ETHIOPIA'S TEXTILE AND GARMENT SECTOR HAS YET TO REACH ITS

UNCLAS SECTION 01 OF 04 ADDIS ABABA 001389 SIPDIS SENSITIVE DEPARTMENT FOR EEB/IFD/OMA - JWINKLER AND EEB/CBA - DWINSTEAD DEPARTMENT PASS TO U.S. PATENT AND TRADEMARK OFFICE - AMY COTTON USTR FOR PATRICK COLEMAN, CECILIA KLEIN, AND BARBARA GRYNIEWWICZ DEPT OF COMMERCE WASHDC FOR ITA MARIA RIVERO DEPT OF TREASURY WASHDC FOR REBECCA KLEIN E.O. 12958: N/A TAGS: BEXP ETRD ECON EFIN EINV EAGR ET SUBJECT: ETHIOPIA'S TEXTILE AND GARMENT SECTOR HAS YET TO REACH ITS FULL POTENTIAL ADDIS ABAB 00001389 001.2 OF 004 SENSITIVE BUT UNCLASSIFIED; BUSINESS PROPREITARY INFORMATION; NOT FOR INTERNET DISTRIBUTION -------------- SUMMARY -------------- ¶1. (SBU) From humble beginnings, Ethiopia's textile and apparel sector has been rapidly expanding in recent years. Sector exports under the U.S. African Growth and Opportunity Act (AGOA),which more than doubled from 2007 to 2008 to reach USD 9.4 million, accounted for most of this growth. The populous country has significant potential for continued growth because it is a huge source of cheap unskilled labor and has strong domestic demand for textile and garment products. Other positive indicators include the availability of suitable land for cotton growth and the improvement of critical road transportation corridors. Although Ethiopia has a good track-record of producing textiles and garments, the sector faces real challenges to long-term viability and growth. Lack of capacity on a variety of levels--ranging from production capacity to marketing expertise--is suffocating producers in an increasingly competitive global marketplace. Product quality concerns, skilled human resource voids, reliance on imported inputs, and infrastructure challenges are driving up operating costs and squeezing profit margins. Fortunately, the Government of Ethiopia (GoE) remains committed to the sector's growth--offering a package of financial and logistical incentives to exporters and development plans for cotton farms. The GoE is on the right track, but needs to boost and revamp these efforts to address the specific needs of producing high-quality cotton, educating the labor force, and filling the domestic demand. Without additional GoE action in these areas, short-term growth bursts will fade away and the sector's long-term potential will be left unrealized. END SUMMARY. -------------- -- KEYS TO SUCCESS: AGOA, COTTON, AND LABOR FORCE -------------- -- ¶2. (U) Ethiopia's textile and garment sector experienced significant growth in the last few years, primarily due to AGOA and the European Everything But Arms (EBA) duty free import initiatives offered to Sub-Saharan Africa. The value of Ethiopia's textile and apparel AGOA exports to the United States more than doubled in 2008 to USD 9.4 million, from USD 4.6 million in 2007. Mr. Endalkachew Sime, Secretary General of the Ethiopian Textile and Garment Manufacturers' Association, reported to EconOffs that this growth was attributed mainly to various U.S. buyers purchasing small quantities of basic quality goods (e.g., uniforms, t-shirts). Total sector exports of USD 15.2 million comprised about fourteen percent of Ethiopia's total USD 106.3 million exports to the United States, but only one percent of Ethiopia's total USD 1.47 billion exports in fiscal year 2007/08 (Note: Ethiopia's fiscal year runs from July 8, 2007 through July 7, 2008. End Note.). State Minister of Trade and Industry Tadesse Haile and various managers of textile and garment firms told EconOffs that Ethiopia's textile and garment sector is "just now" ready to benefit fully from AGOA and that they plan to request further extensions of the 2012 third-country fabrics importation and the overall 2015 AGOA timelines. ¶3. (U) Ethiopia is geographically blessed with large swaths of suitable land for cotton growth and has agreeable climatic conditions. Sime told EconOffs that much of this land is underutilized and more research needs to be done so that high-quality cotton can be produced locally. Additionally, Ethiopia is the second most populous country in Africa, with around 80 million people, and therefore has vast amounts of cheap unskilled labor and strong domestic demand for textile and garment products. The combination of Ethiopia's large population and the increasing cost of labor in competing Asian economies has provided a potential comparative advantage for Ethiopia to attract additional foreign investment in the sector. Nova Star Garment and Knit to Finish Garments are two successful garment firms that have taken advantage of this market opportunity. Additionally, two Turkish firms, Ayka Addis and Elsi have recently entered the market. Ayka Addis recently started yarn production with an initial investment capital of USD 150 million, while Elsi is in the process of acquiring land. ADDIS ABAB 00001389 002.2 OF 004 Finally, while infrastructure remains a challenge in Ethiopia, the sector has benefited from the recent mass road construction efforts given the fact that many large-scale factories are located close to the main road arteries. -------------- CAPACITY CHALLENGES LOOM -------------- ¶4. (U) While Ethiopia's textile and garment sector has grown rapidly, it faces real impediments to reaching its full long-term potential. The major challenges include the lack of: 1) capacity to produce the demanded quality and quantity of products; 2) skilled human resource capacity; 3) an infrastructure conducive for business operations; and 4) a strong marketing platform to promote Ethiopian products. Knit manufacturers current produce one million kilograms (kg) of knitted fabrics, falling well short of the estimated 40 million kg domestic demand. Similarly, weaving mills produce about 43 million meters of woven fabrics annually, supplying just over half of the estimated 70 million meters of total demand. Sime told EconOffs that one of the reasons that factories cannot produce to meet demand is the lack of vertical integration and modern equipment in most operations. Currently, only three of the over 80 textiles and garment firms are vertically integrated. (Note: Two more factories should be vertically integrated in the near future. End Note.). Furthermore, a recent government assessment found that the products that firms are producing fall short of international standards--to include the all-important Worldwide Responsible Accredited Production (WRAP) certification. This quandary has exacerbated the already worrisome trade deficit, as many producers cannot attract foreign buyers and domestic consumers are forced to import goods from abroad. Ethiopia imported over USD 106 million in textile goods in fiscal year 2007/08. Garment factories importing woven fabric accounted for the majority of these sector imports, since they were unable to source enough suitable fabrics from the local market. Ethiopia imported an additional USD 166 million in apparel in fiscal year 2007/08 to supply domestic demand for clothing. ¶5. (SBU) Sime informed EconOffs that Ethiopia currently produces short- and medium-staple cotton which is most suitable for heavier weight items such as canvas and basic quality t-shirts. Also, current cotton production processes in Ethiopia generate high percentages of waste. Sime believes that the sector needs to invest in more refined cotton-production methods that produce higher quality long-staple cotton and fewer waste products. Sime told EconOffs that the GoE is too focused on garment production as a means to short-term growth, leaving long-term growth possibilities of improved and increased textile production ignored. For example, GoE incentives for cotton producers are not as attractive or sector specific as those incentives offered to the floriculture industry. Most factories are operating with outdated equipment and spare machine parts cannot be imported under the current duty-free incentives offered. Furthermore, it is more difficult to attract investors to build a textile mill, as they are capital intensive and require an initial investment of about USD 900,000 to 1.3 million. On the other hand, an investor could establish a garment factory with just USD 90,000 to 180,000. Sime finally noted to EconOffs that cotton production involves complex irrigation systems and delves into a whole range of complicated socio-political issues (e.g., land, regional development). ¶6. (U) Human resource constraints, such as the lack of skilled manpower and low labor productivity, are also crippling the sector according to a recent government assessment of the sector. Domestic textile firms face severe shortages of capable managers with the entrepreneurial know how to run a business. The assessment stated that 85% of firms responded that they have severe problems finding qualified staff. As such, skilled labor has been imported from Turkey, India, and China, which only increases operational costs and cuts into profits. Sime noted to EconOffs, however, that some World Bank program money is being used to hire foreign expertise. Although there is an abundant local supply of unskilled labor, labor productivity is extremely low. Sime told EconOffs that labor productivity is 23 to 25 percent lower than the standard benchmark for countries similar to Ethiopia. This fact increases direct ADDIS ABAB 00001389 003.2 OF 004 product costs and indirectly costs factory management hours to monitor the productivity of its workers. ¶7. (SBU) Another factor increasing manufacturing costs is the poor infrastructure in place to support businesses. When compared to other developing countries, Ethiopia suffers more than its fair share of power interruptions, has abysmal telecom services, has difficulty accessing transportation routes, and offers limited access to finance. Time is money and if a company cannot power its factory, receive an email attachment, or make a phone call, it is difficult to remain globally competitive. Profit margins are already squeezed based on the sector's reliance on imported inputs, but these margins are further reduced by the high transportation costs associated with a landlocked country where paved roads are the exception, not the rule. Sime told EconOffs that most sector products are transported via truck to Djibouti and the condition of this route is quite poor. According to a recent U.S. International Trade Commission report, shipping times and costs from Ethiopia rank among the worst when compared to its peers. Furthermore, many non-exporting companies are unable to obtain the financing to expand their operations due to restricted credit amounts offered by the underdeveloped financial sector. Finally, a lack of marketing expertise is hindering growth. While the GoE is making some efforts to promote this sector, Ethiopia does not have a coordinated strategy to promote "Made in Ethiopia" products and combat any negative images of the country as a marketplace. On the other hand, many manufacturers lack the market information necessary to understand the demand both domestically and internationally. In Sime's opinion, the sector needs more private sector involvement to boost marketing efforts. -------------- GOVERNMENT COMMITMENT -------------- ¶8. (U) The GoE ambitiously envisaged in its five-year strategic plan to generate USD 500 million from the textile and garment sector in 2009, which is 30 times more than what the sector actually generated in 2008. Despite missing this mark, the GoE remains committed to the sector and has a development program anchored on two pillars: 1) cotton farm development; and 2) increasing garment production. Its cotton farming initiatives include both large scale and small farm operations. The GoE's program also includes seeking joint venture partnerships to rehabilitate outdated government-owned factories. To encourage sector growth, the GoE offers a variety of financial incentives to investors--especially for garment exporters. The incentives are focused on exporting entities and include: 1) a loan guarantee scheme whereby the government guarantees 70 percent for any new garment sector commercial loan with a favorable long-term interest rate; 2) relatively easy and affordable access to land; 3) tax holidays of up to five years; 4) duty-free imports of equipment, fabrics for export production, and other supplies for investment; and 5) simplified customs procedures for garment exporters. ¶9. (U) State Minister Tadesse told EconOffs that the GoE is particularly committed to increasing the value-added product portion of the textile and garment sector. Therefore, the GoE has established a textile and apparel institute in order to undertake research and development activities. State Minister Tadesse also said that the GoE plans to open a textile department in all of the public universities in Ethiopia. The new departments will augment the existing Department of Textiles at Bahir Dar University, which is in the process of upgrading its facilities. Sime told EconOffs this type of investment in education is necessary for the long-term health of the sector. The GoE has also had some success reaching out to international investors during high-level visits abroad. Both Turkish and Indian investment increased in the sector after Prime Minister Meles Zenawi's visits to their respective countries. -------------- A SECTOR WOVEN INTO HISTORY -------------- ¶10. (SBU) Ethiopia has a long tradition of cultivating cotton and producing textiles and garments based on handloom weaving techniques. Textile mills date back to the mid-1940s and today 16 ADDIS ABAB 00001389 004.2 OF 004 textile and over 65 garment factories exist. According to Sime, the sector has only formally established itself in the past ten years, with the number of companies increasing about 25 percent in the last five years. Five of the 16 existing textile factories are owned by the government. Sime remarked to EconOffs that this is an improvement from the past when nearly all factories were government-owned and operated inefficiently. The lion's share of production is dominated by the ruling party affiliated company Almeda Textile and by billionaire Sheikh Mohammed Al-Amoudi's MAA Garments, which are both located in the ruling-party's home region of Tigray. The textile and garment sector is currently comprised of both woven and knitted garment producers, but also includes yarn spinning. The knitted garments sub-sector maintains a slight advantage over the woven sub-sector because the quality of yarns used meets the standards for basic export items such as t-shirts and polo shirts. Overall, Ethiopia's manufacturing sector is quite small, accounting for less than 4% (USD 804 million/9.04 billion birr using the current exchange rate of 11.24 birr/USD) of total nominal GDP of USD 21.9 billion (245.6 billion birr) in the fiscal year 2007/08. -------------- COMMENT: GOVERNMENT SHOULD LOOK LONG-TERM -------------- ¶11. (SBU) While this sector has tremendous potential for growth, it is still in the infant stages of development. As the sector only accounts for 1% of total exports and is working off a relatively small base, any growth experienced produces large percentage growth rates. The sector has a long way to go in order to overcome its reliance on imports and sector-specific trade deficit as Ethiopia is importing over 18 times more textile and garment goods than it is exporting. Consistent growth over time is needed in order to take advantage of economies of scale in such a low-margin business. ¶12. (SBU) The GoE is taking action in the critical needs area of cotton production and labor force education, but it needs to do more in these areas and focus on the long-term benefits of investing in textile research and education. Any focus on short-term boosts to volume (e.g., low quality garment exports) will be lost if concerted efforts are not made in these areas because short-term boosts in volume are not sustainable if the quality is not there. Cotton production research would improve upon the current product quality. Additional investment in education is also critical as qualified managers are sorely needed to run efficient operations and work on increasing labor productivity. ¶13. (SBU) The GoE should look to create sector specific incentives that would attract more investors to textile production as a long-term solution to reducing the country's reliance on imports. Increased private sector investment would also allow factories to update aging equipment and modernize sector operations overall. On the domestic side, the market potential is being virtually ignored as the GoE primarily offers incentives to exporters in efforts to boost foreign exchange reserves. These incentives could be extended to those factories producing for the domestic market. Filling domestic demand with local supply would reduce the trade deficit and indirectly increase foreign exchange as sector imports would decrease. In practice, Sime told EconOffs that the GoE may find it difficult to introduce additional incentives because it does not fully trust the private sector to apply the incentives in good faith. All of these long-term commitments will not be easy to uphold, but are necessary for this sector to reach its ultimate potential. END COMMENT. YAMAMOTO