Extract 1: Ethiopia -­‐ Could A Devaluation Promote Growth and Development? Ethiopia is one of the fastest-­‐growing countries in the world with real GDP growth expected at 8% for both 2015 and 2016. Growth is being driven by public investment in transport and power networks, which benefit both industry and agriculture. The country has untapped reserves of coal, gold, oil and gas and FDI is relatively low (below 3% of GDP). Inflation has remained in the single-­‐ digit range since mid-­‐2013, as a result of lower food and fuel prices and tight monetary policy. The IMF believes that Ethiopia requires higher domestic savings to finance its significant infrastructure and human development needs. Total savings has increased to about 18-­‐19 percent of GDP, reflecting solid growth in private savings. However, given the authorities' investment target of 40 percent of GDP, more resources are needed. A more effective tax system could also help raise resources to finance development. With an estimated tax-­‐to-­‐GDP ratio of 12.9 percent in 2015, Ethiopia falls short of its revenue potential. Measures that increase the tax base—such as promoting private sector growth and increasing the scale of commercial agriculture in place of subsistence farming—would support higher levels of tax revenue The Ethiopian economy is vulnerable to external shocks. Rain-­‐fed agriculture (accounting for almost 50% of GDP) remains Ethiopia’s main source of employment and export earnings, which results in vulnerability to weather shocks. The country is also exposed to fluctuating global commodity prices, particularly for coffee, oilseeds and gold (22%, 16% and 14% of their exports respectively). Ethiopia is the 121st largest export economy in the world and the 108th most complex economy according to the Economic Complexity Index (ECI). The nation earns most foreign exchange from state-­‐
owned Ethiopian Airlines, while coffee exports from Africa’s largest producer of the beans are the highest grossing commodity. The current account deficit is structurally high, given low-­‐ value exports and large capital imports (45% of imports) for infrastructure development. Major power generation projects are under way and should boost exports when completed. China is Ethiopia’s main trading partner (17% of exports, 19% of imports). Although external accounts have benefitted from lower oil prices and a Eurobond issuance, the country’s foreign exchange reserves remain low. The fiscal deficit is likely to remain at around 3% of GDP despite high spending on infrastructure. (Capital spending was 11% of GDP in 2014, representing around 60% of total expenditures). Public debt is low at 22% of GDP – forecast in 2015. The government benefits from large foreign-­‐aid inflows, at 9% of government revenues in 2014, although the share is declining. Aid is supported by Ethiopia’s geopolitical importance as a key Western ally in the unstable, terrorism-­‐prone Horn of Africa. GDP per capita is very low (around USD 600 PPP in 2015) and Ethiopia ranks 173/187 on the UN’s Human Development Index. However, significant progress has been achieved in the last decade, particularly regarding the extreme poverty rate (30% in 2011 from 60% in 1995). Income per capita has more than doubled in real terms since 2004. At the same time, poverty has fallen (to 29.6 percent in 2010, and likely even more since then), while inequality has remained low (a Gini coefficient of 0.30 in 2010). However, institutions are weak as per the governance indicators from the World Bank. In July 2014, economists at the World Bank published a report arguing that Ethiopia’s birr was overvalued and the country would benefit from a devaluation to boost export revenue and accelerate growth. Reducing the currency’s value by 10 percent in real terms may lead to a 5 percent increase in export earnings and a 2 percent increase in growth according to the World Bank analysis. Sources: Deutsche Bank Research and World Bank Research, 2014 Extract 2: The Ethiopian Balance of Payments Current account 2014 Current account as % of GDP -­‐12.8 Current account balance $ Million -­‐7,892 Trade balance in goods $ Million -­‐13,464 Trade balance in services $ Million -­‐20 Net investment income $ Million -­‐226 Net private transfers $ Million 4,601 Net official transfers $ Million 1,217 Capital account Foreign direct investment $ Million 2,202 Other investment $ Million 5,317 Errors and omissions $ Million 520 Change in official reserves $ Million -­‐148 Extract 3: Financial Balances for Ethiopia Gross domestic savings % Of GDP Gross domestic investment % Of GDP Resource gap % Of GDP Current account deficit % Of GDP External debt % Of GDP 2014 19.0 36.8 -­‐17.8 -­‐12.8 22.1 2015 Projection -­‐9.4 -­‐6,553 -­‐13,171 279 -­‐404 5,450 1,293 2,856 3,249 0 449 Source: IMF Staff Report, September 2015 2015 Projection 18.2 40.0 -­‐21.8 -­‐9.4 26.2 Source: IMF Staff Report, September 2015 Assignment Questions (a) With reference to Extract 2, outline whether the Ethiopian economy was able to finance their current account deficit in 2014 (5) (b) With reference to Extract 1, analyse two reasons why Ethiopia’s economy is vulnerable to external shocks (8) (c) Assess the argument that Ethiopian human development requires continued assistance in the form of overseas aid and external debt relief (10) (d) Assess the possible effects of a devaluation of the Ethiopian birr on the Ethiopian economy. (12) (e) With reference to the information provided and your own knowledge, evaluate the supply-­‐side policies that the Ethiopian government should pursue to sustain their rapid economic growth and development (15)