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  • Writer's pictureGrowth Capital Analytics

Ethiopia’s Debt Restructuring: A Pathway to Fiscal Sustainability


In an era where African economies are increasingly grappling with the complexities of debt sustainability, Ethiopia's fiscal narrative offers a compelling study of the delicate interplay between development aspirations and financial stability.


Ethiopia’s ambitious public investment-driven growth, once a beacon of hope, has encountered daunting headwinds of surging debt levels. This development journey serves as a cautionary tale about the perils of external borrowing and underscores the importance of sustainable fiscal management.


Commencing in the mid-2000s, Ethiopia embarked on an audacious path to accelerated growth via extensive public investments, known as the developmental state model. While initially promising, this approach precipitated a substantial debt pile-up. The country's predicament extends beyond mere figures; it reflects the crucial balance between developmental ambition and fiscal caution.


As Ethiopia now undergoes a process of debt restructuring with its creditors, this article delves into Ethiopia's debt evolution, evaluates the merits of its recent debt moratorium agreement, and looks at the next steps towards achieving debt sustainability and the wider ramifications for its fiscal sovereignty and stability. We will unpack the historical backdrop of Ethiopia’s debt accumulation, examine the present-day debt architecture, and scrutinize the strategic maneuvers undertaken, including the suspension of debt service and its repercussions.

A Decade of Debt: Ethiopia’s Borrowing Spree

 

The genesis of Ethiopia’s current debt quandary dates back to an array of bold public investment programs launched in the late 2000s, designed to ignite economic growth and elevate the nation to a regional economic powerhouse. However, this growth model was considerably underpinned by foreign funding, resulting in a ballooning of debt service obligations.

 

From 2008 to 2021, Ethiopia witnessed its external public sector debt mushroom from a modest $2.8 billion to an eye-watering $29.5 billion. This exponential growth was fueled by the state’s proactive borrowing to bankroll infrastructural, developmental projects, and state-owned enterprises. While these ventures were projected to catalyze long-term economic expansion, they concurrently cultivated a burdensome debt, straining the nation’s macroeconomic stability.


An analysis of Ethiopia’s debt makeup reveals a complicated scenario. As of June 2023, domestic debt represented 55.4 percent of total public sector debt, with the remainder constituted by external debt. Overall, public sector debt amounted to roughly 40.8 percent of GDP, with nominal external debt accounting for nearly 18.2 percent of GDP.



On paper, the overall debt stock seems low for the size of the Ethiopian economy. But, servicing this debt has emerged as a dire concern. For the fiscal year 2022/23, debt service payments absorbed a formidable 37 percent of Ethiopia’s total tax revenue, highlighting a pivotal facet of the debt dilemma: the increasing share of governmental revenue earmarked for debt repayment, thereby curtailing the nation’s investment capacity in pivotal public services and development initiatives.

Ethiopia’s external debt scenario is further complicated by the pattern of debt disbursements versus repayments. While the principal repayments to external creditors were less than the total disbursements accrued, a net external debt resource flow was observed. However, when combining principal and interest payments, the country witnessed a net resource outflow, indicating a scenario where debt servicing surpasses new borrowings. With Ethiopia’s critical shortage of foreign currency reserves, servicing debt has become a major challenge.

The Path to Debt Restructuring

Ethiopia's three-year-long engagement with the Common Framework for debt treatment, steered by the Paris Club, delineates the complexities inherent in managing sovereign debt. The Common Framework is designed to offer a structured methodology for debt treatment to mitigate liquidity constraints and foster debt sustainability for low- and middle-income countries. Nonetheless, its practicality and efficacy are subjects of fervent discourse, as evidenced by Ethiopia's and other nations' experiences.


On November 15th, Ethiopia reached an agreement in principle with its official bilateral creditors on an interim debt-service suspension. This suspension is expected to be a temporary fix until a more sustainable debt restructuring is negotiated.


The debt suspension agreement under the Common Framework offers Ethiopia crucial short-term liquidity relief. However, it does not fundamentally alter the nation's debt obligations. The condition of Net Present Value (NPV) neutrality in the agreement means that while immediate payment pressures are eased, the total debt value remains unchanged, potentially leading to increased financial strain in the medium term.

Furthermore, Ethiopia also appeared to be on the brink of a debt default on its private debt after talks with key holders of its $1 billion international bond ended without agreement, and the finance ministry told bondholders that it would not be in a position to pay a $33 million bond interest payment due on December 11 due to "acute external liquidity pressures", an event which would trigger a default.


These events undoubtedly emphasize the need to reach a comprehensive framework that covers all of Ethiopia’s debt to ensure long-term debt sustainability.



Figure - The Complex Debt Restructuring Process under the DSSI Common Framework


Ethiopia's journey towards resolving its debt crisis is intricately linked to its negotiations with the International Monetary Fund (IMF). The agreement with bilateral creditors for temporary suspension of debt payments until December 2024, and the possibility of long-term debt restructuring are both contingent upon Ethiopia securing an IMF program by March 31, 2024. This requirement places Ethiopia at a critical juncture, where its economic policies and future debt restructuring efforts are heavily influenced by its engagement with the IMF.


The IMF's involvement brings with it a sense of urgency and a set of conditions that Ethiopia must meet to access financial support and restructure its debt. This situation can potentially constrain Ethiopia's economic autonomy. Adhering to IMF conditions might compel the government to implement reforms that may not fully align with its long-term strategic goals or the immediate needs of its citizens. These reforms, often focusing on liberalization and austerity measures, can have significant implications for the nation's socio-economic fabric.

Reforms such as exchange rate liberalization or significant currency devaluation, while potentially beneficial for attracting foreign investment and improving market efficiency, can also lead to short-term economic volatility. Such measures might result in heightened inflation and exchange rate fluctuations, adversely impacting the cost of living and the broader economy. For a developing country like Ethiopia, the immediate consequences of these reforms can be particularly challenging, affecting the most vulnerable segments of the population.


Another critical aspect of the IMF's conditionality often involves significant tax increases and fiscal austerity measures. These policies are aimed at stabilizing the economy by reducing deficits and controlling inflation. However, they can also lead to reduced public spending, impacting social services and potentially increasing economic hardship for the populace. In Ethiopia, where public services play a crucial role in social welfare, the reduction in spending could have far-reaching consequences.


Ethiopia's predicament underscores the delicate balance required in implementing necessary reforms while mitigating their socio-economic impact. The urgency driven by the IMF program deadline might not allow for the careful planning and gradual introduction of reforms, essential to cushion their potential adverse effects. Furthermore, the focus on meeting IMF conditions may shift attention from other vital policy areas, potentially leading to an overemphasis on fiscal and monetary stability at the expense of broader economic development goals.


As Ethiopia navigates the complexities of its debt situation, a strategic and multifaceted approach is essential. The country must seek a comprehensive debt restructuring agreement under the Common Framework that transcends short-term liquidity solutions, focusing on significant debt relief, elongation of maturities, and reduction of interest rates, with the possibility of debt forgiveness where practical.


Enhancing domestic revenue is also critical, with a need to broaden the tax base, improve tax administration, and clamp down on tax evasion. This would reduce reliance on external borrowing and demonstrate a commitment to fiscal discipline to international creditors and investors.


Economic diversification remains a key pillar for reducing vulnerability to external shocks and improving Ethiopia's capacity to manage debt. Investments should target sectors with sustainable growth potential, such as agriculture, manufacturing, and the digital economy, emphasizing value addition and export promotion.


In addition, engagement with creditors needs to be proactive and transparent, encompassing discussions with bilateral, multilateral, and private creditors to secure support for a comprehensive debt restructuring process. This engagement is vital to ensure that all parties are aligned with Ethiopia's economic challenges and debt sustainability objectives.

 

No doubt, it will be difficult, but with a thoughtful approach that integrates comprehensive restructuring, active creditor dialogue, and robust fiscal management, Ethiopia can forge a path toward sustainable debt management and economic resilience.

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