Economist suggests 26% COVID bond on banks

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The recently published policy response for COVID 19 impact conducted by an economist suggested the government to mobiles finance through different instruments including imposing a 26 percent forced COVID bond on banks.
The paper published under the title ‘The Macroeconomic and Social Impact of COVID-19 in Ethiopia and Suggested Direction for Policy Response’ by Alemayehu Geda, Professor at Addis Ababa University, advised the government to include the 28 billion birr supplementary budget ratified by the parliament few weeks ago under the fund to tackle the challenge because of COVID 19.
He estimated that macroeconomic instability such as high inflation (in particular food inflation) is a real possibility that may emerge as part of the economic shock and policy response related to the COVID effect if it is not properly managed via different monetary and fiscal policies.
Alemayehu reminded that the fiscal posture of the Ethiopian government has been precarious for years that it is characterized by significant budget deficit every year (especially if the financial position of the state-owned enterprises is taken on board) and also characterized by requesting supplementary budget each year.
“This had implications for monetization of deficit, indebtedness and macroeconomic instability (as depicted by total debt to GDP ratio of 60 percent or more, double digit inflation, shortage of foreign exchange and significant parallel market premium as observed in recent years),” the paper added.
He underlined that the latest pandemic will further accentuate the problems if cautious and prudent macroeconomic policy is not accompanied with the effort to fight the economic impact of the pandemic.
He estimated capital expenditure might be halted until at least the current challenge solved or subsidized by other means.
To fund the problems that affect the total economy and fight the virus, the government has allocated 300 million birr, provide 15 billion birr for private banks to support their liquidity and it disclosed further USD 1.6 billion (51.2 billion birr) required to mitigate the challenge.
“This adds up to 66.2 billion birr which could raise the government’s current expenditure by 30 percent from its current level,” the professor on his paper said.
He recommended the supplementary budget should be included in the stated 66.2 billion birr to abate the pressure on macroeconomic instability in general and inflationary pressure in particular.
“I insist this supplementary budget to be part of the COVID related planned spending of USD 1.6 billion for otherwise the scale of macroeconomic instability could be much larger,” he added.
According to Alemayehu With these assumptions, the total public expenditure could increase by 17.4 percent compared to the base-run situation (the current expenditure increasing by 30 percent). He has also assumed that the government revenue will be shrunken by 16 percent, while combined effect of a rise in public expenditure (Birr 66.5 billion, 17.4 percent increase) and a fall in revenue (Birr 50.5 billion, 16 percent reduction) is to bolster public deficit by Birr 117.1 billion just to have a fiscal posture that the country had before COVID.
According to the paper taxes and non-tax revenues are expected to decline by 18.8 and 7.7 percent, respectively. He estimated that direct tax will reduce by more than22 percent, and indirect tax by 16.3 percent.
He said that if the supplementary budget will not be included in the stated 66.2 billion birr the budget deficit of the country will be wider.
“The combined effect of government revenue loss and a hike in public expenditure is to put unprecedented pressure on public deficit and strong pressure on monetization of this deficit,” he added.
Policy measures of monetization of the deficit by borrowing from the National Bank of Ethiopia that means printing money should be avoided according to Alemayehu because that would have massive damage for the macroeconomic stability of the country.
“Though the government of PM Abiy was in the course of controlling the excessive money supply (broad money) growth in the last decade by reducing its growth rate from 30 percent in 2017/18 to 20 percent in 2018/19, this growth rate itself is still on the high side,” he says “during the previous EPRDF regime money supply has been growing by an average annual rate of 30 percent for more than a decade.”
This has resulted in an unprecedented increase in the money supply form a meager figure of 68 billion birr in 2006/07 to 886.8 billion birr in 2018/19, thirteen-fold growth in just 12 years.
He showed this annual growth rate is about 5 times higher than a healthier growth rate that could have avoided the current double-digit inflation, high debt burden, structural trade deficit and shortage of foreign exchange – in short, unstable macroeconomic environment.
He added that the average money supply growth rate is about 26 percent in the last three years. He underlined that monetizing the budget deficit by borrowing from NBE will expand the money supply growth rate to 37 percent by additional 11 percent from the latest average growing rate and gallop the inflation significantly.
Due to such effect the government should look other alternatives to fill the budget gap that is occurred due to COVID 19 responses. He said half of the required fund should be secured from external sources that will expand the money supply to 32 percent with relatively lower inflationary pressure than the effect of borrowing from the central bank.
On this type of source of finance, he added that to halt inflationary pressure part of the external finance is used either to finance the importation of food and related essential or ensure their domestic production besides additional policy measures.
As third alternative to solve the effect of filling the budget deficit by Alemayehu is using mixed (heterodox) policies like shifting resources from others, avoiding devaluation, allow major economic sectors to function (unlike lockdown), strategic shift in some sectors like Ethiopian Airlines that shifted to cargo operation, and provision of credit or some kind of assistance for firms.
In his paper Alemayehu stated the use of the renaissance dam financing type bond selling scheme that may re-impose the 26 percent forced deposit on banks for COVID purpose for a limited period is worth considering.
“This could be an alternative way of financing to minimize the danger of macroeconomic instability significantly,” he recommended.
“Prior consultation with banks and financial institutions on this issue need to be part of this process, however,” he said.
Different scenarios
The paper has evaluated the expected effects in three different scenarios based on the timeframe that may continue based on condition of the virus.
The best case scenario is considering the effect of the virus will continue until the first quarter of the coming budget year (2020/21). In this scenario the country GDP will shrink by 5.6 percent or 114 billion birr.
The second scenario considered the effect period will last in the second quarter of the coming budget year that is the end of 2020. This period mostly stated as likely scenario for the effect of the virus in the economy of the country.
The worst case is considering the period until the third quarter of the budget year, which is almost one year from now. In this scenario the country’s GDP will be dropped by 16.7 percent or 341 billion birr.
The average effect of the virus in the economy will be 11.1 percent or 227 billion birr that included the last quarter of the current budget year that will end in July 7.
The paper that mentioned complete lockdown is impossible for the country stated that the major sector that will be affected by the pandemic is the industry sector.
This shock is found to be the highest in the industrial sector which is expected to shrink by 17 percent. This will be followed by the services sector which is expected to shrink by 15.6 percent and agricultural sector is expected to contract by only 1.6 percent, according to the paper.
The external sector is the most vulnerable one to the economic impact of COVID-19 since it is a global challenge.
Alemayehu estimated a most likely condition that the economic shock may last at least for the first and second quarters of the year 2020/21 and exports are expected to decline by about 16.2 percent.
“Oil seeds export leads this, by a decline of 25 percent. This is followed by pulses, coffee and leather and leather products, which are expected to decline by 21 percent,” he added, “similarly, the last quarters of the current fiscal year (March to June 2020) is expected to witness a decline in exports of about 16.2 percent.”
In the worst-case scenario total exports may decline by 24.3 percent.
He also estimated that import that is mainly focused on strategic products will be affected and its effect will be all rounded since most of the country import shall be related with projects and industries as input.
In average the import shall be dropped by 12 percent because of the virus that might be worsen to 18 percent at the worst case.