Ethiopia’s guarded financial sector

Ethiopia is not a country I think of immediately when someone mentions a desire to invest, especially a desire to invest in the financial sector. So when the question “Does Ethiopia allow foreigners to invest in the banking sector?” was posed I was completely caught off guard, surely one of the fastest growing economies on the continent had to be open to foreign investment in their financial sector? As it turns out there’s a lot going on in Ethiopia, especially in the field of investment.

Ethiopia has an economic history and associated identity that has taken wild turns over the last century.  It started out as one of the most autocratic monarchies in the world that was ended in a coup lead by a Marxist–Leninist military junta, the ominously-named ‘Derg’. Communist Ethiopia saw its share of coups, wars and natural shocks during its 17 year duration but as the USSR’s power faded so did the ruling party’s power to defend itself and the era of communist rule came to an end in 1991.

As the country was recovering from decades of war and harmful policies from the Derg era, the democratically elected government opted for a state lead development approach. Foreign investment was limited to a few select sectors with added incentive for investment aimed at development needs, such as reduced capital entry requirements for joint ventures, duty free importation of capital goods, and a huge cut in the capital gains tax from 40{fdf3cafe0d26d25ff546352608293cec7d1360ce65c0adf923ba6cf47b1798e1} to 10{fdf3cafe0d26d25ff546352608293cec7d1360ce65c0adf923ba6cf47b1798e1}. Constitutionally land cannot be sold to foreigners as it is designated to belong to “the state and the people” but leasing of land is allowed for up to 99 years and the government prioritized obtaining land for foreign investors.

Sectors that used to be state owned and exclusively reserved for government investment, or joint ownership with Ethiopian citizens, stretched from services like rail and air transportation to electricity generation and supply. It was said that nationalizing these sectors would prevent development in favour of profit seeking ventures and subsequent neglect of rural communities. Many businesses and services in the trade sector were reserved for domestic investors, including broadcasting, retail and wholesale trade (except in petroleum and locally produced goods), import trade, and export trade of local agricultural products.

Some of these sectors have opened up in recent years and a programme to privatize state owned enterprises (SOE’s), managed by the Ethiopian Privatization Agency (EPA), was initiated in 1994. The EPA received a stock of 113 SOEs marked for privatization, these include enterprises from the manufacturing, construction, agriculture and agro-industry, hotels, transport, trade, and mining sectors. It was later merged with the Public Enterprises Supervising Authority, which became the Privatization and Public Enterprises Supervising Authority/Agency (PPESA) since 2004. However, during the high rate of growth Ethiopia elected to maintain domestic control over strategic sectors.

In an interview conducted last year (2014) on Ethiopia’s WTO accession progress and the reserved services sectors, Geremew Ayalew, director general of trade relations and negotiations at the Ministry of Trade, stated that the sectors reserved for domestic investors are of strategic value to the government especially during a time of rapid development and transformation, and that the status quo is likely to remain intact. Negotiations on Ethiopia’s accession are continuing with the latest round of membership and terms of reference revision posted by the WTO working group on the 20^th March 2015.

However, Ethiopia is likely to receive some pressure to reform its services sector policies from the working group parties. Although Ethiopia has made notable steps to move its accession process forward, the working group listed the following areas as likely to require further reform: investment and pricing policies, import regulations, customs procedures, export restrictions, state-trading enterprises, sanitary and phytosanitary measures, technical barriers to trade, intellectual property and services. The services sector negotiation documents are expected to be provided during the final stages of bilateral negotiations with WTO members.

The most recent ‘Investment incentives and investment areas reserved for domestic investors’ Council of Ministers Regulation announcement, 2012, stated that the banking, insurance and micro-credit and saving services are reserved for domestic investors. This continued desire to maintain domestic control of the financial sector is said to be driven by fear of losing control of the economy when liberalization takes place. This is an unfortunate and possibly harmful position the government has taken as numerous studies on the effects of financial sector liberalization in developing economies show a positive result, albeit the process does have to be carefully managed in order to minimise the potential for balance of payments shocks.

Currently Ethiopia’s financial market is underdeveloped. There is no stock exchange and the largest bank, the Commercial Bank of Ethiopia, is state-owned.

Even though a lot of work still needs to be done, we’re reminded of China’s marathon accession process of more than 15 years, the desire for full WTO membership is one of the greatest drivers of market reforms alongside the IMF’s Structural Adjustment Programs. Ethiopia’s Industry Minister and WTO Chief negotiator, M. Mekonnen Manyazewal, stated that WTO membership would mean an additional tool for economic growth and an improved means of alleviating poverty.

On the IMF front Ethiopia, under its lending arrangements, has an outstanding amount of just over US$ 200 million, and despite the small amount relative to its GDP is required to observe specific terms. In the annual IMF consultation 2014 (Article IV Consultation) the Executive Board observed that the sustainability of the current public sector-led growth strategy was threatened by several downside risks, specifically naming the external financing of the public investment program. Recommendations on mitigating these risks included greater policy coherence and appropriate structural reforms, with the aim of shifting the balance toward private sector-led, sustainable growth.

Additional efforts to attract foreign investment are underway as Ethiopia intends to tap into the international bond markets, specifically by issuing a euro bond. The credit rating agencies S&P, Moody’s and Fitch assigned Ethiopia a fairly stable rating (B, B1 and B respectively) upon which Ethiopia made its first sovereign-debt offering, selling $1 billion worth of Eurobonds to European and American investors. In addition the manufacturing and retail sectors have been opened up for foreign investors and national infrastructure plans, that would require foreign investment, are quickly taking shape.

The case for liberalization, especially in the financial sectors, seems like a pragmatic move but one that might require some convincing. It is most likely that the Ethiopian government will follow Deng Xiaoping’s well known dictum: ‘cross the river by feeling the stones one at a time’.