By Nyende Magidu,
ERITREA is aiming at creating a modern, private sector-led economy (Macro Policy 1994; National Indicative Development Plan 2014-2018). Attaining this objective is, however, compromised by an inadequately enabling investment and business environment, United Nations sanctions, and overall weak macroeconomic conditions.
Real GDP growth is projected to increase from 2.0% in 2014 to 2.1% in 2015, double the rate recorded in 2013, because of increasing investments in the mining sector. Over the medium term, the government sees further prospects in improved trade with Middle-Eastern and Asian countries, additional mining activities, the growth of the food sector and the development of the tourist industry.
The current GDP composition is: services (59.9%), non-manufacturing (17.3%), agriculture, hunting, forestry and fisheries (16.9%) and industry (5.9%).
The budget deficit increased to 10.7% of GDP in 2014, up from 10.3% in 2013, but will fall back again to 10.3% in 2015 and 9.9% in 2016 as a result of increasing revenue from mining projects, access to more grant resources, and the government’s continued implementation of strict fiscal rules and consolidation strategies.
Inflation declined slightly in 2014 because of food-supply shocks, high foreign exchange demand, and high commodities prices on the international market. Lower international food prices and weaker oil prices in 2015 and 2016 should contain inflation at an annual average of about 12% for the period 2015-16.
Exports are forecast to grow in 2014-15, due to mineral production at the Asmara project, but the current account balance is forecast to deteriorate from 0.2% of GDP in 2014 to -1.2% and -1.5% in 2015 and 2016 respectively, partly due to decreases in both remittances and the “development and recovery tax” (a 2% tax levied on the Eritrean diaspora).
Based on IMF Article IV 2009, Eritrea is a pre-decision point highly indebted poor country (HIPC) and is therefore eligible or potentially eligible for HIPC Initiative multilateral debt relief (MDR). However, no discussions on an IMF-supported programme have been initiated, although the government is engaged with the IMF’s capacity-building institute through the East African Regional Technical Assistance Centre (E-Afritac), located in Tanzania, and has also agreed to participate in the African Development Bank’s Transition Support Facility.
The medium-term outlook could present some risks because of the size of the fiscal and current account deficits coupled with high inflation. Improved management of these conditions and enhanced control of the exchange rate regime and public debt could attract more private investment. Thus, medium-term economic prospects will be influenced by:
i) tensions over the border with Ethiopia, which are a basis for high security infrastructure expenditure;
ii) relations and co-operation with the international community;
iii) implementation of the regional programme on drought resilience and sustainable livelihoods under the Intergovernmental Authority on Development (IGAD), plus capacity building under the African Development Bank’s new Transition Support Facility;
iv) increasing investments in the mining sector, and
v) continued engagement with Middle-Eastern and Asian countries.
Recent Developments and Prospects
Recent economic performance has been positive, driven mainly by the mining sector. Real GDP growth is projected to increase from 2.0% in 2014 to 2.1% in 2015, double the rate in 2013. Growth will further benefit from a revitalised housing and construction sector, infrastructure development, and improved financial services.
Agriculture, animal husbandry and fishing remain the mainstay of the economy, with approximately 70% of the population relying on this sector for their livelihoods. The growth outlook is promising if Eritrea exploits all its opportunities for trade and opens to foreign investment other than in the mining sector.
The Government of the State of Eritrea (GoSE) has placed high priority on building an efficient national government and developing its own capacities to manage policies and productively exploit the country’s abundant natural resources for sustainable socio-economic development (Ministry of Land, Water and Environment, 1997).
Eritrea’s resources include arable land (26% of the total, but only 4% under cultivation) and minerals (copper, gold, iron ore, nickel, silica, sulphur, marble, granite and potash).
Although the majority of the population still rely on agriculture, animal herding and fishing for their survival, the sector only accounts for about 16.9% of GDP (Table 2) and about 20-30% of commodity exports (Agriculture Sector Strategy, 2014). This low contribution to GDP and exports is attributed to highly variable climatic conditions, inefficient traditional farming methods, limited resource allocation, and low profit margins. Moreover, private-sector activity, dominated by trade and services, remains weak, and access to hard currency is a major constraint.
The fact that over 80% of the poor live in rural areas and depends on agriculture suggests that increasing agricultural production and productivity would have a significant impact on poverty. For this to happen would require modernising the sector through shifting away from the current farming systems and crops to semi-commercial and peri-urban agriculture; small-scale irrigated horticulture, commercial farming, and agro-pastoral spate irrigation systems based on flash flooding (“spates”).
The recent AfDB Board approval of the regional on Drought Resilience and Sustainable Livelihoods Program (DRSLP) under IGAD will enable the government to strengthen greatly the resilience of communities, especially in the rural areas.
In the forthcoming National Indicative Development Plan (NIDP) 2014-2018, the government has given priority to three pillars: human resource development, infrastructure development and food security.
There have already been targeted public investment programmes in education and skills development and in agricultural production and productivity improvement. The GoSE is continuing to implement the Strategic Partnership Cooperation Framework (SPCF) 2013-2016, signed with the UN system in 2013, focusing on five strategic areas: basic social services; national capacity development; food security and sustainable livelihoods; environment and gender equity; and the advancement of women.
The government is also committed to engaging with countries to the East due to its Geo-strategic location and cost-effective means of doing business. Moreover, its long coastline could offer maritime services to countries in East and Central Africa as well. To buttress planning and development policies, Eritrea is considering key elements of economic management. While the initial focus is on strengthening existing institutions, selected institution building and new strategies that are more appropriate to an inclusive economy are also being introduced. Progress in eliminating many restrictive policies has been made, laying emphasis on creating favourable conditions for private-sector growth. In seeking food security, the government is also addressing social needs while rehabilitating productive infrastructures.
In support of such initiatives, Eritrea could consider engaging the services of the African Development Bank under the African Legal Support Facility (ALSF), as well as seeking the support of other development partners to develop capacity in managing mining contracts in order to ensure broad-based and sustainable growth over the long term.
Progress made through structural reforms is expected to improve planning, policy formulation, and the assessment of results. Institution building in the Ministry of Finance (MOF), alongside progress in improving public financial management through institutional enhancement, and the IMF’s technical assistance to the Bank of Eritrea, focusing on risk-based supervision, could boost public investment and monetary-policy management. The Ministry of National Development is strengthening the capacity for evidence-based planning and policy formulation in Eritrea through the generation and dissemination of economic and social data. In 2014, at the request of the government, the UN fielded a team of specialists to explore and establish a reliable framework for
producing and managing reliable and current national data and statistics, including GDP figures and socio-economic statistics.
Eritrea’s isolation and weak inclusive institutions have undermined domestic and regional peace and stability, while UN sanctions have had a negative impact on the overall investment and business environment beyond the mining sector. There is a need for continued dialogue at both the regional and international levels. Eritrea still believes that IGAD has a critical role to play in achieving regional peace and stability, and the country’s commitment to participate in the DRSLP is highly commendable.
Despite challenges to the development and recovery tax on the diaspora, its collection has continued though with a declining performance; private remittances are also being affected by the economic, investment and business environment. With the right policies, however, and building on the country’s rich human and mineral resource potential, Eritrea could rebound as the fastest growing country in the Horn of Africa.
Tighter fiscal policies and the maintenance of strict rules of adherence to tight budget and spending priorities, supported by reduced dominance of monetary policy in economic management, have resulted in favourable fiscal outcomes. According to estimates by various sources, including the IMF, increased revenue from the mining sector and conservative spending kept the fiscal deficit at about 10.7% of GDP in 2014 (Table 3) and is expected to decline to 10.3% and 9.9% in 2015 and 2016 respectively. The government anticipates that this trend will improve further when the Integrated Financial Management System (IFMS) is fully adopted, as it will improve budgetary planning, revenue generation and management, and budget implementation.
Tax revenue, excluding grants, is projected to increase from 11.2% of GDP in 2014 to 11.3% in 2015. The government is optimistic about the impact of the mining investments as they present new opportunities to generate revenues, which, if invested in sectors like infrastructure, agriculture and fisheries, and human resource development, will have the greatest impact on the living standards of the people and on the economy. Any substantial reduction in international prices for minerals would, however, negatively affect the revenue inflows.
Revenues from the 2% development and recovery tax on the Eritrean diaspora have been an important source of government income. However, this has been declining, partly due to the UN sanctions imposed on its collection and transfer to Eritrea. To counter the effect of the decline in the inflows, the government has made investments in the mining sector, infrastructure including energy, and control of wage-bill growth its priorities. The government is also strengthening fiscal-management systems, including the customs and internal revenue divisions, to maximise revenue collections. Some subsidies, for example, on fuel have also been scrapped.
Monetary policy has been geared towards maintaining price stability. Broad money has been reduced from 119% of GDP in 2011 and 2012 to an estimated 14.3% of GDP in 2014 on account of a shift from funding the budget through printing money and the pursuit of tighter spending.
Credit supply to the private sector is estimated to have increased from between 1% and 4% over the period 2009-11 to 15.8% in 2014. Food shortages caused by poor harvests put periodic upward pressure on domestic food prices.
Inflation was 12% during 2012-13 and is projected to remain at 12% or slightly higher in 2014 due to food-supply shocks, scarcity of hard currency and dynamics in the global economy. Lower international food prices in 2015 and weaker oil prices in both 2015 and 2016 should help contain inflation at an annual average of 12% over 2015-16.
The currency has been pegged at ERN 15.38 (Eritrean Nafka) per USD since 2005. Strict government controls of the foreign-exchange market and a reduction in remittances have resulted in an overvalued Nakfa, foreign-exchange shortages and a growing parallel market. The government relaxed some foreign-currency transactions in early 2013 and took modest steps towards liberalising the economy. In addition, potentially important institutional reforms on risk supervision, regulation and reporting by financial institutions are underway to strengthen financial stability and mitigate financial risks. It is, however, unlikely that the currency peg will
be dismantled in favour of a free-floating exchange rate in 2015/16.
Moreover, the relaxation of the foreign currency regime and of controls on declaration and accountability has not delivered the desired impact on private-sector operations. The government needs to improve the business environment and dismantle all controls in the foreign-currency market to encourage private sector investment.
Economic Co-operation, Regional Integration and Trade
Eritrea has placed a high priority on regional integration. Consequently, it belongs to various regional trading blocs including the Common Market for Eastern and Southern Africa (COMESA), the Community of Sahel-Saharan States (CEN-SAD), and the Inter-governmental Authority on Development (IGAD). However, relations between the Eritrean and the Ethiopian governments have remained at “no-peace-no-war”, with no improvement expected any time soon.
The trade balance is projected to worsen from -5.0% of GDP in 2014 to -5.8% of GDP in 2015 (Table 4) due to higher growth in imports than exports. However, the major concern is that exports have been highly variable, from 1% of GDP in 2006 to some 15.1% of GDP in 2012, then down by 1.7% of GDP in 2013 before improving marginally by 2.4% of GDP in 2014.
UNCTAD’s 2014 Report indicates that in 2012-2013 Eritrea’s merchandise exports were mainly primary products (e.g. food and agriculture; minerals, metals and ore), accounting for about 86.9% of the total, while manufactured goods represented only 9.7%. Trade with other developing countries represents only 11% of the total, compared to about 87% with the United States and Canada. Imports are mainly manufactured goods, accounting for 60.8% of the total, compared to 38.5% for primary goods.
The GoSE continues to engage with the international community. In 2014, Eritrea participated in the African Development Bank Group’s Annual meetings in Kigali, Rwanda, the Annual Meetings of the IMF and World Bank Group and the UN General Assembly. A side event was organised at the 2014 UN General Assembly during which Eritrea showcased its performance in the Health MDGs. Since 2013, the government has submitted a Universal Periodic Review (UPR) of human rights to the UN and demonstrated its commitment to ensuring that the recommendations are implemented. UN delegations have also been welcomed into the country to discuss pertinent development issues with senior government officials.
Eritrea has skilled people with experience in entrepreneurship, commerce, and international trade. Added to its strategic location in relation to the countries of the Middle-East and Asia, this should offer significant opportunities. However, the country is still less competitive than East African countries, while the 2014 World Bank Logistics Performance Index (LPI) ranks Eritrea at number 122 out of 160 with a score of 2.08 out of 5, reflecting a deterioration since the 2012 rankings of 2.11 and 2010 of 1.70. Trade challenges to address are in customs management, infrastructure, and logistical competence.
The industries which contribute to foreign currency earnings include: i) mining projects; ii) fisheries at a limited scale due to infrastructure gaps, including energy supply and cold storage facilities; and iii) the manufacturing industry. This last is comprised of about 200-300 medium sized enterprises representing 80% of industrial GDP and presently operating at very low capacity utilisation (26% on average), mainly in the textile/leather and associated food sub-sectors.
The rest are small and micro-enterprises. Taken together, their contribution to foreign earnings is limited due to constraints in: i) capacity and unavailability of qualified technical manpower; ii) poor quality or in some cases unavailability of raw materials; iii) lack of maintenance; and iv) shortage of energy. The first constraint can be explained by factors such as unattractive wages and brain-drain.
Debt levels have not improved substantially despite the government’s fiscal consolidation strategies, more revenue from the mining sector, and emerging strong preference for grants over loans. Based on IMF staff projections and reports by the national authorities, the level of the public debt will remain high at 105.8% of GDP in 2015, a slight fall from 108.1% in 2013.
At the end of 2014, the central government’s domestic debt stood at 83.9% of GDP and its external debt at 21.9%. The high domestic debt is attributed to UN sanctions’ impact on the collection of the development and recovery tax from the diaspora.
Although Eritrea is classified as a pre-decision HIPC potential beneficiary, according to the IMF, the GoSE has so far not committed itself to concluding an IMF Staff Monitored Program that would have given Eritrea the opportunity to reduce its external indebtedness through the HIPC and MDR mechanisms.
Economic and Political Governance
The private sector remains small and underdeveloped. It is thus critical to promote it through policy reforms and public-private partnerships for enhanced economic growth and service delivery. The continued dominance of the public sector in the economy, inadequate domestic and foreign private investment, and trade challenges, all suggest that immediate attention should be paid to creating an enabling environment for private-sector development.
In the 2015 World Bank report on the Ease of Doing Business in countries world-wide, Eritrea is placed last and has been among the bottom ten countries for each of the last five years of the survey. According to the report, an entrepreneur in Eritrea needs an average of 84 days to open a business, 59 days to get electricity; and 59 days to import goods, costing USD 2 000 per container. In highest-ranked Singapore, it takes just 2.5 days to open a business, 31 days to get electricity, and 4 days to import goods, costing USD 440 per container.
Progress in the privatization of some state-owned enterprises, announced in 2012, has been slow, limiting the inflow of private capital beyond the mining sector. The offer of shares in the Eritrean Telecommunications Corporation (EriTel), the National Insurance Corporation of Eritrea (NICE) and the Asmara Brewery to domestic investors has not created a visible impact in the economy.
Improvement in the overall implementation of the privatization process will require addressing deficiencies in energy, communication and property rights. Equally important is a sustainable macroeconomic dynamic built on a sound and effective fiscal management, sustainable balance of payments deficits, and a sustainable public debt.
The government says it is committed to improving the overall business environment, driven by the conviction that an efficient business climate can reduce poverty by fostering inclusive economic growth and job creation. The start of five-star flight services by Qatar Airlines to Eritrea indicates a commitment to opening the country for stronger business ties and facilitating greater market-oriented commercial development.
Eritrea has also commenced a programme to reduce export and import lead-times by strengthening its computerized systems for on-line submission of documents and monitoring business volumes. The government is to switch to a fully electronic customs system in anticipation of participation in a number of markets, while customs administration generally is being improved.
The financial sector in Eritrea comprises the central bank, two commercial banks, one development bank, and one insurance company. With the exception of the commercial bank (the Housing and Commerce Bank of Eritrea), the government owns all financial institutions. The commercial banks and the insurance company dominate the financial market. With more than 85% of the domestic market, the Commercial Bank of Eritrea covers all sectors of the economy.
Domestic macroeconomic challenges, coupled with unattractive fiscal and monetary policies, have stifled the development of the financial system. Based on 2014 UNCTAD calculations, gross domestic savings represent only 6.3% of GDP, among the lowest in sub-Saharan Africa.
Although the GoSE enacted a comprehensive Bank and Financial Institutions Act, permitting the licensing of private financial institutions, including foreign banks, no other local or foreign private financial institution has been allowed to work in Eritrea (except the foreign exchange bureaux). Money and capital markets are non‐existent, so open-market operations are not possible in monetary policy management. Currently, commercial banks are required to set aside 20% of their deposits as reserves.
Privatization could inject private equity into the system and foster the development of a stock market (assuming state-owned enterprises are privatised through the stock market). Extractive industries also provide opportunities for attracting private-equity firms. It is expected that there will be many more mining investment opportunities as the global demand for minerals increases.
Eritrea actively participates in regional integration initiatives, but is still unable to meet the precondition of attaining macroeconomic stability due partly to weak financial capacity and underdeveloped financial infrastructure. While several institutional and risk factors contribute to the financial-development gap, the government considers trade finance as critical in facilitating international trade, and therefore necessary for economic growth. However, it will require improving regulatory frameworks to attract private capital in the commercial banks to close the financial-demand gap.
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