The rapid and sustained economic growth that Ethiopia registered over the past years was mainly driven by aggregate demand and it was recorded largely as a result of the expansion of government funded large-scale infrastructure developments. These public investments were financed through heavy debt and external aid. The manner in which these public investments were realized, and the rapid growth achieved over the years has also caused continuous inflationary pressures. In addition, despite its rapid growth, the economy failed to raise productivity and create adequate job opportunities. Due to the heavy debt burden, it has become challenging to sustain the rapid pace of growth, calling for a new growth financing approach doing away from the heavy reliance on public spending and debt financing .
The country’s external debt reached 30.36 Billion USD in 2020 and external debt shock accounts for 28.4% of the Gross National Income (GNI) . For investment in environment and infrastructure, the country received net official development assistance that accounts for 11.58% of GNI of the country in 2010, and this declined to 4.89% of GNI in 2019. Ethiopia has received an approved 389.5 million USD in climate financing from the multilateral climate change funds up to December 2020 .
To implement the updated Nationally Determined Contribution 2021 (NDCs) in the next 10 years, Ethiopia needs an estimated USD 316 billion. The mitigation interventions identified in the NDCs require USD 275.5 billion and adaptations efforts require approximately 40.5 billion. Ethiopia is committed for an investment of 63.2 billion on climate change mitigation and adaptation actions from domestic sources, but is expecting the remaining (conditional) finance of USD 252.8 billion to be received from international climate finance sources .
Ethiopia has heavy reliance on external sources of finances in terms of debt and development assistant, as the country has very low level of saving and low capital accumulation.
The main issue Ethiopia faces is the fact that funding is not readily available for investments required to reach its growth targets. In addition, Ethiopia’s current savings-investment gap is large. While Ethiopia expects to invest 27.5% of GDP over the coming five years, average domestic savings will equal only 11.9%. The projected levels of foreign direct investment, grants, and transfers will not be sufficient to fund the additional investments that is required .
KEY POLICIES AND GOVERNANCE APPROACH
A total of 1,222 climate-related projects were committed to Ethiopia in the period of 2013-2017, with the related total climate commitments summing up to 2.87 billion USD, of which 1.1 billion USD was committed in 2017 to over 326 projects. The four largest providers of climate finance to Ethiopia were the World Bank (WB), African Development Bank (AfDB), United States and United Kingdom, providing around 34%, 9%, 9% and 8% of all climate-related finance flows over the period, respectively .
Successes and remaining challenges
To build the green economy would require an estimated total expenditure of around USD 150 billion over the next 20 years. By developing a green economy, Ethiopia could exchange GHG emissions abatement for climate finance to fund some of the required investment. Ethiopia needs to mobilize international capital to close the funding gap.
In addition, the capital constraint is also a threat to sustainable growth because the infrastructure development projects required for economic growth have high capital costs and long lives. Moreover, many existing carbon-inefficient solutions often require less upfront investment than their low-carbon alternatives .
Climate finance received by Ethiopia predominantly targets adaptation. Climate impacts and risk significantly increase the cost of borrowing in vulnerable developing countries like Ethiopia. In effect, this makes the interest repayments attached to climate-related loans more expensive to return. To finance limited activities in countries such as Ethiopia – vulnerable to the impacts of climate change and at high risk of debt distress as defined by the International Monetary Fund (IMF) – through loans, jeopardizes financial stability and the ability of the government to invest in social infrastructure. Despite these risks, from 2013 to 2017, 50% of total climate finance commitments received by Ethiopia were provided as loans .
Initiatives and Development Plans
Although the government is exerting efforts to increase domestic sources of finance through its fiscal policy instruments, the level of tax revenue is one of the lowest in Sub-Sharan Africa and the tax to GDP ratio has been below 10%. The country has been exerting efforts to raise domestic sources of finance for investment in the construction of renewable energy sources through mobilizing the public to purchase bonds for financing the construction of the Grand Ethiopian Renaissance Dam, which is set to generate about 6000 MW electric power when completed.
Goals and Ambitions
Ethiopia has set a number of targets in its 10 years development plan (2021-2030), as stated above. The investment required for achieving the climate change mitigation and adaptation goals using climate resilient green economy as a key strategy is not indicated in the current 10 years strategic plan. However, the fiscal policy direction of the country in the coming ten years is around the maintenance of a healthy balance between government revenue and expenditure. This will be achieved by:
- Reforming the tax policy and regulations;
- Increasing tax collection efforts and expanding the tax base and hence raising sufficient revenue that will allow the country to reduce the high reliance on external sources of finance (aid and loan);
- Modernizing the tax system and administration;
- Reforming the tax structure and fighting illegal trade activities
All the actions are projected to raise gross domestic revenue from birr 395 billion to birr 3.9 trillion. This is equivalent to an average growth of 26.1% per year. In order to achieve this goal, the tax revenue is projected to increase from birr 317.9 billion to birr 3.5 trillion .
- Ethiopian government is exerting effort to increase domestic sources of finance through its fiscal policy instruments, however, the level of tax revenue in the country is one of the lowest in Sub-Sharan Africa and the tax to GDP ratio has been below 10%.
- As a long-term sustainable finance strategy, the country has to increase its tax base by attracting foreign direct investment, promoting private sector’s role in creating green jobs to the growing labor force, and reducing the debt burden of the country.