Ethiopia – Major progress toward debt restructuring
- Agence MC WEB
- Aug 13, 2024
- 5 min read
Context
More than three years after requesting a debt restructuring under the G20 Common Framework, Ethiopia reached Ethiopia has finally obtained the IMF approval needed to move the process forward. The restructuring of Ethiopia's debt is not yet finalized but it is expected be relatively easier than for Zambia or Ghana, as Ethiopia's default is more the symptom of an external liquidity issue than a structural solvency crisis.
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IMF financing agreement
The IMF has lately paved the way for Ethiopia’s debt restructuring by granting the country a 4-year financing program (ECF), until 2028. This agreement is a major break through for Ethiopia.
First, the IMF agreement represents significant financial support with immediate relief in terms of liquidity needs.
Structurally dependent on international financial support, the withdrawal of donors in 2020 significantly impacted the country which was not able to cope with the double shock resulting from the civil war in the Tigray region and the pandemic. Over the period covered by the ECF program and to rebuild its stock of foreign currency reserves, Ethiopia displays a financing gap of USD 10.7 Bns or 7% of GDP (Chart 1). The IMF envelope will make up USD 3.4 Bns of the total, with USD 1 Bn disbursed immediately. Besides, the World Bank approved USD 1.5 Bns in budget support financing that comes on top of the USD 2 Bns in concessional financing granted each year by the institution's development agency. This financing will cover the country’s immediate external liquidity needs, while foreign currency reserves currently represent less than one month of imports.
At the same time, the country is committed to pursuing far-reaching reforms aimed at structurally improving its external position beyond the program period.
The central bank of Ethiopia (NBE) has begun to liberalize its exchange rate, allowing its currency, the birr (ETB), to depreciate by 30% against the USD (Chart 2). The reform put an end to the strict control of the currency that has artificially long been overvalued. This exchange rate distortion was precisely causing the balance-of-payments imbalances that led to the sovereign's default in November 2023. The liberalization of the exchange rate has come with a reform of monetary policy in order to better control inflation through the conventional interest rate channel. So far, the NBE's measures to combat inflation have mainly involved capping consumer credit growth and limiting central bank's direct advances to the government (i.e. reducing the monetization of the budget deficit).
Finally, the IMF agreement lays the foundations for the sovereign debt restructuring.
The country had originally request a debt rework under the G20 Common Framework in February 2021. Negotiations had so far stalled, as this framework requires the country to receive financial support from the IMF, which defines the restructuring envelope and the relief needed to ensure debt sustainability. The recent IMF analysis indicates that Ethiopia would need debt relief of at least USD 3.3 Bns over 2025/28 to restore sustainable debt ratios and meet external financing needs. Recently, bilateral creditors have given assurances that they will restructure their loans to Ethiopia in a way that is consistent with the IMF program.
Debt restructuring
The next decisive step for Ethiopia will be to reach a debt restructuring agreement with its external creditors.
Negotiations will be held in respect with the principles of the Common Framework, which requires comparability of treatment between creditors: all creditors are required to grant comparable debt restructuring terms in terms of i) nominal debt service relief over the IMF program period, ii) extension of the duration of the claims and iii) debt stock reduction in present value terms.
Ethiopia's external public debt currently represents accounts for 18% of GDP, or USD 29 Bns. Of this amount, multilateral debt will not be rescheduled, given its degree of concessionality. However, bilateral creditors will have to reschedule almost USD 8 Bns of debt owed to Ethiopia (Chart 3). Of this amount, China holds USD 7 Bns in debt (25% 02/08/2024 2
of external public debt and almost 90% of bilateral debt), with servicing representing around 30% of the total. China also holds a significant proportion of private debt (around 6% of external debt) through its commercial banks. Its role will therefore be key in the restructuring process. Eurobonds represent just USD 1 Bn (3.5% of external public debt), with only one Eurobond. The latter was issued in 2014 with a 10-year maturity and a coupon of 6.625%. Payments on the bond were interrupted in November 2023.
Debt restructuring aims to bring Ethiopia's debt ratios below those recommended by the IMF: current figures implies a reduction in debt service and/or a lengthening of debt maturity, as the challenge is mainly to reduce pressure on liquidity.
The stock of public debt, at around 36% of GDP, is limited and in line with the country's debt carrying capacity. By way of comparison, public debt stood at 88% of GDP in Ghana and 140% in Zambia at the time of their default. The major problem in Ethiopia lies in liquidity indicators, with breached in debt servicing indicators , expected worsening in the coming years, and a significant shortage of foreign currency due to weak exports: in the absence of restructuring, debt service could reach almost 18% of exports (against a limit set at 10%) and 16.3% of revenues (against a limit set at 14%) in 2028. Should the objective of saving USD 3.3 Bns on debt servicing meet, debt liquidity ratios will be in line with IMF thresholds by 2028.
Credit Risk
Recent development points toward a significant improvement in the credit risk associated with the Ethiopian sovereign.
Firstly, the shortage of foreign currency should be addressed in the short term, resulting in lower pressures on the balance of payments.
The amounts granted by the IMF and the World Bank indicates that needs will be met during the transitional reform phase. The effect of the currency's fall on inflation should be mitigated by temporary budgetary measures (subsidies and transfers to the population) to soften the blow on the population's purchasing power and prevent the risk of social unrest, as currently observed in Kenya and Nigeria.
Ethiopia is also expected to reach a relatively rapid agreement on its external debt restructuring, with associated losses expected to remain limited.
The IMF has set the Ethiopian authorities the target of a reaching a restructuring agreement by the time of the second review of the ECF program, scheduled for December 10th. Negotiations with official bilateral creditors already appear well advanced. Ethiopia currently benefits from an interim agreement of debt service moratorium (since August 2023 with China and November 2023 with Paris Club creditors), which is likely to lay the foundations for restructuring in the form of an extension of the duration. The main creditor, China, has historically favored debt relief in the form of loan term extensions rather than cancellation. In the case of the Addis-Djibouti railroad loan in 2018, for example, China granted a 20-year maturity extension to the Ethiopian authorities.
Ethiopia's debt structure is less complex than in previous restructurings, with a limited number of private creditors and a single eurobond. Prior to the country’s default in 2023, eurobond holders submitted a proposal for preventive reprofiling to the authorities, aimed at extending its maturity and delaying interest payments until 2030. Although the proposal failed because it contravened some principles of the Common Framework, it could form the basis of the new reprofiling proposal. In the meantime time, a discount of 20% of the bond's face value is considered by the Ethiopian Finance Minister (the discount was 37% on Ghanaian eurobonds and 18% on Zambian eurobonds). By conceding a reduction in the security's value, eurobond holders would nevertheless be likely to obtain a smaller extension of interest and principal and thus ensure faster repayment.
Positioning
Our assessment of Ethiopia’s sovereign risk profile has been upgrade accounting for the above-mentioned reforms. Formerly part of the exclusion list, the name is now seen as investable.
Following the agreement with the IMF, the price of Ethiopia 6.625% 11/12/2024 has risen sharply and is now trading at around 79% (Chart 4).
Perrine GUERIN