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    BusinessFuel subsidy cut, looming budget deficit

    Fuel subsidy cut, looming budget deficit

    Just a week after Prime Minister Abiy Ahmed (PhD) announced his decision to lead the Ethiopian national army from the battlefront in its fight against the forces of the Tigray People’s Liberation Front (TPLF), the two officials manning the country’s economy, Yinager Dessie, the governor of the National Bank of Ethiopia, and Ahmed Shide, Minister of Finance, made a rare appearance on state-broadcaster, Ethiopian Broadcasting Corporation, to discuss the macroeconomic impacts of the year-long war.

    Fuel subsidy cut, looming budget deficit

     

    Citing the reforms undertaken in the last two years, the duo looked confident as they disclosed that the country’s economy remains resilient, despite facing numerous challenges since last year. These challenges range from the Coronavirus pandemic that brought the world’s economy to standstill to the war in the Northern part of Ethiopia.

    Despite their optimism, however, it is simple to observe their worry over the impacts of the war on public expenditure and the challenge faced by the government to finance the budget deficit, further widened due to the continued fighting with the rebel group.

    Expressing his hope that war will end very soon with the joining of Prime Minister Abiy on the battlefield, the Finance Minister, Ahmed disclosed the plan to restructure budget and cut unnecessary spending in a bid to narrow the deficit caused by the war and a drastic fall in grants from development partners.

    While this might be a short-term solution to withstand the impacts of the fighting on government coffers, the latest measure of the government to adjust the price of fuel by almost 24 percent is a clear testament that the challenge to finance the deficit economy, already tested by the war, is far from over.

    An outcome of the surge in international price of oil, which has doubled since last year, the adjustment led to the spike of benzene to 31.74 Birr a liter, a 23 percent jump, and almost similar upsurge in price of diesel to 28.74 Birr a liter. Though it was a second price adjustment made since the beginning of 2021, the increase is the highest seen in almost a decade. Officials at the Ministry of Trade & Industry justified the decision by citing how the government has been bearing the burden for years.

    “Had we transferred the entire change in the international price of oil, the local price of petroleum products would have reached above 60 Birr,” said Hassen Mohammed, state minister for Trade, adding that the government still bears 75 percent from the 100 percent international price increase, while only 25 percent is shared with the public.

    The government has been spending an average of seven billion Birr in oil subsidy for the last five months, according to the state minister, who disclosed that eight billion Birr has been spent in government expenditure to finance the change caused by the spike in international price of oil.

    “The government has been trying to finance the change in import bills because of the change in the price of oil but it has now become necessary to share the burden with the public,” said Mohammed, hinting the subsidy has been a tool to contain the already soaring inflation across the country.

    Though officials assert the adjustment has been delayed for almost eight months as an attempt to avert additional burden on consumers who were already struggling because of the surge in inflation, a little has changed ever since. In fact, headline inflation soared from 20.6 percent to 33 percent since the last adjustment of oil prices during February, 2021.

    A strong increase in the prices of food items has also been witnessed. Food inflation surged from 22.8 percent to 38.9 percent during the same period. Consumers blame the last fuel price adjustment for fuelling the inflation. Meseret Hibste, a housewife living in the capital with monthly income of 6,000 Birr, sounded certain of this.

    “Though other factors may have contributed, many items suddenly saw a huge price increase after the last fuel price adjustment,” said the housewife, who fears the latest increase would worsen the inflationary pressure.

    Evidences suggest higher oil prices will lead to higher costs of production, increased inflation, and decreased living standards for consumers. Especially for an oil importing country like Ethiopia, which has spent almost a billion dollars in the first three months of the existing fiscal year, the impact is more severe. It leads to lower income, lower output, higher domestic prices, and higher unemployment. Experts fear the same thing would happen in Ethiopia.

    “Unlike any other goods, fuel has the potential to cause cost-push inflationary pressure. That means its increase would lead to a rise in price of other goods as it would raise cost of production,” says Leta Sera (PhD), an Economist who has been a lecturer at Jimma University.

    Leta believes cutting the subsidy makes little difference in reducing government expenditure, and narrowing the growing budget deficit caused by the war and the surge in spending for humanitarian efforts. “We should not forget the government itself is the largest consumer of oil. Add that to the money it would spend to stabilize the market if the fuel price adjustment would lead to a rise in cost of living, it means more expenditure,” Leta added.

    For the current fiscal year that started in July 2021, a staggering 561 billion Birr budget was approved by the parliament. A large chunk of the budget (200 billion Birr) was allotted to subsidize regional states. Capital spending makes up the second highest expenditure item, reaching 183.5 billion Birr, 20 billion Birr higher than the recurrent expenditure. 

    The aggregate budget saw 18 percent upsurge, resulting in the widening of the budget deficit to 144 billion Birr, of which 66 billion Birr was supposed to be financed through grants. With a little response from international organizations to finance the deficit, this has complicated the task of policymakers to cover government bills, showing an everyday increase due to the unprecedented cost of the war in Northern Ethiopia.

    “The government has no choice but to cut some expenses, like the oil subsidy, as it is facing a budget squeeze, which is not easy to avert due to the current circumstance in the country,” said Tiruneh Assefa, an Economist, who believes the fuel price adjustment can potentially cause an inflation but it is an acceptable trade-off considering the budget deficit the government has been facing.

    Apart from cutting subsidy, restructuring the budget and reducing capital expenditure, the government is also employing treasury bills auction as a tool to finance its deficit, though recent offers made by bidders showed demand is falling for the government bond.

    An offer of six billion Birr has been made for 16 billion Birr in treasury bill brought to the table during an auction held on December 01, 2021. Though the interest for short-term T-bills (28-days) is relatively higher, there is a little interest among bidders to buy long-term T-bills, spanning between 91 days and 364 days. Yet experts believe T-bills can be a reliable source of finance for the government.

    T-bills are a reliable source because the government can force banks or insurers to invest a certain proportion of their profits or income in T-bills, according to Patrick Heinisch, an Economist. “However, as the T-bill rate is way below the inflation rate it would be prudent for the government not to overdo with T-bill financing. This would cause market distortions,” the expert said.

    Direct advance, borrowing from the central bank, is another debt instrument used by the government to finance its deficit. Though this is a tool not preferred by policymakers due to its potential to cause an inflationary pressure, it showed a significant growth since the war started in North Ethiopia. In the last quarter of the last fiscal year alone, central government borrowing from the National Bank of Ethiopia (NBE) grew by a staggering 169.4 percent to 83.5 billion Birr. Despite the increase, however, experts still believe that should not be a concern at all.

    “Direct advances also increased strongly but the level is far lower than that of other debt instruments,” Patrick remarked.

    Leta agrees.

    “It is better to focus on such deficit financing mechanisms instead of cutting subsidies, which could be more inflationary and burdensome for the public that is already facing numerous challenges,” the Economist concludes.

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