Ethiopia's Credit Rating: A Re-confirmation of the Developmental Path


Ethiopia's Credit Rating: A Re-confirmation of the Developmental Path

(Amare Belay 05/20/14)

Ethiopia has come a long way with her home-grown developmental strategy. The developmental state paradigm, which stems from the revolutionary democratic ideology of the Ethiopian Peoples' Revolutionary Democratic Front (EPRDF), was further augmented with the lessons learnt from recent economic success stories, such as the South East Asia.

However, at first, Ethiopia's developmental path had faced pessimist attitude of western analysts and institutions and others. Due to the ideological predisposition of western experts and their strong skepticism a development path engineered in the "hopeless continent".

It was the organizational competence of the EPRDF and the effectiveness of its policy measures that made possible public mobilization possible. Especially in the rural areas and the agricultural sector which takes the lion share for the GDP growth in the first 2-3 years of the consecutive growth observed since 2003.

Ethiopians started to see a bright light and followed directions given through various policy packages including micro and small enterprises development programs, agricultural extension services. This virtuous circle of government efforts and public mobilization and sustained growth brought today what would ordinarily be held as improbable.

International financial institutions, like World Bank, didn't deny the achievements at each stage. However, they had difficulty accepting that Ethiopia is striding through a developmental path incompatible with the neo-liberal paradigm. At the beginning of the year, they put question marks on Ethiopia's growth targets, only to congratulate at the end of the year. But in both instances they insist the achievements cannot be sustained for even one more year without taking neo-liberal reforms.

Lately, the socio-economic stride have become undeniable. Three years ago, the Human Development Index confirmed that:

"Ethiopia is rated among these ”top movers” at rank 11 out of the 135 countries which registered improvement in Human Development Index that stretched the rating between 1970 and 2010. While assessing the achievement status of same countries between 2000 and 2010, Ethiopia’s status goes up to put the country 2nd rank. Same measurement was also conducted between 2005 and 2010. According to the measurement done between 2005 and 2010, Ethiopia’s position comes at the top of the top movers of the development achievers."

Encouraged by these achievements the Ethiopian government and people launched even more ambitious plan - 5-years Growth and Transformation Plan, which envisions to ‘extricate Ethiopia from poverty to reach the level of a middle-income economy between 2020 and 2023′. However, the plan was criticized by many as realistic and improbable, until a two years and half committed effort of the government and the people demonstrated of the viability of the plan.

Nonetheless, last year, the World Bank admitted that:

“Two and a half million people in Ethiopia have been lifted out of poverty over the past five years as a result of strong economic growth, bringing the poverty rate down from 38.7 percent to 29.6 percent between 2004/05 and 2010/11”.

"Ethiopia follows a strategy of increasing exports to facilitate growth. This is appropriate given the limited size of the domestic market and it is consistent with the development experience of some of the recently successful countries, particularly in East Asia”. “Growth of goods exports has mainly been driven by volume growth across a variety of product groups, implying that Ethiopia is increasingly diversifying its export base.”

Nonetheless, the government of Ethiopia was not satisfied with all these achievements - the rate of growth and investment. It has decided to take the next major step. Last year, Prime Minister Hailemariam announced the plans to obtain a sovereign credit rating from reputed international rating agencies.

Therefore, the government requested the three well-known international agencies, which are informally referred to as "the Big Three", to rate Ethiopia's economy. The results were another confirmation of the prudence of Ethiopia's economic policies and the competence of the leadership.

As it was stated by, Sufian Ahmed, Minister of Finance & Economic Development (MoFED), last week:

"The results have confirmed the convictions and beliefs the government had all along.....This shows the reality on the ground. Better economic performance with declining poverty and improving access to infrastructure, which the credit rating reports attribute the nation's status, are in sync with what the government believes to have achieved. This proves the country's suitability for investment and tourism".

To understand the significance of the news, we need to understand what credit rating and sovereign credit rating.

A credit rating is an evaluation of the credit worthiness of a debtor, especially a business/company or a government. The evaluation is made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default.

Sovereign credit rating is a grading of a country's ability to meet its financial obligationsCredit rating agencies provide these ratings and investors use this to assess the level of risk related with investing in a country. The rating may also include and evaluation of a country's political risk. . The three most popular issues of sovereign ratings are S&P, Moody's and Fitch.

Sovereign credit ratings have become increasingly important as countries around the world tap the international finance and investments. These credit ratings - issued to sovereign entities like national governments - take into account political risk, regulatory risk and other unique factors to determine the likelihood of a default

The critical factors that are basis of credit ratings are: Per capita income (since a larger tax base increases a government's ability to repay debt, while it can also serve as a proxy for a country's political stability); Strong GDP Growth (as it makes a country's existing debt easier to service over time, since that growth typically results in higher tax revenues and an improved fiscal balance); High inflation; External debts and the like.

It was based on these rigorous and extensive yardsticks that the three top rating agencies - Moody's, Standard & Poor's, and Fitch Ratings - evaluated Ethiopia and assigned "B" grade.

Standard and Poor announced that:

·         Ethiopia continues to achieve high economic growth, exceeding the average in Sub-Saharan African countries.

·         Its current account deficits are modest relative to peers', supported by a services surplus and large remittances.

·         We are assigning our 'B' long-term foreign and local currency ratings, and 'B' short-term rating, to Ethiopia.

·         The stable outlook reflects our view that over the next year the strong pace of economic growth will be maintained and current account deficits will not rise significantly.

The assessment of Standard and Poor explained that:

"The ratings are supported by strong government effectiveness, which has halved poverty rates over the past decade or so, moderate fiscal debt after debt relief, and moderate external deficits. Ethiopia's brisk economic growth--far exceeding that of peers--also underpins the ratings.

Ethiopia has achieved political stability since it adopted its new constitution in 1995, under the leadership of the Ethiopian People's Revolutionary Democratic Front (EPRDF) coalition. The EPRDF coalition holds 99% of the seats in the national assembly after the last 2010 election. In broad terms, we expect the status quo to be maintained in the upcoming 2015 elections. Ethiopia has reported high economic growth in recent years, reducing poverty and achieving more homogeneous wealth levels than peers'.

Ethiopia faces geopolitical risks from its unstable neighbors Somalia, Eritrea, Sudan, and South Sudan, who are involved in domestic conflicts. However, Ethiopia has been at the forefront of finding peaceful solutions for its neighbors through the Intergovernmental Authority on Development (IGAD) in member states around the horn of Africa and east Africa.

Ethiopia's economic growth has consistently well outpaced the average for peers in Sub-Saharan Africa, averaging at least 9% real GDP growth over the past decade, partly due to significant government spending in public sector infrastructure.

We estimate GDP per capita at a low $630 in 2014. However, strong economic growth has translated into significant poverty reduction and fairly homogeneous wealth levels.

The stable outlook on Ethiopia reflects our view that over the next year the current pace of economic growth will be maintained and current account deficits will not rise significantly, supported by positive services accounts and large inflows of remittances."

The assessments of the other international rating agency, called Fitch Ratings, were similarly positive.

Fitch assigned 'B' grade to Ethiopia. It stated that the Outlooks of Ethiopia's long-term and short-term foreign currency and local currency issuer ratings is Stable.

The valuation of Fitch experts noted that:

Economic performance is strong. With an average real GDP growth of 10.9% over the past five years, Ethiopia has outperformed regional peers due to significant public investments in infrastructure as well as growth in the large agricultural and services sectors. Despite a track record of high and volatile inflation, it declined significantly in 2013, reflecting lower food prices and the authorities' commitment to moderate central bank financing of the government.

Fitch expects real GDP growth of 9% in 2014 and 8% in 2015. Ethiopia's growth over the medium-term can be sustained by large, untapped resources, including large hydro-electric potential.

Significant investments in infrastructure (including roads, electricity and railways) have been made possible by the heavy involvement of state-owned enterprises (SoEs), which finance a large part of investments on their own, mostly through heavy recourse to domestic bank credit.

Most importantly, Fitrch emphasized that:

"The ratings are reliant on [the assumption of] continuity in the development model of the country".

The assessments of the rating firm, called Moody, point out important matters: The rating firm said:

"Moody's Investors Service has today assigned first-time local and foreign-currency issuer ratings of B1 to the Government of Ethiopia. The ratings carry a stable outlook.

The rating assignment is based on the following key drivers:

(1) Ethiopia's relatively small economy and low per-capita income, balanced by a track-record of strong economic growth over the past decade.

(2) Weak institutional strength, in line with B-rated peers.

(3) Moderate fiscal strength, with the debt burden and related financing cost remaining low given a largely concessional funding base, balanced by its increasing reliance on non-concessional financing.

(4) Moderate susceptibility to event risk, which balances (i) credit strengths such as an adequately capitalised banking sector and low government liquidity risk given stable inflows of grants and concessional lending; against (ii) credit constraints, such as political risks stemming from Ethiopia's geographic location in the Horn of Africa, and low levels of foreign-exchange reserves and low foreign direct investment flows into the economy.

Moody's has also assigned a Ba3 ceiling for local-currency bonds and deposits, a B1 ceiling for foreign-currency bonds and a B2 ceiling for foreign-currency deposits.

Moody's notes that Ethiopia has made significant progress in developing the country over the past decade, mainly supported by significant public sector investment, and has reached key targets set out in the Millennium Development Goals.

The ratings agency notes that per capita GDP income is rising quickly (having almost tripled in just 10 years), and growth prospects remain favourable given the investment in developing the country's power-generating capacity and infrastructure, mainly through public sector investment.

The government produces five-year plans which support policy continuity and the administration shows a strong track-record of fulfilling or even outperforming the targets set in these plans.

More than 75% of government expenditure is targeted at poverty-reducing programmes. Capital spending overall reached 14% of GDP last year -- one of the highest in the region. Ethiopia benefits from substantial donor support, with grants making up 11% of total central government revenue. In fact, Ethiopia is the largest aid recipient in nominal terms in Africa mainly on account of its critical geopolitical role that it plays in the Horn of Africa -- a region that is prone to political upheaval -- but also driven by the notable achievements donor funds have had on the key social indicators. Over the past decade, donor funds have been very stable at around $900 million per year."

With all these positive assessments, Moody rating firm provides a very imporatnt caution. It said:

Moody's assessment of the country's moderate susceptibility to event risk, primarily political event risk. This stems largely from the country's geographic location in the Horn of Africa, with neighbouring countries such as Somalia, Sudan and South Sudan. In addition, there is an unresolved border conflict with Eritrea that adds to geopolitical event risk.

the rating agency sees some risk of demonstrations and instability in the period leading to and following the elections in 2015. This view is based on an outbreak of violence during previous elections in 2005, itself due to allegations of potential voting irregularities.

This is an important message to all Ethiopians and friends of Ethiopia. As the rating firm noted, Ethiopia's hard earned international status as reliable investment destination can be damaged if another post-election violence takes places in the next election in 2015.

The government and citizens of Ethiopian shall be watchful and vigilant to preserve and continue the positive national image we now have and the impressive growth we have achieved so far.

God bless Ethiopia.

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