• The Ethiopian government on 9 September announced its newly proposed 'Home Grown Economic Reform Program', which aims to increase foreign-exchange (FX) availability and create a more conducive operating environment for foreign investment.
• We assess that investor protections are likely to be strengthened before December 2019, but FX availability is very unlikely to improve during 2020-21.
• IHS Markit's forecast is 7.7% growth in GDP in 2019 - and supporting the economy's transition from public and foreign-debt-financed investment to equity-based investment via the privatization of state-owned enterprises and liberalization of several sectors.

The newly created National Reform Committee (NRC) will co-ordinate several measures to sustain economic growth and increase foreign investment in Ethiopia's largely state-controlled economy, although policy implementation will very likely only advance piecemeal during 2020. The NRC comprises representatives of the Ministry of Finance, the Ethiopia Investment Commission (EIC) - based within the prime minister's office - and the National Bank of Ethiopia (NBE), the central bank. Overall, the NRC is tasked with sustaining economic growth.

The NRC has identified the key economic weaknesses that need to be addressed, but no specific policy measures have been introduced. The NRC will need to address the piecemeal progress made on economic reforms by overlapping committees that have been established within the prime minister's office since the new government was appointed in April 2018. Prime Minister Abiy Ahmed's 'New Horizon of Hope' strategy, which underpins the government's economic strategy, is only one-page long.

Foreign-exchange (FX) scarcity is the main impediment to boosting foreign investment in non-agricultural sectors such as construction, manufacturing, and tourism, yet foreign reserves are very likely to remain at less than two months of import cover during 2020-21, with small and medium-sized businesses facing FX delays beyond 90 days on average. FX scarcity is driven by several factors, including poor non-agricultural export growth. Total export growth during the third quarter of fiscal year 2018/19 declined by 7%, compared with the previous quarter. GDP growth is largely driven by public investment and is not strictly correlated with export performance. Exports reached USD678.5 million in June 2019, compared with imports at USD3.6 billion during the same month. The NRC recognizes that the manufacturing and tourism sectors are priority areas for addressing the persistent balance-of-payments deficit, given the ongoing dominance of agricultural exports that are highly exposed to coffee price fluctuations. Foreign investors will face FX delays when importing construction materials, equipment, or inputs into manufacturing processes, and typically depend on risk mitigation measures being agreed in advance with the authorities, such as FX guarantees issued by the NBE.

The cycle of weak exports and depleted reserves is not likely to be broken by devaluing the currency or transitioning to a flexible exchange rate, given the continued dominance of agricultural exports. Strong political opposition to the resulting inflation pressures indicates that such a policy is, in any case, very unlikely to be considered before the scheduled August 2020 legislative elections. FX shortages are also driven by large outlays for underperforming infrastructure projects that were financed via domestic sources (primarily the two largest state-owned banks), the channeling of FX to service external debts (FX accounted for 8.0% of external debt servicing in 2018), in addition to weak non-agricultural export diversification. Officials previously have discussed liberalizing the managed exchange rate and devaluation of the currency. However, floating the currency's exchange rate is very unlikely at this stage, because the Ethiopian People's Revolutionary Democratic Front (EPRDF) coalition, which dominates the government, faces grassroots political opposition ahead of the scheduled 2020 elections, which would be worsened by any resulting increase in core inflation (already at 10.3% in June 2019), and higher food prices.

More positively, the ratification of the New York Convention on the Recognition and Enforcement of Arbitral Awards ('New York Convention') and revisions to the 59-year old Investment Code are likely to be finalized before December 2019, thereby strengthening commercial dispute resolution. The EIC is coordinating the government's 'Doing Business Initiative', which was launched in July 2019 and is tasked with implementing several improvements to the business environment before December 2019. Revisions to the outdated Commercial Code will be tabled, and very likely approved, thereby enhancing shareholders' protections and improving corporate transparency. By ratifying the New York Convention and consolidating existing arbitration law, the Ethiopian courts should provide foreign investors with a legally recognized and enforced process to resolve commercial disputes and claim compensation via foreign courts.

Indicators of changing risk environment

Increasing risk

• Failure to increase export market and product concentration away from the agricultural sector and China as a key trading partner.
• Not addressing currency devaluation sufficiently and related inflation pass-through effects to make space for a gradually introduced flexible exchange-rate regime.
• Failure to introduce incentives for exporters such as tariff-free imports, increasing domestic savings, as well as maintaining a tight fiscal policy.

Decreasing risk

• The central bank makes further monetary policy adjustments, such as raising interest rates to address high headline inflation, indicating that a balanced exchange rate will be considered as a potential policy option, although this is still unlikely to be fully implemented given the high price sensitivity of exports.
• Developing trade access to ports in Eritrea, likely raising Ethiopia's commercial profile and helping to support greater export growth.
• Stronger FX inflows via tourism receipts, as well as strong growth in remittance inflows.

Posted 17 September 2019 by Alisa Strobel, Principal Economist, Global Economics SSA, S&P Global Market Intelligence and

Chris Suckling, Associate Director, Risk Quantification, S&P Global Market Intelligence