By Jiro Honda | IMF African Department

The IMF approved a $50 million loan for Ethiopia to help its economy adjust to the steep increases in international prices of fuel, fertilizer, and cereals in 2008.

The price increases considerably weakened Ethiopia’s international reserves position and contributed to inflationary pressure.

The IMF Executive Board’s approval of the loan, based on sound policy commitments from the authorities, will help the East African country rebuild international reserves and catalyze financing from other international partners.

Recent reversal of some international commodity price hikes suggests that the exogenous shocks to Ethiopia’s economy may prove temporary. Nevertheless, the authorities, while pursuing macroeconomic adjustment, intend to take advantage of this opportunity to rebuild foreign exchange reserves to levels covering 1.8 months of imports by the end of the current fiscal year, in line with their medium-term objective.

Ethiopia’s loan was approved under the rapid-access component of the Exogenous Shocks Facility. “Together with stepped-up assistance from Ethiopia’s other international partners, the IMF’s financial support under the Exogenous Shocks Facility will help to mitigate the risk of an erosion of Ethiopia’s gains in poverty reduction in recent years.” said IMF Deputy Managing Director Takatoshi Kato.

Policy commitment

To mitigate the impact of exogenous shocks on the balance of payments, address domestic economic imbalances, and protect Ethiopia’s most vulnerable people, the authorities have taken or intend to take key policy measures including

• Eliminate domestic fuel subsidies. The fuel subsidy was abolished in October 2008 by adjusting regulated domestic prices to import parity. From now on the authorities will review domestic fuel prices monthly, adjusting them as needed but keeping a margin above world prices in order to repay the debt of the Oil Stabilization Fund.

• Mitigate the impact of high food prices. In late 2008 the government imported wheat equal to more than 3 percent of domestic crop production and distributed it to low-income families and flour mills at import cost—well below domestic prices. It is prepared to do so again if necessary.

• Significantly tighten fiscal policy and eliminate domestic borrowing. In the revised 2008/09 budget, general government domestic borrowing is targeted at zero —down from 2.7 percent of GDP in 2007/08—by containing expenditures and enhancing revenue mobilization through administrative measures such as integrating the three revenue agencies.

• Reduce domestic borrowing by public enterprises. Such borrowing will be kept to 4-8 billion birr, 1.1-2.2 percent of GDP, in 2008/09, down from 4.4 percent in 2007/08, by limiting investment activities and also by repaying the debt of the Oil Stabilization Fund. The authorities have established an inter-agency committee to monitor key public enterprises and public institutions.

• Tighten monetary policy. The National Bank of Ethiopia plans to reduce broad money growth to less than 20 percent in 2008/09 from about 23 percent at the end of the previous fiscal year. It also intends to closely monitor and control money creation arising from its net lending to the government.

• Increase exchange rate flexibility. Reflecting this commitment, the official exchange rate against the U.S. dollar depreciated by 5 percent on January 15, 2009. This, together with a similar-size depreciation on January 2, brings the cumulative depreciation since end-2008 to over 10 percent.

Partners to raise support

Tighter economic policies to adjust to the shocks and domestic imbalances are expected to significantly slow Ethiopia’s economic growth in 2008/09. Given the intensifying global economic downturn, the planned adjustment path is also subject to considerable risks and uncertainties, particularly because Ethiopia is highly dependent on external resource flows from remittances, aid, and foreign direct investment.

Stepped-up donor assistance will help to soften the impact by providing financing for capital projects and foreign exchange for essential imports. This, along with lower import prices, should make it possible to rebuild foreign exchange reserves over the medium term. Ethiopia’s international partners have recognized the country’s difficult situation and plan to substantially raise concessional project financing and budget support.

Implementation key to success

Kato stressed that forceful implementation of Ethiopia’s adjustment policies is essential. This would not only ease the pressures on the balance of payments and domestic prices, but also lay the basis for sustainable economic growth.

“In the current global economic environment, there are significant risks that exports, remittances, and foreign direct investment may fall short of expectations. If this proves to be the case, additional policy tightening will be needed to preserve the viability of the balance of payments.” Kato stated.

Comments on this article should be sent to [email protected]