Macroeconomic Development and Private Sector Performance in Ethiopia: The 1990s Experience

Introduction

After the downfall of the military government in 1991, the transitional government of Ethiopia committed itself to implement the Stabilization and Structural Adjustment Program (SAP) under the auspices of the International Monetary Fund (IMF) and the World Bank. The objective of the program was to remove cost-price distortions, improve market-related incentives, promote private enterprises and exports, liberalize the economy, and reduce the role of the public sector in the economy. A private led, competitive economy operating under a free market and prudent fiscal and monetary policy environments was optimistically expected to emerge from this.

The practical experience of the adjustment program in the last decade, however, revealed that the expected results could not be obtained. The present study tries to explain this failure from a theoretical point of view and from the practical experience of East Asian countries. To this end the article is structured as follows. Following this introduction, I discuss the macroeconomic policies and programs that were put in place in Ethiopia during the period 1992/93–2000 to encourage the private sector in particular and business activities in general. The third part of this article reviews the performances and problems of the private sector during the same period in the country. The fourth part of the article is devoted to reviewing the practical experience of successful East Asian countries and the fifth part tries to highlight the donor agencies' private sector development (PSD) agenda and the link to poverty reduction. The final part concludes the study and draws lessons for Ethiopia.

Macroeconomic Policies and Programs for Private Sector Development (1992/93–2000)

Fiscal Policy

Within a disciplined macroeconomic framework, fiscal policy in Ethiopia was focused on providing basic services and infrastructure while at the same time reducing the overall fiscal deficit. The key objective of the fiscal policy was to strengthen public sector savings, with the twin aim of making available additional domestic and foreign reserves to develop the private sector and of supporting productive public investment (particularly in infrastructure and human capital) to benefit the private sector.

The focus on reducing the fiscal deficit for private sector development is simply due to the fact that the private sector considers the sustainability of the fiscal adjustment when making investment decisions. If deficits are perceived to be unsustainable, then the private sector will expect future tax increases or money creation (inflation tax), which in turn affect its investment decisions.

Therefore, several measures including rationalizing public expenditure, limiting the number of zero-tariff related items and import exemptions, broadening the tax base, introducing rental income tax, reforming interest income and capital gains taxes, reducing the maximum customs tariff rate, and so on were taken. These measures are believed to improve revenue performance while at the same time raising expenditures only moderately and thus allowing for a reduction in the consolidated overall deficit.

Monetary and Financial Policies

Monetary policy in the period under consideration was formulated in such a way as to ensure that the money supply would grow at a rate consistent with targets for inflation, economic growth, and the balance of payments (BOP), while allowing reasonable credit growth to meet the needs of the productive sectors, particularly the private sector. To improve the mobilization and allocation of financial resources, monetary policy was also targeted at ensuring a positive real interest rate for both depositors and lenders. Moreover, to improve the efficiency and soundness of the financial system in creating an environment conducive to private sector development, the policy included institutional and regulatory reforms.

Along these lines, several measures were taken. These included liberalizing interest rates and allowing them to be market determined, allowing for the establishment of private commercial banks and insurance companies, replacing direct monetary policies with indirect ones, and establishing a modern legal and institutional framework for the National Bank of Ethiopia (NBE). In trying to liberalize the interest rate, currently only the minimum deposit rate is set by the NBE. With regard to the indirect monetary policy instruments, treasury bill auctions were introduced in January 1995.

External Sector Policies

The external sector...