Conflict will weigh on the recovery in 2022

Slowed by the conflict in the Tigray region and the COVID-19 pandemic in the fiscal year 2021, economic activity is expected to accelerate moderately in 2022. It will be constrained by ongoing fighting and a fragile health situation, which will continue to depress domestic demand. Population displacement and the disruption of agricultural activity (75% of total employment and 40% of GDP) in the north of the country will affect the contribution of household consumption (65% of GDP) in 2022. Furthermore, by limiting the supply of food products and contributing to the depreciation of the birr, insecurity will continue to fuel high inflation, eroding purchasing power. With the vaccination campaign progressing slowly (less than 2% of the population was fully vaccinated by the end of 2021), consumption will also remain exposed to further restrictions that could constrain activity, particularly in urban areas. Investment contribution (more than one-third of GDP in 2019), a critical factor in the country’s strong growth before the pandemic, is also expected to remain sluggish after contracting in 2021 as companies continue to defer investment decisions in response to the conflict. The threat of economic sanctions and the slowdown in debt restructuring negotiations will also discourage private investors. Public investment under the ten-year program will be held back by the narrowing fiscal space, while deteriorating relations with major international creditors may also limit financing options. While domestic demand constraints will impact imports, net exports are expected to make only a small contribution to growth, with tourism earnings continuing to be curbed by the slow vaccination campaign and the conflict. Although prices are expected to remain favorable, growth in coffee exports (more than 30% of the total) could be slowed by further locust outbreaks and drought conditions. 

Difficulties in accessing external financing due to the conflict

Increased conflict-related expenditures and debt service (mainly owed to China for 2020-2022) will weigh on the public accounts in the fiscal year 2021/22, accentuating the budget deficit. The deficit is expected to be financed mainly through domestic sources (commercial banks, central bank), with the conflict affecting relations with major external creditors. External public debt is set to increase owing to the depreciation of the birr. The high risk of debt distress forced the country to request a restructuring in January 2021 under the G20/Paris Club Joint Framework. Ethiopia has announced reforms (liberalization of the exchange rate and currency market) to reach an agreement and reduce the debt service burden (more than 25% of total exports in 2020), but the restructuring process is taking time.

The current account will remain in deficit in 2022 after being pulled down by the large trade deficit. Birr depreciation will contribute to an increase in the import bill that exports will not offset. The surplus in the balance of current transfers (from expatriates), which rebounded in 2021, will remain insufficient to offset the trade deficit. Deficits in the services and primary income accounts also burden the current version. Internal conflict and political instability will affect FDI, which will likely remain low, and official loans will be needed to finance the current account deficit. However, accessing these loans will be challenging. Foreign exchange reserves, which cover about two months of imports, remain weak, fuelling chronic foreign exchange shortages and limiting the central bank’s ability to slow the birr’s depreciation (more than 20% in 2021).

International relations undermined by Tigray conflict

The country is a mosaic of ethnic groups. Hostilities sometimes break out between these groups, and tensions frequently arise between the central government and the regional states. In 2018, Abiy Ahmed of the Oromia-based Oromo Democratic Party became prime minister, ending nearly 30 years of dominance by the Tigray People’s Liberation Front (TPLF) in the Ethiopian People’s Revolutionary Democratic Front (ERPDF), the four-party coalition that governed the country between 1991 and 2019. Mr. Ahmed embarked on a drive to open up the state-run economy and established a new party – the Prosperity Party – in December 2019. However, TPLF leaders refused to join the new party, seeing the reforms as an attempt to centralize power. The feud with the central government intensified in September 2020 when Tigray defied the government by holding its regional elections. In November 2020, fighting between Tigrayan and Ethiopian (Eritrean-backed) forces began, resulting in several thousand casualties, increased famine, massive internal displacement, and deteriorating relations with the country’s leading donors. Some multilateral aid was temporarily suspended, and the U.S. government removed Ethiopia from the AGOA trade program. The special relationship with China, which has significant interests in the country, could also deteriorate.