Press Release No. 01/11

Press Release: IMF Approves In Principle US$112 Million PRGF Arrangement for Ethiopia

March 20, 2001

The Executive Board of the International Monetary Fund (IMF) approved in principle a three-year arrangement for Ethiopia under the Poverty Reduction and Growth Facility (PRGF)¹ for SDR 87 million (about US$112 million) to support the government's 2000/01-2002/03 economic program.

A final decision by the Executive Board is pending discussion of Ethiopia's interim Poverty Reduction Strategy Paper (PRSP) by the World Bank's Executive Board, which is expected today. A final decision will enable the release of a first loan under the PRGF arrangement in an amount equivalent to SDR 17.4 million (about US$22 million) immediately.

In commenting on the Executive Board's discussion, Shigemitsu Sugisaki, Deputy Managing Director and Acting Chairman, said:

"The authorities' medium-term framework for macroeconomic stability within a comprehensive interim Poverty Reduction Strategy Paper (PRSP) provides a sound basis for development of a full PRSP, for Fund concessional assistance, and for moving toward a decision point under the enhanced HIPC Initiative. The interim PRSP seeks to promote rapid, broad-based, and equitable growth. Preparations for a full PRSP are underway and a key challenge is to broaden the policy dialogue to include all stakeholders.

"The PRGF-supported program for 2000/01 sets realistic, albeit ambitious, objectives to achieve higher GDP growth, contain inflation, and rebuild international reserves. These are essential to foster sustained poverty reduction over the long term. The central reforms under the program will focus on public finances and the financial sector. Most important will be the reorientation of spending from defense toward poverty alleviation, and maintaining a durable peace.

"To attain the program objectives, it will be crucial for the authorities to maintain public finances on a sustainable path, improve monetary management and the functioning of financial markets, and carry out structural reforms—notably to improve governance, transparency, accountability, and public sector efficiency.

"Ethiopia's eligibility for debt relief under the enhanced HIPC Initiative has been endorsed in principle. A final decision on the timing of the decision point and the granting of interim relief will be taken later this year once Ethiopia has established a performance record under the new PRGF, and made further progress on the preparation of a full PRSP in close consultation with social partners," Mr. Sugisaki said.

ANNEX

Program Summary

Ethiopia's progress with market-oriented reforms during the 1996/97-98/99 program was notable, although uneven. However, adverse external circumstances and the border conflict with Eritrea increasingly hampered the government's efforts to consolidate stabilization gains. In 1999/2000, Ethiopia's economic situation deteriorated sharply as a result of severe drought, a major worsening of its terms of trade associated with lower coffee export prices and the steep rise in petroleum import prices, as well as the impact of the border conflict.

In the second half of 2000, Ethiopia resumed its economic reform efforts after considerable progress had been made toward restoring peaceful conditions with Eritrea. The government reconfirmed and updated its development strategy formulated in the mid-1990s in the second five-year National Development Program (NDP). Its mid-term economic strategy focuses on poverty reduction by fostering rural development, expanding and improving a comprehensive food security program, and building conditions for high and sustainable growth. The first annual program envisages real GDP growth rates of 7-8 percent in 2000/01-2001/02 and seeks to maintain consumer price inflation close to 5 percent. The external current account deficit is expected to decline initially only modestly from 7.5 percent of GDP in 1999/2000 to about 6 percent a year in 2000/01 and 2001/02 before resuming a downward trend, starting with a deficit of 5 percent of GDP in 2002/03.

In the immediate period ahead, the government's strategy is to reconcile the country's security needs with the requirement to finance both the emergency programs for reconstruction and demobilization and to improve priority public services, all within a sustainable fiscal framework. For the next three years, fiscal policy's two main objectives are to redirect resources from defense-related expenditures toward poverty-reducing outlays (while addressing the country's post-conflict recovery needs), and to lay the foundation for strong tax revenue mobilization. The government envisages that a rapid recovery in nonmilitary core expenditure would accelerate investment spending. Overall expenditure is targeted to decline by 5 percentage points of GDP during the program period to 28 percent in 2002/03. The revenue strategy calls for an increase in tax revenue of 2.5 percentage points during the three-year period. Tax policy reforms will focus on streamlining income taxes, improving the efficiency of the incentive system, and strengthening indirect taxation. These actions would culminate in the introduction of a value-added tax in January 2003.

Monetary policy attaches high priority to keeping inflation in the low single digits. Progress in fiscal consolidation, supported by substantial disbursements of foreign aid, would allow for adequate growth in domestic credit to the private sector, which, in turn, would set the stage for private sector-led growth and facilitate the rebuilding of international reserves. The net domestic assets of the national bank would be the key aggregate in steering monetary policy, but developments in other monetary aggregates would also be followed closely.

The structural reforms under the program focus on financial and external sector reforms in addition to capacity building, and judicial and civil reforms. The government's plans for comprehensive financial sector reforms aim at modernizing monetary management; improving interbank operations; strengthening the soundness of smaller banks; and upgrading the management of the largest state-owned bank, the Commercial Bank of Ethiopia. The country's integration into the global economy will be fostered by taking mutually reinforcing steps to further liberalize the foreign trade and exchange regimes, allow market determination of the exchange rate, and promote export development. Balance of payments projections assume a reversal of the recently unfavorable conditions. Renewed reform policies and the expeditious post-conflict reconstruction and reintegration efforts should lead to growing investor confidence and sustained foreign support.

Any external borrowing during the program period will be contracted only at highly concessional terms, with the goal of keeping the external debt burden manageable. In the immediate post-conflict period, the debt burden (after traditional relief mechanisms) will rise by 2002/03 to 266 percent of exports of goods and nonfactor services (net present value terms) from 243 percent in 1999/2000, because of the immediate large external borrowing needs. Subsequently, the debt ratio would decline to 179 percent by 2009/10 and to an average of 129 percent during 2010/11-2019/20. Given the highly concessional borrowing terms, the debt-service ratio (under traditional debt-relief mechanisms) would fall from 19 percent in 1999/2000 to 15 percent in 2002/03, to 9 percent by 2009/10, and to an average of 7.5 percent during 2010/11-2019/20. The program assumes that the interim HIPC Initiative debt relief would allow a gradual increase in the government's poverty-targeted spending of US$46 million (0.7 percent of GDP) in the second fiscal year and US$77 million (1.1 percent of GDP) in the third fiscal year. HIPC Initiative debt relief is critical for allowing the needed expansion in poverty-targeted outlays.

In the Interim Poverty Reduction Strategy Paper, the government outlined the main elements of its existing poverty reduction strategy, which centers around promoting economic growth and increasing the income-earning capacity for the poor. Within one year, the government is expected to complete the formulation of a broad overall poverty reduction strategy with the participation of elected officials, civil society, nongovernmental organizations, and development partners.

Ethiopia became a member of the IMF on December 27, 1945. Its quota² is SDR 133.7 million (about US$172 million), and its outstanding use of IMF credit currently totals SDR 59.14 million (about US$76 million).