Dents in a ‘Deep State’s’ Fiscal & Financial Meta Strategy & Public Policy

Dents in Ethiopia's ‘Deep State’

Fiscal & Financial Meta Strategy & Public Policy:

Stemming Macroeconomic Imbalances

Business After Hours

The Premier Networking Event in Addis!

Costantinos Berhutesfa Costantinos,

President, Lem Ethiopia – the Environment & Development Society & Chief Scout

A World Bank Memo asserts that the poverty-focused development & infrastructure development strategy has registered notable success. The shift in macroeconomic policy in the early 1990s has decisively contributed to stability, raised growth rates and created new margins of manoeuvre for sectoral and structural tranfromaion.

Nonetheless, in effect, Ethiopia’s growth potential is yet to be mobilised, mired by self-reinforcing dynamics locking the country in low fiscal equilibrium.

Statement Of Challenges

• The state still has snags in demarcating its governing and mercantile roles, resulting in significantly tinsel fiscal behaviour, chronic deficit in economic orderliness, tainted by graft and influence peddling.
• State-owned arenas of financial intermediation, airlines, shipping lines, telecommunication, power generation and transmission are haemorrhaging the economy when they can actually be agents of transformation under a liberalised regime.
• The IMF (2011) main concerns stem from trajectories that threaten Ethiopia’s macroeconomic stability. The alarm is predicated on
• heavy financing needs that have not been secured & insufficient prioritisation;
• limited role envisaged for the private sector;
• high and rising inflation and entrenched negative real interest rates and debt distress;

“Ethos” of Policymaking in Ethiopia

As far as economic matters are concerned, in one sense or other, profits are evil, and that the search for profits involves, in one form or another, the exploitation of the rest of society. Things done in the public sector tended ipso facto to be viewed in a positive light; those done in the private sector were correspondingly viewed with suspicion. The idea that market forces could be trusted to bring about a socially desirable outcome is given almost no credibility at all by the Ethiopian elite (Harberger, 2010:4).

The state is committed to alleviating poverty via private sector development and integrating Ethiopia into the global economy. However, it is slow to privatise large state-owned Enterprises, allow for private ownership of land, or open the financial sector to foreign competition (Kiyota, et al., 2007:5).

Issues for Discussion

Questions provided by the Organizers

• What are the causes of macroeconomic instability?
• How do we lower the level of debt distress, protect growth and restore the stock of foreign exchange?
• What is the impact of inflation?
• Does the recent reform initiatives addresses the challenges in the economy adequately?
• if not, to put the economy on the right track, what should be done?

This is a tall order that may need weeks of discussion but will focus on Financial Repression, Intermediation & Liberalisation

According to McKinnon (1973) and Shaw (1973), a repressed financial market discourages savings, retards efficient allocation of resources, increases the segmentation of financial markets and creates financial disintermediation of the banking system. This orthodoxy has brought a shift of emphasis in policy priorities of the World Bank and IMF, as the result, they are strongly challenging the wisdom of the conventional financial repression.

As such, they pointed out the important role of the financial sector in increasing the volume of savings because it creates appropriate incentives. In order to reach higher savings and hence investment rates, they argue that governments should abolish interest rate ceilings and allow real interest rates to be determined by the market. This they argue will lead to increase in savings and investment and ultimately lead to economic growth as well as bringing inflation down

(Owusu & Odhiambo, 2011).

There are multiple and deep-rooted controversy concerning the causal relationship between financial liberalisation and economic growth/development.

• Some suggest, by promoting risk-diversification, financial liberalisation fosters specialization, efficiency in capital allocation and growth.
• By generating international competition, it may also improve the functioning of domestic financial systems with beneficial effects on savings / allocation.
• On the other hand, financial liberalisation may be harmful for growth in the presence of distortions. It may trigger financial instability & misallocation of capital, which are detrimental for macroeconomic performance.
• The literature has not been able to settle this theoretical controversy - that it affects growth, some say the effect is positive, yet others say it is negative

(Bonfiglioli, 2005; Bumann, et al., 2012).

Inflation in the economy

A small amount of inflation is

often viewed as a positive effect on the economy.

• One reason is that it is difficult to renegotiate some prices, particularly wages downwards, inflation takes care of it!
• Inflation is also viewed as a hidden risk pressure that provides an incentive for those with savings to invest them, rather than have the purchasing power of those savings erode through inflation.
• Inflation also gives central banks room to manoeuvre, since it is a tool to control money supply / velocity of money by setting interest rates - the discount rate at which banks can borrow from the NBE.

Nevertheless, in general, rates above amounts required to give monetary freedom & investing incentive, are regarded as negative, particularly because in current economic theory, it begets further inflationary expectations.

Devaluation, exports & inflation

Devaluation by itself falls short of addressing the problem of exports, which reflects numerous and complex factors.

• In the first instance, given the role that the exchange rate peg had played in promoting domestic price stability, the most recent devaluations, which follows on the heels of a sequence of previous devaluations, leave open the question of maintaining macroeconomic stability while boosting export.
• It is not out of the question that the devaluation alone might prove to be disappointing in terms of its impact on trade performance, both in the very short term due to a J-curve response whereby the trade balance initially deteriorates as import costs are driven up while the export response is slow to take effect.
• The Marshall Lerner Condition (MLC) shows the conditions under which a change in the exchange rate of a country's currency leads to an improvement or worsening of a country's balance of payments.

Empirical evidence used to analyse the politics of financial liberalisation in Ethiopia.

Ethiopian Politicians & Pundits say that

• The development of a viable domestic banking sector will be threatened. Foreign banks have capital, experience and reputations; the sector is too young to compete.
• Entry by foreign banks will further skew credit allocation towards large-scale industrial, real estate and service enterprises and away from agriculture, small-scale and cottage/micro enterprises. Foreign banks will concentrate lending in urban centres using foreign funds, contributing little towards rural banking.
• Furthermore, foreign banks will “cherry pick” the best companies and sectors.
• Foreign banks would lend in foreign currencies, would not be interested in mobilising domestic savings, and may serve as conduits for the inward and outward flows of capital. This may cause foreign exchange and/or liquidity shortages, with potentially adverse effects on the country’s capital account.
• The concern is more pronounced in view of limited regulatory capacity of the NBE;

True, liberalisation has failed in developing countries not because of the defect of the system itself. The failure is attributed to the defects of other factors. Pill and Pradhan, 1997 in Kiyota, et al., 2007, stated that financial sector liberalisation in developing countries especially in Africa has been less successful because of absence of supportive policy conditions. Hence, it is hard to say that the justifications given are credible supported by sound analysis.

Capital markets

Credit and capital markets are a viable option for financing sustained growth s for 'market economic structures'. This comprises financial institutions, which provide intermediation processes required to speed up the pace of economic growth, facilitate the mobilisation of savings and channelling these savings into investment in agriculture, mining, industry, commerce and other tertiary services.

Capital markets provides opportunities for small and big savers to choose to hold their savings in either cash or securities or both. It is also important in both foreign direct and indirect investment. The impersonal nature of stock exchange transactions implies, for example, investors need not necessarily be in the country or be identified in their own names, they can buy and sell their securities without interference.

Given the internationalisation of capital markets, stock exchanges can facilitate debt-equity swaps & other debt conversion schemes.

Capital markets facilitate the privatisation of public enterprises as small investors have opportunities to invest in privatised enterprises.

Financial intermediation

The development predicament of Ethiopia could be attributed partly to the inadequacy of financial intermediation and mechanisms to mobilize the existing and potential financial resources for economic development. Savings and capital formation levels are low. Investment rates and performance levels are unable to generate sustained development. In effect, besides the mobilization of saving, improvement in the financial intermediation process is one of the critical preconditions for economic growth, transferring savings from surplus to deficit sectors and by doing so enhance investments that accelerate growth. This underscores the importance of capital markets in the financing development.

How do we create and sustain the enabling environment for macroeconomic stability and the establishment and development of capital markets in Ethiopia. What lessons of can we learn from other African countries in macroeconomic stability and development of capital markets?

Lessons from the African experiences in capital markets development over decades include:

• increasing reforms and liberalisation of financial markets in the growing internationalisation of capital markets; changing institutional structures of financial markets;
• tightening of prudential regulation of financial system;
• general inhibiting factors which are more prevalent in Africa vis-à-vis other countries;
• promotional programmes for capital markets through the education of the public;
• privatisation of public enterprises and capital markets development;
• mobilisation of foreign direct investment (FDI) resources through capital markets;
• debt conversion schemes such as debt-equity swaps and
• lack of access for and/or to the international securities;

Going Forward -

Concluding Remarks

• Credit & Capital markets will enable entrepreneurs the flexibility of tapping this source of finance as well as the discipline of working under pressure from stock or capital markets;
• Consultation and consensus-building between planners and policy-makers in government and different sectors and levels of the business community.
• Government information systems on micro-economic behavior including market networks or linkages between firms, and the specific requirements of technology transfer and adaptation.
• The government aims should be to reorient fiscal policy to meet the basic needs for public services and infrastructure, while eliminating inflationary domestic financing and avoiding protected reliance on external assistance.
• Lowering weight of the Government in the economy releases entrepreneurship development.
• Interest rates which favor of private investment -- removal of preferential interest rates.

Increased import substitution

A study by the AACCSA (Feyissa & Garomsa, 2011) recommends at the macro level (value chain context), strong vertical and horizontal linkages must be established among chain actors through value chain multi-stakeholders platforms to discuss common issues and find common solutions. National/regional level macro institutions need to orient public and private sector support providers on value chain as a development approach and its application. Private/public capacity building service providers should be stimulated to engage in the provision of information, business plan development, training on business management, accounting, auditing, inventory and quality control systems, etc.

Rebalancing the trade deficit

There are a number of policies that can be introduced to achieve an improvement in a country's trade balance – some of them focus on changing the growth of demand, others look to improve supply-side competitiveness.

• Improving trade performance in the short & long run takes expenditure-reducing policies
• designed to control demand and limit spending on imports - squeeze on demand,
• encouraging rising private sector saving and expenditure-switching policies - designed to change the relative prices of exports and imports - this causes changes in spending away from imports and towards domestic/export production;
• Examples of major economies with the largest deficit in current account balance (CAB), based on data from 2017 est. as listed in the CIA World Factbook are US, UK, Canada, Turkey, Brazil, France, Algeria, Argentina, Australia, Egypt, Mexico, Indonesia, India, Iraq, Colombia, Pakistan, Oman, South Africa, Lebanon and Kazakhstan.

On the supply-side improvements,

• Policies to raise productivity, measures to bring about more innovation and incentives to increase investment in industries with export potential are supply-side measures designed to boost exports performance and compete more effectively with imports. Time-lags for supply-side policy to impact are long.
• Policies to encourage business start-ups augurs on successful small businesses with export potential, investment in education and health-care to boost human capital and increase competitiveness in fast-growing and high value industries such as bio-technology, engineering, finance, medicine, investment in modern critical infrastructure to support businesses and industries involved in international markets. Protectionist measures such as import quotas and tariffs are rarely used because of international agreements (WTO).

Ethiopia’s capital projects and corruption draining the treasury

Ethiopia is on a major spree of building infrastructure in power generation and transmission, industrial parks, roads and rail links, sugar and fertilizer factories, etc… Some of these projects have been daring the economy because of corruption and state incompetence. Billions have been spent on this mega projects without significant revenues generated from their outputs.

• The sugar and fertilizer industries have failed after tens of billions birr in expenditure
• Power generation and transmission investment has yet to pay dividends (delays in hydro dam and transmission line construction), after hundreds of billions of birr expenditure;
• Corruption in high places and illicit financial flows (estimated at more than a hundred billion birr per annum) are hampering the economy ;
• Unaccountability in state expenditure (the Auditor General has indicated tens of billions missing);
• Commercial agro-investments have failed that could have fed the nation and substituted huge imports (350,000 hectares of land have largely gone defunct, many of the companies have left the country and the few remaining are still struggling to survive)

Thank You

Costantinos Berhutesfa Costantinos

costy@costantinos.net

https://addisababa.academia.edu/CostyCostantinos

Music - Elais negash, Sithed Siketelat by Tilahun Gessesse