Where will huge state investments lead Ethiopia?

Ethiopia plans to build 960,000 houses in the next 10 years, besides thousands of kilometres of roads and railways. Photo/Andualem Gessesse 

By Andualem Sisay Gessesse

In Summary

• Everywhere you turn in Ethiopia, construction is ongoing — roads, railways, and thousands of houses — all led by the government with local or external funding. What are the short and long-term implications for the private sector?

From thousands of kilometres of railways and highways to mega dams to tens of thousands of partially government-sponsored houses to cobblestone roads, Ethiopia is a nation under-construction.

About a fifth of the 10.3 per cent growth registered in the 2013/14 budget year was attributable to construction activity, according to the World Bank. Over the same period, the total investment rate rose from 32.1 per cent of GDP to 40.3 per cent. 

Some $1.5 billion from the $8.5 billion budget of the country this year is earmarked for construction of roads. In addition to the government, there is huge investment by the private sector in real estate.

For the 13th most populous country in the world, with 90 million plus people, of which the majority are young, the huge investments by the government in infrastructure and construction by private sector are the major source of jobs.

Today tens of millions of Ethiopians are working on various construction sites.

“Ethiopia is indeed a nation ‘under construction,’ the construction boom is increasingly supporting economic growth,” said Lars Christian Moller, lead economist and programme leader at the World Bank Ethiopia office, which is currently involved in 25 projects in Ethiopia with $6 billion in commitments, making it the largest country programme in Africa.

Railway

Out of the total 4,744km of railway line the country planned to construct, about 2,000km was built during the first Growth and Transformation Plan period 2010/11-2014/15.

Currently, 50 per cent of the 800km Addis Ababa-Djibouti railway is complete while the 700km Mekele-Awash line is set to be launched this year.

While 70 per cent of the cost of the $3 billion Addis Ababa-Djibouti railway is secured from the Chinese government, the remaining is financed by the government. The construction and consulting is being undertaken by Chinese companies CREC and CCECC.

“A $1.7-billion soft loan has been secured from Swiss Bank by Turkish company Yapi Merkez for the construction of the 389km Awash-Weldiya railway,” according to Dereje Tefera, head of communications at the Ethiopian Railway Corporations.

“The electric railway will save Ethiopia hard currency that would have been spent on fuel imports,” Mr Dereje said, adding that 254 professionals including the rail master have already trained in China.

About 80 per cent of the 34km Addis Ababa light railway is completed. A $470 million loan was secured from China’s Eximbank for the project. CREC of China is carrying out the construction while SweRoad of Sweden handled the consulting.

READ: Why every entrepreneur wants a piece of Ethiopia

One of the major construction areas is the government housing project started 10 years ago. Annually, an average 25,000 houses are built and distributed to the public. In Addis Ababa, over one million people have registered for these low-cost houses.

To meet demand, the government redesigned the programme a few years ago, making it mandatory for house owners to save for the houses of their choice.

Under the new programme, one has to register for the house of his/ her choice and start saving at the state-owned Commercial Bank of Ethiopia, which has a 50 per cent share of the market.

The government is currently constructing 65,000 low-cost houses in the capital and plans to build a total of 960,000 houses in the coming 10 years by engaging foreign real-estate developers, according to Diriba Kuma, Mayor of Addis Ababa.

The programme has three different packages: 10/90, 20/80 and 40/60. The numbers refer to the financial contribution of the prospective house owner and the government, respectively.

Under the 10/90 and 20/80 programmes that target the urban poor, the house owner is expected to contribute 10 per cent and 20 per cent, respectively, of the total cost of the house constructed by the government then pay the remaining while living in the house.

The 40/60 programme targets the middle income urban population.

Big government

In 2011, Ethiopia had the third highest public investment rate in the world, but the sixth lowest private investment rate, according to the recently released “Second Economic Update Report Laying the Foundations of Middle Income Status.”

“We believe in big government ownership of the country should not be left to the market because there are market failures,” said Foreign Minister Dr Tedros Adhanom at a recent development partners’ meeting in Addis Ababa.

“The government should not be like a night watchman… Our investment not only enhances development and makes the economy competent but also improves the social services,” Dr Tedros said.

This is a view shared by the World Bank’s Mr Moller.

“Large-scale public investments in the provision of basic services such as education and health have contributed to poverty reduction both by contributing to growth and by preferentially increasing the welfare of the poor,” said Mr Moller.

The World Bank, which is involved in 25 projects in Ethiopia with $6 billion in commitments, making it the largest country programme in Africa.

“Tremendous investment in infrastructure and market development, especially in road networks, has reduced remoteness, integrated markets and reduced marketing margins,” he added.

Sources of money 

The government uses different strategies to raise money for its mega projects. Key among these is foreign borrowing.

Under this scheme, any company from across the world, with experience in the specific project implementation, can take the contract of a mega project if it can bring in the financing fully or partially as a soft loan from its government bank.

Sometimes the negotiations begin at the government level and once the financing is approved, the lending country sends in its national company to implement the project.

The Chinese government takes the lead in such project financing in Ethiopia. From the over $500 million 85km expressway between Addis Ababa and Adama city, which was inaugurated this year, to the Addis Ababa-Djibouti and Addis city railways and several power projects, at least 70 per cent of the cost is being financed by Chinese government banks such as China Eximbank.

In addition, the government has been mobilising domestic savings to finance its housing programme and the $4.2 billion Great Ethiopian Renaissance Dam.

To support these mega projects and provide the necessary lending to the private sector to invest in the manufacturing sector through the state banks, the government has also ordered private banks to set aside 27 per cent of their lending portfolio to purchase government bonds.

The cost

While concessional finance from multilaterals such as the World Bank is currently offered at zero per cent interest, the average interest rate of new non-concessional borrowing increased from 2.7 per cent in 2012/13 to 3.4 per cent in 2013/14.

A prospective sovereign bond issuance would be much more costly (10-year sub-Saharan African sovereign bonds are currently trading at 6-6.5 per cent). 

“As global interest rates rise in the coming years, so will the cost of non-concessional borrowing.  The higher cost of borrowing is another reason to be cautious,” Mr Moller said.

As most of the inputs for construction except cement and a few other items are being imported, the construction boom is also contributing to the widening of Ethiopia’s trade deficit, which reached $10 billion this year.

“As a big government following developmental state path, we intervene aggressively in development of infrastructure, road, railway, power generations and sugar. We waited for decades for the private sector to invest in these sectors but they didn’t come.”

Some observers worry about the diminishing role of the private sector as a result of huge investment by the government. The government is engaged in various businesses ranging from production of consumer goods such as cigarettes, sugar and beer production to assembling of motor vehicles.

Government-led growth

“High public investment can be justified from a perspective of Ethiopia having a substantial infrastructure deficit to cover. The strategy aims to crowd-in the private sector in the medium to long term, but may inadvertently crowd it out in the short term as it absorbs scarce credit and foreign exchange, which inhibits private sector growth,” said Mr Moller. 

He asserted that the only sustainable long term engine of growth is the private sector while government support is key in the form of adequate physical infrastructure and creating a conducive business environment for the private sector.

The government’s growth strategy is currently centred around providing the necessary infrastructure. However, the overall economy is facing a scarcity of capital and foreign exchange, especially in the context of a negative real interest rate and an overvalued real exchange rate. 

“As a result,” said Mr Moller, “The ongoing public investment boom is absorbing scarce credit and foreign exchange, which could otherwise have been available to the rest of the economy. The policy challenge is to ensure a soft landing rather than a crash.

“The strategy, therefore, has some short-term negative implications for private sector development. However, if successful, it should be able to crowd in private sector activity in the future as infrastructure investments are completed and start paying off,” Moller said.