Ethiopia 1

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Country Reports - Ethiopia

28 Aug 2014 IHS Economics and Country Risk

Our Take

Key PointsNew prime minister continues same old policies.Economy continues to grow impressively, but problems abound.State maintains control of key economic sectors.Government prioritises infrastructure development.

AnalysisSix-Factor Country Risk - Ethiopia

Risk Score Description

Political 4.00 VERY HIGH

Economic 3.75 HIGH

Legal 4.00 VERY HIGH

Tax 3.50 HIGH

Operational 3.50 HIGH

Security 4.25 VERY HIGH

Overall 3.84 HIGH

12-Month Rating Trend Negative Trend

Note: 1 = minimum risk, 5 = maximum risk. Ratings form part of enhanced Country Analysis & Forecast suite of services.

Sovereign Risk Ratings - Ethiopia

Medium-Term 55(B+) High Payments Risk

Sovereign Risk Outlook Stable

Note: 0 = minimum risk, 100 = maximum risk. Ratings form part of enhanced Economic and Sovereign Risk services.

New prime minister continues same old policies. Having been promoted to the country's highest political office following the sudden death in office of hispredecessor, Meles Zenawi, in August 2012, Prime Minister Hailemariam Desalegn has continued to follow the path set out by Meles as he serves out thelatter's remaining term until 2015. However, despite the policy continuity, Hailemariam has adopted a more collegial style of leadership, compared to the more"presidential" style of his predecessor, while promoting several of his allies and sidelining individuals associated with Meles. The new prime minister has alsolaunched an anti-corruption drive, targeting a number of senior government officials and businesses figures, which may be expanded once the 2015 election isout of the way.

Economy continues to grow impressively, but problems abound. Ethiopia has been among Africa's fastest-growing economies in recent years andcertainly one of the best-performing non-oil economies in the region. Although double-digit economic growth was sustained over 2004-10, the currentmacroeconomic policy of large-scale public spending is projected to slow growth to below the governments estimated 10% in the short to medium term.. Astrong policy focus on boosting economic growth has brought problems, including periods of spiralling inflation and a large current-account deficit.

State maintains control of key economic sectors. The government's continued refusal to liberalise the key sectors of telecoms and banking, as evidenced inthe states choice to possibly delay World Trade Organization accession as a precautionary measure, is a major impediment to economic growth. The absenceof competition and innovation has resulted in Ethiopia having one of the lowest mobile phone/internet penetration rates in the world, with the state-owned EthioTelecom remaining the only operator. IHS expects the government to maintain its effective control of key sectors, such as banking and telecoms, for theforeseeable future.

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Government prioritises infrastructure development. As part of the so-called Growth and Transformation Plan (GDP), Ethiopia is in the process of a hugeinfrastructure development campaign, which the authorities believe will help to transform the economy. This sees the development and upgrading of thecountry's power, road, air, rail, and telecommunications facilities, with a brand new railway network, including a new light railway system in Addis Ababa, andthe construction of a number of hydroelectric power stations that will allow the country to export power to neighbouring countries among the projects currentlybeing implemented.

Forecast SummaryIHS is forecasting economic growth in the high single digits in coming years. The government has outlined an average real GDP growth of 11.0% to14.9% under two scenarios in its current five-year plan that runs to June 2015, underlining that the focus of fiscal and monetary policy will remain on supportinggrowth rather than suppressing inflation. Under the regime of former prime minister Meles Zenawi, who died in August 2012, the government placed a strongemphasis on infrastructure projects, most notably hydropower dams, as the key features for economic growth, with the 5,250-megawatt Grand EthiopianRenaissance dam as the most grandiose scheme at an estimated cost in excess of USD5 billion. While these projects are likely to remain a stimulus to theeconomy, IHS is forecasting slower economic growth in the coming years on the back of a less-conducive external environment and the need for a morebalanced policy mix to address the recurring problems of high inflation and the widening current-account deficit.

Inflation is likely to remain in the single digits in the short term. After a difficult three-year period during which the rate of inflation acceleratedrapidlypeaking at 64.2% in July 2008the rate decelerated considerably throughout 2008 and 2009 before bottoming out and reentering double-digit rates inOctober 2010 and accelerating rapidly in 2011, reaching a peak of 40.6% in August, due to drought conditions impairing food supply and the central bankfinancing of the budget. With domestic and global food prices rising and fiscal and monetary policy in Ethiopia likely still expansive, we see a risk that consumerprice inflation will return to double digits over the medium term after having dipped to an average of 8.1% in 2013, with concomitant pressures on disposableincome and private consumption.

The continued discrepancy between strong domestic demand and weaker external demand is likely to keep Ethiopia's external position underpressure. Having been buffeted by a series of shocks to the balance of payments, including declining reserves, Ethiopia's economy is likely to remain underpressure due to the continued uncertainty in the global economy. This has led to below-projected export receipts and remittances as well as slow inward directinvestment, pushing the current-account deficit to USD3.6 billion, or 7.6% of GDP in 2013, according to IHS estimates. The rapid economic growth of the pastseven years, fueled by expansive fiscal and monetary policy, has led to a massive increase in imports, which has widened the trade deficit and weighed on thebirr. While increased energy, horticultural, and mineral exports should boost foreign-exchange earnings, we expect the trade and current-account deficits toremain wide, as domestic demand growth continues to outpace that of Ethiopia's main export markets.

Changes Since Last ForecastAugust interim forecast versus July interim forecast

GDP Up We upgraded our estimate for real GDP growth in 2013 from 7.7% to 9.4%, largely on the back of expectations for a better

performance in gross capital formation growth and net exports.

Trade

deficit

Down We adjusted our estimates for both exports and imports in 2013. With the latter adjustment being more significant, we reduced

our estimates for the trade deficit from USD8.6 billion to USD8.4 billion, or from 14.6% to 14.7% of GDP.

Current

Account

deficit

DOWN Partly as a consequence of the above and a higher estimate for incoming transfers, we reduced our estimates for the current

account deficit from USD3.8 billion to USD3.6 billion, or from 8.0% to 7.6% of GDP.

Inflation DOWN The momentum of non-food prices has continued to slow, prompting IHS to adjust our consumer price index forecasts.

Country Risk - Overall Statement

OverallEthiopia remains a promising destination for foreign investment, despite challenges associated with it being an underdeveloped country. Since coming topower in 1991, the Ethiopian People's Revolutionary Democratic Front (EPRDF) administration has taken a number of positive steps to address some of themain concerns cited by investors, such as reforming the tax and legal environments, protecting investments from forceful takeover, easing the repatriation ofdividends, and signing deals to avoid double taxation and improve the business climate. However, there is still a lack of policy consistency in both areas amidallegations of routine political interference in the workings of the judiciary. Among the areas prohibited from foreign direct investment (FDI) are media,transport, and retail, as well as key sectors such as banking, telecoms, and power generation. The private sector also remains excluded from the latter two,due to the government's preference for state-led development policies, which risk limiting Ethiopia's growth potential, while restricting competition andinnovation in these sectors. Notwithstanding such challenges, the authorities continue to put a great deal of resources into upgrading the country's transportand communications infrastructure to facilitate more rapid economic growth, while boosting its power output in response to the growing demand and inanticipation of future domestic and regional needs. Elsewhere, Ethiopia's security environment continues to be an area of concern, with the governmentcurrently fighting off low-level insurgency threats from a number of nationalist and secessionist movements at home, as well as from radical Islamists in


neighbouring Somalia, due to its military involvement in Somalia. Its long-running border conflict with Eritrea remains as a threat to Ethiopias stability whilegovernment restriction of political freedom have limited the political space in which opposition parties, civil-society groups, and the independent media canoperate. The government also faces growing accusations of religious intolerance, with the country's Muslim population charging that the authorities are trying tointerfere in the way they practise their faith.

Economic: Country Risk StatementEthiopia remains one of the poorest countries in the world and one of the largest aid recipients. The 17 years (197491) that Ethiopia spent under the rule ofthe Communist-oriented military junta, the Dergue, were particularly ruinous, with the country adopting a disastrous collective system of farming blamed forundermining its agriculture-based economy, as well as for fueling a perennial food crisis. Average annual GDP growth during the 1980s was just 1.1%, with thecountry racked by drought and a long-running civil war. Since ousting the dreaded military regime in 1991, the ruling Ethiopian People's RevolutionaryDemocratic Front (EPRDF) government has pursued a macroeconomic strategy focused on agricultural development as the catalyst for the economy, with thegovernment being at the heart of the policy. Although the annual GDP growth rate has picked up significantly, averaging 10.9% between 2004 and 2013,poverty is still widespread. While Ethiopia has made encouraging progress in weaning itself from its over-reliance on its main commodity, coffee, the country'seconomic prospects remain vulnerable to external factors such as commodity price fluctuations and adverse weather conditions. To help lift economic activity,the government has undertaken heavy investment in the hydropower sector, aimed at increasing electrification and raising foreign-exchange earnings byexporting power through transmission lines to neighboring countries. While this should underpin economic activity in the years ahead, the continuance ofrobust economic growth in the medium term will be dependent on the government moving towards a further liberalization of the economy, which will bechallenging for the EPRDFs state-centric ideology. Nonetheless, with the current policy mixwhich is heavily focused on supporting economic growth throughpublic expenditurehaving resulted in increasing volatility in the inflation rate and Ethiopias external accounts, the government may be forced to reconsiderother options to achieve its aims. It is thus encouraging that the government has opened up to some more innovative options, such as joining the World TradeOrganization and issuing an international sovereign bond to finance infrastructure investment.

Short-Term Outlook

Key Points

IHS is forecasting economic growth in the high single digits in coming years.Inflation is likely to remain in the single digits in the short term.The continued discrepancy between strong domestic demand and weaker external demand is likely to keep Ethiopia's external position under pressure.

Analysis

IHS is forecasting economic growth in the high single digits in coming years. The government has outlined an average real GDP growth of 11.0% to14.9% under two scenarios in its current five-year plan that runs to June 2015, underlining that the focus of fiscal and monetary policy will remain on supportinggrowth rather than suppressing inflation. Under the regime of former prime minister Meles Zenawi, who died in August 2012, the government placed a strongemphasis on infrastructure projects, most notably hydropower dams, as the key features for economic growth, with the 5,250-megawatt Grand EthiopianRenaissance dam as the most grandiose scheme at an estimated cost in excess of USD5 billion. While these projects are likely to remain a stimulus to theeconomy, IHS is forecasting slower economic growth in the coming years on the back of a less-conducive external environment and the need for a morebalanced policy mix to address the recurring problems of high inflation and the widening current-account deficit.

Inflation is likely to remain in the single digits in the short term. After a difficult three-year period during which the rate of inflation acceleratedrapidlypeaking at 64.2% in July 2008the rate decelerated considerably throughout 2008 and 2009 before bottoming out and reentering double-digit rates inOctober 2010 and accelerating rapidly in 2011, reaching a peak of 40.6% in August, due to drought conditions impairing food supply and the central bankfinancing of the budget. With domestic and global food prices rising and fiscal and monetary policy in Ethiopia likely still expansive, we see a risk that consumerprice inflation will return to double digits over the medium term after having dipped to an average of 8.1% in 2013, with concomitant pressures on disposableincome and private consumption.

The continued discrepancy between strong domestic demand and weaker external demand is likely to keep Ethiopia's external position underpressure. Having been buffeted by a series of shocks to the balance of payments, including declining reserves, Ethiopia's economy is likely to remain underpressure due to the continued uncertainty in the global economy. This has led to below-projected export receipts and remittances as well as slow inward directinvestment, pushing the current-account deficit to USD3.6 billion, or 7.6% of GDP in 2013, according to IHS estimates. The rapid economic growth of the pastseven years, fueled by expansive fiscal and monetary policy, has led to a massive increase in imports, which has widened the trade deficit and weighed on thebirr. While increased energy, horticultural, and mineral exports should boost foreign-exchange earnings, we expect the trade and current-account deficits toremain wide, as domestic demand growth continues to outpace that of Ethiopia's main export markets.

Assumptions

Despite criticism over the narrowing of political space and concerns about policy direction following the demise of Prime Minister Meles Zenawi inAugust 2012, the ruling Ethiopian Peoples' Revolutionary Democratic Front government will remain in power beyond the next elections, scheduled for2015.


The current "no-peace, no-war" border stalemate with neighboring Eritrea will continue, or be settled peacefully, without the two countries deciding tosettle the issue militarily.The government will continue to invest heavily in physical infrastructure as part of its development strategy, despite the policy being questioned by theInternational Monetary Fund, which has warned the spending drive could undermine price stability and crowd out private-sector investment.International economic assistance, upon which Ethiopia still depends heavily, is likely to continue to flow steadily despite the occasional disagreementwith bilateral and multilateral partners due to the government's refusal to accept certain policy prescriptions and its reluctance to introduce genuinepolitical reforms.Economic growthaided by domestic consumption and a continued diversification of exportsis likely to slow somewhat in the next few years, but willremain among the highest in sub-Saharan Africa.

Changes Since Last ForecastAugust interim forecast versus July interim forecast

GDP Up We upgraded our estimate for real GDP growth in 2013 from 7.7% to 9.4%, largely on the back of expectations for a better

performance in gross capital formation growth and net exports.

Trade

deficit

Down We adjusted our estimates for both exports and imports in 2013. With the latter adjustment being more significant, we reduced

our estimates for the trade deficit from USD8.6 billion to USD8.4 billion, or from 14.6% to 14.7% of GDP.

Current

Account

deficit

DOWN Partly as a consequence of the above and a higher estimate for incoming transfers, we reduced our estimates for the current

account deficit from USD3.8 billion to USD3.6 billion, or from 8.0% to 7.6% of GDP.

Inflation DOWN The momentum of non-food prices has continued to slow, prompting IHS to adjust our consumer price index forecasts.

Alternative Scenarios

Ethiopia's agrarian-based economy is highly vulnerable to adverse weather conditions, such as the droughts that have decimated agricultural productionin recent years. Eritrea could escalate the still-unsettled border dispute into an all-out war, if the government feels there is no other option but to forcethe issue militarily, as Ethiopia continues to reject an international border arbitration ruling. With Ethiopian troops having reentered Somalia in November2011, Addis Ababa could also find itself more deeply involved in the Somalian conflict on an undetermined basis were security conditions to deteriorateagain.The government's failure to plan adequately for Ethiopia's growing energy demand in the short term resulted in the country suffering prolonged powerblackouts throughout 200809. The completion of three hydropower plants in 2009 and 2010 has at least temporarily curbed the problem by more thandoubling the country's power-generating capacity. Nonetheless, the government must keep investing in the power sector to meet rising demand andsupport the expansion of the manufacturing sector.The development of Ethiopias manufacturing, part of the governments Growth and Transformation Plan, takes off to a higher degree than anticipated,giving economic growth a further boost.Ethiopia's development partners could tighten their purse strings due to the sustained narrowing of political space. Ethiopia's continued refusal to settleits border dispute with Eritrea, per the UN resolution, could lead the country into another round of costly fighting with its neighbor or see some of itsdevelopment partners withhold their assistance.

Data


Key Macro-Economic Indicators

2010 2011 2012 2013 2014 2015 2016 2017 2018

Real GDP (% change) 12.6 11.2 8.5 9.4 8.6 8.4 8.3 7.7 7.5

Nominal GDP (US$ bil.) 26.6 30.3 41.6 47.7 53.2 57.0 62.3 67.9 72.3

Nominal GDP Per Capita (US$) 297 330 442 494 537 562 600 638 664

Consumer Price Index (% change) 8.1 33.2 22.8 8.1 7.4 9.3 10.0 9.1 9.0

Fiscal Balance (% of GDP) -1.5 -5.4 -4.1 -3.7 -3.5 -3.1 -2.8 -2.6 -2.4

Population (mil.) 89.39 91.73 94.10 96.51 98.94 101.41 103.90 106.42 108.96

Current Account Balance (% of GDP) -1.6 -2.6 -7.2 -7.6 -7.0 -6.4 -0.2 0.1 0.1

BOP Exports of Goods US$bn 2.4 3.0 3.2 3.1 3.6 4.1 4.6 5.3 5.9

BOP Imports of Goods US$bn 7.4 8.3 10.5 11.5 12.5 13.5 14.5 15.5 16.5

Exchange Rate (LCU/US$, end of period) 16.55 17.21 18.18 19.06 21.88 24.61 27.21 29.64 31.79

Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated on the 15th ofSource:each month from monthly forecast update bank (GIIF). Written analysis may include references to data made available after the release of the GIIF bank.

Medium- and Long-Term Outlook

Key Points

Economic prospects remain strong, albeit with serious challenges.Ethiopia's medium- and long-term outlooks remain favorable.

Analysis

Economic prospects remain strong, albeit with serious challenges. Ethiopia's economy has, over the past decade, enjoyed its best spell in modernhistory. Its medium- and long-term growth prospects remain strong despite the recent slowdown, during which annual GDP growth slowed from double-digitrates over 200311 to 8.5% in 2012 and an estimated 9.4% outturn in 2013. On the flip side, the government has taken some positive steps in its effort todiversify the economy and thus become less reliant on its leading export, coffee, and foreign aid as its main sources of foreign exchange. The Growth andTransformation Plan for fiscal years 2010/112014/15, presented in August 2010, is largely focused on developing the agricultural sector. However, the mostdaring policy decision on the economic front has been to invest billions of dollars in upgrading Ethiopia's physical infrastructure, including the building andupgrading of thousands of kilometers of roads and the construction of several large hydropower dams. The government is hoping that this will sustain the highreal GDP growth rates, and has so far taken only limited measures to support the expansion of private-sector credit by opening up the economy for increasedcompetition.

Ethiopia's medium- and long-term outlooks remain favorable. IHS is forecasting annual real GDP growth to average around 8% over the medium term.Large private-sector investment, especially in the agro-industry sector, combined with public infrastructure development, is expected to drive real GDP growthin the coming years. Nevertheless, risk to economic growth outlook remains high. Ethiopia's growth prospects over the medium to long term remain dependenton a large array of factors. Continued electricity shortages, reduced foreign aid, and/or a sharp drop in coffee prices would place our projections at risk. Theagricultural sector, the biggest employer in the economy, is also vulnerable to exogenous factors such as droughts pushing up food prices and, by extension,inflation.

Growth

GDP

Key Points

In the current five-year economic plan, the Growth and Transformation Plan, the government has outlined two scenarios for economic growth.Large hydropower projects, such as the Gilgel Gibe III and Grand Ethiopian Renaissance dams, will underpin gross fixed capital formation in theupcoming years.The authorities' continued inability to contain inflation will probably drag on economic growth.


Analysis

In the current five-year economic plan, the Growth and Transformation Plan, the government has outlined two scenarios for economic growth: abaseline scenario with GDP growth averaging 11% and a high scenario with growth averaging 14% over the period. As in the previous five-year plan,agriculture is the main sectoral focus, although other sectors, such as manufacturing, construction, and services, are expected to become increasinglysignificant if the growth rate in the past decade is anything to go by. Despite the rhetoric, Ethiopia's economic fortunes in the coming years will to a large extentremain dependent on remittances, foreign aid, and weather patterns in spite of the government's progress in boosting its external-sector performance and itsquest for economic diversification. Commodity prices will remain a risk factor, because of volatility in the price of key export items, such as coffee, and upwardpressures on the import side, mainly from oil. Our more conservative forecasts see Ethiopia's GDP growth slowing slightly to 8.09.0% in 201415, followingan estimated 9.4% outturn in 2013, although the government still insists that it is on course to record continued double-digit growth. Impetus for growth isexpected to come from strong domestic demand driven by robust activity in the agricultural, services, trade, tourism, and construction sectors, despite theexpected slowdown in the growth of remittances and overseas development assistance.

Large hydropower projects, such as the Gilgel Gibe III and Grand Ethiopian Renaissance dams, will underpin gross fixed capital formation in theupcoming years. When completed, the projects will undoubtedly boost the economy by improving power supply and stabilizing the external accounts throughexports to neighboring Djibouti, Kenya, and Sudan. In addition, foreign manufacturers are setting up shop in Ethiopia, which should boost foreign-exchangeearnings over the medium term. Nevertheless, the requirement that private banks allocate a substantial share of their lending funds to government bonds tosupport the national development plan will reduce the available credit and affect capital investment in the private sector.

The authorities' inability to contain inflation will probably drag on economic growth. Capital controls imposed in January 2011 proved to be largelyinefficient with price growth accelerating to 40.6% in August 2011, before moderating over 2012 and 2013 to 8.1% on average in the latter year. We believethis is a cyclical low with higher inflation likely to weigh on private consumption in the near to medium term. The sharp swings in consumer price inflation willlikely keep the risk premium demanded on investments in Ethiopia at an elevated level. Ethiopia received sovereign credit ratings from the three main ratingagencies in May 2014, which will aid its aim of issuing a Eurobond in order to finance infrastructure investment. We expect Ethiopia to issue a debutUSD500-million eurobond in 2015.

Data

Economic Growth Indicators

2011 2012 2013 2014 2015 2016 2017 2018

Real GDP (% change) 11.2 8.5 9.4 8.6 8.4 8.3 7.7 7.5

Real Consumer Spending (% change) 3.4 8.2 8.2 8.7 8.2 8.1 7.7 7.5

Real Government Consumption (% change) 3.9 7.3 7.8 8.5 8.0 8.0 7.7 7.5

Real Fixed Capital Formation (% change) -0.9 16.6 12.1 10.4 9.9 9.1 7.7 7.5

Real Exports of Goods and Services (% change) 2.5 -3.0 9.9 7.6 9.6 9.2 7.7 7.5

Real Imports of Goods and Services (% change) -0.9 22.2 4.3 8.5 8.4 8.4 7.7 7.5


Nominal GDP (US$ bil.) 30.3 41.6 47.7 53.2 57.0 62.3 67.9 72.3

Nominal GDP Per Capita (US$) 330 442 494 537 562 600 638 664


Inflation

Key Points

IHS expects inflation to rise moderately in 2015.There is a substantial risk of further devaluation of the birr, reinforcing the inflationary cycle.

Analysis

IHS expects inflation to rise moderately in 2015.

Consumer price inflation in Ethiopia fell from 8.5% year-on-year (y/y) in June to 6.9% in July, according to the Central Statistical Agency. On a month-on-month(m/m) basis, the growth in the consumer price index (CPI) accelerated from 0.5% to 0.6%. Food prices, with a 53.0% weighting in the new CPI, increased from0.2% in June to 1.8%, but this was largely seasonal, with the y/y rate easing from 6.2% to 5.8%. Non-food prices fell by 0.8% m/m, following a 0.7% increase inJune, with the y/y rate falling back from 11.5% in May and 11.0% in June to 8.2%, the lowest level recorded in the new CPI based in December 2011. The JulyCPI reading was slightly lower than our forecast (7.2%) and constitutes a continued mitigation to the upside risks to inflation we identified earlier this year. Thisis due to a stronger-than-expected moderation in non-food prices countering the expected increase in food prices, as evidenced in July. We expect inflation toremain in the high single digits in the second half of the year before accelerating next year, as demand-side pressures rise. We now forecast inflation toaverage 7.4% in 2014, down from 8.1% in 2013, before rising to 9.3% in 2015. Among the upside risks to inflation are the renewed acceleration in domesticcredit expansion in the fourth quarter of 2013, the latest available data in late August 2014, lifting credit growth to 30.6% in December, and the potential foradverse weather affecting food supply (the UN declared a fourth year of drought in neighboring Djibouti on 12 June).

There is a substantial risk of further devaluation of the birr, reinforcing the inflationary cycle. With high inflation having eroded the improvement in pricecompetitiveness from the Ethiopian birrs 20% devaluation in September 2010, the prospect of new devaluation, which would only serve to prolong the highinflation rate, remains tangible. In addition, we see a risk the government will again revert to central bank financing, as it did in 2011, as its priority remains toboost economic growth through state-led investment projects. As a consequence, with the economic recovery from the policy-induced 200809 slowdown stilllooking vulnerable, we believe the government will opt to tolerate a higher inflation rate in the short term.

Data

Inflation Indicators

2011 2012 2013 2014 2015 2016 2017 2018


Consumer Price Index (% change) 33.2 22.8 8.1 7.4 9.3 10.0 9.1 9.0


Exchange Rates

Key Points

Foreign-exchange policy remains unchanged despite a disagreement in government.A nominal effective exchange rate appreciation raises need for new devaluation.

Analysis

Foreign-exchange policy remains unchanged despite a disagreement in government. A disagreement over monetary policy has allegedly emerged withinthe core leadership of the ruling Ethiopian People's Revolutionary Democratic Front, prompted by reports of a shortage of foreign exchange in the economy inlate 2012. Central Bank Governor Teklewold Atnafu refuted these reports, arguing they are based on unfounded rumors in the business sector, which haveprompted panic requests for foreign currency. Opponents of this view, which include influential Industry Minister Mekonnen Manyazewal, according to mediareports, claim there is an expanding gap in the supply and demand of foreign exchange in the economy, which threatens to stunt economic development byimpeding imports for investment projects. Foreign-exchange shortages are common in economies operating under a fixed or managed exchange-rate regime,especially if they are also running a current-account deficit, as is the case with Ethiopia. While timely current-account data are not available for Ethiopia, thesharp widening of the trade deficit in 2012 to USD7.3 billion, or 13.5% of GDP, was compounded by weaker coffee prices in 2013, which depressed exportrevenue while import growth also slowed. IHS estimates that the trade deficit widened to USD8.4 billion, or 14.7% of GDP, in 2013, with the current-accountshortfall also widening to USD3.86 billion, or 7.6% of GDP. Similarly, while the reduction in consumer price inflation from a cyclical peak of 40.6% y/y inSeptember 2011 to an average of 8.1% in 2013 and 6.9% in July 2014 has bolstered confidence in holding the domestic currency, an extended shortage offoreign exchange in the economy could force the Ethiopian authorities to devalue the birr again.

A nominal effective exchange rate appreciation raises need for new devaluation. The Ethiopian birrs 20% devaluation in September 2010 wassignificantly larger than previous devaluations. Although that devaluation brought the birr closer in line with its real value and boosted Ethiopia's trade accountsin its immediate aftermath, the cycle of the birr becoming overvalued in real terms in recent years as a result of Ethiopia's comparatively high inflation has yet tobe convincingly broken. The government appears intent on keeping the currency stable, but this aim is complicated by inflation remaining considerably higherthan in the United States, which is again making the currency overvalued in real terms.

Data

Exchange Rate Indicators

2011 2012 2013 2014 2015 2016 2017 2018


Exchange Rate (LCU/US$, end of period) 17.21 18.18 19.06 21.88 24.61 27.21 29.64 31.79

Exchange Rate (LCU/US$, period avg) 16.90 17.70 18.63 19.80 22.59 25.29 27.85 30.72

Exchange Rate (LCU/Euro, end of period) 22.26 23.99 26.28 28.44 30.76 35.10 38.83 42.16

Exchange Rate (LCU/Euro, period avg) 23.50 22.75 24.73 26.69 28.83 32.04 36.22 40.52


Policy

Monetary Policy

Key Points

Public-sector borrowing needs will continue to strain credit availability.IHS is identifying the risk of renewed fiscal dominance of monetary policy amid persistent upward pressures on government expenditure.

Analysis

Public-sector borrowing needs will continue to strain credit availability. Domestic credit increased by 29.5% year on year (y/y) in December 2013, anacceleration compared with 23.4% in June, according to the National Bank of Ethiopia (NBE). We view this as an indication that growth in the aggregate hasbottomed out after decelerating steadily since early 2012. In mid-February 2013, the NBE reduced the reserve requirement ratio for commercial banks from10% to 5% to address a liquidity shortage threatening economic growth. The reserve requirement was previously reduced from 15% to 10% in January 2012.Banks were also given a two-year grace period to restructure their loan portfolios, so that 40% of loan advances comprise short-term loans, in order to reducethe mismatch between assets and liabilities. IHS views the reduction in the reserve requirement ratio as a symptom of the authorities continued difficulties inmobilizing domestic financing for its infrastructure-investment plans without inhibiting credit availability for the private sector.

IHS is identifying the risk of renewed fiscal dominance of monetary policy amid persistent upward pressures on government expenditure. Thegovernment eased reserve requirements for commercial banks in early January 2012 in order to increase funds available for lending amid negative real depositgrowth. The reason for the easing of reserve conditions is that the government was facing a severe fiscal pinch in 2012, with the sharp uptick in inflation todouble-digit rates over fiscal year (FY) 2011/12 (1 July30 June), year, raising its costs on both the expenditure and financing sides. To counter thesepressures, the government resorted to heavy-handed measures, such as obliging commercial banks to invest in government bonds at a highly negative interestrate, but we believe this will be insufficient to adequately solve the financing situation. With the government likely to face increasing pressures to raise publicwages in response to higher inflation, while at the same time remaining committed to large-scale infrastructure projects to drive growth, we see an increasingrisk that it will continue to periodically resort to central bank financing of the government budget or further reserve-requirement reductions in situations of fiscalstress. The reduction in base money in FY 2011/12 contributed to bringing consumer price inflation back into single digits in FY 2012/13 following the highinflation of the previous fiscal year. Reserve money increased 12.4% in 2012 and 12.5% in 2013, below nominal GDP growth.

Data


Monetary Policy Indicators

2011 2012 2013 2014 2015 2016 2017 2018

Short-term Interest Rate (%, end of period) 0.90 0.90 0.91 0.91 0.91 0.91 0.92 0.92

Long-term Interest Rate (%, end of period) 8.03 8.03 8.04 8.04 8.04 8.04 8.05 8.05


Fiscal Policy

Key Points

Fiscal policy remains focused on infrastructure development.The prime minister has opened for a Eurobond issue.

Analysis

Fiscal policy remains focused on infrastructure development. The Ethiopian parliament passed a budget for fiscal year (FY) 2014/15 (JulyJune) worthETH179 billion (USD9.2 billion) on 7 July before going into recess. The budget was presented to parliament on 9 June by State Finance Minister AbrahamTekeste and was deliberated in the Budget and Finance Affairs Standing Committee in the following weeks. The budget constitutes a 15.6% increase on theETH154.9-billion budget for the current fiscal year, with budget recurrent expenditure up 38% to ETH45 billion, capital expenditure up 4% to ETH67 billion(from ETH64.32 billion budgeted in FY 2013/14), and allocations to regional governments up 18% to ETH 51.5 billion. The remaining ETH15 billion ingovernment revenue is allocated to projects aimed at achieving the eight millennium development goals. Total domestic revenue is projected at ETH115 billion,with the remainder to be raised through non-tax sources and foreign aid and loans. The FY 2014/15 budget entails a stronger projected increase in recurrentexpenditure in healthcare and other areas and less in capital expenditure than in previous fiscal years. We believe this is due to a desire to not set capitalexpenditure targets too high and to focus more on completing existing capital projects in the five-year Growth and Transformation Plan, which expires in June2015. The projected economic growth rate of 11% in FY 2014/15 is higher than our real GDP forecasts of 8.6% and 8.4% in 2014 and 2015, respectively.

The prime minister has opened for a Eurobond issue. Prime Minister Hailemariam Desalegn started speaking in mid-October 2013 about the governmentsplans to attain a credit rating and issue a debut sovereign bond. The former was finally attained in early May 2014, and IHS expects a debut USD500-millionEurobond issue in 2015. The IMF continues to advise the Ethiopian authorities to seek concessional external financing for its Growth and Transformation Planand to adjust the level of public investments if scaled-up external financing on manageable terms is not forthcoming. The IMF also said that there was scopefor improving the functioning of the foreign-exchange market and that greater exchange-rate flexibility would help to clear the foreign-exchange market andpromote the traded-goods sectors competiveness.

Data

External Sector

Key Points

Notwithstanding the rise in exports in recent years, Ethiopia's overall balance-of-payments position is likely to remain deep in the red in the medium termas imports outpace exports.

Analysis

Notwithstanding the rise in exports in recent years, Ethiopia's overall balance-of-payments position is likely to remain deep in the red in the mediumterm as imports outpace exports. The trade deficit, which widened from USD7.3 billion in 2012 to an estimated USD8.4 billion in 2013, is unlikely to improvein coming years as remittances, foreign aid, and investment inflows continue to drive domestic demand. Despite improvements in goods exports to USD3.2billion in 2012, before falling back somewhat to an estimated USD3.1 billion in 2013, the sharp increase in imports in recent years underlines the challengeahead. With little domestic supply of vital goods, further devaluations of the Ethiopian birr are unlikely to lead to much import substitution. Therefore, IHSexpects the trade deficit to narrow somewhat to around 14% of GDP in 201415, but continue to weigh heavily on the current account. While rising remittancesand energy and mineral exports should help contain the current-account deficit, there is still a high probability Ethiopia will experience renewedbalance-of-payments pressures if it does not tighten fiscal and monetary policy and/or allow another birr devaluation. Foreign-exchange reserves dropped to


1.8 months of imports in September 2013, according to the National Bank of Ethiopia. They then improved somewhat in the fourth quarter, according to theInternational Monetary Fund (IMF) and the Ethiopian authorities. IHS Economics sees a possibility Ethiopia will require assistance from the IMF in 201415 tobolster its foreign-exchange reserves toward the targeted three months of import cover.

Data

Trade and External Accounts Indicators

2011 2012 2013 2014 2015 2016 2017 2018

Exports of Goods (US$ bil.) 3.0 3.2 3.1 3.6 4.1 4.6 5.3 5.9

Imports of Goods (US$ bil.) 8.3 10.5 11.5 12.5 13.5 14.5 15.5 16.5

Trade Balance (US$ bil.) -5.3 -7.3 -8.4 -8.8 -9.4 -9.8 -10.2 -10.6

Trade Balance (% of GDP) -17.7 -17.6 -17.6 -16.6 -16.5 -15.7 -15.0 -14.6

Current Account Balance (US$ bil.) -0.8 -3.0 -3.6 -3.7 -3.7 -0.2 0.1 0.1

Current Account Balance (% of GDP) -2.6 -7.2 -7.6 -7.0 -6.4 -0.2 0.1 0.1



Key Indicators and Forecasts

Data (Forecasts)

Detailed Macro-Economic Indicators

2010 2011 2012 2013 2014 2015 2016 2017 2018

Real GDP (% change) 12.6 11.2 8.5 9.4 8.6 8.4 8.3 7.7 7.5

Nominal GDP (US$ bil.) 26.6 30.3 41.6 47.7 53.2 57.0 62.3 67.9 72.3

Nominal GDP Per Capita (US$) 297 330 442 494 537 562 600 638 664

Nominal GDP Per Capita (PPP$) 1,871 2,071 2,205 2,387 2,569 2,770 2,982 3,194 3,415

Real Consumer Spending (% change) 11.4 3.4 8.2 8.2 8.7 8.2 8.1 7.7 7.5

Real Fixed Capital Formation (% change) 4.6 -0.9 16.6 12.1 10.4 9.9 9.1 7.7 7.5

Real Government Consumption (% change) 12.3 3.9 7.3 7.8 8.5 8.0 8.0 7.7 7.5

Real Imports of Goods and Services (% change) 14.7 -0.9 22.2 4.3 8.5 8.4 8.4 7.7 7.5

Real Exports of Goods and Services (% change) -6.5 2.5 -3.0 9.9 7.6 9.6 9.2 7.7 7.5

Consumer Price Index (% change) 8.1 33.2 22.8 8.1 7.4 9.3 10.0 9.1 9.0

Short-term Interest Rate (%) 0.90 0.90 0.90 0.91 0.91 0.91 0.91 0.92 0.92

Long-term Interest Rate (%) 8.03 8.03 8.03 8.04 8.04 8.04 8.04 8.05 8.05

Fiscal Balance (% of GDP) -1.5 -5.4 -4.1 -3.7 -3.5 -3.1 -2.8 -2.6 -2.4

Population (mil.) 89.39 91.73 94.10 96.51 98.94 101.41 103.90 106.42 108.96

Population (% change) 2.6 2.6 2.6 2.6 2.5 2.5 2.5 2.4 2.4

Current Account Balance (US$ bil.) -0.4 -0.8 -3.0 -3.6 -3.7 -3.7 -0.2 0.1 0.1

Current Account Balance (% of GDP) -1.6 -2.6 -7.2 -7.6 -7.0 -6.4 -0.2 0.1 0.1

Trade Balance (US$ bil.) -5.0 -5.3 -7.3 -8.4 -8.8 -9.4 -9.8 -10.2 -10.6

Trade Balance (% of GDP) -18.7 -17.7 -17.6 -17.6 -16.6 -16.5 -15.7 -15.0 -14.6

BOP Exports of Goods US$bn 2.4 3.0 3.2 3.1 3.6 4.1 4.6 5.3 5.9

BOP Imports of Goods US$bn 7.4 8.3 10.5 11.5 12.5 13.5 14.5 15.5 16.5

Exchange Rate (LCU/US$, end of period) 16.55 17.21 18.18 19.06 21.88 24.61 27.21 29.64 31.79

Exchange Rate (LCU/Yen, end of period) 0.20 0.22 0.21 0.18 0.21 0.23 0.26 0.28 0.30

Exchange Rate (LCU/Euro, end of period) 22.11 22.26 23.99 26.28 28.44 30.76 35.10 38.83 42.16


Debt Indicators

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Foreign Exchange Earnings (US$ bil.) 3.6 5.1 6.3 6.5 7.3 8.3 9.3 10.6 12.1 13.7

Portfolio Investment, Net (US$ bil.) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0


Portfolio Investment, Net (% of GDP) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Foreign Direct Investment, Net (US$ bil.) 0.2 0.3 0.6 0.9 1.7 2.1 2.3 2.4 2.6 2.8

Foreign Direct Investment, Net (% of GDP) 0.8 1.1 2.1 2.1 3.6 3.8 3.9 3.8 3.6 3.6

Foreign Exchange Reserves, Excl. Gold (US$ bil.) 1.8 2.7 2.3 2.1 2.7 3.2 3.9 4.3 4.7 5.2

Import Cover (Months) 2.4 3.3 2.3 1.8 2.0 2.2 2.3 2.3 2.4 2.4

Total External Debt (US$ bil.) 5.2 7.3 8.6 10.5 11.9 13.7 16.2 18.1 20.3 23.2

Total External Debt (% of GDP) 18.4 27.6 28.4 25.1 25.1 25.4 27.6 28.2 28.8 30.6

Total External Debt (% of forex earnings) 144.4 145.1 136.9 161.3 164.2 164.7 174.0 171.0 168.1 169.7

Short Term External Debt (US$ bil.) 0.0 0.3 0.2 0.0 0.0 0.1 0.1 0.1 0.1 0.1

Short Term External Debt (% of total external debt) 0.9 4.3 2.0 0.4 0.4 0.4 0.4 0.3 0.3 0.3

Short Term External Debt (% of international reserves) 2.5 11.6 7.7 1.7 1.7 1.6 1.5 1.5 1.5 1.5

Total External Debt Service (US$ bil.) 0.1 0.2 0.4 0.4 0.6 0.8 0.9 1.0 1.1 1.1

Interest Payment Arrears (US$ bil.) 0.0 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.2 0.3

External Liquidity Gap (% of forex earnings) 62.9 13.4 16.2 46.7 56.2 53.7 54.1 49.9 45.9 41.0

Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated live from quarterlySource:Sovereign Risk forecast bank (SRS).

Key Facts and DemographicsArea: 1,127,127 km (sq miles 435,186)2

Language: Amharic and English(official), Oromiffa, Tigrinya, Sidamigna, Guaragigna, Somali, Arabic and Welaitigna

Religion: Ethiopian Coptic Christianity, Christianity, Sunni Islam

Time Zone: GMT +3

Population: 91,730,000 (2012, World Bank)

Neighbours: Djibouti, Eritrea, Kenya, Somalia and Sudan

Capital City: Addis Ababa

Primary Airport: Addis Ababa Bole International

Primary Port: Djibouti-ville (Djibouti)

Currency: Ethiopian Birr (ETB)

External Trade

OverviewEthiopia's principal export is coffee, which, despite its recent fall in terms of importance, still accounts for over one-third of the country's foreign-exchangeearnings. Other exported goods include khat (a mild stimulant classified as a narcotic in some countries), gold, cut flowers, leather products, live animals, andoilseeds. The country's traditional import destinations include Saudi Arabia, the United States, Switzerland, and Italy, with China now becoming a verysignificant source. Major export destinations are Germany, China, Japan, Saudi Arabia, Italy, and Djibouti (whose port Ethiopia relies on heavily). Given thesmall size of its economy, Ethiopia's top trade partners can fluctuate wildly on account of one-off, expensive imports, such as aircraft and ships. Ethiopia'sprincipal import commodities are food, petroleum products, chemicals, machinery, motor vehicles, cereals, and textiles. Also, in common with many Africaneconomies, China is becoming by far Ethiopia's most significant trading partner, overtaking traditional partners such as the US, Europe, and the Middle East.Ethiopia allocated significant resources in the generation of hydroelectric power and geothermal energy. The ambitious Growth and Transformation Plan isexpected to help Ethiopia produce between 8,000 and 10,000 MW of energy to satisfy its domestic needs and for export to Djibouti, Kenya, and Sudan.

Data


DataEthiopia: Major Trading Partners, 2013

EXPORTS IMPORTS

Country Billions of USD Percent Share Country Billions of USD Percent Share

China 0.3 13.0 China 2.1 15.3

Saudi Arabia 0.2 8.3 Saudi Arabia 1.1 8.1

Germany 0.2 8.3 India 1.0 7.2

United States 0.2 8.1 United States 0.7 5.6

Belgium 0.2 7.1 Italy 0.4 3.0

Japan 0.1 3.8 Turkey 0.4 3.0

Netherlands 0.1 3.4 France 0.3 1.9

Djibouti 0.1 3.0 Germany 0.3 1.9

Israel 0.1 2.9 Belgium 0.2 1.8

Italy 0.1 2.8 Sudan 0.2 1.5

Source: IMF, Direction of Trade

Ethiopia: Major Trading Partners, 2000

EXPORTS IMPORTS

Country Billions of USD Percent Share Country Billions of USD Percent Share

Germany 0.1 21.5 Yemen 0.2 19.6

Japan 0.1 12.9 Italy 0.1 9.5

Djibouti 0.0 11.3 China 0.1 7.1

Saudi Arabia 0.0 8.8 Japan 0.1 6.1

Italy 0.0 7.2 India 0.1 5.0

Switzerland 0.0 6.5 United States 0.1 4.6

United States 0.0 4.0 United Kingdom 0.1 4.3

Belgium 0.0 3.8 Germany 0.0 3.6

Israel 0.0 3.8 France 0.0 2.8

France 0.0 3.3 Sweden 0.0 2.7

Source: IMF, Direction of Trade

HighlightsEthiopia remains a promising destination for foreign investment, despite challenges associated with it being an underdeveloped country. Since coming topower in 1991, the Ethiopian People's Revolutionary Democratic Front (EPRDF) administration has taken a number of positive steps to address some of themain concerns cited by investors, such as reforming the tax and legal environments, protecting investments from forceful takeover, easing the repatriation ofdividends, and signing deals to avoid double taxation and improve the business climate. However, there is still a lack of policy consistency in both areas amidallegations of routine political interference in the workings of the judiciary. Among the areas prohibited from foreign direct investment (FDI) are media,transport, and retail, as well as key sectors such as banking, telecoms, and power generation. The private sector also remains excluded from the latter two,due to the government's preference for state-led development policies, which risk limiting Ethiopia's growth potential, while restricting competition andinnovation in these sectors. Notwithstanding such challenges, the authorities continue to put a great deal of resources into upgrading the country's transportand communications infrastructure to facilitate more rapid economic growth, while boosting its power output in response to the growing demand and inanticipation of future domestic and regional needs. Elsewhere, Ethiopia's security environment continues to be an area of concern, with the government


currently fighting off low-level insurgency threats from a number of nationalist and secessionist movements at home, as well as from radical Islamists inneighbouring Somalia, due to its military involvement in Somalia. Its long-running border conflict with Eritrea remains as a threat to Ethiopias stability whilegovernment restriction of political freedom have limited the political space in which opposition parties, civil-society groups, and the independent media canoperate. The government also faces growing accusations of religious intolerance, with the country's Muslim population charging that the authorities are trying tointerfere in the way they practise their faith.

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