EthiopiaEnhanced Structural Adjustment Facility

Medium-Term Economic and Financial Policy Framework Paper, 1998/992000/01

I. Introduction
1. In mid-1996, the government of Ethiopia adopted a medium-term adjustment program for the
period 1996/97-1998/99,1 which was supported by a three-year arrangement under the Fund's
Enhanced Structural Adjustment Facility (ESAF), by the World Bank in the form of new sector
investment loans, and by other multilateral and bilateral donors. However, the midterm review
under the first annual ESAF arrangement could not be completed, and the arrangement was
allowed to expire in October 1997. Ethiopia intends to deepen the reform process while
strengthening macroeconomic performance (Table 1). The government has adopted a new
medium-term adjustment program for the period 1998/99-2000/01 and, in this context, is
requesting financial assistance from the Fund under the ESAF, from the World Bank, and from
other multilateral and bilateral donors.

II. Performance and Policies During 1996/97 and 1997/98

A. Developments in 1996/97
2. Performance of the economy in 1996/97 was in most instances better than envisaged in the
initial ESAF program. Output grew by 5.6 percent, marginally below the expected rate of 6
percent, while inflation decelerated to a negative 6.4 percent (Table 2). Broad money increased
by 3.4 percent against a targeted rate of 9.1 percent. The fiscal deficit including grants (1.3
percent of GDP) was smaller than targeted, owing to an unexpected rise in revenue that helped
offset largely an unforeseen decline in foreign grants. The external current account deficit
(excluding official transfers), estimated at just over 7 percent of GDP, was smaller than
projected. Transfers were smaller than originally anticipated, but exports were higher owing to
higher coffee volumes and prices.
3. Important liberalization and structural reform measures were undertaken in 1996/97. In the
external area, these included opening foreign exchange bureaus within the banking system;
increasing the frequency of the foreign exchange auction from biweekly to weekly; reducing the
export proceeds surrender requirement; and allowing exporters and recipients of private
remittances to open foreign currency deposit accounts. Other structural reforms implemented
during the year included the establishment of a review process for adjusting domestic petroleum
prices; the elimination of controls on retail prices of fertilizers; and a lowering of the maximum
import tariff rate and a reduction in the number of tariff bands. Also, a national consumer price
index was introduced, and the reporting lag in balance of payments data was reduced.

B. Developments in 1997/98
4. In 1997/98, the economy suffered from the adverse effects of El Nio on agriculture and
transportation. GDP growth slowed to an estimated 0.5 percent. However, as the effect of crop
shortfalls on food prices was mitigated by buffer stocks and extraordinary food imports, while
nonfood inflation was subdued owing to prudent monetary policy, inflation was kept well within

the initial program target of 3 percent. After the substantial deceleration of the previous year,
broad money growth reached about 12 percent (somewhat higher than the targeted rate of 9
percent), led by a rapid expansion in credit to the private sector. The inflow of official foreign
grants again fell below the initial estimate, while fiscal revenue was below expectations.
However, the fiscal deficit in 1997/98 was smaller than expected, owing to an underexecution of
investment outlays. The overall general government deficit (excluding grants) is estimated at 6.4
percent of GDP, compared with 7 percent in the budget and 4.9 percent in the previous fiscal
year. The external current account deficit (excluding official transfers) widened somewhat to 7.6
percent of GDP-but at less than initially expected. Official transfers were smaller, while net
capital inflows were larger. As a result of special expenditures toward the end of the fiscal year,
gross official foreign reserves declined from the equivalent of 4.2 to 2.9 months of imports of
goods and nonfactor services during 1997/98.
5. Despite the expiration of the first annual ESAF arrangement, the government continued to
deepen the structural reform process. Interest rate liberalization, which was initially intended to
await the emergence of a treasury bill rate that could be used as a reference rate, was accelerated
by lifting the control over bank lending rates in January 1998 and setting the minimum deposit
rate at a positive level in real terms. These measures, and the termination of government bank
borrowing, paved the way for deregulating the treasury bill market. Moreover, banks were
allowed to trade surplus funds in the interbank market. However, foreign exchange market
liberalization, which would have entailed a phased relaxation of the foreign exchange surrender
requirement and elimination of exchange controls on payments for services transactions (such as
foreign travel and education abroad), stalled in light of the uncertainties surrounding the balance
of payments support for the country. Weighted-average import tariffs (weighted by the number
of items in each band) were reduced as scheduled from 24.5 percent to 21.5 percent. Finally, the
investment code was liberalized, particularly to allow foreign investments in the
telecommunications and power sectors.
TABLE OF CONTENTS

III. Objectives, Strategies, and Policies for 1998/992000/01

A. Objectives
6. The overriding objective of the government is to attain relatively fast, broad-based, and more
equitable economic growth with macroeconomic stability. A rapid increase in agricultural
output-sparked by productivity gains and rural development programs to upgrade infrastructure
and social services-is expected to be the cornerstone of economic growth and poverty alleviation.
At the same time, agricultural development will provide the springboard for higher export
earnings of farm commodities and agro-industrial goods. An additional and equally important
objective is to attain relative stability of prices to help protect the poor from the ills of inflation
and encourage saving and long-term investment.
7. Closely related to the twin objectives of growth and price stability is the aim of the progressive
integration of Ethiopia into the global economy. The focus of this integration effort is on the
further liberalization of foreign trade in goods and services, which calls for a further reduction in
import tariffs and removal of all restrictions on external current account transactions. Clearly, a
strengthening of international competitiveness is essential for attaining a high growth rate of

exports and moderating the growth in imports of goods and services, which are, in turn, key
factors for both sustained economic growth and macroeconomic stability.
8. The objectives of growth, relative price stability, and global integration of the real economy
provide a guiding framework for the formulation of a medium-term economic program for the
period 1998/99-2000/01. The major macroeconomic objectives (on an average annual basis)
under this program are a growth rate of real GDP of 7 percent; an inflation rate of about 4
percent; an external current account deficit (excluding official transfers) of 8-8 percent of
GDP, taking into account the weak prospects for international coffee prices and the large import
requirements associated with the envisaged increase in domestic investment in priority sectors;
and a rebuilding of international reserves to a more comfortable level. As noted earlier, economic
growth would come from the expansion of agriculture, beginning with a recovery of output in
1998/99, but there would also be some acceleration of growth in the industrial sector (following
the commencement of production of new factories and further increase in capacity utilization
from firms established in recent years) and in services. Inflation is expected to be held in check
through appropriate macroeconomic policies; also normal rainfall conditions would yield an
appreciable expansion of crop output and keep food prices relatively stable. The exchange rate
would remain market determined.
9. Gross domestic investment would reach an annual average of 21.7 percent of GDP in 1998/992000/01, following a significant increase in public investment. Total private investment, both
domestic and foreign, also is likely to rise somewhat above the average of 11.1 percent of GDP
in 1995/96-1997/98 to 11.8 percent in 1998/99-2000/01. This expansion would be promoted by a
favorable climate and the acceleration of privatization. Government investment as a share of
GDP would increase by about 2 percentage points above the average level of 1995/96-1997/98 to
an annual average of about 9.9 percent over the period 1998/99-2000/01, mainly as a result of the
expansion of sector investment programs. During the same period, the financing of the
investment effort would rely on an increase in private saving, to an annual average of 3.2 percent
of GDP from 0.5 percent in 1995/96-1997/98, and on the mobilization of foreign resources;
government saving would average 6.4 percent of GDP per annum, about the same as the average
of the past three years.
10. Consistent with the objectives and targets above, the macroeconomic policy package for the
medium term focuses on continued pursuit of prudent fiscal and monetary policies, with virtually
no net domestic borrowing by the public sector; a further reduction in import tariffs; full
deregulation of external current account transactions; and development of a modern and sound
financial system. Simultaneously, structural reforms will focus on export promotion and private
sector development, particularly by streamlining and improving the legal, regulatory, and
institutional framework; building capacity in the public and private sectors; liberalizing the
investment code; and accelerating privatization. Moreover, the government will implement
development programs in the key areas of agriculture, infrastructure, education, health, and
population, and create an environment conducive to export diversification.

B. Strategies

11. Improving Ethiopia's growth prospects will rely heavily on providing the proper incentives to
smallholder farmers, domestic entrepreneurs, and direct foreign investors. First, agriculture-led
growth is to be driven by productivity improvements in smallholder agriculture. Progress will
depend critically upon the diffusion of technology, export promotion policies, and the
availability of affordable credit as a result of the active promotion of rural banks.
12. Second, private sector-led growth rests on domestic entrepreneurship. Despite nearly two
decades-until 1991-of a centrally planned command economy, recent times have witnessed a
sharp acceleration in private sector development and a reduction in rent-seeking activity. The
private sector will be supported by efficient and transparent modes of service delivery, including
in the customs and inland tax administration, the judicial system, the public utilities, and the
financial sector. In this connection, steps will need to be taken to develop markets for credit to
small enterprises (even those unable to provide adequate collateral), loans for long-term
investments, and urban land lease markets.
13. Third, foreign direct investment will play an increasingly critical role in Ethiopia's
development, both in terms of financial resources and technological and managerial know-how.
The strategy is to create a favorable and credible environment for investment while opening up
foreign investment to all sectors except for those few to which participation would be explicitly
prohibited in the immediate future. In that regard, the government has already permitted foreign
entry in hitherto restricted areas, such as telecommunications and power generation. Ethiopia has
achieved political stability, rapid economic growth, low inflation, relatively stable and marketdetermined conditions in the exchange market, and fiscal discipline, but there is room for making
these achievements known better so as to help attract foreign investors.
14. Another arm of the economic development strategy concerns the maintenance of a stable
macroeconomic environment, along with the implementation of further policy reforms in the
financial sector and the foreign trade regime. Of key concern is the need to create the conditions
for interest rate liberalization through the development of appropriate short-term money markets
and longer-term securities markets, and to ensure neutrality of tariff reduction on government
revenue. To develop an indirect monetary instrument, the emergence of a debt securities market
will be encouraged (focusing on long-term bonds), and steps will be taken to foster the
development of short-term money markets (see paragraph 22). By relying on corporations such
as Ethiopian Air Lines, Ethiopian Electric Power Corporation, and the Development Bank of
Ethiopia to issue bonds, yields would be realistically fixed, taking into account the rate of return
of investments. This would provide an appropriate setting for effective market determination of
interest rates in the long-term end of the yield curve. Revenue neutrality of further cuts in import
tariffs becomes important because tariffs will have been lowered by December 1998 to an
average of 19.5 percent, without enactment of any compensating tax revenue measures over
several years. Subsequent gains from broadening the tax base will need to go toward fiscal
strengthening rather than financing of tariff reform; this is all the more important in view of the
need to make government finances less dependent on counterpart funds.
15. Lastly, the government's strategy will focus on promotion and diversification of exports,
given the need to reduce the reliance on coffee receipts and sustain over the long term the rapid
rate of export growth of recent years. Although the coffee sector will continue to be exposed to

high price volatility and sluggish growth in world demand, it will probably remain the country's
most valuable export for quite a while. Resilience to price fluctuations and competitiveness in
the world market should be strengthened through further improvement that may be needed in the
domestic coffee market structure and in the infrastructure for coffee exports, as well a through an
increased share of washed coffee and further liberalization in the foreign exchange system.
Meanwhile, export diversification will be sought in the areas of horticultural products, meat,
semiprocessed and finished leather articles, and in the introduction of new items, such as textile
garments.

C. Macroeconomic Policies
Fiscal policy
16. The fiscal deficit is expected to rise somewhat over the program period before beginning to
decline, owing to increased public investment under the sectoral investment programs (SIPs)
developed with the assistance of the World Bank. The SIPs (see para- graph 18 below) are fiveto ten-year programs in priority sectors that are mostly externally funded under the leadership of
the World Bank. The government remains committed to avoiding domestic bank borrowing for
the financing of budgetary deficits in order to minimize inflationary pressures. Thus, the bulk of
financing will emerge from external concessional sources. The government will also utilize the
primary domestic budget surplus (i.e., excluding interest payments and foreign-financed outlays)
as a measure of fiscal adjustment under its own resources; this surplus is expected to improve
from 0.1 percent of GDP in 1997/98 to 2.8 percent in 2000/01. Given Ethiopia's low per capita
income and the need for infrastructure and social welfare improvement, the temporary rise in the
public sector deficits mentioned above is deemed warranted, especially as it can be financed at
highly concessional rates.
17. Revenue policies will aim at further broadening the tax base and gradually bolstering
government savings as a share of GDP. New tax measures will be implemented over the next
three years by an average of about 0.5 percent of GDP per annum to offset the envisaged decline
in nontax revenue and any potential revenue losses from lower customs duties, as well as to
provide resources for raising priority outlays. To achieve these goals in 1998/99, the government
will review a number of options for raising revenue proposed by a technical assistance mission
from the Fund's Fiscal Affairs Department in July 1998, with a view to fully compensating for
expected revenue losses from the planned tariff reform in December 1998. New tax measures are
expected to include (i) a unification of sales tax schedules for goods and services, with the
application of the maximum rate of 12 percent to all goods and services (except food items,
financial service, and construction contracts); (ii) an increase in excise taxes sufficient to offset
fully the decrease in import duties from tariff reduction on excisable goods; and (iii) application
of a simplified and uniform rate structure to all forms of income. The government will also
continue to reform agricultural income and land taxation, broaden the use of presumptive
taxation methods, and implement the new financial services tax. Tax administration will be
strengthened by assigning and computerizing taxpayer identification numbers; expanding the tax
fraud unit and assigning penalties and interest charges to late payments; completing the reform of
the Customs Office and the Federal Inland Revenue Authority, including delegating enhanced
authority to enforce and monitor existing regulations; and stepping up efforts to improve regional

collection capacity. The government will undertake preparatory work before the end of 1998/99
for the introduction of a value-added tax (VAT) by the end of the program period. The
composition of revenue is expected to change slightly (as nontax income declines and tax
revenue rises), while tax collections would shift away from customs duties toward indirect taxes.
Tax revenue would increase from an estimated 12.8 percent of GDP in 1996/97-1997/98 to 14.5
percent in 2000/01, while nontax revenue (including privatization receipts in the budget) would
decline from 6 percent of GDP to 5 percent over the same period. The level of foreign grants,
which averaged an estimated 3.3 percent of GDP during 1996/97-1997/98, will depend on the
pace of SIP implementation. After an initial rise to 6.4 percent of GDP in 1998/99, government
saving is expected to remain flat in spite of new revenue measures.
18. Public sector capital outlays are expected to increase faster than GDP, owing to the needs in
the priority sectors of roads, education, and health, that are addressed under the SIPs. (Higher
investment in the power and telecommunications sectors will also be undertaken by the stateowned enterprises, but it will be treated as private sector investment since these public utilities
are financially autonomous and are run on a commercial basis.) The redirection of public sector
capital spending toward urgently needed infrastructure will be strengthened and prioritized
through the three-year rolling public investment program established in 1996/97. Public outlays
are expected to rise by some 2 percentage points of GDP above the 1996/97 level over the
program period, and they will be reviewed on the occasion of midterm reviews and the beginning
of each annual ESAF-supported program, to take account of expected disbursements of foreign
grants and concessional loans and the results of World Bank Public Expenditure Reviews
(PERs). Any revisions would be consistent with three principles: first, recourse to additional
foreign financing should be on concessional terms to ensure that the external debt burden
remains manageable; second, higher capital spending should not lead to inflationary domestic
bank financing; and third, the projected growth in revenue will need to be adequate to meet the
increasing recurrent expenditure generated by any higher capital outlays. Additional financing
from receipts from the sale of state-owned enterprises will be used to build and maintain the
country's capital stock, consistent with the PERs.
19. Current expenditure is expected to increase slower than nominal GDP, depending, however,
on the pace of implementation of the SIPs and the success of the civil service reform program.
This would create space for the capital budget while providing for a redirection of the recurrent
budget to priority areas, such as adequate infrastructure maintenance and improved health,
education, and agricultural extension services. (This process will be facilitated in the transport
sector by a separate road fund, not shown in the budget, which will be self-financing and
responsible for road maintenance.) In addition, the ongoing reform of the civil service at both the
federal and regional levels should ensure that the maintenance of adequate remunerations will be
partly offset by a restructuring of personnel, so as to maintain wage and salary outlays under 6
percent of GDP. Defense expenditure would fall back to the range of 2-3 percent of GDP,
following a sharp rise in 1997/98 owing to the border dispute with Eritrea. To strengthen
financial management, all accounts maintained by line ministries and other spending agencies
will be consolidated in a single treasury account.
20. The government will begin consolidating the financial statements of the major public
enterprises to facilitate the conduct and monitoring of fiscal policy. Moreover, the government

may also need to make in the next several years equity contributions to certain state-owned
firms, including the Commercial Bank of Ethiopia, to put them on a sound financial footing.
Such contributions, however, would be covered by noninflationary domestic resources or
concessional foreign borrowing.
21. The control of the regions' fiscal operations will be enhanced by timely and systematic
reporting of revenue and expenditure data from the regions to the federal government, and by the
establishment of a centralized accounting system that consolidates all regions and includes the
extent and use of donor funding. Criteria will be developed to determine appropriate revenue
shares for the central and regional governments, improve the formula used to determine grants
from the central government to the regions, and ensure that the allocation of expenditure at the
regional levels is consistent with the government's development aims. Any borrowing by the
regions will continue to be monitored closely to safeguard overall macroeconomic stability.
Monetary and exchange rate policies
22. Monetary and exchange rate policies during 1998/99-2000/01 will be geared toward
achieving the inflation and external sector targets envisaged under the program. Exchange rate
policy will be consistent with the envisaged liberalization of the external current account and the
need to foster export diversification and rebuild net foreign assets to a more comfortable level.
The differential between the parallel and the official, auction-determined exchange rates has
been practically eliminated, as the exchange rates in the two markets have converged since
January 1998. With only a small segmentation of the exchange market, the exchange rate is
largely market based. The government's policy will be to allow the exchange rate to be
determined by market forces, while the planned reforms in the exchange system are meant to
eliminate the remaining restrictions on the making of payments for current international
transactions and to establish an interbank market for foreign exchange (see below).
23. At the same time, in the wake of the financial sector reforms described in paragraphs 24-30,
the monetary program will be premised on an increase in the demand for broad money that is
consistent with the envisaged financial deepening. In addition, and to improve the efficiency of
the financial system, the use of indirect monetary policy instruments, such as open market
operations with public securities, will be stepped up, while less reliance will be placed on reserve
requirements.

D. Reforms and Policies in the Financial and External Sectors

Financial sector reforms
24. The government has already taken a major step toward the liberalization of interest rates. In
January 1998, it lifted the control over the lending rates of commercial banks and kept only a
minimum floor on their deposit rate set by the National Bank of Ethiopia (NBE), while ensuring
that it was made positive in real terms. Henceforth, the NBE will be maintaining the minimum
deposit rate for banks at a positive level in real terms. From a regime in which both deposit and
lending rates were fixed, liberalization commenced with the deregulation of the lending rate,
which, in a way, is the more difficult side. As the excess liquidity in the banking system tapers

off gradually, it will be possible and appropriate to remove the remaining control on the interest
rate regime. This process will be expedited by the establishment of an interbank money market in
the near future (see paragraph 26) as well as a securities market subsequently, which would help
redirect the asset holdings of public entities' funds from bank deposits. The development of a
securities market will therefore facilitate market determination of interest rates at real positive
levels, contributing to resource mobilization and macroeconomic equilibrium. As noted earlier,
the focus will be on bond issuance by nonbudgetary public entities, and, since the government
will seek to minimize domestic borrowing, the market for treasury bills will complement the
bond market. To facilitate this development, the government will securitize as necessary part of
its overdraft position with the NBE.
25. The modalities of the treasury bill auctions will be modified so as to make them more
competitive and allow wider participation. The interest rate on the treasury bills will be allowed
to be market determined. In addition, the minimum denomination of the bills will be reduced to
Br 5,000 to facilitate a broader participation in the auctions by the private sector. The NBE's
open market operations will not be offset by central bank rediscounting and lending, and the
NBE will be fully supported by the holding of all government deposits. Furthermore, public
enterprises will freely hold their deposits in commercial banks of their choice, and all banks
holding savings and time deposits of public enterprises will remunerate them at competitive,
market-determined interest rates.
26. Recognizing that a substantial portion of the excess liquidity of the banking system is held by
the state-owned Commercial Bank of Ethiopia (CBE), a number of steps have been already taken
to foster the development of an interbank market in local currency: (i) the CBE has agreed to
provide overnight lending to other banks to enable them to cover shortfalls in their reserve
position with the NBE, and it is studying the feasibility of providing term loans to private banks;
(ii) commercial banks have agreed to provide syndicated loans, and they are seeking to establish
a pooled rating system to assess the creditworthiness of clients; and (iii) commercial banks are
forming a bankers' association and have already drafted its by-laws. During the program period,
the authorities will adopt additional measures to make the interbank market more functional. A
vibrant money market will facilitate greater reliance on indirect instruments of monetary policy
(such as open market operations with government paper) and-to a lesser extent-on reserve
requirements to influence banking system liquidity and interest rates.
27. The NBE recently completed an update of its June 1997 examination report on the financial
situation of the CBE, which accounts for some 90 percent of bank deposits. Based on the
findings of the original report and its update, several steps will be taken to strengthen the CBE's
financial situation. First, loan collection efforts will be intensified so that the CBE's net
outstanding stock of nonperforming loans, which was reduced from 35.8 percent of total loans at
end-November 1996 to an estimated 24 percent at end-February 1998, will be reduced further to
15.4 percent by end-June 1999. Second, the CBE will be required to provide adequate provisions
for all nonperforming loans, and to write off all assets deemed worthless, unless such loans or
assets have been collected in full in cash or brought current with respect to contractual
repayment of principal and interest. Third, the CBE will be required to comply strictly with all
prudential banking regulations, including the NBE's directive on the single borrower loan limit,
and it will be required to bring all loan balances exceeding this prudential limit into compliance

by September 1998 and to reassess all overdrafts since September 1997 and take appropriate
actions. In addition, the CBE will develop, in consultation with the NBE's Banking Supervision
Department, a comprehensive policy and procedure manual on the renewal/conversion into termloans of expired overdrafts. Fourth, the CBE's capital and reserves will be strengthened to ensure
that they are equivalent to not less than 9 percent of total risk-weighted assets, and not less than 7
percent of total assets.
28. Other structural reforms of the financial sector will focus on improving the environment
within which banks operate. A foreclosure law has already been enacted; mechanisms for sharing
information on borrowers and arrangements for undertaking credit rating of clients (such as the
setting up of an information bureau on borrowers among the banks) will be developed; and steps
will be taken to upgrade the training program for bankers and encourage banks to introduce
modern banking organization, technology, and practices. These measures will enhance the
efficiency of financial intermediation and assist in tackling the problem of nonperforming loans.
In the case of the CBE, an external financial and managerial audit will be carried out by an
independent, internationally reputed firm, with a view to providing recommendations for
improving the operations of the bank. This audit will be launched shortly by issuing invitations
to bid, and a firm will be selected to conduct the audit by December 1998. Taking the audit's
recommendations into account, it is envisaged that the CBE will enter into a management
contract with a reputed international institution to help increase its efficiency. At the same time,
to boost the competitiveness of the banking system, additional banks will be allowed to begin
operations; the Construction and Business Bank (the second-largest commercial bank) will be
privatized; and the capital requirement of banks will be raised from the present level of Br 10
million. To ensure the soundness of the new entrants without however, unduly discouraging new
entry; the existing banks will be allowed time to adjust their capital levels.
29. At present, the financial sector is not adequately equipped to provide medium- and long-term
loans, credit to small and microenterprises, or venture capital. To address these shortages, the
Development Bank of Ethiopia will be strengthened both in terms of management and finance,
while rural banks will be encouraged to expand. Regarding the creation of venture capital, it is
envisaged that the International Finance Corporation (IFC) will provide support in establishing a
suitable financial institution.
30. As an integral part of the expansion and development of the financial sector, the capacity of
the NBE to supervise and regulate financial intermediaries will be improved. In particular, the
legal and regulatory framework to govern all financial institutions will be updated; the NBE's
Banking Supervision Department will be strengthened, as will prudential guidelines; and a
standardized reporting system will be put in place for all commercial banks to permit the
consolidation of their accounts in the monetary survey. With regard to strengthening the capacity
for banking supervision, in particular, the staffing and training facilities of the NBE will be
improved, and the framework for banking supervision and prudential regulation will be extended
to cover all financial institutions. To this end, the NBE will draw on technical assistance
provided by the Fund and bilateral donors. A satisfactory bank supervision system will be put in
place over the next three years, after which the government will consider allowing foreign banks
to enter the banking system.

Trade and exchange system reforms and debt management

31. Substantial liberalization of the exchange and trade system has already been undertaken,
driven by the aim of integrating Ethiopia into the global markets for goods and services. In
pursuit of this objective, import tariffs have been progressively reduced, and the payments and
exchange regulations for foreign trade in goods and services have been increasingly liberalized.
In the medium term, further progress will be made in tariff reduction, and the current account
will be fully deregulated. Currently, the tariff structure consists of a maximum rate of 50 percent,
seven tariff bands excluding the zero-duty rate, an average rate of 21.5 percent, and no
discretionary duty exemptions. While there is room for further reduction, fiscal considerations
need to be taken into account. During 1998/99, the maximum tariff will be reduced to 40 percent,
the tariff bands excluding the zero-duty band to six, and the average rate to 19.5 percent. In the
following two years the average rate will be lowered by 2 percentage points to 17.5 percent, and
a further reduction to 15 percent will be studied. In this area, the government will benefit from
the technical assistance recommendations provided by the Fund. To encourage exports, the duty
drawback scheme will be operated on a deferred payments basis-allowing exporters to import
inputs at world prices up front. Initially, the deferred payments system will apply to a few
selected commodities, and it will be expanded subsequently along with the strengthening of the
capacity of the Customs Office to operate such a system.
32. In the exchange system, the envisaged reforms are intended to eliminate the remaining
restrictions on the making of payments for current international transactions relating to
education, travel allowances, and remittances, and to establish an interbank market for foreign
exchange. The external current account will be fully deregulated during 1998/99 in accordance
with the timetable of measures set out in the attached policy matrix. Foreigners residing in
Ethiopia will be allowed to buy foreign exchange for remittances, with only ex post verification.
Thus, the exchange restriction arising from limitations imposed upon the transferability of
balances maintained in the nonconvertible birr accounts of nonresidents will be eliminated. The
envisaged deregulation of the external current account transactions will be communicated in a
public announcement.
33. Another measure of exchange market liberalization consists of the elimination of the foreign
exchange surrender requirement in August 1998. Exporters will be able to sell their foreign
exchange receipts to any bank or foreign exchange bureau at freely negotiated rates over an
extended conversion period of four weeks, and they will be able to retain the remaining 10
percent in a foreign currency deposit account indefinitely. In addition, they will be free to use the
foreign exchange repatriated to the country for bona fide imports of goods and services within
the conversion period. Although the existing conversion period of three weeks provides ample
time for market participants to effect sales of foreign exchange, it will be extended by an
additional week to give extra time to exporters. Inward private remittances will be allowed to be
held in foreign currency deposits accounts, subject to retention and conversion requirements
similar to those that apply to exporters. The exchange restriction arising from the unremunerated
bid bond requirement imposed upon the purchase of foreign exchange in the auctions will be
eliminated. Additionally, investors with large import requirements-over US$500,000 at a timewill continue to be allowed to buy foreign exchange directly from the weekly wholesale auction
of the NBE. Finally, following the public announcement of the above exchange liberalization

measures, the commercial banks will be responsible for ascertaining that their clients, when
purchasing or selling foreign exchange, are in full compliance with the existing import and
export licensing and foreign exchange regulations. Hence, the NBE will no longer check ex ante
traders' compliance with trade and exchange regulations. It may, however, conduct ex post
checks of transactions on a sample basis to forestall underinvoicing and overinvoicing.
34. An interbank market for foreign exchange will be established to replace in stepwise fashion
the present auction system of retail trading of foreign exchange for imports. As a first step, at the
end of each week, the excess holding of foreign exchange-determined in relation to the foreign
exchange exposure of the banks and bureaus and their capital-will be resold to the NBE at the
marginal exchange rate of the auction held at the beginning of that week. During the week, the
exchange rate will be market determined in an interbank market, which will entail the buying and
selling of foreign exchange freely between banks, foreign exchange bureaus, and clients, and
between banks themselves. Thus, there will be a wholesale auction trade of foreign exchange at
the beginning of each week, in which banks and foreign exchange bureaus buy foreign exchange
from the NBE, and a settlement of the excess holding at the end of the week. Consideration will
also be given to increasing the frequency of the auctions. Finally, with the progressive
development of the interbank foreign exchange market, the NBE will be expected to become a
participant in that market-buying and selling foreign exchange in the interbank market while
taking due care to secure the target level of net official foreign assets. For purchases and sales of
foreign exchange outside the auctions, the NBE's buying (selling) rate on any given day will be
the average buying (selling) rate prevailing in the interbank market on the preceding business
day. As the NBE shifts an increasing volume of its net foreign exchange sales from the auctions
to the interbank market, the auction market would eventually be phased out.
35. With regard to foreign exchange bureaus, their scope of operation will be widened by
allowing them to conduct all approved spot/cash (current account) transactions within the
specified limits without prior authorization by the Exchange Control Department of the NBE.
Moreover, consideration will be given to allowing bureaus to operate outside the banking system
after the implementation of the present ESAF arrangements, as part of the measures to liberalize
the capital account.
36. As a low-income, heavily indebted country, the government of Ethiopia will neither borrow
nor guarantee debt on nonconcessional terms. Ethiopia will continue to seek debt relief from
Paris Club creditors on concessional terms even after the end in October 1999 of the
consolidation period under the 1997 Paris Club agreement. Concurrently, it will continue to seek
debt relief on at least comparable terms from all other bilateral and commercial creditors. Under
the present Naples terms flow rescheduling, entailing a 67 percent reduction in net present value
(NPV) terms of debt service on eligible debt, the debt relief provided by these creditors would
reduce the average debt-service ratio over the 1996/97-1998/99 period from 46 percent of
exports (before rescheduling) to below 15 percent (after rescheduling). While this reduction is
significant, the remaining nonreschedulable debt service will remain relatively large. For the
future, the government plans to continue to pursue a prudent debt-management policy, borrowing
only on concessional terms. The government will aim at eliminating all outstanding external
payments arrears through debt relief from Paris Club and other bilateral creditors, and it will not
incur new arrears on debt that is not expected to be subject to rescheduling. Furthermore, the

government will strengthen its capacities for management and monitoring of foreign aid and
external debt to ensure, among other things, the timely disbursement of external aid.

E. Other Structural Reforms and Sectoral Policies

37. Ethiopia has achieved economic stability and progressed successfully toward a market-based
economy. Commodity prices are virtually all decontrolled; macroeconomic prices, such as the
exchange rate, will be fully decontrolled in 1998/99, along with the liberalization of external
current account transactions in goods and services; and steps have been taken toward
deregulating the interest rate. The challenge is to deepen these gains, actual and foreseen, by
enabling the supply responses of economic agents to be realized satisfactorily. In particular, the
central objective of rapid, broad-based and sustainable growth with concomitant poverty
reduction requires both the maintenance of macroeconomic stability as well as implementation of
a set of structural measures for consolidating or further strengthening reforms pertaining to (i)
agricultural and rural development; (ii) the nexus of exports and private and financial sector
development; (iii) poverty alleviation and social sectors; (iv) infrastructure and the environment;
and (v) capacity building, including reform of the civil service.
38. Many of the policies already described have an important bearing on these areas. Additional
measures with a more "sectoral" flavor are outlined below. First, however, it is worth
emphasizing a central tenet of economic strategy in Ethiopia, namely, widespread sharing of
growth is to be achieved through an emphasis on agricultural and rural development in the
context of the existing egalitarian distribution of land.
39. This emphasis on rural development and poverty reduction runs through not only the
provision of education, health and other social services, but also that of infrastructure, notably
roads. Because Ethiopia's road density is the lowest in Africa, the difficulty of access to markets
and social and infrastructural facilities is a major contributor to the severity of poverty and the
isolation and vulnerability of the poor, as manifested most tragically in the famines of the 1970s
and the 1980s. The commitment to improve the living standards of the rural population as the
primary focus of development strategy is reflected in calling the strategy AgriculturalDevelopment-Led Industrialization (ADLI). As such, this is also an industrialization strategy, the
impetus for which is provided by agricultural growth, notably by an expansion in demand for
industrial goods. The growth of agriculture, in turn, will be facilitated by tapping the demand for
its products in overseas markets. Similarly, considerations of economies of scale and
employment dictate that industry must also look for sources of external demand. ADLI then can
be said to visualize an integration of the domestic economy with the global economy, leading to
rapid export growth, both for agriculture and industry.
Export development
40. Exports have been receiving much attention in policy formulation and thinking. An array of
additional measures are under consideration for the further encouragement of exports. One
important set pertains to improving the access of exporters to finance, land, and free trade status.

41. As regards finance, the measures comprise (i) removing restrictions on foreign
suppliers'/partners' credit and on importing inputs without payment from foreign collaborators, as
well as on other implicit forms of credit not involving formal loan agreements; (ii) allowing all
exporters of manufactures (including of agro-processed products) to obtain foreign commercial
borrowing; (iii) easing the constraints on debt-equity ratios for exporters by allowing the NBE to
authorize exporters to exceed the limit of 60/40 that currently obtains; and (iv) allowing banks to
open usance import letters of credit for exporters with confirmed letters.
42. With respect to land, the authorities, recognizing the difficulties of acquiring land quickly in
Addis Ababa and that the full implementation of the lease system will take some time, are to ease
the constraints faced by exporters on an urgent basis by making at least ten sites with electric
power available to exporters for immediate occupancy, along with underutilized land on the
Nefas silk estate.
43. Regarding the strengthening of free trade status for exporters, the measures include
eliminating price and quality preferences for domestic input suppliers and further improving the
duty drawback and exemption schemes, with the aim, inter alia, of having a transparent,
automatic, and computerized administrative mechanism with pretabulated input-output
coefficients.
44. Other actions to promote exports that are under implementation or are to be implemented
during the course of 1998/99 are as follows: (i) elimination of price verification for all
nonagricultural exports and those agricultural exports for which verifiable international prices
are not readily available; (ii) for other agricultural exports, except coffee, the replacement of ex
ante price verification with ex post audit, and, for coffee, the replacement of the verification of a
single point price with the verification of a range of prices for each variety; (iii) the further
strengthening of the important initiative of the recently established Export Promotion Council
(chaired by the Prime Minister) for private sector consultations by the more frequent scheduling
of meetings; (iv) the simplification of procedures for nonequity collaboration with foreign firms,
including extending all services provided to equity investors by the Ethiopian Investment
Agency (EIA) to other partners; (v) the provision of any certification required from the Bureau
of Standards within three days, failing which it will be deemed to have been automatically
provided; and (vi) the clearing of customs for exports in no more than three days.
45. In addition to the above-mentioned array of measures to be implemented during 1998/99, the
government is examining a range of other actions, with technical assistance from the World
Bank. The aim is to formulate a package of additional export promotion reforms during the
current fiscal year. The measures under consideration require further examination of details,
costs, design, and feasibility, especially to minimize demands on scarce administrative capacity.
They include the following: (i) a set of measures pertaining to finance (i.e., collateral
agreements, domestic usance finance, an import finance revolving fund, export finance
guarantees, and investment finance and leasing); (ii) other actions to fortify free trade status for
exporters, such as a scheme for bonded manufacturing warehouses; and (iii) a set of sundry
measures proposed in a World Bank study to further facilitate entry into exporting activities,
coffee and mining exports, and air freight.

Private sector development and foreign investment

46. The reforms on exports outlined above have an obvious and important bearing on private
sector development more generally, including foreign investment. The government also
envisages several other measures to promote private sector development with a less immediate
and direct export dimension.
47. One highly significant set of measures aims to both encourage foreign investment and a
greater role for the private sector in the provision of infrastructure. These measures comprise the
implementation of the recent decisions to allow foreign participation in the telecommunications
and power sectors.
48. A further revision of the investment code is envisaged. This will remove for foreign investors
in the engineering, metallurgical, pharmaceutical, chemical, and fertilizer industries the
requirements for a minimum size of investment in joint ventures and for an upper limit in sole
ventures.
49. Notwithstanding the considerable efforts that have been made in recent years to ease
regulatory constraints, they remain an important area for future reform. The next step in this
process is the demanding one of undertaking a comprehensive study, with technical assistance, to
identify systematically the regulatory constraints and the measures needed to address them, in
particular by classifying the remaining regulations into the following categories: (i) those to be
removed; (ii) those to be modified; and (iii) those to be retained.
50. The task of fostering more private sector development is likely to be greatly facilitated by
establishing a broad-based forum for regular consultations between the private sector and the
government, along the lines of the Export Promotion Council.
Privatization
51. While considerable progress has been made with the privatization of smaller enterprises,
especially in trade and other service sectors, which account for the bulk of the 175 enterprises
privatized to date, the more complex divestiture of larger industrial firms and state farms has
lagged behind. To accelerate the pace of privatization, the government sought the assistance of
the World Bank, particularly in financing a study by Price Waterhouse to identify ways of doing
so. The large, multivolume study has just been completed.
52. Among other things, the study suggests different modalities of privatization for each of the
114 enterprises to be divested. These proposals, along with ways to strengthen the Privatization
Agency, are to be examined with technical assistance from Germany, which is expected to
commence in November 1998. During 1998/99, the government aims to develop a Privatization
Action Plan to accelerate the speed of privatization.
53. The aim is to complete the process of privatization over the 1998/99-2000/01 period.
Whether that will be achieved will depend, of course, on the response of the private sector, but
also on the capacity of the Privatization Agency, the timing and extent of external technical

assistance, and the passage by parliament of a set of amendments to privatization-related laws.

The government expects to be able to formulate these amendments by December 1998.
54. In light of the constraints noted above, it would not be prudent to set a firm target date for
completing the privatization of all 114 enterprises. The government is committed to doing so at
the earliest feasible date, subject to these constraints, as well as to the objective of establishing a
transparent, corruption-free process that obtains reasonable prices for public assets.
Notwithstanding the uncertainties with regard to the pace of the program and pending the
completion of the action plan, at this stage it is considered feasible to set a firm target of bringing
at least 80 enterprises to the point of sale by June 2001. The action plan would examine how this
target could be made more ambitious. In any event, by December 1998, ten state farms and two
large enterprises (a brewery and a cement plant) are to be brought to the point of sale.
Capacity building and reform of the civil service
55. "Regionalization" refers to the devolution of powers from the federal government to the
regional governments. A primary goal of the regionalization program is promoting inter-regional
equity and reversing the neglect of rural areas relative to urban areas. The implementation of a
wide range of developmental programs and projects is now left to the regions. Their capacity to
deliver effective and efficient development interventions varies widely, as does their capacity for
revenue collection. Problems of staffing and communication across regions remain. The
government's strategy for addressing these issues centers around the Civil Service Reform
(CSR), supported by a number of donors.
56. The CSR covers a much broader agenda than traditional civil service reform programs. It
covers judicial, legal, and financial management reform designed to improve the functioning of
the public sector and to deal with the ongoing decentralization program by creating the
framework and strengthening the institutions needed to exercise the powers and responsibilities
of the regional administrations.
57. There are five major components of the CSR: (i) the economic management and control
component includes the reform of procurement, auditing, and internal controls and the provision
of training for relevant staff, including those from the regions; (ii) the human resource
management component seeks to reform performance appraisals and job classifications, and
improve the incentive system; (iii) the service delivery component is designed to improve the
quality of services provided by public sector employees, including the establishment of a
complaint-handling mechanism; (iv) the top management systems component aims to improve
the selection and performance of senior government officials; and (v) the ethics and judicial
reform components are designed to overhaul the legislative framework to reflect the 1994
constitution and strengthen the judiciary.
58. Given the scope of the CSR, it is unlikely that all its goals will be achieved by the announced
completion date of June 2000; however, important progress has been made in the first three
components listed above, and continued progress is essential to the decentralization program.
The CSR will be important in improving the environment for the strengthening of social capital
by increasing the efficiency, transparency, and accountability of public administration.

Rural development
59. As noted above, agricultural and rural development is the highest priority of the government.
In the reforms undertaken by the present regime since its inception in 1991, improvement of the
living standards of the rural population has been an abiding concern. In this endeavor, the
liberalization of agricultural prices and marketing, and the hefty depreciation of the exchange
rate-coupled with measures to strengthen rural institutions (notably the provision of extension
services, seeds, fertilizers, and credit, the improved functioning of markets, and enhanced
security of land tenure)-have had a major impact.
60. The next phase of rural reform is less amenable to quick actions and results. It comprises the
interrelated nexus of the further strengthening of rural institutions (especially for provision of
credit) and measures to increase yields per hectare (particularly through increased fertilizer use),
reduce the vulnerability to weather-related risks (which is exceptionally high in Ethiopia), and
improve the provision of infrastructure (especially roads) and social services.
61. In recent years, the increase in yields per hectare of the land already under cultivation has
been offset by lower yields in new, less productive land brought under cultivation, so that the
average yield has stagnated. Raising agricultural yields involves many factors, including
improving extension and agricultural research (which is being assisted by a World Bank project),
and increasing the effective demand for, and availability of, improved seeds and fertilizers, as
well as irrigation. The quickest impact is likely to come from a greater application of fertilizers.
62. In this context, it should be borne in mind that the use of fertilizers in Ethiopia, at 7
kilograms of nutrients per hectare, is about half of the sub-Saharan Africa average of 13
kilograms; meanwhile the world average is 97 kilograms of nutrients per hectare. Moreover,
there has recently been a sharp reduction in the farmers' benefit-cost ratio (the addition to net
total revenue due to a unit increase in expenditures on fertilizers). Given the relatively high ratio
that rational, risk-averting Ethiopian peasants are believed to require to invest in fertilizer-partly
because of the high variability of yields- this matter deserves serious consideration. The less
controversial part of the solution is to exploit the potential for reducing fertilizer costs through
improved marketing and credit distribution. A more difficult task-pending the improvement in
infrastructure-is to design and implement a scheme for risk sharing in fertilizer use. Whether and
what type of a scheme that is administratively simple and affordable (without involving
subsidies) can be devised is to be examined.
63. Another set of measures involves improving the incentives for peasants to invest in low-cost,
labor-intensive land improvement. In addition, to facilitate access to land held by smallholders
for commercial farming, adoption of the recent measure enacted in the Oromiya region to
increase the allowable lease period to 15 years should be encouraged throughout the country.
Furthermore, procedures for leasing agricultural land (such as those pertaining to duration and
marketability of lease, and environmental protection) should be reformed.
64. The above-mentioned areas-along with measures to strengthen institutional capacity in the
regions for assisting land improvement and rural investment-are to be examined. So are actions
to promote rural nonfarm activities (such as the provision of finance and related services), and a

pilot project, to be implemented by nongovernmental organizations (NGOs), to organize rural

handicrafts for exports. The actual implementation of these measures is expected to commence
mostly during the next fiscal year, 1999/2000.
65. Another set of measures whose implementation is to go into full swing in the current fiscal
year pertains to the provision of roads, education, and health in the context of the SIPs, supported
by several donors. The Road Sector Development Program (RSDP), whose implementation is
just getting under way, aims to reduce the proportion of farms that are more than half a day's
walk from the nearest all-weather road from the current 75 percent to 50 percent over five years,
and to 25 percent over ten years. The targets for improved rural coverage of education and health
services are discussed elsewhere.
Infrastructure
66. Development of the road network is a critical part of the government's strategy to integrate
the rural population into the economy. Ethiopia's current road network of 23,812 kilometers
translates into one of the lowest road densities in Africa, and, as mentioned in the preceding
paragraph, 75 percent of farms are more than half a day's walk from the nearest all-weather road.
The RSDP plans to expand the road network by 80 percent by 2007, at a cost of US$3.9 billion.
A number of donors have pledged support, including the World Bank, which, in January 1998,
approved a loan for US$309 million, the first of three loans planned.
67. Reforms undertaken in support of the RSDP include giving autonomy to the Ethiopian Roads
Authority, implementing a road fund for sustainable road maintenance, increasing the
involvement of the private sector, liberalizing transport charges, and privatizing parastatal freight
transport enterprises and relief fleets.
68. The recent closing of the border with Eritrea means that the main port for Ethiopia has
shifted from Assab to Djibouti, which has comparable capacity. Efforts are under way to
improve the capacity of the Djibouti port, and several steps have been taken to ease restrictions
on its use, including the ending of the parastatal monopoly on customs clearing and forwarding
services, and the easing of restrictions on commercial road transport on the Djibouti corridor, and
of customs, visa, and passport requirements for truck drivers.
69. Ethiopia has one of the lowest levels of energy consumption in the world-only 5 percent of
the population has access to electricity. Private sector participation will clearly be needed if this
is to change in the near future, and the government accordingly has recently decided to remove
restrictions on private sector participation in electricity generation (see section on private sector
development), and also to privatize the Calub Gas Company. Parallel reforms include the
elimination of all subsidies to, and commercialization of, the public utility, and the enactment of
a new regulatory framework.
70. The very limited access to telephone services should improve with the recent decision to seek
a strategic private partner for the Ethiopian Telecommunications Corporation (ETC). This will
be done in a way that seeks to ensure that the rural population is not left out as the
telecommunications sector develops.

71. Four critical steps should follow. First, the new policy for the sector, which foresees private
participation, should be formulated in a telecommunications policy statement; the statement
would set out the objectives, the options it proposes to achieve those objectives, and exactly how
it plans to allow private participation and to amend the legal framework to allow private sector
participation. Second, labor issues, appropriate levels of capital expenditure in the run-up to
privatization, the level of the ETC's debt, and the rebalancing of tariffs in preparation for private
participation in ETC should be examined. Third, how sector policy and structure can be set up in
such a way as to attract as much private participation in providing service in rural areas should
be analyzed, as well as what form of public-private partnership will be needed for this purpose.
Finally, appropriate advisors for the sale itself-usually high-quality international investment
bankers and lawyers-should be recruited.
72. The water sector faces a critical deficiency of physical infrastructure. Only 27 percent of the
population has access to potable water, and only 7 percent has access to sanitation facilities.
Water supply and sanitation operations were decentralized to the regional governments in 1993,
but the regional bureaus have a relatively low capacity for managing operations and regulating
functions. In addition to the need to strengthen the regional bureaus (which is being undertaken
with support from a World Bank project), the Ministry of Water Resources aims to develop the
capacity to handle water resource policy, which would also enable Ethiopia to participate in the
Nile Basin management initiatives more effectively.
Environment
73. The three most urgent areas of environmental concern are as follows: (i) the considerable
land degradation, including loss of nutrients owing to removal of animal manure and crop
residues for use as fuel and cattle feed; (ii) the low quality and availability of water, as a result of
which only about one-fifth of the population has access to safe water; and (iii) the rapidly
growing urban environmental problems, including lack of sanitary facilities, inadequate refuse
collection, and low standards of housing.
74. The government has had a comprehensive National Conservation Strategy (NCS) in place
since 1994. Grant funds are being used to fund implementation. An Environmental Protection
Agency has been established, and basic environmental legislation has been prepared. Continued
and strengthened implementation of the NCS will be important for the protection of Ethiopia's
environment.
Poverty
75. Ethiopia's per capita GNP of US$110 is one-fourth the average for sub-Saharan Africa and
just about the lowest in the world. Pervasive poverty is manifested, inter alia, in the highest
incidence of malnutrition and the lowest primary school enrollment ratio in the world. Severe
infrastructural shortcomings, notably the lowest road density in sub-Saharan Africa, contribute to
the isolation and vulnerability of the poor, particularly in drought years.
76. The low level of average income severely limits the scope for transfers, subsidies, and social
safety nets (although such limited safety nets as exist exhibit a low level of leakages, according

to a United States Agency for International Development review). As noted above, the
pervasiveness and severity of poverty makes redressing it an integral and central part of the
overall development strategy.
77. There is evidence of a significant decline in poverty during the recent years of rapid
economic growth and good harvests. The widespread sharing of the benefits of growth,
particularly through the emphasis on agricultural and rural development in the context of an
egalitarian distribution of land, has been stressed above.
78. Measures to reduce the high variability of incomes, as indicated in earlier sections, are likely
to have a particularly beneficial effect on the poor, who lack a consumption-smoothing
mechanism.
79. In addition to broad-based growth, the government has acted promptly and decisively to
make food available from stocks, exceptional imports, and surpluses areas to food-deficit areas
in bad agricultural years. It has thereby succeeded in avoiding the famines that have
unfortunately occurred in recent decades. The government will continue to exhibit this vigilance
to avert future threats of famines. At the same time, a systematic program to alleviate food
insecurity is to be finalized during 1998/99. This strategy needs to take account not only of
drought-related insecurity but also of the more regular seasonal insecurity.
80. In this regard, the authorities' road sector program is of special significance, not only because
it will bring markets and imports within reach of families, particularly in isolated areas, but also
because it will facilitate getting food into food-deficit areas in the lean season.
81. The other two sector investment programs, for education and health, also have a significant
bearing on the alleviation of poverty. These are discussed below.
Social sectors
82. The very high priority given by the government to the social sectors is seen in the
development of comprehensive sector development programs for health and education. Both
programs are being supported by almost all the donors active in these areas in Ethiopia,
reflecting the consensus reached on objectives, strategies, policies, and implementation
arrangements.
83. The Health Sector Development Program (HSDP) addresses all health service activities of
the central and regional governments from basic services to specialized and referral services. It is
expected to bring significant improvement to the entire health system, and, in particular, to longneglected rural areas and to especially vulnerable groups (such as mothers and children) that
would benefit from the expansion of health services.
84. The focus will be on the health conditions that contribute most significantly to the burden of
disease in Ethiopia: reproductive health care, treatment and control of basic infectious diseases
(upper respiratory tract infection and tuberculosis, in particular), control of epidemic diseases
(especially malaria), immunization, and control of sexually transmitted diseases (particularly

AIDS). All health institutions will incorporate in their services preventive and promotive aspects
of health, as well as education on health and nutrition and on environmental health and safety.
The HSDP aims, by 2002, to improve primary health coverage from 40 percent to 55 percent,
contraceptive use from 9.8 percent to 20 percent, and immunization coverage from 67 percent to
80 percent.
85. The Education Sector Development Program (ESDP) seeks to raise enrollment rates,
especially in underserved rural areas, and improve the quality, equity, and relevance of
education. Target populations will include girls, who will benefit from gender-sensitive curricula
and books, and more female teachers, and children out of school and dropouts, who will have
access to nonformal education. The ESDP aims to raise the primary school enrollment ratio from
30 percent to 50 percent, reduce the student-to-book ratio from 5:1 to 1:1 in core subjects, and
facilitate private sector involvement in education.
86. The strategy focuses on four areas: (i) a restructuring of the education system into
kindergarten for children aged 4-6, primary school from grades 1 to 8, secondary school from
grades 9 to 12, and higher and vocational education; (ii) a curriculum change in line with the new
education objective and to increase the relevance of education; (iii) an improvement in the
quality of education throughout the system; and (iv) the expansion of primary and vocational
education to meet the demand, and to improve equity and sustainability of the education system.
87. Both sector programs will primarily be implemented and managed by regional, zonal, and
"woreda"-level officials, coordinated by steering committees established at the central and
regional levels. An annual review will be undertaken jointly by the government and donors to
reexamine the objectives, priorities, and targets, and a work program and budget will be agreed
to for the following year. The government aims to increase the share of the budget allocated to
health and education every year to the extent consistent with macroeconomic stability.
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IV. External Financing Requirements and Debt Sustainability

88. Over the program period 1998/99-2000/01, real export growth is projected at an average
annual rate of 9 percent. Coffee export volumes are projected to grow by 3 percent per annum
and international coffee prices to decline by more than 25 percent over the program period. With
the envisaged increase in the share of washed coffee, Ethiopia's coffee will command premium
prices. Noncoffee exports are expected to grow by 15 percent a year, sparked in part by the startup of operations of the recently privatized gold mine. Import volumes are projected to grow at
about 4.5 percent annually during the program period, reflecting the import requirements of the
SIPs financed by the World Bank and other donors. The projected deterioration in the terms of
trade and additional import requirements for the SIPs would result in a widening of the trade
deficit from 14 percent to 15 percent of GDP during the program period. Accordingly, after
taking into account projected increases in private transfers and service receipts, the current
account deficit (excluding official transfers) would stay in the range of 8-8 percent of GDP
during the period 1998/99-2000/01.

89. Over the same period, the total external financing requirement is projected at US$8.6 billion,
taking into account the projected current account deficits, the targeted reserve accumulation, and
the need to clear all external payments arrears (Table 3).2 Disbursements from existing grant and
loan commitments are estimated at US$0.44 billion, while disbursements from expected but notyet-pledged new commitments are projected at US$1.56 billion. Total disbursements are
projected at US$2 billion, of which about US$780 million would be from IDA and US$275
million from the African Development Bank. The initial financing gap of US$6.59 billion could
be covered by debt relief from Paris Club and other bilateral creditors, as well as prospective
drawings under the Fund's ESAF.
90. For 1998/99 the total external financing requirement is projected at US$6.35 billion,
reflecting a current account deficit (excluding official transfers) of US$0.54 billion, scheduled
debt amortization of US$0.52 billion, a targeted reserve accumulation of US$0.1 billion, and a
planned reduction of arrears of US$5.20 billion. These requirements are expected to be covered
by disbursements from existing commitments of grants (US$0.10 billion) and concessional
medium- and long-term loans (US$0.15 billion); disbursements from commitments to be
mobilized of grants (US$0.15 billion) and concessional medium- and long-term loans and other
capital (US$0.23 billion); concessional debt relief (US$5.68 billion); and ESAF disbursements
(US$40 million).
91. At the end of June 1998, Ethiopia's external public debt was estimated at US$10.0 billion, or
about 160 percent of GDP. Of this amount, US$5.2 billion represented arrears to Russia, nonParis Club creditors, and commercial creditors. About 60 percent of the outstanding principal of
US$4.8 billion was owed to multilateral creditors, with most of the remainder owed to official
bilateral creditors. In NPV terms, the debt including arrears at end-1997/98 represented 855
percent of exports of goods and nonfactor services (Table 4). It is projected that after the full use
of existing mechanisms for bilateral debt relief, Ethiopia's NPV of debt-to-exports ratio would
fall to 265 percent at end-2000/01, while the debt-service ratio would decline from 45 percent in
1997/98 to 16 2/3 percent in 2000/01.
92. The NPV of debt-to-exports ratio would remain over 250 percent until 2002/03. To attain
long-term external debt sustainability, Ethiopia will request assistance under the Initiative for
Heavily Indebted Poor Countries (HIPC Initiative), contingent on a successful track record of
implementation of reforms under the program. Given the large external financing needs, it would
also continue to require substantial inflows of official grants. In addition, the external sector
would remain vulnerable to fluctuations in coffee export prices and supply shocks that
customarily affect the country every few years; moreover, in the event of a slower-thananticipated export diversification, external prospects would be considerably weaker than in the
baseline scenario. Policies aimed at facilitating further export diversification and efficiency gains
are consequently essential to attaining external viability.
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V. Statistical Issues and Technical Assistance Requirements

93. Significant improvements have been made over the past few years in the timeliness and
coverage of data, but a number of important weaknesses in the national accounts, fiscal,

monetary, and balance of payments area remain to be addressed as a high priority, since they
hamper macroeconomic and financial monitoring and policymaking. More specifically, the
timeliness and reliability of price and external trade indicators will be improved, the range of real
sector statistics will be broadened, and, the monetary accounts will be revised and the new
system of compilation adopted as soon as possible, building on the findings and
recommendations of recent technical assistance provided by the Fund on banking and monetary
statistics. In addition, following the termination of the use of the birr as a legal tender in Eritrea,
the redemption of old birr notes in Eritrea and the settlement of outstanding balances between the
two central banks will be completed. Finally, strong efforts will be made to reconcile the fiscal
accounts with those of the government's position at the NBE, and to move to a consolidated
presentation of nonfinancial public sector operations.
94. The government will seek technical assistance as needed to bolster the effectiveness of its
economic and structural reform program. Priority areas for assistance include foreign exchange
markets, banking supervision, and tax policy and administration. Support for critical technical
assistance needs, including resident experts, will be sought from appropriate donors. In the
meantime, progress will be made, building upon the findings and recommendations of the
extensive technical assistance provided in a number of areas in recent years.
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Letter
Addis Ababa, September 24, 1998
Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431
U.S.A.
Dear Mr. Camdessus:
1. On behalf of the government of Ethiopia, we are pleased to forward to you a copy of our
medium-term policy framework paper, prepared in close collaboration with the staffs of the
International Monetary Fund and the World Bank, which describes the government's basic
economic objectives for the three-year period 1998/99-2000/01, and the macroeconomic and
structural adjustment policies designed to achieve these objectives. We are also forwarding this
document today to the President of the World Bank.
2. To facilitate a wide dissemination of the policy framework paper, the government of Ethiopia
authorizes the Fund to publish it, including on the IMF Internet site.
3. The government of Ethiopia will remain in close contact with the staffs of the Fund and the
World Bank in monitoring developments and progress in implementing the policies described in
the attached policy framework paper, which will be updated each year as the program is
executed.

Sincerely yours,