Ethiopia's Foreign Debt Crisis
“Give a man a fish and he’ll eat for a day, teach him how to fish and he’ll eat forever.” This is an infamous Chinese proverb. It is essentially talking about the value there is in giving knowledge on how to solve one’s problems instead of giving temporary relief to seemingly long-term and everlasting problems. As we all know, most developing countries in the global south face my challenges to ensure the economic stability as well as prosperity of their state and people. As a result, they turn to other counties for help to gain a temporary relief without gaining any real expertise on how to solve their problems for the long term. This help comes in the form of foreign aid and millions of dollars in loans that must be repaid with interest. This aid, instead of solving our problems, is becoming a problem in and of itself as it is facilitating economic dependence on foreign countries which gives way to economic exploitation and political interference. Nevertheless, developing countries continue to borrow giant loans, while knowing that the inability to pay them off could potentially lead to having to give up key resources as repayment and destroy their long-term interests.
What it
seems that our governments don’t understand is that while foreign aid is enough
to build the country a boat to keep it from drowning, it is not enough to teach
it how to sail through the toughest of tides. This is to say that foreign aid is not a real
solution to our problems as it merely diverts them for a given period of time.
However, the authors of the proverb above understood that giving the knowledge
of fishing creates self-sufficiency and prosperity while, the mere act of
giving the fish creates dependency and obedience. It is the awareness of this
fact that is motivating powerful countries like China, USA, Russia, India, and
more to keep giving us “aid” in the form of grants and loans that facilitate respective
cycles of dependency and exploitation. As a result of this, most developed
nations, are practicing what is widely known today as “debt trap diplomacy” and
most developing nations are stuck in what seems to be a never ending cycle of
“debt crisis”. This crisis is a
macroeconomic problem that is ravaging the economic growth of most countries in
the global south. In this piece, we will discuss the nature and effect of this
crisis as it pertains to Ethiopia.
Debt crisis is a situation in which a country is unable to pay back its government debt. A country can enter into a debt crisis when the tax revenues of its government are less than its expenditures for a prolonged period. It covers its expenditures primarily by raising money through taxation. When tax revenues are insufficient, the government can make up the difference by issuing debt. That is done primarily by selling government treasury bills in the open market to investors. A government with a good reputation and little debt or an established track record of paying back what it has borrowed usually does not face much difficulty in finding investors who are willing to lend to it. However, if the debt load of a government becomes too large, investors begin to worry about its ability to pay back, and they start demanding higher interest rates to compensate for the higher risk. That results in an increase in the cost of borrowing for that government. As investor confidence deteriorates further over time, pushing the cost of borrowing to higher levels, the government may find it more and more difficult to roll over its existing debt and may eventually default and enter into a debt crisis. And in recent years, Ethiopia has become one of the many developing nations that are struggling with this crisis.
ETHIOPIA’S DEBT CRISIS
Ethiopia’s debt is closely linked
to economic policy. The previous Ethiopian People’s Revolutionary Democratic
Front (EPRDF) administration had applied a developmental state approach for two
decades. Government was thus the core enabler of the “normative, structural,
institutional, technical, and administrative environments in order to achieve
its national development vision according to a paper entitled ‘Developmental
State’ as an Alternative Development Path in Ethiopia: Miracle or Mirage?’. The
State needed funds for the construction and development of industrial parks,
railways, highways, dams etc. Although it borrowed domestically, the country’s
limited financial system and domestic savings meant it was forced to look to
foreign creditors. In the following years, public debt went from 39.61% of the
GDP (2010) to reach 57.72% of the GDP
(2019).
In recent decades, Ethiopia has been accumulating quite a large sum of economic debt in order to keep up with the growing demand of its population. While one of the first instances of external borrowing dates back to the 1970’s, it is only in the last decade that this country’s foreign debt has been rising at increasingly alarming rates. As of March 31 2022, Ethiopia’s public sector external debt stood at 28.4 billion USD. Below is information regarding the pattern of external debt that has been acquired by Ethiopia in the last five years.
- Ethiopia external debt for 2020 was $30,364,411,863, a 7.01% increase from 2019.
- Ethiopia external debt for 2019 was $28,374,718,501, a 1.91% increase from 2018.
- Ethiopia external debt for 2018 was $27,842,380,883, a 6.39% increase from 2017.
- Ethiopia external debt for 2017 was $26,169,980,395, a 11.86% increase from 2016.
As part of the state-led developmental project pursued by the Ethiopian Peoples’ Revolutionary Democratic Front (EPRDF), most intensively after 2010, the government invested big, both directly and through state-owned enterprises (SOEs). While the injected capital—mainly to finance infrastructure— produced impressive economic growth, the model was heavily reliant on debt. The sustainability of this formula depends both on realizing returns that are higher than the contracted interest rates and securing foreign exchange with which to repay interest and principal. Unfortunately, both conditions for success were undermined, as the implementation of many projects was riddled by waste and a lag in producing profits.
After taking office, as in most
areas, Prime Minister Abiy Ahmed’s government has taken a different direction,
cutting through the EPRDF’s dithering on whether to give up on key elements of
the state-led model and embrace a more free-market approach. The shift heralded by the “Homegrown Economic Reform” had to
do as much with ideological re-alignments and critical evaluations of the
state’s spending effectiveness as with practical necessities. Among these, the
steadily worsening public debt situation was identified as one of the most
critical issues—and rightly so. Total public debt had ballooned from $5.1
billion in 2011 to $30.3 billion in 2020, which represents a six-fold increase.
After Abiy Ahmed's rise to power in 2018, he signaled a shift towards a liberal economic policy gaining wide political and financial international support, including $1bn from the IMF, $3bn from the World Bank (WB) $100m from the French Agency for Development (AFD), and $1bn from the UAE. In 2019, he said: “Prior to our reforms, Ethiopia’s economy was in a dangerous and complex state. A week after taking office, we couldn’t pay salaries, we were facing important foreign currency shortages. We couldn’t pay loans or borrow more and struggled to deal with our budget deficit.” In that context he implemented the ‘Homegrown Reform Agenda’ that reduced debt by 10% between 2018 and 2020. The new administration also renegotiated a considerable amount of debt with China (including $4bn extended by 20 years).
However since 2020, as has been the case worldwide,
the arrival of Covid-19 to Ethiopia has had dire consequences. Although exports
had grown by 17.7% in 2019, they fell to -0.51% in 2020 further exacerbating
the foreign currency shortage and the country’s ability to service its debt,
inflation also increased to 20.6%. Luckily Ethiopia has recently been able to
join the G20 Common Framework for Debt Treatments which is a welcome
improvement but even this framework will need flexibility and adaptable
implementation mechanisms in order for it to effectively address the needs of
Ethiopia and other countries” Yasmin Wohabredbbi, State Minister said in an
interview with the Milken Institute.
THE
IMPACT OF EXTERNAL DEBT ON GROWTH
The scope of debt burden is much wider in that the
effects of debt do not only affect investment in physical capital but any
activity that involves incurring costs up-front for the sake of increased
output in the future. Such activities include investment in human capital (in terms
of education and health) and in technology acquisition whose effects on growth
may be stronger over time. How a debt overhang discourages private investment
depends on how the government is expected to raise the resources needed to
finance external debt service and whether private and public investment are
complementary.
First, the servicing of external debt erodes the meager foreign exchange available for imports. This has led to import compression problem that adversely affect both public and private investment. Since many of the imports of developing countries are essential inputs for their development of intermediate input, cutting these imports has a large loss both on present and future output of the country.
Second, the debt shock
creates a debt overhang problem which shatters the confidence of both foreign
and domestic private investors who are usually sensitive to uncertainty. The
cause of this uncertainty is the anticipation by economic agents of future tax
liabilities for its servicing. Since investors are very sensitive to
uncertainty, their expectation of future tax liabilities will lead them to
invest in other countries, where tax burden is less or believed to be credit
worthy. The diversion effect made the indebted country lose the benefit that
would have gain if investors were eager to invest there.
Third, the resources used to service debt crowd out investment. Since current resources must be divided over some combination of domestic consumption, investment and external transfer the burden of debt servicing will crowd out investment (both public and private) because of the difficulty in lowering consumption below the minimum acceptable level.
Fourth, the huge expansion in the size of debt relative to income leads to capital flight. Although the definition of capital flight is controversial, most writers relate the concept to illegal capital out flows. Capital flight creates three major difficulties for Sub-Saharan African countries:
- Any amount of money sent away to foreign lands cannot contribute to domestic investment. Moreover, this money is not available for importation of equipment and materials that are, necessary for growth of domestic industry and the economy. Thus, capital flight leads to a net loss in the resources a country has available for purposes of investment.
- Income and wealth generated and held abroad are outside the overview of domestic authorities and therefore cannot be taxed. This leads to reduction of government revenue and constrained its capacity of debt servicing.
- Income distribution is negatively affected by capital flows. The poor citizens in the African countries are subject to austerity measures in order to pay for external debt obligations to international creditors, who in turn pay interest to citizens from these countries with assets abroad.
CONCLUSION
Various economists agree that the original cause for
debt crisis is the excessive borrowing by the public sector to service their
existing debt. This happened due to the reverse relationship between the safe
real interest rate in the international market and the overall real GDP growth
rate in the heavily indebted poor African countries (HIPCs). During most of the
years in the decade of 1970’s, the real long –term rate of interest in the
developed world fell well short of the real growth rate of GDP by HIPCs. This opened
a viable option for the public sector to service their existing debt through
new borrowing, rather than generating their own resource for the same action
(servicing debt). As a result many of the countries experienced a large fiscal
deficit.
If the available external loan improves the
productive capacity of the borrowing country, it is unnecessary to take extra
external loan to service the original debt. If marginal productivity of each
available external debt is greater than or equal with the principal and the
interest payment, external debt will have a positive impact on the economy of
the borrowing country. This in turn will require the foreign debt to be used in
productive sectors and in basic infrastructures which can enhance the
productivity of other sectors.
Under this condition external debt servicing doesn’t
affect economic growth. But, if the borrowing country failed to service its
debt, it will lose its’ credit worthiness; and this in turn might affect the
economic performance of the borrowing country by reducing the availability of
foreign debt. In conclusion, seeing the impact that this debt crisis has, it is
essential that we have better economic
policies to get out of this crisis and prevent excessive
borrowing in the future.
POLICY
IMPLICATIONS
On the basis of our findings, we believe that
Ethiopia entering the G20 Debt Service Suspension initiative
(DSSI) is the best way to move forward for the time being. However, for the
long term economic growth and stability of the country, we recommend that the
government pour its current unsuspended debt into industries that have a large
enough productive capacity to service the loan with which they are funded. This
way, the country can move forward, not buy prolonging the re-payment time of
the loans or acquiring more loans to pay off existing ones, but by producing
resources that can pay off the loans while also funding other industries to
start a chain of self-sufficient sectors within the economy.
“Africa’s development demands a new level of consciousness, a greater degree of innovation, and a generous dose of honesty about what works and what does not as far as development is concerned. And one thing is for sure, depending on foreign aid and debt has not worked. Make the cycle stop.” –Dambisa Moyo, 2009
Reference
The Effect of External Debt On Economic growth– A
panel data analysis on the relationship between external debt and economic
growth.
-By;
Dereje Abera Ejigayehu (2013)
https://www.ethiopia-insight.com/2021/05/10/ethiopias-debt-an-economic-and-political-liability/
https://www.macrotrends.net/countries/ETH/ethiopia/external-debt-stock
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