ETHIOPIA CLAIMS MINIMAL IMPACT OF GLOBAL FINANCIAL

UNCLAS SECTION 01 OF 02 ADDIS ABABA 003467 SIPDIS E.O. 12958: N/A TAGS: EAID ECON EFIN ET SUBJECT: ETHIOPIA CLAIMS MINIMAL IMPACT OF GLOBAL FINANCIAL CRISIS REF: A. STATE 134905 ¶B. ADDIS 3462 ¶C. ADDIS 1850 ¶1. (U) In statements to Parliament on October 16 and December 11, Prime Minister Meles has argued that the Ethiopian economy will be largely unaffected by the global financial crisis. Noting with pride that Ethiopia's financial system is insulated from global finance -- with foreign financial services firms barred from entering the Ethiopian market, limiting links to correspondent banking relationships -- Meles argued that the crisis will have no direct effect on the country's financial sector. Still, as the country is facing its own economic downturn driven by poor macroeconomic fundamentals, the global crisis Ethiopia is likely to impact -- but not drive -- a downturn this year. ¶2. (U) Indirect impacts of the global financial crisis on Ethiopia are likely to be mixed. As Ethiopia receives roughly 40 percent of its budget from foreign transfers from international financial institutions and donors -- neither of which is likely to reduce significantly in the immediate term -- the effects on government expenditures are likely to be minimal. The reduction in demand, both domestic and international, however, will likely reduce government revenues. The crisis will also likely spur a reduction in foreign direct investment (FDI) across the board. This will be caused both by the loss of net wealth among potential investors prompting the cancellation or delay of investments, as well as by Ethiopian Government (GoE) responses which turn investors away -- such as increasing the role of the state in the economy and the difficulties presented in doing business by the closed financial system domestically. The most pronounced impact on Ethiopia is expected to be in the loss of remittances flowing into the country. With remittances normally accounting for US$ 2 billion, or 10 percent of GDP, the loss of remittances, which has already been reported anecdotally, will have a potentially large dampening effect on growth. ¶3. (U) We assess that the impact of the crisis on trade will also be mixed. While global demand may negatively affect Ethiopia's exports, most of these are basic primary products facing highly price inelastic demand dynamics. As the Ethiopian Birr is roughly 40 percent overvalued already, yet exports are growing, we do not believe that the reduced global demand for Ethiopian exports will be adequate to cause exports to fall significantly. The IMF shares this view. The downfall in global demand has had, and will likely continue to have, a positive impact on world prices of Ethiopia's imports which we believe will reduce the import bill and trade deficit without reducing significantly the actual volume of imports. Importers will continue to face delays in obtaining letters of credit, but this dynamic stems more from the structural deficiencies and artificially overvalued exchange rate than from the global crisis. ¶4. (U) As Ethiopia is a major recipient of donors' development and humanitarian assistance, we do not expect to see an appreciable downturn in donor support. The IMF is finalizing a minimal US$50 million "Exogenous Shocks Facility" for Ethiopia and the World Bank has engaged the GoE on accelerating assistance in response to the country's domestic macroeconomic crisis as well as the global crisis. The IMF has gone further in actually urging donors to provide expeditiously the over US$ 750 million in pledged assistance for Ethiopia this fiscal year. Resolving the crisis for Ethiopia, however, requires not just additional aid, but structural reforms of the highly-statist economy which may not be easily forthcoming. ¶5. (U) In conclusion, Ethiopia is likely to be affected more by its own economic crisis stemming from ideologically-based economic policies than by the global crisis. Bilateral and multilateral assistance needs are likely to remain massive. As reported in Refs B and C, however, simply providing additional assistance to Ethiopia will only delay the macroeconomic and governance reforms needed. Instead, for both bilateral and multilateral assistance to achieve their development objectives, we recommend: a) An increased and unified "full court press" of dialogue bilaterally and through coordination among other major donors ADDIS ABAB 00003467 002 OF 002 and the international financial institutions to hold the GoE accountable for ensuring an enabling environment for donor partner assistance and facilitating assistance programs; b) A substantial increase in assistance for agricultural development targeting the most vulnerable, conflict-prone, and food aid dependent areas; c) Introduction of formal agreements for all assistance programs which explicitly lay out benchmarks of progress and reform agreed to by the GoE; and d) Maintenance of current levels of assistance to implement health and education reforms, especially girls' education and family planning, as well as for democracy and governance programs. YAMAMOTO