Ethiopia is the seventh-fastest growing economy since 2000
Plenty has been written about Ethiopia’s fascinating growth model, most notably the World Bank’s 171-page tome “Ethiopia’s Great Run: The Great Acceleration and How to Pace It”. Despite an acceleration of GDP growth from 0.5% pa in 1981-1992 to 4.5% over 1993-2004, Ethiopia was the world’s second-poorest country in 2000. Yet the acceleration to 11% in 2004-2014 – better than China or India – gives credibility to the authorities’ target of middle income status by 2025. Life expectancy has risen by one year every year since 2000. World Bank models suggest a growth slowdown is pending, but it still sees GDP rising by 4.5-10.5% annually for 2015-2025, with the midpoint sufficient to again double GDP in a decade.
Having boosted agriculture and investment, now the goal is light manufacturing
China is probably the best comparison for those looking at Ethiopia. Heavy investment in infrastructure appears key. Federal government delivery of inter-state highways, electricity provision and rail connections has been high, without large corruption scandals. Nigeria may well look on Ethiopia’s success with some envy. Agriculture and construction have done well. Now the government wants to widen this growth to boost light manufacturing. Bangladesh among others fear the competitive threat from Ethiopian entry level salaries of $35-40 a month in the textile sector.
Its policy choices send shivers up the spines of orthodox economists
All this success has been achieved with a host of policies that send shivers up the spines of orthodox economists. In one marked contrast to the China or east Asian model, Ethiopia maintains an overvalued currency via extremely strong capital controls. This puts such a premium on dollar receipts, that companies will export goods even when the global price is lower than the local Ethiopian price. Behavior becomes distorted as (for example) flower exporters use their access to dollars to import consumer goods, which is hardly their first managerial or technical area of expertise. Meanwhile banks are directed to allocate loans below the rate of inflation – and unsurprisingly there is a massive demand for loans beyond what Ethiopia itself could possibly fund. But these policies are working. A key issue for the next five to ten years is how to keep funding this model.
Listing Ethiopian companies in London would support faster growth
Ethiopia’s government has an ideological aversion to portfolio investors and foreign banks. It has used domestic resources to fund growth rather than seek foreign portfolio investment. So rather than IPO telecoms as Kenya did, the government has used profits from the state-owned telecom monopoly to fund investment in infrastructure. Ethiopia may be the second-largest economy in the world without an exchange (we think Angola is the biggest) and there are no plans for one in the coming five years. But we think there is room for Ethiopia to attract foreign capital, for example by listing the telecoms company on the London Stock Exchange.
This would also raise the country’s profile globally – and provide the twin benefits (cash and profile) already gained via the 2014 debut Eurobond launch – while keeping speculative capitalism outside Ethiopia.
Listing companies offshore would attract foreign investment and allow Ethiopia to fund faster consumption. The alternative is to continue suppressing consumption in favor of investment – a policy stance that could still allow Ethiopia to grow at 4.5-10.5% annually for the next decade, according to the World Bank.
We have often raised eyebrows by comparing SSA countries to other countries around the world. Ghana’s political economy bears more than a passing resemblance to Hungary’s boom-and-bust cycle over 1990-20101, while the entrepreneurial drive in Kenya and consistently large current account deficits remind us of Turkey. We (and others) have compared Rwanda to Singapore2. When we arrived in Ethiopia earlier this year, it is perhaps not that surprising that we ended up comparing the country to China. We should note of course that Ethiopia is unique and has its own development model – we make these crude cross-country comparisons to provide a heuristic for time-constrained investors.
Both China and Ethiopia have been government-led transformation stories, in contrast to Nigeria for example, where it was the government’s withdrawal from corporate (mis-) management that helped that country thrive after 2000. In both Ethiopia and China, the reform drive has arisen out of a bedrock of hard-line communist economic and political structures. In both cases, key leaders (PM Meles Zanawi from 1995 and Deng Xiaoping from 1978) drove the reform process.
Both countries have an extremely long history of relatively stable government, dating back to 1270 in Ethiopia’s case. It is striking to us how well the Ethiopian government has managed to deliver on its objectives. Francis Fukuyama writes in his recent book, Political Order and Political Decay: From the industrial Revolution to the Globalization of Democracy that a long tradition of civil administration can play a key role in development – from Prussia in the 18th century to modern day China. An effective civil service will help counter corruption and keep development on track during political transitions of regime head or regime type. My notes from Addis Ababa include the line that Ethiopians consider themselves the best in Africa in this regard (I did not write down who provided that undiplomatic comment).
The development lag between Ethiopia and China is wider than the 17-year gap between Meles and Deng taking control of their countries. We estimate the lag at 25 years – if we compare per capita GDP in 2011 PPP dollars using recent World Bank data. The Madison tables of per capita GDP in 1990 PPP dollars implies the lag is around 33 years.
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There are alternative development routes for Ethiopia – but the pace of growth already shows more similarity to China than India or Bangladesh. The graph below compares Ethiopia to SSA peers and only Rwanda is showing similarly rapid wealth creation. Ethiopia is already advancing faster than Bangladesh did when its per capita GDP was at a similar level in the 1990s.
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It is notable that China saw corporate bonds and some company stocks re-emerge in 1984, but it only re-established its stock market in 1990. This implies the stock market should be on the Ethiopian government’s radar about 25-33 years after this, which tells us to expect a development in this area over 2015-2023. The government itself says there are no plans on a five-year horizon. But that plan could change due to financing requirements. Corporate bond issuance (in local currency) by contrast may come as early as 2016, almost exactly in line with China if our Madison table comparison above is accurate that Ethiopia is now like China in 1983. Indeed, that is on the agenda – as we explain near the end of this report.
The China comparison is also worth considering given the good relationship between these two countries. China has helped fund Ethiopian development, in part to showcase China’s involvement with the continent to all those delegates attending African Union functions in Addis Ababa. That funding has also contributed to increased trade flows between the two countries. Nearly 2/5 of all Ethiopian imports now come from China.
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China also takes 12% of all Ethiopian exports – despite Ethiopia not exporting the minerals or energy commodities that China tends to buy from SSA.
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Ethiopia remains an exporter of agricultural goods. Total exports amounted to an average $741mn a quarter over the last five quarters. This is equivalent to $8 per capita each quarter. It compares to $1,197mn that the country earnt from remittances over the same period. The country needs to diversify if it wants to boost export receipts.
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Sectoral growth priorities
Both China after 1978 and Ethiopia more recently have been focused on agriculture and infrastructure. While drought has hit Ethiopian agricultural output in 2016 – to the point where food aid is required this year and GDP and foreign exchange reserves will be affected – data from the last few years shows how much output has risen.
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While agricultural output has boomed – growth has been faster in other sectors – and agriculture’s share of gross value added has shrunk from 55% in 1999-2000 to 39% by 2014-2015. Construction’s share has soared from 3% to 9% over the same period, while hotels and restaurants have boomed from 2% to 5%. Real estate rose from 5% to 9% by 2009-2010 before slipping back to 7% in 2014-2015.
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By contrast financial intermediation has been stuck at 2% throughout this period. Ethiopia’s banking system remains less developed than many others.
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The government’s next priority is to develop manufacturing – which has risen only marginally as a share of gross value added from 4% to 5%.
This goal has first required huge investment into electricity and particularly hydro-power – where output has more than doubled over the five years of 2010-2015. Three more projects are expected to add 8,060 MW to the total – which will quintuple total Ethiopian electricity production. One of these projects, the Grand Renaissance Dam, will alone add 6,000 MW, although we were told that just filling the lake could cap generation below that level until the early 2020s.
Electricity is already being exported to Djibouti. To put these figures into context – Ethiopia is now producing roughly half of Nigeria’s peak 5 GW generation from Nigeria’s formal sources (diesel generators add significantly to Nigeria’s actual consumption) – and with Ethiopia having half the population of Nigeria, this puts the two countries on a par in per capita generation terms.
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It should not be forgotten how low Ethiopia’s per capita GDP is. This is still a rural economy. After Addis Ababa, with an estimated population of 3.3mn, the next four largest cities have populations closer to 300,000 people. Government social priorities include broadening access to water points, so hours a day are not used inefficiently to collect water. Finding firewood is also time consuming for many. Textile factories have a challenge explaining to the workforce that full-time employment does not mean it is acceptable to return home to bring in the harvest. Meanwhile as you would expect in a low per capita GDP country, remittances are a very significant source of foreign exchange earnings. The Saudi decision in 2013 to send home 150,000 guest workers would have hurt many families.
It is impressive given this backdrop that the government has been able to build a successful airline, Ethiopia Airlines which reportedly made more profit in 2014-2015 than all other African airlines put together.
Investment in education is reaping benefits. UN data show that Ethiopia had 29% secondary school enrolment in 2006, which is enough to let Ethiopia escape poverty within 20 years according to the piece we published in 20143. That fits pretty closely with the government’s target to achieve middle income status by 2025. These improved education metrics are coming just in time. The UN estimates that the 20-64 population will increase by 8.8mn (20%) between 2015 and 2020. The new entrants to the workforce will be the most educated demographic that Ethiopia has ever seen.
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An ideological government
Where Ethiopia looks even more interesting (to an analyst who enjoys the contrarian approach) is in its rejection of financial market orthodoxy. State direction, monopolies, exchange and price controls are all central to the model. Five-year plans matter a lot with a focus on land, labour, logistics, loans and lights (electricity). Ethiopia is not in the WTO (it is not keen to open up services, telecoms or the financial sector) and this has allowed it to tax imports heavily. Import duties in 2013-2014 accounted for 4.4% of GDP, more than a quarter of total revenue and grants of 15.1% of GDP. Ethiopia is also keen to avoid IMF assistance. We were told in one meeting that Ethiopia would “prefer to be dragged over burning coals” than turn to the IMF for assistance. Below we focus on a few of the areas affected by this collection of views.
Rather than develop a competitive private sector in the telecoms market, it has chosen to run a monopoly and take the profits from that to invest in transport infrastructure. The government’s belief that it knows best, bears some resemblance to Crystal Ventures in Rwanda – the governing RPF investment vehicle – which has helped that country also achieve rapid growth. But Rwanda embraced telecoms competition, so there are more phones in Rwanda per capita, and emails do arrive on your Blackberry which they do not in Ethiopia (or Iran).
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Rather than run the cheap currency policy of East Asia to boost exports, Ethiopia instead has one of the more overvalued currency policies of any in Africa. Against a spot currency rate of ETB21.2/$ in January 2016, we estimated that fair value for the currency is ETB31.1/$ based on a 20-year average derived from the real effective exchange rate4. That 47% overvaluation was the third largest in our Africa database. The graph below shows that the pace of nominal depreciation has been too slow, and has not kept pace with inflation-driven real appreciation. The currency needs to be at least EBT27/$ to sit back at the levels of 2011-2014.
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That the currency might be overvalued is supported by IMF current account deficit estimates that show an average deficit of 9% of GDP over 2012-2016. The existence of a parallel rate which NBE data show was 11-12% above the official spot rate in mid-2015 is further evidence, as are anecdotal reports on our last two visits to Ethiopia about increasing delays for those trying to take foreign currency of the country.
Our meeting with a senior central bank official was unfortunately cancelled at the last minute. But the latest IMF Article IV included this statement from the Ethiopian authorities “while sharing staff’s view that the birr may be overvalued in real terms, the authorities are inclined to pursue a path of gradual depreciation given the weak export responsiveness to real effective exchange movements but yet pronounced pass through into inflation”. We have heard the argument many times in SSA that until a country has a manufacturing base, there is little point in using a cheap currency to boost manufacturing exports. It may be that Ethiopia will aim to wait until manufacturing is more significant than 5% of GDP to make larger changes to its currency policy.
Currency shortages are having some interesting effects on the economy. We heard that coffee growers will prefer to sell their product abroad, even when prices (at the official exchange rate) are lower in the global market than in the local market. So beloved is foreign exchange that having access to dollars has a large price premium. Stringent capital controls mean exporters have to remit 100% of their receipts, but banks that receive those export receipts will always grant dollars back to companies that provide these foreign currency streams (assuming the government approves). So companies that export roses or coffee, may diversify into importing consumer goods, because they have access to dollars. They may have no managerial expertise in washing machine sales, but will become diversified conglomerates purely as a function of these exchange rate distortions.
The government sees these distortions as a price worth paying to achieve its goals of securing enough dollars to make progress on its infrastructure spending plans.
Further distortion comes via interest rates. The banking sector is treated as the utility which many European and US politicians believe it should be in the West as well. Deposit rates of around 5% and lending rates of around 9% co-exist with an inflation rate which the IMF estimates will average 10.4% in 2015-2016. Companies are effectively paid to borrow money! But only those who are chosen by the government get to borrow significantly at this rate. The rest of the economy is left without access to credit as all available credit is sucked up at this cheap lending rate, driven by the government. The biggest complaint from companies is therefore lack of access to credit. For those who believe the market is the most efficient way to allocate credit, and that growth suffers if currency and interest rates are distorted, Ethiopia is a very large slap in the face.
Meanwhile savers lose 5 ppts a year if they have money in the bank. They are banned from many other alternative saving options. Foreign currency accounts are not allowed and money cannot be taken offshore without authorization. There is no equity market. Real estate becomes an option, as everywhere else, and this is growing in importance in the economy but for the most part savings are trapped. One popular alternative is buying consumer durables as a form of savings (Russians do the same during a devaluation). Buying a vehicle – and using this in construction work – can pay for itself within a few years. A dump-truck could therefore be considered the equivalent of gold jewellery savings in Turkey or India.
The whole picture is rather fascinating. Deng Xiaoping famously said it didn’t matter if a cat was black or white, as long as it caught mice – in what was seen as an endorsement of capitalism. What Ethiopia is trying to show is that it doesn’t matter if your cat uses orthodox or unorthodox policies, providing it achieves the goal of rapid economic growth.
Is Ethiopia running out of money?
The question we had is whether Ethiopia may need new financing options. It has been said that Ethiopia is trying to follow the East Asian development model on a SSA savings base. Was the Eurobond issue in 2014 a sign that the country needed to tap new sources of finances, because dividends from the Telecoms Company and re-distributing savings from the population are finite resources? If so, did this mean 1) we may see more eurobond issues; 2) a welcoming mat laid out to foreign banks entering Ethiopia; or 3) the launch of a stock market in the country? We did not come away from Addis Ababa with all the answers – but we outline some options for Ethiopia below.
Eurobonds and local bond issues
An advisor to the central bank was quoted in October saying a new $2bn Eurobond would come “very shortly, within a month or two”, although two days later the ministry of finance denied this, adding “Ethiopia does not exclude the possibility of issuing new debt instruments in the coming years to finance its ambitious development plans”. Yields the week before these statements were 50 bpts over the yield at the launch of the Ethiopia-2024 eurobond, but within a month they were nearly 100 bpts over, and by December, were 180 bpts over that initial borrowing rate in December 2014. This presumably delayed Ethiopia’s plans. By 23 March 2016, the yield spread had compressed back to around 115 bpts over the debut eurobond launch. We suspect we need to see yields closer to 7% before the finance ministry is comfortable issuing again.
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One problem is that the latest IMF Article IV says the risk of external debt distress has increased from low to moderate. The authorities disagree on this, arguing that Ethio Telecom debt should not be included in debt sustainability analysis. But with an overvalued currency, a large current account deficit, and now this IMF warning, we doubt Ethiopia can borrow as cheaply as it did in 2014.
The authorities are planning to develop a local corporate bond market by July 2016 – as noted above this fits with the China comparison in terms of timing. Concerns over currency overvaluation will deter many (but not necessarily all) foreign investors from getting involved in this market.
Foreign banks
The IMF estimates in its latest Article IV that the ratio of “total loans and bonds to total deposits” has risen from 94% in June 2012 to 101% by June 2014 and 107% by March 2015. This hints at less availability of savings to fund future lending. One option for the government is to open the door to foreign banks. A generation ago, this was said to be likely in five years. The authorities continue to say this may happen in five years. They remain very wary of potential destabilization from foreign banks.
A stock market
We read, and heard in meetings in Addis Ababa, that the government remains averse to public equity portfolio investors. It is concerned that their entry to the Ethiopian economy would be destabilizing and encourage unproductive financial speculation rather than medium- to long-term foreign direct investment.
We think one option the government might consider is the part privatization of Ethio Telecom on the London Stock Exchange. It would achieve the following gains:
1) It would provide funds to the government, with no increase in external debt liabilities. If the company was valued at $3bn (it would be the only way for investors to access Ethiopian equity) – then a 50% stake could save Ethiopia the equivalent of a new Eurobond issue.
2) It may encourage the IMF to take Ethio Telecom out of its debt sustainability calculations for the Ethiopian sovereign, so helping reduce perceived risk for Ethiopia and therefore cut the cost of future eurobond borrowing.
3) It would also raise Ethiopia’s profile in the global economy. Few are aware this is the second most populous country in Africa and the 14th largest population in the world which is roughly the same size as Vietnam. It is the ninth largest economy in Africa at $63bn in 2015 on an exact par with Kenya (based on IMF October 2015 estimates).
Conclusion
Ethiopia has had impressive success with the economic policies – achieving the seventh-best growth rates over 2000-2015 of any country in the world (the top six were China, Myanmar and four oil/gas exporters). It has achieved this without portfolio investors playing any role until the debut Eurobond in late 2014. We do not see any sign of an opening up to foreign portfolio investors or foreign banks, but we believe that the country could attract such investment (without undermining its ideological beliefs) via listing companies offshore. In the meantime, we believe equity investors will need to consider private equity as the most plausible way to access this market. Eurobond investors need to be aware that the currency is overvalued but that the IMF still only sees a medium risk of the country facing a debt distress scenario in the medium term.
Unless the government does attract more foreign capital, we assume that suppression of private consumption will be required to achieve the investment goals that the government is targeting. In that regard again, Ethiopia reminds us of China. If Ethiopia can continue to follow this same path, it will be on track to be one of Africa’s most successful economic development stories.
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