ETHIOPIA: IMF ARTICLE IV MISSION CONCERNED ABOUT

UNCLAS SECTION 01 OF 02 ADDIS ABABA 000776 SIPDIS SENSITIVE SIPDIS STATE PASS TO USTR E.O. 12958: N/A TAGS: ECON ETRD EINV ET SUBJECT: ETHIOPIA: IMF ARTICLE IV MISSION CONCERNED ABOUT SUSTAINING GROWTH, RISING INFLATION ADDIS ABAB 00000776 001.2 OF 002 ¶1. (SBU) Summary: A February 23 - March 9 International Monetary Fund (IMF) Article IV consultation mission concluded that the Ethiopian economy was "fine for now," yet noted privately to emboffs that it had serious concerns about Ethiopia's ability to sustain current growth rates. The mission publicly congratulated the government on the economy's ability to rebound from the 2002/03 drought with annual average growth of close to 11 percent. Privately, however, IMF officials expressed concern about a number of issues, including rising inflation rates and its negative impact on the poor, interest rates that discouraged savings, structural reforms to barriers that threaten sustained growth, and the GOE's ability to service increasing debt levels. The mission advised the government to dampen demand and enhance growth through structural reforms to ensure macroeconomic stability and sustained growth. Significantly, the two sides agreed to consult semi-annually instead of annually. End Summary. ¶2. (U) IMF Deputy Managing Director Takatoshi Kato led the February 23 - March 9 mission and met with many senior government officials, including Prime Minister Meles, Ministry of Finance and Economic Development Sufian Ahmed, Economic Advisor to the PM Neway Gebre-ab, and Governor of the National Bank of Ethiopia Teklewold Atnafu. Senior IMF resident representative Arnim Schwidrowski briefed pol/econ chief and econoff March 13. GROWTH DAMPENING INFLATION -------------- ¶3. (SBU) Schwidrowski told pol/econ chief March 13 the IMF mission was particularly concerned about rising inflation rates. He said the GOE appears to acknowledge that large government public work projects are a significant factor behind both inflation and balance of payments problems, but attributed the rise in inflation to farmer hoarding. (Note: The IMF and USAID do not consider hoarding by farmers as a major contributor to Ethiopia's rising inflation. End Note.) Schwidrowski said that the IMF advised the government to tighten monetary and fiscal policy to dampen demand. He said only time will tell whether the GOE is willing to dampen demand to ease inflation. ¶4. (SBU) In addition to rising inflation, Schwidrowski said �A;that there are some profound imbalances in the economy, especially interest rates. He explained that when bank deposits earn 3 percent while inflation runs at 20 percent, consumers lose money by leaving it in the bank. With a maximum bank loan rate of 15 percent -- still five percent below inflation -- borrowers gain an implicit subsidy of 5 percent, he said. This, Schwidrowski continued, promotes borrowing for construction projects that can ultimately supply rent or other cash flow. He added that the boom in the construction sector reflects this reality. REFORMS NECESSARY TO SUSTAIN GROWTH -------------- ¶5. (SBU) Schwidrowski said that another priority of the mission was to inform Ethiopia that sustaining current growth rates will be difficult without structural reforms to diversify the economy and increase productivity. He added that a study by the IMF's Addis office suggested that the Ethiopian economy's growth has reached its limit. Schwidrowski said that there should be a dialogue with the GOE and the World Bank about how to remove key bottlenecks that will eventually constrain growth, such as the GOE's monopolies in the fertilizer industry and telecom sector and near monopoly in the financial sector. Schwidrowski added that the IMF and international donors need to move beyond "simply clamoring" for change in the telecom and financial sectors. FOREIGN EXCHANGE RESERVES AND EXTERNAL DEBT -------------- ¶6. (SBU) Schwidrowski said that the IMF was concerned that foreign aid and remittances would provide for only two and half months of import coverage in foreign exchange reserves. Schwidrowski said that there was no immediate problem for the GOE because both aid flows and remittances were now rising, but Ethiopia was vulnerable to shocks such as drought or a serious disruption of aid flows/remittances. The IMF, Schwidrowski noted, approved of the GOE's current policy to ADDIS ABAB 00000776 002.2 OF 002 slowly devalue the Birr and said it was a necessary adjustment prudently administered. ¶7. (SBU) Schwidrowski expressed his concern about debt sustainability and Ethiopia's growing indebtedness to China. The mission, Schwidrowski explained, was particularly troubled about the proposed USD 1.5 billion loan from China for modernization of the telecom sector. The mission urged the GOE to carefully evaluate what revenue streams such investments would generate and how much growth would be impacted before agreeing to the loan. According to Schwidrowski, the mission warned the GOE that it should avoid going back into debt for projects that will not pay for themselves or boost the economy significantly in the long run. COMMENT -------------- ¶8. (SBU) The IMF mission raised many eyebrows among donors and press by publicly repeating questionable GOE numbers on annual economic growth. Likely, the Fund's public support of Ethiopia's contested growth statistics was a political decision aimed at deepening the relationship and building trust. Thus far, the Fund's praise in public, criticize in private strategy seems to be effective at moving the two towards greater, though incremental, cooperation. WILGUS