Ethiopia offers scant hope of financial liberalization

By William Davison

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A Chinese contractor and local labourers work at a metro-line station in Ethiopia’s capital Addis Ababa

When members of Ethiopia’s banking and business community gathered in the glitzy Sheraton Addis for an audience with the reform-minded new prime minister, Abiy Ahmed, in the middle of April, any hopes for an opening up of the financial sector were dashed: they were told there would be no liberalization of the banking sector, which bars foreign ownership, according to Reuters.

The president, who has a mainly ceremonial role, reiterated Abiy’s message a week later, while Abiy’s predecessor, Hailemariam Desalegn, who did offer some fresh thinking, then corroborated the new prime minister’s message further in an interview with Bloomberg.

Ethiopia’s economy has expanded at an enviable clip; growth was estimated at 10.9% in the 2016/17 financial year, and averaged just over 10% a year from 2005/06 to 2015/16, according to the World Bank, compared to a regional average of 5.4%. But much of that dynamism has been in the public sector. Domestic and foreign state-owned banks, often Chinese, have funded transport links and power plants, while multilateral lenders have sunk cash into education, health, water and agriculture.

Sustained growth occurred while the government ran one of Africa’s most protected economies. As well as the closed banking sector, state-owned enterprises monopolize or dominate telecommunications, energy, and transport.

The relative success without deregulation means that despite political changes, Africa’s biggest lenders, which have established representative offices in Addis Ababa, will most likely have to wait to start commercial operations.

“I don’t expect a big bang liberalization at any point soon,” says Nebil Kellow, an Ethiopian financial analyst and managing partner of FirstConsult.

Repressive

The government’s approach is instead a financially repressive model that employs capital controls and prioritizes state banks funneling cheap credit for public enterprises to build much-needed infrastructure. Furthermore, it claims it lacks the capacity to regulate foreign banks, partly because the sector was only reopened for domestic private lenders less than three decades ago.

Obviously, this has advantages for the 17 private Ethiopian banks, which do not have to compete with the likes of KCB of Kenya or South Africa’s Standard Bank. Instead, they are up against the state-owned Commercial Bank of Ethiopia (CBE), which controls more than 60% of deposits, although private banks are steadily increasing their share.

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A senior credit analyst at a private bank, who did not want to be quoted by name, says performance has been good in the last nine months for private lenders in a difficult environment. Hailemariam resigned in February because of civil unrest sparked by high unemployment, and Abiy took over at the beginning of April.

“Despite economic and political instability, banks still registered strong growth in profits and assets,” he says.

Ethiopia’s bankers are not expecting monetary policy shifts but have to tackle rising rent, salaries and customer demands, which increases the cost of deposit mobilization, the credit analyst says.

“They want better service, they want proximity,” he says, adding that strong competition is also leading banks to provide premium accounts that offer more than the basic 7% interest rate on deposits.

There’s a foreign exchange shortage because the official rate is simply way too far from its market level 

 – Independent financial analyst

The National Bank of Ethiopia increased its baseline deposit rate to 7% last October, which banks passed on to customers. The central bank’s move was triggered by inflationary concerns after it devalued the birr by 15% in a bid to boost exports. Annual inflation dipped slightly to 14% in April in Ethiopia’s supply-constrained economy.

The government has also been borrowing from the central bank to finance its deficit, according to an independent expert on Ethiopia’s banking sector, Abdulmenan Mohammed. Similarly loose monetary policy in 2011 led year-on-year inflation to reach almost 40%. That isn’t the only risk, according to Abdulmenan. 

Despite a slowdown in borrowing, he is worried that state-owned CBE is over-exposed to under-performing government power, housing, sugar and railway corporations.

“Projects are taking much longer than expected. As a result, their financial feasibility is becoming questionable due to the escalated costs,” he says.

Foreign currency debt repayments are also an issue now as the grace period on Chinese loans expires.

Foreign exchange availability is the current economic headache, which was by no means solved by the devaluation: the birr has returned to a 20% gap between the informal and official exchange rate. The credit analyst offers the standard hope for resolving the hard currency shortage, which is that government efforts to increase manufacturing exports will soon pay off and begin to rebalance a yawning trade deficit, which the IMF forecasts will grow to $13.6 billion, or 16% of GDP, this year. 

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Stuck

Although there is reason for optimism, with more electricity being generated and industrial parks occupied by foreign textiles factories, exports have been stuck at around a meagre $3 billion for the last five years.

Abiy has made no significant economic policy announcements yet, nor changed key policy-making officials such as the finance minister and central bank governor. That means the government is likely to stick to its recent policy of controlling borrowing, which previously had been so heavy that the IMF said it put Ethiopia at a “high risk of debt distress”. 

But while the prime minister has indicated continuity, his predecessor, Hailemariam, deviated in a Bloomberg interview. Although Hailemariam reiterated that the financial sector will remain Ethiopian, he revealed that last year he had proposed the partial privatization of state-owned enterprises such as Ethio Telecom to the ruling coalition, and that he expects Abiy to see this shift through.

An independent financial analyst, who did not want to be quoted by name, hopes that such thinking might presage a liberalization of the exchange rate regime, as occurred in Egypt and Nigeria in 2016. The proceeds from selling stakes in public enterprises could, for example, be used to eliminate foreign exchange shortages at banks, especially if part of a radical reform package that could include exchange rate adjustment and external support to build up the nation’s foreign reserves.

“There’s a foreign exchange shortage because the official rate is simply way too far from its market level,” he says. “You could very quickly get rid of shortages through an adjustment in the rate that helps to shrink imports.”

Abdulmenan, however, believes that would simply mean a sharply depreciating birr and an increased import bill for fuel and other vital materials. That will lead to even higher inflation, because the problem is less price and more supply constraints, while exports will not be boosted.

“I don’t think the government would consider a floating exchange rate for the foreseeable future,” he says.

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