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The Ethiopian economy:

The Ethiopian economy: The good, the bad and the worst

An expert in macro-economics and a vast experience in the Ethiopian financial sector, Eyob Tesfaye (PhD) is one of the pundits willing to express his views and suggest solutions for economic matters of the country. In an interview with The Reporter, Eyob talks about issues ranging from national economic plans to the status of remittance. He argues how the structurally poor economy is paving the way for inflation to hamper poor communities. The views he has expressed in this interview are his own and don’t necessarily reflect the views of the organization or organizations that he works for. Eyob recommends ways of addressing unemployment and uneven distribution of wealth in the country. He also suggests that tourism could be one of the untapped sectors of the economy that would significantly address the challenges of hard currency shortages.  Excerpts:

The Reporter: Some people argue that the developmental state approach the government pursues has crowded out the private sector. They also argue the approach has not been able to create more jobs as needed. What is your view on that?

Eyob Tesfaye (PhD): In any given economy, the role of a government is directed towards leading and helping the economy of that country grow. The state of the economy determines the role its government plays. When we see the case of Ethiopia, it remains to be one of the countries with huge development deficit. Poverty could not be slashed despite the different governments who assumed power. During the first 15 years of ruling, a pro-poor economic strategy which the existing government initiated was so weak to reduce the level of poverty. In fact, it was a very poor strategy to bring about economic transformation in the country. 

The developmental state or the rational plan state approach from strategy point of view could be seen as a necessary and a right approach. It is because the focus is towards reducing poverty and creating a strong powerful force of industrial sector. In fact, there are issues that we could argue on like how long the government should remain as the main leader of the economy? When would it be stepping aside its leading role in the economy and instead plays a supportive role? When will the private sector be empowered to assume the central ground? The argument remains as long as these questions remain unanswered. If we decide to allow a free market economy to function, we need to establish the market at the first place. Without having created pillars of development and productive capacity, talking about free market economic system is to no avail.

On the other hand, if we don’t have such a strategy during the absence of free market economy then it would pose the question; what possible alternative strategy should we have? Road, electric power, education and the like are the necessary infrastructural activities that the government strides to build on. These are the sole responsibilities of the government not the private sector. Hence, the strategy from the reduction of poverty level point of view could help and we cannot deny that on the basis of theory or on actual grounds.  What remains out of the development strategy would only be the philanthropic attitude of Mother Theresa, feed the deprived. Otherwise it could not be a feasible method to alleviate poverty.

The first Growth and Transformation Plan (GTP) didn’t achieve as expected. The GTP-II as well wouldn’t be effective either. What could you say on the two GTPs in general?

This question should have been directed to those individuals assigned to execute the plans. I couldn’t say much on how the plans are performing because I don’t have the figures with me. But I can reflect on some points.  There are some achievements made during the first GTP and there are also some projects visibly achieved in the current GTP-II. When you adopt a strategy, the critical point you should note is how to translate it into a plan, how you translate the plan into programs and the programs into projects. You should have implementation and institutional capability to do that. You need to have a monitoring and evaluation tactics to guarantee the projects implementation on the right schedule and budgeting. You also need to have ample financial resources to help the projects get implemented. Down the line, you need to have a detailed target for operation; you need to work out who implements what and with how much financial resource.

So far, by looking at the scope of the national economic plans, we can infer that they have been over stretched and they are over ambitious. The plans have been derived without having prudent sources of financing. Some of the projects have not been feasibly evaluated. Hence, some of the hiccups we have seen during the first GTP are still lingering in GTP-II. When compared with the first plan, GTP-II lacks political commitments and probably is faces weak oversight.

Please elaborate on the point you have stated saying ‘had been implemented well, the projects would be achieved?’

Huge projects have been introduced without having the right capacity for implementation and follow-ups without having the necessary financial capacity. Some projects should have been slanted for capable foreign companies which have both financial and technical capabilities. Let the local companies have the exposure of working together with foreign firms so that they would grasp a technical know-how and experiences. Foreign companies should be allowed to work in areas where local firms lack in expertise. The other point we need to see is that the projects were sought to be implemented on the basis of credit financing. Foreign firms who are interested to build these projects were required to bring finical resources as well. However, there were other alternatives to look at. Many projects could have been implemented via alternative project financing methods averting the country from increasing its debt burden. For instance, Public Private Partnership (PPP), joint venture, Build-Operate-Transfer and the like could have been considered as alternative financing approaches. Had local investors been encouraged to take part in the agriculture and industry sectors more could have been achieved.

Look at the commercial farming in Ethiopia, it achieved nothing. If you look at the textile sector, you will find out how many plants have been forced to shut down. Though, crafting linkages between agriculture and industry is mentioned in the national economic plans, what you could see happening in reality is very poor. The focus is directed towards building roads or constructing dams. Unless, the industry sector is made to support the agriculture sector, the industrialization path might culminate to no avail.  

Let’s talk about inflation. What are the reasons behind for the rising trends of inflation in Ethiopia?

The inflationary situation is adversely affecting the working-class community and pensioners. The government has stepped in to avert the impacts but little has been achieved. In my opinion, the very basic source of inflation in this country emerges from the economic model the government pursues. For an economy to stride, basic infrastructural necessities are required. You need to have capital formations as economists call it. In development deficit countries, governments tend to create financings or what they call marshal resources via taxes, credits, domestic savings, and privatizations in order to get the required development happen. However, the accumulated financial resources might not cover all the expenditures they have. That imbalance between revenue and expenditure creates budget deficits.

In a bid to relieve the deficit, the government might turn to the central bank. New money could be injected into the economy in order to ease the budget deficit.  This approach is called deficit financing or inflationary financing. In addition to the government’s borrowing from the central bank, the private sector borrows from local banks, the external borrowing and remittances altogether add-up to increase the supply of money in a given economy. This in turn will create an aggregate demand and this will in turn create inflationary pressures. According to the inflationary or deficit financing concept, a rise in the demand side leads to an increase in the supply side which in turn will result in a short term inflationary phenomenon.

However, the supply response might be sluggish in addition to the gestation period of some projects might be extended which will cause a rising inflationary situation. At this point, the economy has already become overheated. This is the major cause of inflation in Ethiopia. The source of financing is causative for the rising inflation. This approach by itself basically can be considered as ‘walking on a tight rope.’ We can’t say this approach is wrong. It can create an environment for a quick exist from poverty. However, you should know what level of inflation the society could tolerate. Inflation is a necessary evil but you have to measure the extent it should be entertained. If not checked in time, the consequences of inflation could be devastating. In my opinion, the inflation rate couldn’t be halted below 10 percent unless the supply side problem is improved.

How long would the inflationary situation remain unresolved in this country?

To have the inflation rate get to the level of zero or below that status has its own minuses. In order to have production growing, the producer needs to have an attractive price in the market. This price necessarily includes inflation to it. As our body needs earnest temperature, an economy as well requires to have the right amount of heat. The approach might differ from one country to another when an economy slows down or gets into recession; governments try to recuperate their slacking economies via increasing the money supply by adjusting exchange rates. This process is known as quantitative easing or helicopter money. In a move leapfrogging the economy, the approach considered by the government of Ethiopia is considered as inflationary financing. The increase in the supply of money has created a situation to an increasing trend in the demand side. The growth in demand was not equated with an adjusted increase in the supply side and that fueled the inflationary situation. Both the monetary policy and the lethargic growth of supply of goods and services have contributed to the rise of inflation.

Various monetary instruments have been implemented to curb the rising trends of inflation but due to the gradual growth in the supply side, it has enabled inflation to remain unchecked. A meaningful supply side intervention, modernizing the agriculture sector could help lower the inflation to the required status. The puzzling issue as to why the growing trends of the economy couldn’t deter the inflationary situation is because of the supply of goods and services not satisfying the demand side. 

The National Bank of Ethiopia (NBE) recently implemented a 15 percent devaluation measure against the dollar. The reason in doing that, according to the central bank, is related to incentivize the export sector in line with narrowing down the trade deficit the country struggles to balance. Would that measure warranty for an effective outcome?

To begin with, an exchange rate is one of the key macro-economic tools that aid in governing the economy efficiently. Let’s say the exchange rate of the birr against the dollar might be found to be overvalued or undervalued. Hence, when we say birr is overvalued, a tourist, a businessperson or who has a dollar will receive small amount of birr. In this situation, you have to adjust the exchange rate in order to facilitate competitive environment for the Ethiopian exporter. The science of economics dictates that. From this perspective, the measure NBE has implemented is correct. But if you ask me if this measure will help narrow the wide trade deficit balance, I would say no. You have to have a surplus production which will be traded at the international market competitively. 

For instance, your coffee should dominate the global value chain. When you have the capacity, you may not need the policy advices from the World Bank or from the IMF. You can adjust your exchange rates as needed. However, adjusting the exchange rate at this time in the view of having future productions could not help reduce the existing trade deficits you have. The deficit will further widen as prices of imported capital goods and commodities continue to rise. Trade deficit will increase unless the structural problems of the economy are resolute and the purchasing power of your currency will also remain in depreciation.

You spoke about hard currency shortage reaching at a critical stage. Currently, the hard currency shortage is adversely affecting the economy. What are the causes of the acute shortages of hard currency the country is experiencing?

In previous years, there were symptoms that indicated the fast-growing trends in the demand for hard currency. We assume some projects of the government might require 50 to 60 percent of hard currency. In addition, those foreign investors whom the government anticipated would come with their own finances, turned out to be looking for hard currencies. During that time, we inquired to public financial institutions to submit a flow chart of hard currencies. Something they never were familiar with and it was difficult for them to comply. What we have analyzed based on the data we had showed; they were nowhere near in accumulating hard currencies to meet the demand. Immediately, we submitted our notes on how the situation has become very subtle and we advised different methods of project financing be devised. We further submitted recommendations for extra work to be done in order to augment the supply of hard currency in the economy. We strongly suggested the challenge would escalate unless immediate intervention is considered. I still have that note with me and can show it.  

Did the notes and warnings you highlighted get any consideration?

I have heard that those who were responsible and who understood the matter found it hard to swallow. But seemed to see how it evolved in time. Otherwise, those officials who were not directly responsible and perhaps could not understand the matter denounced the Public Financial Institutions Agency saying the warnings were over stated. I think they assumed the Business Process Reengineering (BPR) would help them secure ample amount of hard currencies.

How can the acute hard currency shortage be resolved?

This is a difficult question to answer. One of the sources of generating hard currencies is to have a firm export sector in place. Secondly, we have foreign direct investment. Thirdly, we can have official remittances and the rest will include loans and grants. The export sector is found to be in a serious structural economic problem and this forced the sector to perform very low. That’s why the country, in its 112 years of international trading practices, had spent 110 years in trade deficits. The export of coffee and spices alone couldn’t guarantee an improved hard currency gains. The solution to that is to bring about a deep-rooted structural change in the economic system. We can learn a lot from the experiences of Vietnam. In just about 20 years, Vietnam was able to earn USD 244 billion form exports. It’s important to note their development path. We are witnessing a growing trend in foreign direct investment here. Within the coming two or three years, some relief might be expected. Had one seriously considered tourism and remittance sectors, these could be potential areas which could ease the acute shortage. Tourism doesn’t require huge investment. Innovative approaches would enable change within a short period of time.

It is argued that the financial sector partly contributes to the growing trends of divisions in living standards and distribution of wealth. What can you say to that?

In a developmental state, the financial sector basically serves as an instrument to balance wealth distribution. That is why developmental states view their economy from the perspective of political economy. Once wealth is created, a developmental state model, I assume it should be distributed fairly and mutually. Ease of access to finance, have priorities in accessing hard currencies, tax privileges and the like are provided to private investors in a motive to get them contribute to the growth of the economy. In Southeast Asia, the likes of South Korea, Malaysia and Singapore were able to expand and grow their respective economies through the financial services sector. I agree with the notion that the Ethiopian financial sector has contributed in creating unbalanced distribution of wealth in the country. The major criterion to have access to credit in this country is to have collateral. Those smaller and medium sectors would have a slice of credits if they succeed to have one. The lofty businesspersons are not industrialists. Those who amass profits would either shift their earnings to Dubai or try to build some properties.

The Development Bank of Ethiopia (DBE) has been criticized for lacking investor centered and effective policies in place. They issue contradictory directives and at times corrupt practices have been noticed. What is your take on that?

I left the banking sector long ago and I hardly know about the bank’s current situation. These problems as well have persisted for long. Some years back, we noticed alarming issues and we alerted the then Prime Minister Meles and convinced him to take measures. While the bank was about to be restructured, some individuals got in the way to stall the process. Immediately, I submitted my resignation. I hope it is to be recalled the enormous criticisms staged against the bank.

People claim there is a deep-rooted corruption and incapacity within the public financial institutions. Previously, as you had led the sector what can you say about that? How do you see the current situation of the institutions?

This question should have been directed to the Federal Ethics and Anti Commission which fought ill-practices of the sector for the past 14 years. I don’t know the current status of the institutions. I was aware that there were honest employees who worked on their wages and annual bonuses. I remember there was evidence presented to the responsible body of government regarding those corrupt individuals who masked on their party membership and influential officials to appear as if they couldn’t be touched. I can’t give any further detail on that since it is a government secret. There are a few individuals capable of running the sector well and there were those who lacked both the capacity and the membrane. You have to get rid of corrupt practices. The major focus should be directed towards scaling up the human capacity building.

The country is hit by a high level of unemployment and hard currency shortages. To resolve these shortcomings, what needs to be done? 

Despite the economy persisting to grow, it lacks to create more jobs and generate ample hard currencies. That is because the economy is transforming from the agriculture sector. The service sector contributes a small share in creating more jobs. We need to have a fresh outlook. It cannot be business as usual. The policies and strategies of the economy need to be evaluated. It is essential to work on contract farming which should not necessarily divulge farmers into debts. In addition to that agricultural mechanization and commercial farming need to be given due attention. Key institutions need to be de-politicized. Special considerations are essential in telecom, finance, textile, leather, chemical, metal industry sectors to be looked at thoroughly. The export sector has to be radically transformed. You can’t expect that happening with your current capacity of exporting some 40,000 pairs of footwear. Above all, since economic development cannot be achieved without the development of human capacity, the emphasis should entail that end as well.

In order to alleviate the depressing hard currency shortage, could it be possible to increase beyond the existing level of USD four billion received in the form of remittances?

In the first place, the USD four billion volume which has been announced as a remittance is not the right figure. International financial institutions have made erroneous mistakes while anticipating how much money could have been remitted into Ethiopia. It is possible that Ethiopian citizens might have remitted lower or higher amount of money against the stated volume.  On the other hand, based on the Word Bank and the IMF data, the official amount of remittance sent home via banks and money transferring agents is found to be somewhere around USD 700 million. A little over 75 percent of the remittance passes through the banks. From the point of addressing hard currency shortage, remittance is considered as a low hanging fruit. It is necessary to make remittance a national agenda. Many countries have done that and have been able to receive huge sums within a short period of time.

Seven years ago, Pakistan received USD seven billion from remittance. In 2017, Pakistan received USD 19 billion. With a population of a 100 million, Philippines secured USD 29 billion and Mexico amassed USD 30 billion. The likes of Tonga Samoa and Fiji in the Pacific, have huge remittance volumes which contributes to 50 percent shares in the GDP. There are ways in which one can enhance the volume of remittance. In the case of Ethiopia, it is possible to do it by emphasizing on those countries known as high value corridors. We have Saudi Arabia, Lebanon, Israel and others where we can increase the volume of official remittance originated from these countries. International institutions that are found in these countries are more than willing to show us how that can be achieved within a short period of time.