BY MARKUS SPECHT
Markus Specht is a first-year IDEV student and editor of SAIS Perspectives.
On April 23, the Federal Democratic Republic of Ethiopia reported 116 cases of COVID-19 and three deaths in the country.[1] In response to the rising number of cases, the authorities have closed borders and schools, ordered the shuttering of nightclubs and entertainment outlets, and announced social distancing measures. Moreover, most states have banned inter-regional public transport and public gatherings.[2] Since Ethiopia is an investment-driven economy, the expected decline in domestic demand due to COVID-19, while problematic for the country, is unlikely to be the most concerning issue. The major channels through which Ethiopia’s economy will be affected are: strained supply chains; potentially higher import prices (partially offset by higher prices of export goods); and increased likelihood of external debt distress due to tighter global financial conditions.
Pre-Crisis Growth and Outlook
Ethiopia is a low-income country with a current per capita GDP of US$772. The large, landlocked, and diverse East African nation has an estimated 109.2 million inhabitants and ranks as the eleventh poorest country in the world by income per person. The vast majority of people in Ethiopia are rural dwellers, and the natural resources base, which remains the foundation for most livelihoods, is subject to considerable climate risks.
Despite many challenges and volatile growth patterns prior to 2004, Ethiopia experienced strong economic growth for over a decade. Real GDP grew at an average annual rate of 8.97% between 2000 and 2018, while per capita GDP rose by an average of 6% each year (Figure 1). However, the impacts of the economic fallout from the COVID-19 global health emergency will slow growth in Ethiopia significantly, with the most recent IMF outlook predicting a GDP growth rate of 3.2% in 2020 (down from 9.0% in 2019) and of 4.3% in 2021.[3] While Ethiopia is thus not likely to suffer the strongest hit among Sub-Saharan peers and is performing better than the projected average for low-income countries, the country’s economy will face significant strains as a result of the current crisis.
Impacts on Domestic and External Supply and Demand
COVID-19 will affect Ethiopia, an import-dependent and supply-constrained economy, mainly through the channel of imports and interrupted supply chains.[4] Ethiopia sources more than 30% of its imports from China, whose own supply lines have been hit particularly hard by COVID-19.[5] The repercussions of overstretched local supply chains trying to substitute for imports could include longer transport time, higher distribution cost, and eventually shortage of commodities in markets as well as higher prices. This comes at a time when it is already getting more expensive to buy everyday items. Inflation has been elevated and above the authorities’ single-digit objective for over two years, recently standing at 21.8% and posing a potential threat to overall economic stability.
Exacerbating the impact of COVID-19 through the channel of imports and exports is the fact that Ethiopia has recently developed a comparatively strong global and regional value chain participation, especially in agribusiness and apparel.[6] With decelerating growth in major economies, such as China, and the resulting lower demand for exports, Ethiopia’s already weak export performance could be expected to deteriorate further. However, since Ethiopia’s exports stood at only 8.9% of GDP in 2018 and thus remain far below the expected 24% (World Bank estimate based on per capita GDP), a decline in external demand will be less problematic than for countries which are more dependent upon their export sectors.
Further limiting the negative impact on growth is the fact that Ethiopia’s two main export goods, coffee beans and gold, are likely to be among the few commodities seeing rising prices in 2020 (Figure 2).[7] With coffee and gold prices rising up to 20% and the prices of imported goods declining, Ethiopia is projected to offset the negative impacts of declining external demand. Therefore, the IMF projects that the current account deficit of -5.3% of GDP in 2019 will not deteriorate in 2020 and will even improve to -4.6% of GDP in 2021.[8]
However, the strained supply chains could lead to a food security crisis. The World Bank estimates that agricultural production could contract “between 2.6% in an optimistic scenario and up to 7% if there are trade blockages.”[9] This is exacerbated in Ethiopia by what the FAO called “East Africa’s worst invasion of desert locusts in decades.”[10] Locust swarms descending upon the country as a result of changing weather patterns could severely limit domestic food supply, while COVID-19 related trade restrictions, if enacted, would threaten food imports.[11]
Finally, there is a large Ethiopian migrant community in Saudi Arabia, many of whom are now being deported. Although Ethiopia will therefore lose some remittances, the country’s low remittances-to-GDP ratio indicates that the economy as a whole is unlikely to be significantly impacted by this.[12] However, Saudi Arabia sending large numbers of migrant workers home poses a considerable public health risk for Ethiopia, whose health system is not prepared to deal with the sudden influx of potential patients.
Impacts on Investment
As a component of GDP volatile to crises, investment is likely to decline substantially, at least in the short term. Massive public investment has so far been at the center of Ethiopia’s economic strategy, with the public investment rate rising from about 5% of GDP in the early 1990s to 19% of GDP in 2011.[14] However, during the global financial crisis of 2008, the amount of capital investment fell from US$ 61,333.2 million in June to US$ 28,510.3 million in December.[15] While it is hard to estimate the exact fallout now, investment will surely decline in 2020 and only pick up again in 2021. This is also linked to capital flight from emerging markets, as global capital is redirected towards assets that are perceived to be more secure.[16]
Ethiopia receives comparatively low levels of net official development assistance as a percentage of GNI.[17] Therefore, the country is likely to suffer less from aid flows drying up than more fragile neighbors. However, emerging economies can be expected to experience a reduction in foreign direct investment (FDI) over the medium term. Ethiopia has lately been receiving an above-average proportion of FDI (as a percentage of GDP), compared to other SSA and low-income countries.[18] Depending on how the government handles the crisis, FDI might decline in the coming years, explaining the relatively slow projected growth recovery to only 4.3% of GDP in 2021.
Fiscal Impacts
Ethiopia’s government revenue in 2017/2018 was 12.3% of GDP, with tax revenue standing at 10.7% of GDP.[19] The IMF has therefore already stressed the need to strengthen domestic revenue mobilization through a combination of tax policy and administration reforms.[20] This issue is exacerbated by the current crisis. Declining revenue from the country’s struggling state-owned enterprises (SOEs) will strain the public coffers. For instance, state-owned flag carrier Ethiopian Airlines, boasting the largest fleet in Africa, has suspended flights to thirty countries and is reporting sharp losses.[21] Moreover, corporate tax revenue from the nascent private sector is likely to decline due to the drop in both external and internal demand.
While the government’s revenue is likely to decline, expenditures will need to go up. The highest expected pressure will be on the health care line of the budget, which could exacerbate the country’s fiscal deficit of -2.5% of GDP (including grants). Ethiopia is one of more than twenty African countries with less than one hospital bed per 1,000 people and per capita spending on healthcare falls within the bottom half for the region.[22] A widespread outbreak and the necessary response would thus require substantial additional resources. Therefore, any projection of future fiscal revenue development crucially depends on the amount of (severe) cases with which the country’s healthcare system will have to deal. Currently, the IMF expects the fiscal deficit to deteriorate from -2.5% to -3.0% in 2020 and to -3.4% in 2021.
In early March, the government responded with a Br 300 million package to buttress healthcare spending, which was increased to Br 5 billion (US$154 million or 0.15% of GDP) on March 23.[23] A “Multi-Sectoral Preparedness and Response Plan,” to be implemented over the next three months, will require an additional US$1.64 billion in funding (ca. 1.6% of GDP).[24] Additionally, the government has exempted any equipment or material used to prevent or contain COVID-19 from import taxes,[25] and the African Development Bank has stepped in by creating a US$ 3 billion “Fight Covid-19” social bond “to alleviate the economic and social impact of the pandemic.”[26]
A broader set of measures, including support to enterprises and job protection, should be considered with the donor community. The expansion of the Urban Productive Safety Net Programme is under active consideration in collaboration with the World Bank.[27] Ethiopia should consider applying for an additional support loan from the IMF to generally strengthen the fiscal position.
Macroeconomic Issues
Inflation and Deflationary Pressures
Inflation in Ethiopia has recently been elevated, posing a potential threat to overall economic stability. Although the supply and import constraints of the economy could worsen this trend through higher import and domestic prices, the IMF projects the increase in consumer prices to drop slightly, from a 15.8% annual increase in 2019 to a 15.4% annual increase in 2020, and finally to only a 9.0% increase in 2021.[28] This can be explained by the drop in global food prices in response to the uncertainty created by COVID-19 as well as by the price increase of Ethiopia’s main exports. Further deflationary pressures can be expected from lower wage growth, falling asset prices, and generally lower expectations.
Debt Distress
Although public debt stood at only 59.5% of GDP in 2017/2018, the IMF concluded that Ethiopia continues to remain at high risk of external and overall debt distress.[30] This is because near- to medium-term debt servicing needs are elevated, especially relative to exports. Specifically, the high external debt to exports and external debt service to exports ratios paint a worrying picture. In fact, the World Bank points out that Ethiopia’s ratio of external debt service to exports of 25.3% is the largest in the region.[31] However, public and publicly-guaranteed debt were expected to remain on a downward trajectory prior to COVID-19, and the projected reduction of the current account deficit could ameliorate the situation. Nevertheless, tighter global financial conditions might necessitate several new loan programs for Ethiopia.
As a preventive measure targeted against the threat of bankruptcies, the National Bank of Ethiopia (NBE) has provided 15 billion birr (0.45% of GDP) of additional liquidity to private banks with the aim of facilitating debt restructuring.[32]
Exchange Rate
Recent poor export performance has been linked to an overvalued real exchange rate, which is in part driven by the high and rising inflation in the country.[33] With inflation projected to decline and the current account deficit shrinking slightly, this situation may potentially improve. Generally, the Ethiopian exchange rate has been shown not to be as volatile in response to global crises as other SSA exchange rates.
However, as a result of the recent overvaluation, there have been widespread shortages of foreign exchange and FX reserves are estimated to cover less than two months of prospective imports, despite significant rationing.[34] Plummeting sales by Ethiopian Airlines, previously a major source of foreign exchange, are exacerbating the issue. With an additional IMF loan, urgently needed foreign exchange could be obtained. Ethiopian authorities have formally requested IMF support in the form of an RFI at 100% of quota (given maxed out use of PRGT resources under the ongoing ECF/EFF program).[36]
Conclusion
While any of these predictions are highly contingent upon both the local and global development of the pandemic as well as governments’ responses to it, Ethiopia seems less likely to suffer catastrophic blows than other developing economies. However, if the current crisis hits some or all of the pressure points of an already fragile system, a range of calamitous consequences, including food insecurity and debt distress, will leave policy-makers scrambling.
References
[1] International Monetary Fund, “Policy Responses to COVID-19: Ethiopia,” URL: https://www.imf.org/en/Topics/imf-and-covid19/Policy-Responses-to-COVID-19 (last updated April 23, 2020; accessed April 27, 2020).
[2] Ibid.
[3] International Monetary Fund, “World Economic Outlook. Chapter 1: The Great Lockdown (April 2020),” URL: https://www.imf.org/en/Publications/WEO/Issues/2020/04/14/weo-april-2020 (published April 14, 2020; accessed April 27, 2020): 24.
[4] Getachew T. Alemu, „Economic Analysis: #Covid-19’s Test to the Ethiopian Economy,” Addis Standard (March 28, 2020), URL: https://addisstandard.com/economic-analysis-covid%E3%83%BC19s-test-to-the-ethiopian-economy/ (accessed April 9, 2020).
[5] Observatory of Economic Complexity, “Ethiopia,” URL: https://oec.world/en/profile/country/eth/ (accessed April 11, 2020).
[6] World Bank, “COVID-19 (Coronavirus) Drives Sub-Saharan Africa Toward First Recession in 25 Years,” Press Release, URL: https://www.worldbank.org/en/news/press-release/2020/04/09/covid-19-coronavirus-drives-sub-saharan-africa-toward-first-recession-in-25-years (posted April 9, 2020; accessed April 11, 2020).
[7] International Monetary Fund, “Regional Economic Outlook Sub-Saharan Africa: COVID-19: An Unprecedented Threat to Development April 2020),” URL: https://www.imf.org/en/Publications/REO/SSA/Issues/2020/04/01/sreo0420 (published April 1, 2020; accessed April 27, 2020).
[8] IMF, “World Economic Outlook,” 24.
[9] World Bank, “COVID-19 (Coronavirus) Drives Sub-Saharan Africa Toward First Recession in 25 Years.”
[10] United Nations News, “Fight against desert locust swarms goes on in East Africa despite coronavirus crisis measures,” URL: https://news.un.org/en/story/2020/04/1061482 (posted April 9, 2020; accessed April 11, 2020).
[12] World Bank, “Africa’s Pulse: An Analysis of Issues Shaping Africa’s Economic Future. Assessing the Economic Impact of COVID-19 and Policy Responses in Sub-Saharan Africa,” (Washington, D.C.: The World Bank Group, 2020): 31.
[14] World Bank, “Federal Democratic Republic of Ethiopia: Priorities for Ending Extreme Poverty and Promoting Shared Prosperity (Systematic Country Diagnostic),” Report No. 100592-ET (Washington, D.C.: The World Bank Group, 2016): 6.
[15] Isaac Paul, “The global financial crisis: origin, contagion and impacts on Ethiopia,” Journal of Business and Administrative Studies 2, no. 1 (2010).
[16] McKinsey & Company, “Tackling COVID-19 in Africa,” URL: https://www.mckinsey.com/featured-insights/middle-east-and-africa/tackling-covid-19-in-africa (accessed April 11, 2020).
[17] World Bank, “Africa’s Pulse.”
[18] United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2018, (Geneva: United Nations, 2018).
[19] International Monetary Fund, “Article IV Consultation and Requests for Three-Year Arrangement under the Extended Credit Facility and an Arrangement under the Extended Fund Facility - Staff Report,” IMF Country Report No. 20/29 (Washington, D.C.: International Monetary Fund, 2019): Indicator Summary.
[20] IMF, “Article IV Consultation,” 13.
[21] IMF, “Policy Responses to COVID-19: Ethiopia.”
[22] World Bank, “Africa’s Pulse,” 18-22.
[23] IMF, “Policy Responses to COVID-19: Ethiopia.”
[24] Ibid.
[25] World Bank, “Africa’s Pulse,” 76.
[26] McKinsey & Company, “Tackling COVID-19 in Africa.”
[27] IMF, “Policy Responses to COVID-19: Ethiopia.”
[28] IMF, “Regional Economic Outlook Sub-Saharan Africa: COVID-19,” 18.
[30] IMF, “Article IV Consultation,” 9.
[31] World Bank, “Africa’s Pulse,” 39.
[32] IMF, “Policy Responses to COVID-19: Ethiopia.”
[33] IMF, “Article IV Consultation,” 4.
[34] Ibid.
[36] IMF, “Policy Responses to COVID-19: Ethiopia.”
PHOTO CREDIT: Free use image from Canva Pro.