Ethiopian Business Review

It is too Early to say whether the Gov't Should Continue with Developmental state Model or not.

Eyob Tesfaye (PhD), a macroeconomist and policy analyst, is among the few scholars who are known for voicing their concerns about the well-being of Ethiopia’s economy. He has served in different governmental positions, including as the Director-General of the Public Finance Institutions Supervisory Agency and Director of the Academy of Financial Studies at the National Bank of Ethiopia. He has been an external examiner of post graduate students at Addis Ababa University and advisor to post graduate students of the London School of Economics and Georgetown University.

Eyob, who is now Program Director at the United Nations Capital Development Fund (UNCDF) believes Prime Minster Abiy Ahmed (PhD), inherited an economy in shambles from his predecessors, and is facing an uphill task. According to Eyob, the PM should devise a plan to put the economy back on track and address the problems that have deterred structural transformation, adding  that the Prime Minister should have his own economic road map, even though it is too soon to conclude whether or not the government should continue with developmental state model. EBR’s Ashenafi Endale sat down with him to discuss the flaws in the economy and the recent reforms.

The government and global financial institutions like the International Monetary Fund (IMF) claim that the economy is growing by double-digits. On the other hand, the economy is characterized by towering inflation, high youth unemployment, recurrent trade deficits, high budget deficits and a massive external debt burden as well as severe foreign exchange shortage. Isn’t it strange to claim economic achievements in the presence of these problems?

When it comes to education, social services and health, Ethiopia is still in the growth stage. As a result, the government has been following a developmental state ideology, especially in the last decade. In a developing country like Ethiopia, neglecting the role of the government in the economy is not an option because the state has to play a large role, especially in terms of infrastructure development and provision of social services. 

However, when the developmental state philosophy was devised and implemented, its likely adverse effects at the macroeconomic level were overlooked. The government focused only on fuelling economic growth through massive investment, with little emphasis on the adverse effects of enormous spending. Due to this, the remarkable economic growth registered in the past few years was accompanied by double digit inflation, weak export performance, a widening current account deficit, and ballooning external debt. In simple terms, the government pursued a loose monetary policy to achieve double digit economic growth that unfortunately resulted in macro-economic imbalance 

On top of this, the government’s monetary policy is heavily dependent on domestic and external borrowing. On one hand, high domestic credit allows more money to be injected into the economy, which in turn, stimulates inflation. Since the economy mainly depends on imports, the country spends huge amounts of hard currency, which has resulted in a whopping current account deficit. 

On the other hand, many huge public projects were financed with external loans. However, the government failed to complete the projects on time and start servicing its debt, which consumed scarce foreign currency, on top of piling up external debt. 

Do you agree with the government’s recent decision to halt the launch of new projects before finalizing those in progress? 

Yes. It does not make sense to start new projects when the current ones are not finished, and there is a critical hard currency problem. Most of the loans borrowed to finance the projects are short term with relatively higher interest rates. Under these circumstances the hard currency crunch was inevitable. The government was finally forced to privatize some key public enterprises, just to generate hard currency. The recent government decision to shelf new projects is very rational.

With the adjustment of some of the government’s strategies, which we mentioned previously, is it possible to achieve the targets outlined in the current five-year economic plan?

The targets of both the first and second phases of the growth and transformation plan (GTP I & II) were overambitious and planned without giving due emphasis to the financing aspects of the projects included. The government wanted to emulate the success registered by the East Asian tigers and make Ethiopia an African Tiger. However, the government forgot that there are no vegetarian tigers: you cannot plan without adequate financial resources.  So I am not surprised that GTP II failed to meet its targets, just like GTP I. 

The other problem when it came to achieving targets is the lack of institutional and human capacity to translate and execute policies, strategies and projects. 

In light of this, what approach should the government take while devising the third five-year economic plan after the 2019/20 fiscal year? 

Firstly, the government must be smart enough to learn from past mistakes. Secondly, it must learn to prioritize. The other thing is that there should be efforts to mobilize domestic resources and ensure that there are adequate resources and capacities to execute the plan. Undertaking feasibility assessments and introducing effective fiscal and monetary policies are key to achieving the next set of targets. 

Do you think the government is undertaking measures to minimize the adverse impacts of fuelling economic growth?

There is no doubt the economy is growing. However, it is not the kind of growth that creates job opportunities or generates adequate foreign exchange, since it focuses more on infrastructure development. Yet the government has been very complacent because it was eager to register double digit growth. As a result, it failed to see the looming danger behind the growth, such as the swelling of the unemployment rate. 

The government introduced a revolving fund scheme to address youth unemployment two years ago. Do you think it can address the issue?

That was a knee jerk reaction to quell the dissatisfaction of the youth. The solution would be leaving ample space for the private sector to create more jobs, not [introducing the fund] after unemployment got worse.  

Can we really say the government did not know the economy would get stuck at some point if it continued like this?

The government is willing to accept the recommendations put forward by international financial institutions such as the IMF and the World Bank, to some extent. However, in economics, fundamentals are fundamentals. You cannot circumvent basics. They will catch you up at some point. There cannot be sustainable growth without adhering to fundamental macroeconomic principles. That is what we are facing. It was clear that the loose monetary policy would result in high inflation and rapid exchange rate depreciation.

Do you think the monetary policy is incongruent with the fiscal policy?

There have been no well-choreographed efforts to coordinate the fiscal and monetary policies. The central bank is more subservient to the government’s fancies.

The Poverty Analysis Report compiled by the government indicates that poverty has decreased to 23Pct. But that is computed based on the assumption that an individual can survive if they earn a minimum of USD20 a day (below ETB600 a month). Many economists think that poverty is understated in Ethiopia. 

Economic growth was achieved mainly through massive investment in infrastructure, but is not translated into earnings for people. Of course, there are people who benefit, but there are also those whose incomes dwindled and stagnated. Even though the government has made strides on many fronts it is not enough because it has not solved productivity problems. As a result, income inequality has gotten worse. Unless the economy is structurally transformed, it will keep getting worse. In addition, a vibrant private sector is needed to create more jobs and more investment. However, to do that, it is necessary to achieve macroeconomic stability and remove policies and directives that are stifling the private sector are necessary. 

Are you saying it is wrong to invest available resources in infrastructural development first?

Focusing on infrastructure is not wrong. But little has been done on the supply side, particularly to increase agricultural production and productivity, and on top of that, even the government has utilized the economic efficiency of completed infrastructural projects. If the strategy does not solve unemployment and productivity problems or address income inequality you should revise it. You must go back to the drawing board and re-evaluate against the basics. 

Export earnings stayed around three billion dollars over the past five years, despite various measures, including the devaluation of the Birr. What is the solution?

The problems related to export are obviously structural problems. The country’s exports by and large are raw agricultural commodities. Because agricultural productivity is low, exporting primary products is disadvantageous.  On the other hand, export items can’t be diversified, because the economy cannot structurally transform from agriculture-based to manufacturing-based. On top of that the country has no export strategy and promotion of the export sector is done in haphazard manner.

Those government institutions responsible for improving export earnings are not working in a coordinated manner. Unlike Ethiopia, many countries pursuing export-led growth have export promotion strategies and institutions. 

Equally, an import substitution strategy is also necessary. You cannot achieve sustainable growth and ensure income equality with an economy heavily dependent on imports. 

Recently, the exchange rate on the black market decreased to the official rate, mainly due to the Prime Minister’s calls for individuals to deposit the hard currency they have to banks. Do you think this new trend is sustainable and reliable, without an established mechanism?

The Prime Minister’s call resulted in a positive response. This is one of the shortcut avenues to mitigate the foreign currency crisis. But this has to be supported by further introducing more sustainable and reliable mechanisms such as boosting remittances, in addition to working on the tourism and the mining industries, which have the potential of resolving the hard currency crunch. However, the Central bank and National Planning Commission should devise a medium and long term plan to address the problem. 

The share of tax out of the total domestic revenue decreased from 82.8Pct to 78Pct over the last three years, which is attributed to the fact that more businesses are shutting down or operating in the informal sector. Do you think domestic resource mobilization will improve under these circumstances?

It is necessary to improve the business environment, expand the tax base, and modernize and strengthen the tax administration regime. Giving the private sector more space is essential to bring businesses operating under the tax radar into the tax net. 

The other critical bottleneck to domestic resource mobilization is that the financial sector is not in a right shape to boost savings and increase the credit flow to the private sector. The financial sector should be reformed and scaled up so it can satisfy the huge demand in the economy.  The financial sector needs to be more robust, so it must introduce support for investment, import-export, construction, small and micro enterprises, housing and mortgages. I have not seen a country that has achieved sustainable  growth without a robust Financial Sector. 

In a discussion with the private sector in July this year, the newly appointed governor of the National Bank of Ethiopia announced that minor fixes will be made to directives that govern the financial industry, while not promising any fundamental changes. So how can the private sector become vibrant without a vibrant financial sector?

The private sector cannot grow without government support at least in the medium term. Access to finance and hard currency are essential for the growth of the private sector. Secondly, we need to improve the archaic business regulations. It must be a serious and genuine public private partnership. The private sectors in China and South Korea grew with government help through the creation of a pro-profit and pro-development private sector. I am sure that the new Governor and the Board Members of the National Bank will come up with new reform ideas.

Is there a shortcut to improve the private sector’s performance, to provide solutions to Ethiopia’s economic problems?  

There is no quick fix to address Ethiopia’s economic problems. What are needed are medium-term and long-term measures. The government can start by solving the cumbersome tax procedures, trade logistics, and flow of credit, curtail the rampant corruption among others.

Do you think the government should continue with the developmental state ideology?

It is too early to say whether it should continue as it is or modify the developmental state model. What I want to stress as a bottom line is that the Prime Minister needs his own economic road map.

But do you think the new Prime Minister is giving due attention to macroeconomic issues?

 

The new Prime Minister inherited from his predecessor an economy which is in Shambles.  Current economic problems are result of a severe   Macro Economic Mismanagement. Prime Minister Dr Abiy is facing a   very arduous task, or you can call it an uphill task.  It is not fair to say that he has ignored the macroeconomic issues. But as a government, you must prioritize. I hope he will come around to macroeconomic issues, once the political issues are addressed. In fact, he established a macroeconomic team, which is a right step in the right direction.


6th Year . Sep 16  - Oct 15 2018 . No.66


 

 

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