Ethiopia’s Eurobond Surges Amidst Favorable Financial Backing from World Bank

Ethiopia’s $1billion Eurobond coupon soared for the 12th consecutive day following good news from international financial backers, including the World Bank and the IMF. Marking a record run since its debut in 2014, global investors welcomed a $1.72 billion financing agreement from the World Bank and an extended timeline to finalize IMF financing. The bond reached its highest level in over two years, trading at 73.893 cents on the dollar last Friday. 

In December, Ethiopia chose to selectively default on its $1 billion Eurobond obligations, sighting the G20 framework, which reprieved the country from debt repayment responsibilities for two years. Authorities in Addis Ababa maintain that the default is therefore within the rules of treating all creditors equally as it missed a coupon payment on its Eurobond. European creditors were left ruing as a result. “The thing is, we have an international obligation to treat all creditors the same, and we cannot just pay our obligations on the Eurobond, and choose to ignore other creditors, that’s not how it works”—Said Finance Minister Ahmed Shide to local media. 

The economy faced significant headwinds due to the pandemic, internal political turmoil, and the war in Ukraine, all of which contributed to high inflation, a scarcity of foreign currency, and mounting repayments for external debts, which began to accumulate rapidly starting in the mid to late 2000s. However, these indicators have improved lately and the debt to GDP ratio continues to recover as growth picked up pace in 2023. IMF data indicates overall external debt has been decreasing.

Moreover, following an armed rebellion that erupted in the northern Tigray region on the 4^th of November, 2020, the E.U and U.S severed funding to the government in Addis Ababa, cutting off what was once Africa’s donor darling. Official development assistance (ODA), which the country has relied on historically, decreased by 40% between 2020 and 2022, hitting a ten-year low of USD 2.7 billion. Additionally, citing the Tigray conflict, the U.S suspended the African Growth and opportunity Act (AGOA), a preferential trade deal allowing select African states to import goods freely into the U.S market. Consequently, the shortage of foreign currency worsened, and foreign exchange reserves dwindled to USD 1 billion by June 2023, barely covering one month of imports.

In the latter half of 2023, the U.S and the E.U declared the reinstatement of Official Development Assistance (ODA) to Ethiopia, but nevertheless voiced apprehension over continued armed conflicts and stressed that their financial aid programs hinged on the fulfillment of the peace agreement. Therefore, any resurgence of conflicts could potentially delay the debt restructuring procedure as well, a condition the federal government would no doubt feel is onerous, given it cannot fully control a decision by warring sides to break peace agreements. Critics argues this policy has the consequence of undercutting the GoE while emboldening belligerents. 

For the time being the country’s authorities are under pressure by the IMF to restructure the economy, a move the government has resisted for years. The primary issue causing deadlock in negotiations is the depreciation of the Birr, a reform initiated as part of the previous IMF program in 2019 but terminated in 2021. Over many years, the National Bank of Ethiopia (NBE) has controlled the exchange rate, resulting in the Birr being significantly overvalued. As a consequence of the foreign exchange scarcity, the gap between the official rate and the parallel market rate has steadily widened, reaching nearly 100%

The GoE is concerned devaluation will worsen price inflation of key imported items, such as fertilizer, fuel, and pharmaceuticals. These are goods with highly inelastic demand, meaning consumers have no option but to continue to buy them even if prices soar, an outcome that will have dreadful consequences on households. Nonetheless, to reconcile the official and parallel exchange rates and to liberalize the foreign exchange system, NBE will likely need to devalue the currency. 

It’s estimated that approximately 35% of currency transactions are conducted on the parallel market due to restricted access to the dollar. Discussions between the Ethiopian government and the IMF are ongoing regarding the extent of this devaluation. However, a complete adjustment of the overvaluation would undoubtedly have a significant impact on inflation, which has already been very high, with consumer prices rising by over 25% year-on-year since June 2021. Devaluation is necessary, but the question is how to best minimize the inflationary impact it will bring.

If the foreign exchange market is opened, it needs to be done alongside changes to how the government manages money to control inflation better. Right now, the National Bank of Ethiopia tries to keep prices stable is by limiting how much banks can lend and reducing how much money the government gets directly from the central bank. But stopping direct payments to the government will be tough because the government needs a lot of money quickly and it’s struggling to get enough. 

According to the IMF, tax revenue has been declining relative to GDP from 15.6% in 2016 to just 8.5% in 2022, making it one of the lowest tax collection rates in sub-Saharan Africa. This is due to a narrow tax base and failure to collect taxes from an expanding economic activity. For example, farming, comprising more than 30% of GDP is not taxed. Until very recently property tax was not assessed either. But the government has been spending more money, so the gap between what it gets and what it spends has been getting bigger, reaching 4.1% of GDP in 2022. To make sure public financing has enough money to run things and show good will to the IMF, the government is looking for ways of getting more money coming in while also spending less on things like fuel subsidies and social payments, which made up more than half of what it spent in 2020.

More long-term reforms are being undertaken to consistently attract foreign investment and enhance external accounts. Securing IMF financing may also necessitate actions such as advancing the development and liberalization of the financial sector, continuing with the program to privatize public enterprises, and fostering improvements in the business environment. As expected, the government is stiffly resisting privatizing of key national champions such as Ethiopian Airlines, Ethiopian Electric Corp and Ethio-telecom, a policy stance that has popular support. But it has offered to sell off Ethiopian Sugar Corporation, which is debt distressed and failing to attract buyers.

The wild card remains how to calm political tensions which flare up into armed conflict, oftentimes ethnic in nature, reflecting the country’s identity based governing structure, which became entrenched in the 1990s under the previous government and festered even more in recent years. More than anything else, the country’s ambitious economic goals are threatened by these prevailing political fractures.