On the announcement that Ethiopia is about to secure a $9bn loan from various sources

Filed under: Opinion & Analysis |

By Zerihun Gudeta (Prof.), Potchefstroom Campus, North-West University
December 15, 2019

  1. THE NEWS

I see the news that Ethiopia is likely to secure a total loan/grant amounting $9 billion is a welcome development. None of the available documents I quickly checked today, while thinking of putting my views on this together, provided me a breakdown of the amounts into loans and grant components. In most sovereign loan transactions, the grant components are expected to be small percentages of the total amount. Therefore, one can, with little loss of generalization, safely analyze the possible benefit and cost implications that such an inflow is going to have in an economy. In general, the development indicates wide acceptance of the planned macroeconomic, sector and structural policy reforms (espoused in the ‘Home Grown Economic Reform Agenda’) by external lenders. It also indicates that the lenders are convinced (as implicitly implied in all sovereign loan transactions) on the political commitment the current administration has to push through the proposed reforms.

According to the news, the $6 bn. out of the $9 bn. estimated loan amount is expected to come from the Bretton Wood institutions. Loans coming from these institutions are in general relatively concessional. The remaining is to come from other development partners. Not sure which ones though as many development partners operate in the country. May be they represent bilateral lenders? Who knows? Highly likely. This implies that even coming from bilateral sources (China expected to be on top of the list as usual), one would expect the loans would still be concessional although it is expected to be less concessional compared with that coming from the IMF and the WB. In general this is a good development. This is happening at the time when it has become hard to raise emergency loans as country’s sovereign credit rating status is going down spiral.

  1. IMPLICATIONS

The loan is expected to have important implications. They include among others that it would: assist in addressing foreign exchange liquidity shortages, blamed for the recent lackluster GDP growth performance against previous years; help address pressing debt repayment challenges; support the ongoing debt restructuring initiatives; and help somehow sanitize the composition of county’s public debt portfolio. On the down side, it might have drawback in that given than Ethiopia is in a cash strap situations, Bretton Wood sourced loans unavoidably come with some strings attached. They are not popular by most recipient country economists for the reason that they in most cases are not participatory or are considered prescriptive in nature. Further, its lack of popularity could be attributed to the failure of the Structural Adjustment Programs of the 1980s and 1990s championed by such intuitions (this applies to Ethiopia too).

The influence of the Britton Wood institutions in policy making in developing countries is no longer a headline issue. However, to the dismay of many, it is coming through the backdoor, hence as strong as it used to be. This is despite the launch of the Paris Declaration on Aid Effectiveness in the mid-2000s. The declaration promotes consultations with donor organizations to encourage recipient country ownership of reform programs. Nevertheless, it has become a common practice to see its main tenets disregarded by the recipient countries. This is knowing that it is meant to protect their own interests. This is true especially in situations where recipient countries are in dire need of financial support.

It has become a common practice that countries (applicable to Ethiopia as well) fail to take corrective policy reform actions when signs of deteriorating macroeconomic stability are apparent (starting from the 2014 in the case of Ethiopia). This is the time a country can implement corrective reform actions at reasonably lower socio-economic costs. Instead, complacency would set in one way or another (taking developmental state as antidote to all kinds of economic problems in the case of Ethiopia). Unfortunately, countries wake up to the reality once after the damage has been done. This is the time they realize that the going would get tougher without a bailout of some sort from such institutions (the years 2017 to present in the case of Ethiopia) and alternative sources of debt/development financing becomes nonexistent (due to country’s junk credit rating status). This gives Washington based Bretton Wood institutions the upper hand in loan negotiation be it budget or precautionary balance of payment support operations (Ethiopia cannot be an exception).

  1. WHAT NEXT

The fact that the news about the loan is collaborated by the government and the Bretton Wood institutions (confirmed on the IMF website) indicates that the loan negotiation is in an advanced stage. This means that an agreement has already been reached between the two (in the language of policy based loan operations) on a policy matrix outlining the prior and trigger reform conditions. The prior conditions are the simplest of all to guess. According to my reading from IMF’s website, it looks the ‘Home Grown Economic Reform Agenda’, already endorsed by the WB/IMF would constitute an important prior condition. This makes it highly likely, assuming the loans would be disbursed in two tranches (a normal practice), the first tranche could be disbursed soon while the last tranche possibly in the next two to three years. Second tranche disbursement is possible only provided that Ethiopia satisfies the trigger conditions after a coordinated review processes is conducted in due course by the lenders. We do not know the magnitude of the first tranche yet; but it is expected to be less than the second tranche due to the stakes at hand. This is unless it is front-loaded taking into account the gravity of the foreign exchange liquidity constraint situation the country is currently faced with.

Experiences show that a good a number of similar budget or precautionary balance of payment support operations in developing countries have been aborted prematurely. Most of them due to recipient countries failure to comply with the strict review processes, integral part of the agreed trigger conditions. Several reasons could be behind this. The common one in the African contexts include. (i) Lack of political will on the part of the recipient countries caused by shifts in government priorities (e.g. change in government). (ii) When ‘reality strikes’ or that countries come to the realization (having conducted a credible cost benefit analysis of policy reforms) that the proposed reforms would result in higher socio-economic and political costs than originally anticipated.

  1. WHAT TYPE OF REFORM

In the Ethiopian context, what is available to the public regarding the ‘Home Grown Economic Reform Agenda’ is not that much detailed. Only the overarching priorities of the reform agenda are available for public consumption. Hence, in the absence of access to the agreed policy reform matrix, it would be difficult to analyze with a reasonable level of confidence its possible economic and welfare impacts. However, noting that (i) deteriorating macroeconomic conditions are principally behind the need for external resources. And (ii) the government believes macroeconomic imbalances would be addressed by transitioning from a public sector infrastructure investment to private sector led growth (the end goal of the homegrown economic reform agenda). One can make an educated guess that the reforms would target structural change (on the back of private sector development). This is expected to be supported, inter alia, by (i) introducing policy, legal and regulatory reforms (we know some work in this area is already in progress). (ii) Privatization of government assets (an already widely discussed topic and relatively in advanced stage in terms of implementation). (iii) The big elephant in the room i.e. revision of country’s foreign exchange policy (a new discussion topic dominating the local media since the loan announcement was made this weekend). My focus will be on the last point since the first two have been with us for quite some time and that they are already very well digested by the public.

No doubt, the foreign exchange market has been in a crisis mode for an extended period. This can  be attributable in the main (in the eye of an economist) to country’s increased exposure to balance of payment risks considered structural in nature (i.e. higher commodity dependency, growing foreign exchange demand for imports, subdued diaspora remittances, lower capital inflows, etc…). The intention of the government to move from a demand to a supply driven economic model (that the “Home Grown Economic Reform Agenda” promotes) is in full recognition of these constraints. Therefore, in my view, in a situation where the structure of the economy is not in a required shape, a big jump to a market determined exchange rate system (that the Bretton Wood institutions are passionate about) or a once off but significant devaluation (that some are recommending instead) might not yield the intended result.

I am of the view that the country need to come up with a right mix of policies –a foreign exchange generation oriented structural reform coupled with a well-thought-out incrementally flexible accommodative foreign exchange regime. The structural reforms (macroeconomic and sectoral) need to focus on supporting diversification of the foreign exchange base of the country. The exchange rate policy, on the other hand, need to take into account Ethiopia’s socio-economic and political conditions. It must also be tailored to make it friendly to the structural adjustment program. It needs to be designed in such a way that it supports strategic public and private sector initiatives critical for the achievement of the envisaged structural change. A case in point is the 9 to 10 industrial parks already in operation and the 13 or so in the pipeline originally planned to augment foreign exchange generation capacity of the country.

There are experiences out there that Ethiopia can learn from (including from within the continent). I for one recommend an incremental approach to liberalizing the foreign exchange market. For starters, Ethiopia can introduce a multiple exchange rate system (a system of multiple foreign exchange windows). This would allow priority sectors in having access to foreign exchange from a dedicated foreign exchange window at official rates whereas forex demand by others met by separate windows at market-determined rates. The number of forex windows to be created is dependent on the size of foreign exchange reserve and sector level forex demands. Such a policy, I believe, would help somehow mitigate the strangling effect a premature move to a market determine exchange rate regime might have on priority sectors with higher growth and structural change potential.

  1. The Wayforward

I understand the weak bargaining position Ethiopia has is constraining its ability to dictate terms in the negotiation table with the external lenders. But I am of the view that the Ethiopian government can push for some form of leniency (if not done already) to ensure that the policy reforms contained in the policy matrix are readjusted in such a way that they are tilted more towards supporting structural reforms than correcting foreign exchange misalignment. This would give the Ethiopian government the breathing space to evaluate situations on the ground as the loan flows into the economy. One area to look at in the meantime would be to conduct a proper assessment of the magnitude of the pent-up demand for foreign exchange in the economy. This is important for the success of any foreign exchange regime whichever form or shape it takes. This is particularly so as a country transitions from a highly controlled to a relatively liberalized foreign exchange rate regime.

Thank you

Zerihun Gudeta Alemu, (Prof.)

Economist

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