Ethiopia stands at the cusp of a transformative financial evolution. Over the past two decades, the country has emerged as one of Africa’s fastest-growing economies, fueled by substantial public investments in infrastructure and services. Yet, behind this remarkable growth lies a significant challenge—a financial ecosystem constrained by limited domestic savings, an over-reliance on foreign debt, and an underdeveloped capital market.
The establishment of Ethiopia’s capital market framework in 2021 marked a pivotal moment. It was a step toward creating a dynamic financial environment capable of addressing these challenges. But how large could Ethiopia’s capital market become? More importantly, what would its growth mean for the nation’s economic trajectory?
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A Dual Reality: Growth Amidst Challenges
Ethiopia’s economic journey has been marked by both remarkable achievements and stark vulnerabilities. While the country has enjoyed periods of rapid growth, the foundation supporting this growth has shown cracks. Macroeconomic imbalances—persistent inflation, budget deficits, a widening trade gap, and declining investment and savings—threaten to undermine progress.
Budget Deficits: Ethiopia’s fiscal health has deteriorated, with budget deficits widening as government spending outpaces revenue. A declining tax-to-GDP ratio has compounded the problem, forcing the government to rely heavily on borrowing, which increases fiscal pressures.
Inflation Woes: Inflation has consistently exceeded the government’s target, reaching an annual rate of 34% in 2022. Rising food and non-food prices, supply chain disruptions, and a depreciating currency have eroded purchasing power, stifling economic activity.
Trade Deficits: Ethiopia’s reliance on imports has created a chronic trade imbalance. Despite efforts to boost exports, global commodity price fluctuations and foreign trade policies have deepened this gap, leaving domestic industries vulnerable.
Declining Savings and Investments: Gross national savings and capital formation as a share of GDP have both fallen, raising concerns about long-term economic resilience. A robust capital market could serve as a solution, but it requires significant groundwork.
Reforming the Foundation
To address these vulnerabilities, Ethiopia launched the Home-Grown Economic Reform (HGER) in 2019, with a bold agenda to stabilize the economy and improve financial access. While promising, the reform faced disruptions from the COVID-19 pandemic, internal conflicts, and global shocks, delaying its impact.
Recognizing these setbacks, the government introduced HGER 2.0 in 2023, a recalibrated plan aimed at restoring stability, enhancing private sector access to finance, and promoting financial inclusion. Key actions under this reform include:
- Phasing Out Direct Advances: Reducing reliance on direct advances from the National Bank of Ethiopia for deficit financing and converting outstanding debt into long-term government bonds.
- Market-Based Treasury Bills: Implementing an auction system to attract diverse investors and foster financial market growth.
- Strengthening Financial Regulations: Aligning with global standards through Basel II & III frameworks to bolster the resilience of the banking sector.
- Capital Market Development: Enacting the Capital Market Proclamation in 2021, creating the Ethiopian Capital Market Authority and the Ethiopian Securities Exchange to lay the groundwork for a robust market.
- Promoting Financial Inclusion: Introducing mobile money systems, movable asset collateral registries, and licensing initiatives to bring more Ethiopians into the formal financial system.
Projecting the Capital Market’s Future
Using a hybrid methodology informed by the IMF’s Financial Programming and Policies framework, a projection of Ethiopia’s potential capital market size reveals three scenarios:
- Scenario I (Baseline): Limited progress with slow economic growth and underdeveloped financial markets.
- Scenario II (Proactive): Successful implementation of HGER 2.0, resulting in robust growth and a thriving capital market.
- Scenario III (Deteriorating): Economic setbacks due to shocks, stalling capital market development.
Key Projections:
- National Savings: All scenarios anticipate an increase, with Scenario II predicting the highest growth due to reforms and economic stability.
- Government Debt Market: Scenario II forecasts a significant increase, with demand for treasury bonds reaching 745 billion ETB by 2028.
- Private Sector Debt Market: Currently nonexistent, this market could grow to 73 billion ETB by 2028 in Scenario II.
- Equity Market: Scenario II projects growth in the State-Owned Enterprise (SOE) market to 31 billion ETB and the private equity market to 15 billion ETB by 2028.
Implications for Policy and Growth
The capital market’s growth potential underscores the importance of targeted policies and reforms. For Ethiopia to unlock this potential, policymakers must:
- Commit to HGER 2.0: Ensure consistent implementation of reforms to stabilize the macroeconomic environment and enhance financial sector resilience.
- Promote Financial Literacy: Educate citizens on the benefits of formal savings and market participation to foster inclusion.
- Strengthen Regulation: Build robust oversight mechanisms to inspire investor confidence and safeguard market integrity.
- Diversify Funding Sources: Balance domestic financing with external options to mitigate risks and ensure sustainable growth.
A New Chapter for Ethiopia
The establishment and growth of Ethiopia’s capital market represent more than an economic milestone—it is a catalyst for the nation’s broader aspirations. By successfully implementing reforms and building a dynamic financial ecosystem, Ethiopia can attract investments, reduce reliance on foreign debt, and create jobs, paving the way for inclusive and sustainable growth.
Ethiopia’s journey toward a thriving capital market is not without challenges. However, the vision of a resilient and self-reliant financial system offers a compelling narrative of hope and progress, one that could reshape the nation’s economic future.
Source: POTENTIAL MARKET SIZE ESTIMATION AND PROJECTION FOR THE DEVELOPING ETHIOPIAN CAPITAL MARKET, Tewodros Makonnen Gebrewolde (PhD) and Getachew Ahmed Abegaz
