Abdulmenan Mohammed (PhD) is a financial analyst based in London, United Kingdom. He is well-known for providing his views on the financial industry across many media channels. Abdulmenan is presently working as an Account Manager at London Portobello Ltd. He has been praised for his analysis of the performance of banks and insurance firms. He is among the experts who are pleased with the recent adjustment in policy in the banking industry, which has made the sector more open to competition from overseas banks. However, he has certain reservations, including a worry that international banks may be unwilling to enter the Ethiopian market. Ashenafi Endale of The Reporter sat down with him to discuss the banking sector and the economy as a whole.
The Reporter: You live and work permanently in London, and you just arrived in Addis Ababa. What are your observations and impressions of Addis from this trip?
Abdulmenan: There is an air of stability in the capital now, compared to my previous trips. Relatively, it is peaceful now, but the traffic and mobility chaos in Addis Ababa remain as they are.
You closely follow up on the Ethiopian financial sector and the economy. Recently, the government has been preparing to end protectionism and liberalize the banking sector. Do you see local banks having a copping mechanism in place? Which entry modality do foreign banks prefer out of the four allowed by the National Bank of Ethiopia (NBE)?
Local banks are extremely worried that foreign banks will come in mass and force them out of the market. But that will depend on what type of service products the foreign banks will bring to Ethiopia. If foreign banks offer the same service lines as local banks, local banks will face difficulties. The worry is also there with the NBE to some degree. That is why you see a lot of restrictions in the banking open-up policy document and the draft proclamation of the Banking Business.
So the NBE is not going to just open up the sector at once; rather, it will be gradual. Only a certain number of foreign banks will be allowed, and there will be a limit on the number of branches they can open and how much their management can be involved. I do not think there is anything to fear. The opening will take place in controlled scenarios that will not put local banks at risk. But basically, local banks should not be afraid of competition. But I don’t think the big international banks have the appetite to come to Ethiopia as the government expects. They know the Ethiopian market is too small for big financial institutions like Barkley. Most of the banks that will come are African. Apart from that, NBE officials said all the laws and restrictions applied to local banks will apply to foreign banks. This will also highly discourage the foreign banks, which do not want government intervention to this extent. There are a lot of interventions, apart from the 21 percent mandatory investment in government bonds.
A number of local banks are already considering merging. Is that the only survival mechanism?
If their services and market niches are similar, they can succeed by merging. But if a merger is forced upon the local banks by the NBE, the outcome will be bad. A merger should be based on market congruency and the full consent of the banks. The shareholders also must agree. Local banks can also consider specializing in certain business areas.
The NBE protects local banks’ interests, and local banks, in turn, protect shareholders’ interests. But from the consumer side and access to finance perspectives, there is a wide gap. Will the market open up under a restricted scenario, improving the low access-to-finance situation in Ethiopia? Will the opening up of the banking system actually spur economic growth?
Access to finance is one big challenge in the Ethiopian economy. This is because the economy is largely informal. Lack of access to finance cannot be fully attributed to the banks. A large number of businesses cannot access banking finance because those businesses are engaged in informal economic activities.
Of course, the central bank considered the banks’ interests in this open-ended process. This is also largely because the sector has to remain stable. If the economy is to be stable, the banking sector must remain stable. So, the NBE has to protect the banks’ interests to maintain the stability of the sector. Arbitrary action by the banks can damage a country.
There are numerous tasks that must be completed in order to maximize the consumer’s benefit from banks. A well-compiled record and information about each consumer are necessary. If banks have all the information they need about citizens, it will be simple to give loans. But so far, less data is available. Many banks do not know their customers well. People are taking out loans with multiple fake IDs. This has to improve to boost access to finance. Compiling data and information on all citizens is also important for credit rating work. One of the reasons for the restrictions in the Ethiopian financial sector is due to the poor data collection. But Ethiopia cannot protect its banks forever. They have to compete.
Do you think the insurance sector should also be opened up?
Definitely. The opening up of the financial sector should be holistic. I even expect more foreign investors to come to Ethiopia if it is opened up. The central bank recently established a minimum premium. Insurance companies say they are losing revenue because of stiff competition. One of the aims of competition is to expel unfit competitors. So that is normal.
What is the major challenge in the financial sector?
The government’s budget deficit is still disrupting the financial sector, and its domestic credit is very large. The government is also forcing banks to invest around 21 percent of their loans in government bonds. During the EPRDF, the government had an ideological reason to engage in economic activity. For example, it said 27 percent of the money from banks was invested in development projects via the Development Bank of Ethiopia. The current government even has no such excuse. The government is doing this just because its revenue and expenditure could not match. The current government is intervening in the financial sector as well as the economy at large. This is the worst type of state intervention in the economy. It even has no ideological base.
In reverse to EPRDF’s developmental state approach, in which the state’s investments crowded out the private sector, the Prosperity Party (PP) introduced reforms pledging state withdrawal from economic activities. But we also see the new government asserting itself in the economy. Can we say that the four years of reform have shifted the economy from a state-run to a private-sector-led economy? Do you think the state’s crowding of the financial sector has diminished and more bank loans are going to the private sector now?
The reform had very insignificant changes. The new government pledged to leave the economy to the private sector. But it came back and reasserted itself, even with more depth. The private sector never ran the economy. The government never left the economy to the private sector. The former government, for example, used to force banks to invest 27 percent of their loans in T-bills. The current government also introduced a 20 percent mandatory investment requirement in government bonds. Banks’ hard currency surrendering is currently constrained. The current situation is even worse. The previous administration’s 27 percent bill and overall state participation in economic activities had some ideological support. It was under the developmental state model. But the current government is taking money from the economy, mainly to finance the deficit. This is the worst case.
In Ethiopia, most of the factors of production are under government monopoly. The big and key institutions are under state control, land, and finance is also under government control. If an economy is to operate properly, the factors of production must be led by the market.
The reason there is a lot of conflict and war in Ethiopia is because all resources are controlled by the state. When every resource is in the government’s hands, the only way to access that resource is by assuming power in the government structure. So, everybody is fighting for power in Ethiopia to get hold of the resources. The main reason everybody is going to the forest, taking up arms, and fighting in this country is to control that resource in the government’s hands.
But if the government withdraws from controlling every resource and the resources are left for the citizens to access in the market, the war route cannot be used as an option. The reform is much talked about, but nothing is progressing so far. Many projects, like the sugar factories, could not find buyers. The government initiated some new projects, and it still has a significant hand in the economy.
Do you think ethnic politics, which is largely based on the land ownership of ethnic groups, will diminish if land is privatized?
Yes. Everybody can work on the land it owns. It was Derg that first enabled farmers and peasants to own land. However, the EPRDF made no progress in terms of land privatization. During the Derg, the EPRDF, and the current government, land has remained the government’s property.
This is the primary cause of Ethiopia’s interminable conflict. The major reason there is displacement and conflict is because land is owned by the government. There is also no land supply for housing, investment, or development. So, land must be returned to its owners, the citizens.
You also work on property and mortgages in London. In Ethiopia, a number of new banks were formed in the past year, pledging to work on mortgages. The housing market and property market bubbles, however, remain.
The mortgage market in Ethiopia cannot improve in the near future. There are many complicated problems. Those new banks that pledged to specialize in mortgages will soon convert to commercial banking and conventional business. First of all, what we call a “mortgage” in Ethiopia is concentrated only in Addis Ababa. Most of those who can buy houses in Addis are employed professionals. But the average housing price is much higher than the average income of employed professionals in the city. It is incomparable.
So housing is unaffordable for the majority. Even if it is a mortgage, they cannot afford the monthly payment. A housing unit’s monthly payment can range between 40,000 and 60,000 birr. How many Ethiopians have such disposable income that it covers all their other expenses as well? Plus, it needs stable employment because the mortgage is paid for up to 25 years.
The inflation spike in the country is also disturbing the market. Housing properties also have complications related to documentation problems, making it difficult to transfer title deeds. Starting a good mortgage business in Ethiopia is difficult. Several problems have to be addressed before establishing mortgage banking in Ethiopia. The reason housing prices are highly inflated is because the price of land is highly inflated. Basically, land cannot be sold, but it is being sold indirectly at high prices. The reason land prices are inflated is because land is under the monopoly of the government. So this is distorting everything.
The current government says the economy is market-based. But there is a lot of intervention under the pretext of development. Do you see that the developmental and profit-seeking aspects of the economy are balanced?
That is why we see a lot of problems in the economy. There is confusion between capitalism and socialism. In the 1990s, there was massive privatization and a significant shift from a command economy to a market-based system. But after the 2005 national election, everything reversed, the state’s role in the economy rose, and the government completely controlled the economy. The EPRDF said it emulated the East Asian tigers, but its practice greatly deviated from their principles.
In the East Asian model, public institutions and businesses are highly professional. Under the EPRDF, there was no line between party and government institutions. Now, after the PP came to power, there is no clear approach. They talk about market-based systems, and then they talk about developmentalism. In the meantime, some reform efforts are underway. But PP is running everything based on what it inherited from the EPRDF. The entire body inherited remains in place.
Some privatization and liberalization work is currently underway. Many criticize the government for doing so, not because it is opting to reduce its hand in the economy but as a result of the foreign currency shortage and the strict preconditions of International Financial Institutions (IFI).
Take the sugar projects, for example. The government invested in 10 sugar projects, but they could not find buyers now. MetEC was engaged in embezzlement because of state intervention policies. The state’s intervention has done enough damage to the economy.
By the way, without strict principles in place, humans have the tendency to embezzle any resource. So the current government had to learn from the EPRDF and reduce state intervention in the economy. The government’s current privatization and liberalization efforts are largely motivated by western pressure.
Currently, the privatization of ethio telecom’s 40 percent stake and sale of a second license are underway. What do you expect?
This was in the pipeline for the past two to three years. The government had suspended the sale for a year, but it is now back in action. This is because the foreign currency shortage has reached a very critical stage. And this forex crunch can be solved only by selling some of the public assets, among other options.
How much revenue do you expect from ethio telecom’s 40 percent sale and License B sale?
My rough estimation for the 40 percent is around USD seven or eight billion. This is considering ethio telecom’s annual revenue, which is growing significantly faster. There will be evaluations by the government, investors, and consultants.
Local banks are also allowed to sell up to 40 percent of their stakes to foreign investors. Do you think that will also generate sufficient hard currency?
Yes, but the local banks must have an interest in selling equity first. If there is a capital market, foreign investors can buy shares of a bank bit by bit and eventually control 40 percent of a local bank. But if a single foreign bank came today and asked to buy 40 percent, the shareholders might refuse. The valuation can also be tricky without a capital market.
Under the current circumstances, it is highly unlikely that shareholders will allow the sale of equity in their banks. But once the stock market is operational, they cannot do anything. If a local bank offers a large volume of shares at once and wants to generate forex by selling the shares to foreign investors, then it might attract foreign investors. But this too needs shareholders’ consent. Of course, foreign banks want easy access. They do not want a complicated operating environment.
Ethiopia’s distressed debt is currently creating huge pressure on the economy, with most of those external debts maturing now. Its annual external debt service will double to USD 4.1 billion in the next couple of years. On the other hand, the national foreign exchange reserve remains below USD 1.6 billion.
Yeah, the forex reserve does not cover even one month of import bills. The government in the past has taken external loans without a second thought on how to pay them back. The loans were not used on good investments that could pay back the debt. And now that the maturity date has approached, the government is in hot water.
The International Monetary Fund’s (IMF) debt restructuring is our only hope right now. Since the current government is undertaking the reforms and a peace agreement between the federal government and the Tigray People’s Liberation Front (TPLF) has been signed, there is hope. IFIs can also disburse fresh funds now. So, working on the G20 scheme is not optional for Ethiopia. All in all, unless the G20 and IMF schemes succeed, Ethiopia will default on its debts. The political tension between the East and the West can affect Ethiopia. Though China is the major creditor, it is the IMF that does the detailed work of debt restructuring analysis. So, the IMF plays a key role in making decisions, including putting pressure on the creditors.
Ethiopia is trapped in a vicious circle of foreign currency crunches, devaluations, and inflation. Do you see any breaks from these?
There is a wrong assumption that the devaluation of the birr improves export performance. Ethiopia tried it in 2010, 2017, and consecutively in the past few years. The currency depreciated rapidly until the end of March, but it never improved the export sector. Why does the government always do the same things with the same bad results? I do not understand. Ethiopia has a problem with boosting export earnings, which is not due to price. Devaluation works when you have abundant export items in the domestic market but fail to compete in the international market due to price. But Ethiopia is facing a critical supply-side shortage. As long as we work on agriculture and manufacturing, exports can grow even without the need for devaluation. Improving the supply side of the economy is important not only for getting rid of the forex shortage but also for keeping inflation in check.
The government has taken measures to shift the Treasury bill market from a government-led to a market-based system. Do you think the Treasury market is productive now?
Previously, banks and the private sector were not investing in the Treasury bill market. Only the pension funds were investing in Treasury bills. However, since private banks began investing in Treasury bills in the past few years, the size of the market has increased significantly. The interest rate also doubled, from just three percent.
New legislation has recently allowed public and private employee pension fund administrations to invest in assets other than Treasury bills. Will this change pension funds for good?
The new legislation is good for the pension fund. In the past, they were forced to invest only in treasury bills, with less than three percent interest. Now, they can invest in other portfolios with better interest rates, so pensioners’ money will be spent on good investments at least now, and pension benefits might get better dividends in the near future.
The government is crafting two documents for the post-Tigray War economic recovery. The first is on reconstruction, while the second is on economic reform. The government is saying up to USD 28 billion worth of property was damaged during the war in the country. What should the post-war recovery approach look like? What kind of economic trajectory can we expect?
The economic reform plan cannot continue with the same mentality for another two years. The reform must take into consideration the impacts of the war and the dynamics in both the domestic and international markets. The “homegrown” reform was first planned without considering the war. Many things have changed now.
As a result, the government must walk a fine line between reform and reconstruction. Otherwise, it should put aside the reform agenda and fully focus on the reconstruction aspect. It is difficult to implement both plans at the same time.
Given the depleted external sources of finance, the government should mobilize resources internally. But this cannot be done unless there is economic growth. As a result, it appears that both reconstruction and growth must go hand in hand.
The external finance probability is very uncertain. At least Ethiopia reached an agreement to stop the war now, which is a very positive thing. Europe’s and the US’s position is unpredictable now, in relation to the Ukraine war. They are unlikely to provide us with additional funds in the coming years. So, the Ethiopian government must wisely use the scarcely available resource and capitalize on the reconstruction.
Ethiopia’s stock market is currently in the making. Do you expect it will change access to finance?
It will be a good platform to raise capital for the banks as well as prospective enterprises. The stock market will also create realistic share prices in Ethiopia. Currently, bank share prices in Ethiopia are decided arbitrarily. But after the stock market, there will be a new price discovery, facilitating the trading of stocks. The stock market will also help create corporate discipline in Ethiopia for the first time. Every piece of information about publicly traded companies will be available. If there is a flaw, nobody buys your share.
Foreign direct investment (FDI) inflow has dropped since the Tigray war. Do you think the investment uncertainty is improving now?
We hope so. The peace agreement has a significant impact on this end. Of course, some parts of the country still need stability. However, there is a chance that FDI inflows will gradually improve.
Government expenditure has ballooned over the past couple of years. But the return is nowhere to be seen, largely because a large portion of the expenditure has gone to non-productive areas. How can the government reprioritize its resource allocation?
There are no quality projects in Ethiopia. It would be good if we could focus on development. But the time we are in does not allow that. We see financing to construct parks. That is good, but other key public investment areas also must get the appropriate focus.
There are a lot of market disruptions in Ethiopia. Parallel markets are created for almost every item.
That is largely due to government interventions. For instance, the cement market has been in chaos for the past couple of years. That was because the government was trying to set prices and control supplies.
Since its recent withdrawal from the cement market, cement availability is returning to normal. The government should also stop setting the price for cement. Then everything will improve.
Government control should be limited to making sure that producers, suppliers, and wholesalers do not make deals under the table and determine prices. There is consumer protection legislation in place to avoid this. What the government should do is enforce the law and regulate malpractice in the markets. But regardless of the consumer protection law, the government’s intervention has further complicated matters.
In developed economies, the economy usually responds to monetary actions. For instance, inflation can be reduced by cutting interest rates or raising tax rates. Why do monetary policies remain indifferent in developing countries like Ethiopia?
It reacts quickly in economies close to or in equilibrium. A well-established market system is in place, and they are in a functional economic system. All the economic actors have their own expectations, and they respond immediately.
Simply put, a developed economy is a big machine. It is a complicated machine, but it functions properly. Ethiopia’s economy is far from that. The market in Ethiopia is not even functioning properly.
So can we expect the policies introduced in Ethiopia to be effective?
If the policies are well tuned, yes, they can work. The policies must be fine-tuned to specific problems. Experienced and professional policymakers are required for this. For instance, Kenya managed to maintain control over inflation not because it has a fully developed market but because it has independent and functional institutions. They have better institutions.
You often say the NBE should be reformed first in order to reform the financial sector. Do you see progress in that direction?
Financial and economic institutions must be free of politics. The central bank, in particular, must be independent of the government’s political interests. The central bank is responsible for both monetary policy and regulation.
As long as the government orders the central bank to print and inject money to fill the budget deficit, monetary policies cannot work and are useless. Regarding regulation, the central bank does not treat state banks and private banks equally. Many restrictions introduced by the NBE do not work for the Commercial Bank of Ethiopia (CBE). CBE is not penalized for the same issue that private banks are.
So, if the financial system and the economy are to be stable, the central bank must be fair and not controlled by anyone else. This will also help control inflation. Key institutions, such as the central bank, must be independent of the executive branch and strictly accountable to the legislature.
Is the national macroeconomic team strong enough to introduce policies that are tailored to the specific challenges and economic distortions the country is going through?
The macro team is usually occupied with fiscal, political, and other issues. However, the NBE was established solely to control inflation and maintain a stable monetary system.
Everything is laid out by the macro team. The NBE’s task is monetary. However, because the macro team is also involved in political issues, the central bank is put under pressure. The macro team orders the central bank to do what the government wants. Then the central bank goes out of its way and starts serving the government’s interests.