Economic Growth Performance Over the Past Two Years Has Been Very Strong And Broad based. After a significant drought-induced contraction, Ethiopia's economy rebounded in 2003/04 and 2004/05. Real GDP growth was 8.9 percent in 2004/05, following an 11 percent growth rate rebound in 2003/04.

Growth was driven by a strong agriculture sector (12.1 percent growth) but also reflects good performance across sectors (6.6 percent growth in industrial production and 5.8 percent in services). The IMF is projecting growth of 5.1 percent in 2005/06 as it anticipates the recovery of agriculture to taper off, though the government is expecting higher growth of around eight percent.

Macroeconomic stability has been a critical underpinning both to the foundations for economic growth, and increased levels of development assistance that have flowed through the budget until recently. According to a recent report of the World Bank, a number of factors emerged in the first half of 2005/06, however, that posed risks to macroeconomic stability and placed pressures on the balance of payments.

They included large public infrastructure investments with high import content to support growth (draining the National Bank of Ethiopia (NBE) reserves), uncertainly surrounding donor support with the suspension of USD 399 million out of the USD 414 million in direct budget support which has been budgeted for the year, and fiscal pressures arising from government's fuel price subsidy scheme. To maintain the scheme, the Ethiopian Petroleum Enterprise (EPE) has increased borrowing from the Commercial Bank of Ethiopia (CBE) to cover a bill of around USD 20-25 million per month. By December 2005, the IMF had identified a balance of payments gap of around USD 570 million, and financing gap of the fiscal deficit of around USD 345 million.

In discussions with the IMF at the end of 2005, the government committed itself to several actions to close part of these gaps and maintain macroeconomic stability. These included curtailing public enterprise investment programs with high import content by USD 240 million (Ethiopian Telecommunications Corporation by USD 100 million and Ethiopian Electric and Power Corporation by USD 140 million, the latter causing federal budget outlays to be revised down by 1.25 billion birr), and maintaining domestic financing of the fiscal deficit at no more than four percent of GDP.

The World Bank report indicated that underscoring their firm commitment to ensure macroeconomic stability through strict adherence to the domestic financing and international reserves limits, the authorities stressed that they would take additional measures, such as additional cuts in spending, to close the remaining gaps if the fiscal or external accounts came under further pressure.

On the fiscal front, careful regular monitoring of expenditure and revenue performance (including external financing) in 2005/06 will be required. At the federal level, during the first half of the 2005, the fiscal performance was encouraging. On the revenue side, the federal authorities collected 45 percent (7.4 billion birr) of the total revenue budgeted for the whole year. This constitutes a particularly strong performance given that the revenue targets for this year were budgeted at a considerably higher level compared to last year. The revenues realized this year to date represents an increase of 20 percent compared to the first half of 2004/05.

The report showed that on the expenditure side (figures available only for the first five months of 2005/06), recurrent expenditure by the federal government, at 2.7 billion birr, was slightly higher than last year (35 percent of budget vs 30 percent), although capital expenditure at 3.6 billion birr, was lower (32 percent of budget vs. 40 percent). The overall deficit remained approximately the same as during the same period of last year (2.66 billion birr or USD 305 million). Borrowing from banks to finance the deficit reached around 985 million birr.

At the regional level the recent measures taken to rationalize the presumptive tax assessment are expected to stimulate small business growth and to expand the tax base in the medium-term. This year, however, regional tax revenue has been revised down by approximately 300 million birr compared to the original budgeted estimate, partly due to start-up difficulties in an estimated 400 million birr, as a result of a public sector wage increase awarded by government, effective July 2005. As a compensatory measure, the government, recently transferred an additional 400 million birr to the regions. Overall, recent projections indicate that, despite the efforts already made on both the expenditure and revenue sides, the authorities still face the prospect of having to make significant cuts in originally planned financing of basic service delivery at the local level through federal grants.