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China, Ethiopia – it’s complicated …

Ethiopia is a leading investment destination in Africa, particularly for China.

The 2018 Beijing Summit of the Forum on China-Africa Cooperation (Focac) held early in September saw Africa’s top diplomats meet with Chinese President Xi Jinping to discuss a new agenda for Sino-Afro cooperation. 

With China consolidating its position in Africa, much of the focus fell on the financial commitments that would be announced.

President Xi’s commitment comprised $20 billion in new credit lines, $15 billion in foreign aid (grants, interest-free loans and concessional loans), $10 billion for a special fund for development financing, $5 billion for a special fund for financing imports from Africa, and $10 billion to come from Chinese companies through their own investment projects.

Ethiopia is a vital element in China’s foreign policy plan, with over $12 billion provided to the country in loan finance in less than two decades. But is it time investors kept an eye on the country’s dues to China? The Eastern African country is one of continent’s most exciting investment destinations at the moment, with Coca-Cola recently unveiling a $200 million investment plan for the next five years, H&M already set up, China’s Lifan automotive group assembling cars in Addis Ababa and Volkswagen ready to follow suit.

The reasons are not hard to understand – Ethiopia has one of the continent’s fastest-growing economies, a market of over 105 million with GDP-per-capita income at US$909 according to the International Monetary Fund (IMF), and a government determined to establish investor-friendly policies.

However, there are some red lights flashing and investors are watching the relationship between the Ethiopian government and the Chinese with some concern.

Public unease

For much of the last decade Ethiopia has been a leading investment destination in sub-Saharan Africa, particularly for China, with cheap labour luring investment. The McKinsey Global Institute puts Ethiopia’s unit labour costs for the manufacture of polo shirts at 0.14 dollar per unit, less than half the level in China and Vietnam.

And with new Prime Minister Abiy Ahmed in place, the expectations are higher. As Warren Beech, head of mining at Hogan Lovells, says: “The recent political changes and promise of further political reform in Ethiopia, like many African countries, created a wave of optimism. At the same time however, the wave of optimism created great expectations from a population which has, historically, faced significant political and socio-economic depression.”

Since the country faces ethnic unrest, with reports of thousands fleeing the country in 2018 alone, many final investment decisions are uncertain.

Ethiopia debt distress

Ethiopia’s government-debt-to-GDP ratio peaked at 59% this year, up from 46.8% in 2014, as the state went on an infrastructure investment binge.

“China’s choice of Ethiopia as its investment destination of choice is no surprise given the vast mineral resources, including the battery minerals” says Beech. Consequently, more than $12.1 billion has been extended to Ethiopia through various financial instruments since 2000. Arguably the biggest announcement last week came with the announcement of the restructure of a US$4 billion loan for a railway linking the capital Addis Ababa to Djibouti. The loan for the 756-km rail project, which was meant to be paid over 10 years, was extended to 30 years.

It can be argued that infrastructure investment is essential for growth, but how much debt an economy should incur to bridge its infrastructure gap remains a contentious issue.

“Higher public deficits and debt levels are not necessarily undesirable,” says Tao Zhang, deputy MD at the IMF. “For instance, when countries borrow to pay for infrastructure investment that can boost long-term growth, which in turn generates revenues to service the higher debt.”

Despite its stellar economic growth, Ethiopia’s debt and debt-servicing costs are bound to cause fiscal stress. In the 2016/17 financial year, economic growth was estimated at 9%, with new public external loans (including loans not guaranteed by the government) amounting to $2.8 billion. About half of the new commitments were concessional loans from multilateral development agencies and institutions. Of the remainder, close to half were at below-market rates with a grant element of roughly 30% from the Export–Import Bank of China. New loan commitments from private creditors on commercial projects were small, amounting to US$97.3 million, and used for power rehabilitation projects in the power generation and transmission sector.

“Ethiopia’s current financial position has not made the situation any better,” says Beech. “There is an increasing shortage of foreign exchange, because imports to Ethiopia have outstripped exports for the last three to five years. China would understandably be cautious about this. There are also concerns regarding the Ethiopian government’s debt management generally, which is also creating jitters.”

In a statement on Ethiopia’s debt, the IMF reports that “the start of principal repayments on non-concessional loans related to transportation projects and the start of principal repayments of a deposit from a bilateral creditor debt service-to-revenue ratios will peak in 2019/20.”

Dr Martyn Davies, managing director of emerging markets and Africa at Deloitte, says: “We can’t outsource our responsibility of good fiscal management to Beijing, this is ultimately for sovereign countries in Africa to manage themselves. Of course China’s lending and its disbursement of capital is very unique as it tends to lend money with a different calculation of risk.”

With debt restructuring in the form of debt-to-equity swaps gaining popularity, one can only wonder if colonialism has a new face.

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