Ethiopian Economy AgEc3126

Bonga University

Undergraduate Program Department of Agricultural Economics

Course title: Ethiopian Economy Course Code: AgEc3126

Program: BSc in Agricultural Economics Cr.Hrs: two

Instructor: Mr. Fami A. Semester: 2nd

Module Name: Applied Economics ( AgEc-M3121) Target Group: Year III

Status of the course: Compulsory

Course objectives

After successful completion of this course students will be able to:

• Explain the structure of the national income and national income account of Ethiopia

• Evaluate the performance of different sectors in the Ethiopian Economy

• Analyze the Ethiopian Economy and different socio-economic conditions

• Examine import and export performance

• Comprehend the situation of financial sector and public finance

• Review the contemporary development policies and their effects on the economy

Chapter 1. Introduction to the Ethiopian economy

1.1. Structure of the Ethiopian economy

1.2. National Income Account (NIA)

1.3. Reading the NIA of Ethiopia

Chapter 2. Recent Performance of the different sectors in the Ethiopian economy

2.1. Agricultural sector

2.2. Industrial sector

2.3. Service sectors

Chapter 3. Ethiopian Economy Socio-economic Conditions

3.1. Production and Capital Formation

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3.2. Poverty

3.3. Infrastructure

3.4. Unemployment and Underemployment

Chapter 4. Import and Export Performance

4.1. Export Performance

4.2. Balance of Payment

4.3. Exchange rate

Chapter 5. Trade, public finance, financial sector in Ethiopia

5.1 Public finance in Ethiopia

5.2 The finance sector in Ethiopia

5.3 Contemporary Development Policies

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1 INTRODUCTION TO THE ETHIOPIAN ECONOMY

This chapter presents an overview of the structure and the national income account of the
Ethiopian economy.

1.1 An Overview of the Structure of the Ethiopian Economy

The Ethiopian economy has experienced changes in economic systems over time. Under the
Monarchy (up to 1974), the economy of Ethiopia was primarily agricultural. The economy was
based on a feudal system under which land ownership was highly inequitable. The major
portion of farmland was in the hands of wealthy landlords. There were very few industries,
most them owned by foreigners.

During the Military Regime (1974 – 1991), the economy shifted to a command economy where
socialist principles and ideologies ruled. Substantial land reforms were introduced in the
agricultural, industrial and financial sectors. The government owned all the large-scale
manufacturing industries, banks and insurance companies.

Since the assumption of power by EPRDF (1991), its government has followed a market-
oriented economy. It has supported a process of economic reforms based on privatization of
state enterprises, promotion of agricultural exports and deregulation (move towards free
market) of the economy.

Currently, though the contribution of the service sector and the industrial sector is improving,
the Ethiopian economy is based on agriculture.

The Agricultural Sector

Agriculture contributes about 45% of the overall GDP of the country; generates more than 80%
of export earnings; employs about 85% of the population; and supplies about 70% of raw
materials to the secondary activities. Ethiopian agriculture is predominantly rain-fed
subsistence agriculture, troubled by recurrent droughts. Agricultural commodities also
dominate the export sector, mainly coffee, chat, and hides and skins. Agriculture plays a
significant and decisive role in the social and economic development of the country. However,
owing to natural and man-made causes, the country has not properly benefited from its
abundant natural resources conducive to agricultural development, and consequently failed to
register the desired economic development that would enable its people pull out of the
quagmires of poverty. The major impediments to agricultural development are the

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predominance of subsistence agriculture and lack and /or absence of more business/market-
oriented agriculture; adverse climatic changes; failure to use agricultural land according to
appropriate land use management plan and resource base; limitation in information base; lack
of provision of supply and dissemination of appropriate technology; failure to integrate relevant
activities; and lack of adequate implementation capacity.

The agricultural sector produces both crops and livestock. The crops produced include food
crops, cash crops, fruits, and vegetables.

Recent developments:

✓ Crop production and productivity in both volume of production and yield per hectare
have shown consistent increases for almost all categories of main crops during the last
few years;
✓ Diversification of agricultural production;
✓ Establishment of an agricultural marketing system;
✓ Development of research and extension services;
✓ Improvement in the supply of agricultural inputs;
✓ Expansion of small-and medium-scale irrigation;
✓ Better management of natural resources.

The Industrial Sector

Industrial development in Ethiopia is still in its infancy and has a narrow base. Its linkage with
the agricultural sector is also weak. The integration between the agricultural and industrial
sectors plays a key role to accelerate the country's economic development and to bring about
socio-economic transformation. The agricultural sector plays a major role in supplying inputs
to the industrial sector as well as creating the market for outputs of the industrial sector. The
linkages between the agricultural and industrial sector also provides the opportunity for the
expansion of the service sectors.

The sector contributes about 13% of GDP and 9.5% of employment. Its growth was modest,
not exceeding 6.7 percent for the last four decades except during the years from 1997/98 to
2009/2010. The industrial sector is dominated by three sub-sectors: manufacturing (38%),
construction (25%), and electric and water supply (18%). The remaining subsectors, mining
and quarrying, etc., constitute the remaining 19%.

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Major problems in the sector:

• Low industrial base

• Low productivity level
• Underutilization of capacity
• Shortages of foreign exchange, new investment, raw materials and spare parts
• Very low level of technology/high dependence on imported technology
• Low-level skills and management

Recent developments:

❖ Privatization of state enterprises

❖ Liberalization of investment regulations to attract foreign investment
❖ Tax incentives for potential investors
❖ Modernisation of the technological base through technology transfer agreements
❖ Establishment of industrial estates
❖ Implementation of training program for managers and technicians, both in the country
and abroad
❖ Establishment of research and development (R & D) institutes
❖ Establishment of the National Network of Information System to ensure the flow of
industrial information among different users
❖ Improvement of the National Standards Regulation System
❖ Development of infrastructure, including transportation and telecommunications.

The Service Sector

The service sector includes wholesale and retail trade, hotels and restaurants, transport and
communication, banking and insurance, public administration and defence, education, health
and other services.

The sector’s share in GDP was 45.1% during 2008/09. A relatively small percentage of
population (about 10%) has been engaged in the services sector. The large contribution of the
sector to the GDP comes mostly from government employment. Significant achievements have
been made in areas of health, trade, tourism, banking and insurance in the past few years. The
service sector grew by an impressive 10.2% in 2014/15, mainly due to improvements in hotels

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and tourism (29.2%), transport and communications (13.3%), wholesale and retail trade (9.9%)
and financial intermediation (6.9%).

Resource Base of Ethiopia

In terms of its natural resource base, Ethiopia is potentially a rich country, with fertile soil and
good rainfall over large areas of the country. Farmers produce a variety of grains, including
wheat, teff, sorghum, corn, and millet. Coffee, a cash crop, grows well on southern slopes.
Herders raise cattle, sheep and goats in nearly all parts of the country. Additionally, Ethiopia
possesses several valuable minerals including gold and platinum. Ethiopia is also one of the
few African countries with the potential to produce hydroelectric and geothermal power.
Furthermore, it has regions where dense forests exist, and its many lakes, rivers, reservoirs and
their coastlines are fertile fishing grounds. Another notable point in the wider context of the
resource base of Ethiopia is that over 50% of its population is in the working-age group of 15
– 64 years. The country has also good potential for tourism and mining. However, the country
is not realizing these potentials.

1.2 National Income Account of Ethiopia

National Income Accounting refers to the process of record keeping for the overall economic
activities of a given country. The main measures of aggregate economic activity are GDP and
GNP.

Gross Domestic Product is the total/aggregate market value of all final goods and services
produced in an economy in a one year period. This means it measures/calculates the value of
final goods and services produced within a geographic boundary regardless of the nationality
of the individual or firm.

Gross National Product is the total/aggregate market value of all final goods and services
produced of citizens and firms of an economy/country in a one-year period. That is this measure
includes only citizens and domestic firms including the value of their production generated
outside of the economy/country.

GDP can be calculated using either the expenditure approach which focuses on the
expenditures made by the households, firms, the government and foreign sector for goods and

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services or the income approach which focuses on the income households receive (wages and
salaries, rent, interest incomes and profits) for supplying their factor services.

Ethiopia’s GDP reached $55 Billion with per capita GDP of $631 by end of 2013/14.
Agriculture, industry and services sectors respectively contributed 40%, 14% and 46% to the
GDP. Real GDP grew by 10.3% in 2013/14 and 5.3% of this growth came from the service
sector, 2.7% from industry and the balance from agriculture. In 2014/15, real GDP grew by
10.2%, keeping the momentum of the 10.3% growth rate of 2013/14. The services sector
contributed 4.7 percentage points of this growth followed by industry and agriculture
contributing 3 and 2.5 percentage points, respectively. While the share of agriculture in the
GDP declined over ten years from 47% in 2004/05 to 39% in 2014/15 that of the services sector
increased from 40% to 46% in the same period. Meanwhile, the contribution of the industrial
sector remained low, at 15% of GDP in 2014/15. The strong economic growth has been
underpinned by the country’s public sector-led development strategy, with its focus on heavy
investment in infrastructure.

Despite its declining contribution to GDP over the years, agriculture remains the leading sector
in terms of contribution to the country’s overall economy.

2 RECENT PERFORMANCE OF THE DIFFERENT SECTORS IN THE

ETHIOPIAN ECONOMY

2.1.The Agricultural Sector in Ethiopian Economy

As records reveal, the agricultural sector in Ethiopia is the mainstay of the country’s economy.
It is also the most volatile sector, as exhibited in the unevenness of its growth patterns, which
is the effect of its heavy dependence on rainfall and the seasonal shocks that are frequently
observed in Ethiopia. However, it contributes the largest share to the GDP, export trade
earnings (source of foreign currency), and employment. It also provides raw materials for the
various industries in the country to a great extent. It serves as source of food, and source of
capital (transference of surpluses of savings and taxes from the agricultural sector to other
sectors).

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2.1.1. Structure of the Agricultural Sector

The agricultural sector of Ethiopia is composed of the crop-production, livestock, forestry, and
fishery sub-sectors. About 65% of the sector’s GDP comes from crop-production, while animal
husbandry contributes 25%. The remaining 10% is generated from the allied sectors, forestry,
fishing and others.

Currently, the following farming systems are widely practiced in Ethiopia.

o The smallholder farming system: It is the most important or dominant system. It accounts
for more than 90 percent of the agricultural production and for about 95 percent of the total
area under crop production.
o The pastoral/nomadic system: About 40% of Ethiopia’s land area is in the arid and semi-
arid zones and is located in the lowlands, below 1,500 m. There rain fed crop production is
not possible because of low-level erratic rainfall, and people rely more on livestock for
subsistence.
o The modern commercial farming system: Commercial farming system was officially
introduced during the third five-year plan (1968 – 73) of the Imperial Government of
Ethiopia. Among the strategies envisaged to modernize agriculture and increase marketable
surplus, the plan stated that available government land would be utilised for the
establishment of large commercial farms.
2.1.2. Specific Policies and Strategies of the Agricultural Sector Since 1960s

Although Ethiopia does not have a long history of adopting economic policies, attempts begun
in the 1960s in the form of five-year development plans. Starting from then, both sectoral as
well as national development plans have been launched with varying priorities and institutional
frameworks.

2.1.2.1.Pre–1974 Agricultural Policies and Strategies

There were two policy paths for the development of the agricultural sector in the late 1960s.
They were large-scale mechanized commercial farms and the establishment of package projects
to assist the sector in diffusing agricultural innovations.

A. Large-Scale Mechanized Commercial Farm

The main objective of this path was to facilitate agricultural exports and to create new
employment opportunities.

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As the name implies, Large Scale Mechanised Commercial Farm requires bringing extensive
areas of land under cultivation with the use of modern agricultural inputs such as modern
technology, machinery, equipment (tractors and combiners), chemical fertilizers and hired
labour, in contrast to the family labour used in the small-holder farming system.

The government took some fiscal measures to encourage the expansion of these farms in the
country. Among the resulting policy measures were credit arrangements, tax holidays for the
first five years for investments in excess of 200,000 Birr, low land use fees, tax-free import of
heavy machinery, and possibilities of remitting profits to investor countries of origin. As a
result, some foreign-owned profitable plantations developed. They mostly produced food and
fiber. However, these results were too small to achieve the given incentives. They accounted
for almost 5% of the total agricultural output and 3% of the total area cultivated. The 1974
popular uprising led to the nationalization of these farms and their conversion into state farms
in 1975.

B. Establishment and Development of Package Projects

The package approach was successful in improving the productivity of farmers in Mexico,
India, Bangladesh, Israel, etc.

The basic objective of donors and the government in initiating the package project in Ethiopia
was to repeat the success of the Green Revolution of India in Ethiopia. The Green Revolution
was a type of agrarian revolution characterized by the large-scale use of improved and high
yield variety (HYV) seeds and other inputs.

There were two types of package projects: comprehensive package projects and minimum
package projects.

Comprehensive Package Projects: These are package projects include integrated rural
development. They were designed to supply important inputs such as chemicals, fertilizers,
improved seeds, improved farm tools, credits, pesticides, and know-how. These inputs were
for the purposes of:

➢ raising the living standard of the poor peasants by raising per-capita income;
➢ creating employment opportunities by encouraging labour-intensive technology;
➢ encouraging peasant participation in the development process to solve problems;
➢ expanding experimental stations for propagating new ideas in agricultural technology and
providing improved farm tools.

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The criteria for selecting areas for such a package were the availability of adequate rainfall,
good weather conditions, fertility of soil, the possibility that the areas are conductive for further
expansion, etc. Accordingly, the Chilalo Agricultural Development Unit (CADU), the
Welayita Agricultural Development Unit (WADU), and the Adaa District Development
Package Project (ADDP) were established. These projects were sponsored by the Swedish
International Development Agency (SIDA) and the United States Agency for International
Development (USAID).

Some achievements were observed in the project areas. For example, income of participating
farmers increased by Birr 340 per year, productivity in crops and livestock increased
significantly, and the adoption of modern inputs expanded in the project areas. But there were
also some adverse effects, such as an increase in the eviction of tenants. For example, in 1969
and 1970, over 500 tenant farmers were evicted from CADU. This means that the number of
landless people increased. The other problem associated with these projects was their huge
cost. At the start of the project, the cost per beneficiary farmer was Birr 15,000. Because of
these problems, the comprehensive package project was too difficult to be duplicated in other
areas of the country. Therefore, a relatively less costly package programme, known as the
minimum package programme, was launched, substituting for the comprehensive package
projects which covered larger areas.

Minimum Package Projects (MPP): These projects were designed in order to raise
production and income of smallholders quickly over a wide area with a minimum reliance on
scarce resources. These projects involved the diffusion of a few proven imports of agriculture
such as chemical fertilizer, improved seeds, and farm implements.

The first minimum package project was established in 1971. It was hoped that these would be
duplicated at a rate of 10 projects every year to cover all rural areas. But, as with the
comprehensive package projects, the benefits were poorly distributed in favour of landowners
and large cultivators, and the eviction of tenants was still a problem in some areas.

The second phase, MPP II, launched in the first half of the 1980s, continued well through the
Military Regime. However, the over ambitious objectives attached to the projects and the
relatively small amount of resources allocated made the projects unsuccessful. The projects
largely concentrated on the cooperativization process.

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2.1.2.2.Agricultural Policies and Strategies During the Derg

The uprising in 1974 led to the overthrow of the Imperial regime and to changing the official
national ideology to socialist principles. This was followed by overall shifts in the economic
policies of the country. State control of the economy was overextended. There were no
circumstances in which private-sector participation in economic activity was encouraged. The
new policy paradigm was manifested in the different sectors of the economy.

The comprehensive and the minimum package projects launched during the Imperial regime
continued in the Derg period. CADU was transformed into Arssi Rural Development Unit
(ARDU) and then to Bale-Arssi Rural Development Unit (BARDU), which resulted in the
thinning of resources over wide areas. Finally, all these projects were transformed into Peasant
Agricultural Development Extension Projects (PADEP) which were organized along pluralist
principles. Some of the objectives of PADEP included decentralization of the activities of the
Ministry of Agriculture.

These objectives resulted in the formulation of eight PADEP zones, each with its own plan,
budget, administration, and research activities, but by 1988, PADEP came to an end due to
shortage of funds and changes in administrative structure. The financing of PADEP was
expected from international development agencies like the World Bank, SIDA and
International Fund for Agriculture, upon conditions which would be fulfilled by the
government of Ethiopia, such as the adoption of liberalization programmes. Research and
feasibility studies were conducted by foreign experts especially by the World Bank.

The government also organized the small holders along socialist lines for the purpose of the
collective production and marketing of agricultural output and distribution of inputs. There
were three types of associations, namely peasant associations, service cooperatives, and
producers’ cooperatives. By 1989 most peasant households were organized into 17,000 peasant
associations, 3,700 service cooperatives, and 3,300 producers’ cooperatives. But these
associations could not help the farmers due to various problems, such as their inability to make
decisions in their own affairs and the emphasis given to politics at the expense of everything
else. These facts led to poor leadership and the embezzlement of funds.

In general, the agricultural sector policies of the military government were characterized by the
following:

❖ Nationalization of all private and commercial farms

❖ Prohibition of private investment in the agricultural sector

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❖ Involuntary collectivisation of peasants into peasant associations, and into producers’ and
service cooperatives
❖ Forced villagization and settlements
❖ Government control of virtually all agricultural input and output markets
❖ Forced food-grain quota deliveries at predetermined low prices
❖ Restriction of the movement of agricultural outputs from one part of the country to another.

These ill-conceived government interventions were the primary reasons for the lack of success
in the development of the agricultural sector, in particular, and the national economy, in
general.

2.1.2.3.Post-1991 Agricultural Policies and Strategies

The Transitional Government of Ethiopia adopted a new economic policy in 1991, with a
general objective of replacing the command economy with an economic system driven by
market forces. Some of the changes observed in the agricultural sector include:

• dissolution of producers’ and service cooperatives;

• encouragement of smallholders and private commercial farms;
• termination of public investment in state farms; and
• abolition of compulsory food-grain quotas and restoration of freedom of market.

The government also adopted Agricultural Development-Led Industrialization (ADLI) in 1993,

which revolved around enhancing the productivity of smallholder agriculture and
industrialization based on the utilization of domestic raw materials via adopting labour-
intensive technology.

The essence of this strategy rests on the belief that the agricultural sector can serve as the
driving force for the rest of the economy. This means that the strategy aims at better use of the
massive agricultural labour force in rural areas. It has internal forward and backward linkages
with the industrial sector. This strategy has been adopted by the government to fit in the
Ethiopian context.

These linkages can be explained as follows:

o Agriculture will provide the domestic food requirement, supply industrial inputs, and
provide commodities for export.

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o Development of agriculture expands the market for domestically produced goods as a

result of increased farmer incomes.

The development of the agricultural sector is said to be achieved through the improvement in
the productivity of smallholdings and the expansion of large scale private commercial farms.
The smallholder farmers are the major source of stable food production for the national food
supply. Food security could be achieved through promoting smallholder development in a
sustainable manner. In order to do this, special emphasis is given to raising production and the
productivity of farmers. In this regard, policies focused on designing incentive packages, such
as access to fertile land, provision of inputs, credit and tax incentives; improving budgetary
allocations; developing human resources; and improving the infrastructure and logistical
support.

Agricultural extension services are the basis for raising the productivity of the smallholder
farmers, who are the participants at the grass-roots level. Thus, a new system of agricultural
extension activities, named “Participatory, Demonstration and Training Extension System”
(PADETES), was formulated. The system is based on demonstrating to and training farmers in
proven technologies in line with the philosophy of bottom-up development approaches. This
strategy gives special emphasis to human resource development along with efforts to transfer
appropriate technologies that are suitable to conditions in rural areas. Human resource
development in this context implies improving the status of agricultural labour by upgrading
skills by way of investments in health, education and appropriate training.

The implementation of this strategy involves a package approach geared towards different
agro-ecological zones: areas with reliable moisture and nomadic pastorals. According to some
appraisals, the strategy is effective: in the reliable moisture areas, the results achieved in 1994
and 1995 included high output and yield such appraisals help to justify the possibility of
overcoming chronic food shortages in a relatively short time if the strategy is implemented on
a wider scope.

At the program level, ADLI consists of the following:

i. ensuring accelerated economic growth through a rural-centred development program

strategy which mainly focuses on the development of the agricultural sector’s output
using “a package programme” through:
▪ the distribution of improved seeds, fertilizer, and pesticides to farmers;
▪ the provision of credit and improved extension services;

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▪ the construction of small-scale irrigation schemes;

▪ the development of livestock resources through an improved feed base, improved
veterinary services, better use of improved breeding, and improved livestock products;
▪ conservation and rehabilitation of natural resources;
▪ implementing a favourable land-use policy;
▪ establishing agricultural marketing services;
▪ encouraging private sector development;
▪ expanding the economic and social infrastructure; and
▪ establishing peasant associations and service cooperatives.
ii. Ensuring accelerated economic growth to improve the living standards of urban
dwellers through:
▪ rapid changes in urban dwellers’ living condition;
▪ supporting indigenous investors; and
▪ the development of urban infrastructure.
iii. The programme also targets adopting an effective education strategy which:
▪ spells out the efficiencies of the existing educational curricula;
▪ suggests measures to increase the quality of the existing educational curricula;
▪ ensures the fairness of the curricula;
▪ takes appropriate measures necessary for the expansion of vocational education;
▪ encourages the participation of the community, NGOs, and private investors to improve
the standard of education; and
▪ improves educational administration.
iv. The preventive and primary health care strategy of the programme is aimed at:
▪ the identification of health service problems in Ethiopia;
▪ the expansion of preventive and primary health care services;
▪ improving the supply of basic medicine; and
▪ encouraging private entrepreneurs to participate in rendering health services.

In general, ADLI aims at improving the productivity and production of smallholders by

improving both allocative and technical efficiency.

At local levels, efficiency will be improved by using existing resources of land, labour, and
capital in a better way through improved agronomic practices. But the technical efficiency of
smallholding farmers will be improved by increasing their resources, essentially capital, to
introduce improved technology, be it biological, chemical, or mechanical.

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2.1.3. The Performance of The Agricultural Sector

The performance of the agriculture sector has been unsatisfactory relative to the rapidly
growing population. During the period of the Derg, especially from the years 1980/81 to
1990/91, the growth rate of the value added in agriculture and allied activities averaged a mere
1% per annum. Crop production and livestock rearing, forestry, and fishing exhibited annual
average growth rates of 0.8, 2.6 and 4.6 percent, respectively, for the period. Besides population
growth was about 2.9% per annum over the same period, per capita agricultural value added
increased at only a little less than 2% per annum. The sector did not register any significant
improvements after the reform period. Between 1993/94 and 1999/2000, the average annual
growth rate of value added in agriculture was only 1.8% while that of population growth was
2.9%. This value indicates the level to which the productivity of the agriculture sector is
incompatible with population growth.

The economic policy and strategy reforms of the 1990s positively influenced the performance
of Ethiopian agriculture. Total production of food crops increased. However, the drought of
2002/03 weakened the capacity to produce food. In some parts of the country where agriculture
has performed relatively poor, drought has forced people to depend on food aid.

The Crop Production: involves the production of food crops and cash crops.

Food crops: include grains, root and tuber crops, pulses and oil seeds. About 97 percent of the
food crops are produced by smallholders. Cereals are the most dominant food crops in terms
of areal coverage and total output. Cereal production, in terms of output, shows fluctuation
from time to time. For example, it varied from 8.8 quintals per ha in 1984/85 to 14.4 quintals
per ha in 1994/95.

Cash crops: Ethiopian cash crops include coffee, chat, cotton, tea, cut flowers, etc. The three
most important cash crops are coffee, chat and sugarcane. These days, the production of cut
flowers is gaining importance.

Coffee, chat and sugarcane were cultivated by about 1.5 million, 0.5 million, and 2.1 million
farmers, respectively, in 2001/02. The average holding size was 0.062 ha per holder for chat,
0.021 ha per holder for sugarcane and 0.12 ha for coffee.

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Fruits, vegetables and flowers: Ethiopia’s agro-climatic conditions make it suitable for the
production of a broad range of fruits and vegetables. Cut flower and vegetable production have
been fast-growing export businesses in recent times.

In 2001/02, 3.1 million farmers cultivated different kinds of vegetables on about 98.2 thousand
hectares of land. Out of this, 0.5, 6.5, 51.1, and 2.9 percent were planted with improved
varieties, irrigated, treated with organic and inorganic fertilizers, and treated with pesticides,
respectively. The average landholding size was about 0.03 ha. Red peppers and Ethiopian
cabbage occupy about 56.2 and 24.8 percent of the total area under vegetable crops,
respectively.

Similarly, 2.1 million farmers cultivated different kinds of fruits on about 40 thousand hectares
of land. Out of this, 1.13, 14.63, 26.5, and 0.41 percent were planted improved varieties,
irrigated, treated with organic and inorganic fertilizers, and treated with pesticides,
respectively. The average landholding size was about 0.019 ha.

Vegetables and fruits are not only important for domestic consumption; they also generate
some foreign earnings. The major trade partner for Ethiopia’s fruits and vegetables is Djibouti.

In recent years, both local and foreign investors are showing a growing interest in the
production of cut flowers due to the high demands for fresh cut flowers in European markets,
especially in the Netherlands. In 2001/02, 10 tons of flowers were exported. Following
government support, in terms of providing suitable land, finance and other incentives, this sub-
sector is growing rapidly.

The Livestock Production: Livestock resources in Ethiopia mean many things. It is a source
of food, draft power, fuel, cash reserves, and pride. The output of this sub-sector can be divided
into food, and non-food items. The food items comprise meat and meat products, milk and milk
products, eggs, honey, etc. The non-food items include draft power, hides and skins, bees-wax,
manure, transport facilities, etc.

The livestock sub-sector contributed 23.4%, to agricultural exports and 10% to total exports,
respectively, in 1987/88. However, the trend in the following years was a decline. The reason
for the decline was the rise of cash crop exports. Almost 96% of the livestock exports was
accounted for by hides and skins in the same year.

Apart from hides and skins, meat production occupies a significant position. It consists of beef,
mutton, chicken, goat, and camel meat. From 1980/81 - 1996/97, it increased by 0.9%. Beef,
mutton and goat meat accounted for 61.3%, 20.5% and 17.4%, respectively, of the overall meat
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production in 1980/81. The per capita meat production was 7.5 kg per head per annum in
1996/97, which was insignificant compared to world standards.

Similarly, the standard of milk production per head per annum was very low in the same year,
accounting for 22 litres per head per annum. The largest share of milk production came from
cows, followed by milk obtained from goats.

Fisheries: Ethiopia has large potential fishery resources in the country’s bodies of water: lakes,
reservoirs, rivers, and others. The lakes and rivers support a wide variety of aquatic life,
including more than 100 fish species, of which 40 are endemic to Ethiopia.

According to FAO, 2003, the major lakes account for 45%, while small rivers account for the
least (14%) of the fish production in Ethiopia. Although hundreds of local fish species have
been identified in Ethiopian bodies of water, the bulk of production is of tilapia, lates, Nile
perch, etc. It is estimated that this sub-sector provides a means of livelihood for more than
20,000 people.

2.1.4. Problems of and Possible Remedies for the Agricultural Sector

It has become an every-day saying that agriculture has been the mainstay of the Ethiopian
economy for decades. However, its performance in achieving food security and generating
capital for the other sectors is poor. This situation has attracted the concern of policy makers,
experts, and international organizations, who hope to change the situation. Why is this so?
What are the problems? What are some possible remedies?

Problems: According to the studies made so far, the sector’s problems identified fall into two
major categories:

a. Natural problems – Unpredictable Weather Conditions

b. Human-Made Problems- These are negative effects that result from the social and
economic practices. These problems include: land fragmentation, lack of infrastructure,
lack of credit facilities, lack of effective land-ownership entitlement, erosion and land
degradation, traditional practices, the use of backward technology and inadequate rural
markets.

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Remedies: to reduce or mitigate the problems affecting the agricultural sector of Ethiopia, the
following possible remedies are proposed.

i. Reduce the prevailing heavy dependence on rain-fed agricultural practices

ii. Production of drought-resistant crops in drought-prone areas so that the recurrence
of acute shortages of food will be minimized.
iii. Pursue an effective land-ownership right so that the farmers will develop long-term
developmental commitments.
iv. Promotion of extension services supported with consistent capacity- building tasks.
v. Promote committed literacy campaigns to help farmers understand price and farm-
technique information.
vi. Promote infrastructure facilities as per their availability.
vii. Inclusion of the issue in school curricula.

2.2. Industrial sector in Ethiopian Economy

The national income account of Ethiopia classifies the industrial sector into these sub sectors:
manufacturing, mining and quarrying, construction, and water and energy supply.

Economic development cannot be achieved without the development of this sector. A

developed industry is likely to boost the entire economy by making it nationally integrated,
flexible, and capable of self-generated and self-sustained growth. That is why the ultimate
objective of the developing nations, including Ethiopia, is industrial development.

Ethiopia has a long tradition in the development of handcrafts and cottage manufacturing
activities such as weaving, blacksmithing, pottery, and woodwork. But the introduction of
modern industries began at the end of the 19th century. Particularly, the following two major
early 20th century events contributed to the introduction of modern manufacturing industries
in Ethiopia: the emergence of a strong central government, which resulted in political stability
and the construction of the Ethio-Djibouti railway.

These events gave way to the establishment and expansion of cities and the settlement of
foreigners, mainly from Armenia, Greece, Italy, and India, which in turn increased the demand
for imported commodities and hence created the basis for industrial development.

According to Sutcliff, there are three criteria for a country to be an industrialized one.

• 25% of the GDP should come from the industrial sector.

• At least 60% of the industrial output should originate from the manufacturing sector.

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• At least 10% of the population should be engaged or employed in the industrial sector.

From the above criteria, Ethiopia is one of the least industrialized nations in the world.

2.2.1. The Role of the Industrial Sector in the Ethiopian Economy

According to the International Standards for Industrial Classification (ISIC), the Ethiopian
industrial sector is composed of mining and quarrying, manufacturing, electricity, water
supply, and construction. During the years 1991/92 - 1997/98, large- and medium-scale
manufacturing contributed 38.4% of the gross value of industrial production, while small-scale
manufacturing and handcrafts contributed around 18.7%. The contributions of mining,
quarrying, and electricity-supply activities were 3.9%, 15.8%, and 23.2%, respectively. From
this we can conclude that the manufacturing sub-sector dominated the Ethiopian industrial
sector, providing more than 57% of the sectoral output.

Since the manufacturing sub-sector is the most dominant and dynamic component of the
industrial sector, and also due to availability of time series data, we will concentrate on this
sub-sector as we analyze the contribution of the industrial sector to the national economy.

Output Contribution: According to ISIC, the manufacturing sector is characterized by the

physical or chemical transformation of materials or components into new products, whether
the work is performed by power-driven machines or by hand, and whether it is done in a factory
or in the worker’s home.

The manufacturing sector can be classified into groups of food and beverage, textiles, leather
and footwear, wood and furniture, paper and printing, chemicals, non-metal and metals.
According to CSA, 2008, during 2007/08, food and beverages accounted for about 48% of the
gross value of output of manufacturing establishments in 2007/08, followed by non-metal and
chemicals. These three industrial activities accounted for more than 74% of the entire gross
value of products in large- and medium-scale manufacturing organizations during the same
period.

In terms of the value added by the large- and medium-scale industry sub-sector, the food and
beverage industrial group is the leading one. For example in 2007/08, the contribution of the
food and beverage industrial group was 50.7%.

Looking at the data on revenue obtained from sales, the food and beverage industrial group
generated around 8.3 billion Birr, which is close to 48.5% of the total revenue obtained from
large and medium scale manufacturing in 2007/08.

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Employment Contribution: The industrial sector, in general, and the manufacturing sub-
sector, in particular, serves as important sources of employment, especially for the rapidly
growing urban population in Ethiopia. In 2007/08, there were 1,677,906 persons engaged, out
of which 678,911 were employees in the industrial sector. The number of persons engaged and
employees during this period showed an increase of 6.4 and 5.8 percent, compared to that of
2006/07, respectively. These increases in the number of persons engaged and employees could
be attributed to the increase in the number of establishments created in 2007/08 (CSA, 2009).

When we examine the employment capacity of each industrial group in the manufacturing
sector, as of 2007/08: the food and beverage group employed 50%, and the non-metal, and
paper and printing industrial groups contributed 14% and 10.9% of the sector’s employment,
respectively.

These three industrial groups, together, employed close to 75% of the total workforce in the
manufacturing sub-sector for the year 2007/08. The relative importance of the rest of the
industrial groups, in terms of employment, varies between 2.1% in wood and furniture
manufacturers to 8.8% in textile-product manufacturers. The decline in the share of
employment of these sectors is mainly due to increased employment opportunities in other
industrial groups such as in non-metal, paper and printing.

Foreign Exchange Contribution: The poorly developed industrial sector of Ethiopia

contributes very little to the foreign currency earnings of the nation.

According to CSA, 2009, textiles generate 41.5% of the sector’s foreign exchange, which is
the largest contribution. Food and beverages, leather and footwear follow as the second and
third with 32.9% and 10.8%, respectively. This pattern has remained almost the same in recent
years. The only noticeable change is in the wood and furniture and chemical groups. The total
value of wood and furniture and chemical exports in 2007/08 was Birr 43,269.7 and 30,198.9,
respectively. This can be taken as an indicator of the potential the nation has in bringing in
foreign currency from non-traditional commodities.

2.2.2. Industrial Development Strategies since 1960s

The policies are one of the major factors influencing the development of the industrial sector
of a nation. In Ethiopia, various industrial development strategies have been employed in order
to develop and direct this sector since the 1950s.

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2.2.2.1.Industrial Development Strategies During The Imperial Period

Industrialization in Ethiopia was at an incipient stage during the Imperial period. A conscious
effort towards developing a modern industrial sector did not start till the1950s. It was only in
the 1950s, when development plans (the three five-year plans) were formulated, that the
development of the industrial sector began to be shaped by policies and strategies pertinent to
the manufacturing sub-sector.

The main agents for the expansion of the industrial sector during this period were foreign
nationals residing in Ethiopia. It was believed that the settlement of foreigners and the
expansion of commercial farms would continue to give impetus to the growth and expansion
of the industrial sector. Hence, development programs and government policies were
formulated to pursue this objective. A number of proclamations were declared to encourage
foreign investment, and the investment proclamation was revised in 1964.

A number of incentives such as tax holidays, easy financing loans, exemptions from duty
payments, and effective tariff protection from foreign competition were given. However, these
incentives were based on some conditions. For example, a tax holiday was for those who had
an initial investment of, made more than Birr 200,000 and duty exemption was for heavy
machinery.

During the later years of the Imperial era, the main strategy for industrial development was
import-substitution, a process assisted by a system of import duties intended to encourage the
domestic production of goods and to discourage imported goods. The government placed much
faith on private foreign investment and it went to a considerable length to attract it. There was,
however, an obvious neglect of small scale industries during that period as the investment
incentives benefited only the medium- and large-scale manufacturing establishments.

Although the trend was mildly encouraging in the last few years of the Imperial government,
the actual level of manufacturing activity and its employment creation was very low compared
with the case in other developing countries. Although several reasons can be given to explain
the poor performance of the industrial sector, poor infrastructure facilities and the level of
articulated government economic policy towards the development of the sector were the main
constraints.

Manufacturing can be classified into different categories by using different criteria. The criteria
vary from country to country. Ethiopia also has its own criteria.
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According to the Central Statistical Authority (CSA), the Ethiopian manufacturing sector is
classified into three, namely large- and medium-scale, small-scale and cottage/handcraft
manufacturing. This categorization is mainly based on the number of people employed and use
or non-use of power-driven machinery. Large- and medium-scale manufacturing
establishments use power-driven machinery and employ 10 persons and above. Small-scale
industries are those establishments that employ less than 10 persons and use power-driven
machinery. Cottage/handcrafts units are those establishments that produce goods and services
primarily for sale but do not use power-driven machinery in performing their main activities,
regardless of the number of persons employed.

According to the Ethiopian Economic Association (EEA) report, during the Imperial period,
industrialization, with an inward looking orientation based on import substitution, was pursued
as a matter of government policy. As a result, a good number of manufacturing enterprises
were established, including 80 factories, mostly by private businessmen of foreign origin. Only
eight of these eighty establishments were fully government-owned, while another five were
joint ventures where the government had over 50% ownership. By 1974, only 26 of the total
number of manufacturing enterprises were either fully or partially owned by the government,
and in seven of them the government’s stake was less than 50%. The great majority of the
manufacturing firms in Ethiopia before the 1974 revolution, especially the medium- and large-
scale ones, were owned by foreigners. Out of 273 establishments, 178 or 65% were set up with
the assistance of foreigners, and 101 or 40% were totally owned by foreign nationals. In short,
by 1974 the industrial sector of Ethiopia was small and characterized by production for the
domestic market, mainly to substitute for imports, and its enterprises were largely private and
foreign owned. The role of the government in the evolution of the Ethiopian manufacturing
industries prior to 1974, at least as direct producers, was very limited.

2.2.2.2.Industrial Development Strategies During The Derg Period

The industrial sector underwent a radical change in the structure of ownership and management
during this period. As a first step in this process, the government nationalized almost all the
medium- and large-scale enterprises which were formerly owned by the private sector on
December, 20, 1975. It also imposed a capital ceiling on private sector investment, limited to
Birr 500,000, and investors were not allowed to have licenses for more than one line of
business. This discouraged any possible revival of the private sector in medium-, large-scale

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and handcrafts activities. The tax structure was also very harsh, with the maximum rate on
personal income going as high as 89%. The interest rate was also higher for private borrowers,
relative to that for public enterprises and cooperatives. These polices severely hampered the
expansion of the manufacturing sector during the Military government by paralyzing the
private sector.

Later on, the Ten-Year Perspective Plan (1984/85 – 1993/94) sought to promote the production
of intermediate and capital goods and the expansion of small scale industries. The state took
responsibility for developing and managing the medium- and large-scale industries with wide
linkages to capital-good producing industries that could be used to develop other
manufacturing industries. The prevailing economic management policy created different
hierarchies in the industrial sector. Putting the Ministry of Industry at the top, corporations
were established to supervise the management of the grouped enterprises. The general
managers had the responsibility of supervising the day-to-day operations of the industrial
enterprises in accordance with the guidelines prepared by the Ministry.

The plan, however, failed to attain its goals for various reasons, and significant improvements
were not witnessed in the structure and the level of development of the sub-sector. For example,
government corporations decided whether these enterprises were efficient. Accordingly,
producing enterprises had weak links with market forces, which did not permit them to have
the necessary feedback so as to become more competitive in the market. In short, the industrial
policy of the Derg stifled the speedy development of the sector by creating too much
government intervention and by limiting the participation of the private sector.

To support small-scale industrial enterprises, the government established the Handicrafts and
Small-Scale Industrial Development Agency (HASIDA) in 1975. But this did not help much
in achieving the required pace of growth in the small-scale industrial sector. This might have
been due to the lack of institutional and other supportive measures that should have been taken
to boost the capacity and the efficiency of the small-scale and handicrafts enterprises.

After the collapse of socialism in Eastern Europe and, later, in the former Soviet Union, the
regime tried to introduce some economic liberalization by way of introducing a mixed
economic policy. A number of constraints that stood in the way of private-sector development
were lifted. For instance, the capital-ceiling restriction was relaxed. However, several of these
encouraging measures did not attain their goals because as the civil war reached its climax and
diverted government resources towards resolving security problems.

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No adequate database was available to use to analyze the growth in the number of
manufacturing establishments until the CSA conducted surveys of manufacturing industries in
1995/96 for each of the industrial groupings. It is only for the 10+ group (manufacturing
establishments with 10 or more employees) that time series data was available. According to
this survey, the number of manufacturing establishments with 10 or more employees in
1975/76 was 430. This number declined to 402 in 1985/86, a decline of 0.82% per annum. It
further declined to 273 in 1992/93, the lowest ever registered, eventually growing to 642 by
the time of the survey in 1995/96.

There are several reasons that explain this decline.

➢ The first is the decrease in the number of employees, owing to low capacity utilization
which in turn was caused by the unfavorable government policies towards private
activities to obtain foreign exchange (for raw materials, spare parts and replacements),
credit and licences. Therefore, some of the establishments fell below the “10 and above”
employee category. The way the number of establishments fluctuated year after year
seems to prove this.
➢ The possibility was high for establishments to cease operation for the obvious reasons
of the period, such as war, burdensome regulations, and lack of foreign exchange.
Indeed, the economic policy of the time did not encourage the establishment of firms.
➢ The third reason the independence of Eritrea, achieved by 1991/92, which reduced the
number of industries by the number of those that existed in Eritrea.

A few surveys have been conducted on handicrafts and small-scale industries. These include
the survey undertaken by HASIDA in 1989 and 1991 on private small-scale manufacturing
establishments and the one conducted by CSA in 1997 on handicrafts/cottage and small-scale
industries.

According to HASIDA, private small-scale manufacturing establishments are those:

• which use manually operated machines or motor-driven machinery;

• which employ at least one person (other than the owner and the owner’s families); and
• those with fixed assets not exceeding a million birr, excluding land and buildings.

Given this definition, the number of private small-scale manufacturing establishments was
7,706 in 1985/86 and 7,600 in 1986/87. These numbers appeared to dramatically change as
reflected in the results of the 1997 CSA survey, which registered 892,719 cottage/handicrafts
and 2,731 small-scale industries. Clearly the main cause this apparent change was the change

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in definitions, in that the later survey included cottage and handcrafts industries which were
not included in the former survey. Furthermore, a significant increase in these establishments
owing to the more liberal economic policies of the new government probably contributed real
changes, since these are the first categories to quickly respond to changes in policy regimes.

The contribution of 10+ manufacturing firms accounted for only 9.15% of the value added of
the manufacturing sector in 1975/76, and the value has declined since then, reaching its lowest
point of 3.5% in 1989/90. As in the early cases, and for similar reasons, the recovery started
with the new economic policy after 1992/93.

2.2.2.3.Industrial Development Strategies During The Post- Derg Period

After replacement of the socialist government by the Ethiopian Peoples’ Revolutionary

Democratic Front (EPRDF) in 1991, the government sought to rationalize its role in the
economy while enhancing the active participation of the private sector.

Accordingly, the transitional government of Ethiopia announced an economic policy which

could be described as “cautious capitalism’’. Believed to be conducive for investment, the
government accepted the Structural Adjustment Programs (SAPs), though with some
reservations.

With respect to the industrial sector, the Transitional Government of Ethiopia (TGE) indicated
that the role of the state would be limited to areas of large-scale engineering, metallurgical
plants, communications, power, and pharmaceutical industries from which the private sector
was bared. The government, undertook a Public-Enterprises Reform Program in August 1992,
which aimed at enhancing efficiency, productivity, and competitiveness in public enterprises
(most of which were manufacturing) through the granting of managerial autonomy and
responsibility. This was done by dismantling the sub-sectoral corporations under the Ministry
of Industry. The overall management of each manufacturing enterprise was thus put under its
own board of directors and a general manager responsible for output, price, and investment
decisions as well as appropriate market channels.

In general, these measures were designed with the long-term objective of raising the share of
the industrial sector in the economy, both in terms of output and employment creation and of
enhancing the development of strategic industries which were expected to have multiplier
effects through contributing to the expansion and development of other economic activities.
Laws were enacted to give enterprises management autonomy, a more flexible labor code was
proclaimed, prices were largely decontrolled, foreign trade and financial institutions, including

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the foreign exchange market, were particularly taken to encourage private sector participation
in the economy. These include:

▪ the lifting of the restrictions on private-sector investment capital and the number of
business ventures;
▪ the easing of licensing requirements and regulations;
▪ the enactment of an investment code which, upon successive revisions, opened up a
wider range of economic activities for both domestic and foreign investors. In addition
to the investment code, investment incentives were offered in the form of tax holidays,
duty-free importation of investment goods and the like designed to favour investment in
selected sectors and regions; and
▪ the downward revision of taxes and tariffs from the extremely high levels that existed
before the reform period. The marginal tax rate on personal income was also slashed
from 89% to 40%. Business profit tax was reduced from 59% to 35%, while the
maximum tariff on imports was reduced to 50% down from 240%.

In addition to the above measures, the government introduced an overall development strategy,
the Agricultural Development-Led Industrialization (ADLI) strategy. The basic assumption is
that agriculture would become a source of domestic market demand and a reliable raw material
base. This strategy is also expected to strengthen the inter-sectoral linkage between agriculture
and industry.

To sum up, several interventions have been made to enhance the development of this sector.
Key among these measures is the establishment and strengthening of institutions necessary to
promote industrialization. A policy goal is to create a conducive environment for industrial
development by developing infrastructure and the nation’s technological capability. Other
goals are to promote inter- and intra- sectoral linkages, create an appropriate financial
environment, encourage balanced regional industrial development and strengthen the linkage
between industry and other sectors. Also, in addition to expanding the domestic market for
industrial products by increasing the income of the rural population as a result of the ADLI
strategy, the government policy is also designed to promote industrial exports.

According to the CSA, 2010, there were 1,930 large- and medium scale, 43,338 small-scale,
and 974,676 cottage/handicraft establishments during 2007/08. The majority of the
establishments do not use power driven machinery, irrespective of the number of persons
employed.

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The sectoral structure of the manufacturing sub-sector, 2007/08 based on numbers of

establishments, reveals that food and beverage establishments accounted for 52% of the total
manufacturing enterprises, while textiles accounted for 22%, as indicated in Table 1.

Table 1: Structure of the Manufacturing Sub-Sector by Number of Establishments, 2007/08

Source: CSA, 2010.

As shown in Table 1, food and beverage, textile and non-metallic minerals dominate the
Ethiopian manufacturing sub-sector. These groups accounted for 83% of the total number of
establishments during 2007/08. The concentration of Ethiopian manufacturing activities in
these establishments might be due to the fact that they depend heavily on local inputs and due
to the availability of domestic markets for their products.

The number of large- and medium-scale establishments reached 779 in 1998/99 from its level
of 642 in 1995/96, with an annual average growth rate of 6.8%. This growth rate is not
satisfactory, given the low level of manufacturing activities in the nation.

When we come to the ownership structure, small-scale and cottage/handcrafts enterprises are
totally owned and managed by the private sector. The ownership of large- and medium-scale
manufacturing enterprises has shown changes in the past few decades. During the Imperial
period, this sub-sector was dominated by the public sector, due to various measures taken by
the governments. The proportion of public-to-private establishments showed continuous
increase during the period of the Derg, reaching a maximum of around 120% in 1991/92, with
152 out of 279 enterprises owned by the government. However, this trend has been reversed
due to the economic policies adopted by the EPRDF government.

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As you can see from Table 2, the share of the private sector increased from 46.3% in 1995/96
to 91.5% in 2007/08. This is due to the active involvement of the private sector, the
privatization program, and the withdrawal of the government from new investments in the area
of large- and medium-scale manufacturing.

Table 2: Ownership Structure (share in %)

Source: EEA, 2002; CSA, 2007/08.

However, this does not mean that the private sector has the largest share in terms of output.
Even though the value of output of the private sector, using both Gross Value of Product (GVP)
and Value Added at Factor Cost (VAFC), showed increments from 1995/96 to 2007/08, it is
very recently that the public sector dominance in large- and medium-scale manufacturing in
terms of output has been overtaken by the private sector. This is one underlying reason that the
private sector employed 66.3% of the total labour force engaged in this sub-sector.

When we look at the regional distribution of the manufacturing establishments, we see

unbalanced distribution. In general, it is better to have evenly distributed manufacturing
establishments, but distribution depends on several factors including infrastructural
developments, including those in roads, electricity, communication, water, proximity to input
and output markets and social services.

Table 3: Distribution of Large- and Medium-Scale Manufacturing in Ethiopia, 2007/08

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Source: CSA, 2009

From Table 3, we can see that Addis Ababa has the largest number of establishments land
provides the most employment in the sector: 46.4%, and 48.4%, respectively. Oromia follows
Addis Ababa with 16.7% of the establishments and 24.0% of total employment in the sector.
Tigray takes the 3rd place in establishments, value added and employment shares. The category
“Others” includes the four relatively less developed regions, namely Somali, Afar,
Benishangul-Gumz and Gambella, which, together, have only 1.5% of the establishments.
These values indicate the unbalanced manufacturing establishment distribution. In an attempt
to narrow this gap, the existing investment code of the country promises special incentives for
investors who want to work in those backward regions.

2.2.3. The Performance Of The Industrial Sector

The performance of the industrial sector can be measured, among other things, by:

❖ Gross value of output (GVO), which refers to the total output produced during a given
period of time;
❖ Value added at factor cost (VAFC), which is the difference between the gross value of
output and the value of intermediate inputs, such as the cost of raw materials;
❖ Value added at current market price (VACMP), which is the sum of value added at
factor cost and indirect taxes, regardless of any subsidies.
❖ Value added per person employed (VAPPE), which refers to the ratio of value added
generated in a given period to the number of people employed during the same period.

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Given these definitions, we can briefly look at the contributions of the Ethiopian industrial
sector to the national economy.

The available evidence indicates that the industrial sector accounted for 13.6 % of the national
GDP during the period 1961-1974. This share declined to 12.2% and 10.9% in the periods
spanning from 1980 - 1990 and 1991 - 1999, respectively. This implies that even if the broader
definition of industry is taken (including mining and quarrying, manufacturing, electricity and
water, and construction), the contribution of this sector to the national economy is not only
marginal but declined over time. According to the information obtained from the National Bank
of Ethiopia (NBE, 2008/09) the industry share of GDP for 1999/00 – 2008/09 was 13.1%. If
we look at the GDP role of each component of the industrial sector in the national economy,
we find that large- and medium-scale manufacturing accounted for 4.3%, small-scale 2.01
percent, and handcrafts 2.58 percent of the national output in the period spanning 1991-1999.
The major contribution came from the large- and medium-scale manufacturing sector, as
indicated in Table 4.

Table 4: Major Components of the Industrial Sector (as % of total industrial GDP)

Source: CSA, 1999, 2009

As indicated in Table 4, the GDP contribution of large- and medium-scale manufacturing

industries declined for the three decades of 1980 - 2008. The share of small-scale and
handcrafts showed marginal increments during the last two decades of that period and then
declined thereafter. ‘Other’ sub-sectors which, together, contributed about 20.3% and 58.6%
to the total industrial GDP during the periods of 1991-1999 and 2000 -2008, respectively,
include mining and quarrying, water, and electricity.

The size of 1995/96 manufacturing output shown in Table 5 indicates that a significant
proportion of the gross value of output came from a small number of large- and medium-scale
manufacturing activities, followed by cottage and handcrafts.

Table 5: Gross Value of Output of Manufacturing Subsector of 1995/96 (in thousand Birr)

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Source: CSA Survey, 1997.

The bulk of output, which is about 72.2%, is created by large- and medium scale
manufacturing, and the contribution of small-scale industry is insignificant. In terms of value
added at factor cost, large- and medium-scale manufacturing establishments contributed a
significant proportion of the total value added, followed by cottage/handicrafts. This suggests
that we should have a closer look at the performance of large- and medium-scale manufacturing
establishments. The following analysis will be limited to large- and medium-scale
manufacturing establishments because of the availability of adequate information on these
establishments and because of their greater contribution to the national economy.

The Ethiopian large and medium-scale manufacturing sub-sector is characterized by the

dominance of four-consumer good producing industrial groups, namely the food and
beverages, textiles, and leather and shoes groups. These groups of industries account for the
bulk of the gross value of output and for the value added of the sub-sector. For instance, the
four groups of industries (but substituting chemical for leather and shoes) accounted for 78%
of the gross value of output during the 1980s. However, the gross value of the output of the
large- and medium scale manufacturing sub-sector declined by about 1.6 percent during
the1980s due to a sharp decline in the production of the chemical and textile groups.

The decline or stagnation in the gross value of output of the large- and medium scale
manufacturing sub-sector reversed after the launching of the economic reform program. The
available official documents indicate that almost all large- and medium-scale manufacturing
industrial groups showed significant improvement after the reform program was implemented.
The gross value of output of the large- and medium-scale manufacturing sector registered an
average annual growth rate of 20.2 % during the period covering 1991/92 - 1998/99 as shown
in Table 6.

Table 6: Gross Value of Output of the Large- and Medium-Scale Manufacturing Sub-Sector
(in thousand Birr)

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Source: CSA, 1997 and 2000

In absolute terms, production increased from Birr 1.8 billion in 1991/1992 to Birr 7.3 billion
in 1998/99. That is, production quadrupled, representing an annual average growth rate of
20.5%. The major share of the increment in the value of production was contributed by food,
chemical, non-metal and metal, which achieved average annual growth rates of 22.9%, 26.9%,
30.2%, and 35%, respectively, during the period of 1991/92 - 1998/99. The smallest annual
average growth during the reform period in gross value of output was observed in the tobacco
industrial group. It registered an annual average growth rate of 7.8% during the period under
consideration.

Note that a mere increase in the gross value of the output of manufacturing industries might
not have meaningful economic importance unless it is supported by a commensurate growth in
the value added. Evidence indicates that the value added in the large- and medium-scale
manufacturing declined annually at an average rate of 2.4% during the 1980s. However, this
trend has been reversed since the introduction of the economic reform program. The value
added at factor cost of large- and medium-scale manufacturing increased from Birr 336.8
million in 1991/92 to Birr 1,982.9 million in 1998/99, representing an annual average growth
rate of 25.3% during the period covering 1991/92 - 1998/99.

Table 7: Value Added of the Large- and Medium-scale Manufacturing Subsector (in thousand
Birr).

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Source: CSA

Food, non-metal, leather and shoes, and chemicals registered high annual growth rate of 34%,
33.2%, 27.6% and 25%, respectively, in value added in the period spanning 1991/92 - 1998/99.
The lowest annual growth in value added during that period was recorded in the wood and
furniture group. Also, the value added by beverage and textile groups increased by 1.9% to
11.9% annually during the same period, respectively.

Another indicator of the performance of the manufacturing sector is the value added per person
(also known as labor productivity). Value added per person declined at an annual average rate
of 3.4% during the 1980s. This might have been be due to, among other things, redundancy of
labor in the sector together with obsolete and outdated technology causing the marginal product
of labour to decline over time. After the reform, however, value added per person increased.
Labor productivity was highest in metal, followed by those of food and leather and shoes. Labor
productivity registered an annual average growth rate of 33.9%, 30.1%, and 25.6% in the metal,
food, and leather and shoe industrial groups, respectively, during the 1991/92 - 1998/99 period.

The manufacturing sector has shown improvements in terms of gross value of output, value
added, and value added per person during the post-reform period. This might be attributed to
the incentive for profit and the creation of a relatively conducive environment induced by the
granting of managerial autonomy to public enterprises; the active involvement of a number of
private manufacturing establishments; the improved availability of inputs and spare parts; and
the recovery of the agricultural sector, which enhanced the supply of raw materials to the

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manufacturing sector. These factors are expected to continue to contribute to the improvements
in the performance of the manufacturing sector.

2.2.4. Problems of and Possible Remedies for the Industrial Sector

The manufacturing sector of Ethiopia is in its infant stage due to many interrelated problems.
These problems are generally related to finance, technology, market, policy, input supply and
other socio-economic factors.

Lack of Finance: The possible sources of this finance have been agricultural- and non-
agricultural-commodity producing sectors in the economy. The agricultural sector has not been
capable of generating the required surplus for the industrial sector, given its subsistence nature
and backwardness. The other commodity-producing sectors, especially the manufacturing
industry, are underdeveloped and most public enterprises are heavy users of foreign exchange.
That is, they are highly import-dependent. This means that they have not been net savers and
hence have no surplus. Given such a low saving rate, it is difficult to undertake industrial
investment.

High collateral requirements by the formal lending institutions have aggravated the problem of
financial shortage.

Market-Related Problems: According to CSA, 2000, market-related problems accounted for

39.5% of the underutilization of the capacity observed in the large- and medium-scale
manufacturing establishments.

Market-related problems arise due to the following factors:

o Weak domestic demand for manufacturing output — this is due to the subsistence nature
of agriculture on which the vast majority of the people rely for food, etc. As a result, the
purchasing power of the people is very low.

o Lack of marketing information about both local and export markets.

o Strong competition from cheap imports.

o A consumer bias against local products.

Technology-Related Problems: It is argued that it is impossible to think of industrial

development without the application of modern science and technology.

Technological problems may reveal themselves in one of the following ways:

❖ Lack of sufficient information on appropriate technology.

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❖ The technology we have today is not developed based on available local raw materials.
This limits the linkage that is expected in the domestic economy of the manufacturing
sector.

❖ The technology we use is also capital intensive. This approach is basically not
recommended for economies like Ethiopia where unemployment is rising.

Input-Related Problems: Input-related problems also hamper the development of industry in

Ethiopia. This is mainly due to the high cost and shortage of foreign exchange for imported
inputs and to the unreliability of domestic sources of inputs and their poor quality. The survey
conducted by CSA in 2000 ranked the shortage of raw materials as the second most serious
problem that contributes to the underutilization observed in large- and medium-scale
enterprises, accounting for 25.9% of the total underutilization.

There are also other problems like policy problems and human-resource-related problems in
relation to lack of skilled manpower and absence of industrial discipline and work ethics. These
and other problems do not only limit new investments, but also reduce the productive capacity
of the already existing enterprises. For instance, according to CSA (2000), the large- and
medium scale manufacturing establishments used only 49.2% of their capacity due to various
problems, the most serious of which were market-related problems and the shortage of raw
materials. Therefore, in order to create accelerated industrialization in Ethiopia, it is imperative
to identify and tackle the problems that are hampering the development of this sector.

2.3.Service Sectors in Ethiopian Economy

The service sector or the service industry is one of the three main economic sectors. The basic
characteristic of this sector is the production of services (also known as ‘intangible goods’),
and does not include the goods-producing sector.

This sector is composed of various sub-sectors. More specifically, the service sector includes:
trade, hotels and restaurants, transport and communication, education, banking and insurance,
public administration and defense, health, and other services. According to the Ethiopian
National Income Account classification, the first five sub-sectors are referred to as distributive
services while the remaining are in the ‘Other’ service sector.

According to MOFED, 2009/10, the GDP share of the service sector increased from 41.1% in
2002/03 to 46% in 2009/10. This is mainly the result of the fast growth in the areas of real
estate, hotel and restaurant, education, and health. In contrast, the share of agriculture fell from
its level of 56.7% in 1995/06 to 42% in 2009/10.
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There are a number of ways to consider the service sector such as: its divisions, its components,
and the types of activities within the components.

The service division includes a wide variety of industries, but they can be categorized into
primarily consumer-oriented (providing a service directly to a consumer), primarily business-
oriented (providing a service directly to another business) or mixed (providing services to both
businesses and individual consumers).

Alternately, the activities of the services division can be described in reference to their
economic activities as:

i. Physical activities: involve working with objects; examples include repairing cars,
hairdressing, and cooking.
ii. Intellectual activities: involve providing education or training at such levels as university
and vocational school.
iii. The aesthetic activities: entail providing consumers with artistic experiences such as offered
by museums, theatre performances, art shows, and musical performances.

The Role of the Service Sector in the Ethiopian Economy

The service sector plays an important role in the country’s economy. Its contribution can be
seen from three angles, namely: output, employment, and foreign exchange contributions.

Output contribution: The service sector has played a dominant role, next to the agriculture
sector, in the Ethiopian economy. But in 2008/09 and 2009/10, the output contribution of the
service sector in Ethiopia dominated the agriculture sector, contributing about 45% and 46%
respectively.

This mainly the result of the fast growth of education, health, socio services, tourism, transport
service, construction and related engineering services, wholesale and retail trade, hotel and
restaurant sub sectors. Moreover, relatively large investment is expended on the sector.

Employment contribution: In Ethiopia, the service sector is the second largest sector, next to
agriculture, in terms of absorbing a significant part of the labor force. About 1.4% of the total
labor force is employed in the health and education sectors, while about 0.5% is employed in
the communication and transport sectors.

Foreign exchange contribution: The value of exports of services increased from $261 million
in 1980 to $348 million in 1998, representing an average growth rate of 33%. In 2008/09,
foreign exchange income earned from service providers such as Ethiopian Airlines and

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Ethiopian Shipping Lines, as well as from various service sub-sectors such as tourism,
communication, insurance and financial services, collectively reached nearly 2 billion dollars,
when compared to just 1.5 billion dollars for the export of goods.

The Education Sector in Ethiopia

The economic and social development of any country depends on the scope and level of the
peoples’ education. Education in Ethiopia dates back to the 4th Century. For about 1,500 years,
the church controlled most of the traditional educational institutions. However, education in
Ethiopia has undergone tremendous changes since the 19th century as a result of government
policies that have attempted to improve basic education.

Formal education began in 1908. However, the education system in Ethiopia suffered from
shortcomings in quality, coverage, efficiency, and relevance, due to the following four key
problems.

First, the education and training policies that were in place for many decades focused only on
solving immediate problems, rather than tackling major long term challenges at the national
level.

Second, children – especially girls – were not encouraged to attend school.

Third, since there were no specific learning profiles set for students at different levels, neither
the student nor the teacher had a clear vision of what and why they were learning or teaching.

Fourth, too many subjects were taught, both at primary and secondary levels (up to 15 in some
cases), which resulted in lessons being too fragmented to develop necessary skills, attitudes,
and behaviors.

Because of these and other constraints, the educational system was unable to contribute to
solving the development problems of the country. The same hypothesis holds true for
institutions of higher education. Higher education started 50 years ago and was entrusted with
the task of producing capable, problem-solving, responsible citizens. Nevertheless, the reality
prevailing in higher institutions was far from encouraging. This was especially true during the
Imperial Regime.

Due to the inappropriate education policy of the Military Regime, the coverage of education
was, relatively, very narrow. One of the characteristics of the Derg was its spending on defence
rather than expanding the education sector. Between 1987 and 1991, only 8.94% of the annual
budget was allocated for education.

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But, according to Education Statistics Annual Abstract, 2007/08, the budget allocation for
education between 2003/04 and 2007/08 was 22.6%. School construction at different levels in
different regions of a country increased rapidly post-1990. The population of school-age, both
male and female, increased from 69,126,001 to 73,819,951 between 2003/04 and 2007/08.

The Health Sector in Ethiopia

The health status of many Ethiopians remains very poor and the system is not yet large enough
to meet demand. The major limitations of progress in the sector are: high population growth;
low educational and income levels, especially among women; lack of access to clean water and
sanitation facilities; and nutritional disorders and insufficient access to health services.

The Ethiopian health care delivery system has historically been unable to respond
quantitatively and qualitatively to the health needs of the people.

Definite policies and strategies for the development of health service were not formulated until
1963. However, efforts were made to include the health sector into the development plans.
After the 1974 revolution, Ethiopia embarked upon different approaches towards solving
health-sector problems, through the declaration of primary health care in a ten-year
development plan in 1978. In these approaches, priority was given to creative types of
strategies. It was highly centralized and there was little collaboration between public and
private providers.

The Ethiopian Transitional and Federal Government formulated the 1993 Health Policy and
Strategy. Goals of the Federal Government and the regional administrations included
reorganizing health services to make them more cost effective and efficient so that they can
contribute more to the overall socioeconomic development effort of the country.

Then a comprehensive rolling 20-year Health Sector Development Plan (HSDP) was
formulated in 1997. Both the 1993 National Health Policy and the 1997 HSDP are the results
of the critical assessment and analysis of the nature and causes of the country’s health problems.
The major goals of the health policy are decentralization of the health care system, development
of preventive, facilitative, and curative components of health care, assurance of accessibility
of health care for all segments of the population, and the promotion of private-sector and NGO
participation in the health sector.

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The national health policy focuses on a comprehensive health service delivery system to
address: communicable diseases, malnutrition, and improving maternal and child health.

The health service delivery system is decentralized with the responsibility for implementation
being largely devolved to the districts, which operate on the basis of block funding for the
sector.

The policy emphasizes inter-sectoral collaboration, particularly in ensuring family planning for
efficient family health and population planning, in formulating and implementing an
appropriate food and nutritional policy, and in accelerating the provision of safe and adequate
water for the urban and rural populations.

The Transport Sector

Transportation is fundamental to civilization. The roles of transportation in socio-economic

development are that it allows for: division of labor and labor specialization, procurement of
raw materials from various sources, and dispatch of goods to marketplaces, etc.

In Ethiopia, the early means of transportation were foot and pack animals like donkeys, horses,
and camels. These means of transportation are important even today, especially in rural areas.
However, this set of transportation constrains the socio-economic development of the country
because it is time-taking and tiresome.

During the Military Government, the transport sector was put under close state regulation and
control. The entire commercial truck and passenger transport system was under strict control
of the government through Proclamation No.107/1976.

The policy changes in the sector that occurred on May 8, 1992 heralded the deregulation of the
freight transport industry. Major liberalization of the transport industry began with government
Proclamation No. 14/1992. It emphasizes the promotion of efficiency and equitable
distribution.

Following the 1992 Proclamation, many of the private commercial freight and passenger
transport activities left the corporation and formed their own independent association. Some,
however, continued as associates of government enterprises.

The other content of the new policy allows: free entry into existing associations, and obtaining
licenses to form new associations.

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The transport sector in Ethiopia includes road transport, railways transport, air transport and
marine transport (shipping lines).

The Communication Sector

Communication services include telecommunication, postal and media services. Upgrading

and expanding the telecommunications network and services have been essential to
modernizing the sector and bringing about national growth as well as greatly supporting the
rural economy. For example, having basic telephone access in villages allows farmers to get
information on prices for their crops and livestock products; improves the efficiency of local
administration; encourages the development of trade and small businesses; and facilitates the
provision of social services such as health, education and agricultural extension.

The history of the communication service in Ethiopia dates back to 1894 when various
innovations were introduced in Ethiopia during the time of Emperor Menelik II.

A telegraph line from Addis Ababa to Djibouti was installed parallel to the construction of the
then Franco-Ethiopian Railway, which was commenced in 1898 and completed in 1917.

Until 1904, communication services were supervised by a foreign adviser but later, as
telephone and telegraph lines were found to be vital for administrative and foreign-relation
purposes and for the dissemination of news, communication facilities began to be run by an
office in the Imperial Palace and were accorded the direct attention and supervision of Emperor
Menelik II himself, assisted by a foreign expert, M. Chefneux.

The first telecommunication and postal administration started in 1909 and was completed in
1911. It was the cornerstone of the establishment of the Ministry of Postal, Telegraph and
Telephone (MOPTT).

After the establishment of MOPTT, Ethiopia became a member of the Universal Postal Union
(UPU) and the International Telecommunication Union (ITU) in the years 1908 and 1932,
respectively.

In the period from 1915 to 1932, there were only 200 telephone subscribers in Addis Ababa.
The first telephone subscriber in Addis Ababa was the then Bank of Abyssinia.

Following the end of the Italian occupation of Ethiopia (in 1941), the first automatic telephone
exchange system was installed in Addis Ababa and Asmera.

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In 1981, the Board of Telecommunication was renamed as the Ethiopian Telecommunication

Service Organization without much change in its functions. This name lasted for over 5 years
and in 1981, the organization came to be known as the “Ethiopian Telecommunication
Authority”.

As to postal services, Proclamation No. 240/1996 set the administrative infrastructure for the
improvement, expansion, and modernization of the Ethiopian postal system. Under this
Proclamation, the post office was organized as an independent department of the MOPTT.

As to the development of media service in Ethiopia, the press was the pioneer in this area. It is
one of the media used for relaying information to the public and to exchange news, views,
ideas, etc.

As the data shows, the numbers of copies of Addis Zemmen and the Ethiopian Herald sold
were 4.4 million and 2.6 million in 1998/99, respectively, and it rose to 5.8 million copies of
Addis Zemmen and 3 million copies of the Ethiopian Herald in 2002/03, (Ministry of
Information and Culture, 2002/03).

Television service was established in 1964. The service was confined to Addis Ababa.
Additional TV stations were not installed until 1992. Television service coverage had reached
up to 35% of the total area of the country by the end of the Derg regime. After the downfall of
the Derg, 39 additional towns got TV services. By the year 2006, the TV penetration rate in
Ethiopia had reached up to 55% of the total area of the country.

The Tourism Sector

Tourism deals with the movement of people away from their normal residence for: business,
conference, vacation, transit, visiting relatives, and other purposes. Tourism is the activity of
providing services for these people, and it is also an important source of foreign currency and
employment for citizens of many countries.

Ethiopia has great tourism potential. It was the recognition of this great potential that
encouraged Ethiopia in the 1960’s to start a tourism industry. After an initial period of rapid
growth, the industry underwent a fast decline and stagnation for many years due to the political
and economic problems that prevailed for a long time in the history of the country.

During the Derg government (from 1974 to 1991), Ethiopia’s tourism industry suffered from
the adverse effects of a prolonged civil war, recurrent drought and famine, strained government

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relations with tourist-generating countries, and restrictions on the entry and movements of
tourists. However, tourism is now operating in a more conducive climate for growth and
development, as evidenced by statistics compiled by the Ethiopian Tourism Commission.

Because Ethiopia has so many historical and natural sites and diverse cultural tourism
attractions, tourism should have been one of the country’s largest industries, but unfortunately
the country has been unable to realize the economic benefits it deserves from the sector.
Nonetheless, in recent years, due to the development of infrastructures, like roads and hotels,
and to the crucial role of the government in marketing and changing the image of the country
through its embassies, tourism has shown significant growth. But still there is a long way ahead
before we will fully exploit the benefits of the tourism sector efficiently and secure its
appropriate position in the economic sectors.

3. ETHIOPIAN ECONOMY SOCIO-ECONOMIC CONDITIONS

There are various indicators of development employed to compare the level of

development countries or regions. The following are widely/frequently used in the
Ethiopian context. GDP or GNP (Gross Domestic Product/Gross National Product) per
capita, Illiteracy rate, Infant mortality rate, expected life expectancy, Population growth
rate, Percentage of population who have access to clean water and Level of infrastructural
development, etc.

Based on the above indicators, Ethiopia’s present socio-economic features are treated as
follows.

1 GDP per capita: It is believed that Ethiopia’s GDP per capita is one of the lowest in the
world. PASDEP’s target has achieved a growth rate of Ethiopia’s GDP per capita status
will join the middle in group countries with in the coming five years (2010-2015). The
current status of Ethiopia’s GDP per capita is estimated to be US $344 per annum (source:
wikipedia, the free encyclopedia).

2 Literacy rates: Like many of the less developed countries, the illiteracy rate in Ethiopia
has been high. The literacy campaign that had under taken before 1991 contributed much
to the ongoing task to eradicate illiteracy. Since 1996, the illiteracy rate has decreased by
50%. Welfare Monitoring Surveys Undertaken so far exhibits a sharp rise in gross school
enrollment that considerably confirm the decline of illiteracy rate in the country. The
current literacy rate of Ethiopia is said to be 42.7% in the year 2009
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(Source: wikipedia, the free encyclopedia).

3 Infant Mortality Rate: Like in many developing countries, IMR in Ethiopia has been
high. The UNDP 1997 census reveal that Ethiopia’s infant mortality rate was 111/000
which even above the average of subsharan countries (97/1000). The recent development
strategies adopted to achieve growth and sustained development, has target to lower down
the IMR to 47/1000 with in the coming five years.

4 Expected life expectancy: the life expectancy of any country is the reflection of varied
social, economic, psychological and other factors. In most developing countries life
expectancy does not exceed 55 years. Likewise, in Ethiopia, it was 43 about ten years ago
due to the prevalence of HIV impacts. The recent strategies adopted both in the primary
health care services and supply of HIV/AIDS medicines extensively, the expected life
expectancy in Ethiopia has reached to 55.8 years in 2009/10.

5 Population growth rates: Rapid population growth with an average rate per annum has
been one of the many threats to Ethiopia’s development pace. Estimates or surveys reveal
that 38,000 people are added to the population each week incurring high costs of
providing additional services. Addressing this issue GTP the continuation of PASDEP
has designed to slow the rapid population growth by applying spacing of births through
health service institutions and extension package services

6 Percentage of population with access to clean water: for many decades lack of access to
clean water has been our people’s serious problem. Most illness caused both in urban and
rural areas are related to unsafe water.

7 Based on the surveys made by a welfare monitoring organization, a greater proportion

of rural population had been very far away from sources of drinkable water. Mothers and
daughters were travelling long distances to fetch for water.

8 Level of infrastructural development: This indicator of development includes a vaguely

of elements that promote the living standard of people. In our context; we here by examine
the road networks, electric power supply, rehabilitation/ resettlement of pastoralists,
access to health services and strengthen the urban-rural link.

3.1.Production and Capital Formation

Ethiopia is becoming one of the prime destinations for foreign investment. The country is
attracting investors with tax incentives, low-cost labour, strategic location for trade, and

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improved transport infrastructure.

In recent years, the Government of Ethiopia has made considerable effort to improve the
country’s business and investment climate through the issuance of targeted legislative
measures. The revised Investment Code of 1996, as well as the Investment Proclamation,
provide incentives for development-related investments and have gradually removed most of
the sectorial restrictions on investment. Furthermore, the 2012 amendment to Ethiopia’s
Investment Proclamation introduced provisions for the establishment of industrial development
zones, both state-run and private, with favourable investment, tax and infrastructure incentives.
Other measures include the revision of regulations for potential investors, standardization of
appropriate accounting practices (to more accurately assess tax and other operating liabilities),
increased protection for shareholders, provisions for bankruptcy filings, and the modernization
of trade and registration processes.

These measures have paved the way for increased foreign direct investment (FDI) flows to the
country. Ethiopia ranked as the third largest FDI recipient in Africa in 2013, a 240 percent
increase from 2012 (UNCTAD, 2015). The country also registered a significant increase in
FDI stock – the amount of investment from abroad held within the economy. FDI inflows
reached USD 1.2 billion in 2014, up from USD 279 million in 2012. As a share of GDP, FDI
raised from 0.4 percent in 2008 to 2 percent in 2013.

The sectors that have attracted the most FDI are floriculture, horticulture, textiles and leather.
Recently, commercial farming has attracted Indian, Saudi, European, and U.S. investors.

The private sector and foreign investors are playing an increasingly important role in the
economy. The country has comparative advantages in agriculture, agro-processing, leather and
leather products, and textiles and garments.

3.2.Poverty

Poverty is reflected in low GNP per capita. It is not relative poverty but absolute poverty that
is more important in assessing poverty. Absolute poverty is a state of poverty where an
individual’s daily income is below one dollar. Absolute -poverty is measured not only by low
income but also by malnutrition, poor health, clothing, shelter, and lack of education. Thus,
absolute poverty is reflected in low living standards of the people.

In the mid 1980s, the poverty situation in Ethiopia was among the worst in the world. It has
been documented that about 50% of the population in the country cannot afford the minimum
food requirement. For instance, 52% of the rural and 36% of the urban population were unable
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to meet the minimum food requirement. This means that food poverty in rural areas was higher
than in the urban ones. On top of this, 47% of the rural population and 33% of the urban
population were found to be in absolute poverty.

However, poverty in Ethiopia has declined at an annual average of 1.94% since 1995. The
population share of persons living below the national poverty line fell from a baseline of 48%
in 1990 to 45.5% in 1996 and 29.6% in 2011, and is estimated to have further declined to 23.4%
in 2015, which is below the MDG target of 24%. The sharp decline in poverty is attributable
to the implementation of welfare programmes such as the Productive Safety Net Programme
(PSNP), other food-security programmes as well as of urban food-distribution and subsidies.
In 2015, Ethiopia was facing drought due to the effects of El Niño, and 10.2 million persons
were in need of emergency aid into 2016.

3.3.Infrastructure

In recent years, Ethiopia has made significant progress in infrastructure development. Public
investment rose from about 5 percent in the early 1990s to 18.6 percent of gross domestic
product (GDP) in 2011, making it the third highest in the world (Moller and Konstantin, 2015).
Its infrastructure indicators compare relatively well with other low-income countries. In an
analysis of 124 countries over four decades, Ethiopia ranked among the fastest 20 percent in
terms of infrastructure growth (World Bank, 2015).

Railways: Railway infrastructure development was one of the priority programmes of the first
Growth and Transformation Plan (GTP I) and the Addis Ababa Djibouti corridor was given
priority. A new 756 km electrified railway route eastward to Djibouti is being constructed, the
shortest distance from Addis Ababa to a seaport; it is expected to transport 11.2 million metric
tons of freight in 2016. Contracts were also awarded to start the construction of Mekele-Hara
Gebeya (Woldya) (268 km) and Hara-Gebeya-Semera Assayita (229 km) railway projects.
Construction has already begun for the Awash-Kombolcha-Hara Gbeya (Woldiya). Ethiopia is
also actively developing a rail industry to serve the broader region including South Sudan,
Somalia (Punt land) and northern Kenya.

In order to improve accessibility to the Djibouti port, the Government of Ethiopia (GoE)
initiated the construction of a 5,000 km railway to connect the port with major Ethiopian cities.

The construction of a 34 km Addis Ababa Light Rail Transit project is complete and operations
started in 2015. Railways will increase integration within the country and within the region.

Roads: As a land-locked country, Ethiopia is highly dependent on road transport for the
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movement of passengers and freight. The Government has prioritized improving the road
network and dedicated more than 5 percent of GDP to road investments, one of the highest
shares in Africa. As a result, the road network increased from 48,800 km in 2009/10 to 60,466
km in 2013/14. Under the Universal Rural Road Access Program, 39,070 km of all-weather
district roads were constructed. As a result, the proportion of Kebeles (lowest administrative
unit) connected by all-weather roads increased from 39 percent in 2009/10 to 68 per cent in
2013/14. At the same time, road density increased from 44.5 km/1000 km2 to 90.5 km/1000
km2 in the same year. Thus, the average time to reach the nearest all-weather road was reduced
from 3.7 hours in 2009/10 to 1.8 hours by 2013/14 (National Planning Commission, 2015).

Air transport: Ethiopia is a regional leader in air transport. Ethiopian Airlines is one of the
three main sub-Saharan African airlines and Bole International Airport serves as a regional air
transport hub for passenger and commodity transport. Ethiopian Airlines is the largest airline
group in Africa, with an active fleet of almost 80 aircraft and a network of 92 international and
19 domestic destinations.

It is the largest African carrier with revenue topping USD 2.3 billion in 2013, according to the
airlines ranking of the International Air Transport Association (Ethiopian Airlines, 2014).

Sea transport: The Government has established the Ethiopian Shipping and Logistics
Enterprise to ensure efficient, cost effective and reliable import and export movement of cargo
to and from the seaports of neighboring countries. The enterprise is currently operating two dry
ports, which are located at Modjo and Semera, 73 kms and 588 kms from Addis Ababa,
respectively. The enterprise is also operating another four sub-terminals, which are located at
Dire Dawa, Mekele, Kombolcha and Gelean, 515 kms, 783 kms, 376 kms, and 34 kms from
Addis Ababa, respectively.

Addis Ababa is linked by road and railway lines to the Port of Djibouti (910 kms) at the Gulf
of Aden. The ports of Barbara (964 kms) in Somaliland and Port Sudan (1881 kms) in Sudan
are other external trade routes that provide services for export-import trades between the
countries. Another potential port accessible to Ethiopia (in the south) is Port Mombasa in
Kenya (2077 kms).

Ethiopian Shipping Lines (ESL) also provides a sea transport service using its own fleet. The
main focus of the shipping sector of ESL is to provide coastal and international marine transport
services to and from Djibouti Port, through the Ports of Indonesia, Japan, Republic of China,
Republic of Korea, Singapore and South Africa.

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Telecommunication: Telecommunication is another area that has seen major investment

aimed at improving service quality, expanding service coverage and enhancing institutional
capacity. The number of subscribers in the overall telecom services increased from 7.7 million
in 2009/10 to 29.63 million in 2013/14. The number of mobile subscribers increased from 6.25
million in 2009/10 to 28.3 million in 2013/14. Similarly, the percentage of the rural population
with access (within a 5 km radius) to telephone services increased from 62.1 percent in 2009/10
to 96 per cent in 2013/14.

Energy supply: Ethiopia has also invested significantly in the development of its energy
sector. Large investment projects were initiated to support on-going efforts to ensure
sustainable development. The Great Renaissance Hydro Electric Power Project (6000MW),
Gilgel-gibe III (1,870MW) and Genale-Dawa III (254MW) and other wind power projects
(Adama and Ashegoda), were distinctive features of the first GTP. The projects are all well in
progress. Wind power projects, Ashegoda and Adama No. I and II have already begun
generating electricity.

3.4.Unemployment and Underemployment

The labour force is one of Ethiopia’s competitive advantages. The country has an abundant
young and easy-to-train labour force. In 2014, Ethiopia’s workforce amounted to 47 million,
with around a million people added to the labour force every year.

Unemployment is said to occur when a person actively seeking for jobs and could not find it.
It is the amount of labor, which is unused. Most of the time we can see unemployment when
the economy fails to perform adequate and well-paying job opportunity for the existing labor
force.

The overall economic performance of the country is depending up on job opportunity that every
individual may have. In Ethiopia, there is an open unemployment and it is becoming the major
problem. Unemployment rate is higher in urban areas compared to the rural areas and among
women compared to men.

Unemployment in Ethiopia seems to be urban phenomena. In cities, the majority of the

unemployed are young people with modest level of formal education.

Causes for unemployment:

➢ rural to urban migration

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➢ absence of sufficient employment opportunities

➢ Fast population growth and stagnant economic performance
➢ Poor educational system of the country
➢ The issue of promoting productive education along with sustained private sector
investment is believed to be crucial in reducing urban youth unemployment.

In general, according to CSA (2000, 2006, 2014), there is a decline in the national rate of
unemployment from 8.2 percent in 1999 to 5.4 percent in 2013. Over the same period, urban
unemployment is noted to drop from 26.1 to 21.0 percent.

4. IMPORT AND EXPORT PERFORMANCE IN ETHIOPIA

People buy hundreds of items, such as food, clothing, transport services, health services, etc.
Other people sell these items. This process of buying and selling is called trade. Trade can be
of two types. These are domestic and international trade. Domestic trade involves the exchange
of goods and services among citizens in a country, whereas international trade is the exchange
of goods and services among the citizens of independent or sovereign nations.

International trade allows a country to specialize and export those goods and services that it
can produce at relatively low cost and import those goods and services whose domestic
production is relatively costly. This happens on the basis of the principles of absolute advantage
and comparative advantage. As a consequence, international trade enables a country to
consume and produce more than would be possible without trade. In other words, international
trade enlarges the consumption choice of people by allowing them to consume those goods
which they cannot produce.

The foreign trade policy of the Derg had four major objectives.

o Mobilizing government revenue by imposing taxes on imports and exports,

o Protecting domestic economy participants from foreign competition,
o Maintaining a favorable balance of payments at a sustainable level, and
o The gradual prevention of the private sector from foreign trade participation.

Consistent with the last objective, the government discouraged private importers and exporters
from exporting traditional export items, such as coffee, pulses, oil seeds, and the like. Public
enterprises were established to run such activities. During this regime: exporters were not
allowed to export commodities at prices less than the reference prices provided by the

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government; exporters were also forced to surrender 100 percent of the foreign exchange they
obtained to the government; there was a restrictive foreign exchange licensing system for
private use; the exchange rate was fixed at Birr 2.07 for a dollar for quite a long period of time;
and the government provided marketing channels for all imports and major exports of the
country.

However, after the overthrow of the Derg, the TGE started taking a number of foreign trade
policy measures in 1992. The government changed the fixed exchange rate regime to that of a
managed floating exchange rate regime (that is, a rate determined by the market).

The other main external trade reform measure was the suspension of taxes and duties levied on
exports, except on coffee. It was introduced in January 1993. But the tax on coffee was also
removed after the recent historic coffee price decline in order to reduce the adverse effects of
this price decline on coffee growers and other citizens participating in the coffee market. This
tax removal on export of all commodities together with the devaluation provides a strong
incentive to exporters because it allows them to receive the equivalent of world prices for
exports. Government subsidies to exporters were also terminated when export taxes were lifted.

Complementary to this measure, the government introduced an export duty drawback scheme
in August 1993 to further encourage investment in the production of exportable item. There
were two versions in this incentive scheme.

i. The first was the duty draw-back scheme. It provided persons or enterprises that
were wholly, partially, or occasionally engaged in exporting their products, refunds
of the duty paid on raw materials (whether imported or locally produced) used in
the production of the exportable item.
ii. The second version of the scheme is known as the duty-free importation scheme.
This scheme authorizes organizations and persons wholly engaged in supplying
their products to foreign markets to import or locally purchase raw materials they
use in production of such commodities free of duty.

Furthermore, within the framework of promoting exports, other complementary measures such
as simplifying procedure for getting licences for coffee exporters were undertaken.

With respect to import trade liberalization, the government has been introducing policies step-
by-step or gradually. For example, maximum import duties were lowered from 280 percent to
80 percent during the first move of import liberalization and then to 50 percent; and the system
of granting import licenses and permits were simplified.

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In line with the government’s policy to build a market-based economy, the external sector has
also benefited from the abolition of monopolistic operations of public enterprises, which used
to dominate the export and import sector alike. Since then, the private sector has been
encouraged (including by the simplification of entry to market) to participate in the external
sector.

4.1.Export Performance

Because Ethiopia’s economy is underdeveloped heavily depends on agriculture, the structure

of Ethiopia’s exports is dominated by agricultural products, which alone accounted for more
than 90% of the export proceeds of the country. Among the agricultural products, coffee
accounted for the lion’s share — about 70% — of agricultural exports and for 60% of total
export earnings. Hides and skins and chat distantly follow second and third and they account,
on average, for 12% and 7% of total exports, respectively.

Coffee was the dominant export item as far back as the 1960s, constituting, on average, 55-
60% of total exports. From 1994/95 – 1996/97, coffee alone accounted for 66% of total exports
on average. Hides and skins were the second most important export items, and they showed a
general trend of improvement until their share peaked at 21% of total exports in 1991/92. From
this year onwards, the available evidence indicates that hides and skins (as a proportion of total
exports) exhibited consistently declining trends. Pulses and oil seed were important export
items of Ethiopia.

When we look at the 2008/09 figures, we find that the same commodities dominated in the
export activities of Ethiopia, as in the 1990’s but with different shares. For instance, in 2008/09,
coffee contributed only 26% of the total value of exports. This was due to a very large decline
both in the price of coffee and in the volume of export, which resulted from the huge increase
in the supply of coffee in the international coffee market offered by some new and old suppliers.
However, coffee was the single most important contributor to the foreign exchange earnings of
Ethiopia in 2008/09. The second and the third places were occupied by oil seeds and chat, with
24.6% and 9.6% shares, respectively (see Table 8).

Table 8: Value of Exports, by Major Commodity Group (in millions of USD)

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* Previously known as hides and skin

Source: NBE, 2008/09

The dominance of agricultural commodities makes the country’s external sector susceptible to
adverse shocks that affect both the agricultural and the industrial sectors. The shock
experienced in the beginning of the 21st century by coffee- exporting countries is good evidence
for this. Also the shock that hit the oil market is recent evidence of the problem of dependence
on the export of primary products.

Export Earnings: The performance of the export sub-sector during the 1980’s was
characterized by stagnation with some sporadic erratic fluctuations. During the late 1980’s and
early 1980’s, however, a clear trend of decline in export earnings was observed. Export
earnings during this period declined so drastically that they financed only 17 % of imports in
1991/92. In absolute terms, export earnings declined from USD 443.6 million in 1988/89 to
USD 154.2 million in 1991/92.

The introduction of the reform measures in 1992 seemed to have a positive impact on export
performance. Export earnings showed continuous revival in the years following the reform,
reaching a level of USD 453.6 million in 1994/95, restoring export earning and the capacity of
financing imports back to the 1988/89 level, 43 %. It was documented that a considerable

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growth in export earnings was occurred in 1994/95, mainly due to windfall gains from an
increase in the world price for coffee. A marginal decline in export earnings was observed in
1995/96, which was mainly attributed to the decline of world coffee prices in that year. Export
earnings, on average, showed an increasing trend during the post-reform period. For instance,
total export earnings increased from Birr 923.8 million in 1985/86 to Birr 3,511.6 million in
1998/99. Moreover, non-coffee earnings accounted for 34.5 % of the total export earnings,
while coffee accounted for the remaining earning’s during the post-reform period.

In the year 2003, export earnings were Birr 4,470.9 million indicating a close to 27% increase
from its level in 1998/99. But they could finance only around 19.4% of the import bills in 2003.
Total merchandise exports reached USD 1.45 billion in 2008/09, about 1.2 % lower than the
previous year’s exports. Earnings from coffee, pulses, leather products, and fruits and
vegetables tended to falter. Export receipts from coffee declined by 28.3% as a result of lower
volume and international price. The volume of coffee exports went down to 21.5% due to
problems associated with the domestic trading system, to lower demand in the international
market following the global economic recession, and to the import ban by Japan, the second
largest buyer of Ethiopian coffee. Consequently, the share of coffee in total exports fell to 26%
from 35.8% a year earlier.

Similarly, export revenue from pulses dropped to 36.8% because of the 40.8% fall in the
volume of exports, despite a 6.7% increase in international prices. Thus, the share of pulses in
total exports shrank from 9.8% to 6.3% during the period under consideration.

The global economic downturn worsened. Export earnings from leather and leather products
fell to 24.1% as the volume of exports went down by 51% in spite of a significant rise in
international prices. On the other hand, export earnings from oil seeds, the second largest export
item, increased by 62.8% due to 88.7% surge in volume, offsetting the 13.7% decline in
international price.

Public versus Private Exports

The private sector development initiative that began to thrive during the Imperial Regime was
thwarted with the advent of the totalitarian moves of the Derg. Private-sector participation in
the export sector was marginalized, and government enterprises took the dominant role. For
instance, the share of the private sector in total export earnings never exceeded 16 percent.

Following the introduction of the economic reform program, which encouraged a market-
oriented system through reducing the role of the state in the economy and encouraging private-

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sector participation, the share of the private sector in export marketing grew continuously,
increasing from 16% in 1990/91 to 48.2% in 1994/95, and then to 63% in 1996/97. This trend
continued in 1997/98 when private exporters produced about 80 percent of the country’s
exports.

The general improvement in private-sector participation in the export sector was not
accompanied by either a significant increase in the volume or in the diversification of export
products. Just as in the case of overall export, the composition of private-sector exports is
dominated by coffee, oil seeds, pulses, and chat, which altogether accounted for 85% of the
private sector’s annual export earnings. Coffee dominates the private sector’s export earnings,
accounting for 55% of the total revenue from exports.

Table 9: Annual Foreign Exchange Earnings from Merchandise Export

Source: MEDaC, 1999

The major route of Ethiopia’s external trade is towards Europe, followed by Asia. According
to NBE, 2009, during 2008/09, Europe remained the largest market for Ethiopia’s exports,
accounting for 41.7% of the country’s total exports. Among the European countries, Germany,
which mainly imported coffee and flowers, was the largest buyer of Ethiopian goods. The
Netherlands, the main destination for Ethiopian flower exports during the review period, was
the second biggest market in Europe, followed by Switzerland, the sole importer of gold from
Ethiopia. Italy, whose main imports included leather and leather products, coffee, and textiles
and garments, held the fourth place. Exports to the Asian market accounted for 35.6%, of which
35.3% went to China, 21.6% to Saudi Arabia, 11.2% to the United Arab Emirates (UAE), and
7.8% to Israel. The major export items to China included oilseeds, leather, and leather products.
Meat and meat products, coffee, live animals, and oilseeds constituted the bulk of exports to
Saudi Arabia, while meat and meat products, pulses, and live animals were the major items
exported to the UAE. Israel mainly imported oilseeds from Ethiopia.

When we consider export destinations by country over the years, some fluctuations have been
witnessed. For instance, 16.6% of Ethiopia’s exports went to African countries, of which about

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88.6% went to three neighboring countries: Somalia, the Sudan, and Djibouti. Chat was the
principal export item to Somalia, followed by live animals. The major exports to Djibouti
include chat, pulses, fruits, and vegetables. The Sudan mainly imported coffee, pulses, live
animals, and spices. The share of the Americas in total exports was 5.7%, of which 73% was
to the United States of America, 9.8% to Canada and 1.6% to Mexico. The main export items
to the US were coffee and oilseeds.

Ethiopia’s export performance has not only declined overtime, its position compared to the
SSA countries has been very low. As figure below depicts over the last decade Ethiopia’s
export of goods and services averaged nearly 12 percent of GDP, while the average for SSA
countries was 28 percent.

Source: IMF: Regional Economic Outlook: SSA Restarting the Growth Engine: April 20017

Among the export commodities the performance of gold significantly accounted both for the
positive and negative developments over the last decade. Its enhanced performance contributed
for the noticeable overall export growth (38 percent) in 2010/11. As could be recalled in 2011
gold price hit the highest price in the global market. While its price decelerated and reached at
very low in 2016. Accordingly, it has become the major source of ups and downs in the overall
export performance of the country

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Annual Growth and Value of Major Commodity Export (percent)

Source: National Bank Ethiopia of and staff computation, 2017

Yet the structure of exports hardly changed over the last two decades and the country’s export
earnings still depend on few agricultural commodities (Table 6.4.2). Though, diversification is
still lacking, a shift within the major commodity categories has been evident. Ethiopia’s
traditional export item coffee represented about 60 percent of the total export item in the 1990s.
Its share decelerated to an average of 45 percent in 2000/01 and further to 22 percent in
2013/14. The share of the top five exports (coffee, leather & leather products, oil seeds, pulses
and chat) declined on average from about 87 percent during 1990/91-2000/01 to 65 percent
during 20011/12- 2016/17. This indicates the emergence of new export items such as gold,
flowers, and textiles in recent years. However, although the share of coffee declined over time
from its high of the earlier years, its position has stabilised about a quarter of the overall export
earnings and even rising in late years. This has a message that the structural shift has not
sustained and the performance of the modern sector (manufacturing products) role in the export
market is not yet realized.

Share of major export items in total export (percent)

Source: National Bank of Ethiopia

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4.2.Imports in Ethiopia

In the second half of the 1980’s, Ethiopian imports had stabilized at around USD 1 billion,
except for slight declines to USD 874.8 million and USD 915 million in 1991/92 and 1993/94,
respectively. The level of imports remained more or less stable within the same order of
magnitude until 1994/95. A growth in imports, however, was registered in 1995/96, when
imports increased to USD 1.4 billion, showing a nominal growth of 32.9% over the previous
year. The preliminary estimates for 1996/97 and 1997/98 indicated that imports stabilized
within the ranges of the 1995/96 level. Imports were estimated at USD 1.4 billion for 1996/97
and at USD 1.45 billion for 1997/98. As a share of GDP, imports consistently increased from
8.7% in 1991/92 to 23% in 1995/96 but slightly declined to 20% in 1996/97.

As indicated in Table 10, in 2009, the value of imports was about Birr 9 billion, which was 5.1
times more than exports for the year. The annual average growth rate for the Reform Period far
exceeded the performance during the 1980’s. The construction and rehabilitation efforts
following the initiation of the reform and the balance-of-payment support from external
financiers enhanced the growth of imports.

Ethiopian imports are usually classified into five major categories, based on their final use: raw
materials, semi-finished goods, fuel, and capital and consumer goods. The data for the period
1991/92 to 1996/97 shows that imports of capital goods were dominant throughout the period
except for the years 1993/94 and 1994/95, when imports of consumer goods accounted for a
slightly larger share. The third import category was the import of fuel until 1993/94, when it
overtaken by expanding imports of semi-finished goods. The share of imports of raw materials
was quite insignificant and stood at 2% of total imports during the whole period.

As indicated in Table 10, total imports went up to USD 7.7 billion in 2008/09 from USD 6.8
billion in 2007/08. The ratio of imports to GDP, however, declined to 24.5% in 2008/09 from
26.4% in 2007/08.

Some of the categories of imports by end use are so broad that a detailed analysis is required
for a better understanding of the subject under consideration. Beginning with imports of raw
materials, they were 37.4% in 2008/09, presumably indicating the increased level of industrial
economic activities as reflected in the growing share of raw materials in total imports from
3.8% in 2007/08 to 4.6% in 2008/09. Imports of capital goods also went up — by 29.7% over
2007/08, reaching USD 2.5 billion due to booming investment activities in the country. Hence,
the share of capital goods in total exports rose from 28% to 32% in 2008/09.

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Similarly, imports of consumer goods increased by 54.7% as a result of higher imports of both
durable and non-durable consumer goods. The rise in nondurable consumer goods was due to
increased imports of cereals, and of medical and pharmaceutical products. Consequently, the
share of consumer goods in total imports in the same year (2008/09) grew to 30.3% percent,
compared to 22.3% in 2007/08. Meanwhile, Ethiopia’s fuel-import bill declined by 22.5% to
USD 1.26 billion, mainly because of the drop in international oil prices, offsetting a 3.5%
increase in the volume of oil imports. Accordingly, the share of fuel in Ethiopia’s total import
bill fell from 23.8% 2007/08 to 16.3% in 2008/09.

Table 10: Imports, by Use (In Millions of USD)

Source: NBE, 2008/09

According to NBE, 2009, as to the origin of imports, Asia remained the largest supplier to
Ethiopia, with a share of 64.7%, followed by Europe (24.8%), America (6.5%), and Africa
(3.9%). Out of the total imports from Asia, about 71% originated from countries, namely China
(26.2%), Saudi Arabia (25.0%), India (10.8%), and the UAE (9.0%). The major import items
from China included clothing and textiles, metals, telecommunication apparatus, vehicles,
electric materials, and machinery. More than 70% of the imports from Saudi Arabia and 60%
from the UAE were petroleum products. Metal and metal manufacturing goods constituted the
bulk of imports from India. Regarding imports from Europe, Italy accounted for 24.5%, Russia
9.3%, and Turkey 8.9%. Machinery, metal, and grain were the main import items from Europe.

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About 76.8% of imports from African countries originated from three countries: Egypt
(29.2%), the Sudan (28.1%), and South Africa (19.5%). The Sudan’s major export to Ethiopia
was petroleum products. Imports from the Americas accounted for 6.5% of the total imports,
of which 97.5% was from three countries – the USA, Brazil, and Canada.

Despite low export performance the share of imports of Goods and Services averaged 30
percent of GDP between 2008/09-2016/17 which is comparable to average of SSA countries.
Figure: Ethiopia and SSA imports of Goods and Services in percent of GDP

Source: IMF Regional Economic Outlook

The structure of imported items is dominantly capital goods, raw materials, semi-finished
goods, fertilizer and fuel which accounted on the average about 70 percent for the last 8 years;
compared to 30 percent of consumer goods as the following table. Fuel imports increased from
17.7 percent in 2001/02 to 19.4 percent of total imports in 2011/12, although its share has been
relatively low in recent years owing to the lower international oil price.

Structure of Imports by End-use (percent)

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4.3.Balance Of Payment In Ethiopia

Trade balance: refers to the difference between the export and import of goods and services.
If the difference is positive, it is called a trade surplus, and if it is negative it is called a trade
deficit. A chronic trade deficit has remained the dominant feature of Ethiopia’s external trade
in merchandise in the past two decades or so. With relatively small but significantly expanding
exports and sizable imports, the trade deficit is generally widened between 1991/92 and
1997/98. A clear trend of decline in the trade deficit existed in the period 1991/92-1994/95.
However, the trade deficit has been in a general state of expansion since 1995/96, owing to the
increase in imports which was much faster than exports. In 2008/09, for instance, the trade
deficit was estimated at USD 6.27 billion.

While the export performance declined over the years, the trade deficit widened as import
continued to rise. Moreover compared to the SSA countries performance Ethiopia’s trade
balance on goods is more pronounced as observed in figure below

Figure: Ethiopia’s Trade Balance (percent of GDP)

Source: IMF: Regional Economic Outlook: SSA Restarting the Growth Engine: April 20017

Obviously poor performance of export value which is not commensurate with an increased
import value results in availing insignificant level of hard currency. As a result the share of
exports earnings in financing imports exhibits a declining trend over years. The only highest
ratio registered was 34.3 percent in 2010/11, whereas it declined to nearly 17 percent in
2015/16.

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Figure: Export Capacity in Financing Imports (percent)

Source: National Bank of Ethiopia: 2015/16 Annual Report

Current Account Balance: The current account records all exports and imports of goods and
services and unilateral transfers. It is the combination of the trade account, the service account,
and the transfer account.

As indicated in Table 11, between 1992/93 and 2008/09, the services account was the only
component of foreign trade in Ethiopia that usually registered a positive balance of payments.
Net services stood at USD 23.1 million in 1992/93. They subsequently declined and stood at
USD 10.9 million in 1993/94. In later years they showed an overall substantial increase. The
increase came particularly from the improvement of earnings from other services (particularly
transport-service earnings), on the one hand, and from the decline in the net interest payment,
on the other hand.

The successive decline in Ethiopia’s net interest payment to the rest of the world is a result of
two factors: the decline in the interest payments on external debt, which is attributed to the
effects of debt cancellation and rescheduling and the interest received on our foreign reserves
in foreign banks and to the rise in interest earned on foreign securities since 1994/95.

Despite substantial private transfer inflow and a small but increasing net receipt from services,
the current account balance continued to experience deficit during the years spanning 1992/93

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to 2008/09. The balance of payments for the beginning of the post- reform period is
summarized by Table 11.

Table 11: Balance of Payment (in millions of USD)

Source: National Bank of Ethiopia, several reports

The Capital Account Balance: Unlike the current account, the capital account covers
transactions in financial assets and liabilities. It is different from the current account
transactions in that it necessarily involves domestic residents either acquiring or surrendering
claims on foreign residents. Hence, it deals with changes in the level of claims on foreign
residents.

Ethiopia’s surplus in the capital account significantly rose by 57.7%, to reach USD 1.66 billion,
by the year 2008/09, reflecting higher official long-term capital inflows and a modest increase
in estimated inflow of foreign direct investment. Net official long-term capital increased 123.7
% to USD 739.3 million as disbursement of loans was 107.1% up and amortization payments
10% down during the same period.

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Table 12: Balance of Payments

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National Debt Service and Performance: National debt is an accumulation of annual loans
entered between the Ethiopian government and creditor nations and lending institutions.
National debt can be domestic or external or both.

Domestic debt is the accumulation of annual loans that the government borrows from domestic
financial institutions, whereas external debt refers to the accumulation of annual loans that the
government borrows from international financial markets. Domestic debt is the amount of
public sector borrowing from different banks and other financial institutions in the country.
This might have a crowding out effect (a reduction in private sector borrowing and spending
caused by increased government borrowing) when looking into the predomination of the public
sector within the financial market and reducing the real credit to the private sector. When deficit
persists and is financed by domestic borrowing, the servicing capacity of the public sector will
eventually be questionable. The origin of external debt could be traced to the willingness of the
debtor countries to borrow and the lenders to lend. National debt service is simply the amount
of foreign exchange required to repay the debt and the interest on the debt.

It has been indicated that foreign borrowing allows a country to invest and consume beyond
the limit of current domestic production. However, inappropriate and excessive foreign
borrowing will generate debt service obligation that will constrain future economic policy and
growth. The debt servicing burden is simply the amount of foreign exchange required to pay
the external debt and the interest on the debt, which shows an upward trend over time.

The external debt profile of Ethiopia showed remarkable changes in its magnitude in the period
between 1991/02 and 2008/09 as shown in Table 13.

Table 13: Stock of External Debt (in million USD)

Source: NBE

As indicated in Table 13, the size of external debt grew until 1998/99, thus imposing a higher
debt service ratio (the ratio of principal and interest payment on external debt that it had to

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export goods and non-factor services) that was beyond the service capacity of the country. The
available documents indicate that the size of external debt was USD 371 million in 1974/75
and that it had increased to USD 10.2 billion by the end of 1998. However, following the huge
discount made by the Russian Federation, the total debt stock of the country was reduced by
half and stood at USD 5.45 billion at the end of 1999. By the end of 2008/09, Ethiopia’s stock
of external debt reached USD 3.3 billion, 20% higher than the previous year.

Table 14: Indicators of Debt Burden

Source: EEA, 1999; NBE, 2008/09

As shown in Table 14, between 2005 and 2008/09, external debt as a proportion of GDP
declined from 12.3% to 10.5%. The ratio of the stock of debt to export of goods and non-factor
services, however, showed no significant change over the last year. Debt owed to multilateral
creditors constituted 61.4% of the total debt, and increase by 32.5%. Similarly, debt owed to
bilateral creditors rose 7.8% and accounted for 30.9% of the total debt. On the other hand,
commercial debt, which accounted for just 7.7% of the total debt, showed a 7.6% decline. The
debt service ratio fell from 2.5% in 2007/08 to 1.4% in 2008/09 as a result of lower debt service
payments.

However, the debt burden did not exhibit a decline. This was mainly because export earnings
were less than what the country paid for imports, which created debt accumulation. As
indicated earlier, export earnings were much lower than import bills, producing a huge deficit
in the current account balance and creating a balance-of-payments problem for the country.

Thus, debt accumulation and repayment retards economic growth. In other words, our
economic growth would have been higher had it not been for the draining of foreign exchange
to service the debt.

4.4. Exchange Rate

The exchange rate can be defined as the amount of domestic currency (let’s say Birr) that must
be paid per unit of foreign currency (may be US$).

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Ethiopia had been following fixed exchange rate regime during both the Imperial period and
the Derg period. During the Derg regime, the government restricted foreign exchange licensing
system for private use. The exchange rate was fixed at Birr 2.07 for a dollar for quite a long
period of time.

However, after the overthrow of the Derg, in 1992, the TGE changed the fixed exchange rate
regime to that of a managed floating exchange rate regime (that is, a rate determined by the
market), and introduced a bi-weekly foreign exchange auction market in May 1993.

Currently, this auction system is changed on a daily basis. The marginal rate (the market
clearing rate) established at the auction used to be used as a secondary rate applicable to all
current and capital account transactions until the next auction, with the exception of a limited
number of payments for which the foregoing exchange rate was made available at the official
rate. However, the two rates were unified on July 25, 1995, and a weekly foreign exchange
auction was introduced a year later.

In August 1998, the government replaced the retail auction market with wholesale auctioning
in which commercial banks, the foreign exchange bureau, and investors in need of large
amounts of foreign exchange (above USD 500,000 per auction) could participate. An inter-
bank market for foreign exchange has also been introduced and is still practiced.

5. PUBLIC FINANCE AND FINANCIAL SECTORS IN ETHIOPIA

5.1. Public Finance in Ethiopia

Public finance deals with the financial activities of the government such as collection of
taxes from those who benefit from the provision of public goods by the government, and
the use of those tax funds toward production and distribution of the public goods and
social services. Whereas, private finance deals with individual financial activities. Both
Public and private finance are important, as both are the main determinant in the policy
matters of any nations.

The status of public finance in Ethiopia during Derg was directed towards expanding the
public sector. The government adopted special tax increase policies in both direct and
indirect taxes to discourage the private sector. In this period, the rise in government
expenditure on defense, strong involvement of government into the economy, overall
expansion of the public sector, high degree of centralization and mismanagement of
economic resources have led to considerable increase in government expenditure.

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After the fall of the Derg, EPRDF has been forced to take different measures. Most of
these measures focused on the revenue and expenditure reform which increase
government revenue and reduce government expenditure. The measures taken helped to
remove the budget deficit.

Fiscal policy is a policy of government that guides the revenue and expenditure of a
government. Fiscal policy instruments are tax and expenditure items.

The roles and functions of fiscal policy in the economy can be outlined as:

✓ The allocation of resources into the production of public and private goods.

✓ The distribution of income in order to reduce inequality and poverty.

✓ The promotion of economic growth and the stabilization of the economy by

reducing fluctuation in the level of prices, output and employment.

Sources of government revenue can be classified into tax and non-tax revenue. Though
the revenue sources are numerous, those items which form the bulk of the total revenue
are few. Taxes from wages and salaries, agricultural income tax, rural land-use fees and
business profit tax are the major sources of revenue. According to Ministry of Finance,
2009, government revenue increased from 21,797,100 in 2006/07 to 30,802,400 in
2007/08 and 40,644,000 in 2008/09.

More than 90% of the total government expenditure is absorbed by the following sectors:
general administration (organ of the state, public order and security, and justice); primary
and secondary education (including TVET); public health; agriculture and natural
resources; clean water supply; and rural road construction and maintenance.

Although they appear to have lower shares, the development of micro- and small scale
enterprises and urban development are crucial to addressing urban problems, particularly
unemployment and poverty reduction. As of recently, these areas are getting more
attention in government policy.

Government budget is a financial plan of government revenue and expenditure for a

specific period, usually for one fiscal year. Ethiopia’s fiscal year starts on Hamle 1, and
ends on Sene 30, based on the Ethiopian calendar.

The usual objectives of the government budget include relating expenditure decision to
policies, to current and future resources and to efficiently implement programs.

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Most of the time government budget is divided into two major areas such as, revenue and
expenditure budget. Revenue budget consists of the annual forecast of government budget
from tax, non-tax, external assistance and capital source of revenue.

SOURCE OF GOVERNMENT REVENUE

A. Ordinary revenue

The total of ordinary revenue is made up by tax revenue and non-tax revenue. Tax revenue
is further divided into three parts – direct tax, indirect tax, and foreign trade tax.

A tax is generally defined as a compulsory payment that the citizens of a country have to
make to the government without a quid pro quo, i.e., the taxpayers cannot expect to get
any direct benefit in return for the tax paid by them. Those who are liable to pay tax have
to pay the tax; otherwise they can be prosecuted and penalised by the state.

i Direct tax: The term direct tax means a tax paid directly to the government by the
persons on whom it is imposed. The burden of the tax cannot be shifted onto anybody
else. Examples include income taxes, such as the following. • Personal income tax:
Every person deriving income from employment in any government or other private
organization or non-governmental organization and income from employment including
any payments or gain in cash or in kind which he/she received from employees. •
Business Income Tax: Is a tax imposed on business enterprises, professional or vocational
activity or any other activity recognized as trade pays tax based on their profit. •
Corporate tax: refers to a direct tax levied on the profits made by companies or
associations and often includes capital gains of a company. • An inheritance tax (also
known as an estate tax): is a tax which arises on the death of an individual. It is a tax on
the estate, or total value of the money and property, of a person who has died. • Transfer
tax: a tax on the passing of title of property from one person (or entity) to another. • Tax
on dividends: is an income tax on dividend payments to the stockholders (shareholders)
of a company. • Income from games of chance: Every person deriving income from
winning at games of chance – for example, lotteries, tombolas, and other similar activities,
are subject to tax at the rate of fifteen percent /15%/ except for winnings of less than 100
Birr. • Rental income tax: Rental income is any payment you receive for the use or
occupation of property. • Interest Income on Deposits: Every person deriving income
from interest on deposits shall pay tax at the rate of five percent.

ii Indirect tax: a tax levied indirectly, as one levied on commodities before they reach

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the consumer but ultimately paid by the consumer as part of the market price. Examples
includes sales tax or value added tax (VAT).

Value added tax (VAT): is a sales tax based on the increase in value or price of product
at each stage in its manufacture and distribution and the cost of the tax in added at the
final price and eventually paid by consumer on the purchase price of 15%.

Sales tax: a consumption tax charged at the point of purchase for certain goods and
services. The tax amount is usually calculated by applying a percentage rate to the taxable
price of a sale. Turnover tax (TOT): It is an indirect tax which is similar to a sales tax or
VAT, with the different that (TOT) tax imposed on those who are not register for VAT
which their annual taxable transaction is under the total value of 500,000 birr.
Withholding tax: is a government requirement for the payer of an item of income to
withhold or deduct tax from the payment, and pay that tax to the government.

Stamp duty: is a tax that is levied on documents. This include the majority of legal
documents such as cheques, receipts, marriage licenses and land transactions. A physical
stamp (a tax stamp) had to be attached to or impressed upon the document to denote that
stamp duty had been paid before the document was legally effective.

Excise duties: This tax is imposed on selected goods, such as luxury goods and basic
goods which are demand-inelastic. Tax on gasoline and other fuel and tax on tobacco and
alcohol.

iii Foreign trade tax: It comprises both import and export taxes.

Import tax: An import tax collected on imported goods. Such as a tariff is a tax levied on
imports or exports.

Export tax: An export tax is a tax collected on exported goods.

iv Non-tax source of government revenue: are government revenue not generated from
taxes. These include income of the government by way of sale of goods and services by
various departments of the government. Examples include: • charges and fees • sales of
government goods and service • government investment income • privatization
proceeds

B External Assistanc: Grants received in cash, or some other form, from outside the
country are known as external assistance. These receipts form an important source of
financing the deficit budget of the government and play an active role in economic

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development of the country. External assistance received from friendly countries is called
bilateral assistance; whereas assistance (grant) received from multilateral or international
institutions is known as multilateral assistance. Generally, It comprises of grants, loans
and technical assistance from bilateral or multilateral agencies.

C Capital revenue: It comprises the money received by the government from the sale of
government assets, collection of loans, counterpart fund and external loans.

Government expenditure is divided into two principal headings: recurrent and capital
expenditure. The recurrent budget is mostly financed from domestic revenue sources, i.e.,
from tax and non-tax revenue. Recurrent budget expenditure consists of expenses that
repeated in nature like salaries of civil servants. The capital budget is usually financed by
external loans and grants.

Recurrent Expenditure: Recurrent expenditure represents expenses made by the

government which are recurrent in nature, i.e., they are repeated. Normally, it is an
expense on consumables that facilitate productive activities, for example, salaries of civil
servants, purchase of raw materials, fuels and other factors of production. The recurrent
expenditure is classified in Ethiopia under four functional categories: Administrative and
General Services; Economic Services; Social Services; and Other Expenditures.
Administration and general service are Organ of state, Justice, Defence, Public order,
General service. Economic servise include agriculture and natural resource, trade and
industry, mining and energy, tourism, transportation and communication, construction.
Social service: education and health, culture and sport, labor and social affairs, prevention
and rehabilitation. Others are transfer payment, repayment of public debt, contingency
and pension payments, provision of unforeseen expenses and similar items.

Figure1: Share of sectoral recurrent expenditure from total recurrent expenditure

(percent)

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Source: Ministry of Finance and Economic Cooperation

Among the recurrent expenditure components, the share of social service expenditures
averages 42 percent, followed by general services (37 percent) and economic services (14
percent) over the last decade. Other expenditures largely dominated by external debt
servicing averaged 7 percent of the aggregated recurrent expenditure in the same period.
The trends of recurrent expenditure during the last ten consecutive years have shown
significant shift to the social sector. In 2016/17, expenditure on social services had the
largest share from the total recurrent expenditure (49 percent), compared to 38 percent a
decade ago. The share of administrative and general service on the other hand declined to
30 percent from a high of 40 percent in the same period. Such developments demonstrate
Government’s commitment to expand social services including education and health
services as an important tool in achieving its development target.

Capital Expenditure: Capital expenditure represents expenses made by the government

for the implementation and expansion of development projects. These are in the nature of
acquisitions of fixed assets like buildings, machinery, equipment, etc. Government
expenditures on construction of infrastructure, industries, and research and development
programs are also part of capital expenditure. The capital expenditure is classified in
Ethiopia under three categories: Economic Development; Social Development and
General Development. Economic Development includes production activities in the

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agricultural and industrial sectors and economic infrastructure in mining, roads, energy,
commerce and communication. Social Development includes such activities as education,
health, urban development and social welfare. General Development includes services in
statistics, cartography, and public and administrative buildings. In most developing
countries, recurrent expenditure is mostly financed from domestic revenue sources — that
is, from tax and non-tax revenues, whereas capital expenditure is usually financed by
external borrowing and grants. The annual budget for the Federal Government of Ethiopia
is prepared by the Ministry of Finance and Economic Development (MoFED) and the
budgets for the regional governments by the respective regional finance bureaus.

As it has been discussed earlier in Ethiopia over the last decade, the share of capital
expenditure exceeded that of the recurrent except fiscal year 2016/17 outturn. The overall
Government expenditure in fiscal year 2016/17 amounted to Birr 329.3 billion in 2016/17,
surpassing by Birr 48.4 billion (17.2 percent) and grew by 5.6 percent from the preceding
fiscal year performance. However, the actual execution rate of capital expenditure was
about 86.2 percent of its budget. A number of factors can be cited for low actual
performance of the capital expenditure. Revenue generated during fiscal year 2016/17
was below expectation. Thus to maintain reasonable level of deficit the Government has
to curtail capital expenditures. From total capital expenditure, about 75.9 percent was
financed from treasury sources. Besides, the Government capital expenditure is supposed
to enhances economic growth by encouraging private sector investment attributable
through facilitating role of government in the provision of public infrastructure. In this
case, capital expenditure on economic infrastructure averaged 68 percent over the last
decade. The share of social capital expenditure averaged 25 percent over the same period
(Fig2). It is obvious that Ethiopia has a huge challenge to eliminate poverty and improve
the livelihood of its citizens. This entails designing appropriate polices, investing in social
sectors and building infrastructure as well as creating conducive environment for the
private sector. In this regard, providing emphasis for the rural development and food
security where the majority involves is highly decisive. Provision of basic services and
infrastructure such as education, health, water, and road are equally important in boosting
the living standard of the population. Consequently, government expenditure in financing
such vital basic services and infrastructure building over the last decade substantially
increased, albeit starting from low aggregated expenditure shares in percent of GDP.

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Figure 2: Share of Sectoral Capital Expenditure from total Capital Expenditure

(percent)

According to Ministry of Finance, 2009, the total government recurrent expenditure

shows an increment by 28.8% in 2007/08 and 18.24% in the year 2008/09. As compared
to 2006/07, the total government capital expenditure increased by 31.1% in 2007/08 and
26.9% in 2008/09.

Government Budget

Budget shows the details of the planned expenditures of the government program and the
expected revenues from tax and non-tax sources for a year.

Objectives of a Government Budget The general objectives of a government budget are

the following:

Economic Growth: to promote rapid economic growth so as to improve the living standard
of the people.

Reduction of Poverty and Unemployment: to eradicate mass poverty and unemployment

by creating maximum employment opportunities and providing maximum social benefits

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to the poor. Social welfare is the single most important objective of the government.

Reallocation of Resources: to reallocate resources in line with social and economic

objectives.

Reduction of Inequalities: to reduce inequalities of income and wealth through levying

taxes and granting subsidies. Equitable distribution of wealth and income is emphasized.
Economic progress in itself is not a sufficient goal but the goal, must be equitable
progress.

Price Stability: to maintain price stability and correct business cycles involving
depression characterized by falling output, falling prices, and increasing unemployment.
Management of Public Enterprises: to manage public enterprises which are of the nature
of monopolies like railways, electricity, etc.

Classification of government budget

A government budgetary deficit occurs when governmental expenditure is greater than

government revenue. A deficit budget implies that the government is pumping more
money into the economic system than it is pumping out. When it puts in more money into
the economy, the level of economic activity expands. This will move the economy further
on the growth path. Usually governments of developing economies plan for a deficit
budget. A deficit budget is financed by domestic borrowing, external borrowing, and the
printing of new currency (money printing).. Government budgetary surplus occurs when
government revenue exceeds government expenditure. A surplus budget implies that the
government is pumping out more money from the economic system than what it is
pumping back in. When the government draws money from the economic system, it has
a contractionary effect. The level of economic activity falls. Balanced Budget: If the
receipts of the government equal its expenditures, the government will be said to have a
balanced budget. A balanced budget will have a neutral effect on the level of economic
activity. It will have neither an expansionary effect nor a contractionary effect on the
economy.

According to MoFED, 2009, fiscal deficit has shown a declining trend with a –7.2 percent
of GDP in 2001/02 to –2.9 percent of GDP in 2007/08. The overall fiscal deficit improved
to –2.9 percent of GDP in 2007/08 from –3.6 percent in the previous fiscal year.

5.2.The Finance Sector in Ethiopia

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Monetary/ financial policy refers to the management of the money supply and its link to prices,
interest rates and other economic variables. More generally, monetary policy is a bundle of
actions and regulatory stances taken by the central bank including all of the following:

❖ Setting a minimum interest rate on deposit

❖ Setting reserve requirements on various classes of deposit

❖ Increasing or decreasing commercial bank reserves through open market purchase and
sales of government securities.

❖ Constraining commercial bank financial activities by setting minimum capital

requirement

❖ Intervening in foreign exchange markets to buy and sell domestic currency for foreign
exchanges

❖ Decide the level of total-deposit required reserve of commercial banks

Financial institutions (FIs) such as commercial banks, credit unions, insurance companies, etc.
perform the essential functions of channeling funds from those with surplus funds (suppliers
of funds) to those with shortage of funds (users of funds). Hence, the existence of such kinds
of institutions helps to facilitate domestic saving and investment.

Modern banking in Ethiopia started in 1905 with the establishment of Abyssinian Bank, which
was based on a fifty year agreement with the Anglo-Egyptian National Bank.

National banks are the government authorities in charge of monetary policies. National banks’
actions affect interest rates, the amount of credit available, and the money supply, all of which
have direct impacts not only on financial markets, but also on aggregate output and inflation.
A national bank is a financial institution established to act on behalf of the government to
control and regulate activities of the financial sector. It has different names in different
countries.

The National Bank of Ethiopia (NBE) was established with capital of Birr ten million. It was
owned and operated by the government and managed by a board of directors. The NBE was
restructured by the government with Proclamation No 206/1963 and began its operation in
1964. After the fall of Emperor Haile Sellasie I, it was restructured by Proclamation No
99/1976. The roles and functions of the NBE were redefined again after the downfall of the
Derg in Proclamation No 83-84/1994.

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Currently, the Ethiopian financial sector consists mainly of banks (three public and 16 private),
insurance companies (one public and 15 private) and 31 micro-finance institutions. The
banking system accounts for about 80 percent of total assets of the financial sector and is
dominated by state-owned banks, mainly the Commercial Bank of Ethiopia. Currently, public
banks account for 51.1 percent of bank branches (1,724), 54.6 percent of total capital, 68.4
percent of total deposits and 63.5 percent of outstanding bank loans, although their dominance
is declining with the entry of more private banks, as well as the expansion of existing ones.

The Commercial Bank of Ethiopia is the biggest and the leading commercial bank in Ethiopia.
It had 32.9 % of the banking sector in Ethiopia in 2008/09.

Financial Sector Policies and Reforms in Ethiopia

The Financial Policies during the Imperial Period (pre-1974)

The pre-1974 financial sector policy of the government was in line with the pro-capitalist
economic system, which allows the participation of the private sector in the economy,
particularly in the financial sector. As a result, there were both foreign as well as local private
banks and insurance companies operating in Ethiopia until they were nationalized in 1974.
There was no capital ceiling requirement by the government. However, the monitoring and
regulatory capacity of the National Bank of Ethiopia was limited in the period under discussion.

The Financial Policies of the Derg Period (1974-1991)

This was a regime characterized by absolute government control of major economic activities
in the country. During this period all private banks were nationalized and converted into
institutions organized along socialist principles. It was the duty of the National Bank of
Ethiopia to regulate the activities of these institutions on behalf of the government. As noted
earlier, Commercial Bank of Ethiopia (CBE), Agricultural and Industrial Development Bank
(AIDB) (Development Bank of Ethiopia (DBE)), Housing and Saving Bank (HSB)
(Construction and Business Bank (CBB)) were in operation during this period. In addition to
these banks, there were also two other financial institutions: Ethiopian Insurance Corporation
(EIC) and the Pension and Social Security Authority (PSSA).

The government also attempted to offset its budget deficit by borrowing from the banking
system which constrains the amount of money that goes to the private sector; this reduced the

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participation of the private sector. For instance, the interest on saving deposits made by the
private sector remained at 6% on deposits up to 100,000 Birr and 2% over this amount so as to
discourage “accumulation of capital”. In fact, saving deposits by socialized sectors were not
allowed. Interest rates on time deposits were between a minimum of 4% to 7.5%, depending
on the sources of the funds.

Lending rates were also discriminatory in nature. Cooperatives were the most favoured
customers of banks, followed by public enterprises. The lending rates remained between 9%
and 10.5% for most of the activities in the different sectors of the economy: 8.5% for export
trade, 3-5% to the central government, and 5-6.5% for banks until June 1986. These rates were
revised on July 1, 1986, becoming slightly higher for public enterprises, and were further raised
for the private sectors.

All in all, the financial policy of the Derg favored inefficient public sectors at the expense of
private sectors, and it proved to be a failure for the development of the financial sector. The
attempt of the government to expand the public sector was very much limited due to the
shortage of foreign exchange. This in turn led to borrowing and dependency on foreign
assistance. However, it was difficult to get external financial assistance due to political
ideology differences, and the funds were allocated in non-development areas such as defences,
and military expansion.

The government kept the exchange rate at a low level by establishing a fixed exchange rate
regime. Exchange rate affects the price of both export and import goods. The fixed exchange
rate policy was adopted primarily to prevent the domestic cost of imported goods, especially
that of imported raw materials and inputs. However, the overvalued exchange rate has affected
the growth of the export sector by making the price of exported goods expensive at abroad.

The government also adopted a very restrictive foreign exchange policy in order to reduce
aggregate demand for foreign exchange in the economy. It also introduced a high import tariff.
This restrictive measure, however, led to the smuggling of goods, both imported and exported,
and to the flourishing of a black-market foreign exchange market.

In general, huge government borrowing, restrictive financial policies, and lack of participation
of private sector and inefficient use of financial resources by the public sector were the major
characteristics of the Derg regime. However, relative macroeconomic stability was achieved at
the expense of overall economic growth due to forced measures of saving by the good-
performing public enterprises and non-bank financial institutions, and by the draining of the

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foreign reserve.

The Financial Policies of EPRDF (Post-1991)

Proclamation No. 84/1994, which allowed the private sector (owners have to be Ethiopian
nationals, however) to engage in the banking and insurance businesses, marked the beginning
of a new era in Ethiopia’s financial sector. Following this proclamation the country witnessed
a proliferation of private banking and insurance companies.

The attempt to control inflation, to maintain it at a low level was mainly carried out by adopting
a monetary policy which kept the pace of growth in money supply in line with the growth rate
of the nominal gross domestic product (NGDP). The government has also envisaged ensuring
the availability and expansion of credit to the growing private sector and has made some
adjustments to interest rates. For instance, the government abolished the discriminatory lending
interest rates and fixed minimum deposit and the maximum lending rates since 1994/1995.
However, the government later abolished the ceiling rates, freeing them to be determined by
market forces of demand and supply in January 1998.

Auctioning of securities in the open market was started in January 1994/95 with three types of
treasury bills (TBs) maturing in 28, 91, and 180 days, respectively. This marked the start of the
development of the money and capital market in the country. Besides, such instruments relate
to non-inflationary financing monetary policy which could help to avoid draining the amount
of credit available to the private sector.

The government devalued the Birr in October 1992 and introduced the auction market for
foreign exchange in May 1993 in an attempt to determine the exchange rates by market forces
and to increase exports. Importers, banks and investors participated in the retail market until it
was replaced by the weekly wholesale foreign exchange market in 1999 that only allowed the
participation of banks and investors. This was replaced by the inter-bank foreign exchange
market in 2001 which allows the participation of licensed foreign exchange dealer banks to
determine the daily value of a foreign currency in terms of Ethiopian Birr.

In general, the EPRDF government has taken a number of policy measures to enable the
financial sector to contribute to the development of the economy since 1992. Among these
measures:

➢ The adoption of monetary and banking proclamation that enabled the NBE, the

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licensing and supervision of banking;

➢ The formation and reorganization of the two government owned specialized banks of
DBE and CBB;

➢ The transferring of non-performing loans from the existing banks to the Ministry of
Finance;

➢ The restructuring of NBE as a separate entity outside the government with the foreign
exchange management and other functions; and

➢ The proclamation for the establishing and restructuring of Agricultural Cooperative

Societies so as to mobilize savings and allocate credits in rural areas.

Performance of the Financial Sector in Ethiopia

Government owned banks performed poorly during the Derg Regime due to its restrictive and
discriminatory policies, lack of institutional arrangement and capacity. Banks were obliged to
comply with the government plan by advancing credit and loans to public enterprises, state
farms, cooperatives and the central government.

Money, narrowly defined in the Ethiopian context, includes currency in circulation outside the
banking sector and demand deposit. A demand deposit is a deposit that can be withdrawn at
any time without giving prior notice. In contrast, broad money supply is defined as narrow
money plus savings and time deposits. Savings and time deposits together are known as quasi
money. Hence, broad money supply is the sum of narrow money supply and quasi money.
Between 1972 and 1991, the narrow money supply showed an annual average growth rate of
10%. For the same period, broad money showed an annual average growth of 12.5%. However,
the expansion of credit to the non-government sector has shown a declining trend.

The annual growth rate of domestic liquidity per year, as measured by broad money (M2), was
21 % and reached 82.5 billion Birr in 2008/09 compared to the 20.4% of 2007/08. The
expansion in broad money was largely driven by higher net foreign assets and domestic credit.
The growth in domestic credit was attributed to rises in credit to the non-government sector
while credit to the government dropped by 0.9 percent. On the other hand, the rise in net foreign
assets was due to higher inflows from net services, transfers, and external loans and grants.

The fiscal year 2008/09 witnessed a surge in all components of broad money. Narrow money
rose by 19.1 percent to Birr 42.1 billion, driven by 11.7 and 26.6 percent increases in currency

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in circulation and demand deposits reflecting the growing economic activities and higher
transactions demand for money. Similarly, quasi money surged to 23.0%, owing to growing
financial intermediation as banks continued to expand their branches throughout the country.

One of the most important functions of commercial banks in the area of financial
intermediation is deposit mobilization and lending activities. There has been growth in these
activities in the post-reform period.

Minimum interest rates on savings and time deposits remained the same for 2007/08 and
2008/09, at 4%, while the maximum deposit rate rose to 5 percent from 4.5 percent for the
same period. Hence, the average interest rate on savings deposits increased to 4.5% from 4.08
percents and that of time deposits increased to 5.26 percent from 5.16 percent. Similarly, the
average lending rate rose to 12.25 in 2008/09.

Problems Of and Possible Remedies for the Financial Sector in Ethiopia

There are different kinds of bottlenecks for the development of the formal financial sector.
These include, among other things:

➢ A good part of the economy is not monetized;

➢ Some borrowers, both private and public enterprises, fail to repay back loans at the
agreed time in the required amount;

➢ Banks are now forced to sell collateral to enforce repayment of debts which takes time,
a long process and effort;

➢ Lack of weak competition in the sector;

➢ Maintenance of large amounts of financial resources by some banks due to high

collateral requirements and lack of viable projects;

➢ Shortage of trained and efficient human resources in the sector;

➢ Inadequacy of banks to convert cash into credit;

➢ Lack luster financial deepening in the country;

➢ Very low level innovation in financial products and services; and

➢ The availability of medium-term financing for activities such as agricultural land

development, irrigation, purchase of machinery and equipment, plantation, and food
processing and packing are either very limited or unavailable.

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However, the sector has tremendous and unexploited potential for development. The spread of
small financial institutions throughout the country can help to channel surplus funds to the
formal financial sector. This can be done by mobilizing large amounts of local as well as
foreign savings. Efforts are also required to expand the types of financial services provided by
the existing institutions. A strong policy framework and a strengthened regulatory government
body is required to avoid unfair practices in the banking and insurance services.

5.3.Contemporary Economic Reforms and Development Policies in Ethiopia

In 1974/75 Ethiopia made a transition from a mixed economic system to a totally controlled
economy that pushed the economy downward. During the central planned economy, the
restrictions and taxation on the Ethiopian economy were substantial. For instance, farmers in
the main cereal growing areas had to supply a predetermined quota of grain to the government
at a fixed low price and taxation levies on both rural and urban households were substantial
factors of production. Also other markets were restricted, and rural wages and other market
factors were repressed, and private sector developments were totally discouraged.

The performance of the Ethiopian economy progressively declined during the Derg. This major
economic collapse called for substantial reforms in the country. In response to the near collapse
of the Ethiopian economy, coupled with unsustainable internal and external imbalances like
the high inflation rate, negative interest rate and unviable debt ratio, the government of Ethiopia
(GOE) in 1993 initiated a Structural Adjustment Program (SAP) for the period 1993-1996 with
the support of the International Monetary Fund (IMF), World Bank (WB), African
Development Fund (ADF) and other multilateral and bilateral donors.

The Structural Adjustment Program refers to the reorganization of institutions, economic

activities and the entire social system, in line with market-oriented economic systems. The
overall goal of SAP was stabilization and adjustment. The stabilization policy focused on
restoring macroeconomic balance and reducing inflation and government budget, controlling
the economy and the like. The Structural Adjustment Policy focused also on removing
constraints on the supply side and paid a close attention to the production of export crops
through depreciation of the real exchange rate and other incentives.

The Structural Adjustment Polices were also aimed at encouraging the development of the
private sector, fostering competition throughout the economy and promoting the process of
market determination of all prices, including exchange rates and interest rates. The main
objectives of SAP include revival of economic growth, reducing macroeconomic distortion,

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improving economic efficiency and resource allocation and expanding the productive capacity
of the economy.

Broadly speaking, the structural adjustment program has three components: expenditure
reducing policy, expenditure switching policy and institutional policy reform.

The main policy measures for achieving the country’s development objectives were:
macroeconomic reforms (include monetary policy, exchange rate policy, fiscal policy and
interest rate policy), privatization, transport deregulation, domestic price liberalization, foreign
trade liberalization and private sector reform.

Performance of the Economy after the New Economic Reform Program

The trend of economic growth for the period between 1960 and 1992 was unsatisfactory. This
very dismal economic performance was caused by a number of factors, including rigid
macroeconomic policies, protracted war, and recurrent droughts, which drained huge amounts
of the country’s resources and created a hostile external environment. The problem of the
drought was the most severe of all.

It has been documented that the extent of drought varies from period to period, and that,
between 1960 and 1992, drought and famine occurred at least nine times. The size and
magnitude of rainfall has substantial effect on the performance of the entire economy, and so
the above-mentioned drought conditions shrank the economy significantly.

Between 1963/64-1998/99, regardless of the policy regime, real GDP grew, on average, by
2.97%, while population grew, on average, by 2.9%, resulting in a 0.06% (2.97%-2.91% =
0.06) annual growth rate per-capita income. This indicates that the economy had stagnated for
the last three decades or so.

The public sector deficit declined between 1989/90 and 1998/99, except in 1993/94 and
1998/99. In the latter years there was the Ethio-Eriteria war, which resulted in the highest
recurrent expenditure. Thus, in the area of public deficit reduction, it can be concluded that the
program was a success.

The average growth rate of agriculture decreased, the industry sector showed improvement,
and the service sector increased rapidly in 1996/97 - 1998/99.

The period of the reform program showed an improvement in all indicators (aggregate
consumption, public consumption, private consumption, gross capital formation) except in
gross domestic saving (GDS). A higher share in gross capital formation (GCF) was achieved

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due to the creation of an enabling environment, especially for the development of the private
sector, and to the mobilization of available resources.

All those measures aimed at developing the private sector bore fruit. The number of approved
investment projects has risen rapidly even since the implementation of the program. A total of
50/50 projects were approved between 1992/93 and 1998/99 for a total amount of 41.5 billion
birr, of which 1491 have actually commenced operation for a total amount of 8.8 billion birr.
This trend is expected to accelerate as the privatization program moves into full capacity.

Recently, a number of economic reforms have been taken in different sectors and institutions
in the country. In this respect, different development plans have also been developed and
implemented. The development plans implemented in the country in the most recent years
include: the Sustainable Development and Poverty Reduction Programme (SDPRP), which
covered the three years, 2002/03-2004/05, and the Plan for Accelerated and Sustained
Development to End Poverty (PASDEP) for the five-year period 2005/06-2009/10. To
undertake the above plans, Agricultural Development Led Industrialization (ADLI) strategy
was applied. Then the Growth and Transformation Plan (GTP I) followed for the five-year
period 2010/11-2014/15 to carry forward the important strategic directions pursued in the
PASDEP. Now, Ethiopia’s economic policy is guided by the second phase of the Growth and
Transformation Plan (GTP II, 2015/16 - 2020/21). The ultimate goal is to push the country into
middle-income status by 2025.

Sustainable Development and Poverty Reduction Programme (SDPRP) : The program was
launched in 2002 following wide-ranging public consultations in 2001 and covered a period
of three years 2002/03 – 2004/05.

It was built on the following goals and concepts:

✓ Agricultural Development-Led Industrialization – ADLI,

✓ Food security, Decentralization and empowerment,
✓ Capacity building in the public and private sector, and
✓ Reforms in both the justice system and the civil service.

The first year of the programme was marked by a drought which led to an 11.6% fall in
agricultural productivity, contributing to a 3.6% fall in gross domestic product. It was

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because of this that the average growth for the three-year period was 5.5%. However, the
country experienced 11.3% and 8.8% growth during the second and third years, respectively.

Plan for Accelerated and Sustained Development to End Poverty (PASDEP): The programme
covered a period of five years — 2005/06 – 2009/10. It was built on the directions pursued
under SDPRP and aimed at private-sector development and at the scaling up of resources to
achieve the MDGs (Millennium Development Goals).

Overall Objectives of PASDEP : The main objective of PASDEP was to lay out the directions
for accelerated, sustained, and people-oriented development and to pave the groundwork for
the attainment of the MDGs by 2015. The purpose of achieving this PASDEP objective was
to contribute to the attainment of Ethiopia’s vision of becoming a middle-income country.
The country’s vision, specifically for the economic sector, set the following goals:

✓ To build an economy which has a modern and productive agricultural sector with
enhanced technology and an industrial sector that plays a leading role in the economy;
✓ To sustain economic development and secure social justice; and
✓ To increase per-capita income of citizens so that it reaches at the level of those in
middle-income countries in the coming 20 years.

The term of the programme was completed in June 2010, and its performance has yet to be
evaluated. However, the general observations were that it achieved good results in the road
construction and energy sectors, although the performance of the agriculture and export
sectors was less than expected. Note that the five-year period of PASDEP was affected by
multiple problems, including less donor support than expected, poor rainfall, and the global
financial crisis of 2008-09.

Growth Targets for PASDEP

✓ Annual average real GDP growth rate of 7% per annum during the PASDEP period
2005/06 to 2009/10;
✓ Annual average agricultural value-added growth of 6.2% per annum;
✓ Annual average industrial value-added growth rate of 11.5% per annum;
✓ Annual average services sector value added growth rate of 7.1% per annum

The second Growth and Transformation Plan (GTP II) is Ethiopia‟s medium term
development plan covering the period 2015/16-2019/20. As a vehicle towards the realization

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of the country‟s vision of becoming a lower middle income country by 2025, GTP II is built
on sectorial policies, strategies and programs, lessons drawn from the implementation of the
first GTP, and the post-2015 Development Agenda. It has also taken into account global and
regional economic situations with direct or indirect bearing on the Ethiopian economy.

The overarching goal of GTP II is to sustain the accelerated growth of the country‟s economy
and to establish a spring board for economic structural transformation, thereby enabling the
nation to realize its vision of becoming a lower middle-income country by 2025.

GTP II has the following objectives:

✓ Achieve an annual average real GDP growth rate of 11 per cent within a stable
macroeconomic environment, while pursuing comprehensive measures towards
narrowing the saving-investment gap and bridging the widening trade deficit.
✓ Develop the domestic engineering and fabrication capacity and improve productivity,
quality and competitiveness of the productive sectors (agriculture and manufacturing
industries) to speed up structural transformation of the economy.
✓ Further solidify the on-going mobilization and organized participation of the public
in the development process to ensure that the public become both owners of and
beneficiaries from the development outcomes.
✓ Deepen the hegemony of developmental political economy by strengthening a stable
democratic developmental state.

Strategies GTP II in order to achieve the objectives of GTP II were

✓ Sustaining the rapid, broad based and equitable economic growth and development
witnessed during the last decade or so including the GTP I;
✓ Increase productive capacity and efficiency to reach the economy‟s productive
possibility frontier through rapidly improving the quality, productivity and
competitiveness of productive sectors (agriculture and manufacturing industries);
✓ Enhance the transformation of the domestic private sector so as to enable it to become
a vibrant development force;
✓ Build the capacity of the domestic construction industry and bridge critical
infrastructure gaps, with particular focus on ensuring quality provision of
infrastructure services;

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✓ Proactively manage the on-going rapid urbanization to unlock its potential for
sustained rapid growth and structural transformation of the economy;
✓ Accelerate human development and technological capacity building and ensure its
sustainability;
✓ Continue to build democratic and developmental good governance through enhancing
implementation capacity of public institutions and actively engaging the citizens;
✓ Promote women and youth empowerment, ensure their effective participation in the
development and democratization process and enable them to equitably benefit from
the outcomes of development; and
✓ Build a climate resilient green economy.

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