Ethiopia targets debt restructure amid default fears

For over two years, since Ethiopia first requested debt relief under the G20 Common Framework, the East African country has teetered on the edge of default. Talks with the International Monetary (IMF) to restructure the debt were stalled by the onset of civil war in the Tigray region in November 2020, but since then, Ethiopia’s economic woes have only become more serious.

The civil war destroyed whole swathes of industry in Tigray and is estimated to have cost Ethiopia around $20m in monthly export revenues. Inflation, partly driven by the disruption to supply chains caused by the war in Ukraine, is currently running at over 30%. The Ethiopian birr has posted steep declines against the US dollar, weakening by 40% since the start of 2020. A weakening currency, alongside higher interest rates in the US, has pushed up the cost of servicing dollar-denominated debts, which stand at over $43bn.

All of these problems are reflected in Fitch Ratings’ assessment of Ethiopia’s creditworthiness. In January 2023 the rating agency downgraded Ethiopia to CCC-, saying that this was the result of “the lack of identified external financing necessary to meet substantial external financing gaps, along with a material decline in Ethiopia’s external liquidity.”

“The CCC- rating reflects the significant risk of a default event,” Fitch added.

Given this, Ethiopia is seeking to borrow at least $2bn from the IMF as part of a wider reform programme. However, the IMF has calculated that Ethiopia faces financing gaps of at least $6bn until 2026, meaning the country would still be $4bn short even if the loan were approved. This means Addis Ababa is likely to require a more comprehensive package of debt restructuring if it is to avoid defaulting on its external liabilities.

Time for a currency devaluation?

Mirkarim Yakubov, chief financial officer at 54 Capital, an asset management firm based in Addis Ababa, tells African Business that talks with the IMF to restructure the debt have been slow to progress, but that optimism is growing that a workable solution is on the horizon.

“One issue has been that the IMF has been pushing to bridge the gap between the official and the unofficial exchange rate,” Yakubov says. “This liberalisation has always been one of the conditions of restructuring the debt. The World Bank, IMF, Ethiopia’s minister of finance, and the governor of the central bank have previously stated that they will take some bold measures to resolve this. But they are yet to reveal any kind of details or indications as to what would actually happen, or the timeframes.”

Another problem for Ethiopia and the IMF to grapple with is ensuring that all of Addis Ababa’s various creditors are aligned and consent to the terms of the new package. Ethiopia has an estimated $13.7bn in debt to China, with smaller amounts owed to Paris Club members and international financial institutions.

As other African countries, such as Zambia, have found out in recent months the complex structure of modern sovereign debt can make renegotiating debts tricky.

While debt used normally to be an arrangement between two clearly identifiable parties, new instruments such as eurobonds often involve several different holders of the security, which might not be easily distinguishable.

US hold-up

There has been speculation in Ethiopia and local media in the country that the US is responsible for holding up the talks. Yakubov tells African Business that “there have been suggestions, at least in the media, that progress now depends on the US administration to give final approval to the restructuring.”

The US is thought to have political as well as financial motivations, given a dispute with the Ethiopian government regarding allegations of human rights abuses during the civil war in Tigray. Ethiopia is seeking to end the mandate of the United Nations’ International Commission of Human Rights Experts on Ethiopia, which is tasked with investigating potential human rights violations and war crimes. The US has strongly opposed ending its mandate.

“The IMF recently said that there has to be alignment and commitment from all the creditors regarding availability for funding – meaningful financing assurances from the creditors,” Yakubov says. However, the fraught politics of the situation will also need to be resolved.

The credit ratings agency S&P Global Ratings recently declared that an IMF deal is “definitely back on the table” and there appears to be a growing sense that a package will be agreed in the near future. The precedent of Chad – which managed to reach an agreement with the IMF and its various creditors under similar circumstances – has given Addis Ababa cause to believe that a deal is within reach.

How to avoid default?

Yakubov notes that Ethiopia has made several contingency plans in order to try to continue financing its debts, even if a restructuring fails – but says that the prospect of a default is “very daunting for the government”.

“In the event of the talks failing, there would be some mobilisation of resources. The government is looking for other sources of dollars, such as by liberalising the financial markets and allowing foreign investors into the telecoms market, for example,” Yakubov says.

“There is also the privatisation of the most significant coffee and sugar corporations, as well as the banking sector,” Yakubov adds. “So, this will help bring some revenue that would help the government to try and build up some reserves for the debt repayments. But it’s hard to imagine that Ethiopia would want to default – that would be the first time it had happened.”

A default would significantly hinder Ethiopia’s attempts to open up its economy to foreign investment and to liberalise the country’s markets. The impact would partly be reputational – putting Ethiopia in the category of debt defaulters – but also practical, limiting the government’s ability to sell sovereign debt bonds at reasonable rates.

Momentum is growing in Ethiopia’s quest to restructure its debts. However, there is still work to be done to avoid a default and all the consequences that would bring.