Structural Weakness Drives Persistent Current Account Deficit


BMI View: High import demand driven by an ambitious state-led investment agenda will see Ethiopia maintain a persistent, albeit narrowing, current account deficit over the next few years. While we expect these successive shortfalls to be adequately financed by investment inflows, dwindling foreign reserves will mean that the external accounts and the economy will remain susceptible to shocks.

We have upwardly revised our projections for Ethiopia's current account deficit to incorporate full year 2011 balance of payments data that revealed a greater-than-expected narrowing of the trade account shortfall. Whereas previously we saw the deficit in 2013 coming in at 5.7%, we now project a shortfall equal to around 2.8% of gross domestic product, representing a slight deterioration from an estimated 2.7% the previous year. Despite these upward revisions our overarching view is largely unchanged and we expect Ethiopia to sustain a continuing, albeit narrowing, shortfall in the current account between 2013 and 2017.

High demand for capital goods imports due to the government's investment-fuelled Growth and Transformation Plan (GTP) will continue to be the driving factor behind Ethiopia's persistent current account shortfall over the medium term. This shortfall should nonetheless narrow gradually over the next few years given our relatively positive outlook for coffee and gold exports, while over the medium-to-long term the country's plans to become an exporter of hydropower pose significant upside for the country's terms of trade. Although we expect these successive current account shortfalls to be adequately covered by investment inflows, foreign exchange reserves are below three months worth of imports, leaving the country vulnerable to external shocks.

Imports Weigh On Terms Of Trade
Ethiopia - Current Account Forecasts

Heavy Investment Keeps Import Up

A combination of a narrowing manufacturing base, a vast and growing consumer market, and a government committed to an ambitious, investment-led growth strategy will see the demand for imported goods in Ethiopia remain high and the trade account remain deep in the red deep for the foreseeable future.

Capital goods imports in particular will continue to prove a major burden driven by major investment projects in the energy and transport sectors. Capital goods are the largest component of the import basket - accounting for nearly 31% of the total according to the latest data from National Bank of Ethiopia (NBE) - and witnessed an increase of 38% y-o-y in Q4 2011/12 (or Q311). Similarly, we expect consumer goods imports (which account for around 25% of the basket) to also register strong growth over the next few years, underpinned by a robust outlook for private consumption. Meanwhile, a weakening currency will continue to add to these persistent downward pressures on the trade balance.

That said, over the near term we anticipate a slight easing of the import burden, driven largely by our expectation of lower average oil prices in 2013 and subdued growth in food imports. Despite recent upward revisions to our forecasts for global oil prices (we are now forecasting US$110/bbl for Brent and US$93.5/bbl for WTI in 2013 compared to US$107/bbl and US$92/bbl previously) but we maintain our conviction that prices will edge downward towards the end of the year based on long-term fundamentals. These lower prices will, at least partially, ease the burden of costly petroleum imports (they accounted for 20% of total imports in 2011/12) (on which Ethiopia remains heavily reliant). Meanwhile, growth in food imports is likely to be more subdued in 2013 given an improved outlook for domestic food security and lower prices.

Prices Moderating, But Volumes Solid
Arabica Coffee Prices

Exports Drive Narrowing Trade Account Deficit

We believe a relatively positive outlook for exports will see a gradual improvement in Ethiopia's terms of trade over the medium-term, though we expect the deficit to remain sizeable. This view is underpinned by our relatively positive outlook for Ethiopia's two main exports in terms of value - coffee and gold. Both coffee and gold have seen strong growth in export revenue in recent quarters - witnessing a y-o-y increase in Q4 2011/12 of 9.0% and 14.5% respectively - and we expect conditions to remain broadly supportive of solid growth over next few years. That said, we expect weaker global prices for both commodities to have a softening impact on growth in 2013.

Ethiopia is the world's seventh largest coffee producer and the largest in Africa and the commodity is the largest provider of foreign exchange for the country. While BMI's Agribusiness team forecast coffee production to expand at a solid rate over the coming years, aided by government programmes to boost production and the fact that the country's high quality bean will see demand for the product continue to expand. However, our expectation of lower average global prices in 2013 and 2014 will likely see revenue growth come in slower than in 2012. Although BMI's commodities team have recently turned neutral towards gold prices following a previously bullish stance, we expect prices to remain relatively supported in 2013, based on our forecast for continued loose global monetary policy over the coming months.

External Imbalances To Persist

We believe that surpluses in the capital and financial accounts will adequately finance the successive shortfalls predicted in the current account over the next few years. This cover will primarily come from the large foreign direct investment associated with the major infrastructure projects being implemented as part of the country's Growth and Transformation Plan. That said, public investment remains heavily reliant on domestic borrowing as Ethiopia's weak business environment inhibits private (and foreign) investment. While we do not believe a balance of payments crisis is imminent, it remains our view that this public sector-led, import-intensive growth model is not sustainable over the longer term and will lead to a build up of external imbalances.

BMI notes that while the current account deficit continues to be covered by investment, foreign reserves have nonetheless witnessed a significant decline as the government uses FX sales to combat currency depreciation. This has left reserve cover below 3 months' worth of imports and well below the 7.1 months recommended for the country by the IMF. As a result we believe that Ethiopia's external accounts and by extension macroeconomic stability will remain susceptible to shocks.

This article is tagged to:
Sector: Country Risk
Geography: Ethiopia, Ethiopia