Impact of Global Economic Slowdown on Ethiopian Economy
By Yared HM
Sub-prime mortgage, credit-crunch and recession are no more jargons of economists and politicians. They have become part of our day-to-day conversations be it at the bus stops, the coffee shops or breakfast tables. Somehow we all know what those words mean, but what will be their impact on our life and Ethiopian economy?
In the following article I would like to highlight some of the potential impacts of the credit crunch and global recession on the life of ordinary Ethiopians and Ethiopian national economy.
How the problem started?
The crisis in the US financial sector started with a slowdown of the housing sector. Particularly after the dot.com bubble burst in 2001/2002, a lot of money has been going into the housing and construction sector to create a real estate boom. As shown in Figure 1, house price in US has grown by 50% between 2004 and late 2006 alone. Similarly, in the UK house price has doubled in 10 years (the average price of a house has gone from £70,000 in 1998 to £180,000 in 2007-Figure 2). As a result of this boom in the last 10 years, even more people wanted to have a slice of this cake by borrowing heavily and investing it on property. In fact, this exuberant growth of housing market led to a very misleading cliché of “you can’t go wrong with bricks and mortar”. But the use of such a cliché came to an end at the end of 2006 in US and around the end of 2007 in UK. Since then house prices began to reverse, slide and tumble down at a much faster rate.
Many who bought properties assuming that it is going to go up found themselves trapped in negative equity. In simple terms, the house began to be valued less than the money they borrowed from Banks to purchase the property. This in effect became more of a problem to the Banks who were reckless in lending money failing to see the property price will not go up forever.
When the financial experts suddenly woke up to the terrible truth that a great many of the borrowers may not, after all, be able to pay back their debt, a crisis brewed. All the lenders started panicking and the financial market responded cruelly. Their share values plummeted to new lows not seen in recent times. The underlying cause of this slump came to be dubbed the Sub-Prime Mortgage.
Then in May 2006 Washington based Merit Financial Inc became the first mortgage provider to file for bankruptcy. Since then many financial institutions exposed to sub-prime mortgages have collapsed. These phenomena triggered fear among banks to stop lending to each other and mortgage for house buyers. This came to be known as “The Credit Crunch”. The rest is, as they say, history. This fear led into a standstill of inter-banks lending which led to the collapse of banking giants such as Lehman Brothers, Bear Stearns, HBOS, Northern Rock, and the stock-market to panic and politicians to intervene to stop collapse of the financial sector.
This in effect accelerated the house price crash and slowdown of the economy, which is now heading into the next level of economics jargon, that is recession. UK is now officially in recession and almost all Western countries are either certified or heading towards it. In layman’s terms recession means negative economic growth. It is a phase where companies are closing down rather than new ones opening for businesses; it is a phase where companies are making employees redundant than hiring new ones.
Ethiopia’s financial sector, as mortgage borrowing is not a particularly significant activity of the national economy, is not directly affected by any “Sub-Prime Mortgage” crisis. However, it would be naïve to say that Ethiopia’s economy will not be affected by the credit crunch or global recession, not least because a big chunk of the money spent in Ethiopia comes from those countries that are now in dire-straits. The money flowing into the country; be it through international aid or remittance etc, is all subject to this global phenomenon.
In what ways Ethiopia will be affected?
Knock-on effect of the Credit Crunch
According to budget presented to the parliament, Ethiopia’s next budget will be about 33% dependent on bilateral aid, loan and direct budget subsidies. Out of the approved 4.5 billion dollars budget, 1.5 billion dollar is expected to be covered by loan, aid and direct budget subsidies. Hence, no doubt that global recession will have a knock-on effect on Ethiopia’s economy. How?
Economic crisis in donor countries would make them very reluctant to honour their pledges, while their own economy get into recession, unemployment is increasing and their tax revenue is shrinking.
Though one cannot say for sure, the reason behind UK’s suspension of aid to Ethiopia, but it is indicative of the trend to come. According to Associate Press of 18th of October British International Development Minster, Douglas Alexander, suspended aid to Ethiopia “after learning that malnourished children has been moved so a British official would not see them” during his hospital visit in Eastern Ethiopia. In non politicians’ language this only means, the Minster punished Ethiopia, because Ethiopia felt embarrassed to parade its own malnourished kids for photo shoot.
What makes the story baffling is, Ethiopia has been accused of downplaying the number of people who need aid from what had been estimated by NGO’s. In all honesty any humanitarian mission, who believes Ethiopia is in a more serious problem than it admits, does not suspend aid.
This made me wary that politicians in donor countries may use similar excuses to cut aid to the third world; until they pull themselves out of domestic crisis.
Particularly projects related to ambitious “Millennium Development Goals”, such as eradicate extreme poverty and hunger; achieve universal primarily education; promote gender equality and empower woman; reduce child mortality; improve mental health; combat HIV and AIDS, malaria and other diseases; ensure environmental sustainability and develop a global partnership for development will not be honoured fully.
To be frank, the 8 Millennium Development Goals were adopted during economic boom time, under pressure of pop-stars, church leaders and anti-poverty campaigners. Hence, under current market turmoil it is unlikely that these dreams will be honoured.
That is why poor countries like Ethiopia need to adopt a realistic expectations and re-write their budgets to reflect the reality on the ground or work harder to find alternative sources of revenue to fund these projects.
Impact on Commodity Prices
Ethiopia’s Economy is dependent on export of Coffee, flower, leather and livestock.
As can be seen from Figure 3, coffee’s price has already gone down by 30%. If this trend continues, Ethiopia might lose at least $100 million revenue of around $350 million, going by what it earned in 2007. These drops in coffee price mean loss of revenue to the national economy as well as millions of farmers and traders.
According to figures published by HBAG, cut flower price in Dutch Flower Market has gone down by 20% while cost of transportation increased by 20% leaving flower grower’s upto 40% worse off compared to last year. This too is going to affect Ethiopia’s 2009 foreign exchange earning, putting more pressure on new entrants to the market.
Similarly prices of many of the commodities Ethiopia exports have gone down by similar percentages, reducing the country’s foreign exchange earnings significantly.
Ethiopia’s export value in 2007 was about 1.5 billion dollar and the government was hoping to earn about 2 billion dollars this year. This may not be achieved at current commodity prices. Even losing 30% of export value from last year earning is going to leave a 450 million dollar foreign exchange deficit in the economy.
Blessing: Crush of Crude Oil Price
On the positive side crude oil price has come down from $147 per barrel to around $65 per barrel. This would significantly reduce Ethiopia’s spending on import of oil. According to IMF document, Ethiopia could have spent about $180 million dollars a month (2.1 billion/year) on oil imports if the price remained around $135 per barrel. That means Ethiopia potentially could save up to a billion dollar if the price remains under $70.00. However, anything like OPEC grip on output, political instability in the Middle East, Hurricane in Gulf of Mexico or rebel attack in Niger Delta could push the price of oil higher to deny Ethiopia this vital saving.
The other source of Ethiopian foreign exchange is remittance from Ethiopians living abroad. According to recent National Bank of Ethiopia press release, remittance from Ethiopians living abroad reached $1 billion last year. Recession and loss of jobs in the West could affect Ethiopians in Diaspora and reduce the money flowing into the country. Some sources of exchange generated from Ethiopians living abroad, such as tourism and air travel could impact earnings of companies like the Ethiopian Airlines. It is not possible to accurately predict the impact of global recession on Diaspora remittance, but even 30% reduction in remittance would mean a $300 million loss to the economy, which is equivalent to the lose of foreign exchange income from coffee export.
Development Commercial Loans
Ethiopia in the last 3 years had been investing heavily to expand its infrastructure, communication and power stations. If the credit crisis continues some of the projects planned with private banks may not be available to start or complete. The credit squeeze has also increased the cost of borrowing to push projects beyond planned budget.
The World Bank and IMF cash reserve is also dwindling as the number of countries queuing for bailout goes up. Already, Iceland ($6 billion), Ukraine ($16.4 billion) Hungary ($25 billion), South Korea ($11 billion) and Pakistan ($5 billion) have received bailout package and many more countries are still queuing at the door of World Bank/IMF cup in hand. So countries like Ethiopia may be pushed down the list of priorities and altogether drop out of favour as Wold Bank and IMF struggle to bailout collapsing middle income countries.
Inflation and Investment
The biggest problem currently facing Ethiopia is high inflation. A year ago the debate between Ato Lidetu Ayalew and PM Meles in parliament was whether inflation was flu or high blood pressure to the economy. I am inclined to agree with analogy of high blood pressure since it can significantly affect the economy more than all the above factors.
According the official Central Statistic Agency, inflation in September was 37.2%, but inflation related to food items was 51.8 %.
This price increase in goods and services is going to reduce disposable income and limit spending to essential food items only; pushing private sector and small industries into contraction or bankruptcy. That in return may lead to default on loans and slowing down of construction, agro-industry and manufacturing.
Particularly huge increase in land price and construction materials may make it unaffordable even for the Diaspora community to invest in real estate.
What can be done to avoid recession in Ethiopia?
As shown above there are many ways the Ethiopia economy could get into trouble as a result of global credit crunch and recession. Before going to my recommendation, I would like to summarise potential impacts of the global economic crisis on Ethiopia.
Commodity price could go significantly down to affect coffee and flower farmers with loss of up to 450 million dollars.
Aid, loan and direct subsidy may dwindle leaving a big hole in the government current budget of 4.5 billion of which $1.5 billion is expected to be covered through aid, loans and budgetary support.
Diaspora remittance could go down significantly, while businesses like Ethiopian airlines and hotels could feel the squeeze from dwindling tourists. Inflation could make purchasing of non-essential goods beyond everyone’s reach driving small industries into banckrupcy and default of loan and reduction of tax revenue.
In particularly, Inflation would discourage direct investment in the country to make export of garment, flower, and leather uncompetitive in the global commodity market. Investment in real estate, agro-industry, textile and leisure industry could slowdown to shrink the economy growth of the economy or lead into contraction. As we have seen in the rest of the world, slowdown in one sector of the economy could feed into other sectors and bring the whole economy into difficulty.
Overall, Ethiopia could lose up to a billion dollars of income as a result of global recession. Of course, drop in oil price is good news and may reduce the impact. However, considering OPEC’s firm control on the supply, potential instability within the Middle East, Hurricane in Gulf of Mexico or attack in Niger Delta could push the price overnight. So we could only hope oil to remain below $70 per barrel, but it is out of our control.
Underestimating the Danger
From some interviews that I have read, the potential impact of global recession on the Ethiopian economy is not fully recognized by the Ethiopian government. Rather than focusing on practical solution like improving efficiency, control of price hike by capping price increase by government controlled utility companies, reduce high rate of Value Added Tax (VAT) and increasing supply of land to reduce cost of construction and investment, the government was entertaining many fanciful solutions like use of bio-diesel, that will never be materialised in 5 years, and increase in interest rate, in a country where the majority of the people have no bank account. Now inflation has gone from 19% last year to 37% in less than a year. Inflation is already many times higher than interest rate and increase in saving rate would not encourage to put your saving in birr.
Potential Remedial Solutions
Though it is very difficult to fight from this level, it is still possible to control inflation if the government put cap on increase of utility bills like Electricity, water and telephone.
Improve efficiently and reduce waste in the government institutions. Cut VAT since it contributes for at least 15% increase in the price of goods and services.
Increase supply of land for house building. This might reduce land prices from current 500,000 – 1,000,000 birr price tag for 500 SqM of land in Addis Ababa. It is worth nothing the corollary of the Sub-prime mortgage problem in the Western world. This hyper inflated price will soon lead to subprime type of collapse in the real estate and construction industry in Ethiopia. By fighting inflation as a priority, the government could reduce the absurd amount of money that is being pumped into real estate as safe heaven from collapsing purchasing power of birr day by day. At current inflation rate 1 birr this year will have a purchasing power of 63 cents next year. This discourages saving and encourage investing in sky scrappers (bricks and mortars) with no renters in the market or luxury items that contribute little towards economic development or wealth creation
High inflation also encourage many wealthy individuals to keep their money in dollar or other currencies, which may leads to shortage of foreign currency and transfer of wealth from the country to a foreign land.
Higher inflation also discourages Ethiopians living abroad from brining their money into the country and converts it to birr at the time where purchasing power of birr drops upto 37% year on year.
The government needs to liberalise further by creating a system for shareholding companies and stock-market so that small capitals could go into investment making citizens stakeholders and moping out excess cash in circulation.
The current investment climate is only open to tycoons or well connected individuals who have a means to borrow huge amount of money from the government banks often without collateral. This is exactly the root cause of sub-prime mortgage in the West and Ethiopia need to avoid “me too” investment that isn’t backed by proper business plan.
In any Economy the biggest employers and backbone of the economy are small scale companies driven by entrepreneurs than wealthy investors. The system must be simplified so that form an elderly lady who wants to keep chickens – to a good artesian who needs tin shade where he can bash a scrap metal to make kitchen Knives or something useful. By providing land, power, water and other utilities at reasonable price, a country could embark on to new phase of development and help citizens to employ themselves rather than look to the government for jobs. The government’s obsession of talking in billions birr has disenfranchised millions; stifled entrepreneurship and creativity while encouraging corruption and get rich quick ambitions.
Be smart to alert global anti-poverty coalitions and pop-stars who made the Millennium Development Goal a reality. Their support is needed to press donor countries honour their pledges. Considering the amount of money spent to bailout private Banks, the amount needed to alleviate poverty in the third world is like a chicken feed. For example 700 billion dollar bailout signed by US congress to save few banks is equivalent to 155 years total budget for Ethiopia at current 4.5 billion dollars. So it is morally dishonrable to punish the poorest of poor while saving multi-national financial institution, who gambled on saving, pension and assets of ordinary people. But the view from their side is that, bailing out the financial institutions is not just for the sake of it, but to energise the economy, set it back in motion and benefit the ordinary citizens who are going to be victims of the recession. So, although it won’t be easy to be heard in the current confusion, making the argument about our dire needs clearly and loudly shouldn’t be overlooked.
The government need to cut spending on luxury goods, like expensive cars for each and every government official, division manager and political cadres. Cut spending on celebration, meeting, parades and non-productive propaganda that nobody believes or find it entertaining, to stream-line this unproductive work force which had been a burden on the economy. (Current decision made to fold and remove Ministers of Information off the government payroll is a good beginning)
Try to bring forward loan facilities from Wold Bank, IMF and private institutions so that planed projects could be implemented. Delaying the requests on Ethiopia side could put loan facilities into jeopardy as countries fight for bailout. Half built Dam is worst than no Dam at all.
Unlock Ethiopia’s dead capital primarily land, minerals and energy resources. According to renowned Latin America economist, Hernado de Soto, land is a trillion dollar worth dead capital in Africa. Land by itself has no value unless something is planted and harvested on it. Land has no economic benefit unless something is built on it. Million tonnes of underground coal, Iron, Gold or oil reserve has zero value until it is mined out to be brought to the market. So, Ethiopia needs to encourage investment to come into the country to turn these dead capitals into valuable goods. This can only be realised by further liberalising investment laws, cutting red-tapes, reducing corruption and inflation and providing better protection for investors and property right to millions of farmers.
By adopting a flexible and open system; having a better financial control and reducing waste, adopting a business friendly environment and openly debating the impact of the global economy, Ethiopia could come out leaner, stronger and a competitive economy out of the looming recession. If not the impact on our economy could be long lasting