Officials at the Ministry of Finance (MoF) are using every available tool to ensure that the budget deficit is the least of their concerns in the coming years. All options appear to be on the table, from reducing capital expenditure to persuading bilateral and multilateral partners to increase external financing and achieve the debt restructuring required.
This year, they have been tasked with addressing the federal government’s record-high 310 billion birr deficit during the current fiscal year, which will end on July 8, 2023. A gap of this amount appeared at the end of a period that was marked by a sluggish increase in tax revenue due to both internal and external reasons.
“Following the pandemic and domestic conflict, it has been a challenging time for Ethiopia to meet tax revenue targets and resume fiscal consolidation,” Alisa Strobel, senior economist at S&P Global, told The Reporter.
As the country was beginning to recover economically from the coronavirus pandemic, which caused a loss of income tax in the billions of birr as businesses saw a sharp decline in revenues and the dominant segments of the economy, service and construction, were hit hard, Ethiopia found itself in the midst of a civil war.
The war exacerbated an already dire situation. It caused a spike in government spending due to rehabilitation programs for victims of war and an accompanying hike in the defense budget. The humanitarian expenditure could have gone even further if it weren’t for the assistance of donors. Also, in war-torn regions, tax authorities had no way to collect revenue.
When humanitarian aid and the cost of supplying the military are factored in, even a conservative estimate of the war’s economic impact puts the loss at more than 400 billion birr. War direct damages are not included because officials have previously estimated they could top USD 20 billion (one trillion birr).
Following the speedy execution of the peace agreement agreed between the federal government and the Tigray People Liberation Front (TPLF), reconstruction is now on the table, and officials are using all available alternatives to gather resources. Between USD 20 billion and USD 29 billion has been bandied about as the likely cost of reconstruction.
The budgetary pressure will be exacerbated by higher spending on reconstruction costs too, according to Alisa.
“A larger fiscal deficit this year is expected at around four percent of GDP,” the economist said.
One strategy adopted by the authorities to cope with the budget constraints is to reduce spending as much as possible. The education and transportation sectors both scrapped a number of their capital-intensive projects. The subsidies that had been imposed in the past to provide assistance to those in need are either partially or completely lifted.
“The decline in the government’s monthly outlay for fuel subsidies, which began gradually since July 8, 2022, will modestly support some of these fiscal pressures,” Strobel remarked.
However, Abdulmenan Mohammed (PhD), a financial specialist with over two decades of expertise, sees inflation as undermining efforts to cut expenditures. Year-on-year inflation has been above 30 percent for more than a year and even went above 34 percent last month.
“The government must work on the inflation, which is increasing government expenditures,” said Abdulmeman, adding, “The government must seriously consider restructuring the government apparatus, aiming to reduce expenditures, waste, and corruption. This helps to reduce the budget deficit and borrowing from the central bank.”
Another approach to closing the budget gap is to increase domestic revenue. Currently, tax laws are being revised. Regional and municipal governments will shortly begin collecting property tax, which will reduce their reliance on the federal government and give it more fiscal space. The VAT proclamation is being revised to include industries that were previously exempt from this form of tax. Likewise, the income tax proclamation is being revised. All changes are intended to increase tax revenues.
Despite efforts to increase revenues, certain expenditure components have already pushed government spending well beyond what can be raised locally. In recent years, debt service costs have escalated due to the approaching maturity of external loans secured during the previous decade. It’s so serious that the government had to ask external creditors to restructure their debt.
In light of the country’s budget crunch, experts believe restructuring or direct budgetary assistance is essential.
“We do expect to see an increase in project-based financing from multilateral and bilateral sources, for example, for reconstruction efforts, but direct budgetary support from the IMF or debt restructuring under the G20 Common Framework is ultimately needed. And indeed, the urgency for prompt debt restructuring is exacerbated by higher debt servicing costs over the next two years,” Strobel said.
Currently, grants from external sources appear to be growing at a snail’s pace. After reaching almost null during the war in North Ethiopia, which scared away donors such as the European Union, external grants in the form of direct budgetary support are now showing a slight increase but are still far below the sum required to finance the government’s deficit.
The ongoing delays in budget grants and external concessional loans have prompted the government to place significant emphasis on domestic financing in the form of treasury-bills and direct central bank advances, according to Alisa.
About 473.4 billion birr in treasury bills have been put up for auction by the government since the beginning of the current fiscal year. A total of 277 billion birr worth of T-bills were sold to banks and non-bank institutions (mainly pension agencies), with one-third of the bills maturing in less than six months and the remainder in one year. As of December 31, 2022, there were a total of 315.4 billion in outstanding T-Bills.
The average yield on T-bills hovered around 9.5 percent, making them the government’s main source of deficit financing, although not sufficient to close the gap. Direct advances from the central bank, which are often regarded as being the same as printing money, are currently being used to cover the gap, which remained high even after the sale of T-bills.
During the first half of the current fiscal year, the federal government borrowed 40 billion birr from the central bank as a direct advance. But direct advance is the government’s last resort, and it is highly unlikely that it will be used due to pressure from the Bretton Woods institutions.
“With a resumption of an IMF support program, it is unlikely, however, that direct central bank advances will continue in this regard. The government has overall reoriented its public spending away from productive projects and toward rehabilitation and Ethiopia’s reconstruction needs,” she remarked.
For economist Girum Kassa, securing lasting peace stands out as the most effective method for preventing Ethiopia’s economic misfortunes.
“Political will and commitment for a lasting peace are crucial currencies that Ethiopia needs more than ever. Once political stability is ensured, we can secure budgetary support from bilateral and multilateral agreements, among others, to stabilize the economy. Plus, additional investment programs could be forged,” Girum emphasized.