Public Information Notice No. 02/113

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Ethiopia

October 3, 2002

On September 23, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Ethiopia.¹

Background

Overall economic performance in Ethiopia during 2000/01 (fiscal year ended July 7) and the first part of 2001/02 was good, in the context of Ethiopia's steady progress toward peace with Eritrea. The authorities have been implementing wide-ranging structural reforms and pursuing prudent macroeconomic policies. However, with per capita income still about US$100, Ethiopia remains one of the poorest countries in the world and continues to face major challenges.

Following a bumper crop, real GDP growth rose to 7.7 percent in 2000/01 but declined to 5 percent in 2001/02, as prices of coffee and cereals continued to fall and the growth of agricultural output returned to a more sustainable pace. Consumer price inflation remained negative in 2001/02. However, since July 2002, there has been a drought which is affecting food production. The authorities have been requesting additional food assistance from donors. The external current account deficit (including official transfers) widened to 6.6 percent of GDP in 2001/02 from 4.2 percent in 2000/01, on account of higher food imports. Coffee exports, which account for 40 percent of merchandise exports, were lower than expected, as both volume and prices fell.

The fiscal deficit (including grants and special programs) increased in 2001/02, as a result of the accelerated implementation of special programs, capital expenditure, and poverty-targeted expenditure, the latter of which reached 16.7 percent of GDP. With regard to tax policy measures, the large taxpayer unit and tax reform implementation task force established in 2001 have been strengthened, and draft legislation for the introduction of a value-added tax (VAT) was passed by parliament in early July 2002. Defense outlays were cut from 6.4 percent of GDP in 2000/01 to 5.9 percent in 2001/02.

Broad money rose by 10.9 percent in 2001/02 compared with 9.5 percent in 2000/01. Several measures were taken to improve the soundness of the financial sector. The wholesale foreign exchange auction began to operate more efficiently before its replacement by an interbank foreign exchange market in October 2001.

Progress was also made in implementing other structural reforms focused on public sector management, including civil service and public expenditure policy, and on private sector development. Revised investment and urban land lease laws were adopted. However, implementation of the privatization program slowed because the larger companies, including industrial enterprises, that were being sold attracted fewer potential buyers.

The poverty reduction strategy paper was prepared with full participation by civil society and development partners, and was submitted to the Fund and the World Bank in August 2002.

Executive Board Assessment

Executive Directors noted that the authorities have made good progress in the implementation of sound macroeconomic policies and structural reforms. However, after the bumper crop in 2000/01, real economic growth is estimated to have decelerated from 7.9 percent in 2000/01 to 5 percent in 2001/02. Since July of 2002, Ethiopia has suffered from a drought, which is affecting food production and causing food shortages in some regions, as well as a rebound in cereal prices after a two-year decline. The authorities have subsequently requested additional food assistance from donors.

Directors observed that, as one of the poorest countries in the world, Ethiopia faces major challenges, particularly the achievement of sufficiently high rates of real GDP growth over the medium term to help reduce poverty. To this end, Directors encouraged the authorities to implement decisively structural reforms that enhance the efficiency of the economy and improve its competitiveness, and to continue with prudent macroeconomic policies, including a sustainable fiscal policy.

Directors noted that the largely agricultural-based economy is vulnerable to exogenous shocks, and shared the authorities' concern about the continued drop in producer prices of cereals and coffee. They encouraged the authorities to take action to mitigate the impact of these developments. From a long-term perspective, they considered that a key challenge for the authorities in the medium term will be to diversify the production base of the economy. Directors underlined that a significant reduction of the fiscal deficit in the coming years is needed for macroeconomic stability and debt sustainability. They urged the authorities to persevere with their cautious expenditure policy, and stressed the need to pursue vigorously their efforts to improve the planning, tracking, and reporting of public spending, especially poverty-reducing spending. In this context, they shared the view that decentralization of public spending should be conditional on an improvement in the effectiveness, reporting, and monitoring of local government spending. Directors welcomed, however, the shift in spending from defense to the social and economic sectors since the Poverty Reduction and Growth Facility-supported program was adopted in late 2000, and encouraged further steps in this direction.

Directors were encouraged by the authorities' efforts to mobilize tax revenue by strengthening tax administration and reforming the tax systems, noting the rise in the ratio of collections to GDP in the last two years. However, they considered that there is room for further improvement in revenue collection, and urged the authorities to continue to implement the tax reforms in a timely manner. They welcomed the planned introduction of the value added tax and the tariff reform in January 2003, and urged the authorities to step up the preparations for these measures.

Directors endorsed a cautious monetary policy stance to maintain price stability, sharing the staff view that the authorities should keep interest rate policy under review. They considered appropriate the current exchange rate regime and policy stance. Directors welcomed the elimination of certain exchange restrictions, and encouraged the authorities to further liberalize the foreign exchange market and eliminate the remaining restrictions.

Directors urged the authorities to pursue vigorously their efforts to strengthen the financial sector and enhance its competitiveness, and to improve monetary management. They welcomed the ongoing efforts to address the difficulties of the largest state-owned bank. Many Directors recommended that the authorities reconsider the existing policy of not allowing entry of foreign banks, stressing that foreign banks would bring more diversified lending and enhance bank efficiency by increasing competition.

Directors stressed the importance of implementing other structural reforms that are conducive to economic growth and poverty reduction, including agricultural reform, capacity building, export promotion, the strengthening of the existing legal and regulatory framework, and civil service reform. They encouraged the authorities to accelerate the privatization program in order to spur private sector activity.

Directors welcomed the completion of the full Poverty Reduction Strategy Papers (PRSP), which should substantially help Ethiopia's fight against poverty. They commended the authorities for the wide and full participatory process with civil society and development partners. They observed, however, that more prioritization is needed and that there are downside risks to the implementation of the proposed policies and reforms, including the vulnerability of Ethiopia to exogenous shocks. Some Directors noted that the PRSP projections might be overly optimistic, particularly in light of the pressures currently facing Ethiopia. Directors agreed that the medium term macroeconomic framework incorporated in the PRSP should be carefully evaluated once additional external assistance is identified.

Directors noted the progress being made in improving the macroeconomic statistics in line with Fund recommendations, and urged the authorities to intensify their efforts in this area. They welcomed Ethiopia's intention to participate in the General Data Dissemination System.