The escalation of political tensions in Ethiopia into outright military conflict threatens to morph into civil war that would push the economy into a deep recession and raise the risk of a sovereign default. Even if this is avoided, Ethiopia’s reputation as a rising economic star has already lost much of its shine.
- The escalation of political tensions in Ethiopia into outright military conflict threatens to morph into civil war that would push the economy into a deep recession and raise the risk of a sovereign default. Even if this is avoided, Ethiopia’s reputation as a rising economic star has already lost much of its shine.
- Political friction between Ethiopia’s federal government and the Tigray region escalated into military confrontation last week. Relations have been gradually worsening since Prime Minister Abiy Ahmed rose to power in 2018 after the county emerged from widespread protests (also over ethnic issues).
- The situation is clearly very uncertain at this point, especially because verifiable information is hard to come by. The federal authorities have shut down communication lines in the region, making it difficult to gauge any economic impact. Even so, investor’s concerns have been reflected in sovereign dollar bonds; spreads over US Treasuries jumped by 100bp since violence broke out. (See Chart 1.)
- There are worrying signs that neither side is ready to lower the heat and turn to talks instead. Prime Minister Abiy Ahmed has so far defied calls from the international community to halt violence and federal forces reportedly carried out several targeted air strikes. Tigray’s leadership accused neighbouring Eritrea of military involvement. It is far beyond our expertise to assess how all of this will play out, but there is clearly a growing risk that Ethiopia slides into outright civil war with devastating consequences.
- Beyond the awful human costs, the economic toll would depend on the length of the conflict as well as the extent to which fighting spreads from military areas into the civilian domain, possibly extending beyond Tigray into other parts of Ethiopia or even beyond the country’s borders.
- An all-out war may very well push the economy into a recession. Previous examples of political turmoil could be illustrative. (See Chart 2.) Growth dropped by around 2.5%-pts, to 8.0%, in fiscal year 2015/16 when massive protests rocked the country. And GDP contracted by 4.2% following a severe drought and the onset of the Eritrean-Ethiopian war in May 1998. Our current forecast is that GDP will grow by 2.0% in the current fiscal year; if the crisis gets worse, the economy could very easily contract.
- The direct impact on lives and livelihoods would be compounded by indirect effects. Even before the pandemic hit or political tensions escalated, the IMF assessed Ethiopia to be at high risk of debt distress. And foreign exchange reserves covered less than one month of imports. With military conflict, investor sentiment is almost certain to sour further, triggering capital flight. And the key tourism sector, already hit hard by the coronavirus crisis, will continue to struggle. Balance of payments strains may very well re-emerge, heightening default risks. A $33mn Eurobond coupon payment due in December could mark a crunch point. It is not clear that the IMF would extend additional financial support.
- Even if such a worst-case scenario is avoided, the crisis is likely to deal a blow to Ethiopia’s economic prospects. Strains in the balance of payments are still likely to persist. The combination of deteriorating investor appetite and a government preoccupied with an intra-state conflict does not bode well for Prime Minister Abiy Ahmed’s ambitious economic reform plans. At the very least, Ethiopia’s transformation into a more market-friendly economy will be delayed.
Chart 1: JP Morgan Ethiopia EMBI Index
Chart 2: Ethiopia GDP (% y/y)
Sources: Refinitiv, Capital Economics
Sources: IMF, Refinitiv, Capital Economics
Virág Fórizs, Africa Economist, email@example.com