Ethiopia: exciting reforms, but don’t expect miracles
GDP growth: could slow as economy rebalances
We retain our GDP growth forecast for 2017/18 at 8.5% y/y, and lower our 2018/19 estimate to 8.0% y/y from 9.0% y/y. The raft of political reforms being undertaken by Prime Minister (PM) Abiy Ahmed is clearly positive for the business environment and investor sentiment. Refreshingly, in addition to building bridges and mending relations with neighbouring countries such as Eritrea where a 20-year military standoff was ended, PM Abiy has acknowledged that economic reforms will be needed to address longstanding FX liquidity challenges which have been a chronic restraint on economic development.
While semi-privatisation may alone not be the solution to improve FX availability, it certainly is a step in the right direction. The government still needs to grow its export base substantially over the coming years. There is concern around external debt, which could limit the government’s capacity to continue spending on new infrastructure projects.
Balance of payments: imports could rise again
We expect the C/A deficit to narrow to 7.1% of GDP in 2018. We suspect that imports will probably rise much slower than previously thought, while diaspora remittances have also been quite impressive. However, export earnings continue to remain sluggish. PM Abiy had announced that implementation of new infrastructure projects may be put on hold due to funding constraints with preference to be given to complete ongoing public projects.
Total imports declined to an average of USD3.8 billion in the six months to March 2018, from an average of USD4.0 billion in the previous six months. Total exports are likely to remain flat at around USD2.8 billion in FY2017/18, and only modestly rise to around USD3.0 billion in 2019. Weak international prices of coffee and further delays in export receipts due to FX liquidity challenges is why we see this rather modest increase in total exports. We expect the C/A deficit to rise to 8.2% of GDP by the end of 2019. FDI should continue to primarily fund the wider deficit in addition to receipts from the semi-privatisation process.
FX outlook: moderate ETB weakness
We still expect the USD/ETB to trade closer to the 29.0 levels by the end of 2018. Following remarks from senior policymakers and PM Abiy, we are more confident that another devaluation similar to the magnitude of that of last October (15%) is unlikely to occur over the coming year. While the new PM acknowledges that acute FX shortages is hampering economic activity, he has acknowledged that these liquidity issues could persist for many years to come and instead tried to encourage diaspora remittances to increase rather than endorse another sharp devaluation of the ETB.
Monetary policy: hawkish bias
We expect the NBE to continue maintaining a somewhat tighter monetary policy stance to ensure inflation expectations begin abating. Headline inflation has remained sticky in double digits, despite drought conditions easing somewhat over the course of this year.
We see headline inflation declining to 10.2% y/y by the end of December 2018 to an average 9.9% y/y in 2019. The risk of adverse weather conditions will always remain a risk to inflation in the Horn of Africa.
Fiscal policy: a pro-poor budget
The government has been trying to adopt a more restrictive fiscal stance over the last few years, which admittedly has been rather difficult to adopt given the large expenditure needs for infrastructure projects as well as a weak tax revenue base owing to soft private sector activity. The FY2018/19 budget was described as a pro-poor budget by PM Abiy, with various social services programmes dominating a large part of expenditure.
While total expenditure as percentage of GDP falls to 13.5% in FY2018/19 from 13.6% in the previous fiscal year, the government will find hard it hard to avoid increasing expenditure on infrastructure projects over the coming year as it endeavours to start exporting more and thus alleviate FX shortages.