Ethiopia: Sinking In Debt? Far from it

Recent news on the size of Ethiopia’s external debt has shocked many and stoked a debate on debt among Ethiopian netizens. If we make a list of issues that routinely popup in the fast changing social media cycle, the concern over Ethiopia’s “burgeoning debt” would be one of them.

Ethiopians’ concern over the debt burden is bipartisan, a rare scene in a polarized political climate. Partisan lines start to emerge on the scale of the concern and the manner in which it is expressed. The level of trust on the economic leadership of the government, the source of information and understanding of the debt data explain much of the difference. However, it is hard to miss an overblown rhetoric, one that smells more of a political fear-mongering intended to pile on existing misconceptions. It is about time for an informed dialogue as we gear up to Ethiopia’s maiden bond issue (i.e. more debt) on international capital markets next January.

How indebted are we?

Our external debt (owed to foreign creditors) is about 12 to 14 billion USD (depending on ongoing debt relief negotiations) of which 6 billion USD is owed to multilateral creditors such as AfDB, IMF and WB while 4 billion USD is owed to bilateral creditors such as governments and official export credit agencies. In contrary to perception the staggering figure creates, it only amounts to about 23 percent of Ethiopia’s GDP that is considered as “low risk of external debt distress” by the WB and IMF. The total public debt, which includes domestic debt (from domestic sources), stands at 36 % of GDP.

One indicator of debt sustainability of a country is a credit rating value given by rating agencies that make an analysis taking various variables and projections into account. A concern about the sustainability of public finance is usually reflected in credit ratings (downgrades) and higher sovereign borrowing costs.

Ethiopia credit ratings, its first ever, done by S&P, Moody’s and Fitch, rates her B and B+ (stable) a fairly good position that led to expectation of a successful bond issuance and lower borrowing costs. This serves as a comparative tool with our African peers like Kenya and Ghana.

What is the limit to watch for?

An optimal level/limit of debt for an economy and even the relationship between external debt and economic growth, interest rate or inflation is an issue yet to be settled.

Many studies have attempted to investigate the effects of debt on economic growth only to reach conflicting results in their conclusions. The main point of contention being the level of debt to be considered as “optimal” marking the line where the amount of debt starts to pose risk to the economy.

A Debt-to-GDP ratio is the common tool used to measure the level of indebtedness of a country.However, there is no consensus on an optimal level of debt, if there is any, which a country should maintain. Several studies suggest various figures as a debt threshold.

A debt-to-GDP ratio of 60% is often cited as a prudential limit for developed countries. This suggests that passing this threshold will threaten fiscal sustainability. For developing and emerging economies, 40% is the suggested debt-to-GDP ratio that should be sustained on a long-term.

A 2010 IMF study on fiscal space emphasizes that the debt limit found in its research “is not an absolute and immutable barrier … Nor should the limit be interpreted as being the optimal level of public debt.” According to this study of 23 advanced countries, the estimated debt limits range from about 150 to 260% of GDP, with a median of 192%. The study assumes that the median long-run debt ratio to be 63% of GDP and the median maximum debt ratio to be 183% of GDP.

However, it concludes, “prudence dictates that countries target a debt level well below the limit as it delineates the point at which fiscal solvency is called into question.” The assumption is that when debt gets hefty, it may be hard to generate a primary balance (i.e., the budget balance net of interest payments on the debt) sufficient to guarantee sustainability, and economic shocks can push countries beyond their debt limit. Therefore, the advice is to stay well under the limit for prudence sake.

In “Growth in Time of Debt,” Reinhart and Rogoff claim that public debt loads greater than 90 percent of GDP consistently reduces GDP growth. A World Bank study puts a 77% of debt-to-GDP ratio for longer period to worry investors resulting in growing interest rate.

Not “how much?” but “For what?”

Most studies from either side of the debate agree on one point. As long as there is additional capacity in the economy or unemployment, higher fiscal deficits add to purchasing power and do not exert any uphill pressure on interest rates or inflation, nor do they cause large current account deficits. It is assumed that as long as the interest on the debt is less than the annual increase in nominal GDP, the debt need not be repaid because it will be a shrinking fraction of GDP.

A July 2010 IMF study of 38 developed and developing economies for the 1970-2007 period found that the effects on growth with respect to debt is only -0.02 while it is much higher with respect to other variables such as initial years of schooling (which contributes positively to growth). Hence, the growth-hindering effects of an increase in debt-to-GDP ratio can be overcome by a proportional increase in growth-fostering variables attained through public spending. This is why examining the composition of debt, instead of focusing on the total value of debt is of vital importance.

Evsey Domar has put it 1944 as “the problem of the burden of debt is essentially a problem of achieving a growing national income”. He emphasized that half a century later as, “the proper solution of the debt problem lies not in tying ourselves into a financial straightjacket, but in achieving faster growth…’.

Hence, informed priority order in applying the loan to projects and sectors with higher prospects of return, capacity building and multiplier effect have been usually advocated.

Ethiopia’s public external debt of about 5.6 Billion USD is owed by public enterprises such as Ethiopian Electric Power Corporation (EEPCO) that embarked on a dam revolution and Sugar Corporation which is building ten sugar manufacturing & refining factories in a bid to make Ethiopia among the top sugar exporters. Ethiopian Railways Corporation that aims to build 5,000 kms of national railway network and Ethiopian Shipping Lines that now holds the largest commercial fleet in Africa, are other public enterprises that make up the government guaranteed external debt stock. Ethiopian Airlines and Ethio-Telecom account for the 2.9 billion USD non-government guaranteed borrowings in the external debt stock.

Transport & communication infrastructure, electricity production and Agriculture are among the leading sectors for government borrowing. These sectors measure high on the scale of their return on investment and contribution to economic growth. The loans Ethiopia obtained so far also rank at top in the necessity scale as most of the projects conducted are infrastructure and capacity building, a prerequisite if the nation is to break off poverty and achieve an economic miracle.

The bottom line is that all the indicators of debt overhang we discussed reveal that Ethiopia is in a good shape. Our external debt is only 23 % of GDP which the WB and IMF called it low risk. Even the total public debt, which includes borrowing from domestic sources stands at 36 % of GDP. Even though there is no consensus on an optimal debt level, our debt to GDP ratio is still under the most prudent suggestion of 40%. Ethiopia’s credit ratings of B and B+ reinforce this point. The sectors the debt is invested on rank at the top of the necessity and return scale, and that’s what matters most.

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