The efforts to restructure repayments come amid increasing challenges.
Since mass protests began in 2015, a lot of analysis has focused on Ethiopia’s security challenges, with sustained unrest followed by momentous change and now a relapse into civil war in Tigray.
But the economic headwinds are equally strong—and they have the potential to compound political dilemmas.
As part of the state-led developmental project pursued by the Ethiopian Peoples’ Revolutionary Democratic Front (EPRDF), most intensively after 2010, the government invested big, both directly and through state-owned enterprises (SOEs).
While the injected capital—mainly to finance infrastructure— produced impressive economic growth, the model was heavily reliant on debt. The sustainability of this formula depends both on realizing returns that are higher than the contracted interest rates and securing foreign exchange with which to repay interest and principal.
Unfortunately, the first condition for success was undermined, as the implementation of many projects was riddled by waste and a lag in producing profits.
On the former, for example, the Ethiopian Sugar Corporation borrowed from mostly Chinese banks to invest approximately $4.6 billion in new plantations and processors, but bungled projects meant cane production has actually dropped over the period—a far cry from ambitions to become one of the world’s top ten exporters.
For the latter, the multitude of hydropower stations built over the past decade not only failed to attain full cost recovery, but problems such as high losses, frequent outages, and lack of access persist. Investments in both the Addis Ababa light rail and the Ethio-Djibouti railways, flagship projects by Ethiopian Railways Corporation, have similarly been loss-making.
Consequently, industrial production meant to reduce imports and increase exports did not take off and the manufacturing sector still represents only around six percent of economic output.
After taking office, as in most areas, Prime Minister Abiy Ahmed’s government has taken a different direction, cutting through the EPRDF’s dithering on whether to give up on key elements of the state-led model and embrace a more free-market approach.
The shift heralded by the “Homegrown Economic Reform” had to do as much with ideological re-alignments and critical evaluations of the state’s spending effectiveness as with practical necessities.
Among these, the steadily worsening public debt situation was identified as one of the most critical issues—and rightly so.
Total public debt had ballooned from $13.7 billion in 2011 to $54.7 billion in 2020, which represents a four-fold increase. Figure 1 illustrates this rise and highlights its structural form. SOEs and the central government have been responsible in equal measure for the increasing debt level and have tapped both domestic and international resources.
The practice of massive domestic borrowing by state and state-backed actors has been criticized as crowding out private players, who might otherwise pursue profitable ventures. But it is the external debt stock that has been the source of most agitation.
In fact, domestic actors are assumed to be more accommodating to the central government. Moreover, the contracted loans are denominated in birr currency. That can and has caused inflationary problems, as the amount of money put in circulation by the central bank outstrips production; but, the liabilities can be managed.
External debt servicing, on the other hand, requires the accumulation of foreign currency reserves, which due to relatively low and volatile personal transfers and FDI inflows and consistently large trade balance deficits have been chronically low in Ethiopia.
The high ratio of debt over exports was mentioned as an important motive behind the World Bank’s downgrading of Ethiopia to “high risk of external debt distress” in its 2018 sustainability analysis.
The government took notice and rolled out measures meant to tackle the debt issue. A demonetization program was implemented to increase the tax base and thus boost government revenues while talks for selling shares of SOEs are in an advanced stage, with the prominent auction of 40 percent of Ethio telecom’s shares being overseen by Deloitte.
As it goes beyond the purpose of this piece to enter into the merits and critics of the vision behind these projects, let us just note under which conditions it was designed.
The National Bank of Ethiopia‘s (NBE) figures for real gross domestic product growth averaged around nine percent per annum over the past decade; the value of exports increased by 27 percent over the period 2015-2019, and the trade deficit, which for the fiscal year (FY) 2018/2019 remained at the high level of $12.9 billion, had in fact stabilized after years of continuous deterioration.
Foreign exchange reserves were at historical lows and the balance of payments was also strongly negative, but the government’s calculations were that economic and political reforms would attract foreign investment, strengthen the tourism sector, and encourage higher remittances flows and diaspora investments.
These circumstances changed dramatically in the first quarter of 2020.
Compounding COVID effect
Because of COVID-19, on 1 May 2020, the G20 followed International Monetary Fund’s (IMF) and World Bank’s recommendations and launched the Debt Service Suspension Initiative (DSSI). The aim was to create the financial space for low-income countries to spend on health and social schemes to face the crisis.
The DSSI allowed 73 low-income countries to request a temporary suspension of loan repayments, of both principal and interests, owed to their official bilateral creditors. Ethiopia applied for and was granted participation in the initiative, which the World Bank estimates saved it $470 million in payments over the past year.
This figure is quite significant considering that in 2019, reimbursements toward external actors were $2 billion and domestic debt service payments were 30 billion birr. The initiative’s duration was extended from 31 December 2020 to June 2021, with a likely further extension until the end of 2021.
As Ethiopia’s economy was hit hard by the pandemic, the government turned to the IMF and the World Bank for further assistance. Both organizations had already committed significant financial resources to Ethiopian economic reform programs over the previous years.
The IMF, which commended the Homegrown Economic Reform Program and passed, in 2019, a three-year $2.9 billion financing package to support it, agreed in 2020 to loosen the deficit requirements stipulated the previous year and encouraged stimulus spending.
Additionally, it approved a request to access its Rapid Financing Instrument, which provided Ethiopia $411 million in emergency assistance. These funds were made available in the form of direct budget support to the central government and were meant to facilitate the purchase of health supplies, to secure essential goods (e.g. food items), and cushion foreign exchange shortages—further exacerbated by export losses, a drop in foreign remittances, and lower than expected FDI.
With a similar objective, the World Bank, which endorsed the Growth and Transformation Plan II with $1.2 billion over the years 2018-2019 and with an additional $500 million in 2020, passed an $82 million USD COVID-19 Emergency Response Project.
At the end of 2020, the G20 launched the common framework for debt treatments, whose aim is to go beyond the DSSI in addressing unsustainable debts deriving from the pandemic. As details are still unclear, determining how ambitious the program is going to be is a guessing game. What seems clear is that it will entail some form of debt reduction.
Analysts don’t believe anything as substantial as the Highly Indebted Poor Countries (HIPC) initiative is being drafted, but they point at the similarities between the G20 statements and the Paris Club guidelines on the issue.
The influential group of creditor countries set six principles underpinning debt restructuring initiatives, namely solidarity, consensus, information sharing amongst Club members, case by case decision making, conditionality on beneficiary country’s engagement in an IMF program, and comparability of treatment for non-Paris Club commercial and bilateral creditors.
Through these principles, creditors, who individually have strong incentives to resist calls for debt revision, hope to attain an equitable distribution of the burden of debt relief. As Ethiopia already communicated that it will seek a restructuring of its sovereign debt, it is timely to examine both the challenges this initiative might pose and the shape in which the country enters the forthcoming negotiations.
The current situation has forced the federal government to continue pursuing its pre-crisis reform agenda while seeking debt relief. Several issues might prevent rapid progress on the latter count.
First, the likely clause of any framework that the country enters agreements with the IMF might slow negotiations down. In fact, while the government is already receiving IMF support for its policies, disbursements are behind the revised schedule.
This may be due to an Ethiopian preference to re-phase payments, but it should not be taken for granted that the IMF will provide unconditional support to the debt restructuring initiatives.
Second, the framework faces issues related to the lack of transparency in public finances, which stem from accusations directed towards China and private creditors of often concealing loan conditions. In this respect, Ethiopia is no exception.
Overall, the record of the central government has been improving, mostly scoring Bs on public finance transparency measures in a 2019 PEFA assessment, which evaluates the quality of countries’ public finances management on a scale from A to D.
Still, while the structure and ownership of $1 billion worth of Eurobond are open to the public, the conditions of the remaining 85 percent of external debt incurred with the private creditors, split between suppliers (25 percent) and commercial banks (60 percent), are not verifiable.
Moreover, concerns have been raised about opaque Chinese lending practices, which creates uncertainty for other parties involved in the initiative.
Third, the biggest unknown in the framing of the agreement is what terms the country will be asked to demand from other creditors. If recent debt restructuring frameworks, like the Evian approach, set the tone of the discussion, participant countries might be required to “…seek debt relief from non-Paris Club commercial and bilateral creditors on comparable terms to those granted by the Paris Club members.”
In other words, if the G20 were to request a similar clause to be included, private and bilateral public sector creditors, be they state lenders or commercial entities, would have to grant similar conditions for the agreement to take effect.
Why those might be long and complex negotiations emerges clearly from Figure 2, which shows the percentages of Ethiopian external debt by owner. Since 52 percent of it is owned by official bilateral or private creditors, multilateral actors are unlikely to agree upon a solution that would have them as the sole losers.
A promising sign here is the support so far from China, which is normally reticent in offering debt restructuring and owns a significant share of the Non-Paris Club bilateral debts. Still, private actors, who own around 23 percent of the total figure, might complicate the government’s plan.
Despite the cautious statements coming from the Finance Ministry, bondholders weren’t pleased by the price drop recorded on their Ethiopian debt titles, which followed the downgrading by rating agencies of Ethiopia’s long-term foreign currency credit rating.
The reputational damage suffered on international capital markets as a consequence of similar shocks, which are likely to make it more difficult to borrow from private actors in the future, is serious, so much so that countries like Kenya already announced they will not enter similar agreements with the G20.
Internally, the establishment of the Liability and Asset Management Corporation is a step to solve the debt issues of SOEs. The corporation will acquire these companies’ debt and finance itself primarily through proceeds from their privatization. Still, with little details public about how it will operate, it is hard to know whether the plan is going to be anything more than a debt-reshuffling exercise.
Even if a sound implementation yielded the expected short-term results, long-term success in managing debt can only be achieved in a flourishing economy within a cohesive country.
Unfortunately, the current environment doesn’t seem conducive to the latter two conditions. The macroeconomic situation has deteriorated significantly, with IMF estimates for the past and the upcoming year suggesting that growth has all but stalled, the balance of payments deteriorated to a historic negative value, and exports shrank to 2017 levels. For the FY 2019/2020, the NBE reported for the first time a negative balance between its Foreign Exchange Holdings and Liabilities.
Moreover, investors and creditors have for years underplayed the political risks in Ethiopia. With the outbreak of conflict in Tigray, continued turmoil in Oromia, and the regional tensions around the government’s flagship investment —Grand Ethiopian Renaissance Dam— these are now impossible to ignore.
In the meantime, the government’s response to these challenges has so far been inconsequential, with exercises such as the launching of the Ten-Year Pathway to Prosperity Plan that appears to be detached from the contingency of reality. It is doubtful that the ambitious goals set in the plan are going to be met when, according to OCHA, 23 million Ethiopians are currently in need of humanitarian assistance.
These internal problems have short-term financial implications as well, as shown by the European Union’s decision to block $107 million budget support as long as humanitarian aid is prevented from reaching civilians in Tigray.
Finally, it is unclear what role the US is willing to play. Last year President Trump personally intervened to cut aid over the Grand Ethiopian Renaissance Dam dispute, while the current administration has pressured Ethiopia to find a peaceful solution to the Tigray conflict, but still increased assistance towards the region.
In the face of non-compliance to its appeal for a withdrawal of Eritrean troops, the US might pursue other strategies to prevent further escalation in the humanitarian crisis. Given its direct and indirect influence over the World Bank and IMF, further financial repercussions cannot be ruled out.
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Main photo: Prime Minister Abiy Ahmed opening the discussion with development partners and the diplomatic community on Homegrown Economic Reforms; Office of Prime Minister; 9 September 2019
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