Press Release No. 13/407

Press Release: IMF Executive Board Concludes 2013 Article IV Consultation with the Federal Democratic Republic of Ethiopia

October 17, 2013

On September 18, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Federal Democratic Republic of Ethiopia.¹

Recent macroeconomic developments are encouraging, with a significant deceleration in inflation and continued robust economic growth. Despite significant decline in coffee prices and supply bottlenecks, growth remains robust, supported by better agriculture output and construction and other services activities. Inflation declined from the peak of 40 percent in July 2011 to around 7 percent in June 2013. This has significantly eased the extent to which real interest rates were negative. Pressures resulting in foreign exchange shortages in the wake of the passing away of Prime Minister Meles have eased.

Fiscal policy at the general government level remains prudent, with cautious execution of the government budget. Overall revenue-to-GDP ratio is estimated to fall from 14 percent in 2011/12 to 13.2 percent in 2012/13. Reflecting the strong pro-poor focus, the ratio of poverty-reducing expenditure to GDP is being maintained and non-priority expenditure will likely be compressed in 2012/13. The government budget deficit, including grants, is estimated to be 2.8 percent of GDP.

Overall fiscal stance for the consolidated public sector (including public enterprises) is likely considerably more expansionary. While appropriately consolidated data on the overall public sector finances are not available, external financing of public enterprises in 2012/13 and the monetary survey suggest that overall public sector (including public enterprises) borrowing exceeded 9 percent of GDP in 2012/13.

Although the monetary stance remains generally tight to keep inflation in single digits, recent developments point to some relaxation. Base money contracted by 4 percent in 2011/12, but by end-May 2013 expanded by 18 percent at an annual rate. The authorities adjusted slightly the base money target for the year to 13 percent from 12.2 percent. Achieving the 13 percent target implies a very tight monetary policy for the remainder of the fiscal year. The reserve requirement ratio has been further lowered recently (March 2013) from 10 percent to 5 percent, following an earlier (January 2012) lowering by 5 percentage points, and the National Bank of Ethiopia (NBE) sterilized the resulting liquidity injection through the sale of certificate deposits. Broad money growth remains on the high side and was 28 percent in 2012/13.

The external current account deficit widened slightly to US$3 billion in 2012/13 from US$2.8 billion in 2011/12, reflecting a weaker trade balance, although it improved as a ratio of GDP from 6.6 percent to 6.4 percent. Export performance suffered from a decline in prices and weak external demand conditions, growing only 3.2 percent (in nominal terms), while continued infrastructure and industrial investment and higher fuel importation contributed to an increase in imports by 6.3 percent. Transfers brought in a net inflow of around US$5 billion due to a surge in net private transfers that more than offset a decline in official transfers. Increased loan disbursements to the central government and public enterprises yielded a capital account surplus of US$3.4 billion. The NBE’s gross international reserves declined slightly to US$2.2 billion (1.8 months of imports) at the end of 2012/13 from US$2.3 billion (1.9 months of imports) at the end of 2011/12.

Foreign exchange supply came under pressure in the first half of 2012/13. The passing of Prime Minister Meles created uncertainty and excess demand in the foreign exchange market which was also reflected in a widening of the premium in the parallel market. Since its previous peak in October 2008, the Real Effective Exchange Rate (REER) reached the highest level in November 2012, although this has started to turn around with the recent decline in inflation.

Executive Board Assessment

Executive Directors commended the authorities for the Federal Democratic Republic of Ethiopia’s strong growth performance and impressive progress in decreasing poverty and inequality under the Growth and Transformation Plan (GTP). Prudent macroeconomic management has ensured a significant deceleration in inflation. Going forward, Directors agreed that the Federal Democratic Republic of Ethiopia’s public-sector-led strategy needs to be recalibrated, with greater participation by the private sector to sustain robust and inclusive growth and mitigate vulnerabilities. They emphasized the importance of policies to maintain fiscal sustainability, preserve low inflation, rebuild external buffers, and improve financial intermediation and the business environment.

Directors welcomed the authorities’ prudent budgetary stance, but underscored the need to gain a fuller picture of public enterprises’ finances and to pace public investments appropriately. Sustaining pro-poor expenditures will require increased domestic revenue, and Directors therefore encouraged the authorities to continue the momentum of revenue administration and tax policy reforms. Further public financial management reforms as well as a medium-term debt management strategy would also help maintain fiscal sustainability and achieve the fiscal objectives under the GTP.

Directors agreed that a continued cautious monetary stance is warranted to preserve low inflation. They underscored the importance of improving the efficiency and flexibility of monetary policy instruments, including through greater flexibility of nominal interest rates and the development of market-based liquidity management. Directors called for better coordination between exchange rate and monetary policies and for greater exchange rate flexibility to help reconstitute foreign exchange reserves, strengthen competitiveness, and eliminate the spread between the parallel and official rates.

Directors noted that the banking sector remains well-capitalized and profitable. They stressed the need to carefully monitor concentration of large exposures to single entities, and for strengthened capacity to ensure effective financial sector supervision and regulation. Directors encouraged policies to improve the private sector’s access to finance and promote financial inclusion. In particular, phasing out the directive requiring commercial banks to hold low-yield central bank bills would facilitate financial deepening. They also encouraged the authorities to address the remaining deficiencies in the Anti-Money Laundering/Combating the Financing of Terrorism regime.

Directors underscored the transformational power of the private sector, which can be further harnessed to generate employment and sustain development. Accordingly, they advised the authorities to enhance competitiveness and attract Foreign Direct Investment by improving the business climate and fostering competition.

Directors acknowledged recent improvements in GDP statistics. They encouraged the authorities to make further efforts to improve data quality, particularly financial sector, fiscal and balance-of-payments statistics, with support from the International Monetary Fund technical assistance.