This article was published in partnership with Ethiopia Insight.
In the first half of the last decade, there was a focus on Ethiopia’s considerable economic growth and infrastructure development. However, also during that period, the debt stock grew at a fast rate. The previous administration implemented a debt-reliant strategy that ran out of steam after loans were invested in underperforming ventures.
State-Owned Enterprises (SOEs) borrowed copiously from local and international lenders for the expansion and commencement of megaprojects that were expected to boost the manufacturing sector and exports. Due to poor management, inefficient investments, and corruption, these enterprises sometimes failed to achieve their objectives and so struggled to service their debts.
Consequently, the economy has been experiencing an increasing level of debt distress. Still, as Brook Taye, a senior advisor at the Ministry of Finance, points out, although debt servicing is burdensome – especially when projects aren’t able to help with repayments – the nation’s debt-to-export ratio and debt-servicing capacity are more of a problem than the total debt. “Our debt-to-GDP ratio of around 50% is better than most African countries, we still have room to borrow.”
Brook added that as export growth has lagged, a debt re-profiling exercise aims to revert the country’s debt distress risk from high to moderate in the next three years.
Improving the debt vulnerability status potentially allows differing debt payments, which would provide the government space to channel resources to other projects. When debt-servicing obligations mature in a few years’ time, the country would be in a better economic position, according to Brook.
He added that overall exports are growing, the government isn’t borrowing on commercial terms, concessional loans are not extensive, and, as a result, the debt stock is shrinking.
Meanwhile, heavily indebted state enterprises generating income that is incompatible with their liabilities created the need for a debt-servicing mechanism that is reliant on a source other than the SOEs’ revenues.
In February, the Council of Ministers enacted a Regulation for the establishment of the Liability and Asset Management Corporation (LAMC), a public enterprise whose mandate is to overtake and service residual debts of state-owned enterprises and manage residual assets and liabilities of privatised enterprises.
The corporation, supervised by the Ministry of Finance, was authorised to receive Br570bn ($11.5bn) worth of capital, to be allocated to it mainly from the Industrial Development Fund (IDF). According to Brook, the genesis of LAMC was laid under the Homegrown Economic Reform Agenda. The intended beneficiaries are heavily indebted SOEs, such as Ethiopian Railway Corporation, Ethiopian Electric Power, and the Sugar Corporation.
“This debt re-profiling exercise would create the fiscal space for the government to engage in further activities to support the economic reform,” he says. In August, with the Ministry of Finance as a guarantor, LAMC overtook Br398.7bn from debts owed to the Commercial Bank of Ethiopia by six state-owned enterprises: Ethiopia Electric Power, Ethiopia Electric Utility, Ethio-Engineering Group (formerly MeTEC), Chemical Industry Corporation, Ethiopian Railways Corporation and Ethiopian Sugar Corporation.
Deputy Chairman of LAMC, Mulualem Getahun, told Ethiopia Insight that the corporation so far received Br36.5bn ($850m), proceeds from a telecom license sale to Safaricom earlier in the year. In turn, it settled Br34.1bn with the Commercial Bank of Ethiopia, which had cumulatively been owed by the chemical, engineering, and electric utility enterprises.
The number of debts transferred to LAMC from the above-mentioned six state enterprises was determined based on assessments of each enterprise’s payment capacity. The portion of liabilities exceeding their estimated debt-servicing capacity, designated as residual debts, will be serviced by LAMC.
This appraisal is based on a forecast of their future performance, which is made with consideration of “baseline” and “reform” scenarios. “The reform scenario takes into account possible reform measures that aim at increasing profitability down the road,” Mulualem explains.
Currently, the corporation is aiming to pay Br340bn, debts which the railways, sugar and electric power corporations owe the Commercial Bank of Ethiopia.
“The debts overtaken from these enterprises are the biggest and more complicated to handle,” says Mulualem. “Some of the loans were taken based on political decisions rather than economic rationalities, thus the enterprises couldn’t pay them back. Such debt is an economic bottleneck and needs special handling and solutions.”
The corporation, for now, is focused on servicing domestic debts. However, when the G-20 Debt Service Suspension Initiative is finalised, the corporation will absorb loans borrowed from external lenders as well. Once foreign debts are transferred to LAMC, the corporation will be required to service an average of Br100bn debt per year, according to Mulualem.
The government’s current action to work out what portions of their total domestic debts major SOEs (e.g. railways, sugar, electricity) can and can’t service is a pragmatic first step, as it reveals the extent of the issue.
Mulualem commented that in the case of the Chemical Industry Corporation, it was determined that it can service the loan taken for the expansion of Mugher Cement Factory. LAMC, for its part, settled debts incurred for fertiliser production, which the corporation couldn’t repay.
Similarly, the power corporation and engineering group have been relieved of a portion of their debt, but are expected to service the rest on their own. In contrast, after going through the debt-repayment capacity assessment, the entire domestic and external debt of the railway corporation has been transferred to LAMC.
The article continues below
Get your free PDF: Top 200 banks 2019
The race to transform
Complete the form and download, for free, the highlights from The Africa Report’s Exclusive Ranking of Africa’s top 200 banks from last year. Get your free PDF by completing the following form
The residual debts settled by the corporation for the chemicals corporation and Ethiopia Electricity Utility amount to a considerable majority of debts they incurred with the Commercial Bank of Ethiopia.
In addition, LAMC is also mandated to overtake and administer residual assets of public enterprises that have been privatised, which would otherwise have been managed by a Board of Trustees that was established in 1996 as a public agency. While the board’s objective was limited to upkeep, LAMC is allowed to engage in ventures to transform such assets into income-generating ventures.
Transforming underutilised properties of public enterprises into income-generating ventures and administering other public assets that may be assigned to it by the government are also part of LAMC’s mandate. Finally, the corporation is allowed to invest the injected capital until it is used for debt repayment. These activities are allowed as mechanisms that facilitate LAMC’s core mandate of debt servicing.
As mentioned, LAMC relies on the Industrial Development Fund (IDF) as a main source of capital. IDF is normally funded from profits made by SOEs, paid in as dividends, which average around Br20bn a year, according to Mulualem.
Other exceptional but significant contributions to the fund are proceeds from the privatization of SOEs and sales of licenses to the private sector, which are to be paid in full into it. Apart from SOEs annually deposited dividends, the Br36.5bn acquired from the sale of a telecom license is the only contribution made to the IDF in the recent past. This is also the only capital injected into LAMC to date.
Commenting on the imbalance between LAMC’s capital resources and the debt-servicing requirements, Mulualem says that the IDF raises Br20bn a year, while LAMC seeks to service Br100bn a year. The mismatch means they are seeking a debt-service extension to bring down annual debt payments to Br30bn or Brn20bn.
“We also need to invest in new ventures not addressed by the private sector to generate dividends,” he adds. “Otherwise, it will be difficult.” Achieving a debt-service extension will be laborious, as there are a large number of loans that each require distinct renegotiations, says Mulualem.
Moreover, IDF has been used by state enterprises as a source of loans for expansions and projects such as railway construction. Now, LAMC has been added to the list of beneficiaries, although Mulualem says that IDF’s existing commitments will not be affected.
Although the corporation is allowed to invest its capital until the maturation of debts it took over, it hasn’t engaged in any such activity yet. Brook says the corporation can identify investment opportunities, such as time deposits, and also invest in under-utilized assets of public enterprises.
“It is a growing economy with a lot of opportunities, and with finance and know-how it won’t be marginal but, rather, central,” he says. Strategies and mechanisms that would allow LAMC to attain its objectives are still under discussion and the corporation is in the process of hiring consultants and employees.
According to Mulualem, due consideration is being given to several factors, such as: what portion of the IDF can be allocated to debt servicing; if dividends from state enterprises will improve, and if they won’t, what other sources can be allocated to LAMC; the impact of debt rescheduling will have on the balance sheet, and; the liquidity of the Commercial Bank of Ethiopia.
“It is a complicated macro-economic issue which requires a case-by-case evaluation of all relevant factors,” Mulualem said. As stated by Brook, the mandates to utilise residual public assets and make temporary investments could prove profitable. Hence, LAMC needs an efficient structure to handle the bundle of tasks assigned to it, while simultaneously managing to fund its own operations.
It is in the process of acquiring possession of residual properties from around 120 privatized public enterprises. Moreover, it is also planning to lease idle government buildings to generate income and cover its running costs. So far, LAMC has been operating with a handful of staff, but now that the setup of its headquarters has commenced, hiring will soon be underway.
Although it remains to be seen how its broad room for manoeuvre will be exploited, privatisation proceeds are the only realistic way to keep LAMC financially afloat. Thus, privatising state enterprises is now of paramount importance in confronting the debt challenge.
Apart from being part of the liberalization policy, the resulting proceeds will be a major contribution towards debt servicing, avoiding a fiscal crisis, and creating room for economic reform initiatives.
Additionally, the decision to utilise capital acquired from the sale of state enterprises to service their debts is economically sound and has also been advocated by economists. Sugar projects and a second telecom license are next up for sale and Mulualem says: “The entire proceeds from these transactions must and will be injected into LAMC through IDF.”
Nonetheless, he expressed concern with the fact that privatization proceeds, while substantial, are still one-off contributions to the corporation’s capital and so do not represent a sustainable source of income. Still, given the circumstances, the corporation counts on these two planned initial transactions to service debt it absorbed from the railways, sugar, and electric power corporations.
Meticulous and analytical
As part of economic liberalisation measures, the administration is preparing to privatise major state enterprises. The telecoms sector has been liberalised. The government is now looking to sell 40% of Ethio telecom and all Sugar Corporation projects, which will be accompanied by a significantly increased role for private companies in the energy sector.
The Homegrown Economic Reform Agenda envisages that privatisation of SOEs will import capital, settle public enterprises’ debts, and improve service quality. However, there are also potential drawbacks: the profit motive of private sectors conflicting with public interest, a natural monopoly status empowering large companies, and short-term profit-seeking at the cost of necessary long-term investment.
Brook agrees that transfers of public entities to private holdings have in many instances created problems and that in any society individuals trusted with public assets may not act in the country’s interests. “To avoid repeating the mistake made by other nations, we’ve implemented a system with checks and balances; the new privatisation law separates the pre-privatization, post-privatization, and the actual privatization activities,” he says.
Furthermore, extensive preliminary studies are being conducted to enable better decision-making, which is the main reason why no major state enterprise has been privatized under the current administration yet, according to Brook. “Significant amount of work needs to be done beforehand; this is not a rush job, rather it is analytical and meticulous.”
Still, the reform agenda hasn’t been without criticism, as some prominent Ethiopian economists questioned the ‘homegrown’ nature claimed by the government, arguing that, in fact, it was copied and pasted from the IMF’s liberalising playbook.
“Opinions aren’t always facts and the contents of the reform agenda testify that it is indeed homegrown,” says Brook in response. His stand is that most Ethiopian economists know the macro-financial problems and recognise the need to make structural and sectoral reforms, handle debt burdens, arrest inflation, resolve the foreign currency shortage, and privatize public companies. The inspiration from other nations’ success is the only foreign influence that Brook acknowledges. “We live in a global world, knowledge is there to be shared, and there is nothing wrong with emulating what worked for other countries.”
The public enterprises’ privatization proclamation allows different types of sales. The fundamentals for the choice are transparency and securing the most favourable terms for the government.
According to Brook, the preferred method for the upcoming privatization plans is competitive public tendering. Ethiopia Insight asked him if the government has a preference towards domestic ownership.
The amended Investment Regulation will be the guideline as to which sectors are open for foreign investors. Banking, insurance and microfinance businesses, export trade of minerals, electric power distribution through the integrated nation grid system, aircraft maintenance and ground handling, and related services are some areas of investment exclusively reserved for local investors. Brook stresses that achieving the most beneficial outcome for Ethiopians and domestic investors is the Finance Ministry’s primary goal.
“Although sectors are open for foreign participation and we would like them to invest in Ethiopia and bring their finance, know-how, and advanced technology, ultimately, if there is a domestic participant who can enter a certain sector and flourish, we want to enable our own success stories,” he says. “Foreign participation is needed in sectors where we can’t have a competitive advantage. So, we’ll make a balance.”
Encouraging domestic participation is expected of any government. However, for any benefit to materialise for the public, due regard must be given to the intertwined objectives of increasing available capital to these enterprises and improving the quality of services.
Particularly, the energy and telecom sectors, whose privatisation has already been planned, have always been under state control. Accordingly, Ethiopian companies did not get the opportunity to accumulate experience. Such businesses, in which a high skill set is crucial and not yet available, are instances where local businesses lack a competitive advantage.
Ethiopia Insight asked Brook whether decisions regarding privatisation and other economic reforms are somewhat political or purely based on economic analysis. His assessment is that although it might be difficult to separate the two, the current administration is pragmatic and works closely with technocrats.
“We analyse our status and deploy whatever solution we believe will solve the problems we identify,” he says. “Some people want to extend that and emphasise a certain political ideology to it, but ultimately we’re trying to implement what works for Ethiopia.” Privatisation decisions are made by the Council of Ministers with some support from the national macroeconomic committee, both of which comprise politicians.
At all stages of the process, decision-makers are sufficiently backed by experts. Brook offers the recent telecom liberalization as an example, as the recommendations of six international consulting companies were reviewed by an Ethiopian technical team. Furthermore, the administration, as it seeks to reform a state-led economy, has broken away with tradition in Ethiopia and appointed young technocrats to key economic jobs, such as Brook himself. “Some people might question that, but it’s because the appointees have technical expertise,” he says.
Resolving the issue of SOE liabilities is crucial, although capital acquisition for servicing debts is almost fully reliant on privatization proceeds that are yet to be realised. While this is a sensible approach for the government to take given the circumstances, the prevailing insecurity will hinder reform plans and exacerbate existing economic problems. The privatisation proceeds needed for debt servicing are therefore at risk, as security concerns will likely depress the price that investors are willing to pay for assets.
Understand Africa's tomorrow... today
We believe that Africa is poorly represented, and badly under-estimated. Beyond the vast opportunity manifest in African markets, we highlight people who make a difference; leaders turning the tide, youth driving change, and an indefatigable business community. That is what we believe will change the continent, and that is what we report on. With hard-hitting investigations, innovative analysis and deep dives into countries and sectors, The Africa Report delivers the insight you need.View subscription options