The Impact of Grants and External Borrowing on Ethiopia's Fiscal Balance

Ethiopia, like many developing nations, relies on a mix of domestic revenue and external sources to finance its budgetary needs. Grants and external borrowing play a pivotal role in bridging the fiscal gap, ensuring that the nation can meet its developmental objectives. This article delves into the impact of these external financial inflows on Ethiopia's fiscal balance, based on data from the "National Bank of Ethiopia Quarterly Bulletin" for the third quarter of 2022/23.

During the third quarter of 2022/23, the Federal government's total revenue and grants reached Birr 87.7 billion, marking an 11.1% annual growth. This growth in revenue and grants is a testament to the country's ability to attract external funds and effectively utilize them for its developmental needs.

On the expenditure side, the government's spending amounted to Birr 164.3 billion, reflecting a 5.6% annual decline. This reduction in expenditure, juxtaposed with the growth in revenue and grants, provides insights into the government's fiscal management strategies.

However, despite the growth in revenue and grants, the overall fiscal balance (including grants) showcased a deficit of Birr 76.5 billion during the review period. This deficit underscores the challenges faced by the Ethiopian government in balancing its books and highlights the critical role of external borrowing and grants in managing the fiscal situation.

Grants are non-repayable funds provided by one party (grant makers), often a government department, corporation, foundation, or trust, to a recipient, often (but not always) a nonprofit entity, educational institution, business, or an individual. In the context of Ethiopia:

• Grants serve as a crucial source of non-debt creating inflows, helping the government finance its developmental projects without adding to its debt burden.

• They often come with specific conditions or objectives, ensuring that the funds are used for targeted developmental or humanitarian purposes.

External borrowing provides the much-needed funds for large-scale infrastructure and developmental projects. However, it's essential to understand its implications:

• Positive Impact: Borrowed funds can be used for projects that yield high returns, ensuring that the country can repay its debt while also boosting its economic growth.

• Debt Servicing: Interest payments and principal repayments can strain the country's fiscal resources, especially if the borrowed funds do not yield the expected returns.

• Currency Risk: Borrowings in foreign currencies expose the country to currency risks, especially if the local currency depreciates.

External borrowing is a crucial financial tool for many countries, especially developing nations like Ethiopia. It provides the necessary funds for developmental projects, infrastructure, and other essential services. However, it's vital to understand the dynamics and implications of such borrowings:

• Sources of External Borrowing: Ethiopia's external borrowings come from various sources, including international financial institutions, bilateral agreements, and commercial loans. Each source has its terms, interest rates, and repayment schedules.

• Purpose of Borrowing: The borrowed funds are often earmarked for specific projects or sectors. For instance, funds might be allocated for infrastructure development, health, education, or other social services.

• Debt Sustainability: While borrowing provides immediate financial relief and funds for development, it's essential to ensure debt sustainability. This means that the country should be able to service its debt (both principal and interest) without compromising its economic stability.

Grants play a significant role in Ethiopia's fiscal landscape. They are essentially funds provided without the expectation of repayment. Here's a closer look at their impact:

• Nature of Grants: Grants can be general or specific in their purpose. While some grants are provided for general budgetary support, others are earmarked for specific projects or sectors.

• Advantages of Grants: The most apparent advantage is that they do not add to the country's debt burden. They also often come with technical assistance, helping in capacity building and knowledge transfer.

• Challenges with Grants: While grants are beneficial, they can sometimes come with conditions. These conditions might relate to governance, policy reforms, or specific project outcomes.

The interplay between grants and external borrowing has direct implications for Ethiopia's fiscal balance:

• Positive Impact on Fiscal Deficit: Both grants and external borrowings can help reduce the fiscal deficit by providing the necessary funds to bridge the gap between revenue and expenditure.

• Foreign Exchange Reserves: External funds, especially grants, can help boost the country's foreign exchange reserves, essential for imports and debt servicing.

• Debt Servicing Obligations: While grants do not add to debt servicing obligations, external borrowings do. It's crucial for Ethiopia to ensure that the borrowed funds are invested in projects that provide a return, enabling the country to meet its debt obligations.

In the third quarter of 2022/23, the Ethiopian banking sector showcased stability in certain interest rate structures. The average savings deposit rate remained consistent at 8.0 percent. Similarly, the lending rate was unchanged at 14.3 percent. However, the weighted average time deposit rate was noted at 7.7 percent.

A significant observation was the performance of T-bills during this period. The average yield on T-bills for the quarter was recorded at 9.01 percent. This was a slight decrease from the 9.23 percent observed a year ago. When juxtaposed with the 32.8 percent headline inflation, it's evident that real interest rates on deposits, lending, and T-bill yield were in the negative spectrum during the review quarter.

The stability in the savings deposit and lending rates indicates a steady monetary policy approach by the Ethiopian central bank. However, the negative real interest rates, especially in the context of T-bills, can be a cause for concern for investors. Negative real interest rates can deter investments in government securities, as the returns might not be sufficient to cover the inflation rate. This can have implications for the government's borrowing and fiscal balance.

Furthermore, for the general public, the negative real interest rate on savings means that the money saved in banks is losing its purchasing power over time due to inflation. This might encourage people to invest in other assets or spend rather than save, which can have broader economic implications.

In the next section, we will delve deeper into the broader monetary developments in Ethiopia during the third quarter of 2022/23, focusing on money supply and credit dynamics.

The third quarter of 2022/23 witnessed significant monetary developments in Ethiopia. The broad money supply (M2) grew by 20.8 percent, reaching ETB 1,741.6 billion. This growth was primarily driven by a 23.5 percent expansion in domestic credit.

The domestic credit expansion was primarily attributed to a 28.4 percent surge in net claims on the central government by the banking system. This was coupled with a 19.5 percent growth in claims on other sectors. The credit to the private sector also witnessed a growth of 18.5 percent, reaching ETB 783.4 billion.

The expansion in domestic credit, especially the significant growth in net claims on the central government, indicates the government's reliance on domestic sources for financing its budgetary needs. This aligns with the broader theme of the report, highlighting the impact of grants and external borrowing on Ethiopia's fiscal balance.

The growth in credit to the private sector is a positive sign, indicating that businesses and individuals are accessing more funds for investment and consumption. However, it's essential to monitor the quality of this credit to ensure that it's being used productively and not leading to non-performing loans in the banking sector.

The monetary developments, especially the growth in M2, can have inflationary pressures if not matched by a corresponding increase in the production of goods and services. Given the already high inflation rate in Ethiopia, this is a crucial aspect to monitor.

In the next section, we will explore the external sector developments, focusing on the balance of payments, trade balance, and foreign exchange reserves.

The external sector plays a pivotal role in shaping a nation's economic trajectory, especially for countries like Ethiopia that are intricately linked with global markets. This section delves into the key external sector developments during the third quarter of 2022/23, shedding light on the balance of payments, trade dynamics, and foreign exchange reserves.

The balance of payments provides a comprehensive snapshot of a country's transactions with the rest of the world. It encompasses trade in goods and services, capital flows, and financial transfers. During the review quarter, Ethiopia's balance of payments showcased some notable trends:

• Trade Deficit: Ethiopia continued to grapple with a trade deficit, primarily driven by a higher import bill compared to export earnings. This deficit underscores the challenges faced by the country in boosting its export-oriented sectors and reducing dependency on imports.

• Capital and Financial Account: On a positive note, the capital and financial account witnessed a surplus, indicating robust foreign direct investment inflows, grants, and external borrowings. These inflows play a crucial role in offsetting the trade deficit and ensuring macroeconomic stability.

Trade dynamics offer insights into a country's economic health, competitiveness, and global linkages. Key observations from the review quarter include:

• Exports: There was a growth in export earnings, driven by increased shipments of primary commodities. However, the country's export basket remains concentrated, underscoring the need for diversification.

• Imports: The import bill remained elevated, with capital goods, consumer goods, and intermediate goods constituting the bulk of the imports. The high import bill can exert pressure on foreign exchange reserves and the local currency.

Foreign exchange reserves act as a buffer, ensuring that a country can meet its external obligations and maintain currency stability. During the third quarter:

• Reserve Levels: Ethiopia's foreign exchange reserves witnessed a decline, reaching a level that covers just a few months of imports. This is below the recommended international standards and can pose challenges in terms of external debt servicing and import financing.

• Impact on Currency: The decline in reserves can exert pressure on the Ethiopian Birr, leading to depreciation. A weaker currency can increase the import bill and debt servicing costs, further straining the fiscal balance.

In conclusion, while grants and external borrowings play a pivotal role in Ethiopia's fiscal landscape, it's essential to strike a balance. Over-reliance on external sources can lead to debt sustainability issues, while inadequate reserves can pose macroeconomic challenges. A holistic approach, encompassing fiscal discipline, export promotion, and prudent debt management, is crucial for Ethiopia's sustainable economic growth.