97916 4th Ethiopia Economic Update: OVERCOMING CONSTRAINTS IN THE MANUFACTURING SECTOR 4th Ethiopia Economic Update Overcoming constraints in the manufacturing sector July 8, 2015 iii Table of Contents Acknowledgements.................................................................................................................................. v List of Abbreviations.............................................................................................................................. vii Executive Summary................................................................................................................................... ix Recent Economic Developments and Outlook....................................................................... 1 The Short View...........................................................................................................................................................1 Real Sector..............................................................................................................................................................1 Monetary Sector......................................................................................................................................................3 Financial Sector.......................................................................................................................................................5 Fiscal Sector............................................................................................................................................................7 External Sector........................................................................................................................................................9 The Long View: The Effect of Falling Oil Prices on the Ethiopian Economy............................................................13 Recent Oil Price Developments.............................................................................................................................13 Ethiopia’s Oil Market............................................................................................................................................13 Ethiopia’s Oil Position...........................................................................................................................................14 Likely Impact of the Oil Price Decline..................................................................................................................14 Potential other Impacts of the Oil Price Decline....................................................................................................16 The Future View: Outlook and Challenges...............................................................................................................19 Outlook................................................................................................................................................................19 Challenges.............................................................................................................................................................20 Growth and Transformation through Manufacturing............................................... 23 Industrialization in Ethiopia.....................................................................................................................................23 Productivity and Skills for Development..................................................................................................................26 Productivity Benchmarking...................................................................................................................................26 Skills and Productivity..........................................................................................................................................29 Constraints for Manufacturing Growth....................................................................................................................33 Access to Finance: Particular Challenge for SMEs.................................................................................................35 Operational Constraints........................................................................................................................................40 Entry Barriers........................................................................................................................................................42 The Role of Industrial Parks and FDI for Manufacturing Growth.............................................................................45 Rationale for Industrial Parks (IPs)........................................................................................................................45 Ethiopia’s Experience with IPs so Far.....................................................................................................................46 iv 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Lessons Learned for IP’s in Ethiopia: Design and Implementation .......................................................................49 Short Summary and Recommendations for Manufacturing Development................................................................52 ANNEXES........................................................................................................................................................... 55 Annex 1: Ethiopia: Selected Economic Indicators (High Frequency)........................................................................56 Annex 2: Ethiopia: Selected Economic and Social Indicators (Annual Frequency)....................................................57 References.................................................................................................................................................... 59 List of FIGURES Figure 1.1: Economic Activity......................................................................................................................................2 Figure 1.2: Monetary Sector.........................................................................................................................................4 Figure 1.3: Financial Sector..........................................................................................................................................6 Figure 1.4: Fiscal Sector................................................................................................................................................8 Figure 1.5: External Sector.........................................................................................................................................10 Figure 1.6: Key Facts on Oil and Its Price Decline in Ethiopia ...................................................................................17 Figure 1.7: Economic Outlook: Selected Projections to 2017.....................................................................................21 Figure 2.1: Real GDP Growth and Sector Contribution.............................................................................................25 Figure 2.2: Productivity Benchmarking .....................................................................................................................27 Figure 2.3: Education, Skills and Employment...........................................................................................................30 Figure 2.4: Top 10 Business Environment Constraints...............................................................................................34 Figure 2.5: Access to Finance for Enterprises..............................................................................................................36 Figure 2.6: Business Environment Constraints Identified by Firms.............................................................................43 Figure 2.7: FDI inflows..............................................................................................................................................47 List of TABLES Table 1.1: Assumption on the Maximum Pass-Through to Domestic Market of the Oil Price Decline................................ 15 Table 1.2: Macro-Fiscal Outlook Indicators, 2012 to 2017.......................................................................................22 Table 2.1: Employment by Sector.............................................................................................................................24 Table 2.2: Unit Labor Cost (Wages-Productivity Ratio) in Manufacturing, 2011......................................................28 Table 2.3: Unemployment of TVET Graduates, Selected Training Areas, 2012.........................................................32 Table 2.4: Most Binding Constraints to Doing Business in Ethiopia, Various Rankings............................................33 Table 2.5: Structural Constraints to Selected Light-Manufacturing Sectors...............................................................34 Table 2.6: Types of Collateral Used by MSMEs........................................................................................................37 Table 2.7: MSME Definitions by National MSE Development Strategy...................................................................38 List of BOXES Box 1: China’s secret weapon in light manufacturing: Small and Medium Enterprise-oriented “Plug and Play” industrial zones......................................................................................................................... 48 v Acknowledgements T he World Bank greatly appreciates the close Growth in the Manufacturing Sector (World Bank, collaboration with the Government of Ethiopia 2014b: Tazeen Fasih and Asya Akhlaque); Ethiopia (the Ministry of Finance and Economic Investment Climate from the Perspective of Regions: Development, in particular) in the preparation Addis Ababa, Oromia and Dire Dawa (World Bank, of this report. The report was prepared by a team 2014c: Asya Akhlaque and Johanne Buba); and led by Michael Geiger (Sr. Country Economist, SME Finance in Ethiopia: Addressing the Missing GMFDR) under the guidance of Lars Christian Moller Middle Challenge (World Bank, 2014d: Francesco (Lead Economist and Program Leader, GMFDR). Strobbe). Gelila Woodeneh (Communications Officer, Direct contributors to the report were for Chapter 1: AFREC) reviewed the document, provided editorial Mesfin Girma (Economist, GMFDR), Ashagrie Moges content and designed the cover page. The report was (Research Analyst, GMFDR), Francesco Strobbe (Sr. prepared under the overall guidance of Albert Zeufack Financial Economist, GFMDR), and Eyasu Tsehaye (Practice Manager, GMFDR) and Guang Zhe Chen (Economist, GPVDR); direct contributors to Chapter (Country Director, AFCE3). The peer reviewers 2 were: Susan Kayonde (Consultant, GTCDR) and were: Vincent Palmade (Lead Economist, GTCDR), Asya Akhlaque (Sr. Economist, GTCDR). The report and Andrea Coppola (Sr. Economist, GMFDR). benefitted from three reports, which served as inputs Comments and guidance were also provided from to Chapter 2: Ethiopia Skills for Competitiveness and Kevin Carey (Lead Economist, GMFDR). vii List of Abbreviations CBE Commercial Bank of Ethiopia   IP Industrial Park CPI Consumer Price Index IPDC Industrial Park Development CSA Central Statistical Authority Corporation DB Doing Business   IZ Industrial Zone DBE Development Bank of Ethiopia LMSMI Large- and Medium-Scale EAL Ethiopian Airlines Manufacturing Industries   EDRI Ethiopian Development Research MFI Microfinance Institution Institute MoFED Ministry of Finance and Economic EEPCO Ethiopian Electric Power Development Corporation MoU Memorandum of EIA Ethiopian Investment Agency   Understanding EIC Ethiopian Investment MSME Micro, Small, and Medium Commission Enterprises EIZ Eastern Industrial Zone NBE National Bank of Ethiopia ERCA Ethiopian Revenue and Custom OSS One Stop Shop   Authority PPP Public Private Partnership ES Enterprise Survey RER Real Exchange Rate ESLSE Ethiopian Shipping and Logistics ROA Return on Assets Enterprise ROE Return on Equity FDI Foreign Direct Investment   SEZ Special Economic Zones GDP Gross Domestic Product   SME Small and Medium Enterprises   GEP Global Economic Prospects SOE State-owned Enterprise GoE Government of Ethiopia SSA Sub Saharan Africa GTP Growth and Transformation TFP Total Factor Productivity Plan ToT Terms of Trade IC Investment Climate TVET Technical and Vocational Education ICA Investment Climate Assessment Training IFC International Finance VAT Value Added Tax Corporation WBG World Bank Group IMF International Monetary Fund   ix Executive Summary Recent economic developments The Ethiopian economy continued its strong expansion in FY14 with real GDP growing by 10.3 percent. Growth was driven mainly by the services sector from the supply side and public investment from the demand side. At the same time, inflation has remained in single digits for the last two years on account of tighter monetary policy and lower international commodity prices. However, in recent months in 2015, domestic food prices are increasing partially as a result of shortage rainfall during the short rainy season. On the fiscal side, the budgetary stance at the general government level has been cautious even though recently rising debt levels and borrowing costs are cause of concern. In an effort to adjust for the rising cost living, the FY15 budget incorporates an increase in public sector salaries after years of no increases which could also be the first step to adjust the balance between capital and recurrent expenditure. The salary increase accompanied by a supplementary budget in the middle of the fiscal year could potentially increase the budget deficit. The current account balance weakened due to trade balances and declining transfers. The deterioration is on account of a worsening trade deficit which was driven by weak export performance and large imports of capital goods for public investment programs. Goods exports showed positive growth in 2013/14 but rates remained far below their historical growth; furthermore, export growth fell into negative territory again in the last quarter of 2014 and first quarter of 2015. In addition, private and official transfers, one of the largest external resources to Ethiopia, dropped over the past year and accounted for 7.4 and 2.1 percent of GDP , respectively, in 2013/14. The strong economic growth in the past decade helped to reduce poverty significantly. The poverty headcount, measured by the national poverty line, fell from 38.7 percent in 2005 to 29.67 percent in 2011. Measured with the international poverty line (US$1.25 per day) Ethiopia saw the second fastest rate of reduction in Africa. Economic growth, particularly in agriculture, has been an important driver of poverty reduction in the last decade. Favorable weather conditions and improving terms of trade for rural producers have been reasons of this past trend supported by strong improvements in access to basic services and rural safety nets. Low levels of inequality have been maintained with the Gini coefficient remaining stable at 0.30. Economic outlook and challenges The recent fall in global oil prices is expected to have a positive economic impact on Ethiopia. The country is a net importer of fuel, which accounts for one-fifth of goods imports. The growth effect is expected to be positive in part because declining oil prices increase disposable real income and support stronger domestic consumption. The price decline will result in an estimated 1.8 percent reduction in the price of goods and services. Improvements in terms of trade also support the external sector: Staff estimates suggest Ethiopia’s terms of trade could increase by about 6 percentage points in FY15. Inflation is also expected to decline, especially due to indirect impact and its positive effect on expectations. The current account deficit is expected to improve by 1.5 percentage points of GDP in FY15. Growth will remain high in the short term while gradually declining in the medium term. While a rising working age population will continue to support potential GDP growth, total factor productivity growth and investment are gradually expected to decline. High growth and lower oil prices will drive further reductions in poverty. Lower oil prices will aid poverty reduction. This comes through a reduction of consumer prices by an estimated 1.8 percent for the average Ethiopian household. This reduction will be relatively larger for urban and wealthier households. For those rural households that depend on cereal sales, welfare gains from lower consumer x 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector prices may be partially offset by lower cereal prices. Lower oil prices reduce import prices and require local cereals to be more moderately priced to be competitive. An appreciated real effective exchange rate does not help competitiveness, especially in manufacturing. The real exchange rate appreciated by 22.5 percent (y/y) at the end April 2015 showing a cumulative appreciation of 71 percent since the nominal devaluation in October 2010. In addition, Ethiopia is now on an appreciation path against all currencies that are depreciating against the US$. This is because the Birr is closely managed against the US$. The de facto exchange rate arrangement is classified as a crawl-like arrangement by the IMF (2013b). The authorities describe it as a managed float with no predetermined path for the exchange rate. The annual pace of nominal depreciation, however, has been stable at 5 percent in recent years. There is concern that the appreciated currency does not help improving export competitiveness; much more, since exports are falling again and the Government is trying to encourage a thriving manufacturing sector to develop. Maintaining a competitive exchange rate is an important component of maintaining external competitiveness, but its macroeconomic effects, for instance on import prices and inflation need to be managed closely (World Bank, 2014a). Growth and transformation through the manufacturing sector The Growth and Transformation Plan (GTP) seeks to transform the economy toward an industrialized economy and to increase per capita income of its citizens by 2025. To this effect, the Government has adopted policy focused on the development of the manufacturing sector through the use of industrial parks to attract FDI and to support SMEs. Targeting SMEs is important as they are an engine for jobs creation and a manifest of a thriving and dynamic economy. But, with services and agricultural sectors contributing almost 90 percent of GDP the GTP has not been able to accelerate structural transformation. At the same time, the share of the manufacturing sector in GDP remained just above 4 percent of GDP for most of the past decade. Furthermore, Ethiopia has not made significant progress in pulling labor out of agriculture into more productive and industrial jobs. The share of employment in the manufacturing sector has changed only slightly and is virtually unchanged since 1999 at below 5 percent of total employment. Ethiopia is wage competitive, but productivity performance varies across firms. In Ethiopia, productivity performance is heterogeneous among firms; foreign owned, publicly owned, and older firms appear more productive than domestic, private, young firms. Although labor productivity in Addis Ababa compares well with firms in peer countries with same level of development, this appears to reflect higher capital intensity rather than more efficient production. Still, low wages in Ethiopia of about $1,100 per worker per year enable (based on data from Enterprise Survey, 2011) firms to remain competitive even if firms in other countries are more productive. A key determining factor of productivity is the ability of an economy to supply the skills needed for companies to grow and to thrive. Ethiopia has made significant progress in expanding access to education, but challenges remain. A more literate and trainable labor force would not only increase productivity in Ethiopia, but also make the country more attractive to international firms seeking to invest in Africa. Yet, skills shortages in Ethiopia constitute a key constraint to growth and improved productivity in the manufacturing sector despite the country has made significant progress in expanding access to education. In the short run, Ethiopia may not need to wait for higher levels of enrollment and improvements in the quality of education provision at secondary and tertiary education levels to stimulate the growth of the manufacturing sector. In fact, its education sector policy should focus, inter alia, on the provision of a diverse range of TVET and second-chance general education programs for primary and secondary graduates who seek further education and skills development. Private investment, both domestic and foreign, is crucial for developing the manufacturing sector. A better investment climate that fosters the growth of existing firms, while encouraging the creation of new firms is key to attracting and increasing private sector investments. The business environment affects the performance of all firms, irrespective of their size; however certain aspects such as regulatory burden and information asymmetry may be of particular consequence to SMEs. Access to finance is a top obstacle to SMEs as firms in Ethiopia are more likely to be credit constrained than global comparators. There is strong evidence that lending to micro-enterprises and larger firms in Ethiopia is relatively adequate, while SMEs are left behind (“missing middle phenomenon”). The intensity of business operational constraints and entry barriers vary depending on whether firms are large, FDI- Executive Summary xi financed, or domestic SMEs. Business entry regulations and processes are consistently highlighted by the private sector as burdensome and obstructive of firm entry and dynamism. The Government is implementing an industrial parks (IP) development program to address investment-climate-related issues to land access, infrastructure, and logistic and customs processes, and to further the attraction of FDI. Combined with comparatively low labor costs in Ethiopia, the IP program is beginning to attract FDI especially in the manufacturing sector. But given that about half of FDI firms in Ethiopia cite investment climate or regulation related issues as important impediments to investment, more FDI could be attracted by addressing those constraints and furthering its IP program. Still, cumulatively more FDI firms succeed in moving from the investment stage to operational phase than domestic firms. But while FDI has a better “conversion” rate over domestic investors, there is still room for substantial improvement. Currently two out of three potential FDI firms do not reach operational state. Important lessons could be drawn from the IP experience around the world. For instance, the performance for IPs is greatly dependent on how well they are designed, implemented and integrated into the local economy. Despite the concept of enclaves, in practice, the success of IPs comes once they are entwined with the overall economy, and the institutional capacity of the Government. The importance of promoting linkages and spillovers with domestic firms and the role of services in developing value chains is key. Thus, addressing the investment constraints faced by firms outside the Industrial Parks needs to remain a simultaneously advanced critical issue. Policy recommendations This Economic Update offers seven policy recommendations, which could contribute to the development of the manufacturing sector in Ethiopia. The recommended actions focus on the key operational constraints and entry barriers both for FDI companies and SMEs. 1. Focus on skills development which is vital for increasing firm productivity. 2. Implement measures to improve access to finance for firms especially “the missing middle,” small and medium sized enterprises, the majority of which are fully credit constrained. 3. Address binding constraints relating to access to land and access to electricity. 4. Improve tax administration and advance the simplification of the MSME tax system. 5. Improve trade logistics, customs procedures and trade regulations, which primarily impacts large (exporting firms) and FDI. 6. Simplify business entry regulations and processes to facilitate entry and exit of firms, which is a key requirement for a dynamic and thriving business sector. 7. Utilize a strategic and phased approach for the development of Industrial Parks in line with international experience and to ensure efficient utilization of and demand for IP infrastructure. 1 Recent Economic Developments and Outlook 1 The Short View followed by private consumption with 14 percent in 2013/14. Public investment, which is largely driven by The Ethiopian economy continued its strong expansion public enterprises, showed an average annual growth of in FY14 with real GDP growing by 10.3 percent. At the 14 percent in the last three years (2010/11–2013/14). same time, inflation has remained in single digits for the last two years. On the fiscal side the budgetary stance at Such investment is fueled by domestic and external the general government level has been cautious. In an credits to public enterprises, which grew on average effort to adjust for the rising cost of living, the FY15 budget by 21 percent during the same three-year period. On incorporated an increase in public sector salaries through a supplementary budget in the middle of the fiscal year. the contrary, the net exports contribution to GDP is Goods exports showed positive growth in 2013/14 but rates –4.3 percent as a result of large capital import of capital remained far below their historical growth; furthermore, goods associated with public infrastructure investment export growth fell into negative territory again—after an earlier dip in 2013/14—in the last quarter of 2014 and which has a positive long-term contribution to growth. first quarter of 2015. Three-fourths of the GDP growth in 2013/14 can be explained by the developments in three sub-sectors: agriculture, construction, and services. Real Sector  In the agriculture sector, the crop production The Ethiopian economy continued its strong value-added increased by 8.2 percent and was expansion in FY14.1 Real GDP grew by 10.3 percent higher than the 6.6 percent increase in 2012/13. compared with 9.8 percent in FY2013 (Figure 1.1.1). Within the crops category, oilseed showed a Economic growth was driven mainly by the services declining trend for now two consecutive years sector, which accounted for about half (5.3 percent- (Figure 1.1.3) due to a decline in the production age points) of the growth contribution, followed by of linseed (decreased by 2.1 percent in 2013/14); industry (2.8 percentage points) due to an ongoing and a combined drop of 24 percent in safflower construction boom. Agriculture, in turn, contributed and rapeseed. At the same time, sesame—one of 2.3 percentage points. The manufacturing sub-sector the major export items of Ethiopia—increased contributed only 0.5 percentage points to the GDP production by 21 percent. growth, less than the 0.7 percentage points contribu-  Construction value-added increased by 36 per- tion of the preceding year. Real GDP per capita grew cent and was the major driver of the industry by 7.2 percent in FY14, which is close to the neces- sector in 2013/14. With this, construction con- sary 8.0 percent annual per capita growth rate needed tributed 2.2 percentage points to GDP growth for Ethiopia to reach middle-income status by 2025. and accounted for 81 percent of the total growth On the demand side, public investment growth contribution of the industry sector. accounted for more than half of GDP growth. Public investment contributed 56 percent to total GDP 1 The Ethiopian Fiscal Year ranges over 12 months from July 8 to July 7. This note draws upon official national accounts data produced by growth in 2013/14 (Figure 1.1.2). Private investment the Government of Ethiopia. The growth rates quoted are expressed growth contributed 24 percent to overall GDP growth in factor prices. 2 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 1.1: Economic Activity 1. Real GDP Growth (Supply Side) 2. Real GDP Growth (Demand Side) 12% 25% 10.3% 9.8% 0.6% 20% 10% 0.7% 8.7% 1.3% 0.5% 1.1% 15% Services 8% 1.7% 2.2% 3.3% 10% 6% 2.2% 0.2% 5% 0.0% 1.9% 0% Industry 4% 0.3% 2.2% 1.3% 0.7% –5% Agriculture 0.5% 0.5% 2% 2.2% 3.1% 2.3% –10% 0% –15% 2011/12 2012/13 2013/14 2011/12 2012/13 2013/14 Agriculture Trade & hotel Manufacturing Other services Private Cons Private Inv Exports GDP Construction Transport & commun. Other industry GDP Public Cons Public Inv Imports 3. Crop Production Growth (%) 4. Ethiopian Airlines Activity Growth Ethiopia: Growth in major season crop production 40% 35% 20% 30% 15% 25% 20% 10% 15% 5% 10% 5% 0% 0% –5% –5% 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 11mon Cereal Pulses Oil seeds Grains Cargo Passengers 5. Electricity Generation and Sales Growth (%) 45% 45% 40% 40% 35% 35% 30% 30% 25% 25% 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% –5% –5% 2010/11 2011/12 2012/13 2013/14 Household sales Industrial sales Commercial sales and street light Production Source: World Bank staff computation, based on: 1.1: MOFED, 1.2: MOFED, 1.3: CSA, 1.4: EEPCO, 1.5: Ethiopian Airlines. Note: 1.5: The difference between production and sales is equal to the export amount; but there is no detailed data available for power exports. Recent Economic Developments and Outlook 3  The services sector had the largest growth Tighter monetary policy supported lower contribution of all subsectors. The trade and inflation even though reserve money growth is hotel sub-sectors increased by 17 percent. very volatile. Reserve money growth (the nominal Foreign merchandise trade, which is one of the anchor) increased by 21 percent in November 2014 items in the sector, increased by 13 percent in compared to the deep –3.7 percent dive in December 2013/14. Meanwhile, within the transport and 2013 and recent peak of 24 percent in February 2013. communications category, Ethiopian Airlines Part of the volatility comes from methodological activities increased by 13.3 and 6.8 percent in changes, but they do not explain the full extent of ups passenger traffic and cargo services, respectively and downs.2 In addition, the sale of a US$1 billion sov- (Figure 1.1.4). In eleven months of FY15 (to May ereign bond in December 2014 would hypothetically 2015), Ethiopian Airlines Cargo service increased increase the foreign assets and accelerate the growth by 26.2 percent and passenger service by 7.7 per- of reserve money unless NBE is able to sterilize its cent—despite the Ebola outbreak in West Africa. effects. Current data seems to suggest that the latter is, Similarly, electricity generation showed substan- in fact, happening but a full picture has yet to unfold. tial growth to 45 percent per year in 2013/14; Importantly, however, inflation was rather stable during yet, power sales to industries grew by only 4 the volatility period of reserve money, which indicates percent against 12 percent, while an estimated a rising role of inflation expectations in the economy at 170MW of power is exported to neighboring the current time (Figure 1.2.2). Low inflation expecta- countries (Figure 1.1.5). Exports are not shown tions have a stabilizing effect on inflation rates. in Figure 1.1.5, but explain the difference between Broad money is growing relatively faster, and overall production and domestic sales. credit growth to state-owned enterprises (SOEs) is the major contributor to that growth. Looking at broad Monetary Sector money growth shows a continuing growth pattern from 21 percent in March 2014 to 30 percent in November Inflation has remained in single digits for the last two 2014 (Figure 1.2.3). Net domestic credit growth reached years. In May 2015, the headline inflation continued 31 percent in November 2014 (Figure1.2.5). Public sec- its upwards trend, albeit on relatively low levels, and tor credit continues to be the main driver with credit reached 9.4 percent. This is slightly faster growth than to the SOEs increased by 37 percent (year-on-year) in on average over the past 6 months mainly due to an November 2014. With this credit support, SOEs play increase in food inflation. While food inflation increased an important role in the economy as a main contributor to 10.1 percent in May, up from 2.9 percent in October, to public investment aimed at closing the infrastructure non-food inflation remained stable (Figure 1.2.1). The gap.3 The share of public enterprises in total outstand- decline in the global prices of fuel contributed to keep- ing domestic credit increased to 64 percent while the ing the non-food inflation relatively low while food prices, especially milk and milk products increased 2 The reserve requirement of banks was reduced from 10 to 5 percent in March 2013, but the National Bank of Ethiopia (NBE) issued CDs substantially (about 24 percent in May); the latter is a to sterilize liquidity. The CDs held by private commercial banks with result of a shortage of milk due to short season rainfall one year maturity were redeemed in March and April 2014, returning liquidity to the system. failure, which caused low animal fodder. Overall, the 3 Investment of SOEs is focused on infrastructure development to close rather low inflation over the past two years contributed the infrastructure gap in the country, which is a binding constraint to growth. Such investment is enshrined into the latest five year develop- to lower real interest rates, which meant that the maxi- ment program – the GTP, where more than half of the planned capital mum lending rate remained positive since December expenditure (57 percent) is allocated to SOEs. Investments aim to expand the road network; increase the power generation capacity; construct 2012. On the other hand, the real minimum deposit new railway lines; and foster industrial sector development through the rate was close to zero in September (Figure 1.2.4). establishment of sugar, textiles, fertilizer, leather and cement industries. 4 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 1.2: Monetary Sector 1. Inflation (y/y, %) 2. Reserve Money Growth and Inflation, (y/y,%) 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% –10% Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 General Food and Non-Alc. Beverages. Non-food Inflation (y/y) Reserve money 3. Broad Money (M2) and Inflation (%, y/y) 4. Real Interest Rates (%) 45% 20% 40% 10% 35% 0% 30% –10% 25% 20% –20% 15% –30% 10% –40% Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-13 Dec-13 5% 0% Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 2009/2010 2010/2011 2011/2012 2012/2013 2013/2014 2014/2015 Broad money (M2) Inflation (y/y) Real maximum lending rate Real deposit rate 5. Broad Money Growth (M2, y/y, %) 6. Composition of Domestic Credit Stock (%) 100% 100% 80% 90% 33 30 28 60% 80% 37 36 40 37 37 40% 70% 7 9 60% 9 20% 11 50% 21 0% 37 32 40% 41 –20% 30% 58 62 64 –40% 52 20% 42 –60% 27 29 10% 21 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 0% 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 5mns Net foreign assets Net domestic credit Other items (net) Broad money (M2) SOEs CG credit Private credit Source: World Bank staff computation, based on: 2.1: CSA, 2.2–2.4: CSA and NBE, and 2.5–2.6: NBE. Note: 2.6: Monetary survey data is used, which excludes DBE in private credits. Recent Economic Developments and Outlook 5 share of private sector credit declined to 28 percent in below the SSA averages for the period reviewed five months of 2014/15. The share of central govern- (Figure 1.3.2). Overall, credit as share of GDP is on ment credit continues to contract (Figure 1.2.6). At the a downward trend and below the SSA average since same time, the growth rate of private sector credit has 2008 (Figure 1.3.3 and 1.3.4). This finding is consis- decelerated sharply over the last year from 14.5 percent tent with the trend of demonetization observed for in 2014 to 5.7 percent in 2015. Ethiopia in the 2013 Ethiopia Economic Update. Maintaining single-digit inflation requires On average, banks appear to be well capitalized continued monetary discipline to maintain low and profitable. Compared with 2013, total capital of inflation expectations and support from fiscal the banking industry increased by 13.2 percent and policy; lower oil prices will also help. International reached Birr 26.4 billion by the end of June 2014. As a commodity prices and monetary growth are among result, the system-wide capital adequacy ratio increased major factors affecting inflation in Ethiopia. to 17.2 percent at the end of March 2014 (it was 14.6 Maintaining low levels of reserve money and broad percent at the end of March 2013) and remains well money growth would further cement the public’s above the 8 percent minimum requirement. Though view of successful fighting of inflation in Ethiopia banks’ operating costs appear to have increased, the and hence contribute to lower inflation expecta- profitability of the banking sector remains high with tions going forward. In addition, while the current return on assets (ROA) and return on equity (ROE) at international environment with low fuel and other 3.1 and 44.6 percent, respectively (as of end March commodity prices supports a low inflation environ- 2014). Both are well above the SSA average of 2 per- ment (see Chapter 1.B for a more detailed analysis of cent for ROA and 17 percent for ROE at end 2013 the effects of falling oil prices), it is also important Asset quality has also improved over time, with non- to align fiscal policy to the current monetary policy performing loans at less than 3 percent of banks’ total stance and contain credit growth to SOEs. loan portfolio at the end of March 2014. The liquidity situation however is showing some signals of stress in Financial Sector the system: at the end of March 2014, the system-wide liquidity ratio (liquid assets to total assets) was only The banking sector’s total assets in Ethiopia slightly above the 15 percent minimum requirement. increased by 13.3 percent over the one-year period Capital markets in Ethiopia mainly comprise up to June 2014, but financial intermediation treasury bills and Government bonds. Treasury bills remains low. Three public banks constitute 77 percent are transacted on a weekly basis while Government of total assets of the banking sector.4 Within this group bonds are occasionally issued. Maturities of T-Bills are the Commercial Bank of Ethiopia (CBE) and the range from 28, 91, 182 and 364 days of which Development Bank of Ethiopia (DBE). CBE holds 91 days and 364 days are the most demanded terms. 80 percent of the total outstanding loans and invest- In December 2014, the country joined Ghana, Kenya, ment used to finance public investments and DBE is Senegal, and Ivory Coast in issuing an euro bond that a large holder of treasury bills. Consequently, finan- raised US$1 billion to fund infrastructure-related cial intermediation remains low and on a declining projects for the electricity, railway, and sugar industry trend. The share of private sector credit of the total banking sector credit has consistently been declin- 4 As of June 30, 2014, there were 16 private and two state-owned com- mercial banks, one state-owned development bank, one state-owned and ing from 66.5 percent in 2007/08 to 40.1 percent in 16 private insurance companies, 31 microfinance institutions, and five 2013/14 (Figure 1.3.1). Similarly, the ratio of private capital goods finance companies. 5 The private sector credit is based on NBE definition, which includes sector credit5 to GDP declined from 15.4 percent in private sector credit by DBE. Private sector credit by DBE includes credit 2003/04 to 10.9 percent in 2013/14, and remained to cooperatives and the private sector. 6 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 1.3: Financial Sector 1. Private Sector Credit in Total Domestic Credit, Ethiopia 2. Private Sector Credit as a Share of GDP, Ethiopia and Selected Countries/Groupings 70 50 60 40 50 40 30 30 20 20 10 10 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Government Bond Total Public Enterprises Credit Ethiopia (NBE Definition) Ethiopia (IMF Definition) Total Private Sector Credit LIC Average Tanzania SSA Average Kenya 3. Domestic Credit as Share of GDP, Ethiopia 4. Domestic Credit as Share of GDP, Ethiopia and Selected Countries/Groupings 30 50 25 40 9.3 10.9 9.8 8.8 20 9.4 7.0 30 15 20 7.7 7.9 10 10.9 15.6 13.0 14.1 10 5 9.9 8.7 5.6 0 2.9 2.5 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1.9 0 2009 2010 2011 2012 2013 2014 Ethiopia LIC Average Tanzania Government SOE Private Credit SSA Average Kenya Source: World Bank staff computation, based on: 3.1–3.2: NBE and FinStat (2015), and 3.3–3.4: NBE and WDI. sectors.6 As issuer, the Ethiopian central Government 49,675 over the past year, reflecting a significant annual is rated B1 with a stable look by Moody´s Investors improvement in financial service outreach. As of June Service, B by Standard & Poor’s Corp. and Fitch rat- 2014, the banking system’s total net deposits showed a ings, four and five levels below investment grade. Rating year-on-year increase of 23.7 percent. Likewise, MFIs agencies agree on Ethiopia´s continuing strong growth mobilized a total saving deposit of Birr 11.8 billion, prospects, in spite of its economy’s small size, low per- about 54.8 percent higher compared to the same period capita income and reliance on the agricultural sector. of the previous year. The outstanding credit of the MFIs Both the banking sector and microfinance scaled up by 31.9 percent on annual bases and reached institutions (MFIs) are expanding in their structure Birr 16.9 billion. As a result, their total assets increased of liabilities and assets, but access to finance for 38.6 percent on annual bases and stood at Birr 24.5 MSMEs remains a challenge.7 Commercial banks billion by the end of June 2014. Access to finance for have branched out in previously unbanked areas and MSMEs, however, remains a critical constraint: only the number of bank branches went from 390 in 2009 to 2,208 in 2014. As a result, the ratio of total bank 6 Deutsche Bank and J.P. Morgan managed the bond sale. branches to total population improved to 39,834 from 7 This is described in more details in Chapter 2 of this Economic Update. Recent Economic Developments and Outlook 7 1.9 percent of small firms have a loan or line of credit. continued to finance part of the deficit by issuing This rate is lower than among micro, medium, and large direct advances from NBE (Figure 1.4.2). firms (6.0, 20.5, and 35.5 percent, respectively) and Government revenues declined modestly from corroborates with assertions that small firms struggle 14.3 percent to 14.0 percent of GDP in 2013/14. the most in obtaining access to finance since MFIs cater The general government revenue performance showed to micro-sized firms, and commercial bank clientele are a relative decline as a result of lower collection of predominantly medium and large firms. non-tax revenues.9 The non-tax revenue declined The small insurance sector has significant from 2.0 percent of GDP to 1.2 percent of GDP growth potential both through public and private since state-owned enterprises were allowed, for the insurance companies. The insurance sector remains first time, to retain earnings for reinvestment instead underdeveloped. Because most insurance is targeted at of paying dividends to the government. This was the corporate market, focusing on general insurance, partly compensated through additional revenues col- about 90 percent of the population does not have any lected from domestic indirect taxes (0.1 percent of type of formal insurance. Insurance premiums repre- GDP) and direct taxes (0.3 percent of GDP). The sent about 0.47 percent of GDP for non-life insur- foreign trade tax remained at a similar level to last year ance, and 0.03 percent of GDP for life insurance. The (Figure 1.4.3). On the other hand, external declined market retail premiums are dominated by motor insur- to 1.1 percent in 2013/14. ance and compulsory insurance include third-party The general government budget execution was policies. A total of 17 active insurance companies are tight in 2013/14. Total actual expenditure remained operating in Ethiopia, most of which are private.8 The the same at 17.8 percent of GDP in 2013/14. significant expansion of the branch network (59 new Recurrent spending increased from 7.3 to 7.5 per- branches in one year) is led by only four major insur- cent of GDP, and the capital spending-to-GDP ratio ance companies, including the state-owned Ethiopian decreased by about 0.3 percentage points to 10.3 Insurance Corporation, which opened 13 new branches percent of GDP in 2013/14. Capital expenditure in 2013/14. In total there are now 332 branches, of on development projects as a share of the general which over 50 percent are concentrated in Addis Ababa. government budget is generally high (59.3 per- cent) but showed a relative decline, mainly due to Fiscal Sector lower spending on road construction (reduced from 3.9 to 3.6 percent of GDP) and, to some extent, lower The budgetary stance at the general government level spending on water. Government spending remains has been cautious. The general government fiscal tilted in favor of capital spending (10.3 percent of deficit (excluding SOEs) remained modest at 2.6 percent of GDP but increased by 0.7 percentage 8 By 2013/2014, private insurance companies accounted for 78.6 percent point of GDP in 2013/14. The general government of the total capital of insurance sector of Birr 2.0 billion. The sector was budget deficit including grants increased to 2.6 per- opened to the private sector in 1994. 9 The contribution of direct taxes to revenues in Ethiopia is relatively cent of GDP in 2013/14, compared to 1.9 percent of limited, which is a reflection of Ethiopia’s low-income economy that pri- GDP in the previous year. A relatively larger decline marily depends on agriculture. The share of direct tax remained constant at around 29 percent of domestic revenue in the past decade. Most of in revenue and grants compared to total expendi- the revenues from direct taxes are generated from payroll tax and taxes ture deteriorated the fiscal deficit. The deficit was on profits of enterprises and individuals. The latter are low and volatile with an overall declining trend; down from a maximum of 2.8 percent financed primarily from external sources (2.0 percent in 2001/02 to as low as 1.4 percent in 2007/08 before it recovered to of GDP) with domestic financing contributing 1.3 2.5 percent of GDP in 2012/13. The recent upward trend may coincide with government measures in strengthening tax administration through percent of GDP while errors and omission accounted tax education, enforcement measures, automation of tax registration, for repayment of 0.6 percent of GDP. The government introduction of a Tax Identification Number and related measures. 8 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 1.4: Fiscal Sector 1. General Government Deficit (% of GDP) 2. Direct NBE Advances to GoE (% of GDP) 0 1.2 –2 1.1 1.0 1.0 –4 0.8 0.9 –6 0.6 –8 0.6 0.4 –10 0.2 0.3 –12 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 0.0 General government deficit 2009/10 2010/11 2011/12 2012/13 2013/14 3. General Government Revenue (% 0f GDP) 4. General Government Spending (% 0f GDP) 15 14.0 13.8 14.3 14.0 14.2 20 13.4 2.0 1.2 1.5 18 2.7 2.0 2.3 12 16 4.4 4.4 4.4 14 10.4 10.3 10.0 4.6 4.5 10.6 10.3 9 4.6 12 9.8 10 3.8 3.9 3.7 6 3.1 8 2.8 3.0 6 3 4 8.4 7.9 7.3 7.5 8.5 4.5 4.5 6.9 3.9 3.8 3.9 4.2 2 0 0 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15B 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15B Direct tax Domestic indirect tax Foreign trade tax Recurrent Capital Non tax revenue Domestic revenue 5. FY15 Budget, % of GDP 6. Real Wages in Public Sector and Other Salaries 20 160 17.8 17.7 18.5 140 15 14.3 14.0 14.2 120 Wage rate index 100 10 80 60 5 40 –1.9 –2.6 –2.9 20 0 0 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 (5) Total revenue Total spending Budget deficit incl. grants Custodial and Manual Professional 2012/13 2013/14 2014/15B Wage in Manufacturing Salary for Maid Source: World Bank staff computation, based on: 4.1: MOFED and WB/IMF, and 4.2–4.5: MOFED. 4.6 Staff Estimate. Recent Economic Developments and Outlook 9 GDP) versus recurrent spending (7.5 percent of The large size of the civil servant salary increase GDP) (Figure 1.4.4). will likely have an impact on overall government On the other hand, the general government expenditure in FY15. For FY 15, Birr 6.5 billion budget deficit envisaged a slight increase to 2.9 per- (US$331million) were provided through the budget cent of GDP in 2014/15.10 The expenditure budget for the salary increase at the beginning of the year. increased faster than revenues as a share of nominal However, half way through the year, this proved insuf- GDP and as a result the deficit deteriorated. Tax rev- ficient to cover the increased cost of more than 1 mil- enues are estimated to remain at 12.7 percent of GDP lion civil servants. As a result, the government approved while non-tax revenues are planned to increase to 1.5 additional Birr 8.0 billion (about $390 million) in a percent. Total expenditure will increase to 18.5 percent supplemental budget. Three-fourth of the supplement of GDP due to an increase of recurrent spending to 8.5 budget is expected to be financed through the fuel sta- percent while capital spending is expected to decline bilization fund; the proceeds are collected by charging to 10 percent of GDP. The general government budget fuel consumers higher prices than the international deficit (2.9 percent of GDP) is expected to be financed market are used to replenish the fund. The total salary through domestic financing of 1.7 percent of GDP increment reached Birr 14.5 billion (1.2 percent of and external borrowing of 1.2 percent (Figure 1.4.5). GDP) and potentially could affect the overall deficit if One feature of the FY15 budget that should planned additional revenues are not collected timely. not go unnoticed is that there is a slight shift from capital to recurrent spending due to public sector External Sector salary increments. The recurrent spending is planned to increase from 7.5 percent of GDP to 8.5 percent in The chronic current account deficit deteriorated FY15 mainly as a result of a rise in civil servant’s wages. in 2013/14 due to trade balances and declining The overall civil servant salaries increased on average transfers. The current account deficit (including offi- by 43 percent, although salary increase varied with pay cial transfers) reached 8.6 percent of GDP up from grade from 33 percent to 46 percent. This civil salary 5.3 percent in 2012/13. This was caused by the large adjustment was not large enough to compensate for the imbalance in import and export of goods and services, erosion of the real wage observed over the past decade which worsened from 16.5 percent to 17.8 percent of though, but a first correction was made now. Real wages GDP (Figure 1.5.1 and 1.5.7). The trade deficit was in other sectors have been rising faster than wages for driven by poor export performance and large exter- government employees. For instance, unskilled labor nal debt financed imports of capital goods for public real wages (e.g. for domestic workers) have been rising investment programs. Private and official transfers, and real wages of the manufacturing sector remained one of the largest external resources to Ethiopia, stable over the decade (Figure 1.4.6). Notwithstanding accounted for 7.4 and 2.1 percent of GDP, have also the net decline of real public sector wages, a recent labor declined in 2013/14 from 8.2 and 3.2 percent GDP market study found that the public sector still remains in 2012/13, respectively. Official transfers tended to very attractive over other sectors and is able to attract decline with fiscal stress in developed countries. The the best prospective employees (World Bank, 2015a). fall in oil prices is expected to improve the current Considering the signaling effect of public sector wages account deficit by 1.5 percentage points in FY15 (see there is a possibility that this adjustment may trigger also Chapter 1.B for a more detailed analysis of the salaries in private companies to increase and in turn effects of falling oil prices). The current account deficit negatively affect the competitiveness of the manufac- turing sector (see Chapter 2 for an in-depth analysis of 10 Nominal GDP growth for FY15 is estimate here at 18.7 percent (IMF the manufacturing sector). 2014 Article IV report). 10 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 1.5: External Sector 1. External current account balance (% of GDP) 2. Gross Official Foreign Exchange Reserves 25 4000 3.5 20 1.6 3.4 4.0 2.3 4.8 3.2 2.3 0.0 3500 3.9 4.2 0.2 15 3.0 2.8 2.4 4.4 3.0 6.4 2.5 2.6 10 4.8 4.9 5.8 3.2 2.7 3000 4.1 2.1 5 8.8 8.3 9.0 8.6 7.5 8.2 7.4 2500 2.5 0 –1.9 –1.0 –4.3 2000 –5 –4.0 –0.7 –5.6 –5.0 –5.3 2.0 –10 –6.5 1500 –8.6 –15 1000 –14.9 –16.5 1.5 –20 –18.1 –19.2 –17.9 –17.8 500 –21.2 –25 0 1.0 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Change in reserves Loans FDI CAB/GDP Official transfers Private transfers Trade balance G&S Foreign reserve (mill $) Reserve in months of import (right axis) 3. Growth in Export of Goods 4. Export of Goods and Services (% of GDP) 50 18 40 16 30 14 8.6 12 20 10 6.7 7.3 10 6.5 5.9 5.4 4.5 8 0 6 –10 4 8.1 5.9 6.0 6.8 6.5 6.0 –20 5.8 2 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 0 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 Value growth Volume gowth Price growth Services Goods 5. Quarterly Export Growth (%) 6. Import of Goods and Service (% of GDP) 40 35 30 5.4 5.1 5.7 6.1 30 1.5 4.7 0.4 0.4 4.8 4.5 25 0.4 4.8 0.7 0.8 1.1 6.0 4.4 5.0 4.1 4.6 4.4 4.0 20 20 5.2 6.3 3.9 4.9 4.6 4.6 15 8.4 10 7.3 7.2 8.2 7.3 7.0 10 6.0 0 5 7.1 7.6 9.6 8.6 6.8 7.5 8.2 0 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 –10 –20 Q1, 2011 Q2, 2011 Q3, 2011 Q4, 2011 Q1, 2012 Q2, 2012 Q3, 2012 Q4, 2012 Q1, 2013 Q2, 2013 Q3, 2013 Q4, 2013 Q1, 2014 Q2, 2014 Q3, 2014 Q4, 2014 Q1, 2015 Capital goods Fuel Others Consumer goods Intermediate goods Service imports (continued on next page) Recent Economic Developments and Outlook 11 Figure 1.5: External Sector (continued) 7. Trade and Services Balance (% of GDP) 8. Real Effective Exchange Rate 20 170 160 157 10 148 150 0 140 130 –10 120 –20 110 100 –30 90 86 –40 80 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 70 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Exports of GNFS Imports of GNFS Trade deficit Source: World Bank staff computation, based on: NBE and MOFED, except 5.5: some data from WB; 5.6: WB; and 5.8: IMF. was financed through external borrowing (4.4 percent passengers and cargo services of Ethiopian Airlines of GDP) and FDI (2.7 percent of GDP), as well as (EAL). Overall, since 2010/2011, Ethiopian exports the drawdown of international reserve by 0.2 percent have been on a declining path in percent of GDP of GDP. Foreign exchange reserves are low at about (Figure 1.5.4). In addition, in nine month of 2014/15, 1.7 months of imports (the following year import) in merchandise export declined by 3.0 percent against November 2014 (Figure 1.5.2). According to recent the same period of same year. The declining trend was data from NBE, reserves have increased to 3.2 months observed in the fourth quarter of 2014 and first quar- in December on account of the sovereign bond issu- ter of 2015 (Figure 1.5.5) as a result of significant drop ance. The external sector is vulnerable to terms of in the prices of oilseeds, leather products, pulses, gold, trade shocks which the government need to take the chat, meat and flowers as well as decline in the volume necessary measure to increase the country’s resilience of live animals, gold, oilseeds, and chat. Although the to shock. Though increased external borrowing could price of coffee rose significantly, the volume of export be a way to ease the reserves constraints, borrowing remained the same as nine months of last fiscal year. (like Eurobond) comes at relatively high cost exposing Faster growth in goods imports contributed the country to debt service obligations. to the deteriorating current account balance in Goods exports showed positive growth in 2013/14. Imports of goods increased by 19.7 percent 2013/14 despite the fact that it remained far compared to 3.7 percent growth in 2012/13. In terms below its historical growth, but the most recent of share in GDP, capital goods accounted for 8.2 developments in export performance are again a percent of GDP (far higher than earning from goods cause of concern.11 Export of goods increased by 5.8 percent in 2013/14 from its decline of 2.5 percent in 2012/13. In the past decade, export growth had aver- 11 There is some evidence that there is the start of a diversion recognizable that shifts sales in some sub-sectors from export markets to the domestic aged 20 percent per year. Export volumes improved market. To illustrate: in 2010/11 over 60 percent of total revenues from in 2013/14 but negative price effects are still present leather and leather products were derived from exports; this has declined to less than 30 percent in 2013/14 despite a 475 percent increase in (Figure 1.5.3). Service export grew by 11.3 percent total leather sector revenues over the same period (based on data from mainly due to an improvement in the number of Ministry of Industry). 12 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector export), and consumer goods import represented 7.0 over recent months and the Birr is managed against percent of GDP in 2013/14. On the other hand, fuel the US$, Ethiopia is on an appreciation path against and intermediate goods constituted 4.6 and 4.1 per- all currencies that are depreciating against the US$. cent of GDP (Figure 1.5.6). It emerged that all major This is because the Birr is closely managed against the categories of imports increased in 2013/14. Despite US$. The de facto exchange rate arrangement is classi- the share of services import decline, it grew by 8 per- fied as a crawl-like arrangement by the IMF (2013b). cent from 14 percent in 2012/13. In the nine months The authorities describe it as a managed float with no of FY15, goods imports grew by 21.3 percent mainly predetermined path for the exchange rate. The annual as a result of the 47.5 and 19.3 percent increases in pace of nominal depreciation, however, has been stable capital and consumers good imports, respectively; at 5 percent in recent years. Moreover, Ethiopia con- fuel imports declined by 17 percent following the tinued to experience a positive inflation differential decline in the global oil prices. relative to major trading partners. An appreciated The real effective exchange rate continued to currency does not help improving export competitive- appreciate into 2014/15. The real exchange rate ness and is a concern for the economy in a situation appreciated by 22.5 percent (y/y) at the end April of exports falling again over the period of only one 2015 showing a cumulative appreciation of 71 per- year. Maintaining a competitive exchange rate is an cent since the nominal devaluation in October 2010 important component of maintaining external com- (Figure 1.5.8). Since the US$ sharply appreciated petitiveness (World Bank, 2014a). Recent Economic Developments and Outlook 13 The Long View: The Effect of Falling Oil enough to have an impact on consumption patterns Prices on the Ethiopian Economy in the economy. The recent fall in global oil prices is expected to have a Ethiopia’s Oil Market positive economic impact on Ethiopia. The country is a net importer of fuel, which accounts for one-fifth of goods imports. The growth effect is expected to be positive in Ethiopia’s oil market is tightly controlled. The part because declining oil prices increase disposable real Ethiopian Petroleum Supply Enterprise is a govern- income and support stronger domestic consumption. The ment monopoly whose function is to purchase from price decline will result in an estimated 1.8 percent reduction international suppliers (Sudan, Saudi Arabia, and in the price of goods and services, bringing welfare gains for the average household, but this reduction will be larger Kuwait) and sell to nine domestic distributors that for urban households and wealthier rural households. then supply fuel to the local market. Distributors Improvements in terms of trade also support growth: Staff can be both of domestic and foreign ownership and estimates suggest an increase of around 6 percentage points in FY15. Inflation is also expected to decline, especially due include: Oil Libya, Total, National Oil Ethiopia, to indirect impact and its positive effect on expectations. Yetebaberut Beherawi Petroleum, Kobil, Dalol Oil, The current account deficit is expected to improve by 1.5 Wadi Alsundus (a Sudanese Company), and TAF Oil. percentage points in FY15. The first four mentioned companies constitute 89 percent of total fuel distribution in Ethiopia. Recent Oil Price Developments Changes in global oil prices are not fully transmitted into the domestic market in Ethiopia. Crude oil prices measured by Brent halved from the Figure 1.6.1 shows that retail fuel price adjustments peak at US$108 per bbl in June 2014 to US$54 per are done on a monthly (sometimes bi-monthly) basis bbl on average in the first quarter 2015. Following depending on market developments but that price four years of stability at around $105/bbl, oil prices changes in global markets of oil are not fully have declined sharply since June 2014. A number of absorbed and that the Ethiopian response is delayed. factors have driven the recent plunge in oil prices: For instance, from July 2014 to end-January 2015, while both demand and supply factors play their roles, the retail price of regular gasoline in Addis Ababa the decline was in considerable measure the result of declined by 16 percent while diesel oil and kerosene technology shocks (hydraulic fracturing and horizon- prices reduced only by 15 and 12 percent, respec- tal drilling) that have made oil and gas markets more tively. One exception is jet fuel, which decreased by competitive, unwinding of some geopolitical risks that 34 percent during the same period. The downward had threatened production, changing OPEC policy corrections of retail prices are far lower than the objectives, and appreciation of the U.S. dollar. (Global decline in the world market crude oil price, which Economic Prospects 2015). more than halved over the same period.12 The current oil prices are likely to persist In fact, the domestic oil price decline in for the next few years. Disruptive innovation led Ethiopia as of January 2015 has only been 18 per- to increased production (6 million barrels a day in cent compared to a 53 percent decline in world US and Canada) and, based on past experience, a market prices. As Ethiopia depends entirely on technological shock has the potential to keep oil imports for petroleum, and the extent of the impact prices low for a prolonged time. In this regard, this section assumes that oil prices will be US$53 (WB 12 In the case of regular gasoline, only 29.2 percent of the declining crude Commodity Market Outlook, 2015) on average over oil price was passed on to the consumers between July 2014 and the end of January 2015; the pass-through for diesel oil and kerosene were 28.6 2015 and slightly increase to US$57 in 2016. The and 21.9 percent, respectively. On the other hand, jet fuel experienced pronounced fall in prices is expected to be significant the largest (63.9 percent) price pass-through of the fuel products. 14 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector on households depends on the level of the pass- Likely Impact of the Oil Price Decline through to the domestic price. The pass-through to the domestic market has thus far been limited because Improvements in terms of trade (ToT) and the of the time lag in transferring costs to the domestic current account balance market and also because of fixed costs in importing and distribution. The domestic oil price decline as of Increased terms of trade and a more balanced current January 2015 (as set by the government) is on average account are likely to be the key effects on Ethiopia, only 18 percent. especially as prices of other key commodities, such as coffee, are expected to remain stable. Preliminary Ethiopia’s Oil Position estimates show that Ethiopian terms of trade could improve by about 6 percentage points, in FY15 for crude Ethiopia is a net importer of fuel with fuel account- oil price of $53/bbl (Figure 1.6.4). At the same time, ing for one-fifth of Ethiopian goods imports in simulating the effects of the declining oil price on the 2013/1413 (Figure 1.6.2). Ethiopian demand for 2014/15 Balance of Payment projection shows that this fuel increased over the past decade as the economy could lead to an improvement of the current account expanded. The value of fuel imports increased on aver- balance by 1.5 percentage points of GDP. age by 22 percent and thereby almost three times as fast as the growth of total import volumes (8 percent). Increase in real income, consumption and Yet, looking at the volume and price developments poverty of fuel imports separately (Figure 1.6.3) shows that much of the increase was driven by higher prices. Falling oil prices are expected to yield real income The growth in fuel volumes (as an input to the gains in oil-importing countries, including Ethiopia economy) over the past decade doubled but is still (GEP 2015). The maximum estimated decline in relatively lower than the rate of expansion of the domestic oil price in 2015 because of a 49 percent fall economy over the same period (10.8 percent GDP in international price is about 37 percent considering growth on average per year, implying a 2.5 times the mark up for refined products and the fixed costs increase of the economy over one decade). The latter in import and distribution (Table 1.1). A 37 percent is a reflection of Ethiopia’s ambitious hydropower domestic price decline of petroleum products would program, which makes Ethiopia relatively less reliant have a significant impact on household welfare.14 Since on fuel for electricity generation compared to many it is unclear, however, if the Government will allow the other countries in SSA. maximum possible pass-through to materialize, this Lower oil prices that persist in the medium- analysis considers an alternative scenario where the term would contribute to global economic growth 18 percent pass-through observed in January 2015 is and lead to real income shifts from oil-exporting assumed to not be further adjusted in 2015. countries to oil-importing ones, including Ethiopia. The direct savings from an oil price reduction is Generally, weak oil prices support economic activity expected to be small (only 0.4 percent of the aver- and reduce inflationary, external, and fiscal pressures age household expenditure), as petroleum is a small in oil importing countries (GEP, 2015), making the share of household consumption for households. recent drop in prices generally good news for Ethiopia. Staff estimates show that the observed increases in 13 Fuel imports accounts for 16 percent of total import of goods and terms of trade could lead to an additional positive services. 14 The direct and indirect impact of the petroleum price fall on house- economic growth in the order of three-fourth of a holds is simulated by price multiplier analysis using the input output percentage point. table (EDRI 2006) and the 2011 household consumption survey (CSA). Recent Economic Developments and Outlook 15 Table 1.1: Assumption on the Maximum Pass-Through to Domestic Market of the Oil Price Decline 2014 2015 % Change International crude oil price $/bbl 105 53 –49% Mark up for refined petroleum ($ /bbl) 17 17 Service charge (suppliers) $/bbl 7 7 Freight to Djibouti ($/bbl) ~ 2 2 Transport from Djibouti port ($/bbl) 8 8 Other costs ($/bbl) ~ 2 2 Cost of refined petroleum in Eth. (exc. taxes) ($/bbl) 140 89 –37% Source: World Bank staff estimates based on EDRI (2006) and the 2011 household consumption survey (CSA). Households spend on average only about 1.2 percent gain 0.6 percent compared to 1.7 percent for the poor- of their expenditure on petroleum, mostly kerosene. est decile in urban areas. Richer households spend a The direct benefit to households of the 37 percent higher proportion of their expenditure on petroleum decline in the oil price in terms of expected household products and outputs of activities that highly depend savings is equivalent to about 0.4 percent household on petroleum as input compared to poorer house- expenditure.15 holds. The benefit of the oil price decline is regressive The greater savings comes from the impact of with household income both in urban and rural areas the price reduction on other goods and services, (Figure 1.6.5). this indirect effect amounts to 1.4 percent of house- Urban households benefit more than rural hold expenditure on average. Petroleum is a major households: the poorest decile in rural areas input in production activities. On average, it accounts would experience savings of 1.2 percent com- for 11 percent of the intermediate cost of economic pared to estimated savings of 3.5 percent for the activities in the country (Ethiopian Development poorest decile in urban areas. The per capita con- Research Institute (EDRI) Social Accounting Matrix sumption of urban households is about 80 percent 2006). Staff simulations show that a 37 percent reduc- higher than rural households on average. In addition, tion in the price of petroleum products would bring there is a significant difference in the consumption about a 1.8 percent reduction in the general price patterns of urban and rural households at similar of consumer goods and services. This is equivalent consumption levels. Urban households consume to saying that, all else being equal, a household’s more than rural households of petroleum products real disposable income would increase by about 1.8 and items that highly depend on oil as an input. As percent. Since the direct effect is 0.4 percent, the a result the benefit from the oil price decline is more indirect effect of the oil price decline through other pronounced in urban areas than in rural places. goods and services is about 1.4 percent of household The benefit to an average urban household is more consumption. Although all income groups benefit as a result of the oil price decline, higher income groups ben- 15 Simulations are in line with expectations: A 2012 study by the Ethiopi- an Development Research Institute (EDRI) found that the counterfactual efit more with maximum estimated savings of 2.2 increase of oil prices of 50 percent in 2012 led to a decline in real incomes percent for the richest decile and 1.6 percent for of both rural and urban “non-poor” households and an associated decline of consumption of 2.1 and 1.3 percent, respectively. Poor households the poorest decile. In the lower scenario (18 percent consume less oil-related products and hence their consumption “only” pass through), the poorest decile in rural areas would declined by 0.9 and 1.7 percent, respectively (EDRI, 2012). 16 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector than twice the average benefit to a rural household Potential other Impacts of the Oil Price (Figure 1.6.6). Decline Inflation is expected to decline due to indirect Likely limited fiscal impact effects and improved expectations. The possible positive fiscal impact observed in many A 30 percent decline in oil prices reduces global other countries is likely to be limited since Ethiopia inflation only by about 0.4–0.9 percentage points. does not have a direct subsidy of fuel prices in place. The GEP (2015) suggests that a 30 percent decline In fact, there may be a negative fiscal impact from those in oil prices, if sustained, would reduce global infla- fiscal trade revenues that are based on ad valorem rates tion only by about 0.4–0.9 percentage points through where a decline in the unit price would lead to a reduc- 2015. Furthermore, for 2016, inflation would return tion of revenues. In Ethiopia, most of the duties are in to levels prior to the plunge in oil prices. While coun- fact ad valorem rates so there is likely to be a negative try-specific circumstances will in some cases influ- fiscal impact from this. The net effect is unclear, how- ence the impact of oil prices on domestic inflation, ever, because the government also consumes oil and the direct impact in Ethiopia is expected to be minor oil-related products; given data constraints the actual since the weight of fuel in the national consumer price net effect cannot be estimated at the moment.17 basket is small: the “gas and liquid fuels” component of the consumer price index (CPI) is 1.1 percent. Lower cost of production may increase profits Energy prices will be largely unaffected by the and investment oil price decline. There are two main reasons for this: (1) The role of hydropwer in Ethiopia’s energy In Ethiopia falling input prices likely will have a mix is about 98 percent and fuel imports increase mixed impact on the main productive sectors of at lower rates than the economy is expanding indi- the economy: (1) The largest impact may be on agri- cating a declining fuel intensity of GDP growth in culture production, especially where fertilizer usage is Ethiopia; (2) There is limited correlation between instrumental, and transportation costs of agricultural energy prices16 in the CPI against oil price develop- products are important. (2) In the export services ments (Figure 1.6.7). This is the case as the consump- sector the key impact is likely to come through trans- tion weight of traditional sources of energy (i.e. solid port services, which accounts for about 60 percent of fuels like firewood, charcoal, and dung cake) constitute the services sector, through lower operating cost of the largest shares of energy consumption of house- Ethiopian Airlines (EAL). The declining oil price is a holds (ranging from 87 to 95 percent in most regions blessing for EAL since fuel accounts about 46 percent (including big regions) to about 73 percent in urban- of its operating expenses (2012/13). (3) Given the oriented Harari and Dire Dawa regions; Addis Ababa overall limited size of the manufacturing sector in the as the main urban center still has a share of 47 percent). Ethiopian economy the effects on economic activity There are two indirect impacts from lower infla- through that sector are probably negligible. tion: (1) Declining oil prices may reduce medium- 16 Energy prices in the CPI incorporate electricity, gas (butane gas), liquid term inflation expectations thereby supporting price fuels (kerosene), and solid fuels (firewood, charcoal, and dung cake). stability indirectly. (2) Petroleum is a major input in 17 Negative fiscal effects are expected from the following ad valorem taxes/ levies (these are examples, and this is not an exhaustive list): On the fis- many activities and the oil price decline can bring cal accounts, the government collects 15 percent VAT on fuel product about general declines in other goods and services imports, and revenue collection will reduce as the value declines. Also, the government collects taxes and fees connected to the domestic retail (estimated to decline by 1.4 percent), indirectly ben- prices, e.g. the 30 percent excise tax on regular gasoline, 15 percent VAT efiting households. on regular gasoline and diesel. Recent Economic Developments and Outlook 17 Figure 1.6: Key Facts on Oil and Its Price Decline in Ethiopia 1. Selected oil prices, 2011–2015 2. Composition of Ethiopian Import, 2013/14 110 100 90 33% 80 33% 70 19% 60 28% 50 40 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Regular Gasoline (E10 blend) Gas Oil (Diesel) Miscellaneous Semi-finished Fuel Lighting Kerosene Jet Fuel Crude oil price Consumer Goods Capital Goods Raw Materials 3. Trend in Fuel Import, Index 4. Oil Prices and Terms of Trade Growth, % 800 15 700 10 600 500 5 400 300 0 200 –5 100 0 –10 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 –15 2011/12 2012/13 2013/14 2014/15 proj Volume Value Unit price TOT (baseline) TOT after fuel price change 5. Real Income Increase through Lower Oil Prices (Share Of Total Consumption) 2.1% 1.7% 1.3% 0.9% 0.5% Lowest decline 2 3 4 5 6 7 8 9 Highest decline Maximum Minimum (continued on next page) 18 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 1.6: Key Facts on Oil and Its Price Decline in Ethiopia (continued) 6. Real income: Amount Saved as a Result of Lower Oil Prices by Rural Urban Income Decile (Share of Total Consumption) a) Maximum impact: 37% domestic oil price decline b) Minimum impact: 18% domestic oil price decline 4% 4% 3% 3% 2% 2% 1% 1% 0% 0% Poorest decile 2 3 4 5 6 7 8 9 Richest decile Poorest decile 2 3 4 5 6 7 8 9 Richest decile Urban Rural Urban Rural 7. Energy Prices (CPI) vs Oil Price, y/y growth 30% 20% 10% 0% –10% –20% –30% –40% –50% Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Energy prices in CPI Crude oil price Source: World Bank staff computation and estimates, based on data from NBE, MOT, EDRI (2006) and the 2011 CSA. Notes: (1) All FY15 calculation assume an oil prices at US$53 (from WB Commodity Outlook). (2) Figure 1.4 uses additional assumptions: a) no change in the compostion of imports; and b) change in international price of oil is the same as change in unit price of imported fuel. (3) Figure 1.5 also assumes: a) the share of fuel import value is unchanged in FY15; and b) the volume of fuel import will increase by 10 percent in FY15. Possibly depreciating real exchange rate (RER) the impact on global inflation, thereby triggering a change in the RER. The 2014 Ethiopia Economic T h e i m p a c t o n t h e re a l e xc h a n g e r a t e Update found that Ethiopia’s real exchange rate is (RER) depends on the relative change of foreign overvalued and the report suggested that a 10 per- inflation against domestic inflation as well as the cent lower real exchange rate could increase export rate of nominal depreciation. The FY15 nominal growth in Ethiopia by more than 5 percentage depreciation rate of the ETB against the US$ can be points per year and increase economic growth by assumed to be similar to the rate of FY14 (5.5 per- more than 2 percentage points. Further analysis is cent), but it is unclear whether the impact of declin- needed to estimate the effect of the oil price decline ing oil prices on Ethiopian inflation is different from on Ethiopia’s RER. Recent Economic Developments and Outlook 19 The Future View: Outlook and next three years. It is expected that the current drop Challenges in exports is temporarily (again) and that exports will increase in importance while investment will slightly decrease its growth contribution (Figure 1.7.2). The Growth will remain high in the short term while gradually declining in the medium term. While a rising working age supply side growth contribution will continue to be population will continue to support potential GDP growth, dominated by services and see a slightly lower indus- total factor productivity growth and investment are gradually try sector over the next three years (Figure 1.7.3). In expected to decline. Fiscal and external balances will slightly deteriorate until 2017, since deficit financed imports of order to industrialize and significantly expand the heavy machinery will continue. High growth and lower oil manufacturing sector in Ethiopia it is important to prices will drive further reductions in poverty. address some of the key bottlenecks identified in the next chapter, such as shortage of skilled labor, access to finance and trade logistics. Outlook Fiscal and external balances will slightly deterio- rate until 2017 as deficit-financed imports of heavy The recent fall in global oil prices is expected to machinery will continue. The current general govern- have a positive short-term economic impact on ment accounts reflect a cautious stance at –1.9 percent, Ethiopia. The country is a net importer of fuel, which is possible as SOEs have taken on significant which accounts for one-fifth of goods imports. The parts of the public investment program of the country growth effect is expected to be positive in part because (and they are not included in the general government declining oil prices increase disposable real income accounts). Staff estimates indicate that this is going and support stronger domestic consumption. The oil to dip to –2.9 percent due to faster spending of gen- price growth effect is projected to be three-fourth of eral government (Figure 1.7.4). At the same time, the a percentage point (see Chapter 1, Section B). chronic current account deficit will further deteriorate, But the high double-digit growth rates of the driven by high imports to support the public infrastruc- past decade will likely fall over the medium term. ture program. The current account deficit is expected Projections of potential GDP growth indicate a slow- to reach –8.8 percent of GDP in 2017 (Figure 1.7.4). down in the medium term due to declining Total Factor Poverty in Ethiopia saw the second fastest rate Productivity (TFP) growth (Figure 1.7.1 and Table 1.2). of reduction in Africa over the past 10 years. The Simulations of real GDP growth depend on three factors: poverty headcount fell from 38.7 percent in 2005 to 1) TFP growth; 2) the share of the working age popu- 29.6 percent in 2011, measured by using the national lation; and 3) capital stock. TFP growth is estimated poverty line. Measured with the international poverty using a Hodrick-Prescott filter for the 1970 to 2008–10 line (US$1.25 per day) Ethiopia saw the second fastest period. Since TFP growth was exceptionally high dur- rate of reduction in Africa. Economic growth, par- ing the growth acceleration, this would lead to gradually ticularly in agriculture, has been an important driver declining TFP growth going forward. The economy’s of poverty reduction in the last decade. Each percent potential to grow depends partly on its labor supply, of overall growth reduces poverty by 0.55 percent, but which in Ethiopia’s case is expected to grow healthily each percent of agricultural growth reduces poverty by over the next couple of decades. Finally, the capital stock 0.9 percent. Favorable weather conditions and improv- depends on assumptions about public and private invest- ing terms of trade for rural producers have been drivers ment. Declining TFP growth and investment results in of this past trend supported by strong improvements a decline in the potential GDP growth rate. in access to basic services and rural safety nets. Low Economic growth will see a rising importance of levels of inequality have been maintained with the exports and an abating role of investment over the Gini coefficient remaining stable at 0.30. 20 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector High growth and lower oil prices will drive will have reductions of 1.6 percent. For those rural further reductions in poverty. But poverty reduc- households that depend on cereal sales, welfare gains tion from agricultural growth will be lower than in from lower consumer prices may be partially offset the past due to less favorable weather and weaker price by lower cereal prices. Lower oil prices reduce import gains for producers. In contrast, urban poverty rates prices and require local cereals to be more moderately will fall faster than in the past owing to an increase priced to be competitive. in the number and the quality of urban jobs as well An appreciated real effective exchange rate does as lower inflation. not help competitiveness, especially in manufactur- ing. The real exchange rate appreciated by 22.5 per- Challenges cent (y/y) at the end April 2015 showing a cumulative appreciation of 71 percent since the nominal devalu- Continued infrastructure improvements offer the ation in October 2010 (Figure 1.5.7). In addition, single best growth prospects for Ethiopia due to Ethiopia is now on an appreciation path against all a still large infrastructure gap and high economic currencies that are depreciating against the US$. There returns. However, rising debt levels and borrowing is concern that the appreciated currency does not costs suggest a need to rely on complementary ways to help improving export competitiveness; much more, closing the infrastructure gap (such as public-private since exports are falling again and the Government is partnerships [PPPs]) in addition to debt-financed pub- trying to encourage a thriving manufacturing sector lic investment. Moreover, a gradual phasing-in of the to develop. Maintaining a competitive exchange rate private sector via credit and foreign exchange markets is an important component of maintaining external is also warranted to reap relatively higher returns to competitiveness, but its macroeconomic effects, for private investment. instance on import prices and inflation need to be Rates of poverty reduction will decrease. The managed closely (World Bank, 2014a). rate of rural poverty reduction will likely be slower Slow recovery in advanced economies and than in the past given the failure of the 2014 Meher slower growth in emerging markets and weather rains in Oromia and Somali regions, and modest shocks all exert potential risks to the Ethiopian terms of trade increases for cereal producers. While economy. Risks associated with sluggish growth in lower fuel prices will reverse the worsening ToT that advanced economies and slower growth in emerging farming households experienced in 2014, ToT gains markets relate to further commodity price declines will not reach the levels observed during the period with a negative impact on Ethiopian exports and from 2008–10. also to declining remittances and FDI. In addition, Lower oil prices will aid poverty reduction. Ethiopia’s domestic agriculture sector remains vul- This comes through a reduction of consumer prices nerable to weather-related shocks. Food production by an estimated 1.8 percent for the average Ethiopian remains largely rain-fed and adoption of improved household. This reduction will be relatively larger for varieties and farming practices remains limited. urban and wealthier households Consumer prices Prolonged droughts would manifest higher food prices of urban households will be reduced by 3.4 percent with associated impacts on inflation and poverty lev- compared to 1.4 percent for rural ones. Likewise, els. In order to mitigate these risks, structural reforms households in the richest decile will see reductions to diversify exports and development of irrigations in prices of 2.2 percent, while poorer households system are important in the medium to long term. Recent Economic Developments and Outlook 21 Figure 1.7: Economic Outlook: Selected Projections to 2017 1. Determinants of Potential Output, 2001–2017 2. GDP Growth (Demand Side), 2009–2017 16 25 14 20 12 15 10 8 10 6 5 4 0 2 –5 0 –10 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2009 2010 2011 2012 2013 2014 2015 2016 2017 Capital stock Potential GDP Private consump. Public consump. GFCF Exports GNFS TFP Working age population Imports, GNFS Stat. discrep. Real GDP 3. GDP Growth (Supply Side), 2009–2017 4. Fiscal and External Balances, 2001–2017 12 0 –1 10 –2 5.8 –3 8 3.9 5.4 5.7 –4 6.2 7.4 4.5 5.6 –5 6 4.5 –6 1.6 3.1 4 –7 1.0 3.0 2.0 2.3 2.1 1.6 –8 1.1 2 4.0 –9 3.0 3.0 2.8 2.3 2.1 2.2 1.9 2.4 –10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2009 2010 2011 2012 2013 2014 2015 2016 2017 Agriculture Industry Services GDP af factor cost Current Account deficit General Gov't primary balance Source: World Bank staff compilation, based on data from the Macro-Fiscal Forecasting Model. 22 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Table 1.2: Macro-Fiscal Outlook Indicators, 2012 to 2017 2012 2013 2014 2015f 2016f 2017f GDP, at constant market prices 8.6 10.5 9.9 9.5 10.5 8.5 Private Consumption 8.7 10.5 5.5 7.9 10.2 8.0 Government Consumption –12.6 10.4 5.4 17.5 10.8 9.8 Gross Fixed Capital Investment 25.5 6.6 23.7 13.8 10.3 8.6 Exports, Goods and Services –10.6 0.2 3.1 3.5 13.5 14.5 Imports, Goods and Services 8.9 1.5 11.5 11.5 10.8 10.0 GDP, at constant factor prices 8.7 9.8 10.3 9.5 10.5 8.5 Agriculture 4.9 7.1 5.4 5.0 7.5 6.5 Industry 19.6 24.1 21.2 13.8 13.2 10.5 Services 9.9 8.8 11.8 12.1 12.1 9.5 Inflation (Household Consumption Deflator) 33.5 4.7 10.2 8.2 7.2 8.2 Inflation (Consumer Price Index) 34.7 13.9 8.1 — — — Current Account Balance (local definition), % of GDP –6.5 –5.3 –8.5 –8.2 –8.6 –8.8 Fiscal Balance, % of GDP –0.7 –1.5 –2.2 –2.6 –3.0 –3.2 Source: World Bank staff compilation, based on data from the Macro-Fiscal Forecasting Model. Notes: f=forecast; annual percentage change. 23 Growth and Transformation through Manufacturing 2 Industrialization in Ethiopia related products; cement; and the metal and engi- neering industries. The Growth and Transformation Plan seeks to transform But the GTP has not been able to foster and Ethiopia towards an industrialized economy and to increase accelerate structural transformation of the econ- per capita income of its citizens by 2025. To this effect, the Government has adopted a policy focused on the omy and the share of the manufacturing sector in development of the manufacturing sector through the use GDP remained stable at a rather low level. In fact, of industrial parks to attract FDI and to support SMEs. But Ethiopia’s past high growth decade has been fueled with services and agricultural sectors contributing almost 90 percent of GDP , the GTP has not been able to accelerate by large services and agricultural sectors. Economic structural transformation. At the same time, the share of growth averaged 10.9 percent per year from 2003/04 the manufacturing sector in GDP remained just above 4 to 2013/2014 compared to the regional SSA aver- percent of GDP for most of the past decade. Furthermore, Ethiopia has not made significant progress in pulling labor age of 5.4 percent (Figure 2.1.1). The two sectors out of agriculture into more productive and industrial jobs. of services and agriculture are the backbone of the The share of employment in the manufacturing sector has economy, together accounting for almost 90 percent changed only slightly and is virtually unchanged since 1999 at below 5 percent of total employment. of GDP between 2003/04 and 2013/14 (Figure 2.1.2). At the same time the manufacturing share in GDP is rather stable at or just above 4.1 percent of GDP. Ethiopia’s Growth and Transformation The manufacturing sector has grown at an average of Plan seeks to transform the economy from 10.9 percent in last decade—about the same rate of a predominantly agrarian to a modern and expansion as real GDP—thereby falling short of the industrialized economy. The current plan (GTP targeted 22 percent in the GTP. In 2013/14 the three 2010/11–2014/15) provides the medium-term stra- sector shares in GDP were: 40.2 percent (agriculture), tegic framework that guides the country’s efforts 45.5 percent (services), and 14.3 percent (industry). towards accelerating GDP growth and employment The agriculture sector still employs more than creation. The GTP seeks to transform Ethiopia to an three-quarters of all workers and the pace of struc- industrialized economy and increase the per capita tural transformation has been slow. So far, Ethiopia income of its citizens to middle-income levels by has not made significant progress in pulling labor out 2025. Integral to the achievement of a vibrant and of agriculture into more productive and industrial competitive industrial sector is a policy focused on the jobs. The share of employment in agriculture is rela- development of the manufacturing sector, for instance tively unchanged between 1999 and 2005, but then through the use of Industrial Parks (IP) to attract declined from 80.2 percent in 2005 to 77.3 percent Foreign Direct Investment (FDI). To bundle efforts in 2013 (Table 2.1. and Figure 2.1.4). At the same, and facilitate this transformation the Government the largest relative gains were recorded by other ser- puts special focus on five sectors thought to maxi- vices (1.3 percentage points) and construction (1.2 mize the country’s endowment and comparative percentage points). Commerce registered a decline advantage in the manufacturing sector: textiles and of 2.3 percentage points. The share of employment garments; leather and leather products; sugar and in the manufacturing sector has changed only slightly 24 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Table 2.1: Employment by Sector Employment by Sector Employment by Sector Employment by Sector (Thousands) (% Total Employment) (Annual Growth, %) 1999 2005 2013 1999 2005 2013 1999–05 2005–13 1999–13 Agriculture 19,869 25,208 30,821 79.8 80.2 77.3 4.0 2.5 3.2 Mining 16 82 195 0.1 0.3 0.5 31.8 11.5 19.8 Manufacturing 1,107 1,529 1,882 4.4 4.9 4.7 5.5 2.6 3.9 Utilities 28 33 90 0.1 0.1 0.2 2.7 13.4 8.7 Construction 229 446 825 0.9 1.4 2.1 11.8 8.0 9.6 Commerce 2,342 2,406 2,845 9.4 7.7 7.1 0.5 2.1 1.4 Transport 123 146 378 0.5 0.5 0.9 3.0 12.6 8.4 Finance 20 38 134 0.1 0.1 0.3 11.6 17.1 14.7 Public services 578 729 1,212 2.3 2.3 3.0 3.9 6.6 5.4 Other services 585 818 1,492 2.4 2.6 3.7 5.7 7.8 6.9 TOTAL 24,897 31,435 39,874 100.0 100.0 100.0 4.0 3.0 3.4 Source: Martins (2015). and is virtually unchanged between 4.4 and 4.7 per- Bank, 2000; and World Bank, 2004). The structural cent of total employment between 1999 and 2013. economic transformation that entails the reallocation Agriculture, commerce, and manufacturing registered of workers from the poorly productive agriculture and the lowest annual growth rates from 1999 to 2013, the informal sectors to more productive economic although agriculture absorbed 73 percent of the total activities in manufacturing, industry, and related increase in employment (Martins 2015).18 services is an important step towards the creation of Recently the industry sector was the highest better-paying jobs in low-income countries (McMillan growing sector, driven by a construction boom and Rodrik 2011). Job creation through industrializa- and expansion in mining sub-sectors. The indus- tion can positively impact equity and poverty indices trial sector growth rate was 18.5 percent in 2013/14 in low-income countries. During the early stages of (Figure 2.1.3). But manufacturing, which forms part industrial development, due to the potential for higher of industry and is dominated by the food, beverages, productivity in the manufacturing sector and the leather, textiles, and apparel industries, contributed manufacturing sector’s utilization of predominantly a meager 4.4 percent to GDP in 2014 and on aver- unskilled and semi-skilled labor, the movement from age grew only by 11 percent during the same period. agriculture to manufacturing tends to benefit the poor The manufacturing export sector is relatively small in (World Bank, 2014b). terms of production and employment, constituting 10 The Ethiopian Government is preparing a percent of total export merchandise. Given that the second GTP five-year program and a ten-year manufacturing sector has grown at the same pace as the perspective plan, both of which place high economy, its contribution to GDP has remained static. emphasis on manufacturing development. With For Ethiopia, a country graduating through GTP II (2015/16–2020/21) and Vision 2025, the the early stages of economic development, growth in the industrial sector is essential for sustained long-term growth and poverty reduction (World 18 Martins 2015. Growth and Transformation through Manufacturing 25 Figure 2.1: Real GDP Growth and Sector Contribution 1. GDP Annual Growth (Percentage) 2. GDP Contribution by Sector 15 60 12 50 % of real GDP growth 40 Percentage 9 30 6 20 3 10 0 0 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 –3 2003 2005 2007 2009 2011 2013 Ethiopia Sub Saharan Africa (Developing only) Agriculture Other industry Services Manufacturing 3. Industrial Sector Contribution to GDP 4. Labor Market Shares Over Time 16 100 14 90 12 80 10 70 Percentage Percentage 8 60 6 50 40 4 30 2 20 0 10 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 0 1999 2005 2013 Manufacturing Electricity and water Agriculture Public services Commerce Construction Mining and Quarrying Manufacturing Mining Finance Construction Utilities Other services Transport Source: World Bank staff computation, based on: 1.1: WDI, 2.2-2.3: MOFED; 2.4: Martins (2015). Government is making a concerted effort towards employment generation. It is for this reason that structural transformation where manufacturing is this chapter of the Economic Update focuses on the expected to play a prominent role in the economy. manufacturing sector to contribute to the discussion Ethiopia’s goal is to become a manufacturing pow- about how to develop the manufacturing sector in the erhouse—with a focus on light manufacturing for next GTP period. 26 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Productivity and Skills for Development prices; Figure 2.2.1).19 Ethiopia, nonetheless, lags behind better performing middle-income economies Productivity gains are a key factor in determining long-term such as China and South Africa in terms of labor pro- economic growth and improvements in living standards. ductivity. Looking at regional productivity, patterns This section moves from using national accounts data for the analysis to firm level data. In Ethiopia, productivity are noticeable. For instance, in Oromia and Dire Dawa performance is heterogeneous among firms—foreign owned, productivity levels lag behind the national average. publicly owned, and older firms appear more efficient than Higher labor productivity of firms in Addis domestic, private young firms. Although labor productivity in Addis Ababa compares well with firms in peer countries Ababa appears to reflect higher capital intensity with same level of development, this appears to reflect higher rather than more efficient production. Differences capital intensity rather than more efficient production. Still, in labor productivity can reflect both differences in low wages in Ethiopia enable firms to remain competitive firm efficiency (firm organization, technology, worker even if firms in other countries are more productive. A key determining factor of productivity is the ability of an economy skills, or the business environment), and differences to supply the skills needed for companies to grow and to in capital intensity. Firms in Ethiopia are more capital thrive, but firms in Ethiopia struggle to recruit candidates intensive than firms in peer countries20 (Figure 2.2.2). with appropriate hard (technical) and soft skills. A more literate and trainable labor force would not only increase Given that labor productivity and capital intensity are productivity in Ethiopia, but also make the country more both high in Ethiopia, it seems likely that the two are attractive to international firms seeking to invest in Africa. linked. That is, labor productivity may be high not because firms are particularly well-managed or techno- logically advanced, but because firms substitute capital Productivity Benchmarking for labor.21 Figure 2.2.3 suggests that Ethiopian firms compare less well with those in peer countries when Productivity gains are a key factor in determining using measures of firm productivity that take capital long-term economic growth and improvement in liv- intensity into account, such as capital productivity22 ing standards. Empirical evidence, globally, reveals that and total factor productivity.23 Indeed, for the median about half of long-term growth is driven by increases in firm in Ethiopia, the ratio of value added to capital productivity rather than just factor accumulation. There is about 85 percent. This is lower than in any of the are two main channels for improving aggregate pro- comparator countries. This suggests that in Ethiopia ductivity: (1) increasing the productivity of individual capital is relatively unproductive. Similarly, total factor firms, and (2) improving allocative efficiency by shift- ing resources from less productive firms to those that 19 World Bank 2014b. are more productive. Ethiopia needs to make progress 20 The median firm in Ethiopia uses about US$6,000 of capital for each worker. For example, the median firms in Nigeria and Cote d’Ivoire have on both fronts: improve how well the firms are man- less than $1,000 of capital per worker and the median firms in Tanza- aged and how products and services are delivered; and nia, Cameroon, Egypt, Zambia, and Vietnam have less than $5,000 of capital per worker. improve how well the overall economy is able to reassign 21 This effect varies across sectors and even manufacturing sub-sectors—a resources from lagging firms to more dynamic ones. fact that is largely kept undifferentiated in this report. More research is needed in the future about the capital utilization rates across all manu- Labor productivity in Addis Ababa compares facturing sub-sectors. well vis-à-vis its peer countries. Analysis of labor 22 Capital productivity is higher in firms that produce a lot of output with only a small amount of machinery and equipment. Hence, capital productivity indicates that firms in Ethiopia (prox- productivity is generally higher for labor-intensive firms (i.e., firms that ied by studies of Addis Ababa) appear to be relatively rely relatively heavily on labor to produce their output) since they produce a lot of output, due to their heavy use of labor, with relatively little capital. productive when compared to firms in other countries 23 TFP is the best measure of overall firm performance because it con- at similar levels of development such as Zambia and trols for levels of all inputs and levels of labor and capital applied to production. Firms with higher total factor productivity are more efficient Vietnam. The median firm in Ethiopia produces about because they produce higher output than other firms that use more, or $4,900 of output (value added) per worker (2009 a similar set, of inputs. Growth and Transformation through Manufacturing 27 Figure 2.2: Productivity Benchmarking 1. Labor Productivity Benchmarking in Selected Countries 2. Capital intensity in Selected Countries (Value Added per Worker in 2009 US$) (Capital per Worker in 2009 US$) $25,000 $25,000 $20,000 $20,000 $15,000 $15,000 $10,000 $10,000 $5,000 $5,000 0 0 Ethiopia Bangladesh Cote d'Ivoire Nigeria Egypt Tanzania Zambia Vietnam Cameroon Kenya China Zimbabwe South Africa Turkey Ethiopia Nigeria Cote d'Ivoire Tanzania Cameroon Egypt Zambia Vietnam South Africa Zimbabwe Kenya Turkey 3. Capital Productivity in Selected Countries 4. Total Factor Productivity in Selected Countries (Ratio of Value Added to Capital) (Percent Difference from Ethiopia) 450% 525% 375% 450% 375% 300% 300% 225% 225% 150% 150% 75% 75% 0% 0% Ethiopia Turkey Kenya Egypt Tanzania Zambia Vietnam Zimbabwe Cameroon Ivory Coast South Africa Nigeria Egypt Vietnam Cote d'Ivoire Nigeria Zambia Tanzania Kenya Cameroon Zimbabwe South Africa Turkey 6. Differences in Total Factor Productivity, 5. Differences in Total Factor Productivity, by Firm Type by Industry 0.8 80% Furniture 0.6 60% Printing Rubber 0.4 40% Fabricated metals Basic metals 0.2 20% Leather Machinery 0 0% Non metallic –0.2 –20% Paper Apparel –0.4 –40% Chemicals Food and beverage Exporter Foreigner Public Young Textile Growth Level –1.0 –0.5 0 0.5 1.0 Source: World Bank staff computation, based on: 2.1–2.3: World Bank (2014c), 2.4: Enterprise Survey (2011), 2.5–2.6: Large and Medium Scale Manufacturing Industry Survey. Note: Productivity in these figures is calculated by tracking companies across time to arrive at truly firm-level annual productivity growth numbers. This method leaves out those companies that were only featured in the data for one year, and it does not recognize the first year productivity contribution of companies. The overall trends are similar to an aggregated economy-wide approach of calculating annual labor productivity that considers all companies in each year regardless of their continuous existence. 28 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Table 2.2: Unit Labor Cost (Wages-Productivity Ratio) in Manufacturing, 2011 China Vietnam Ethiopia Tanzania Polo shirts 100 101 50 102 Wooden chairs 100 888 2,592 1,884 Leather loafers 100 29 15 37 Source: Reported by Rodrik (2014), based on data from African Center of Economic Transformation (2014). productivity is relatively low in Ethiopia compared to the government helps to more effectively deal with any other peer country (Figure 2.2.4). business barriers; for instance, quicker and better Low wages, nevertheless, allow Ethiopian firms access to services (water, electricity, and facilitation to remain competitive even if firms in other coun- with local authorities), and easier access to inputs tries are more productive. The median Ethiopian (including finance and imported raw materials). For firm reports labor costs of about $1,100 per worker new entrants into the market, Ethiopia appears to have (based on Enterprise Survey Data, 2011). Although a preference for foreign investors over domestic ones this is slightly higher than in several of the compara- (largely SMEs). To some extent this reflects the nature tor countries, including Bangladesh, Cote d’Ivoire, and extent of business entry challenges such as starting Tanzania, and Nigeria, labor productivity is also lower business regulatory aspects, land access for FDI, and in these countries. For the countries where labor pro- institutional support. In addition, with the exception ductivity is higher or similar to Ethiopia, labor costs of the leather sector, firms in the priority sectors high- are also higher. For example, the median firm in China lighted in the GTP do not appear more productive reported that wages were about $1,800 per worker than those in the other sectors (Figures 2.2.6). and the median firm in South Africa reported per The investment climate in Ethiopia does not worker labor costs of close to $8,000 per worker. This foster productivity growth for new comers and suggests that lower wages in Ethiopia may allow it an tends to favor well-established and large firms. initial advantage vis-à-vis other countries in attract- Ideally, in a sound and well-functioning business ing new investment. Indeed this is quoted as a prime environment, less productive firms will be swept reason from FDI that is coming into Ethiopia (World out from the market while newcomers will converge Bank, 2013a). Table 2.2 confirms this assessment for towards incumbents’ productivity. Recent estimates the production of polo shirts and leather loafers. It in World Bank (2014c) suggest that firms enter at is noteworthy that Table 2.2 refers to very specific a lower productivity level than incumbents and this products and not product groups. In other words, the difference gradually narrows in the subsequent years. fact of Ethiopia being not unit labor cost competitive Nevertheless, the incumbent firms still show a distinct in wooden chairs does not necessarily imply that it is productivity advantage, even after four years. Findings not competitive in wood and other wooden products. suggest that firms exiting the market experience a Productivity performance is heterogeneous deterioration of their productivity in year two prior to among firms; foreign owned, publicly owned and exit. If newcomers do not manage to converge towards older firms appear more efficient that domestic, incumbent firm productivity, they will likely be swept private young firms. Foreign firms and older firms out from the market, resulting in a high turnover of appear more efficient than domestic and young firms (Figure 2.2.5). Public firms24 are more productive, a 24 Firms either 100 percent owned by the state or firms with public fact that may suggest that having a connection with participation. Growth and Transformation through Manufacturing 29 firms. Well-established firms as well as medium and to get there. Despite the fact that enrollment in all large firms seem to survive, and to exhibit a higher secondary education grew by almost three percent productivity. However they are also stagnant and do between 2006 and 2011 the national enrollment not show any increase in productivity. ratio for the first cycle of secondary education was only 17.3 percent in 2011/2012.27 Overall, the cur- Skills and Productivity25 rent education attainment profile in Ethiopia is still low, equivalent to that of Vietnam in 1960. A lower A key determining factor of productivity is the secondary level of educational achievement endows ability of an economy to supply the skills needed students with the basic knowledge and requisite for companies to grow and to thrive, but firms in cognitive and behavioral skills that signal a trainable Ethiopia struggle to recruit candidates with appro- workforce to potential FDI. priate hard (technical) and soft skills. As Ethiopia A more literate and trainable labor force could moves towards the goal of achieving middle-income make Ethiopia more attractive to international status, its education sector policy should focus, inter firms seeking low-wage countries. As wages rise alia, on the provision of a diverse range of Technical in China, emerging market economies will become and Vocational Education and Training (TVET), more attractive to international firms, resulting in the and second-chance general education programs relocation of low-skill intensive manufacturing jobs to for primary and secondary graduates who seek fur- other low-wage countries, offering an unprecedented ther education and skills development (Joshi and opportunity to low-income countries like Ethiopia Verspoor, 2013). Experience from the East Asian (Chandra et al. 2013). However, firms seeking a low- tigers suggests that FDI was able to capitalize on a wage workforce need a minimum skills base in order large pool of trainable labor, enabling investors to to train workers at low cost (Spence 2011). improve productivity while benefitting from low The productivity of firms is strongly and production costs. Empirical studies show that the gap positively correlated with worker education and between Ethiopia and China is explained by workers training in Ethiopia. This is particularly pertinent in Ethiopia being less educated and poorly equipped given Ethiopia’s relatively poor secondary education (World Bank, 2012).26 enrollment profile. In the manufacturing sector, a Ethiopia has made significant progress in one-year increase in the average education of a pro- expanding access to primary education and has duction worker is associated with an increase of 33 to successfully reached a gross enrollment ratio in pri- 41 percent in various measures of labor productivity. mary education comparable with middle-income countries. However the overall education profile remains low and the country lags behind even lower- 25 This section draws from the recent World Bank Policy Note Ethiopia: Skills for Competitiveness and Growth in the Manufacturing Sector middle-income country enrollment averages at all (World Bank, 2014b). A key source of the work in this section is the other levels of education. While these should remain Ethiopia Skills Module (2013). The module is a survey that was conducted specifically for this study in 2013. The sample is a sub-set of the firms long term goals for the Ethiopian education sector, interviewed in the Ethiopia Enterprise Survey, including 100 manufactur- industrialization can be scaled up rapidly by targeting ing firms surveyed in Addis Ababa. The skills module included questions relating to demand for skills, vacancies, and interactions between firms promising sectors in so called light manufacturing or and TVET institutions. agro-processing where relative modest skill require- 26 The reason for the large impact of education on labor productivity can be explained by the fact that less educated workers are unable to read ments suffice (World Bank, 2012). The profile of a instructions or operate machines properly. It is easier to train workers lower-middle-income country demonstrates gross with some basic level of literacy and numeracy. Moreover, goods pro- duced by less educated workers are poor in quality and uncompetitive enrollment rates in lower secondary education of 80 in the global market. percent—and Ethiopia has a long way to go in order 27 Education Statistics Annual Abstract (2011/2012). 30 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 2.3: Education, Skills and Employment 1. Skills Sought in New Hires 2. Number of Vacancies by Skills Levels 100% 15% Young (0–5 Yrs) 13 4 2 56 32 26% 32% 25% 32% 75% 0% 15% 3% 0% 3% 5% Established (>5… 13 2 7 3 15% % of firms 5% 50% MSME (<20) 11 65% 58% 23% 61% 41% Medium (20–99) 1216 1 25% 31% 18% Large (100+) 10 5 4 41 28 10% 11% 8% 0% Large Medium MSME Established Young 0 20 40 60 80 100 120 (100+) (20–99) (<20) (>5 Yrs) (0–5 Yrs) Number of vacancies Interpersonal and communication skills English skills Managers & Professional Unskilled non-production Work ethic and commitment Other Technical Technical support, Skilled production Computer skills/General IT skills service and sales Unskilled production 3. Time Required to Fill Vacancies 12 10 Number of weeks 8 6 4 2 0 Managers & Technical support, Unskilled non-production Skilled production Unskilled production Professional service and sales Large (100+) Medium (20–99) MSME (<20) Established (>5 Yrs) Young (0–5 Yrs) Sources: World Bank staff computation, based on Enterprise Survey (2011), and Ethiopia Skills Module (2013). Note: Manufacturing firms in Addis Ababa only. Consequently, increasing enrollment at all levels above increased productivity in the manufacturing sector. primary education, as well as improvements to the This observation resonates with the findings of an overall quality of education delivered through the analysis of light manufacturing in Africa (World Ethiopian education sector, should have a strong and Bank, 2012), which highlighted the poor supply positive impact on firm-level productivity of appropriately skilled labor as a major obstacle to Skills shortages in Ethiopia constitute a key improving the competitiveness of the manufacturing constraint to growth and improved productivity sector in Ethiopia. in the manufacturing sector, although data dem- For employers the most common sought after onstrates variation by firm size, the age of the firm, worker skill relates to work ethic and commitment and other characteristics. Analysis demonstrates (World Bank, 2014b). Among all manufacturing that larger and foreign-owned firms are significantly firms regardless of size, the most desired skills are more likely to cite poor skills as an impediment to “soft” rather than technical (Figure 2.3.1). A reason Growth and Transformation through Manufacturing 31 for the high interest in work ethic and commitment progress in improving the policy framework for TVET, could be that the Ethiopian manufacturing sector is significant challenges remain with regard to ensuring still relatively underdeveloped and not heavily reliant that the current context is coherent with policy and on more technical production. Moreover assembly the implementation thereof. line production requires discipline, timeliness, and From the perspective of firms, the low engage- team coordination. Across all firm groups, almost ment between firms and TVET institutions as a a third of firms’ most desired skills are technical in source of technical workers is one of the key con- nature (technical, computer, or information technol- straints on increased productivity. While there are ogy skills). However, positions in skilled production a high number of vacancies for skilled production form proportionately the largest share of reported workers, only a minority of firms contact TVET insti- vacancies (Figure 2.3.2). Younger firms and large tutions regarding vacancies. In a recent survey, only firms take much longer to fill vacancies than other 14 of 60 firms surveyed reported contacting TVETs companies, especially for positions requiring skilled to fill outstanding technical positions (Ethiopia production skills, managers, and professional qualifi- Skills Module, 2013). In the same survey, only half cations (Figure 2.3.3). Addressing the skills deficien- of firms reported hiring TVET workers directly from cies is critical in light of the fact that the majority of an institution.28 firms would like to expand their workforce. Attitudes and expectations on the part of stu- In the short run, Ethiopia may not need to wait dents towards TVET suggest misinformation about for higher levels of enrollment and improvements how the return to training accrues to different areas in the quality of education provision at secondary of specialization. Students demonstrate a strong and tertiary education levels to stimulate the growth preference for white-collar occupations in the ser- of the manufacturing sector. As Ethiopia moves vices sector or the public sector. In fact there is recent towards the goal of achieving middle-income status, evidence that the public sector currently attracts the its education sector policy should focus, inter alia, on large majority of new graduates (World Bank, 2015a). the provision of a diverse range of TVET and second- So while there is evidence that graduates from these chance general education programs for primary and fields have trouble getting jobs (Table 2.3), some of secondary graduates who seek further education and may also be “waiting” for public sector jobs to open skills development. In the medium term, poor nations up (World Bank, 2015a). This, in part, contributes need to invest in overall improvement in education to problems of under-capacity at most TVET institu- quality, with special focus on science and technology tions as students are not willing to join specific fields (Ansu and Tan, 2012). of training in the TVET institutions. The mismatch Ethiopia places particular emphasis on educa- between students’ interests and the fields of study to tion and training policies as an important lever which they are tracked may also contribute to a lack for enhancing productivity, especially in small of commitment and effort on the part of enrolled stu- and medium enterprises and the acceleration of dents, in turn contributing to high dropout rates from employment generation. The GoE has developed a TVET courses of study. The problem is exacerbated National TVET Strategy to improve the quality and by poor communication with prospective and enrolled relevance of the TVET system to more effectively students regarding these issues. The TVET agency address the challenges of unemployment and low currently does not have any information programs labor productivity (Ministry of Education of Ethiopia 2008). The main objective of the TVET sub-sector 28 The exact reasons for the low demand from the firms are unknown, but is to train middle-level manpower for participation are likely related to the fact that firms’ needs are insufficiently addressed in the economy. While Ethiopia has made admirable in TVET curricula. Further research is needed. 32 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Table 2.3: Unemployment of TVET Graduates, Selected Training Areas, 2012 Fields of training Unemployment rate (%) Tailoring 36 Electrical Work 36 Computer Applications and Usage 42 Metal Technology 43 Lower Scale Training of Agriculture (from Agarfa, Ardaeta and Baco) 44 Mason 49 Woodwork/Carpentry 53 Weaving 54 Textile Engineering 60 Plumbing 71 Source: UEUS 2012 data. Notes: (1) Training areas are taken from a variable that asks for any type of vocational or professional training that an individual has undertaken. (2) Unemployment rates shown of secondary and diploma TVET educated individuals. aimed at prospective students. While several TVET are intended to be prepared with input from industry, colleges have implemented their own outreach initia- the TVET institutions, and external experts. However, tives, these programs have not been standardized and in practice, chambers of industries and other repre- are uneven in quality. sentatives of the private sector have not been involved Despite an explicit policy of engaging the pri- in a process of consultation, and input that informs vate sector to improve the TVET sector, mecha- changes to occupational standards remains limited to nisms to facilitate integration of private sector various government ministries. needs into the TVET curriculum and operational In summary, this analysis has shown that to standards have not been established. In order to increase productivity of firms Ethiopia’s education improve quality and certification, the GoE is in the sector will need to develop and supply the appropri- process of transitioning the TVET system to an out- ate managerial, technical and soft skills within the come-based approach. An assessment for Certificate workforce. But improving Ethiopia’s overall educa- of Competency has recently been rolled out in most tion profile will take many years, so promising sectors TVET institutions, and the GoE hopes that the intro- in light manufacturing and agro-processing could duction of the certificate will help address problems be scaled-up by focusing on relatively modest skills associated with the poor quality of graduates from development in the meantime. To this end, TVET TVET programs. New curricula have been adapted programs and second-chance education programs, in line with changes to occupational standards, and in tailored to private sector needs will be important order to graduate, TVET trainees are now required to instruments to upgrade managerial and technical pass assessment tests based on occupational standards. skills, especially among small-scale operators already In theory, occupational standards and assessment tools working in high potential sub-sectors. Growth and Transformation through Manufacturing 33 Constraints for Manufacturing Growth slightly in Doing Business rankings, from 124 to 125 (out of 189) from 2013 to 2014. Figure 2.4 provides Private investment, both domestic and foreign, is crucial for the top 10 business constraints identified through the developing the manufacturing sector. A better investment Enterprise Survey Data (2011). And according to the climate that fosters the growth of existing firms, while encouraging the creation of new firms is key to attracting World Economic Forum’s Global Competitiveness and increasing private sector investments. The business Index (2014 and 2015), the top five problematic environment affects the performance of all firms, irrespective factors for doing business in Ethiopia are: inefficient of their size, however certain aspects such as regulatory government bureaucracy, foreign currency regulations, burden and information asymmetry may be of particular consequence to SMEs. Access to finance is a top obstacle access to finance, corruption, and inadequate supply of to SMEs as firms in Ethiopia are more likely to be credit infrastructure. This is supported by results of a 2014 constrained than global comparators. There is strong public-private dialogue for the National Business evidence that lending to micro-enterprises and larger firms in Ethiopia is relatively adequate, while SMEs are left behind Agenda,29 where firms identified the top five critical (“missing middle phenomenon”). The intensity of business and binding constraints as: tax administration, access operational constraints and entry barriers vary depending to finance, limited access to land and availability and on whether firms are large, FDI financed, or domestic SMEs. Business entry regulations and processes are consistently quality of electricity, and market/unfair competition. highlighted by the private sector as burdensome and Table 2.4 provides a comparison of binding constraints obstructive of firm entry and dynamism. for business in Ethiopia. But there are a number specific constraints in the manufacturing sector that affect both Private investment, both domestic and foreign, is investment and business development. Analytical crucial for developing the manufacturing sector. work carried out in 2011 on Africa’s manufac- Key to attracting and increasing those investments is turing experience, in comparison to China and to better the investment climate to foster the growth of existing firms, while encouraging the creation of 29 See National Business Agenda Report, July 2014. The consultation for new firms. Ethiopia’s overall business climate rankings the NBA is led by the Ethiopia Public Private Consultative Forum with are relatively low albeit the country ranks better than the objective to validate barriers that have been identified in national studies and international benchmarking exercises such as the Global peers in Doing Business Rankings on theme-specific Competitiveness Report. In total, 194 businesses were consulted, 80 of business regulatory measures. Ethiopia has dropped which were in Addis Ababa. Table 2.4: Most Binding Constraints to Doing Business in Ethiopia, Various Rankings Consultations on Global Competitiveness National Business Doing Business 2015 Index 2014–2015 Agenda 2015 Enterprise Survey 2011 1 Starting a business Inefficient Government Tax Administration Access to finance Bureaucracy 2 Trading across borders Foreign Currency Regulations Access to finance Access to land 3 Getting credit Access to finance Access to land and Electricity construction permits 4 Protecting minority investors Corruption Availability/quality of energy Paying taxes 5 Paying taxes Inadequate supply of electricity Unfair competition Customs, trade regulations Source: World Bank Doing Business Report (2015); Global Competitiveness Report (2014 and 2015); and National Business Agenda (2014); and World Bank Enterprise Survey (2011). 34 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 2.4: Top 10 Business Environment Constraints Access to finance Electricity Access to land Corruption Transportation Practices of the informal sector Tax administration Tax rates Customs and trade regulations Inadequately educated workforce 0 10 20 30 40 Percentage of firms Source: Enterprise Survey (2011). Vietnam, provided insights and recommendations enterprises, particularly SMEs, access to finance, for developing Ethiopia’s light manufacturing and access to land, reliability of electricity, and taxation labor-intensive industries. Accordingly, and shown will need to be addressed. In addition, for large firms in Table 2.5, the availability and quality of inputs, (FDI and exporting) improving trade logistics and access to finance and land seem critical constraints to reducing skills gaps remain imperative for enhancing improving competitiveness and accelerating growth competitiveness. Similarly, business entry regulations in selected light manufacturing sectors in Ethiopia and processes that obstruct firm entry and dynamism (World Bank, 2012). require attention so that young firms are encouraged The specific nature and relative importance to establish. Reforms and interventions to address of binding constraints will also vary accord- these constraints can be prioritized and sequenced ing to firm size; these will need to be addressed according to three guidelines: 1) focus on sectors and both at the operational and entry level (World sub-sectors that demonstrate the most promising Bank, 2014c). In order to improve productivity of comparative advantage and job growth; 2) implement Table 2.5: Structural Constraints to Selected Light-Manufacturing Sectors Apparel Leather products Wood products Metal products Agribusiness Small Large Small Large Small Large Small Large Small Large Input industries Important Important Critical Critical Critical Critical Critical Critical Critical Critical Land Critical Critical Important Important Important Important Critical Critical Finance Critical Critical Important Important Important Important Critical Important Entrepren-eurial skills Important Important Important Important Important Important Important Important Important Worker skills Important Important Important Important Important Trade logistics Critical Important Source: World Bank (2012). Growth and Transformation through Manufacturing 35 measures which are the most cost effective in the short Access to finance remains a top obstacle for and long runs with the least fiscal impact; and 3) assess enterprises in Ethiopia. As shown in Table 2.4, firms implementation capacity, implication for governance consistently identify access to finance as one of the and the political economy of policy reforms. top five obstacles to doing business in Ethiopia, rated as the third most binding constraint in the Global Access to Finance: Particular Challenge for Competiveness Index 2015 and number one in the SMEs30 Enterprise Survey 2011. According to the Enterprise Survey, this is perceived as the main business envi- Financial intermediation is a driving force for ronment constraint by micro (41 percent), small (36 economic development—an expansion in credit to percent), and medium (29 percent) enterprises in the private sector enables firms to invest in produc- Ethiopia, compared to a SSA average of 24, 20, and tive capacity, thereby laying the foundation for a 16 percent, respectively (Figure 2.5.1). The same data sustainable growth path. However Ethiopia is fall- indicates that almost 93 percent of small enterprises ing behind its peers in financial intermediation. As and over 95 percent of medium enterprises have either shown in Chapter 1, the ratio of private sector credit a checking or a savings account (a percentage higher to GDP declined from 15.4 percent in 2003/04 to than the respective SSA averages) but only 3 percent 10.9 percent in 2013/14, and remained below the of small enterprises and 23 percent of medium have SSA averages for the period reviewed. In addition, a loan or a line of credit. the decline in Ethiopia comes at the background Young and small firms appear to face more seri- of a global trend of increasing private sector credit ous financial constraints relative to those that are (Figure 1.3.2). According to the Doing Business larger and more established. Across a range of finan- Report 2015, Ethiopia ranks 165 out of 189 in the cial indicators created using the Ethiopia Enterprise ease of getting credit compared to the SSA average Survey (2011), young and small firms are the most ranking of 122 and well-performing peers such as likely to report that access to finance is a major con- Rwanda which ranks 4 of 189 economies (World straint to their business operations and at rates higher Bank, 2015b). than other well developed African countries. In South Firms that are fully credit constrained exhibit Africa in 2010, for instance, only 10.4 percent of poorer performance and productivity. Firms in SMEs rated access to finance as a major constraint. Ethiopia are more likely to be fully credit constrained In contrast, in Ethiopia nearly half of microenter- than global comparators, including SSA countries. prises, 40 percent of small firms, and 18.5 percent of As illustrated in Figure 2.5.2, nearly half of firms medium firms reported access to finance to be a major in Ethiopia are fully credit constrained. Fully credit constraint to daily operations. constrained firms are those without external financing Overall, data indicates the existence of a miss- and were either rejected for a loan or did not apply ing middle phenomenon in terms of financial even though they needed additional capital. For firms, services catering to small firms. Young and smaller being credit constrained means poorer performance firms are much more likely to be rejected for a loan and less productivity. In Ethiopia, a credit constrained or a line of credit than firms who are more established firm has 15 percentage points lower sales growth, 5 or larger (Figures 2.5.2 and 2.5.3). Moreover, despite percentage points lower employment growth, and 11 confirming their need for improved access to finance, percentage points lower labor productivity growth SMEs are discouraged from applying for loans due to than firms who are not credit constrained. Investment decisions of manufacturing firms in Ethiopia are heav- 30 This section draws from the World Bank report: SME Finance in Ethio- ily dependent on cash flows. pia: Addressing the Missing Middle Challenge (World Bank, 2014d). 36 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Figure 2.5: Access to Finance for Enterprises 1. Access to Credit: Ethiopia, SSA and the World 50% 40% 30% % of firms 20% 10% 0% Ethiopia 2011 SSA World Access to finance Micro (0–9) Small (10–20) Medium (21–99) Large (100+) 2. Level of Credit Constraint Companies in Ethiopia 100% 17 25 24% 80% 46 41% 46% 22 57% 49% 49% 10% 60% 28 % of firms 23 10 11% 27% 9% 5% 8% 40% 15 8 10% 9% 7% 9% 13% 1% 20% 38 32 36 38% 29% 36% 40% 36% 36% 0% Enterprise Sub-Saharan Ethiopia Micro Small Medium Large Age=1–5 Age=6+ Surveys 110 Africa Region 2011 (0–9) (10–20) (21–99) (100+) country (2006–2011) average Not Credit Constrained Maybe Credit Constrained Partially Credit Constrained Fully Credit Constrained (continued on next page) excessively high collateral requirements. Only 1.9 per- In high-income countries, SMEs are responsible for over cent of small firms have a loan or line of credit. This 50 percent of GDP and over 60 percent of employment, rate is much lower than that of micro, medium, and but in low-income countries they are less than half of large firms (6.0, 20.5, and 35.5 percent, respectively). that: 30 percent of employment and 17 percent of GDP. Further illustrating the existence of a missing middle This SME gap is called the “missing middle.” Evidence phenomenon, in Ethiopia, small-sized firms (10–20 from international research clearly shows that returns employees) are the most credit constrained of all firm to capital are high in this segment. SMEs aren’t missing segments (57 percent), more than micro medium, because they would not be profitable; they are missing or large firms at 41,49, and 24 percent, respectively. because finance is not reaching them in an effective way. The missing middle phenomenon is a common High collateral requirements are a binding feature to many developing countries that have a constraint for smaller firms since the most com- large number of microenterprises and some large mon type of collateral used are land and build- firms, but far fewer small and medium enterprises. ings or personal assets (Table 2.6). As elsewhere Growth and Transformation through Manufacturing 37 Figure 2.5: Access to Finance for Enterprises (continued) 3. Access to Finance by Age and Size of Firms 60% 100% 50% 80% 40% % of firms 60% % of firms 30% 40% 20% 10% 20% 0 0 Access to Loan Has a loan Has an Has external Access to Loan Has a loan Has an Has external finance is a application or line of overdraft financing finance is a application or line of overdraft financing major was rejected credit facility major was rejected credit facility constraint constraint Young (Age 0–5) Old (Age 6+) Micro (0–9) Small (10–20) Medium (21–99) Large (100+) 4. The Missing Middle: Lending to SMEs 100% 92% 94% Proportion of total lending % 80% 60% 40% 20% 8% 6% 0% Microenterprise SME Large MFIs (N=5) CBE Sources: (1) and (3) based on Enterprise Survey (2011); (2) and (4) based on World Bank (2014d). Table 2.6: Types of Collateral Used by MSMEs Micro (0–9) Small (10–20) Medium (21–99) Large (100+) Land and Buildings 69.6 86.1 81.9 85.4 Equipment 2.1 2.5 33.0 84.9 Accounts 2.1 2.5 4.8 24.5 Personal Assets 26.2 36.8 27.0 22.0 Other 4.2 0.0 0.0 14.3 Source: World Bank (2014d). 38 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Table 2.7: MSME Definitions by National MSE Development Strategy Level of the enterprise Sector Number of Employees Total assets (Birr) Micro enterprise Industry <= 5 Less than or equal to 100,000 (US$ 6,000 or EUR 4,500) Service <= 5 Less than or equal to 50,000 (US$ 3,000 or EUR 2,200) Small enterprises Industry From 6–30 Less than or equal to 1.5 million (US$ 90,000 or EUR 70,000) Service From 6–30 Less than or equal to 500,000 (US$ 30,000 or EUR 23,000) Source: National MSE Strategy of Ethiopia (2011). in developing economies, Ethiopian banks prefer SME market size is large. The small enterprise segment immovable collateral such as land rather than mov- is also identified as the most promising segment for able assets such as machinery. Large firms are the only growth by both commercial banks and MFIs, how- ones who commonly can use equipment as collateral. ever SME lending is limited as MFI deposits and loan The use of accounts as collateral is also rare, even for portfolios are comprised mainly by microenterprises. large firms; less than a quarter of large firms use this The same is true for commercial banks where deposits as a form of collateral. The average value of collateral and loan portfolios typically comprise less than 10 needed for loans in Ethiopia is also very high com- percent of MFIs. pared to other regions of the world as well as to other Financial institutions in Ethiopia lack a com- developed economies in Africa. On average, Ethiopian monly agreed definition of MSMEs which leads firms require 234 percent of the loan amount for col- to poor market segmentation, along with a lack of lateral, compared to 134.3 percent in Eastern Europe in-depth customer knowledge and proper business and Central Asia. In well-developed African countries, strategy While the majority of MFIs use the SME defi- collateral requirements are also much lower than in nition that is laid out in the Government’s National Ethiopia: 120.8 percent in Kenya (2007), and 103.6 MSME Development Strategy (Table 2.7), com- percent in South Africa (2007). mercial banks do not seem to uniformly distinguish A recent ad hoc survey of the supply side of among small, medium, and large enterprise. Typically MSME financing in Ethiopia31 confirms that small banks define SMEs according to the annual turnover and medium enterprises are being underserved of the business, loan size, and number of employees compared to micro and large firms. MFIs primarily and/or revenues generated by the financial institution. cater to micro firms and bank clientele are primarily All MFIs besides one uniformly use the number of large firms. The five MFIs32 who reported lending fig- employees-criteria. Most MFIs also categorize micro ures disaggregated by client size focus their lending on and small enterprise in term of turnover and loan size. microenterprises;33 92 percent of their total loans are disbursed to microenterprises while only 8 percent are issued to SMEs. Among banks, only the CBE reported 31 The survey is informed by responses from 13 financial institutions: disaggregated lending by client size. The CBE tends seven banks representing 87.1 percent of the banking sector asset portfolio and six microfinance institutions representing 70 percent of the micro to focus on large enterprises and provides lending to finance sector asset portfolio. Due to a varying response rates to ques- the SME sector comprising almost 6 percent of the tions, the questionnaires were supplemented by structured face-to-face interviews conducted with six banks and five microfinance institutions. bank’s total disbursements. 32 The five MFIs are: OCSSCO, Adds*, Omo Micro, Wasasa, and The majority of financial institutions believe that Wisdom. 33 Most MFIs define microenterprises to be those with less than five prospects for the SME market are good and that the employees. Growth and Transformation through Manufacturing 39 Having a common MSME definition at the national institutions to broaden their horizons and test these level would ease the design of loans, investments, different methodologies with mutual benefits for the grants, and statistical research. Worldwide, efforts to financial institutions and for the MSMEs. support MSMEs are at the center of the development The legal and regulatory framework affecting agenda. Since the G-20 summit in Pittsburgh in 2009 financial institutions impact the ability of banks the MSMEs opened a debate on whether a universal and MFIs to lend to SMEs. Banks and MFIs report definition of MSMEs could be found. Hypothetically, facing weak liquidity positions due to credit limits the choice of an MSME definition could depend on for SMEs and micro enterprise loans, not being able many factors, such as business culture, the size of the to go beyond 10 percent of their capital for microfi- country’s population; industry; and the level of inter- nances institutions and 25 percent for banks. Financial national economic integration. institutions are required to set their lending portfolio The banks and MFIS’ business models are not for monitoring purpose by the NBE. These lending tailored to address the peculiar needs of the MSME restrictions were imposed on private banks and then clientele. The organization model used by the major- replaced by an NBE directive requiring commercial ity financial institutions does not seem to take into private banks to allocate 27 percent of their loan account the need for a specialized MSME unit or disbursements to purchase fixed and low-interest- department to better serve the MSME clientele. Many bearing NBE Bills. According to private commer- of the financial institutions do not possess a separate cial banks, this directive has had a negative impact SME department.34 Although most MFIs state being on their liquidity and lending capacity and they are involved with SMEs, only 2 indicate their client rela- therefore not able to lend as much as they want. In tionships are managed through a dedicated MSMEs a constrained liquidity environment banks are likely unit. Financial institutions do not have a large product to favor existing, established clients when allocating mix that caters for the specific needs of SMEs. Banks loans as opposed to newer, riskier SMEs. Although a reported that 70 per cent of their loan products are temporary solution was provided by NBE by reducing term loans and other top loans including overdraft, the reserve and liquidity requirements on commercial pre-shipment credit, and advances on import bills. banks, lowering the reserve requirement down from MFIs provide group lending as their main product 10 to 5 percent and the liquidity requirement from loan and they also provide non-financial products such 25 to 20 percent, the liquidity problem of the private as training, technical assistance, and services aimed at banks appears to still be an issue. increasing market linkages to MSMEs. Government financial programs such as partial The combined absence of a collateral registry credit guarantee schemes and the provision of dedi- and ineffective enforcement of contracts in case cated credit lines associated with technical assistance of default can significantly discourage access to can encourage financial institutions to lend more finance for SMEs. Financial institutions can adopt a to SMEs. The Government of Ethiopia is committed possible range of approaches that use different tech- to supporting MSMEs in line with GTP objectives. nologies, monitoring mechanisms, screening, and According to the revised MSE Strategy (2011) the underwriting policies and contract structures where Government has developed comprehensive and prac- the level of collateral involved can vary from no col- tical policy interventions to facilitate the development lateral required (e.g. small business credit scoring of micro and small enterprises. The strategy aims to technology) to full collateral requirements (e.g. fixed- address challenges that impede growth of micro and assets lending). Of course, each technology requires an understanding of the underlying context, but 34 Nine out of the 12 financial institutions interviewed for the financial often, technical assistance interventions help financial sector survey did not have a dedicated SME department. 40 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector small enterprises including skills development, tech- affect the competitiveness of larger firms that include nology transfer, and access to finance. Several of these export-oriented firms and/or FDI. initiatives are already ongoing. For instance, GoE is pro- viding training in entrepreneurship, skills development, Operational-level constraints affecting SMEs and business management through more than 300 TVET centers in the country. Other initiatives include Availability of land has been cited as one of the top a machine-leasing program intended to address col- constraints for enterprise development and expan- lateral problems along with partial guarantee schemes. sion especially for firms in Addis Ababa, where there is an unmet gap in the supply of land vis-à-vis Operational Constraints demand. Over 75 percent of firms consulted for the National Business Agenda considered access to land Countries whose policies are more conducive to and associated issues as a highly or very highly severe foreign investors stand a better chance of attracting problem for doing business in Ethiopia.35 Investors FDI. In Africa, some studies have argued that market can access land only through lease arrangements with size and access to natural resources are the major eco- the Government or through secondary leases. Lease nomic determinants attracting FDI; however other rights can be acquired either through a competitive policies and institutional factors are especially critical tender process or through direct assignment of rights for non-resource rich countries (Morisset 2000; and to investments. The management of urban land is Asiedu 2002). It is argued that African countries can overseen by municipal administrations, including for also be successful in attracting FDI that is not based Addis Ababa. A wide range of government interven- on natural resources or aimed at the local market, but tions influences the operation of land markets, from rather at regional and global markets, by improving policies aiming at modifying the spatial distribution the investment climate. Evidence suggests that FDI of economic activity (for example, industrial loca- is encouraged by trade openness, the good quality of tion) to those promoting specific sectors of activities. infrastructure, and an efficient legal system in the host Moreover, these interventions can affect the land mar- country (Asiedu 2003). Using manufacturing and ket directly through zoning laws or indirectly through services firm-level data for 30 SSA countries between policies that affect capital market. Ambiguous prop- 2000 and 2006, Tidiane Kinda (2014) concluded erty rights sometimes add to the problem and hamper that infrastructure, human capital, and institutions the functioning of land markets. are major drivers for the location of foreign firms in Reported land acquisition delays are very SSA, while taxation is not. long; investors complain of waiting for years and The varied investment climate in Ethiopia has a minimum of six to twelve months. This does resulted in heterogeneous productivity of the pri- not take into consideration the time it takes the city vate sector depending on firm characteristics. The administration to prepare a particular area for lease. investment climate tends to favor established and large Once land is acquired, the biggest obstacle reported is firms, particularly FDI, and does not foster productiv- infrastructure, particularly in outlying expansion areas. ity growth for domestic SMEs including new com- These include electricity, telecommunication, and ers. The intensity of business operational constraints access roads. To mitigate the access to land constraint and entry barriers vary depending on whether firms highlighted by investors, the Government has rolled are FDI or domestic SMEs. While access to finance, out an Industrial Parks (IPs) development program land, reliability of electricity, and taxation are the top ranking constraints highlighted by SMEs, poor trade logistics and skills constraints are key factors that 35 Ethiopia National Business Agenda 2014. Growth and Transformation through Manufacturing 41 that includes setting up IP sites in and around Addis tax payer is only $25,000, such that semi-illiterate busi- Ababa, along with multiple regional cities. ness owners are required to comply with very complex Infrastructure is one of the most critical factors tax filing requirements.40 Another challenge relating affecting firms’ productivity in the long term and to tax administration is the difficulty in accessing the electricity stands out as one of the top bottlenecks tax appeals tribunal due to lengthy processes and high highlighted by firms. The GoE has accordingly made costs.41 As a precondition to having recourse to the Tax massive investments in power plants to meet the tre- Appeal Commission, businesses are required to deposit mendous growth in demand. In 2010, the Ethiopia in cash 50 percent of the disputed amount with inter- Electric Power Company (EEPCO) commissioned est.42 This leads to substantial cash flow constraints on three large hydro power plants and presently has suf- businesses (during a lengthy process) and act as a strong ficient capacity to service the demand.36 However, disincentive to proceed with the appeal. The MSME reliability of electricity remains a critical issue. Firms tax regime is a rather complex schedule of margins (64 in Ethiopia experience frequent outages compared to different sectors) that risks defeating the objective of other countries (Figure 2.6.1). Moreover, these electri- providing a simple and efficient tool for micro taxpay- cal outages seem to last longer than in its comparator ers. Compliance rates for small businesses are dismal. countries (7.8 hours in Ethiopia compared to 3.8 in Severe penalties—imprisonment in most cases—are Kenya, 6.0 in Tanzania, 3.3 in Vietnam and 0.5 in imposed if firms do not pay the correct taxes. As a China according to the Enterprise Survey Unit). result, firms are paying wrongful amounts and they The poor reliability record of Electricity can are rarely reimbursed because of the weaknesses of the be attributed to poor maintenance and a lack of Tax Appeal Commission. upgrades of transmission and distribution grids. Ethiopia has the lowest electricity tariff vis-à-vis its com- Operational constraints for FDI/Large export parator countries.37 This low pricing undermines the oriented firms capacity of the national electricity company to finance network maintenance and upgrades of transmission and Ethiopia has undertaken multiple steps for improv- distribution grids. Strengthening of the grid network is ing logistics infrastructure, but important challenges an essential part of EEPCO’s strategy. A major focus of sector strategy is upgrading the network by reinforcing 36 EEPCO commissioned Tekeze (300 MW), Gibe II (420 MW) and existing (and adding new) transmission and distribution Beles (460 MW) power plants that increased its power generation capacity from about 850 MW to above 2000 MW. In FY2011, EEPCO’s peak lines to provide energy access to high energy-consuming demand was around 1,100 MW, which was well within its capacity. industrial areas as well as for promoting electricity 37 On average, the electricity costs in Ethiopia are $0.023 per kWh while it costs $0.068 in Kenya, $0.083 in Tanzania, $0.118 in China, $0.180 exports.38 The success of this strategy will be instrumen- in South Africa, and $0.240 in Djibouti. tal in reducing the additional costs that are being borne 38 The Electricity Network Reinforcement and Expansion Project (US$200 million), financed by International Development Association by the private sector—and thereby profitability—due to (IDA), consists of two sub-components: (i) grid upgrade and (ii) grid poor reliability and quality of electricity supply. extension in order to improve the overall service delivery of the Ethiopian electricity network, starting with a few cities in Ethiopia, such as Dire Tax administration is costly and time consum- Dawa, Nazret and Jimma (in Oromia). ing. On average, firms make 30 payments per year and 39 Doing Business Report 2015 40 Currently taxpayers in Ethiopia are segmented into three categories. spend 306 hours per year filing, preparing, and paying “Type A” taxpayers (with annual turnover of 500,000 birr or more) are taxes; total taxes paid amount to 31.8 percent of profit, under the general regime of taxation. In theory, “B” taxpayers therefore have almost the same reporting requirements as “A,” the main difference which is more than benchmark countries (Figure 2.6.2 being mandatory VAT registration at the threshold of ETB 500,000. and 2.6.3).39 Estimated average time requirements for Category “C” taxpayers have no obligation to keep records, but these are seen as advisable in dispute situation during the turnover assessment. the VAT alone are 12 payments per year and over 24 41 Ethiopia National Business Agenda (2014) hours spent. In addition, the threshold for a “type A” 42 Article 43 of the Value Added Tax Proclamation 285/2002. 42 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector remain. According to the Logistics Performance Index transportation have been reduced specifically for (LPI), Ethiopia ranks 104th out of 160 economies manufacturing. surveyed.43 It lags behind peers like Kenya (74th) and Modernization efforts are underway as Rwanda (80th) but is ahead of Zambia (123rd) and the Ethiopian Revenue and Custom Authority Tanzania (138th). On specific components of LPI, (ERCA) plans to upgrade its customs processing sys- Ethiopia performs better than its average rank (and tem and implement an electronic Single Window.46 score) in, logistics competence, and timeliness. Overall, Once the coordinated reforms in customs and shipping- it fares poorly on infrastructure and international related agencies are fully completed, it is expected that shipments. Ethiopia has undertaken multiple steps trading will be simplified and costs and dwell time for improving logistics infrastructure. It undertook a reduced. The recently approved Customs Proclamation major organizational merger of three agencies involved provides the legal basis for the development of a modern in trade logistics, shipping lines, maritime services, and customs administration with more focus on facilitation dry ports. At the same time, investments to improve than control. Noteworthy key reforms introduced in trade logistics in the medium term are ongoing. These the proclamation include: the introduction of the use include: several new public investments in roads; a of simplified customs procedures for authorized traders; rehabilitated rail link between Addis Ababa and the pre-arrival clearance of goods; and use of risk assessment rapidly modernizing container port of Djibouti44; the and post-clearance audit. expansion of the dry port in Modjo; and expanded coverage of the multi-modal transport system. Entry Barriers Large firms also cite customs and trade-related regulations as one of the top constraints that Business entry regulations and processes are consis- drive costs up. It takes up to 44 days to comply tently highlighted by the private sector as burden- with all procedures needed to export or to import some and obstructive of firm entry and dynamism. at a cost of US$2,380 and US$2,960 respectively This is reinforced by the Starting a Business indicator per container (World Bank, 2015b; Figure 2.6.4).45 that ranks Ethiopia 168th out of 189 economies vis-à-vis These procedures and documents involve different global comparators (Doing Business Report, 2015). This agencies, which require the manager to go in person is therefore an area of concern for Government, because to all those agencies. As a matter of fact, there is no a growing body of empirical research shows that simpler legal framework in place to recognize documents processes of business start-up are associated with higher exchanged electronically in relation to e-commerce, levels of entrepreneurship and higher productivity. e-signatures and e-payments. All documents for New businesses face complex and bureaucratic information exchange both between the private entry procedures that have led to an escalation in sector and government actors and between govern- ment actors themselves have to be provided to the 43 The LPI comprises six indicators on customs, infrastructure, interna- authorities using a hard copy. Also, it is reported tional shipments, logistics quality and competence, tracking/tracing and timeliness, as assessed by international freight forwarders. by private sector that there is lack of staff with suf- 44 Modernization of the Djibouti port is important, but similarly ficient experience in custom procedures, and those importance needs also be placed on ways to reduce the very high port handling charges, which are very high and hurt the competitiveness of who officiate have limited mandate for decision manufacturing industries exporting through the port. making (World Bank, 2014a). On the other hand, 45 Anecdotal evidence suggests that on the import side, turnaround times have decreased five-fold in response to various policy reforms introduced the Government introduced special procedures for (Government of Ethiopia). the manufacturing sector to reduce customs clear- 46 The electronic Single Window is an electronic facility that will allow all traders involved in the import/export/transit business to discharge all ance times for manufacturing-related imports and their regulatory obligations with relevant government agencies electroni- exports. Likewise, cost of letter of credit and inland cally in a simplified paperless environment. Growth and Transformation through Manufacturing 43 Figure 2.6: Business Environment Constraints Identified by Firms 1. Number of Electrical Outages in a Typical Month Mauritius Turkey Côte d'Ivoire Rwanda Angola Ethiopia Kenya Tanzania Cameroon India Nigeria 0 5 10 15 20 25 30 35 40 Number of outages in a typical month 2. Senior Management Time Spent Dealing with the Requirements of Government Regulation (%) 3. Time for Paying Taxes (Hours per Year) China Rwanda India Tanzania South Africa Zimbabwe Uganda Ethiopia Ghana Turkey Rwanda Uganda China Kenya Ethiopia Botswana Angola Nigeria 0 2 4 6 8 10 10 14 0 200 400 600 800 1000 Percentage of senior management time Hours per year 4. Breakdown of Export Costs 5. Conversion rate over 2012/14 and 2008/12 – Manufacturing firms in Addis 6000 1.0 5000 0.9 US $ per container 4000 0.8 0.7 3000 0.6 2000 0.5 0.4 1000 0.3 0 0.2 0.1 Ethiopia Côte d'Ivoire Kenya South Africa Uganda Zambia Zimbabwe Rwanda Botswana 0 2008/12 2012/14 Documents preparation Customs clearance and inspection Total Domestic FDI Ports and terminal handling Inland transportation Sources: (1) and (2) based on Enterprise Surveys. (3) and (4) based on World Bank (2015b). (5) based on Ethiopia Investment Agency. Notes: (1) Power outages as reported by firms per month. 44 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector time and cost for enterprises setting up business. To Cumulatively more FDI firms succeed in obtain the registration and licenses, firms have to meet moving from the investment stage to operational multiple requirements, pay numerous fees, and inter- phase than domestic firms.50 From 2008 to 2012, act with several agencies. Licensing of businesses in the cumulative data for all domestic, foreign and Ethiopia is governed by the Commercial Registration public firms trying to enter the Ethiopian market and Business Licensing Proclamation (CRBLP No. is not encouraging as just 5 percent of firms are 686/2010).47 Engaging in any commercial activity moving from pre-implementation to operations without registration and obtaining the appropriate (Ethiopia Investment Agency). The picture changes license is prohibited. A business will have to comply significantly when only FDI “conversion” from with about nine steps to obtain a license (IFC 2014).48 pre-implementation to operations phase is exam- There are 35 different competence-certifying agencies, ined: nearly one in three “intended” FDI becomes which clearly could benefit from rationalization. In operational51 (Figure 2.5.4). While FDI has a better addition, all business licenses and many of the com- “conversion” rate over domestic investors, there is still petency certificates have annual renewals. Some of the room for substantial improvement. Currently 2 out bureaucratic processes are centrally managed such as of 3 potential FDI firms do not reach the operational the trade name registration, thus creating an extra bur- state. Even though an OSS service is operational its den for domestic businesses located in the regions.49 effectiveness record is mixed. Bureaucratic hurdles Ethiopia has a de facto preference for foreign continue to affect project implementation along with investors over domestic ones, which needs to be entry obligations remaining burdensome and time- carefully balanced to ensure a level playing field. consuming for investors. Further research is needed The nature and extent of business entry challenges to identify those factors that facilitate the conversion differ between FDI and SMEs and where the firm of successful FDI in Ethiopia. is established. Entry constraints related to business licensing and registration processes are more severe for 47 The Commercial Registration and Business Licensing Proclamation domestic firms than FDI. While FDI firms are sup- No.686/2010 (the CRBLP), and the Commercial Code as amended by ported by the former Ethiopian Investment Agency piecemeal legislation of various kind, promulgated at different times, provide the general legal framework to govern registration and licensing (newly reconstituted as the new Ethiopian Investment of businesses. The licensing regime provided for by the CRBLP applies Commission, EIC), domestic investors have to deal to all business activities except in a limited number of sectors that are regulated by specific laws. with local investment offices with a lower capacity than 48 IFC, Inventory of Business Licenses (April 2014.) the EIC. As part of the One Stop Shop (OSS) service, 49 It is worth noting that there is a positive development towards the decentralization of trade name registration in Ethiopia. Through the FDI firms are offered commercial registration, compe- support of IFC/WBG, the Ministry of Trade is rolling out the Online tency certification, business licensing, and issuance of Trade Registration and Licensing System to the regions that would, among other things, enable them to register trade names in their re- construction permits, among other important services spective regions. at the EIA. Equally significantly, the EIC is expected 50 According to the Ethiopia Investment Agency (EIA), an enterprise entering the Ethiopian market goes through three phases in setting up to provide services following up on critical steps a business, classified as follows: pre-implementation, implementation on behalf of the investors related to access to land, and operation. At the pre-implementation phase, firms declare their intention to invest in the region and claim an allotment of land; at the loans, access to utilities, residence permit requests, implementation firms effectively receive the land and start construction and approval of environmental impact assessments. and installation of machinery; and at the operation phase firms are al- lowed to start operations. Each phase requires compliance with multiple In addition, FDI firms enjoy a preferential access to steps in terms of processes, time, and cost. land—in some cases, free or subsidized land. This dis- 51 A similar, albeit slightly lower, estimate has been reported by another study by Sutton. (EIA, A New Direction LSE, August 2012). Of the crimination is particularly observable in Addis Ababa total number of licensed firms, only about 23 percent of firms become where land is scarce. operational, pointing to entry-level constraints for new investors. Growth and Transformation through Manufacturing 45 The Role of Industrial Parks and FDI for and foreign exchange earnings; and the “dynamic” Manufacturing Growth economic benefits such as skills upgrading, technol- ogy transfer and innovation, economic diversification, productivity enhancement of local firms (Zeng 2010). The Government, in its effort to accelerate manufacturing The results globally are mixed with some countries growth, is implementing an ambitious IP program. In adopting this approach, it is emulating the path of the successful such as China, Singapore, Malaysia, South East Asian countries that have successfully used IPs as Korea, Jordan, Mauritius, etc., and others struggling, a platform to attract foreign direct investment (FDI), in particular those in Sub-Sahara Africa (SSA). especially in manufacturing. While FDI has the potential to generate employment, and earn much needed foreign The IP strategy in Ethiopia hinges on attracting exchange through exports among other benefits, it FDI in the export-led and labor-intensive manufac- also requires a suitable investment climate to bring turing sector.53 The Government is emulating the path about sustainable structural transformation. When fully functional such parks can help alleviate the binding of the East Asian countries that have successfully man- constraints related to land access, infrastructure, and aged to use industrial parks as a platform to catalyze logistic and customs processes. At the same time, learning investments— FDI and domestic—in creating jobs, from the global IP experience, the performance for IPs is greatly dependent on how well they are designed, generating exports, and foreign exchange. Focusing implemented, and integrated into the local economy. on the manufacturing sector, Ethiopia is prioritizing Despite the concept of enclaves, in practice, the success FDI in specific sectors: textile and apparel, leather and of IPs is entwined with the national economy, and the capacity of the Government. The importance of promoting leather products, agro-processing, and pharmaceuticals linkages and spillovers with domestic firms, and the role of and chemicals.54 The imperative is to build on the coun- services in developing value chains is key. Thus addressing try’s agricultural foundations by moving toward new the investment constraints faced by firms outside the tradable activities in manufacturing that absorb large Industrial Parks need to remain on the front burner, as is the strengthening of IP institutions. numbers of young and semi-skilled workers.55 Ethiopia’s potential in the light manufacturing sector is signifi- cant, but faces binding constraints related to access Rationale for Industrial Parks (IPs) to land, infrastructure, trade logistics, and customs regulations as well as skills gap (World Bank, 2012). The Government of Ethiopia (GoE) has embarked FDI inflows into Ethiopia have finally picked on an IP development program,52 partly in recogni- up in 2013, driven by manufacturing FDI, and tion that systematic investment-climate reforms in multiple areas take time to address and are politically challenging to implement. The IPs in Ethiopia aim to 52 Industrial Parks are defined as geographically delimited areas that are administered by a single body, and aim to overcome investment barriers address the market failures related to land access, infra- at the national level by offering services, infrastructure, and incentives for structure, and logistics costs, as well as the high costs of businesses that locate and operate within the site. The term “Industrial Park” is used generically to describe different forms of zones (includ- doing business. The IPs can potentially be an effective ing Industrial Zones, Special Economic Zones, Free Trade Zones, and instrument that offers investors the chance to operate in Export Processing Zones) that vary in size and scope and operate under different incentive regimes. an improved investment climate vis-à-vis the national 53 Labor-intensive manufacturing sector is also referred as light manu- investment climate while giving the Government time facturing. 54 This capitalizes on the country’s endowment and comparative advan- and a natural experiment for testing policy and regula- tage through a special focus on high-potential sectors that have been tory reform to support industrialization, as evidenced identified by the GoE, namely textile and apparel, leather, sugar, cement, metal and engineering, chemical, pharmaceutical, and agro processing. from countries in East Asia and Latin America regions. 55 Overall, 2–2.5 million young people are entering the labor market In general, the successful IPs lead to two main types every year. While unemployment for the youth was only 4.1 percent for men, and 11.2 percent for women in 2005 (World Bank 2012c); of benefits: “static” economic benefits such as employ- this number may increase if young labor entrants are not able to find ment generation, export growth, government revenues, employment opportunities. 46 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector reached more than 2 percent of GDP for the first delayed implementation. The GTP envisions the time since 2008. The country attracted 1.2 billion establishment of five industrial parks in the country: dollars in 2014 with the manufacturing sector being Bole Lemi and Kilinto IPs in Addis Ababa, and one the largest recipient of FDI. For the first time Ethiopia each in Hawassa, Dire Dawa and Kombolcha. To date, is now among the top 5 landlocked countries in terms only the first phase of Bole Lemi has been developed of FDI inflows (UNCTAD, 2015). It is not clear and is partially functioning.56 Bole Lemi Phase I con- how much FDI is flowing into the IPs. Overall, FDI sists of twenty (20) factory sheds that are leased to 12 projects are on the increase again since 2011 (Figures manufacturing firms to produce and export leather 2.7.1 and 2.7.2). The manufacturing sector has the and apparel goods. The IP is still not completed and highest number of FDI projects under implementa- is thus functioning partially. In addition a number of tion. Manufacturing accounts for 41 percent of new private industrial zones have been sanctioned with the FDI projects under implementation and 70 percent Eastern Industrial Zone (EIZ)57 in operation.58 Both of FDI capital investments. Looking at investment the Bole Lemi I and EIZ IPs have faced a number of inflow, Turkey is the largest source of FDI (accumu- challenges in the planning design phases that led to lated), followed by China and Saudi Arabia. FDI in delayed implementation and mixed performance. So leather manufacturing and textile production indicate called, “Plug and Play Industrial Zones” could provide areas where Ethiopia seems to have a comparative ideas to better operationalize parks in Ethiopia as they advantage. To this end, it seems, Ethiopia is success- make it easy to SMEs to come to the zones and work ful in leveraging its access to the European and U.S. in partnerships with the larger firms (see Box 1). markets through the Everything But Arms (EBA) and The inexistence of IP-related policies and manage- Africa Growth and Opportunities Act, respectively, ment experience led to multiple challenges in plan- which provide preferential trade access to Ethiopian ning and implementing of the EIZ and Bole Lemi 1 goods in these markets. industrial parks. A range of issues have held back the Ethiopia could probably attract more FDI by performance of the program, including (World Bank, addressing investment climate constraints and 2011b; and World Bank, 2013b): lack of an effective improving its IP program. Experience from Latin and functioning policy, regulatory and institutional America and East Asian suggest that the failure or framework; weak strategic planning and demand- success of zone development is linked to its policy driven approach; poor on-and-off site infrastructure and incentives framework and the way the zones are planning; lack of specific on-and-off-site costing, located, developed, and managed. Several policy issues performance agreements, and economic and financial related to the sub optimal zone performance include: uncompetitive fiscal incentives, restrictive controls on 56 To date, five factory sheds have been completed in Bole Lemi I, and zone activity, and cumbersome regulations. The use of the remaining 15 sheds are to be completed in the next few months. It is entirely government financed and managed and has attracted FDI in generous incentives packages to offset other disadvan- the leather, shoe, garments, and textile industries. tages such as poor location and inadequate facilities 57 This was established through a Memorandum of Understanding (MoU) between the GoE and the Chinese consortium investment. Set is ineffective in terms of overall zone performance. up in 2009, it is operated by a Chinese enterprise that is also the major Moreover some incentives such as tax holidays impose investor and developer of the EIZ. It is located in Dukem along the highway linking Addis Ababa and the port of Djibouti. EIZ has signed significant costs to the public budget. the lease agreements with a total of 20 firms with actual investments of over US$460 million, and nine firms have started production. The firms cover several sectors, including construction materials, steel products, Ethiopia’s Experience with IPs so Far textile, leather processing, food, chemical products, and automobile assembly. Thus far, only 25 percent of the tenant firms have exported their products overseas. Ethiopia initiated its IP program in a phased, yet 58 Other private investment parks are also under development in the Addis ad hoc manner, resulting in mixed results and and Oromia region. This includes the Huajian IP and the Turkish zone. Growth and Transformation through Manufacturing 47 Figure 2.7: FDI inflows 1. Manufacturing FDI by Greenfield Projects Number, 2. FDI by Number of Projects in Ethiopia, 2008–2013 Selected Countries, 2008–2014 16 15 1000 100% 14 Number of greenfield projects Number of projects 12 11 10 500 50% 8 7 8 6 4 5 5 4 0 0% 2 2008 2009 2010 2011 2012 2013 0 2008 2009 2010 2011 2012 2013 2014 Total project number Share of pre-implementation (%) Share of implementation (%) Share of operation (%) 3. Trend of FDI Projects Under Operation in Ethiopia, by Main Sectors, 2008–2013 150 100 50 0 2008 2009 2010 2011 2012 2013 Agriculture Construction Manufacturing Hotel and tourism (including restaurant, lodge service) Machinery and equipment rental and consultancy service Source: World Bank staff own calculations, based on data from Ethiopia Investment Agency (EIA). analysis; absence of institutional capacity to oversee has the opportunity to avoid missteps of the many IP development; inefficient procedures and controls, failed IPs, particularly in Africa (World Bank, 2011b; including customs administration; lack of systematic and World Bank, 2013b). The failure of these zones is investment promotion to attract committed anchor attributable to a number of factors, which Ethiopia’s investors; and deficiencies in designing and imple- zones can and should avoid. They include: (i) lack of menting a linkages program, a communications and a compelling business case for companies to invest in; outreach strategy, and establishing and tracking per- (ii) establishment of zones, often for political reasons, formance indicators. These factors, combined with in remote areas that lack access to transport infrastruc- a poor business environment and weak eco-system ture, utilities, markets, and labor; (iii) failure to miti- related to skills and technology, have not led to the gate investment environment constraints that prevail envisaged outcomes. in the wider national economy; (iv) minimal private Ethiopia is keen to learn from global IP expe- sector involvement in the development and opera- rience. As a latecomer to IP development, Ethiopia tion of zones; (v) zone authorities acting as regulator, 48 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Box 1: China’s secret weapon in light manufacturing: Small and Medium Enterprise-oriented “Plug and Play” industrial zones The success of Chinese manufacturing growth in recent decades is indisputable and has irrevocably shifted the global landscape for manufacturing competitiveness. In contrast, manufacturing in other regions has failed to deliver broad-based growth and poverty reduction on anything close to the scale as has been observed in East Asia. Although the importance of China’s coastal special economic zones has been well-recognized and documented (e.g. as platforms for attracting export driven FDI and testing grounds for key reforms), China’s experience with smaller industrial zones mostly catering to domestic SMEs is less well known—and yet these have also played a critical role in China’s astonishing industrial development over the last twenty years. One spectacular example of China’s success and the role played by zones is the Weihai Zipper Company in Zhejiang. Starting from virtually nothing, over a span of two decades, it now exports $15 million worth of zippers to about 60 countries. It currently employs 3,000 workers with an estimated daily output of 4 million zippers. This company is part of a zipper industrial cluster which counts more than 500 companies (China has more than 75 percent of the world’s market share in zipper, with the industry employing more than a million workers). Weihai Zipper Company decided to move to an industrial zone because the government offered a great package of cheap and abundant land and a predictable supply of utilities, especially water and energy. The manufacturer said that moving to the industrial zone enabled the scale up of the company by providing more space for plant expansion and for workers’ dorms in the park. China has more than 1,000 industrial zones following a central government policy encouraging the development of such zones. Most cities and counties have followed the models set by the large zones developed by the central and provincial governments. The local governments are motivated to develop industrial zones to get tax revenues and revenues from selling land, as well as nice records of administrative performance. Of course, not all Chinese industrial zones have been successful; the better ones were built on existing or potential industrial strengths, in other words, local comparative advantages. These industrial zones played a critical role in facilitating the growth of Chinese SMEs from family operations catering to the local market to global powerhouses. These zones not only provided Chinese SMEs with good basic infrastructure (e.g. roads, energy, water and sewage), security, streamlined government regulations (e.g. government service centers) and affordable industrial land, they also provided technical training, low cost standardized factory shells allowing Chinese entrepreneurs to “Plug and Play” as well as Chinese workers with free and decent housing accommodations right next to the plants. Hence they played a very critical role in helping Chinese small enterprises to grow into mid-size and large enterprises, avoiding the “Missing Middle” problems that other countries face. These industrial “Plug and Play” zones considerably reduced the start-up investment costs and risks for SMEs at a phase in their development where they are still too risky for bank loans. They also facilitated the development of industrial clusters allowing tremendous economies of scale and scope for Chinese industries (the emergence of clusters was further facilitated by the Chinese government’s support for the development of input and output markets). In a nutshell, the Chinese government facilitated SME development through the efficient provision of public goods and market information about sellers and providers but not subsidies. For example, firms pay market prices for the use of utilities. Most importantly, competition between firms is intense. The government does not bail out failing firms. It should also be noted that most of these zones did not preselect particular light industries, letting market forces drive the organic development of specialized clusters. A large proportion of China’s 350 million migrant workers from the Western Provinces live inside these zones in free housing located right next to the plants. These free accommodations provide decent housing at very low economic costs to the country (they are built using large scale productive techniques). The companies also provide very cheap food through cost effective means to the zones. Not having to spend much on food plus free housing and no need for transportation means that a worker in China can save up to 80% of her salary. In other developing regions, most of the wage is gone by the time the worker pays for his housing (often in slums), food and transportation. This, combined with the fact that a worker can increase her salary by 50 percent through extra hours and productivity bonuses, goes a long way in explaining why Chinese workers are so motivated and productive while costing relatively little (it also explains a big part of the more than 40 percent of GDP saving rate in China)—these workers can earn and save in a few years enough money to change their and families’ lives. By contrast, Vietnam did not develop such SME-oriented zones, relying exclusively on FDI linked industrial zones to develop manufacturing exports and has successfully done so. However, there are limited linkages between such zones and the vast majority of small, informal SMEs which focus on the domestic market and remain small. Export growth in Vietnam does not bring about as much value addition as found in China (20 percent vs 33 percent in China from manufacturing value added) as the large firms also suffer from not being plugged into local clusters and value chains—they import most of their inputs. The Chinese system of SME-oriented “Plug and Play” industrial zones is thus one of the most important and least well publicized factors behind China’s extraordinary competitiveness in light manufacturing industry. Source: Palmade et al. (2010). Growth and Transformation through Manufacturing 49 developer, and manager for the zones; and (vi) inap- sub-contracting, construction and ownership of build- propriate legislative, regulatory, and institutional ings, infrastructure, and investment in IPs. frameworks for zone governance and management (even when zones are 100 percent government-owned, Lessons Learned for IP’s in Ethiopia: Design a successful zone authority should operate with a high and Implementation level of autonomy and lack of political interference). Unlike successful zone programs in other parts of the Design world, most zones in SSA thus far show low levels of investment and exports. Their job creation impact and Site assessment is only the initial step in the devel- integration with the local economies have also been opment of the IP locations. The site assessment limited. In addition, these zones have not facilitated should be followed by a feasibility study for each site industrial upgrading, or acted as a catalyst of wider to determine a business case that includes; i) if the economic reforms, raising serious questions about site can support an IP; ii) what the industry sectors the fundamental competitiveness and utility of these are for each IP location; iii) the short-, medium-, and zone programs. long-term projected demand for the selected sites; The Government has shown a strong commit- iv) the development of a comprehensive master plan ment in putting in place the appropriate policies and associated phasing plans for all locations in accor- and institutional structures necessary to ensure dance with demand; v) identification of on- and off- good performance of IP development and opera- site infrastructure requirements;60 vi) environmental tions.59 Key recent developments to address the and social impacts; vii) the economic benefits to the current weaknesses in the investment regulatory cities and regions in each location; viii) if the projects framework include: (i) the approval of the Industrial are financially viable and sustainable in the long-term; Parks Proclamation by the Parliament on March 30, and finally ix) integration with existing urban plans. 2015; (ii) setting up a regulatory body at the newly IPs should be rolled out in a strategic and constituted Ethiopian Investment Board that will phased fashion in the country. All potential loca- oversee the administration and supervision of indus- tions should be ranked and prioritized for develop- trial development zones, and thereby separate the ment based on the site selection criteria. This is to regulatory function of IP regime from the develop- ensure that IPs do not compete with each other and ment and operational aspects of IP Management; that there is sufficient demand to fill all proposed IP (iii) establishing the Industrial Park Development sites. Experience suggests that it is better to make Corporation (IPDC) for the purpose of, among other one or two IPS work before starting new initiatives. things, developing and administering industrial zones, Lessons learned from international experience shows technology and food parks, and management of a land that this is even more important in countries that Bank; and (iv) strengthening the EIC for the purpose have a small private sector, underdeveloped national of investment promotion, export promotion, imple- transport infrastructure, and unreliable infrastructure mentation of regulation for industrial zones, OSS, and utilities. aftercare services, and policy analysis/market intelli- gence, primarily for FDI. Actions are also underway to develop a systematic approach to encourage private 59 The World Bank is supporting the Government through a “Competi- tiveness and Job Creation Project” in developing an effective framework sector participation in the IP development program in implemented by strong institutional capacity for a successful and effective Ethiopia. The focus of private sector participation is development approach. 60 When there is a clear PPP, this could be different, where the govern- expected to cover the gamut of activities from develop- ment could assess pre-feasibility and go into a transaction process and the ment, operations and management, service provision, private sector would in turn develop their vision, feasibility, and planning. 50 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector In Ethiopia, the strengthening of IP institu- IPs is that they have a high concentration of very tions and capacity building of staff is crucial and skilled people, including many R&D personnel. As an urgent priority. It is imperative that urgent and a result, they have become centers of knowledge and concerted efforts be made to develop the capacity of technology generation, adaptation, diffusion, and the IPDC and regulatory function at the EIC. While innovation. The abundance of FDI provides a good the IPDC is still in the process of developing its busi- opportunity for technology learning. Governments ness strategy and business case, it is critical to adopt also put strong emphasis on technology learning and a service oriented and corporate (financial viabil- innovation, as well as technology-intensive industries. ity) approach to the development function. Because In addition, the IPs are closely linked to domestic IPs are new to Ethiopia, staff responsible for market- enterprises and industrial clusters through supply ing and promoting zones will require state-of-the art chains or value chains. This connection not only helps training. In addition, at present, there are no salary achieve economies of scale and business efficiency, incentives to allow the IP institution to hire promising, but also stimulates synergistic learning and enhances energetic staff. In the future this will limit the quality industrial competitiveness (Zeng 2010). of the hired staff. Currently, in Ethiopia, master planning and Implementation infrastructure is not utilizing best practices. It is important that all zones in Ethiopia be master planned Proper quality and reliable infrastructure is to attract the greatest number of investors to the coun- required in the IP. Key infrastructure should be pri- try. This means providing a combination of serviced oritized along with the construction of the land and land and pre-built facilities with reliable infrastructure factory sheds. It is important that key infrastructure and social services on site. For IPs to succeed location such as wastewater treatment plants, power, and water matters in terms of being near major cities and linked be developed along with serviced land and pre-built to the international market. Successful IPs also have factory sheds so that investors can start operations the good access to major infrastructure, such as ports, moment they take over their leases. This has not been airports, and railways. the case in Bole Lemi I. Power is not consistent and as Viable IPs in Ethiopia should be run as com- such, factories are experiencing power surges, brown- mercially sustainable ventures. IPs must be devel- outs and blackouts. Water has also been a concern oped and operated as commercially sustainable for investors; when the first investors took possession ventures. When zones are subsidized by governments, of their factory sheds, water was erratic. The water then the country is not seen as an attractive invest- treatment system should be up and running in the ment location to private developers because it creates IP before investors moves into their factory premises. an uneven playing field for the private developer, This is an environmental issue that is a requirement who is not in business to subsidize investors. Hence for many international investors. It is imperative that this limits the potential of private zone development basic infrastructure is working properly when inves- in the country. To be a successful zone location, it is tors move into the zone. necessary to have a mix of private developers, PPPs, “Investor aftercare” for current tenants is and public zones in a country, because over time instrumental for future success. Investors have indi- it is not viable for all zones to be developed by the cated the advantages of establishing in Ethiopia, but government. also expressed concern about Customs procedures, Efforts are needed to ensure strong links power quality, and visa/work permit procedures, between the IPs and the domestic economy are among others. Customs procedures and power out- being established. One of the key strengths of the ages topped the list of concerns. Word of mouth has Growth and Transformation through Manufacturing 51 a powerful effect when satisfied investors talk to those IPs areas of excellence in social and environmental considering Ethiopia. A full staff of zone representa- practices through application of low-carbon and tives should be working on a daily basis in Bole Lemi green policies. This is all the more important for I site to manage day-to-day activities in the zone, export-oriented industries since buyers are becom- provide aftercare to investors and to promote the zone ing more and more focused on the ability to certify to future investors. their value chains. It may be noted that China’s Focus on environmental and social sustain- growth model based on low technology and labor- ability. The GoE should focus on effective man- and resource-intensive manufacturing have faced agement and monitoring of environmental and criticism; many SEZs face serious environmental social impacts. There is an opportunity to make the and resource challenges. 52 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Short Summary and Recommendations foreign direct investors need to be attracted by a for Manufacturing Development thriving investment climate. FDI is also instrumental for advancing the Government’s agenda to facilitate Structural transformation through manufactur- IPs. In both FDI attraction and IP development, les- ing development is one of the key goals of the sons from other countries show that they are most Government of Ethiopia. The Government is successful with appropriate linkages to the domestic currently preparing the GTP II five-year program economy, and particularly with strong linkages to (2015/16–2020/21), and a ten years perspective plan domestic SMEs. (Vision 2025). With these instruments, the country Based on the preceding analysis, this Economic is making a concerted effort towards structural trans- Update offers seven recommendations, which could formation where manufacturing is expected to play a contribute to the development of the manufactur- prominent role in the economy. Ethiopia’s goal is to ing sector in Ethiopia. The recommended actions become a manufacturing powerhouse—with a focus focus on the key operational constraints and entry on light manufacturing for employment generation. barriers both for FDI companies and SMEs. Growth in the industrial sector is essential for First, focus on skills development, which is vital sustained long-term growth and jobs creation. The for increasing firm productivity. This can be done structural economic transformation that entails the utilizing two channels: First, through technical assis- reallocation of workers from the relatively low produc- tance that focuses on developing managerial, technical tive agriculture and informal sectors to more produc- and vocational skills for subsectors in manufacturing tive and formal economic activities in manufacturing, in which Ethiopia has a comparative advantage; and industry, and related services is essential for growth second, by addressing the mismatch of private sector and jobs creation. Experience from the rapid growth needs to the graduates of Technical and Vocational of Asian countries supports the view that sustained Education and Training (TVET). In addition, a economic growth requires growth in industry and, in strengthened mechanism to integrate the private sector particular, growth in the manufacturing sector. through industry associations in the development of Productivity gains are a key factor in determin- TVET curriculum and industry operational standards ing long-term economic growth and improvement would be instrumental. in living standards. Empirical evidence, globally, Through clearly communicating the option reveals that about half of long-term growth is driven within the TVET system to count as a continu- by increases in productivity rather than just factor ation of higher education, the public perception accumulation. In order to improve the productivity towards TVET could be improved and with it the of firms in the manufacturing sector it will be instru- efficacy. Finland serves as a good example of a gov- mental to improve the overall business climate start- ernment effectively upgrading the public image of ing with the key binding constraints for both large TVET through improvements to the quality of edu- and MSMEs. For large firms or FDI, the inadequate cation provided, and the publication of the benefits supply of skills and poor trade logistics are some of associated with a TVET education. Singapore also the key constraints to growth. For SMEs, access to offers the example of a well implemented model for finance, access to land, electricity, and a cumbersome shifting the image of TVET from being perceived tax administration constitute key constraints in the as a dead-end stream to an education track that business environment. effectively aligns graduates with high labor market While FDI has the potential to generate demand, and as a means to transition to higher edu- employment and earn much-needed foreign cation (World Bank, 2014b describes those examples exchange through exports among other benefits, in more detail). Growth and Transformation through Manufacturing 53 From the perspective of skills development to establish shop in Ethiopia. In addition, reliability within firms, enterprises with similar technologies of electricity is an important bottleneck that stands and sufficient proximity could pool resources to out as the top third constraint usually highlighted by invest in production lines solely for training pur- firms in Addis Ababa. Continued emphasis on power poses. These production lines would not need to be distribution and transmission will have to be equally utilized by TVET trainees exclusively, but could ben- important as ongoing large-scale power generation efit all employees and the firm as a whole. In practice, projects. the pooling of resources is difficult if firms, or colleges, Fourth, improve tax administration and are competing against each other. A possible approach advance the simplification of the MSME tax system. could be to complement the current Industrial Parks Managers in manufacturing firms spend a significant initiatives with incentives to encourage joint coopera- amount of time dealing with tax administration tive training. An example of a promising joint train- and a quarter of firms report tax administration as a ing model is evident in the experience of the Korean major problem faced in their day-to-day operations. training consortium for SMEs (Almeida et al. 2012 Simplified tax filing requirements would allow higher provide a good account of these experiences). compliance by semi-illiterate business owners. In Second, implement measures to improve access addition, the tax appeal system needs to be reviewed. to finance for firms especially “the missing mid- Over 60 percent of businesses consider the existing dle”—small and medium sized enterprises—the tax appeals process to be lengthy and costly. majority of which are fully credit constrained. Four In particular, the current MSME tax regime is areas are particularly important in this area: (1) Banks overly complicated. For instance, there is excessive and MFIs report facing weak liquidity positions due to compliance burden on ‘type C’ taxpayers due to the credit limits for SMEs and micro enterprise loans, not assessment of tax liability using daily sales estimates. being able to go beyond 5 percent of their capital for In order to reduce the burden of tax administration microfinances institutions and 20 percent for banks. the micro business taxation regime could be based on The legal and regulatory framework affecting the the principle of self-assessment. Likewise, there is no liquidity positions of commercial banks and MFIs to real simplified tax regime for small businesses in place. lend more to SMEs needs urgent review. (2) Financial This has resulted in a low level of voluntary compliance institutions do not have a uniform definition of with the regime, as businesses are reluctant to migrate MSME. Having a common MSME definition at the from ‘type C’ into the ‘type B’ classification. A simpli- national level would ease the design of loans, invest- fied tax regime for non-incorporated small businesses ments, grants, and statistical research. (3) Creating a should be introduced. One way to do this could be by collateral registry would help to reduce the high costs applying lump sum cost deduction ratios instead of of collateral that firms have to provide. (4) Capacity- requiring the calculation of net business profit. building programs for financial institutions to develop Fifth, improve trade logistics, customs proce- an “SME culture” that adopts business models suitable dures and trade regulations that mainly impacts to the needs of the SMEs could make a big difference. large (exporting firms) and FDI. As recommended Third, address binding constraints relating in a previous Ethiopia Economic Update (World to access to land and access to electricity. A more Bank, 2014), improving selectivity of inspections to attractive investment climate could bring about more reduce cost, transit time, and corruption, and provid- and better domestic and international investment ing warehouses with better technology are possible to increase economic activity through productiv- ways to improve trade logistics. The recently launched ity enhancements. An expedited land approval and National Trade Logistics Strategy provides a strong allocation process would encourage more investors foundation on which GoE could mobilize resources 54 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector and coordinate interventions to remove binding Simplifying the most onerous elements of entry bottlenecks in trade facilitation. The implementa- requirements, which relate to securing registration, tion of the new Customs Proclamation (December professional competency certificate, and a business 2014) which puts emphasis on facilitating rather than license could make a big difference. There is also a need controlling trade will usher in much needed reforms to rationalize the responsibilities of the various agen- such as the introduction of use of simplified customs cies responsible in the various stages of registration. procedures for authorized traders; pre-arrival clear- Seventh, adopt a strategic and phased approach ance of goods, and use of risk assessment and post- for implementing the Industrial Parks program clearance audit. in line with international experience. This would Sixth, simplify business entry regulations and ensure that there is sufficient demand for existing processes to facilitate entry and exit of firms, which IPs. There is need to phase implementation based is a key requirement for a dynamic and thriving on the business case for each IP to ensure that there business sector. Ethiopia’s record in entry barriers is sustained demand. Experience from Asia and is among the least facilitating countries for entry of Latin America suggest that it is better to make one companies (Starting a Business Indicator in Doing or two industrial parks succeed before starting other Business: Ethiopia ranks 168th out 189 economies). initiatives. 55 ANNEXES 56 Annex 1: Ethiopian Selected Economic Indicators High Frequency May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Inflation (Year-on-Year): % 8.7 8.5 6.9 7.2 5.8 5.4 5.9 7.1 7.6 8.2 8.5 9.3 9.5 Food 6.3 6.4 5.7 5.2 3.8 2.9 4.8 6.5 7.1 9.6 10.1 10.8 10.1 Non-Food 11.5 11.0 8.2 9.4 8.1 8.3 7.1 7.9 8.3 6.8 6.9 7.6 8.7 Inflation in AA (Year-on-Year):% 8.8 9.0 9.0 7.3 4.7 5.9 5.7 6.4 7.5 7.1 7.7 9.0 9.1 Traded Goods 8.8 9.6 9.7 7.5 7.9 6.3 5.8 6.4 6.3 3.7 Non-Traded 8.6 8.6 8.7 7.1 3.9 5.7 5.5 6.4 7.8 8.0 Monetary Growth (Year-on-Year):% M2 25.1 26.5 26.9 27.8 28.4 29.4 30.2 Domestic credit 28.0 28.4 27.0 27.0 29.8 30.4 31.3 Net Foreigh Assets -2.8 0.9 -0.9 1.4 1.9 5.9 -0.3 Reserve Money* 14.9 18.7 21.7 20.8 21.0 22.1 20.8 Gross reserves (Mill. $) 2786.1 2462.9 2778.8 2791.6 2644.6 2527.7 2815.3 In months of import 1.9 1.7 1.7 1.7 1.6 1.6 1.7 Exchange rate Exchange rate (Birr/$), pa 19.4 19.5 19.6 19.7 19.8 19.9 20.0 20.1 20.1 20.2 20.3 20.4 20.4 Real Effective Exchange Rate index 128.5 129.7 129.8 131.9 133.8 136.2 139.4 143.0 148.1 152.0 156.2 157.0 Annual growth, % 2.9 3.7 1.7 3.7 4.5 6.9 8.6 12.4 15.8 18.5 21.8 22.5 Black market premium (%) 4.6 5.2 5.5 7.0 8.0 6.6 11.5 14.5 13.2 13.2 13.2 12.5 12.0 Trade Deficit, goods, billion US$ 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Trade Deficit, goods, billion US$ -0.9 -0.9 -1.1 -0.9 -1.0 -1.2 -1.1 -1.5 -1.1 -1.0 -1.2 -1.2 Export, (billion US$) 0.3 0.3 0.2 0.3 0.2 0.2 0.2 0.2 0.2 0.2 0.3 0.2 Import, (billion US$) 1.2 1.2 1.3 1.1 1.3 1.4 1.3 1.7 1.3 1.2 1.4 1.4 International Prices Crude oil, average ($/bbl) 105.7 108.4 105.2 100.1 95.9 86.1 77.0 60.7 47.1 54.8 52.8 57.5 62.5 Coffee, arabica (/kg) 4.7 4.4 4.3 4.7 4.6 5.0 4.6 4.3 4.2 3.9 3.5 3.6 3.5 Gold ($/troy oz) 1288.7 1279.1 1310.6 1295.1 1236.6 1222.5 1175.3 1200.6 1250.8 1227.1 1178.6 1198.9 1198.6 World Growth (quarterly: y-o-y) % Q2 Q3 Q4 Q1 China 7.5 7.3 7.3 7.0 Euro area 0.8 0.8 0.9 1.0 US 2.6 2.7 2.4 2.9 OECD-Total 1.9 1.8 1.8 1.9 Sources: CSA; NBE, Customs, WB, OCED-National Accounts. Annex 2: Ethiopia: Selected Economic and Social Indicators (Annual Frequency) Fiscal year ending July 7 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Income and Economic Growth GDP growth at factor cost (annual %) 12.6 11.5 11.8 11.2 10.0 10.6 11.4 8.7 9.8 10.3 GDP per capita growth (annual %) 8.7 7.8 8.5 7.9 6.0 9.6 8.3 5.9 7.7 … GDP per capita, PPP (current international $) 657 730 813 894 955 1,059 1,171 1,262 1,380 … Atlas GNI per capita, US$ 160 180 220 280 340 380 390 420 470 … Private Consumption, nominal (annual %) 33.8 25.9 26.9 51.8 35.7 15.3 28.6 45.1 15.7 16.2 Gross Fixed Investment ( % of GDP) 30.6 32.2 28.2 28.5 29.5 31.6 32.1 37.1 35.8 40.3 Money and Prices Inflation, consumer prices (annual %, end of year) 13.0 11.6 15.1 55.3 2.7 7.3 38.1 20.8 7.4 8.5 Inflation, consumer prices (annual %, period average) 6.8 12.3 15.8 25.3 38.7 3.0 17.9 34.7 13.9 8.1 Treasury bill rate (91-days maturity, annual average) 0.1 0.0 0.8 0.6 0.9 0.9 1.3 1.9 2.2 1.2 Nominal Exchange Rate (End of period) 8.7 8.7 9.0 9.6 11.3 13.5 16.9 17.8 18.6 19.6 Real Exchange Rate Index (1990=100) 84.7 83.2 76.8 66.9 61.5 53.3 39.2 40.2 38.2 … Fiscal Revenue (% of GDP) 14.8 15.0 12.8 12.1 12.1 14.0 13.4 13.8 14.3 14.0 Expenditure (% of GDP) 23.5 22.5 20.9 19.1 17.4 18.8 18.2 16.6 17.8 17.7 Current (% of GDP) 12.6 11.7 10.1 9.3 8.2 8.4 7.9 6.9 7.3 17.7 Capital (% of GDP) 10.8 10.8 10.8 9.8 9.2 10.4 10.3 9.8 10.6 10.3 Fiscal balance including grant (% of GDP) (4.4) (3.9) (3.1) (2.9) (0.9) (1.6) (1.6) (1.2) (1.9) (2.6) Fiscal balance excluding grant (% of GDP) (8.7) (7.5) (8.1) (7.0) (5.3) (4.9) (4.8) (2.9) (3.5) (3.8) a Primary fiscal balance including grants (% of GDP) (3.5) (3.1) (2.4) (2.5) (0.6) (1.2) (1.2) (0.9) (1.6) (2.2) Total public debt (% of GDP) 78.9 66.8 43.9 38.5 35.5 39.4 37.8 32.7 37.4 44.7 External public debt (% of GDP) 48.9 37.3 11.8 10.4 14.8 18.3 22.2 17.9 20.5 22.6 External Accounts Export growth (%, yoy) 41.1 18.1 18.7 23.1 (1.0) 38.3 37.1 14.8 (2.3) 5.6 Import growth (%, yoy) 40.4 26.4 11.6 32.8 13.4 7.7 (0.2) 34.0 3.7 19.7 Merchandise exports (current US$ billions) 0.8 1.0 1.2 1.5 1.4 2.0 2.7 3.2 3.1 3.3 Growth and Transformation through Manufacturing of which coffee exports (current US$ billions) 0.3 0.4 0.4 0.5 0.4 0.5 0.8 0.8 0.7 0.7 (continued on next page) 57 58 Annex 2: Ethiopia: Selected Economic and Social Indicators (Annual Frequency) (continued) Fiscal year ending July 7 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Merchandise imports (current US$ billions) 3.6 4.6 5.1 6.8 7.7 8.3 8.3 11.1 11.5 13.7 Services, net (current US$ billion) 0.3 0.1 0.2 0.1 0.4 0.5 0.8 0.2 0.6 0.7 Private transfers, net (BoP, current US$ billions) 1.0 1.2 1.7 2.4 2.7 2.7 2.7 3.2 3.9 4.0 Current account balance before grant (BoP, current US$ billions) (1.5) (2.3) (2.1) (2.8) (3.2) (3.1) (2.1) (4.6) (4.0) (5.9) Current account balance after grant (BoP, current US$ billions) (0.7) (1.4) (0.9) (1.5) (1.6) (1.2) (0.2) (2.8) (2.5) (4.7) Foreign Direct Investment (current US$ bilions) 0.2 0.4 0.5 0.8 0.9 1.0 1.2 1.1 1.2 1.5 External debt, total (Current US$, billion) 6.0 5.7 2.3 2.8 4.4 5.6 7.8 8.9 11.1 13.9 External debt, total (% of GDP) 48.9 37.3 11.8 10.4 14.8 18.3 22.2 17.9 20.5 22.6 Multilateral debt (% of total external debt) 82.7 81.1 51.6 55.7 46.7 48.6 46.0 45.4 45.0 42.1 Debt service ratio (% of goods and NFS) 8.9 8.0 7.3 2.9 2.3 2.7 4.5 6.9 9.3 10.3 Population, Employment and Poverty Population, total (millions), UN 76.2 78.3 80.4 82.6 84.8 87.1 89.4 91.7 94.1 96.5 Unemployment Rate (urban) 17.0 20.4 18.9 18.0 17.5 16.5 17.4 Poverty headcount ratio at national poverty line (% of population) 38.7 29.6 Poverty headcount ratio at $1.25 a day (PPP) (% of population) 39.0 30.7 Poverty headcount ratio at $2 a day (PPP) (% of population) 77.6 66.0 Inequality – Income Gini 29.8 29.8 Population Growh (annual %) 2.8 2.8 2.7 2.7 2.7 2.7 2.6 2.6 2.6 2.6 4th Ethiopia Economic Update – Overcoming constraints in the manufacturing sector Life Expectancy 56.6 57.6 58.7 59.7 60.6 61.5 62.3 63.0 Others: GDP (current LCU, billions) 105.3 130.2 170.1 245.6 331.8 378.8 505.6 738.6 852.7 1047.4 Nominal GDP (current US$, billions) 12.2 15.0 19.3 26.6 31.8 29.4 31.4 42.8 46.8 53.6 a Doing Business (rank) 101.0 97.0 102.0 116.0 107.0 104.0 111.0 124.0 129.0 Logistics performance index (1=low to 5=high) 2.3 2.4 2.2 2.6 b Human Development index ranking 170.0 170.0 169.0 169.0 171.0 157.0 174.0 172.0 173.0 173.0 a This indicator is ranked out of 175 countries in 2007, 178 in 2008, 181 in 2009, 183 in 2010, and 2011, 185 in 2012, and 189 in 2013 and 2014. b The HDI ranking in 2001 is in relation to 175 countries; from 2005 to 2008, to 177; in 2009, to 181; in 2010, to 169 countries; and, from 2011-2014 to 187 countries. 59 References Almeida, R., Behrman, J., & Robalino, D. 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