RaboResearch - Economic Research

Country Report Ethiopia

Country Report


Ethiopia flag
Ethiopia continues to record robust growth. However, the state-led development model is constraining the private sector and has resulted, from time to time, in macroeconomic imbalances, and therefore seems unsustainable in the long term.

Strengths (+) and weaknesses (-)

(+) Regional geopolitical importance

Ethiopia plays an important role in maintaining stability in the Horn of Africa. Being an important partner to the West, especially the US, Ethiopia receives financial assistance on a structural basis.

(-) Narrow economic base

Agriculture accounts for 50% of GDP, 75% of employment and more than 80% of exports. Hence, the economy is very susceptible to volatility on global commodity markets and to weather patterns.

(-) Unsustainable economic model

Ethiopia’s state-led development economic model is not sustainable in the long term, as financing by the central bank leads to macroeconomic instability and hinders private sector development.

(-) Poor development

Despite progress in recent decades, human development is very poor. Against this background, episodes of double digit inflation that erode purchasing power significantly could spark social turmoil.    

Key developments

1. Economic growth slows, though still robust, and inflation is down to single digits

After a decade of very strong performance (9% average economic growth), economic growth slowed down somewhat, but remained nevertheless relatively high. In 2013, economic growth decreased to 7.1%, from 8.5% in 2012, driven down by a marked slowdown in gross fixed investments. Ethiopia’s economic policy is based on a 5-year Growth and Transformation Plan (GTP), which envisages improvements in infrastructure, human development and agricultural productivity through public support. The large public investments (19% of GDP, third highest in the world) are largely financed domestically, including through compulsory financing by commercial banks and direct financing by the central bank. These high investment levels led to very strong domestic demand, which on its turn fuelled inflation, with consumer price inflation reaching 40% in August 2011, and increased FX demand. FX restrictions are in place to prioritize public demand. Furthermore, private sector investment has been crowded out and private sector development in general has been hampered. Tighter monetary policy, in the form of less monetary financing, aided by lower prices for food and imported fuel, brought down the inflation to single digits in 2013.

Figure 1: Growth decelerates
Figure 1: Growth deceleratesSource: EIU
Figure 2: Inflation back to single digits
Figure 2: Inflation back to single digitsSource: EIU

In 2013, foreign exchange (FX) reserves increased after shortages were reported in late 2012. Looking forward, the economy is likely to grow by roughly 7%. Just like in 2013, growth will be supported by good performance in agriculture, as government programmes and infrastructure development stimulate investment and shift subsistence farmers into commercial farming. However, risks are tilted to the downside, as agriculture remains susceptible to weather conditions. Besides, lack of external financing could slow down infrastructure development or result in more financing by the central bank (already reported in 2H2013), which could once again fuel macroeconomic imbalances.

2. Fiscal and external imbalances increase

Ethiopia’s ambitious public investment plan has also increased pressure on the country’s fiscal and external position. In 2013, the budget deficit increased from 2.8% of GDP in 2012 to 3.3% of GDP and public debt increased from 42% in 2012 to 48% of GDP. While net transfers remained strong at 12% of GDP thank to remittances from the Ethiopian diaspora and donor assistance, the current account deficit also deteriorated, from 7.2% of GDP in 2012 to 9.8% of GDP in 2013. As FDI is moderate (2% of GDP in 2013), Ethiopia relies on debt financing to cover the shortfall. Financing has been provided mainly by official creditors; in recent years, such financing came especially from China. Besides, the critically low level of FX reserves - just under 3 months of imports - makes the country highly vulnerable to a deterioration of the current or capital account balances. External debt is mainly public (at least 95% of it). Its favourable structure, 95% is medium to long term and 76% owed to official creditors, provides some comfort, but the strong increase of the debt burden in recent years is concerning. Indeed, external debt in 2013 was 30% of GDP, twice the level of 2006. The fact that the three international rating agencies have for the first time extended a sovereign rating to Ethiopia has widened access to international markets, which might contribute to a further deterioration of the balances. In 2014, the current account deficit is forecast at 11% of GDP and the public deficit at 3.4% of GDP. All in all, the government’s infrastructure plans are set to further hurt external and fiscal balances. However, the still relatively low levels of both external and public debt provide some comfort.

3. Regional tensions around the Renaissance Dam

The ambitious targets of the GTP have also increased regional tensions. Ethiopia’s goal to quadruple energy capacity to 10,000mw relies on the construction of the Renaissance Dam on the Blue Nile, with a capacity of 6000mw. Construction of the dam started in 2011 and the project was around 25% complete in late 2013. However, it has led to tensions with downstream located Egypt, which relies on the river for 98% of its fresh water needs and 10% of its energy supply, and which held the rights to use most of the water and to veto upstream projects according to colonial agreements. Egypt claims that the dam will seriously affect the volume of Nile water reaching its territory and has therefore opposed its construction. Violent rhetoric by former Egyptian president Morsi was replaced by a more cooperative approach by the current regime, but tensions between the two countries remain high. Though Egypt’s international diplomatic efforts against the construction of the dam could lead to delays in its completion, the tensions between the two countries are not expected to result in violence.

4. Political environment remains stable

The death of prime minister Zenawi in 2012, after he had been in office for 21 years, raised concerns about destabilising political infighting or other tensions. However, events so far indicate that the political environment has remained stable. Protests could become more frequent ahead of elections in 2015, but are not expected to pose a threat to stability.

Factsheet of Ethiopia
Factsheet of EthiopiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Ethiopia, located in Eastern Africa, is the most populous landlocked country worldwide and the second most populous country in Africa. The economy is agriculture based, despite some diversification in recent years. The degree of modernization in agriculture is low, so the economy is highly susceptible to weather conditions. Ethiopia has a history of frequent droughts leading to famine. Large hydropower capacity makes Ethiopia the largest energy supplier in East Africa. The country’s most important trade partner is China. However, neighbour Djibouti is a particularly important business partner, as it gives Ethiopia access to the sea. Ethiopia’s economy is dominated by the state and is relatively closed, since authorities restrict private and/or foreign participation in many sectors. Prioritizing pro-poor spending has led to marked improvement of human development. For example, poverty almost halved between 2005 and 2011 and the country is one of the few African states with a social assistance programme. Ethiopia is one of the oldest countries in the world (2000 years) and the only African country that maintained independence from colonial rule, bar 4 years of occupation by the Italians. The country became a multiparty democracy in 1991, but it is a de facto one-party state dominated by the Ethiopian People's Revolutionary Democratic Front (EPRDF). Prime minister Meles Zenawi ruled the country for 21 years, before dying in August 2012. The oppression of opposition and dissent intensified after improved results for the opposition in the 2005 elections led to protests. Security risks are particularly high in Ethiopia, stemming from conflicts in neighbouring Somalia, South Sudan and Sudan, the post-war border conflict with Eritrea and domestic secessionist groups.

Economic indicators of Ethiopia
Economic indicators of EthiopiaSource: EIU
Alexandra Dumitru
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

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