IMF recommends further devaluation of Birr
Even though the tax to GDP ratio has gone down more than expected, the government is expected to introduce a new tax levy in addition to reforming the excise tax to boost the government revenue. The International Monetary Fund (IMF) has recommended another devaluation of the birr and forex market flexibility.
Since the beginning of the first Growth and Transformation Plan (GTP) the government has expressed its eagerness to expand the revenue from tax in line with the rate of the GDP. It has also show an improvement in the first GTP even though the rate is under the projection. At the heyday of tax collection in 2014/15, which was the end of GTP I, the revenue authority body which at the time was the Ethiopian Revenue and Customs Authority, collected 12.7 percent of the DGP. This is lower than peer economies and countries in the east Africa region.
However the tax collection has not risen in proportion to the growing GDP. For instance, in the 2016/17 budget year the tax collection stood at 11.6 percent of the GDP. According to the latest report of the IMF it has went down more in the previous fiscal year and is now 11.1 percent less than the preceding period, which is very far from the target of 17 percent at the end of the current GTP, which will end in the coming budget year. The IMF forecast indicated that in the current and the coming budget year the tax GDP ratio will stand at 11.2 and 11.3 percent which indicates that the government will never attain its target of over 17 percent in 2020. In its Article IV consultation the IMF usually recommends that expand its tax revenue to widen the public expenditure coverage from tax.
The latest IMF report, which is the final of preliminary reports issued in September this year, stated that Ethiopia has made progress in mobilizing domestic revenue since the mid-1990s, but still lags countries in the region and other low income countries (LICs). “The tax-to-GDP ratio rose from 8.6 percent in 2008/09 to 12.7 percent in 2014/15, but it has declined since then to 11.1 percent in 2017/18,” it said. In the past budget year the government has targeted collecting 200 billion birr, but the actual performance was actually ¼ of the target, which is a significant reduction compared with the recent trend in the tax collation and target achievement ratio.
“Ethiopia relies heavily on trade taxes, while direct and indirect taxes have underperformed. Direct and indirect tax revenue was 56 percent of total revenue in Ethiopia in 2016/17, below the 64 percent average for LICs. Trade tax revenue, at 26 percent of total, is substantially above peers, while non-tax revenue plays a small role in domestic revenue,” it added.
Ethiopia lags behind regional peers on VAT and CIT (corporate income tax) efficiency measures-a key reason for the low tax-to-GDP ratio, according to the IMF consultation report.
“On revenue mobilization, the authorities intend to redouble their efforts, with support from donors, including the Fund, to strengthen revenue administration and were also considering revenue-enhancing tax policy measures-such as excise reforms,” it added.
It has added that the government goal of addressing the decline in tax revenues through a comprehensive Tax Transformation Program (TTP) that has directly followed by the Prime Minister and undertaken a consultant and a task force under Ministry of Finance to improve the tax system and revenue via a browed tax system. The TTP focuses on taxpayer registration, e-filing and digitalized self-assessment, compliance risk management, tax arrears management, and federal regional tax coordination with assistance from the Fund and other development partners.
“Consistent with Fund advice, the authorities are conducting a cost-benefit analysis of existing tax expenditures with a view to their rationalization,” it said. In addition, the authorities could implement reforms in excises and introduce a property tax, thus generating additional fiscal space.
Currently the government has imposed from 10 to 100 percent in excises tax on 19 different types of products. However the property tax would be new for the country if it becomes effective. Source at Ministry of Finance told Capital that initially property tax has been studied by Ministry of Urban Development and Construction. “Because it is not the mandate of the urban development ministry we have now taken it to study under our jurisdiction,” a source, who is in the legal department at Ministry of Finance said.
The urban finance strategy of Ministry of Urban has been included the revenue collection from property in towns that is now revised by Ministry of Finance, according to sources.
Currently individuals are focused on buying houses, which are not taxed, they then invest their capital in other businesses. Property tax has targeted discouraging those who focus on expanding property ownership in addition to expanding government revenue, according to sources. Property taxation is common in other countries. For instance the majority of African states have a property tax system.
Monetary and financial sector policies recommendation
In its latest report IMF under its monetary and financial sector policies recommendation gives the usual suggestion for more devaluation, despite that the government applied a 15 percent devaluation on the birr against major hard currencies in October 2017.
IMF stated that the tighter fiscal and monetary policy stances, coupled with a more flexible exchange rate, would support external competitiveness. “The competitiveness boost from the October 2017 devaluation has since been largely eroded. The birr was kept constant relative to the US dollar while the latter appreciated against major currencies; and Ethiopia’s inflation differential relative to trading partners has stayed high,” the report explained. “As a result, staff assesses that the external position is weaker than medium-term fundamentals and desirable policy settings would imply, and the real effective exchange rate was overvalued by 12–18 percent as of September 2018 only a modest improvement since last year’s assessment,” it added. According to the IMF, more recently, the National Bank of Ethiopia (NBE) has resumed its previous policy of gradual nominal depreciation against the US dollar. It added that a more flexible exchange rate aimed at eliminating misalignments and building up reserves would help competitiveness and foster stability, while reducing foreign exchange shortages.
The report believed that a more flexible exchange rate policy aimed at reducing the real overvaluation of the birr, reducing foreign exchange shortages, and accumulating reserves would help to improve competitiveness.
The report stated that the more restrictive monetary base targets and public sector credit policies, including tighter NBE deficit financing, will help bring down inflation. “These policies need to be complemented by a more flexible exchange rate policy aimed at correcting the birr overvaluation, improving reserve coverage and reducing foreign exchange shortages, as well as by the development of financial instruments with market-based interest rates and other financial development measures, as discussed below,” it added.
The country debt has also grown compared with the past year by close to 4 percent. A year ago the debt ratio compared with GDP has stood at 57.2 percent, while in 2017/18 fiscal year it grew to 61 percent. From the total debt domestic debt has increased by one percent and stood at 28.8 percent. The external debt was 32.3 percent in 2017/18, and was 29.4 percent in 2016/17.
According to the government, due to the growing debt stress in the current 2018/19 budget year, no new projects will be allowed to rely on non-concessional financing, and ongoing projects will largely shift to concessional financing.
IMF stated that the Debt Sustainability Assessment (DSA) shows that Ethiopia remains at high risk of debt distress because of its small export base. Public and publicly-guaranteed external debt breaches the thresholds for the present value of debt-to-exports and debt service-to-exports in the baseline. Debt service payments are expected to increase in the coming years, as grace periods on non-concessional debt acquired in the past expire.
Regarding real GDP growth activity will be supported by continued growth in manufacturing and services, particularly expansion of air transportation, while construction may remain subdued due to restrictive public policies, according to the IMF.
Based on current policy settings, medium-term economic growth is envisaged to converge to around 7 percent, supported by rising FDI, continuing investment in infrastructure by the public sector, and rising productivity levels as export-oriented industries take root and start operations.
The IMF report forecasts that FDI and remittance growth are expected to resume as political uncertainties settle following the leadership transition. “External financing constraints will temporarily ease in 2018/19, owing also to the recent USD 1 billion deposit from the UAE and a USD 1.2 billion World Bank Development Policy Financing (DPF) operation. As a result, international reserves are expected to reach USD 3.4 billion (1.8 months of prospective imports) in June 2019 consistent with the authorities’ projections.
According to the report as of the end of the past fiscal year the country’s reserve stands at USD 2.8 billion of imports of goods and nonfactor services of only 1.6 months (the government stated that it was a 2.1 months) that supposed to be at least 3 months. In the 2016/17 fiscal year the reserve was USD 3.19 billion or importation for two months.
According to the IMF, foreign reserves have increased to USD 3.7 billion in September, following the receipt of a USD 1 billion deposit from the Abu Dhabi Fund for Development (ADFD) in NBE in July. However, foreign exchange shortages persist, as evidenced by the spread between the official and parallel market exchange rates and the long wait times for businesses to obtain foreign exchange.
In the monetary and finical sector policy the IMF stated that the NBE’s stance of containing reserve money growth to 13.3 percent in 2018/19 is a welcome step to bring inflation to target but will need to be complemented by other policy measures.
In recent years, the growth rates of reserve money and of broader credit and monetary aggregates have diverged. This signals that reserve money may be losing its effectiveness as a monetary policy instrument a natural transition as the financial system deepens and becomes more sophisticated. “Hence, the base money target needs to be complemented with policies to contain credit growth, especially to the broad public sector,” IMF recommended.
Beyond the immediate term, however, the NBE’s intention to develop market-based indirect monetary instruments will necessitate the creation of a market for government debt with market-determined interest rates, according to IMF.
It added that Ministry of Finance could issue specially designed marketable securities in gradually increasing volumes to finance the budget, which could be held and transacted by banks and other appropriate institutions.
In turn, the NBE would use interventions in this market to signal its interest rate stance, helping to better control broad money and credit growth. Issuance of these budget-financing securities would allow the gradual phasing out of NBE financing of the government.
Since the commencement IMF opposed the implementation of NBE bills that forced banks to buy 27 percent of every loan with a five year maturity and 5 percent interest rate, which was 3 percent before October 2017. In its latest report it has also recommended the reform of NBE bills in addition to discontinuing the funding of the policy bank, Development Bank of Ethiopia (DBE), the cash collected from private banks on NBE bills.
“These 5-year NBE bills must now be purchased by private commercial banks in an amount equivalent to 27 percent of gross credit extended, irrespective of the maturity of the loans-about 75 percent of these funds are then used to fund the DBE, whose NPL ratio has steadily increased to 39 percent,” it said. It said that NBE bills now represent 30–40 percent of private commercial banks’ loans outstanding, and although the interest rate on them was recently increased, it remains negative in real terms.
“The bills have been successful in reducing banks’ excess liquidity, but their design should be improved to better serve this purpose until a T-bills market develops-by reducing their maturity and possibly basing the purchase obligation on excess reserves,” it said. “Further funding of the DBE by the NBE should be discontinued, at least until the ongoing comprehensive assessment of its financial situation is completed and resolution measures are implemented,” it added
The IMF report has indicated that the country GDP at current market price stood at 2.138 trillion birr in 2017/18 fiscal year; a year ago it was 1.807 trillion birr.