt to attract capital into the country while also restricting outflow during political and economic crises. Its policy instruments in cases of foreign currency exposures, whose effects could be out of the hands of the government, the capital controls imposed should be industry and time-bound.

Opening up the nation’s capital account would force the government to be more restrained in its use of resources and proactive in its policy decisions and regulations. It would compel it not to depend on issuing decrees that merely prohibit the outflow of legitimately obtained profits, but to take the effort in incentivising individuals and firms to keep their capitals within the country.

Published on Jul 14,2018 [ Vol 19 ,No 950]



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