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: Business Constraints and Firm Productivity..............................................................................................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: Types of Collateral Used by MSMEs........................................................................................................37 Table 2.6: 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. 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. 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. 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 of declining oil prices increase disposable real income and support stronger domestic consumption. The price decline will result in a 1.8 percent reduction in the price of goods and services, bringing welfare gains for the average household, but this reduction will be larger for urban households and wealthier rural households. 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 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 x 4TH ETHIOPIA ECONOMIC UPDATE – OVERCOMING CONSTRAINTS IN THE MANUFACTURING SECTOR 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. Productivity gains are a key factor in determining long-term economic growth and improvements in living standards. 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 $1,000 per worker per year enable 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, but firms in Ethiopia struggle to recruit candidates with appropriate hard (technical) and soft skills. 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. 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-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. Executive Summary xi 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 had a positive 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 6.6 percent and was expansion in FY14.1 Real GDP grew by 10.3 percent significantly higher than the 8.2 percent increase compared with 9.8 percent in FY2013 (Figure 1.1.1). in 2012/13. Within the crops category, oilseed Economic growth was driven mainly by the services showed a declining trend for now two consecu- sector, which accounted for about half (5.3 percent- tive years (Figure 1.1.3) due to a decline in the age points) of the growth contribution, followed by production of linseed (decreased by 2.1 percent industry (2.8 percentage points) due to an ongoing in 2013/14); and a combined drop of 24 percent construction boom. Agriculture, in turn, contributed in safflower and rapeseed. At the same time, 2.3 percentage points. The manufacturing sub-sector sesame—one of the major export items of contributed only 0.5 percent to the GDP growth, Ethiopia—increased production by 21 percent. less than the 0.7 percent contribution of the preced-  Construction value-added increased by 36 per- ing year. Real GDP per capita grew by 7.2 percent cent and was the major driver of the industry in FY14, which is close to the necessary 8.0 percent sector in 2013/14. With this, construction con- annual per capita growth rate needed for Ethiopia to tributed 2.2 percentage points to GDP growth 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 (%) 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 very volatile. Reserve money growth (the nominal contribution of all subsectors. The trade and anchor) increased by 21 percent in November 2014 hotel sub-sectors increased by 17 percent. compared to the deep –3.7 percent dive in December Foreign merchandise trade, which is one of the 2013 and recent peak of 24 percent in February 2013. items in the sector, increased by 13 percent in Part of the volatility comes from methodological 2013/14. Meanwhile, within the transport and changes, but they do not explain the full extent of ups communications category, Ethiopian Airlines and downs.2 In addition, the sale of a US$1 billion sov- activities increased by 13.3 and 6.8 percent in ereign bond in December 2014 would hypothetically passenger traffic and cargo services, respectively increase the foreign assets and accelerate the growth (Figure 1.1.4). In eleven months of FY15 (to May of reserve money unless NBE is able to sterilize its 2015), Ethiopian Airlines Cargo service increased effects. Current data seems to suggest that the latter is, by 26.2 percent and passenger service by 7.7 per- in fact, happening but a full picture has yet to unfold. cent—despite the Ebola outbreak in West Africa. Importantly, however, inflation was rather stable during Similarly, electricity generation showed substantial the volatility period of reserve money, which indicates growth from 12 percent per year to 45 percent a rising role of inflation expectations in the economy at per year in 2013/14; yet, power sales to industries the current time (Figure 1.2.2). Low inflation expecta- grew by only 4 percent against 12 percent, while tions have a stabilizing effect on inflation rates. an estimated 170MW of power is exported to Broad money is growing relatively faster, and neighboring countries. (Figure 1.1.5). credit growth to state-owned enterprises (SOEs) is the major contributor to that growth. Looking at Monetary Sector broad money growth shows a continuing growth pat- tern from 21 percent in March 2014 to 30 percent Inflation has remained in single digits for the last two in November 2014 (Figure 1.2.3). Net domestic years. In May 2015, the headline inflation continued credit growth reached 31 percent in November 2014 its upwards trend, albeit on relatively low levels, and (Figure1.2.5). Public sector credit continues to be reached to 9.4 percent. This is slightly faster growth the main driver with credit to the SOEs increased by than on average over the past 6 months mainly due to an 37 percent (year-on-year) in November 2014. With increase in food inflation. While food inflation increased this credit support, SOEs play an important role in the to 10.1 percent in May, up from 2.9 percent in October, economy as a main contributor to public investment non-food inflation remained stable (Figure 1.2.1). The aimed at closing the infrastructure gap. The share of decline in the global prices of fuel contributed to keep- public enterprises in total outstanding domestic credit ing the non-food inflation relatively low while food increased to 64 percent while the share of private prices, especially milk and milk products increased sector credit declined to 28 percent in five months substantially (about 24 percent in May); the latter is a of 2014/15. The share of central government credit result of a shortage of milk due to short season rainfall continues to contract (Figure 1.2.6). At the same time, failure, which caused low animal fodder. Overall, the the growth rate of private sector credit has decelerated rather low inflation over the past two years contributed sharply over the last year from 14.5 percent in 2014 to lower real interest rates, which meant that the maxi- to 5.7 percent in 2015. mum lending rate remained positive since December 2012. On the other hand, the real minimum deposit 2 The reserve requirement of banks was reduced from 10 to 5 percent rate was close to zero in September (Figure 1.2.4). in March 2013, but the National Bank of Ethiopia (NBE) issued CDs to sterilize liquidity. The CDs held by private commercial banks with Tighter monetary policy supported lower one year maturity were redeemed in March and April 2014, returning inflation even though reserve money growth is liquidity to the system. 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 Non-food Food and Non-Alc. Beverages. General 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 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.3 Within this group bonds are occasionally issued. Maturities of T-Bills range are the Commercial Bank of Ethiopia (CBE) and the from 28, 91, 182 and 364 days of which 91 days and Development Bank of Ethiopia (DBE). CBE holds 364 days are the most demanded terms. In December 80 percent of the total outstanding loans and invest- 2014, the country joined Ghana, Kenya, Senegal, and ment used to finance public investments and DBE is Ivory Coast in issuing their its euro bond raising US$1 a large holder of treasury bills. Consequently, finan- billion in 10-year bond 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 sectors.5 As issuer, the Ethiopian central Government banking sector credit has consistently been declin- is rated B1 with a stable look by Moody´s Investors ing from 66.5 percent in 2007/08 to 40.1 percent in Service, B by Standard & Poor’s Corp. and Fitch rat- 2013/14 (Figure 1.3.1). Similarly, the ratio of private ings, four and five levels below investment grade. Rating sector credit4 to GDP declined from 15.4 percent in agencies agree on Ethiopia´s continuing strong growth 2003/04 to 10.9 percent in 2013/14, and remained below the SSA averages for the period reviewed 3 As of June 30, 2014, there were 16 private and two state-owned com- (Figure 1.3.2). Overall, credit as share of GDP is on mercial banks, one state-owned development bank, one state-owned and 16 private insurance companies, 31 microfinance institutions, and five a downward trend and below the SSA average since capital goods finance companies. 2008 (Figure 1.3.3 and 1.3.4). This finding is consis- 4 The private sector credit is based on NBE definition, which includes private sector credit by DBE. Private sector credit by DBE includes credit tent with the trend of demonetization observed for to cooperatives and the private sector. Ethiopia in the 2013 Ethiopia Economic Update. 5 Deutsche Bank and J.P. Morgan managed the bond sale. 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 Government Bond Total Public Enterprises Credit Ethiopia LIC Average Tanzania Total Private Sector Credit 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 3.3–3.4: NBE and WDI. prospects, albeit its economy’s small size, low per-capita about 54.8 percent higher compared to the same period 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.6 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 1.9 percent of small firms have a loan or line of credit. to 2,208 in 2014. As a result, the ratio of total bank This rate is lower than among micro, medium, and large branches to total population improved to 39,834 from firms (6.0, 20.5, and 35.5 percent, respectively) and 49,675 over the past year, reflecting a significant annual corroborates with assertions that small firms struggle improvement in financial service outreach. As of June the most in obtaining access to finance since MFIs cater 2014, the banking system’s total net deposits showed a year-on-year increase of 23.7 percent. Likewise, MFIs mobilized a total saving deposit of Birr 11.8 billion, 6 This is described in more details in Chapter 2 of this Economic Update. Recent Economic Developments and Outlook 7 to micro-sized firms, and commercial bank clientele are a relative decline as a result of lower collection of non- predominantly medium and large firms. tax revenues.8 The non-tax revenue declined from 2.0 The small insurance sector has significant percent of GDP to 1.2 percent of GDP since state- growth potential both through public and private owned enterprises were allowed, for the first time, to insurance companies. The insurance sector remains retain earnings for reinvestment instead of paying divi- underdeveloped. Because most insurance is targeted at dends to the government. This was partly compensated the corporate market, focusing on general insurance, through additional revenues collected from domestic about 90 percent of the population does not have any indirect taxes (0.1 percent of GDP) and direct taxes type of formal insurance. Insurance premiums repre- (0.3 percent of GDP). The foreign trade tax remained sent about 0.47 percent of GDP for non-life insur- at a similar level to last year (Figure 1.4.3). On the ance, and 0.03 percent of GDP for life insurance. The other hand, external grants shrank from 1.5 percent market retail premiums are dominated by motor insur- of GDP 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.7 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 on in 2013/14. In total there are now 332 branches, of development projects as a share of the general gov- which over 50 percent are concentrated in Addis Ababa. ernment budget is generally high (59.3 percent) but showed a relative decline, mainly due to lower spend- Fiscal Sector ing on road construction (reduced from 3.9 to 3.6 per- cent of GDP) and, to some extent, lower spending on The budgetary stance at the general government level water. Government spending remains tilted in favor of has been cautious. The general government fiscal capital spending (10.3 percent of GDP) versus recur- deficit (excluding SOEs) remained modest at 2.6 rent spending (7.5 percent of GDP) (Figure 1.4.4). percent of GDP but increased by 0.7 percentage On the other hand, the general government point of GDP in 2013/14. The general government budget deficit envisaged a slight increase to 2.9 per- budget deficit including grants increased to 2.6 per- cent of GDP in 2014/15.9 The expenditure budget cent of GDP in 2013/14, compared to 1.9 percent of GDP in the previous year. A decline in revenue and 7 By 2013/2014, private insurance companies accounted for 78.6 percent grants that was faster than a marginal decline in total of the total capital of insurance sector of Birr 2.0 billion. The sector was opened to the private sector in 1994. expenditure deteriorated the fiscal deficit. The deficit 8 The contribution of direct taxes to revenues in Ethiopia is relatively was financed primarily from external sources (2.0 limited, which is a reflection of Ethiopia’s low-income economy that pri- marily depends on agriculture. The share of direct tax remained constant percent of GDP) with domestic financing contribut- at around 29 percent of domestic revenue in the past decade. Most of ing 1.3 percent of GDP while errors and omission the revenues from direct taxes are generated from payroll tax and taxes on profits of enterprises and individuals. The latter are low and volatile accounted for repayment of 0.6 percent of GDP. The with an overall declining trend; down from a maximum of 2.8 percent government continued to finance part of the deficit in 2001/02 to as low as 1.4 percent in 2007/08 before it recovered to 2.5 percent of GDP in 2012/13. The recent upward trend may coincide by issuing direct advances from NBE (Figure 1.4.2). with government measures in strengthening tax administration through Government revenues declined modestly from tax education, enforcement measures, automation of tax registration, introduction of a Tax Identification Number and related measures. 14.3 percent to 14.0 percent of GDP in 2013/14. 9 Nominal GDP growth for FY15 is estimate here at 18.7 percent (IMF The general government revenue performance showed 2014 Article IV report). 8 4TH ETHIOPIA ECONOMIC UPDATE – OVERCOMING CONSTRAINTS IN THE MANUFACTURING SECTOR FIGURE 1.4: Fiscal Sector 1. Primary 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 primary 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 20.0 160 17.8 17.7 18.5 140 15.0 14.3 14.0 14.2 120 Wage rate index 100 10.0 80 60 5.0 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 (5.0) 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 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- was financed through external borrowing (4.4 percent turing sector (see Chapter 2 for an in-depth analysis of of GDP) and FDI (2.7 percent of GDP),10 as well as the manufacturing sector). the drawdown of international reserve by 0.2 percent The large size of the civil servant salary increase of GDP. Foreign exchange reserves are low at about will likely have an impact on overall government 1.7 months of imports (the following year import) in expenditure in FY15. For FY 15, Birr 6.5 billion (US$331million) were provided through the budget 10 FDI inflows are above 2 percent of GDP for the first time since 2008, for the salary increase at the beginning of the year. likely reflecting a bettering of the investment climate in recent years. 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, Percent 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 deficit in percent 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. 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. Despite 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 per- 2013/14 despite the fact that it remained far cent compared to 3.7 percent growth in 2012/13. A below its historical growth, but the most recent primary driver of growth was the 26 percent capital developments in export performance are again a goods imports that are associated with government’s cause of concern.11 Export of goods increased by 5.8 large infrastructure investment activities. In terms of percent in 2013/14 from its decline of 2.5 percent in share in GDP, capital goods accounted for 8.2 percent 2012/13. In the past decade, export growth had aver- of GDP (far higher than earning from goods export), aged 20 percent per year. Export volumes improved and consumer goods import represented 7.0 percent in 2013/14 but negative price effects are still present of GDP in 2013/14. On the other hand, fuel and (Figure 1.5.3). Service export grew by 11.3 percent mainly due to an improvement in the number of passengers and cargo services of Ethiopian Airlines 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 (EAL). Overall, since 2010/2011, Ethiopian exports market. To illustrate: in 2010/11 over 60 percent of total revenues from have been on a declining path in percent of GDP 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 1.5.4). In addition, in nine month of 2014/15, total leather sector revenues over the same period (based on data from merchandise export declined by 3.0 percent against Ministry of Industry). 12 4TH ETHIOPIA ECONOMIC UPDATE – OVERCOMING CONSTRAINTS IN THE MANUFACTURING SECTOR intermediate goods constituted 4.6 and 4.1 percent the US$, Ethiopia is on an appreciation path against of GDP (Figure 1.5.6). It emerged that all major cat- all currencies that are depreciating against the US$. egories of imports increased in 2013/14. Despite the This is because the Birr is closely managed against the share of services import decline, it grew by 8 percent US$. The de facto exchange rate arrangement is classi- from 14 percent in 2012/13. In the nine months of fied as a crawl-like arrangement by the IMF (2013b). FY15, goods imports grew by 21.3 percent mainly The authorities describe it as a managed float with no as a result of the 47.5 and 19.3 percent increases in predetermined path for the exchange rate. The annual capital and consumers good imports, respectively; pace of nominal depreciation, however, has been stable fuel imports declined by 17 percent following the at 5 percent in recent years. Moreover, Ethiopia con- decline in the global oil prices. tinued to experience a positive inflation differential The real effective exchange rate continued to relative to major trading partners. An appreciated appreciate into 2014/15. The real exchange rate currency does not help improving export competitive- appreciated by 22.5 percent (y/y) at the end April ness and is a concern for the economy in a situation 2015 showing a cumulative appreciation of 71 per- of exports falling again over the period of only one cent since the nominal devaluation in October 2010 year. Maintaining a competitive exchange rate is an (Figure 1.5.8). Since the US$ sharply appreciated important component of maintaining external com- over recent months and the Birr is managed against 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 a 1.8 percent reduction in the international suppliers (Sudan, Saudi Arabia, and 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 Response time to changes in global oil prices is delayed in Ethiopia. Figure 1.6.1 shows that Crude oil prices measured by Brent halved from the retail fuel price adjustments are done on a monthly peak at US$108 per bbl in June 2014 to US$54 per (sometimes bi-monthly) basis depending on mar- bbl on average in the first quarter 2015. Following ket developments but that price changes in global four years of stability at around $105/bbl, oil prices markets of oil are not fully absorbed and that the have declined sharply since June 2014. A number of Ethiopian response is delayed. For instance, from factors have driven the recent plunge in oil prices: July 2014 to end-January 2015, the retail price of while both demand and supply factors play their roles, regular gasoline in Addis Ababa declined by 16 the decline was in considerable measure the result of percent while diesel oil and kerosene prices reduced technology shocks (hydraulic fracturing and horizon- only by 15 and 12 percent, respectively. One excep- tal drilling) that have made oil and gas markets more tion is jet fuel, which decreased by 34 percent during competitive, unwinding of some geopolitical risks that the same period. The downward corrections of retail had threatened production, changing OPEC policy prices are far lower than the decline in the world objectives, and appreciation of the U.S. dollar. (Global market crude oil price, which more than halved over Economic Prospects 2015). 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 53 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 decile in urban areas. Richer households spend a higher of their expenditure on petroleum, mostly kerosene. proportion of their expenditure on petroleum prod- The direct benefit to households of the 37 percent ucts and outputs of activities that highly depend on decline in the oil price in terms of expected household petroleum as input compared to poorer households. savings is equivalent to about 0.4 percent household The benefit of the oil price decline is progressive with expenditure.15 household income both in urban and rural areas The greater savings comes from the impact of (Figure 1.6.5). the price reduction on other goods and services, this Urban households benefit more than rural indirect effect amounts to 1.4 percent of household households: the poorest decile in rural areas would expenditure on average. Petroleum is a major input experience savings of 1.2 percent compared to in production activities. On average, it accounts for estimated savings of 3.5 percent for the poorest 11 percent of the intermediate cost of economic activi- decile in urban areas. The per capita consumption ties in the country (Ethiopian Development Research of urban households is about 80 percent higher than Institute (EDRI) Social Accounting Matrix 2006). rural households on average. In addition, there is a Staff simulations show that a 37 percent reduction in significant difference in the consumption patterns the price of petroleum products would bring about a of urban and rural households at similar consump- 1.8 percent reduction in the general price of consumer tion levels. Urban households consume more than goods and services. This is equivalent to saying that, all rural households of petroleum products and items else being equal, a household’s real disposable income that highly depend on oil as an input. As a result the would increase by about 1.8 percent. Since the direct benefit from the oil price decline is more pronounced effect is 0.4 percent, the indirect effect of the oil price in urban areas than in rural places. The benefit to an decline through other goods and services is about 1.4 average urban household is more than twice the aver- percent of household consumption. age benefit to a rural household (Figure 1.6.6). Although all income groups benefit as a result of the oil price decline, higher income groups ben- efit more with maximum estimated savings of 2.2 15 Simulations are in line with expectations: A 2012 study by the Ethiopi- an Development Research Institute (EDRI) found that the counterfactual percent for the richest decile and 1.6 percent for the increase of oil prices of 50 percent in 2012 led to a decline in real incomes poorest decile. In the lower scenario (18 percent pass of both rural and urban “non-poor” households and an associated decline of consumption of 2.1 and 1.3 percent, respectively. Poor households through), the poorest decile in rural areas would gain consume less oil-related products and hence their consumption “only” 0.6 percent compared to 1.7 percent for the poorest declined by 0.9 and 1.7 percent, respectively (EDRI, 2012). 16 4TH ETHIOPIA ECONOMIC UPDATE – OVERCOMING CONSTRAINTS IN THE MANUFACTURING SECTOR Inflation is expected to decline due to indirect Potential other Impacts of the Oil Price effects and improved expectations. Decline Fuel accounts for a small portion of the consumer Likely limited fiscal impact price index in Ethiopia and a 30 percent decline in oil prices reduces global inflation only by about The possible positive fiscal impact observed in many 0.4–0.9 percentage points. The GEP (2015) suggests other countries is likely to be limited since Ethiopia that a 30 percent decline in oil prices, if sustained, does not have a direct subsidy of fuel prices in place. would reduce global inflation only by about 0.4–0.9 In fact, there may be a negative fiscal impact from those percentage points through 2015. Furthermore, for fiscal trade revenues that are based on ad valorem rates 2016, inflation would return to levels prior to the where a decline in the unit price would lead to a reduc- plunge in oil prices. While country-specific circum- tion of revenues. In Ethiopia, most of the duties are in stances will in some cases influence the impact of fact ad valorem rates so there is likely to be a negative oil prices on domestic inflation, the direct impact in fiscal impact from this. The net effect is unclear, how- Ethiopia is expected to be minor since the weight of ever, because the government also consumes oil and fuel in the national consumer price basket is small: oil-related products; given data constraints the actual the “gas and liquid fuels” component of the consumer net effect cannot be estimated at the moment.17 price index (CPI) is 1.1 percent. Energy prices will be largely unaffected by the Lower cost of production may increase profits oil price decline. There are two main reasons for and investment this: (1) The role of hydropwer in Ethiopia’s energy mix is about 98 percent and fuel imports increase In Ethiopia falling input prices likely will have a at lower rates than the economy is expanding indi- mixed impact on the main productive sectors of cating a declining fuel intensity of GDP growth in the economy: (1) The largest impact may be on agri- Ethiopia; (2) There is limited correlation between culture production, especially where fertilizer usage is energy prices16 in the CPI against oil price develop- instrumental, and transportation costs of agricultural ments (Figure 1.6.7). This is the case as the consump- products are important. (2) In the export services tion weight of traditional sources of energy (i.e. solid sector the key impact is likely to come through trans- fuels like firewood, charcoal, and dung cake) con- port services, which accounts for about 60 percent of stitute the largest shares of energy consumption of the services sector, through lower operating cost of households (ranging from 87 to 95 percent in most Ethiopian Airlines (EAL). The declining oil price is a regions (including big regions) to about 73 percent in blessing for EAL since fuel accounts about 46 percent urban-oriented Harari and Dire Dawa regions; Addis of its operating expenses (2012/13). (3) Given the Ababa as the main urban center still has a share of 47 overall limited size of the manufacturing sector in the 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, 2013/14 110.0 100.0 90.0 33% 80.0 33% 70.0 19% 60.0 28% 50.0 40.0 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 15.0 700 10.0 600 500 5.0 400 300 0.0 200 –5.0 100 0 –10.0 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 –15.0 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 the next three years. Projections expect that the Challenges current drop in exports is temporarily (again) and that exports will increase in importance while invest- ment will slightly decrease its growth contribution Growth will remain high in the short term while gradually declining in the medium term. While a rising working age (Figure 1.7.2). The supply side growth contribution population will continue to support potential GDP growth, will continue to be dominated by services and see total factor productivity growth and investment are gradually a slightly lower industry sector over the next three expected to decline. Fiscal and external balances will slightly deteriorate until 2017, since deficit financed imports of years (Figure 1.7.3). The latter comes from the back- heavy machinery will continue. High growth and lower oil ground of renewed policy emphasis on the industry prices will drive further reductions in poverty. sector through GTP II, a second GTP that will cover 2015/16–2020/21. In order to industrialize and sig- nificantly expand the manufacturing sector in Ethiopia Outlook it is important to address some of the key bottlenecks identified in the next chapter, such as shortage of The recent fall in global oil prices is expected to skilled labor, access to finance and trade logistics. have a positive short-term economic impact on Fiscal and external balances will slightly dete- Ethiopia. The country is a net importer of fuel, riorate until 2017 as deficit-financed imports of which accounts for one-fifth of goods imports. The heavy machinery will continue. The current general growth effect is expected to be positive in part because government accounts reflect a cautious stance at –1.9 declining oil prices increase disposable real income percent, which is possible as SOEs have taken on and support stronger domestic consumption. The oil significant parts of the public investment program of price growth effect is projected to be three-fourth of the country (and they are not included in the general a percentage point (see Chapter 1, Section B). government accounts). Staff estimates indicate that But the high double-digit growth rates of the this is going to dip to –2.9 percent due to faster spend- past decade will likely fall over the medium term. ing of general government (Figure 1.7.4). At the same Projections of potential GDP growth indicate a slow- time, the chronic current account deficit will further down in the medium term due to declining Total Factor deteriorate, driven by soaring imports to support the Productivity (TFP) growth (Figure 1.7.1 and Table 1.2). public infrastructure program. The current account Simulations of real GDP growth depend on three factors: deficit is expected to reach –8.8 percent of GDP in 1) TFP growth; 2) the share of the working age popula- 2017 (Figure 1.7.4). tion; and 3) capital stock. TFP growth is estimated using Poverty in Ethiopia saw the second fastest rate a Hodrick-Prescott filter for the 1970 to 2008–10 period. of reduction in Africa over the past 10 years. The Since TFP growth was exceptionally high during the poverty headcount fell from 38.7 percent in 2005 to growth acceleration, this would lead to gradually declin- 29.6 percent in 2011, measured by using the national ing TFP growth going forward. The economy’s potential poverty line. Measured with the international poverty to grow depends partly on its labor supply, which in line (US$1.25 per day) Ethiopia saw the second fastest Ethiopia’s case is expected to grow healthily over the next rate of reduction in Africa. Economic growth, par- couple of decades. Finally, the capital stock depends on ticularly in agriculture, has been an important driver assumptions about public and private investment. With of poverty reduction in the last decade. Each percent falling growth rates of capital stock, potential growth will of overall growth reduces poverty by 0.55 percent, but decline on account of declining TFP growth. each percent of agricultural growth reduces poverty by Economic growth will see a rising importance 0.9 percent. Favorable weather conditions and improv- of exports and an abating role of investment over ing terms of trade for rural producers have been drivers 20 4TH ETHIOPIA ECONOMIC UPDATE – OVERCOMING CONSTRAINTS IN THE MANUFACTURING SECTOR of this past trend supported by strong improvements households in the richest decile will see reductions in access to basic services and rural safety nets. Low in prices of 2.2 percent, while poorer households levels of inequality have been maintained with the will have reductions of 1.6 percent. For those rural Gini coefficient remaining stable at 0.30. households that depend on cereal sales, welfare gains High growth and lower oil prices will drive from lower consumer prices may be partially offset further reductions in poverty. But poverty reduc- by lower cereal prices. Lower oil prices reduce import tion from agricultural growth will be lower than in prices and require local cereals to be more moderately the past due to less favorable weather and weaker price priced to be competitive. gains for producers. In contrast, urban poverty rates An appreciated real effective exchange rate does will fall faster than in the past owing to an increase not help competitiveness, especially in manufactur- in the number and the quality of urban jobs as well ing. The real exchange rate appreciated by 22.5 per- as lower inflation. cent (y/y) at the end April 2015 showing a cumulative appreciation of 71 percent since the nominal devalu- Challenges ation in October 2010 (Figure 1.5.7). In addition, Ethiopia is now on an appreciation path against all Continued infrastructure improvements offer the currencies that are depreciating against the US$. There single best growth prospects for Ethiopia due to is concern that the appreciated currency does not a still large infrastructure gap and high economic help improving export competitiveness; much more, returns. However, rising debt levels and borrowing since exports are falling again and the Government is costs suggest a need to rely on complementary ways to trying to encourage a thriving manufacturing sector closing the infrastructure gap (such as public-private to develop. Maintaining a competitive exchange rate partnerships [PPPs]) in addition to debt-financed pub- is an important component of maintaining external lic investment. Moreover, a gradual phasing-in of the competitiveness, but its macroeconomic effects, for private sector via credit and foreign exchange markets instance on import prices and inflation need to be is also warranted to reap relatively higher returns to managed closely (World Bank, 2014a). private investment. Slow recovery in advanced economies and Rates of poverty reduction will decrease. The slower growth in emerging markets and weather rate of rural poverty reduction will likely be slower shocks all exert potential risks to the Ethiopian than in the past given the failure of the 2014 Meher economy. Risks associated with sluggish growth in rains in Oromia and Somali regions, and modest advanced economies and slower growth in emerging terms of trade increases for cereal producers. While markets relate to further commodity price declines lower fuel prices will reverse the worsening ToT that with a negative impact on Ethiopian exports and farming households experienced in 2014, ToT gains also to declining remittances and FDI. In addition, will not reach the levels observed during the period Ethiopia’s domestic agriculture sector remains vul- from 2008–10. nerable to weather-related shocks. Food production Lower oil prices will aid poverty reduction. remains largely rain-fed and adoption of improved This comes through a reduction of consumer prices varieties and farming practices remains limited. by an estimated 1.8 percent for the average Ethiopian Prolonged droughts would manifest higher food prices household. This reduction will be relatively larger for with associated impacts on inflation and poverty lev- urban and wealthier households Consumer prices els. In order to mitigate these risks, structural reforms of urban households will be reduced by 3.4 percent to diversify exports and development of irrigations compared to 1.4 percent for rural ones. Likewise, 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 engineer- ing 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 deliberate 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 deliberate policy jobs. The share of employment in agriculture is rela- focused on the development of the manufacturing tively unchanged between 1999 and 2005, but then sector, for instance through the use of Industrial Parks declined from 80.2 percent in 2005 to 77.3 percent (IP) to attract Foreign Direct Investment (FDI). To in 2013 (Table 2.1. and Figure 2.1.4). At the same, bundle efforts and facilitate this transformation the the largest relative gains were recorded by other ser- Government puts special focus on five sectors thought vices (1.3 percentage points) and construction (1.2 to maximize the country’s endowment and compara- percentage points). Commerce registered a decline tive advantage in the manufacturing sector: textiles of 2.3 percentage points. The share of employment and 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 discourse 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 reforms 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 firm (including finance and imported raw materials). For reports labor costs of about $1,100 per worker (based new entrants into the market, Ethiopia appears to have on Enterprise Survey Data, 2011).. Although this is a preference for foreign investors over domestic ones slightly higher than in several of the comparator coun- (largely SMEs). To some extent this reflects the nature tries, including Bangladesh, Cote d’Ivoire, Tanzania, and extent of business entry challenges such as starting and Nigeria, labor productivity is also lower in these business regulatory aspects, land access for FDI, and countries. For the countries where labor productiv- institutional support. In addition, with the exception ity is higher or similar to Ethiopia, labor costs are of the leather sector, firms in the priority sectors high- 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 one-year increase in the average education of a pro- large firms seem to survive, and to exhibit a higher duction worker is associated with an increase of 33 productivity. However they are also stagnant and do to 41 percent in various measures of labor productiv- not show any increase in productivity. ity. Consequently, increasing enrollment at all levels above primary education, as well as improvements to Skills and Productivity25 the overall quality of education delivered through the Ethiopian education sector, should have a strong and A key determining factor of productivity is the positive impact on firm-level productivity ability of an economy to supply the skills needed Skills shortages in Ethiopia constitute a key for companies to grow and to thrive, but firms in constraint to growth and improved productivity Ethiopia struggle to recruit candidates with appro- in the manufacturing sector, although data dem- priate hard (technical) and soft skills. As Ethiopia onstrates variation by firm size, the age of the firm, moves towards the goal of achieving middle-income and other characteristics. Analysis demonstrates that status, its education sector policy should focus, inter larger and foreign-owned firms are significantly more alia, on the provision of a diverse range of Technical likely to cite poor skills as an impediment to increased and Vocational Education and Training (TVET), productivity in the manufacturing sector. This obser- and second-chance general education programs vation resonates with the findings of an analysis of for primary and secondary graduates who seek fur- light manufacturing in Africa (World Bank, 2012), ther education and skills development (Joshi and which highlighted the poor supply of appropriately Verspoor, 2013). Experience from the East Asian skilled labor as a major obstacle to improving the com- tigers suggests that FDI was able to capitalize on a petitiveness of the manufacturing sector in Ethiopia. large pool of trainable labor, enabling investors to For employers the most common sought after improve productivity while benefitting from low worker skill relates to work ethic and commitment production costs. Empirical studies show that the gap (World Bank, 2014b). Among all manufacturing between Ethiopia and China is explained by workers firms regardless of size, the most desired skills are in Ethiopia being less educated and poorly equipped “soft” rather than technical (Figure 2.3.1). A reason (World Bank, 2012).26 for the high interest in work ethic and commitment A more literate and trainable labor force could could be that the Ethiopian manufacturing sector is make Ethiopia more attractive to international still relatively underdeveloped and not heavily reliant firms seeking low-wage countries. As wages rise on more technical production. Moreover assembly in China, emerging market economies will become line production requires discipline, timeliness, and more attractive to international firms, resulting in the relocation of low-skill intensive manufacturing jobs to 25 This section draws from the recent World Bank Policy Note Ethiopia: other low-wage countries, offering an unprecedented Skills for Competitiveness and Growth in the Manufacturing Sector opportunity to low-income countries like Ethiopia (World Bank, 2014b). A key source of the work in this section is the Ethiopia Skills Module (2013). The module is a survey that was conducted (Chandra et al. 2013). However, firms seeking a low- specifically for this study in 2013. The sample is a sub-set of the firms wage workforce need a minimum skills base in order interviewed in the Ethiopia Enterprise Survey, including 100 manufactur- ing firms surveyed in Addis Ababa. The skills module included questions to train workers at low cost (Spence 2011). relating to demand for skills, vacancies, and interactions between firms The productivity of firms is strongly and and TVET institutions. 26 The reason for the large impact of education on labor productivity can positively correlated with worker education and be explained by the fact that less educated workers are unable to read training in Ethiopia. This is particularly pertinent instructions or operate machines properly. It is easier to train workers with some basic level of literacy and numeracy. Moreover, goods pro- given Ethiopia’s relatively poor secondary education duced by less educated workers are poor in quality and uncompetitive enrollment profile. In the manufacturing sector, a in the global market. 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. team coordination. Across all firm groups, almost Ethiopia has made significant progress in a third of firms’ most desired skills are technical in expanding access to primary education and has nature (technical, computer, or information technol- successfully reached a gross enrollment ratio in ogy skills). However, positions in skilled production primary education comparable with middle- form proportionately the largest share of reported income countries. However the overall education vacancies (Figure 2.3.2). Younger firms and large profile remains low and the country lags behind even firms take much longer to fill vacancies than other lower-middle-income country enrollment averages companies, especially for positions requiring skilled at all other levels of education. While these should production skills, managers, and professional qualifi- remain long term goals for the Ethiopian education cations (Figure 2.3.3). Addressing the skills deficien- sector, industrialization can be scaled up rapidly by cies is critical in light of the fact that the majority of targeting promising sectors in so called light manufac- firms would like to expand their workforce. turing or agro-processing where relative modest skill Growth and Transformation through Manufacturing 31 requirements suffice (World Bank, 2012). The profile that the current context is coherent with policy and of a lower-middle-income country demonstrates gross the implementation thereof. enrollment rates in lower secondary education of 80 From the perspective of firms, the low engage- percent—and Ethiopia has a long way to go in order ment between firms and TVET institutions as a to get there. Despite the fact that enrollment in all source of technical workers is one of the key con- secondary education grew by almost three percent straints on increased productivity. While there are between 2006 and 2011 the national enrollment a high number of vacancies for skilled production ratio for the first cycle of secondary education was workers, only a minority of firms contact TVET insti- only 17.3 percent in 2011/2012.27 Overall, the cur- tutions regarding vacancies. In a recent survey, only rent education attainment profile in Ethiopia is still 14 of 60 firms surveyed reported contacting TVETs low, equivalent to that of Vietnam in 1960. A lower to fill outstanding technical positions (Ethiopia secondary level of educational achievement endows Skills Module, 2013). In the same survey, only half students with the basic knowledge and requisite of firms reported hiring TVET workers directly from cognitive and behavioral skills that signal a trainable an institution. workforce to potential FDI. 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 and medium enterprises and the acceleration of students, in turn contributing to high dropout rates employment generation. The GoE has developed a from TVET courses of study. The problem is exacer- National TVET Strategy to improve the quality and bated by poor communication with prospective and relevance of the TVET system to more effectively enrolled students regarding these issues. The TVET address the challenges of unemployment and low agency currently does not have any information pro- labor productivity (Ministry of Education of Ethiopia grams aimed at prospective students. While several 2008). The main objective of the TVET sub-sector TVET colleges have implemented their own outreach is to train middle-level manpower for participation initiatives, these programs have not been standardized in the economy. While Ethiopia has made admirable and are uneven in quality. progress in improving the policy framework for TVET, significant challenges remain with regard to ensuring 27 Education Statistics Annual Abstract (2011/2012). 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. Despite an explicit policy of engaging the pri- in practice, chambers of industries and other repre- vate sector to improve the TVET sector, mecha- sentatives of the private sector have not been involved nisms to facilitate integration of private sector in a process of consultation, and input that informs needs into the TVET curriculum and operational changes to occupational standards remains limited to standards have not been established. In order to various government ministries. improve quality and certification, the GoE is in the In summary, this analysis has shown that to process of transitioning the TVET system to an out- increase productivity of firms Ethiopia’s education come-based approach. An assessment for Certificate sector will need to develop and supply the appropri- of Competency has recently been rolled out in most ate managerial, technical and soft skills within the TVET institutions, and the GoE hopes that the intro- workforce. But improving Ethiopia’s overall educa- duction of the certificate will help address problems tion profile will take many years, so promising sectors associated with the poor quality of graduates from in light manufacturing and agro-processing could TVET programs. New curricula have been adapted be scaled-up by focusing on relatively modest skills in line with changes to occupational standards, and in development in the meantime. To this end, TVET order to graduate, TVET trainees are now required to programs and second-chance education programs, pass assessment tests based on occupational standards. tailored to private sector needs will be important In theory, occupational standards and assessment tools instruments to upgrade managerial and technical are intended to be prepared with input from industry, skills, especially among small-scale operators already the TVET institutions, and external experts. However, 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 2.4.1 Private investment, both domestic and foreign, is crucial for provides the top 10 business constraints cited by the developing the manufacturing sector. A better investment Doing Business report. And according to the World climate that fosters the growth of existing firms, while encouraging the creation of new firms is key to attracting Economic Forum’s Global Competitiveness Index and increasing private sector investments. The business (2014 and 2015), the top five problematic factors environment affects the performance of all firms, irrespective for doing business in Ethiopia are: inefficient gov- of their size, however certain aspects such as regulatory ernment 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 to SMEs as firms in Ethiopia are more likely to be credit of infrastructure. This is supported by results of a constrained than global comparators. There is strong 2014 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,28 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. The business environment affects the pro- ductivity of firms. Over the last decade, the invest- Private investment, both domestic and foreign, is ment climate in Ethiopia appears to have worsened crucial for developing the manufacturing sector. leading to the continuous deterioration of the per- Key to attracting and increasing those investments is formance of individual firms overall even though to better the investment climate to foster the growth of existing firms, while encouraging the creation of 28 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: Business Constraints and Firm Productivity 1. Top 10 Business Environment 2. Firm-Level TFP Growth Estimates Constraints 100% Access to finance 80% Electricity 60% Access to land Corruption 40% Transportation 20% Practices of the informal sector 0% Tax administration –20% Tax rates Customs and trade regulations –40% 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Inadequately educated workforce 0 10 20 30 40 Percentage of firms Aggregate Average Median 3. Labor Productivity Growth in Addis Ababa 60% 50% 40% 30% 20% 10% 0% –10% –20% –30% 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Aggregate Average Median Sources: (1) Enterprise Survey (2011); (2) and (3) based on World Bank (2014c). Note: Productivity is calculated for all firms irrespective of sectors. 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. some recovery occurred in 2009–2011. The medium enterprises, particularly SMEs, access to finance, individual firm appears to have experience a drop access to land, reliability of electricity, and taxation in productivity as measured by changes in TFP will need to be addressed. In addition, for large firms growth and in labor productivity growth. (Figures (FDI and exporting) improving trade logistics and 2.4.2 and 2.4.3). reducing skills gaps remain imperative for enhancing The specific nature and relative importance of competitiveness. Similarly, business entry regulations binding constraints will vary according to the sec- and processes that obstruct firm entry and dynamism tor and firm size; these will need to be addressed require attention so that young firms are encouraged both at the operational and entry level (World to establish. Reforms and interventions to address Bank, 2014c). In order to improve productivity of these constraints can be prioritized and sequenced Growth and Transformation through Manufacturing 35 according to three guidelines: 1) focus on sectors and than firms who are not credit constrained. Investment sub-sectors that demonstrate the most promising decisions of manufacturing firms in Ethiopia are heav- comparative advantage and job growth; 2) imple- ily dependent on cash flows. ment measures which are the most cost effective in Access to finance remains a top obstacle for the short and long runs with the least fiscal impact; enterprises in Ethiopia. As shown in Table 2–4, firms and 3) assess implementation capacity, implication consistently identify access to finance as one of the for governance and the political economy of policy top five obstacles to doing business in Ethiopia, rated reforms. as the third most binding constraint in the Global Competiveness Index 2015 and number one in the Access to Finance: Particular Challenge for Enterprise Survey 2011. According to the Enterprise SMEs29 Survey, this is perceived as the main business envi- ronment constraint by micro (41 percent), small (36 Financial intermediation is a driving force for eco- percent), and medium (29 percent) enterprises in nomic development—an expansion in credit to the Ethiopia, compared to a SSA average of 24, 20, and private sector enables firms to invest in productive 16 percent, respectively (Figure 2.5.1). The same data capacity, thereby laying the foundation for a sus- indicates that almost 93 percent of small enterprises tainable growth path. However Ethiopia is falling and over 95 percent of medium enterprises have either behind its peers in financial intermediation. In 2011, a checking or a savings account (a percentage higher credit to the private sector was equivalent to about than the respective SSA averages) but only 3 percent 14 percent of GDP compared to the regional average of small enterprises and 23 percent of medium have of 23 percent of GDP (FinStats, 2012). Moreover, a loan or a line of credit. while the global trend has been an increase in private Young and small firms appear to face more seri- sector credit, Ethiopia has experienced a decline of ous financial constraints relative to those that are about 5 percentage points since 2004 (Figure 1.3.2). larger and more established. Across a range of finan- According to the Doing Business Report 2015, cial indicators created using the Ethiopia Enterprise Ethiopia ranks 165 out of 189 in the ease of getting Survey (2011), young and small firms are the most credit compared to the SSA average ranking of 122 likely to report that access to finance is a major con- and well-performing peers such as Rwanda which straint to their business operations and at rates higher ranks 4 of 189 economies (World Bank, 2015b). than other well developed African countries. In South Firms that are fully credit constrained exhibit Africa in 2010, only 10.4 percent of SMEs rated access poorer performance and productivity. Firms in to finance as a major constraint compared to a much Ethiopia are more likely to be fully credit constrained higher rates in Ethiopia. than global comparators, including SSA countries. Overall, data indicates the existence of a miss- As illustrated in Figure 2.5.2, nearly half of firms ing middle phenomenon in terms of financial in Ethiopia are fully credit constrained. Fully credit services catering to small firms. Young and smaller constrained firms are those without external financing firms are much more likely to be rejected for a loan and were either rejected for a loan or did not apply or a line of credit than firms who are more established even though they needed additional capital. For firms, or larger (Figures 2.5.2 and 2.5.3). Moreover, despite being credit constrained means poorer performance confirming their need for improved access to finance, and less productivity. In Ethiopia, a credit constrained SMEs are discouraged from applying for loans due to firm has 15 percentage points lower sales growth, 5 percentage points lower employment growth, and 11 29 This section draws from the World Bank report: SME Finance in Ethio- percentage points lower labor productivity growth 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 2.5). 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 2.5: 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 2.6: 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 2.6), 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 Ethiopia30 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 MFIs31 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;32 92 percent of their total loans are disbursed to microenterprises while only 8 percent are issued to SMEs. Among banks, only the CBE reported 30 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. 31 The five MFIs are: OCSSCO, Adds*, Omo Micro, Wasasa, and The majority of financial institutions believe that Wisdom. 32 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.33 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 33 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.34 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 34 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.39 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.40 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.41 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.35 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 Operational constraints for FDI/Large export comparator countries.36 This low pricing undermines the oriented firms capacity of the national electricity company to finance network maintenance and upgrades of transmission and According to the Logistics Performance Index distribution grids. Strengthening of the grid network is (LPI), Ethiopia ranks 104th out of 160 economies an essential part of EEPCO’s strategy. A major focus of sector strategy is upgrading the network by reinforcing 35 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 36 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.37 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 37 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 38 Doing Business Report 2015 39 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).38 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 40 Ethiopia National Business Agenda (2014) hours spent. In addition, the threshold for a “type A” 41 Article 43 of the Value Added Tax Proclamation 285/2002. 42 4TH ETHIOPIA ECONOMIC UPDATE – OVERCOMING CONSTRAINTS IN THE MANUFACTURING SECTOR surveyed.42 It lags behind peers like Kenya (74th) and and shipping-related agencies are fully completed, it Rwanda (80th) but is ahead of Zambia (123rd) and is expected that trading will be simplified and costs Tanzania (138th). On specific components of LPI, and dwell time reduced. The recently approved Ethiopia performs better than its average rank (and Customs Proclamation provides the legal basis for score) in, logistics competence, and timeliness. the development of a modern customs administra- Overall, it fares poorly on infrastructure and inter- tion with more focus on facilitation than control. national shipments. Ethiopia has undertaken mul- Noteworthy key reforms introduced in the proclama- tiple steps for improving logistics infrastructure. It tion include: the introduction of the use of simplified undertook a major organizational merger of three customs procedures for authorized traders; pre-arrival agencies involved in trade logistics, shipping lines, clearance of goods; and use of risk assessment and maritime services, and dry ports. At the same time, post-clearance audit. investments to improve trade logistics in the medium term are ongoing. These include: several new public Entry Barriers investments in roads; a rehabilitated rail link between Addis Ababa and the rapidly modernizing container Business entry regulations and processes are consis- port of Djibouti43; the expansion of the dry port in tently highlighted by the private sector as burden- Modjo; and expanded coverage of the multi-modal some and obstructive of firm entry and dynamism. transport system. This is reinforced by the Starting a Business indicator Large firms also cite customs and trade-related that ranks Ethiopia 168th out of 189 economies vis-à- regulations as one of the top constraints that vis global comparators (Doing Business Report, 2015). drive costs up. It takes up to 44 days to comply This is therefore an area of concern for Government, with all procedures needed to export or to import because a growing body of empirical research shows at a cost of US$2,380 and US$2,960 respectively that simpler processes of business start-up are associ- per container (World Bank, 2015b; Figure 2.6.4). ated with higher levels of entrepreneurship and higher These procedures and documents involve different productivity. agencies, which require the manager to go in person New businesses face complex and bureaucratic to all those agencies. As a matter of fact, there is no entry procedures that have led to an escalation in legal framework in place to recognize documents time and cost for enterprises setting up business. To exchanged electronically in relation to e-commerce, obtain the registration and licenses, firms have to meet e-signatures and e-payments. All documents for multiple requirements, pay numerous fees, and inter- information exchange both between the private act with several agencies. Licensing of businesses in sector and government actors and between govern- Ethiopia is governed by the Commercial Registration ment actors themselves have to be provided to the and Business Licensing Proclamation (CRBLP No. authorities using a hard copy. Also, it is reported by private sector that there is lack of staff with sufficient experience in custom procedures, and those who 42 The LPI comprises six indicators on customs, infrastructure, interna- officiate have limited mandate for decision making tional shipments, logistics quality and competence, tracking/tracing and timeliness, as assessed by international freight forwarders. (World Bank, 2014a). 43 Modernization of the Djibouti port is important, but similarly Modernization efforts are underway as importance needs also be placed on ways to reduce the very high port handling charges, which are very high and hurt the competitiveness of the Ethiopian Revenue and Custom Authority manufacturing industries exporting through the port. (ERCA) plans to upgrade its customs process- 44 The electronic Single Window is an electronic facility that will allow all traders involved in the import/export/transit business to discharge all ing system and implement an electronic Single their regulatory obligations with relevant government agencies electroni- Window.44 Once the coordinated reforms in customs 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 1992–2014 and 2008–2012 – 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 1992/2014 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 686/2010).45 Engaging in any commercial activity the cumulative data for all domestic, foreign and without registration and obtaining the appropriate public firms trying to enter the Ethiopian market license is prohibited. A business will have to comply is not encouraging as just 5 percent of firms are with about nine steps to obtain a license (IFC 2014).46 moving from pre-implementation to operations There are 35 different competence-certifying agencies, (Ethiopia Investment Agency). The picture changes which clearly could benefit from rationalization. In significantly when only FDI “conversion” from addition, all business licenses and many of the com- pre-implementation to operations phase is exam- petency certificates have annual renewals. Some of the ined: nearly one in three “intended” FDI becomes bureaucratic processes are centrally managed such as operational49 (Figure 2.5.4). While FDI has a better the trade name registration, thus creating an extra bur- “conversion” rate over domestic investors, there is still den for domestic businesses located in the regions.47 room for substantial improvement. Currently 2 out Ethiopia has a de facto preference for foreign of 3 potential FDI firms do not reach the operational investors over domestic ones, which needs to be state. Even though an OSS service is operational its carefully balanced to ensure a level playing field. effectiveness record is mixed. Bureaucratic hurdles The nature and extent of business entry challenges continue to affect project implementation along with differ between FDI and SMEs and where the firm entry obligations remaining burdensome and time- is established. Entry constraints related to business consuming for investors. Further research is needed licensing and registration processes are more severe for to identify those factors that facilitate the conversion domestic firms than FDI. While FDI firms are sup- of successful FDI in Ethiopia. ported by the former Ethiopian Investment Agency (newly reconstituted as the new Ethiopian Investment 45 The Commercial Registration and Business Licensing Proclamation Commission, EIC), domestic investors have to deal No.686/2010 (the CRBLP), and the Commercial Code as amended by with local investment offices with a lower capacity than piecemeal legislation of various kind, promulgated at different times, provide the general legal framework to govern registration and licensing the EIC. As part of the One Stop Shop (OSS) service, of businesses. The licensing regime provided for by the CRBLP applies FDI firms are offered commercial registration, compe- to all business activities except in a limited number of sectors that are regulated by specific laws. tency certification, business licensing, and issuance of 46 IFC, Inventory of Business Licenses (April 2014.) construction permits, among other important services 47 It is worth noting that there is a positive development towards the decentralization of trade name registration in Ethiopia. Through the at the EIA. Equally significantly, the EIC is expected support of IFC/WBG, the Ministry of Trade is rolling out the Online to provide services following up on critical steps Trade Registration and Licensing System to the regions that would, among other things, enable them to register trade names in their re- on behalf of the investors related to access to land, spective regions. loans, access to utilities, residence permit requests, 48 According to the Ethiopia Investment Agency (EIA), an enterprise entering the Ethiopian market goes through three phases in setting up and approval of environmental impact assessments. a business, classified as follows: pre-implementation, implementation In addition, FDI firms enjoy a preferential access to and operation. At the pre-implementation phase, firms declare their intention to invest in the region and claim an allotment of land; at the land—in some cases, free or subsidized land. This dis- implementation firms effectively receive the land and start construction crimination is particularly observable in Addis Ababa and installation of machinery; and at the operation phase firms are al- lowed to start operations. Each phase requires compliance with multiple where land is scarce. steps in terms of processes, time, and cost. Cumulatively more FDI firms succeed in 49 A similar, albeit slightly lower, estimate has been reported by another study by Sutton. (EIA, A New Direction LSE, August 2012). Of the moving from the investment stage to operational total number of licensed firms, only about 23 percent of firms become phase than domestic firms.48 From 2008–2012, 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.51 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.52 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.53 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,50 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 50 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 51 Labor-intensive manufacturing sector is also referred as light manu- investment climate while giving the Government time facturing. 52 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. 53 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.54 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)55 in operation.56 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 54 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 55 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 56 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;58 vi) environmental tions.57 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 57 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. 58 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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