Ethiopia

The Ethiopian economy experienced structural change in 2008-09, in which the leading agricultural sector gave way to the service sector – it emerged as the dominant sector of the economy in terms of GDP share and growth in value added. The share of agriculture in GDP declined from 51% in 2000/01 to 44.6% in 2007/08, before declining further to 43% in 2008/09. Agriculture was expanding at the rate of 6.4% in real terms in 20008/09, down from 7.5% in 2007/08 and 9.4% in 2006/07. In 2008/09, growth in crop production, which accounts for over 65% of agricultural output, was lower than the 8% growth registered in 2007/08 by 1.5 percentage points. Animal farming and hunting also grew by 7% in 2008/09, down from 7.3% in the preceding fiscal year. However, forestry and fishing, which account only for 3.4% and 0.02% of the agricultural sector, were expanding at about 3% and 27% in 2008/09, down from 4.2% and 34% growth in 2007/08 though higher than the 2.9% and 7.7% growth in 2006/07, respectively.

Despite the overall strong performance of the agricultural sector, the country continues to face food insecurity due to failed rains in consecutive seasons in parts of Somali Region, Afar, Oromiya, Tigray, Amhara and Southern Nations, Nationalities, and Peoples (SNNP) regions. The government report released in October 2009 – based on June and July 2009 multi-agency assessment results – estimated that 6.2 million people would require emergency food assistance between October and December 2009. This was in addition to the estimated 7.5 million chronically food-insecure beneficiaries who receive assistance, either through employment opportunities or food assistance and cash transfers, from the government-managed Productive Safety Net Programme (PSNP). The joint Ethiopian government and development partners report released in January 2010 revealed that approximately 5.2 million people would require relief food assistance in 2010.

Non-agricultural sectors expanded at a much faster pace than the agricultural sector. Services, the fastest growing sector since 2005/06, became the largest sector of the Ethiopian economy in 2008/09 – accounting for over 45% of the national output. It registered real growth of 14% in 2008/09, slightly down from 16% in 2007/08. This remarkable growth in services was mainly attributed to rapid expansion in financial intermediation, public administration and defence, hotels & restaurants, and real estate, renting and business activities, each of which grew by more than 16% in 2008/09. In the same year, education, trade (wholesale & retail) and transport & communication recorded real growth rates of 11.4%, 12.1% and 8.7% respectively.

The industrial sector, which exhibited a marginal increase in its share of GDP from 12.1% in 2000/01 to 13% in 2007/08 and 2008/09, registered real growth of 9.9% in 2008/09, down marginally from the 10% growth in 2007/08. The 2008/09 expansion in the industrial sector was driven mainly by the growth in construction (11.7%) and manufacturing (9.4%). Manufacturing has been expanding by almost 10% a year, on average, during 2001/02-2008/09. But as a percentage of both GDP and in industry, its share fell from 5.5% and 39% in 2002/03 to 4.9% and 38% in 2008/09, respectively. The share of construction in industrial output, by contrast, increased from 43% in 2003/04 to 45% in 2008/09 though its share in total GDP also declined, from 6.1% to 5.8% over the same years.  On average, large and medium-scale manufacturing has been growing at a much faster rate than the small-scale and cottage industries since 2005/06. The water and electricity sub-sector expanded at 5.7% in 2008/09, up from 4.8% in the previous year while mining and quarrying grew at almost 13% in 2008/09, down from over 21% in 2007/08.

The plan for accelerated and sustained development to end poverty (PASDEP) represents the second phase of the Poverty Reduction Strategy Programme (PRSP) and runs from 2006/07 to 2010/11. It is based on the country’s strategy of agriculture-led industrialisation and calls for massive investment, particularly in infrastructure. The ongoing transformation of subsistence farming into the commercial farming is being supplemented by institutional reforms and facilitated by the expansion of supporting infrastructure such as road and markets. The World Bank launched a Country Assistance Strategy (CAS) for Ethiopia covering the period of July 2008 to June 2011. The new CAS is intended to support Ethiopia in achieving four main strategic objectives, consistent with PASDEP: fostering economic growth; improving access to and quality of basic service delivery; reducing Ethiopia’s vulnerability to help improve prospects for sustainability; and improving governance.

Domestic demand, mainly private consumption, has grown strongly since 2002/03. Private consumption, the largest component of domestic demand, accounted for about 87% of GDP in 2008/09, up from almost 77% in 2000/01. However, public consumption fell from 15.6% of GDP to 9.2% over the same period. Private investment, by contrast, was not only less than public investment but also falling from as high as 11.2% of GDP in 2000/01 to 6.5% in 2008/09, but public investment increased from 8.9% of GDP in 2000/01 to 14.4% in 2008/09. Overall, gross domestic investment declined from 21.6% of GDP in 2007/08 to 20.8% – the lowest level since 2001/02 – in 2008/09. Gross domestic savings plummeted from 6.3% of GDP to the historically low level of 3.2% in 2007/08 before recovering to 4.2% in 2008/09. Consequently, the resource gap improved to 18.2% of GDP in 2008/09, up from to 19.4% of GDP in 2007/08, owing to both the decline in investment and increase in savings.

The fiscal health of the Ethiopian economy has been improving substantially since 2005/06. The overall fiscal deficit including grants amounted to only 1% of GDP and 5.4% of GDP excluding grants in 2008/09, compared with 3.% and 7% of GDP in 2007/08, respectively. Clearly, donor funding is important in keeping the budget deficit manageable. The substantial improvement in the fiscal position of Ethiopia in 2008/09 was mainly the result of tight fiscal policy that resulted in the decline of government spending from 19.4% of GDP in 2007/08 to 17.6% in 2008/09. Foreign grants also increased from 4.1% of GDP in 2007/08 to 4.4% in 2008/09. Total revenue as a proportion of GDP, including grants, remains low and has been falling since 2002/03. It fell from 21.4% of GDP in 2002/03 to 16.2% in 2007/08 before it marginally recovered to 16.6% in 2008/09 and is expected to decline further to 16.1% in 2009/10 owing to a projected 1% fall in grants. Total domestic tax and non-tax revenue as a percentage of GDP fell from 16.1% in 2003/04 to 12.1% in 2007/08, after which it slightly improved to 12.2% in 2008/09.

There is a considerable shift in the importance of the components of domestic revenue. For instance, the proportion of taxes to total revenue declined from around 80% in 2007/08 to about 72% in 2008/09 while non-tax revenue rose from around one-fourth to about 28% over the same period. Within tax revenues, direct taxes increased from around 29% of the total tax revenues in 2007/08 to about 34% in 2008/09 whereas indirect taxes were slashed from about 71% to around 66% over the same period. Import duties and taxes are the largest component of indirect taxes in particular and the domestic revenue in general. It accounts for 70% of indirect taxes and over 39% of the total domestic revenue mobilised in 2007/08. However, the relative importance in indirect taxes and total domestic revenue fell to 62% and over 29% in 2008/09. Revenue from export taxes has been nil since 2003/2004 owing to the elimination of all export duties and taxes in 2002/03.

The focus of government spending has shifted away from current expenditure to capital expenditure since 2006/07. For the period preceding 2006/07, current government spending was much higher than capital expenditure. For instance, current government spending was 18.4% of GDP in 2002/03 against only 8.6% for capital expenditure.

More of capital expenditure has been pro-poor than current spending. Poverty-targeted government spending (i.e., expenditure on education, health, agriculture and roads) was over 13% of GDP, on average, during 2004/05-2007/08, up from only 6.1% in 2001/02. It declined, however, to 11% of GDP in 2008/09. On average, the poverty-targeted capital expenditure was almost twice as much as the poverty-targeted current expenditure during 2004/05-2008/09. During 2002/03-2008/09, on average, close to 80% of total government capital spending targeted the poor while it was only 40% in the case of current government expenditure. In 2008/09, both poverty reducing capital and current expenditures were less than the budgeted amount and it was more so in the case of capital than current expenditure.     

The dependence on external financing of the fiscal deficit has been falling from as high as 7.4% of GDP in 2001/02 to a mere 1% in 2007/08 and 2008/09. However, domestic borrowing has dramatically jumped from only 0.5% of GDP in 2001/02 to 3.6% in 2006/07, after which it declined to -0.1% in 2008/09. The formation of a unified revenue agency – the Revenue and Customs Authority – in July 2008 and the tax reform, which includes an overhaul of value added tax (VAT), are expected to boost domestic revenue. However, the expected decline in grants and the continued high capital spending is expected to deepen the fiscal deficit to 3.5% of GDP in 2009/10 before it improves to 3.1% in 2010/11.

In recent years, monetary policy has been geared towards achieving low inflation and a stable exchange rate. The National Bank of Ethiopia (NBE) – the central bank and the regulatory authority of financial institutions –is trying to reduce the growth of money supply to contain inflation. Money supply was believed to be one of the main factors behind the country’s very high inflation in recent years. In order to contain inflationary pressure, the National Bank of Ethiopia planned to keep monetary growth below 20% in 2008/09 and under 17% in 2009/10. The growth in broad money supply has been driven by domestic credit, in particular credit to public enterprises. It increased from an average of around 10% during 2001/02-2003/04 to almost 19% during 2004/05-2006/07, after which it accelerated to 23% in 2007/08 and then slowed down to 19.9% in 2008/09. The target growth of broad money supply achieved in 2008/09, which is in accordance with the target of the NBE, was mainly due to the decline in government borrowing needs from 4.4% of GDP in 2007/08 to 2.1% in 2008/09; it is expected to fall further in 2009/10. Banks’ lending to the private sector grew by 12.6% in 2008/09, down from 22% in the preceding fiscal year. Growth in net lending to government contracted from 12.8% in 2007/08 to zero in 2008/09 – i.e., the amount of banks’ net lending to government in 2008/09 was the same as the lending in the preceding fiscal year.     

Inflation has been in double-digit figures with a rising trend since 2005/06. Overall average annual inflation reached 36.4% in 2008/09, up from 25.3% in 2007/08, 15.8% in 2006/2007 and 12.3% in 2005/06. The sharp increase in food prices was behind the unprecedented inflation in Ethiopia in both 2007/08 and 2009/10. However, the overall inflation and food price inflation were observed to have respectively risen by only 3.7% and 2.3% in the second half of 2008/09, i.e., January through June 2009. In other words, the 12 month end-of-period overall inflation rate declined to -3.7% in July 2009 after hitting a historical peak of 64.1% in July 2008. Food prices, especially cereals, were the main driver of headline inflation. Other factors that contributed to the Ethiopia’s high inflation were rising world commodity prices, particularly fuel; the considerable increase in money supply; the increase in domestic demand as a result of strong economic performance; and the shift of donors from food donations to cash assistance. Farmers’ improved access to credit through microfinance reduced the number of distress sales while better access to market information enabled them to smooth out sales throughout the year. Moreover, depreciation of the Ethiopian Birr (ETB) against major currencies, inflationary expectations, and inefficient market mechanisms created additional pressures on inflation.

Food prices are falling in response to a good harvest so the government target of single digit inflation in 2009/10 – given the tight fiscal and monetary policies – is likely to be achieved. However, this may be challenged by the fast depreciation of ETB. The NBE maintained the minimum savings deposit rate and lending rate it revised upward from 3% to 4% and from 7% to 8% in 2006/07, respectively. The Ethiopian Birr has experienced fast depreciation to reach ETB 10.4 per USD in 2008/09 from only ETB 8.79 per USD in 2006/07 and is expected to depreciate further to reach well above ETB 12.5 per USD in 2009/10. This is due to the increasing pressure on foreign exchange reserves that quickly fell from 3.8 months of imports by the end of 2003/04 to 1.9 months of imports by the end of 2006/07 and further down to only 1.2 months of imports by the end of 2007/08, though it slightly recovered to 1.8 months of imports by the end of 2008/09. The adverse impact of the global economic slowdown on merchandise exports, workers’ remittances and foreign direct investment diminished foreign exchange reserves though increased aid inflows helped to improve it. The critical shortage of international reserves forced the nominal exchange rate to depreciate by 5% in 2007/08 and almost 13% 2008/09; the increase in the premium on the parallel market for foreign exchange went from 1.9 in 2006/07 to 3.4 in 2007/08 then spiked to 13.3 in 2008/09.          

Ethiopia experienced a marginal decline of 1.2% in the nominal value of merchandise exports in 2008/09 after registering high average annual growth of 25.5% during 2003/04-2007/08. The drop in merchandise exports was due mainly to the impact of the global financial and economic crisis, which affected the demand for key traditional export commodities of the country.

Among the traditional exports of Ethiopia, pulses, coffee, leather and leather products demonstrated the largest fall in 2008/09 with a decline of 37%, 28% and 24%, respectively. Fruit and vegetables as well as sugar and molasses followed suit with a fall of 5 to 10%. It is the contraction in both volume and price that resulted in the decline of export earnings from coffee, fruits and vegetables, while it was the drop in volume that hit export earnings from leather and leather products, pulses, and sugar and molasses.

By contrast, oilseeds and meat and meat products demonstrated substantial increase in 2008/09, growing respectively at 63% and 27%. An increase in the volume of exports was the only reason behind the high growth in export earnings from oilseeds while it was both higher volume and higher prices contributing to growth in foreign exchange earnings from meat and meat products.

With the exception beeswax (it declined 14.6%) export earnings from all key non-traditional export commodities increased substantially in 2008/09, with export earnings from live animals leading the group at 29%, followed by chat (28%), gold (24%) and flowers (17%). The price, in contrast to the volume, of both flowers and gold contracted slightly in 2008/09. It was the export volume that contracted in the case of live animals and beeswax exports even as prices increased. For chat, both price and volume demonstrated an increase.

Coffee remains the leading source of export earnings from merchandise exports in 2008/09, closely followed by oilseeds as the second largest source of export earnings. Coffee accounted for 26% of the total merchandise exports in 2008/09, down from 36% in 2007/08 whereas the share of oilseeds increased from 15% in 2007/08 to 25% in 2008/09. Chat ranks third (at 9.6%) in the total value of merchandise exports followed by foreign exchange earnings from flowers (9%) for 2008/09. The share of pulses and leather and leather products in merchandise exports declined from 9.8% and 6.8% in 2007/08 to 6.3% and 5.2% in 2008/09, respectively. 

Despite the contraction in merchandise exports in 2008/09, merchandise imports continued to grow at 27% in 2008/09, due to donors assistance supported by the expansion in export earnings from the service sector. Imports of consumer goods, raw materials and capital goods respectively grew at 74%, 53% and 52% in 2008/09 compared to 21%, 82% and 1% growth rates registered in 2007/08. Imports of non-durable consumer goods grew faster than that of durable consumer goods. However, fuel imports contracted by 14% due mainly to the decline in the price of oil in 2008/09 relative to the record high in 2007/08. Inputs for agriculture were another import that declined, by about 13%, in 2008/09.

Capital goods continue to dominate merchandise imports at 31% in 2008/09, up from 26% in 2007/08. Consumer goods were the second largest component of merchandise imports, representing 30% of total merchandise imports in 2008/09, up from 22% in 2007/08, mainly due to the large imports of cereals to stabilise domestic markets.

In the face of the global financial and economic crisis, Ethiopia’s net service exports expanded at a remarkable rate of 145% in 2008/09, compared to the 31% contraction recorded in 2007/08. Net exports from travel and transportation services grew respectively at 39% and 73% in 2008/09. In the exports of transportation services, the role played by the Ethiopian Airlines was significant.

Europe remains the largest export market for Ethiopia though its share declined from 47.6% in 2006/07 to 42% in 2007/08 while Asia’s share rose from 30.2% to 35.2%. Africa stood as the third largest export market for Ethiopia, accounting for 14.2% of total exports in 2007/08, followed by the Americas at 8.1%. At country the level, Ethiopia’s major export destinations in 2007/08 included Germany (9.6%), Saudi Arabia (7.9%), the United States of America (7.3%), The Netherlands (7.0%) and Japan (6.2%). 

Asia is the largest source of Ethiopia’s imports, an increasing trend since 2000/01. Around 65% of Ethiopia’s imports originated from Asia and Middle East in 2007/08, followed by Europe (23.4%), the Western Hemisphere (6.2%) and Africa (5.5%). China overtook Saudi Arabia as Ethiopia’s largest source of imports in 2006/07, accounting for 15.6%; for 2007/08, the figure was 13.2%. India and Germany are a distant second and third at 8.2% and 5.1%.  

As a percentage of GDP, Ethiopia’s total merchandise exports and imports declined from 5.6% and 26.1% in 2007/08 to 4.6% and 24.5% in 2008/09, respectively. As a result of the relatively large fall in imports of goods compared to the decline in merchandise exports, the trade deficit improved somewhat from 20.5% of GDP in 2007/08 to 19.9% in 2008/09. The expansion in net service exports offset the decline in factor income and current transfers leading to a slight improvement in the current account deficit in 2008/09.

With debt relief through the Heavily Indebted Poor Country (HIPC) initiative and Multilateral Debt Relief Initiative (MDRI), Ethiopia’s external debt burden fell to a record low in 2006/07. Ethiopia received considerable debt relief, amounting to 21% of GDP in 2006/07, due mainly to the World Bank’s 100% cancellation of the country’s debt to IDA as part of the MDRI. Total external debt was slashed from 85.4% of GDP in 2002/03 to 11.7% in 2006/07 before steadily rising to 14.8% in 2008/09. Similarly, external debt service as a percentage of exports of goods and services declined from 7.3% in 2002/03 to 1.2% in 2007/08, after which it rose to 3% in 2008/09. Domestic public debt also gradually fell from 39% of GDP in 2002/03 to 18% in 2008/09.

Ethiopia’s private sector is predominantly small scale, informal and service-oriented. Enhancing private sector development has been one of the strategic objectives pursued under both Sustainable Development and Poverty Reduction Programme (SDPRP) PASDEP. PASDEP focuses on private sector development through investment climate reforms that includes speeding up the privatisation of public enterprises.

Although the privatisation process started in the mid-1990s, it gained new momentum with the establishment of the Privatisation and Public Enterprises Supervising Agency (PPESA) in 2004 –an autonomous body in charge of guiding state-owned enterprises to commercial viability before their sale or transfer to the private hands. Reportedly, 16 enterprises were transferred to private hands in 2007/08 in sectors such as industry and agro-industry (12 enterprises) as well as services (4 enterprises). Of the 16 privatised enterprises, 13 were an equity sale to private owners while two of them, nationalised during the Derg regime, were returned to their previous owners; one enterprise was privatised on a lease basis.

Private investment as a percentage of GDP not only remains low but has actually declined since 2003/04. The country performs poorly in a number of the World Bank’s global Ease of Doing Business indicators with slight improvement in the ranking of the country in 2009. From a set of 10 indicators, the lowest scores for Ethiopia in 2009 were "Trading across borders" (159 out of 183 economies), "Getting credit (127), and Protecting investors" (119). The highest scores were in "Paying taxes" (42 out of 183), "Enforcing contracts" (57) and "Dealing with construction permits" (60). The country’s overall ranking improved in 2009 (120 out of 183 economies) relative to 2008 (126 out of 183 countries) thanks to progress in "Starting a business" (122 out of 183 countries in 2008 as against 93 in 2009), "Registering property" (110 against 119) and "Enforcing contracts" (57 against 66).

Ethiopia’s banking system is not yet open to foreign competition. Under PASDEP, Ethiopia has taken steps towards strengthening competitive and healthy financial institutions. The growth of private banks has been much faster than of state-owned banks, although the state-owned Commercial Bank of Ethiopia (CBE) still dominates the banking system; its share in capital fell from 47.5% in 2006/07 to 45.8% in 2007/08 and declined further to 45.5% in 2008/09. In general, the banking sector of Ethiopia is dominated by public banks with the share of capital amounting to 63.5% in 2008/09, down from 70.3% in 2006/07.

Private banks generally performed better than state-owned banks. In terms of resource mobilisation through deposits, net borrowing and collection of loans, the market share of private banks exceeded that of public banks in 2007/08, with the share of private banks increasing from 46.2% in 2006/07 to 50.1% in 2007/08 because of the increase in the market share of both loan collections and deposits from 47.9% and 46.1% in 2006/07 to 49.5% and 52.9% in 2007/08, respectively. However, their share in new loan disbursements in the total banking system recorded considerable decline: from 59.5% in 2006/07 to 43.3% in 2007/08. Private banks accounted for about 36.5% of the banking system’s capital in 2008/09, up from almost 30% in 2006/07. 

However, Ethiopia has been experiencing a reversal in financial deepening as reflected by the decline in the ratios of both broad money to GDP and domestic credit to GDP – from 27% and 32% in 2007/08 to 25% and 27% in 2008/09, respectively. The high levels of non-performing loans (NPLs) and structural constraints on lending remain a significant problem of the banking system in Ethiopia. High inflation may increase the level of NPL as borrowers struggle to make repayments amid rising operational costs. In other words, high inflation could expose credit risks, as the real interest rate is highly negative.

Priority has been given to maintaining and building roads under the Rural Sector Development Programme (RSDP), as well as SDPRP and PASDEP. The first five-year RSDP, launched in September 1997, ended in June 2002. The second phase, RSDPII, stretched over the period 2002-2007, and ended in June 2007. The third phase, RSDP III, continuing where the first two phases left off, will last for three years. The programme focuses on upgrading and expanding the road network. It is a major expansion, with a target of almost 20 000 kilometres (km) of new roads by 2010 (90% of them in rural areas) and improved maintenance so that 84% of the network will be in good condition.

During the first year of the third phase (July 2007 to June 2008), 915 km of roads were rehabilitated and upgraded, 431 km were constructed as new gravel roads, and 1 910 km of asphalt and gravel roads were maintained at federal level. During the first year of RSDP III, rehabilitation/upgrading and construction works registered accomplishment rates of 78% and 93.7% of planned targets, respectively. The regional road authorities also planned to construct/maintain 3 910 km of rural road and managed to construct/maintain about 7 997 km, more than twice the planned target.  

Of the total energy resources of Ethiopia, 98% is accounted for by hydroelectricity, making the country vulnerable to power cuts in years of drought or insufficient rains. Under the Universal Electrification Access Programme (UEAP) of PASDEP, the Ethiopia Electric Power Corporation (EEPCo) – a state-run monopoly – plans to electrify over 6 000 rural town and villages to give 24 million people access to electric power by 2010. The corporation also envisages the export of electricity to neighbouring countries such as Djibouti, Kenya and Sudan. By constructing four main hydroelectric power generation stations – Beles (460 MW), Gilgel Gibe II (420 MW), Tekeze (300 MW) and Fincha Amerti Neshe (97 MW) – as well as promoting windmill power generation (150 MW) the government aims to increase the country’s power generation capacity to 2241 MW from 814 MW in 2007/08. The Gilgel Gibe II and Tekeze projects were completed recently but the Gilgel Gibe II station encountered a problem after completion.

Under PASDEP, Ethiopia seeks to secure sustained development in agriculture. The objectives are: to implement relevant training programmes; introduce high-yielding technologies; increase the quantity and quality of marketable agricultural products for both domestic and international markets; expand small and medium-scale irrigation and water conservation schemes; and ensure prudent utilisation of natural resources.

Ethiopia has expedited structural reforms to boost agricultural productivity. As commercialisation of smallholder agriculture is at the core of Ethiopia’s poverty reduction strategy, the country introduced the Ethiopian Commodity Exchange (ECX), in January 2008, to help improve the marketing of agricultural products. The commodity exchange, which is a new initiative for Ethiopia, has been set up to trade in six commodities: coffee, sesame seeds, haricot beans, teff, wheat and maize. ECX has already started trading in all of them with the exception of teff, which is a minuscule common cereal grain in Ethiopia. 

The government of Ethiopia has undertaken a number of tax reforms since 1992/93 to improve efficiency, achieve greater equity and broaden the tax base by decreasing the tax rate. The policy is also designed to discourage certain forms of production and consumption. A series of tax reforms were also introduced with a view to encouraging investment and foreign trade. For instance, sales tax experienced several amendments since its introduction in 1993 until it was abolished at the end of 2002 and replaced by VAT in January 2003. The 1975 decree on stamp duties was amended in 1998, while the income tax on rural land and agricultural activities issued in 1978 was amended in 1995 and 1997.

Withholding tax, withholding of income tax on payments, and an export trade duty incentive scheme were introduced in 2001. In 2002, the government issued a number of proclamations on, and/or amendments to: VAT, income tax, excise tax, turnover tax and stamp duty.

The government also undertook structural and institutional reforms. The Ethiopian Revenue and Customs Authority (ERCA) was established in July 2008 by merging the Ministry of Revenue, Ethiopian Customs Authority and the Federal Inland Revenue Authority into a single administration. With the establishment of ERCA, a Tax Reform Task Force and a Tax Reform Programme Office were set up. ERCA has become responsible for directing, supervising and co-ordinating the three revenue-collecting institutions: the Federal Inland Revenue Authority; the Ethiopian Customs Authority; and the National Lotteries Administration. This was supported by a strategy to design a simple and transparent tax collection system: to treat taxpayers better by facilitating payment mechanisms, including the use of bank services; to crack-down on defaulters; to keep a tight check on corruption; and to use available technology wisely.

ERCA was established with a view of improving the tax administration and management, and currently, the authority is undergoing Business Process Re-engineering (BPR) as part of the overall reform agenda. The government was also able to include customs reform in the overall reform package, namely the "Revenue sector reform programme" and this was designed to overhaul tax and customs legislation and strengthen the administrative capacity of the Federal Inland Revenue, the regional tax authorities and the Ethiopian Customs Authority. The reform process has taken into consideration international best practices and aims at improving services to taxpayers and achieving optimal revenue collection. These measures are intended to encourage trade and investment, broaden the tax base, and ensure equity, fairness and honesty in the tax administration.

The Ethiopian tax system includes four major types of taxes: income tax, taxes on goods and services, tax on international trade (this is essentially on imports as export taxes & duties were abolished in 2002/03), and other taxes that include stamp duties and withholdings. The federal government’s sources of revenue include duties, taxes and others charges levied on imports, personal income tax collected from employers of federal government and international agencies, taxes collected from national lotteries, taxes collected on income from air, train and marine transport activities, profit, personal income, value added, rental houses, properties, charges and fees on licences and services that are owned by federal government. The joint revenue sources of the central and regional governments include: profit tax, personal income tax and VAT collected from organisations/enterprises; profit tax, royalty and rent of land collected from large scale mining; any petroleum and gas operations, and forest royalty.

The tax policy adopted by the federal and regional government incorporates a reduction of the marginal tax rate from 89% during the Derg regime to 35% for corporate tax of a private company and from 50% to 30% for sole proprietors and corporate entities. The marginal income tax rate was also reduced from 85% in the previous regime to 35% (i.e. profit tax is 30% and legal personal income tax rate ranges from 0 to 35%).

VAT is 15%, applied to good and services with some exemptions to encourage investment and alleviate the tax burden of the lower-income population. Therefore, VAT has a uniform rate of 15% on most goods and services, with a zero rate on exports and exempted goods and services. The scope of exempted goods and services differs from that under the sales tax. The main items exempted under VAT include sales of used dwellings, financial services, medical and educational services, electricity, kerosene, water and transportation.

A turnover tax was issued (in 2003) on business with a volume of sales below the VAT threshold (of ETB 500 000). This proclamation levies 2% on goods and some types of services and 10% on other services. Excise tax proclamation No 307/2003 has been issued and levied on selected local and imported goods.

Land is a public property in Ethiopia. It has been administered by the government since the 1975 radical land reform. Therefore, agricultural income tax is levied on a presumptive base and a land use fee is levied annually on rural lands in an amount varying with plot size.

Government revenue from tax has been increasing in absolute terms. This increase is achieved in the face of customs exemptions, non-buoyant agricultural taxation effects, tax holidays, tax evasion, commercial fraud, weak administration and the pro-poor taxation policy designed to encourage private sector development with large exemptions. 

Total government domestic revenue and grants have been steadily increasing with an annual average of 23% during 2002/03-2008/09. It increased more than fourfold from ETB 12.8 billion in 2001/02 to hit ETB 54.6 billion. However, total revenue and external grants as a percentage of GDP declined from 19.3% in 2001/02 to 16.6 in 2008/09. Grants increased from 3.6% to 4.4% of GDP while total domestic revenue fell sharply from 15.6% to 12.2% over the same years. In absolute terms, total domestic revenue and external grants grew by 22% and 36% during 2002/03-2008/09, respectively. In 2008/09, external grants grew by almost 46% against 35% growth in domestic revenue. This clearly indicates that external grants play an increasingly important role in financing the overall government fiscal deficit in recent years.

Tax revenue constitutes the largest part of domestic revenue in Ethiopia. It accounts for more than 76% of domestic revenue in 2001/02 but declined to a little over 72% in 2008/09, with an average annual growth of 21% during 2002/03 – 2008/09 to hit ETB 29 billion in 2008/09 up from close to ETB 8 billion in 2001/02. Import duties and taxes constitute the largest share of total tax revenue followed by direct taxes and indirect taxes. The share of indirect taxes in total tax revenue surpassed 25% in 2008/09, up from only 19% in 2001/02, mainly owing to the fast increase in revenue from turnover tax. By contrast, the share of direct taxes in total tax revenue fell sharply, down from over 39% in 2001/02 to 34% in 2008/09, due to the considerable decline in the proportion of revenue from business profits. The major source of direct taxes has been income and profits tax that constitute 23% of total domestic revenue and 94% of direct taxes in 2008/09.

Compared with tax revenue, the share of non-tax revenue in total domestic revenue increased from about 24% in 2001/02 to almost 28% in 2008/09 as a result of a significant increase in revenue from residual surplus, capital charges, interest payments and state dividends, which recorded an average annual increase of 45% during 2002/03–2008/09, and an increase in its share in total non-tax revenue from 32% in 2001/02 to 65% in 2008/09.

In absolute terms, total domestic revenue has been increasing considerably though it has not been sufficient to finance government spending targets. Some of the important factors that contribute to low tax revenue are the inability of the government effectively to represent the rural agricultural sector in the tax system. The agriculture sector possesses the larger share of the economic resources of the country. Its average contribution to national tax revenue, including the land use fee of the last six years, was only about 1.8%. This calls for the extension of an effective taxation system to the rural sector.

The lowest average growth rate of tax revenue is observed on business profit tax and agricultural income tax in the last decade. This implies unsatisfactory revenue performance, inadequate enforcement and auditing practices that fall short. Further strengthening of the tax collection system in this area is necessary. VAT and Personal income tax compliance is also relatively low owing to weak tax collection enforcement power and an unhealthy administrative environment.

The critical tax administration problems in Ethiopia are tax evasion and commercial fraud in rental employment, business profit, and indirect business tax. Given the lack of adequate book-keeping, particularly among smaller and medium businesses, and the relative under-reporting of sales, the tax collected is deemed to be lower than the potential. Widespread tax evasion and fraud undermine the tax revenue from business and VAT taxpayers. Moreover, the commercial fraud on import duties through under-invoicing, under-declaration and non-declaration are additional challenges for the tax system. The provision of tax exemption for a range of goods and services also has an effect on tax revenue generation.

The large informal economy is not paying taxes even though the Keble – the lowest administrative unit – is involved in collecting taxes. Its efficiency and effectiveness need more institutional capacity strengthening.

The tax administration in Ethiopia lacks institutional capacity to handle modern operational and enforcement practice to deliver efficient and quality service.  The Ethiopian revenue administration does not have its own training, compensation and incentive scheme to capacitate, attract and motivate qualified experts. BPR measures are being undertaken to address the issues of remuneration and motivation to improve the working environment. The tax administration cost has averaged 2.71% of the revenue collected since 1996. Greater tax administration resources would result in much greater revenue gains if used appropriately.

Political tensions are expected to rise owing to the upcoming federal and regional elections in May 2010 as different parties have already started regrouping for the campaign. Civil tensions also increased in 2009, in particular because of an increase in fighting between the Ethiopian government and the Ogaden National Liberation Front (ONLF) rebels in the potentially oil-rich region of Ogaden.

The hardening of the regime indicator, which reflects the actions of the government against the opposition, foreign NGOs and media, remained pretty stable in 2009. In 2009, the head of opposition party – the Unity for Democracy and Justice (UDJ) – was arrested, amnesty was cancelled, and five opponents of the government were condemned to death and 33 to life-long sentences.  An Ethiopian weekly often critical of the government’s policies, Addis Neger, was forced to close down after months of “persecution and harassment” from the authorities.  Human Rights Watch warned of a progressive hardening of the political stance towards opponents.

Because of the international economic crisis and a severe shortage of foreign reserves, the government adopted a harsher stance towards the private sector. Export licences were revoked and coffee exports were confiscated.

The foreign policy of Ethiopia will be dominated by relations with Eritrea as the long-standing border dispute has not yet been settled despite several attempts at diplomatic solutions. The independent Eritrea-Ethiopia Boundary commission (EEBC) closed its operation in November 2007, followed by the UN Security Council decision to withdraw its peacekeeping force (UNMEE – UN Mission in Ethiopia and Eritrea) in July 2008. This raises the risk of conflict between the two countries. Tensions in the region also remain high as a result of insecurity in Somalia.

Corruption – though perceived as widespread – has shown improvements in Ethiopia since 2005. Based on Transparency International’s Corruption Perception Index, the country’s ranking among 180 countries improved from 126 in 2008 to 120 in 2009; the corruption perception score improved slightly, from 2.6 to 2.7. 

Ethiopia’s House of People’s Representatives passed the Mass Media and Freedom of Information Proclamation in July 2008. This new media and information law, which is an update of the first ever Ethiopian press law of 1992, bans censorship of private media and detention of journalists. It also grants journalists the right to set up an independent press council. However, members of opposition parties and many local and international media groups have expressed their deep concern and frustration over the new law, as it allows state prosecutors to invoke national security as grounds for impounding materials prior to publication and distribution. The other threat to freedom of expression, under this new law, is the government’s appropriation of the right to prosecute defamation cases against constitutionally mandated legislators, executives and judiciaries. It has also raised the compensation for the moral damage caused by a mass media outlet from ETB 1 000 to ETB 100 000.

The government also passed a new proclamation for the registration and regulation of local NGOs and CSOs in January 2009. The heart of this new law is a provision stating that any CSO receiving over 10% of its funding from abroad is classified as a foreign NGO and not allowed to engage in activities concerning democratic and human rights, conflict resolution or criminal justice.  The 10% ceiling may restrict foreign funding and the scope of activities that have been undertaken by these charities or societies. It may also hurt human rights groups critical of the government as this law sets penalties and powers to investigate and oversee charities or societies. It limits activity in human and democratic rights, gender or ethnic equality, conflict resolution, and the strengthening of judicial practices or law enforcement, to Ethiopian charities only. Human rights activists have accused the Ethiopian government of tightening its grip on power through a new law on charity funding that will criminalise human rights work and crack down on political debate ahead of the May 2010 election. Many civil society organisations have also argued that this new law is restrictive in demarcating areas of operations for different types of CSOs.  

The Poverty Reduction Strategy Programme (PRSP), as part of the Sustainable Development and Poverty Reduction Programme (SDPRP) (2002/03–2004/2005), first addressed human development needs and poverty reduction. The policy continued under the second phase of PRSP, the Plan for Accelerated and Sustainable Development to End Poverty (PASDEP) (2005/06 -2009/10). As a result, Ethiopia has made significant progress towards achieving the Millennium Development Goals (MDGs), especially compared to levels in the 1990s. Headcount poverty, which stood at 48% in 1990 and 44.2% in 2000/01, fell to 38.7% 2004/05, with a trend estimate of 34.6% for 2006/07.  Primary school enrolments have almost tripled, i.e. from 32% in 1990 to 91.6% in 2006/07, with a completion rate of 43% in 2006/07, up from 34 in 2004/05. The ratio of girls to boys in primary education reached 0.93 in 2006/07, compared with 0.61 in 1995/96. This ratio also increased in secondary and higher education from 0.57 and 0.24 in 2004/05 to 0.78 and 0.30 in 2006/07, respectively. The number of women in parliament almost tripled: 116 in 2007/08, up from only 42 in 2000/01.

The under-five child mortality rate declined from 190 per 1 000 children in 1990 to 123 in 2004/05 while infant mortality fell from 123 per 1 000 infants in 1992/93 to 77 in 2004/05. Maternal mortality also dropped from 871 per 100 000 in 1990 to 673 in 2006/07, with improvements in the proportion of births attended by skilled personnel and the contraceptive prevalence rate which rose from 9% and 15% in 2004/05 to 16% and 33% in 2006/07, respectively. With regard to HIV/AIDS, its overall prevalence fell dramatically within a short period, down to only 2.1% in 2006/07 from 7.3% in 2000/01; however, it sharply increased among 15-24 old pregnant women, from only 0.9% in 1990 to 8.6% in 2004/05, after which it fell back to 5.6% in 2005/06. The proportion of people living with HIV/AIDS who receive antiretroviral treatment almost quadrupled within just three years: from only 10% in 2004/05 to 37.1% in 2006/07. The percentage of the population without access to safe water dropped considerably from 81% in 1990 to 47.6% in 2006/07.

Most of the improvements in health conditions were due to the provision of essential health services geared especially to the needs of mothers and young children, expanded coverage of rural outreach programmes, and the recent innovative approach in the delivery of a package of health services in rural areas through female health extension workers. The target ultimately to deploy 30 000 female health extension workers to provide services directly to women at the community level is well under way – 60% of the target was achieved by the end of 2006/07. The strategy for achieving significant progress in reducing child mortality has included a focus on delivering an essential package of care that targets diseases affecting children and the poor; a push to improve coverage and delivery of health services in rural areas; and a major effort on vaccination, which has been particularly successful.

 

Ethiopia’s progress in social and human development came about because the country assigned greater priority in policy and spending to education, health, agriculture and roads. For instance, poverty-targeted expenditure (i.e. expenditure geared towards education, health. agriculture and roads) has increased to 64.1% of total government spending in 2007/08, up from 42.8% in 2001/02; 47% of current expenditure and 81% of capital expenditure targeted poverty in 2007/08, compared with 29% and 73% in 2001/02, respectively.