WASHINGTON, July 21 (Reuters) – The International Monetary Fund on Monday urged “forceful” policy tightening in Ethiopia to reduce inflation, as high oil and food prices also strain balance of payments.

The IMF said a year-long impact of higher oil prices will raise Ethiopia’s oil import bill by about $1 billion, or 3 percent of gross domestic product, over its 2006/07 level.

It projected economic growth in Ethiopia would slow sharply to 8.4 percent in 2007/08 from an average 11 percent since 2003/04.

“The recent signs of growing macroeconomic imbalances manifested as higher inflation and a weakening of the balance of payments suggest that demand is running ahead of capacity expansion,” the IMF said in its annual assessment of Ethiopia’s economy.

“Some supply-side factors may also have driven up food prices and thereby contributed to inflationary pressures,” it said, adding: “At the same time, the surge in world oil prices is placing a large strain on the balance of payments.”

Inflation in Ethiopia was almost 40 percent year-on-year in May 2008, driven largely by rapidly rising domestic food prices, while international reserves have fallen to 1.5 months of imports.

The IMF said restraining spending will be critical for the authorities to adjust to current conditions in Ethiopia, a country which has historically been prone to famine.

“Given the importance of public infrastructure investment, a tighter fiscal stance will require capital expenditure to be aimed at projects that enhance productivity and contribute most to economic growth,” the IMF said. “Restraint on domestic borrowing by public enterprises will be essential,” it added. (Reporting by Lesley Wroughton; Editing by Diane Craft)