ERITREA'S ECONOMY ON THE ROPES; DOES THE GSE HAVE

C O N F I D E N T I A L ASMARA 000347

SIPDIS

SIPDIS

LONDON FOR AFRICA WATCHERS
PARIS FOR AFRICA WATCHERS

E.O. 12958: DECL: 04/11/2016
TAGS: PREL PGOV PINR ECON EAID EFIN ET ER
SUBJECT: ERITREA'S ECONOMY ON THE ROPES; DOES THE GSE HAVE
THE WILL TO SAVE IT?

CLASSIFIED BY: AMB Scott H. DeLisi, for reasons 1.4 (b)
and (d).


1. (C) Summary: With telephone outages the norm,
electricity essentially rationed, and imports cut to next
to nil, Eritrea faces an economic crisis. Since the end of
the war with Ethiopia in 2000, Eritrea has maintained a
heightened state of national security. For the Government
of Eritrea (GSE) everything, including the country's
economic stability and viability, is secondary to ensuring
the protection of the nation-or so the government asserts.
For the past four years, economic policy has reflected the
political policy of "no war, no peace", resulting in high
defense spending and continued conscription of a large
percentage of the labor market into national service. This
focus has left Eritrea with a debt that is unsustainable
and an economy crumbling to bits. One possibly positive
note to come from this is that at the IMF meeting in March,
the Eritrean authorities expressed a willingness to engage
more deeply with the Fund, seeking to initiate the process
that will lead to HIPC and other debt relief programs.
However, whether the GSE has the political will to enact
the reforms necessary for IMP and HIPC support is a
proposition that many here question. It is also possible
that the severe economic problems the country faces could
be a further incentive to the GSE to bring the border
stalemate to closure but, again, much will depend on the
GSE's political will and its own assumptions about how much
more hardship the Eritrean people can bear. End Summary.

ERITREA'S ECONOMY: AN OVERVIEW OF THE NUMBERS
--------------


2. (U) Eritrea is one of the poorest countries in the
world, with per-capita income of USD 157 in 2005 and a rank
of 161 out of 177 countries in the 2005 UN Human
Development Index. Various sources estimate that the 2005
real GDP for Eritrea is approximately 770 million USD.
(Note: Changes to the exchange rate in 2005 from 19.5 to 15
Nakfa to the USD affect the conversion on nominal GDP
leading to an overstated GDP estimate. End Note.) GDP
growth is estimated at 4.8 percent, up from 2004 yet due
mostly to the government appreciation of the Nakfa and the
strangling of imports. In the 2005 Article IV
consultations, the IMF estimated the net present value of
the total government debt at 164 percent of the GDP, with
domestic debt representing 111 percent and external debt 53
percent of the total.


3. (C) Inflation is eating away at any small growth in GDP.
The head of the PFDJ-owned Housing and Commerce Bank,
Berhane Tekeste, recently told PolOff that inflation was
running over 20 percent. The World Bank reports pegged the
CPI at 21.5 percent for 2004, significantly above the sub-
Saharan average, yet the 2005 IMF estimates the CPI for
2005 is 12.4 percent. Locals report significant increases
in local prices, commenting that one year ago a candle was
50 cents Nakfa and now it is five Nakfa, if you can even
find one in the store. Moreover, the prices of general
food stuffs are becoming prohibitive for the average
Eritrean. A sixty Nakfa (USD 4) loaf of bread, petrol at
roughly Nakfa 120 (USD 8) a gallon, and coffee at 50 Nakfa
(USD 3.30) per pound instead of the pre-war price of 17
Nakfa make life almost too costly to live for many here.

TRADE, WHAT TRADE?
--------------


4. (U) Eritrea's once burgeoning trade with Ethiopia and
Sudan crashed with the end of bilateral relations with both
countries. A positive current account balance is a thing
of the past; World Bank estimates the 2004 balance was a 45
million USD deficit. Since a high of nearly USD 200 million
in 1997, Eritrea's exports of goods and services have
declined dramatically to an estimated USD 12 million in

2005. Exporting predominantly agricultural items in the
past such as livestock and sorghum, Eritrea historically
had a small textile industry and a small salt industry as
well. Yet, as previously mentioned the termination of
trade with Ethiopia and Sudan decimated the export
business.

REVENUE? FROM WHERE?
--------------

5. (C) As exports are minimal, from where does the
government revenue come? According to the IMF, total
government revenue was USD 370.2 million with 72 percent
coming from tax revenue, presumably including an estimated
USD 100 million paid by Eritreans living overseas. The
remaining come from grants and other non-tax revenues.
What fuels the economy according to Mathewos Woldu of the
Ministry of National Development, are tourism, agricultural
and fishing industries; money from the diaspora (both the
official tax and remittances) and borrowing. In reality, it
is the diaspora and borrowing that keeps the economy alive
today.

SPENDING, SPENDING, SPENDING
--------------


6. (C) With a growing debt, where does the money go? Debt
service is nearly 25 percent of revenues. Estimates for
defense spending vary from 17 percent to nearly 50 percent.
In a speech given in 2005, President Isaias, stated that
half the GSE expenditures are for national security.
Without a transparent budget and the understanding that
hardware purchases such as tanks and weapons may not be
reflected in any published numbers, President Isaias's
statement may reflect a reality. The remainder of
expenditures are essentially on wages for government
employees and on materials. Mathewos told PolOff that the
debt burden is the greatest economic challenge faced by the
government.


7. (U) Of importance is the growing oil bill for the
nation. With an estimated USD 108 million spent on
petroleum products, increases in the global oil prices will
significantly squeeze Eritrea. With gasoline costing USD 8
per gallon and electricity cuts a regular occurrence, the
price of oil is a constant issue in Asmara. In the
monitoring and assessment of avian flu, the government's
delay in allocating funds for gasoline for the Ministry of
Agriculture vehicles to travel in response to reports
stalled the initial efforts to respond. As Eritrea has no
oil production, much of the imported oil comes from Libya.
There are rumors in Asmara that the tab is rapidly growing
and has not been paid in some time.

NO WAR, NO PEACE, NO LABOR MARKET
--------------


8. (U) No one knows the exact number, however an estimated
600,000 Eritreans are believed to currently be in national
service, approximately 40 percent serving in the military
and the remaining 60 percent working for extremely low
wages in government ministries and government-owned
enterprises. Many in the second group are demobilized on
paper, however, they can be recalled to the military at any
time. With the requirement for national service, which
could include working in the fields during harvest,
construction on infrastructure projects or other hard
labor, individuals are not able to participate actively and
freely in the labor market. Many have had their education
or technical training cut off or limited and, with the
University closed and post-secondary education controlled
completely by the government, the future viability of the
labor market remains in question. In fact, when one
considers the national service cadres may constitute
between 15-20 percent of the total population and a much
higher percentage of the available work force pool over the
age of 18, the labor market faces serious strains as does
the labor pool for agricultural production. While the GSE
may claim success with the World Bank-funded demobilization
project, the World Bank Country Director in Eritrea is
quick to point out that meeting the technical requirements
does not always mean a program is successful. National
service seems to have a steady flow of intake, so while
national service members may not be doing military service
on paper, those who are not are Eritrea's ready reserves.

DEBT SUSTAINABILITY
--------------


9. (U) With regards to the debt, heavy government
involvement in the economy and the artificially low setting
of treasury bill interest rates has kept the domestic
portion of the debt low. Basically, the GSE is able to
delay repayment of these domestic loans, most taken out
during the conflict with Ethiopia. Furthermore, GSE has
been able to fob off members of the Diaspora holding this
debt by offering them land in Eritrea and facilitating the
means to construct new houses in the homeland. As for the
external debt, grace periods began expiring within the last
few months, and the pressures of these will be felt
acutely.


10. (U) The bottom line is that Eritrea can not continue to
sustain the debt. At the IMF Executive Board Meeting,
Eritrea announced its interest in engaging in a fund-
sponsored program that would lead to debt relief
initiatives. Cutting it close to the 2006 deadlines,
Eritrea will need to move swiftly if it is truly serious
about its commitment to the program and process. Yet, when
pressed about what the complications might be for Eritrea,
the Ministry for National Development's Mathewos was loathe
to give a specific answer. The concern among many
observers is that the requirements for transparency,
demobilization and reducing defense spending may prove too
much for the GSE to swallow.

COMMENT
--------------


11. (C) In a striking departure from earlier positions, the
GSE now claims to be ready to engage international partners
seriously on the economic reforms that can lead to HIPC
qualification. However, even with the GSE's stated
interest in the debt relief program, they may hold these
programs hostage to border demarcation - or may feel
themselves unable to consider reforms absent resolution of
the border issue. With demobilization and defense spending
reduction among the IMF list of concerns, the GSE may balk
as long as they feel the national security of Eritrea is at
risk. The border and economic reform are inextricably
linked for the GSE. Progress on either, or both, will come
down to whether the GSE has the political will and
commitment to make progress a possibility. In the past,
the Eritrean leadership has shown a willingness to allow
its ideological vision of "one nation, one party, one
people," to trump pragmatism on economic decision-making.
Given that history, it is not a stretch to think that the
GSE may be willing to let Eritreans tighten their belts and
suffer a while longer before agreeing to fundamental
changes in economic policy or philosophy. End Comment.

DeLisi