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Rebuilding Ethiopia: Accelerating economic recovery for a brighter future

Over the past few decades, Ethiopia has weathered a storm of economic difficulties, grappling with a host of formidable obstacles. From surging inflation rates to soaring unemployment, plummeting currency values to restricted access to credit, the nation has faced an arduous uphill battle.

Domestically, factors like rapid population growth, political instability across regions, infrastructure deficiencies, and governance issues have compounded the situation. Externally, the mounting burden of external debt, the ripple effects of Middle East instability, and the Russia-Ukraine conflict have further strained the Ethiopian economy.

This perfect storm of instability and political tensions has emerged as the primary catalyst for the country’s financial woes and economic challenges. Investor confidence hangs in the balance as this erratic state obstructs corporate activities and discourages foreign direct investment. Rising unemployment rates and diminishing funds for crucial sectors like healthcare and education have posed additional hurdles, exacerbated by the rapid expansion of Ethiopia’s population.

External factors also play a significant role in Ethiopia’s financial woes. The country’s main exports, such as oilseeds, textiles, and coffee, are acutely vulnerable to global commodity price fluctuations. Moreover, the weight of external debt has imposed severe limitations on government spending and resource allocation for vital development projects. Although rapid population growth holds the potential to serve as a source of human capital growth, high levels of unemployment within the country challenge its positive impact.

A careful examination of these multifaceted challenges reveals the urgent need for comprehensive solutions. Whether through constructive dialogue or sweeping economic reforms, it is imperative that these obstacles be addressed promptly.

Outlook and Risks

The key to steering Ethiopia out of this quagmire lies in bolstering political stability through the cultivation and popularization of a culture that embraces dialogue as a means of resolving political disagreements. Transparent governance and inclusive policies serve as pillars in this transformative process. Furthermore, to alleviate the economic hardships plaguing the nation, strategic investments in infrastructure development must take center stage, enhancing productivity and competitiveness while simultaneously reducing reliance on primary commodities.

In particular, the persistent armed conflicts in the country have been the impetus behind a major humanitarian crisis, leaving a trail of devastation in their wake. Food insecurity and famine have gripped the nation, with a staggering 20 million Ethiopians in need of urgent humanitarian assistance as of September 2022. These ongoing crises have deepened the cycle of poverty, severely eroding people’s means of subsistence.

Ethiopia’s economic journey has encountered its fair share of obstacles, but the nation’s resilience and determination continue to pave the way for progress. While the real GDP growth dipped slightly to 5.3 percent in 2022 from 5.6 percent in 2021, it outperformed the East African average of 4.7 percent in 2021 and 4.4 percent in 2022.

The pillars driving growth were the robust performance of the industry and services sectors, fueled by strong private consumption and investment activities. However, inflation rose to 34 percent in 2022, up from 26.6 percent in 2021, primarily impacted by internal conflicts, drought, and global commodity price fluctuations due to Russia’s invasion of Ukraine.

The fiscal landscape faced its own challenges, with the fiscal deficit widening to 4.2 percent of GDP in 2022 from 2.8 percent in 2021. This increase was largely driven by higher defense spending and weaker revenue performance. International reserves declined to approximately one month of import cover in 2022, down from 2.2 months in 2021.

Despite these setbacks, the country has managed to reduce its public and publicly guaranteed debt to 50.1 percent of GDP in 2022, with external debt accounting for 23.6 percent of GDP, down from 51.0 percent in 2021.

Ethiopia’s participation in the G20 Debt Service Suspension Initiative in 2020-21 provided some relief, but its subsequent application for the G20 Common Framework for debt restructuring resulted in a sovereign rating downgrade from B to CCC by Fitch and S&P.

The bright spot amidst the challenges was the growth in income per capita, which expanded by 2.7 percent in 2022. However, the internal conflicts and drought amplified the humanitarian support requirements, with the number of people in need rising to 20 million in 2022, up from 15.8 million in 2021.

Looking ahead, Ethiopia’s GDP is projected to grow by 5.8 percent in 2023 and 6.2 percent in 2024, driven by the resilient industry sector, strong private consumption, and increased investment. To fuel this growth, the country requires over USD 316 billion to finance its adaptation (87 percent) and mitigation (13 percent) targets for 2021-2030. Regrettably, only USD 63.2 billion is expected to be mobilized from domestic sources, leaving an average financing gap of approximately USD 33.1 billion per year, hindering the country’s efforts to build climate resilience.

Nevertheless, Ethiopia’s growth outlook is poised to receive a significant boost from the peace dividend, a resurgence in tourism, and the potential liberalization of additional sectors. Inflation is projected to decline to 28.1 percent in 2023 and 20.1 percent in 2024, following the positive impact of the peace dividend.

To harness the potential of green growth and encourage private sector investment in climate-friendly initiatives, Ethiopia must also implement tax relief measures and provide other incentives. By aligning these efforts with private companies’ strategic goals and corporate social responsibility, the nation can create a conducive environment for sustainable economic development.

The country has taken a commendable step forward with the launch of its Natural Capital Accounting Initiative, which aims to establish a robust information system for natural capital to inform national priorities and strategies. Raising awareness and integrating climate and green growth policies into public and private investments, particularly in the natural resource sectors, will be pivotal in unlocking Ethiopia’s natural capital potential and ensuring a sustainable future.

Despite ongoing challenges, Ethiopia’s economy strives to overcome obstacles and pursue a path of growth. However, recent developments indicate a greater need for stability and reforms to attract investments and address humanitarian crises.

In May 2023, the Ethiopian Investment Commission revealed that 51 investors had exited industrial parks due to theft and bureaucratic bottlenecks. During the nine-month period of FY23, the country attracted USD 2.67 billion in capital investment, falling short of the USD 4.5 billion target. Key sectors such as agriculture, manufacturing, tourism, and health remain vital for future growth.

Predictions for 2024 indicate that political instability will persist, with high levels of insecurity nationwide. Fragile peace in the Tigray region and active insurgencies in Amhara and Oromia regions pose significant stability and security risks.

However, a relative improvement in political stability is expected to foster gradual rises in real GDP growth, domestic liberalization, and privatization reforms.

These ongoing crises have further exacerbated poverty and significantly impacted people’s means of survival. There are also concerns regarding the maturation of a USD one billion Eurobond by the end of 2024, coupled with a weak foreign reserve position, puts external financing under pressure, present a high risk of a debt crisis. To mitigate this risk, the country could rely on recovering foreign investment, securing debt relief from major creditors, and securing a new IMF deal by mid-2024 to avoid default.

The prolonged armed conflict in the country has resulted in a dire humanitarian crisis, with widespread food scarcity and hunger. According to UNICEF’s estimates for 2024, approximately 20 million people, including 10.8 million children, require emergency humanitarian aid. To address these challenges and prevent disastrous consequences, UNICEF has appealed for USD 535 million in funding.

The stability of Ethiopia’s banking sector, dominated by state-owned banks, remains intact. However, the nonperforming loans (NPL) ratio was 5.4 percent in 2021, slightly above the required five percent due to conflict-induced project delays.

Furthermore, the current account deficit deteriorated to four percent of GDP in 2022 from 3.2 percent in 2021, primarily driven by higher prices for commodity imports.

A Way Forward

Ethiopia has faced significant challenges in recent years, including economic instability, political conflicts, and humanitarian crises. However, there are potential pathways forward that can help stimulate investor confidence, promote sustainable growth, and address the underlying issues that contribute to instability. The launch of the Natural Capital Accounting Initiative is a step in the right direction, as it aims to build a robust information system for natural capital, which accounts for about 40 percent of Ethiopia’s wealth.

Raising awareness and mainstreaming climate and green growth policies in both public and private investments, particularly in the natural resource sectors, is crucial for harnessing the potential of natural capital. However, limited financing, low technical capacity, and the use of outdated technologies have hindered the operationalization of climate and green growth strategies. Economic reforms and the establishment of money and capital markets can expand the scope for financing green growth and support the transition to a more sustainable economy.

Addressing political instability through open governance and inclusive policies, investing in infrastructure development to enhance efficiency and competitiveness, and diversifying the economy away from primary commodities are pragmatic approaches to improving economic uncertainty and fostering long-term stability. While Ethiopia faces significant challenges, there are avenues for progress. By implementing reforms, attracting investments, and prioritizing sustainable growth strategies, Ethiopia can overcome its current obstacles and pave the way for a more stable and prosperous future.

By Eden Tafesework (PhD)

(Eden Tafesework holds a PhD in International Law and is a senior researcher analyzing areas of concern in the Horn of Africa and the wider East Africa region.)

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