ETHIOPIA MONTHLY ECONOMIC REVIEW FOR JULY 2007

UNCLAS SECTION 01 OF 03 ADDIS ABABA 002561

SIPDIS

SIPDIS

STATE FOR AF/E, AF/EPS, AND EB/TRA

E.O. 12958: N/A
TAGS: ECON ETRD EINV EAGR EAIR ET

SUBJECT: ETHIOPIA MONTHLY ECONOMIC REVIEW FOR JULY 2007

REF: ADDIS ABABA 2324 (AND PRIOR)

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1. SUMMARY.
--FEDERAL BUDGET: The Ethiopian Parliament unanimously approved a
USD 4.9 billion budget for fiscal year 2007/08. The budget is
Ethiopia's highest, representing a 24 percent increase over the
2005/06 budget, and a 44 percent increase over 2004/2005. The
defense budget officially rose for the first time in three years by
16.7 percent, while subsidies to regional states increased by over
44 percent. To finance the budget, the GOE announced two tax
increases, affecting small-to-medium enterprises and rental income.

--The consumer price index (CPI) is still on the rise; CPI inflation
reached 17.8 percent in July.
--The official exchange rate of the Ethiopian Birr against the U.S.
dollar continued to slowly depreciate, reaching 9.0326 Birr/USD at
the end of July.
--Ethiopia's trade deficit widened further in 2006/07. The fuel
import bill reached USD 890 million in 2006/07 and is projected to
reach USD 1.2 billion for 2007/08 (equal to total export receipts).
--Commercial banks are adjusting their interest rate structure in
line with the recent directives issued by Ethiopia's central bank,
the National Bank of Ethiopia (NBE).
--Ethiopian Airlines (EAL) and Gulf Air entered into a code sharing
agreement. EAL has also signed an agreement to purchase MD-11
freighter aircraft from Boeing.
--The Chinese Road and Bridge Corporation won the majority of road
projects tendered recently in Ethiopia.
END SUMMARY.

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BUDGET AND FINANCE
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2. Ethiopia's parliament approved a proposed budget of USD 4.9
billion for fiscal year 2007/08. For the first time in sixteen
years, the budget was approved unanimously. The budget was 24
percent higher than the 2005/2006 budget (USD 4.05 billion) and 44
percent higher than 2004/05 (USD 3.4 billion). The budget consists
of a USD 2.1 billion capital budget, a USD 1.2 billion recurrent
budget, and USD 1.6 billion in subsidies to Ethiopia's regional
states. Over 40 percent of the budget is planned for pro-poor
sectors such as agriculture, irrigation and water resource
development, road construction, education, health, and rural
electrification services. The defense budget officially rose for
the first time in three years by 16.7 percent. Prime Minister Meles
defended the defense budget increase in parliament by saying "The
increase now aims at strengthening the country's military
capability, as a deterrent against anyone who may try to threaten
the country's territorial integrity." Subsidies to regional states
increased by over 44 percent, showing the government's commitment to
expand services at the grassroots level.


3. Nearly 58 percent of the budget is expected to be financed from
domestic revenue, in contrast to 41 percent last year. The increase
in coverage from domestic revenue is mainly due to improved tax
administration, a broadening tax base, and the recently levied
surtax. Some 25 percent comes from external assistance, and 17
percent from domestic and external loans. Given the prevailing
double digit inflation, the real rate of growth in the annual budget
is only 4 percent, indicating a prudent fiscal stance. Generally,
opposition parties and donors welcome the budget.

4. The Ministry of Finance and Economic Development (MOFED) issued
two directives aimed at broadening the tax base of the country and
raising government revenue. The profit tax directive raises
category C presumptive tax rates at the regional level from 7.5-10
percent to 10-30 percent. (NOTE: Category C businesses are those
whose annual turnover is below USD 11,000. END NOTE.) Tax on
rental income was increased from 10 to 30 percent. The directive
was distributed to local tax collecting agencies in Ethiopia's nine
regional states, as well as Addis Ababa and Dire Dawa. Some local
business owners oppose these directives, aimed at raising funds to
cover the record high federal budget. The tax bases were
significantly revised downwards in the aftermath of May 2005
national elections, in response to complaints from taxpayers.
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INFLATION, EXCHANGE RATES AND INTEREST RATES
--------------


5. The annualized country level headline inflation rate has been
steadily rising and reached 17.8 percent in June 2007, in contrast
to 17.3 percent in the preceding month and 12.3 percent a year
earlier. The GOE has been distributing subsidized wheat in Addis
Ababa since February 2007 to curb the rise in inflation. Ethiopia's
central bank, the National Bank of Ethiopia (NBE),has also raised
the minimum bank deposit rate by 1 percent, and raised the reserve
requirement ratio from 5 to 10 percent to reinforce the effort to
abate inflation.

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6. The official exchange rate of the Ethiopian Birr is determined by
the daily inter-bank foreign exchange market in which the NBE
intervenes to regulate the market. The inter-bank rate at the end
of July reached 9.0326 Birr/USD in contrast to 9.0296 Birr/USD at
the end of June. Meanwhile, the parallel market rate at private
shops in different parts of Addis declined to 9.25 Birr from 9.30
Birr last month. The Birr in the parallel market will further
appreciate as more remittances are expected for the Millennium
celebration. (NOTE: According to the Ethiopian calendar, the year
2000 arrives September 11, 2007. END NOTE). Driven by rising
domestic inflation relative to prices of Ethiopia's major trading
partners, the real effective exchange rate is appreciating, making
the country's exports less competitive.


7. The central bank allowed the lending interest rate to be
determined by market forces in January 1998, but continues to
control the floor deposit rate. The minimum deposit rate,
previously fixed at 3 percent per annum, was revised to 4 percent
effective July 4, 2007. Consequently, commercial banks have raised
their lending rates by one percent. Given the double digit
inflation rate, however, real interest rates are currently negative.
The Bank also raised the legal reserve requirement ratio of
commercial banks from 5 to 10 percent effective July 20. The
central bank has rejected the Bankers Association's request for a
three-month grace period to comply with the revised reserve
requirement ratio.

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EXPORTS, IMPORTS AND BALANCE OF TRADE
--------------


8. Total receipts secured from exports of merchandise during the
just-concluded Ethiopian fiscal year reached USD 1.2 billion,
reflecting an 11 percent increase over the previous fiscal year, but
a 21 percent shortfall from the GOE's projected USD 1.5 billion. Of
the total dollar amount, coffee accounted for 36 percent, oil seeds
16 percent, gold 8 percent, khat 8 percent, and leather and leather
products 7.6 percent. On the other hand, the total import bill rose
to USD 5.1 billion--over 18 percent more than last year, leading to
a widening gap in the trade deficit.


9. According to the Ethiopian Petroleum Enterprise's (EPE) latest
data, Ethiopia's fuel import bills in FY 2006/07 year reached USD
890 million, a 19 percent increase from the preceding year. About
1.6 billion liters of fuel were imported, indicating an average
price per liter of USD 0.55. The supply of jet fuel and kerosene
saw an 11 percent increase, while benzene consumption showed 10
percent growth. Fuel oil consumption has remained nearly at last
year's level. The projection for 2007/08 spending of fuel imports
is USD 1.2 billion (1.8 billion liters),34 percent higher than
2006/07.


10. Berki International, a Saudi-based oil company, clinched the
supply contract for the first half of FY2007/08, outbidding four
other companies, including U.S.-based oil company Exxon Mobil, which
had been supplying the country's major fuel imports for the last
three years.

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AVIATION AND ROADS
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11. State-run Ethiopian Airlines (EAL) and Gulf Air, the national
carrier for the Kingdom of Bahrain, have entered into a strategic
code sharing agreement, which will enable the two airlines to open
up routes and service to each other in their respective networks and
provide customers with seamless connections between their networks.
While EAL has various cooperation agreements with other African and
European carriers, this accord is the first with a Gulf region
carrier.


12. EAL also signed an agreement with Boeing Capital Corporation
(BCC) to purchase one MD-11 freighter aircraft for delivery in
December 2008. The MD-11, currently in a passenger configuration,
will soon be converted to a freighter with an 88-ton cargo capacity.
Ethiopian is also negotiating for a second converted MD-11
freighter aircraft on a lease basis, scheduled for delivery at the
end of 2009. Ethiopian now owns and operates two B757 freighter
aircraft.


13. The Chinese Road and Bridge Corporation (CRBC) clinched
two-thirds of the Addis Ababa City Road Authority's (AACRA) road
projects, valued at more than USD100 million. The firm outbid local
and foreign rivals in five of the nine road projects, whose designs
had been undertaken a year earlier by local designers. In addition
to CRBC, another Chinese firm, UE Industrial, has also won one of
the projects. According to the city's latest road project contracts

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signed in July 2007, the CRBC will construct four segments of
asphalt roads stretching a total of 20 kilometers and forty meters
wide. The construction is expected to be completed in two years.

YAMAMOTO