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ETHIOPIA - Ethiopia's impenetrable banking sector.

In Addis Ababa, ATMs are be- coming as ubiquitous as the city's beloved coffee shops. But go to a bank and try to change your stacks of somewhat worn green 100-Ethiopian-birr notes for crisp US dollars and any semblance of convenience disappears in a trail of paperwork.

These restrictions, a headache for foreign companies operating in Ethiopia, have resulted in a long- running guessing game about the opening up of the country's banking sector. Along with some 25 other sectors, including telecoms and media, it remains closed to foreign investment.

This April, speculation about wider change was fuelled when Ethiopia made alterations to its stringent financial rules in order to join the African Trade Insurance Agency (ATIA), which provides export credit insurance, political risk insurance, investment insurance and other financial products in 10 African countries.

The government's policy of not allowing foreign banks in Ethiopia has still not changed. However, as Zemedeneh Negatu, managing partner (Ethiopia) and head of transaction advisory services for Eastern Africa at EY, points out, international banks are opening representative offices, which are allowed. This is partly in anticipation of the sector opening up, and also because of increasing business activities from local correspondent banks and multinational customers investing in Ethiopia. Standard Bank of South Africa, Ecobank and the European Investment Bank recently opened representative offices in the country, with Kenya Commercial Bank to follow in their footsteps.

Ideological barrier

As a macroeconomist based in Addis Ababa says: "There is no attempt to open up the banking sector due to ideological reasons and fear that the government banks will lose their competitive advantage if it opens."

Between 1974 and 1991, Ethiopia was led by a Marxist-Leninist- inspired regime, and even after the revolution that brought the current government to power, that ideology has continued to inf luence areas such as economic policy; hence the country's most important banks are all state owned.

The Commercial Bank of Ethiopia (CBE) is the largest commercial bank in the country, controlling the majority of the industry's assets. CBE has more than 1,100 branches around the country, and more than 12.4m account holders. Its main source of income is net interest, which represents 66% of the bank's total income. Private banks' main sources of income are foreign exchange currency gains and transaction- related fees -- wiring, facilitating a letter of credit -- representing over half of their total income.

Ethiopia's banking industry is highly regulated by the National Bank of Ethiopia, making related investments particularly secure, some claim. Meles Zenawi, Ethiopia's prime minister from 1995 to 2012, famously rebuffed criticisms of his government's tight fiscal policy by pointing out how it allowed Ethiopia to weather the global economic crises in 2008--09.

Others are less persuaded by the benefits of Ethiopia's banking style. "It will make it difficult for the government to have direct credit, based on instructions, and fulfil its developmental agenda," the macroeconomist says.

According to the World Bank Group report SME Finance in Ethiopia: Addressing the Missing Middle Challenge, 56% of Ethiopian small and medium-sized enterprises are credit constrained, the most in the sub-Saharan African region.

Currently the best source for large-scale local finance is the Development Bank of Ethiopia, but only if the investment happens to fall among so-called priority sectors and is export-focused. Loans of up to 70% of the investment for commercial agriculture, agro-processing, manufacturing and extractive industries are available.

Otherwise, local commercial banks typically require a large percentage of the loan as collateral, usually consisting of liquid assets and real-estate physically located in Ethiopia, while various administrative directives constrain banks from making more loans to the private sector.

International impact

"Local banks lack sophistication in terms of their human capital, information technology and processes, such as credit approval, default management, liquidity management, internal controls, internal audits and financial reporting, as well as their strategies, such as deposit mobilization and credit diversification," says an Addis Ababa-based business journalist. That clearly leaves room for improvement.

"Any general step towards integrating with global markets for trade and finance will help the country, but there might be some growing pains initially," says Matt Davis, the Addis Ababa- based founder and partner of RENEW Strategies, a firm that advises international investors seeking to make both social impact and financial returns on their investments in Africa. "International banks have greater access to foreign reserves, better technology and risk management practices, which they can leverage to help the local companies. So liquidity and access to finance for local companies would improve, but at the cost of putting competitive pressure on local banks. So there would be a trade-off."

One major new development underway in the financial services industry, according to Negatu, is the rapid expansion of mobile banking, providing efficient and cost-effective financial transactions for millions of Ethiopians, especially in rural areas. About 80% of the population still works in agriculture.

"By 2020 there will be over 100m mobile subscribers in the country, thereby substantially reducing the un-banked population and also reducing the transaction costs to customers," Negatu says. "This will be a major game change in the financial service sector of Ethiopia."

But that's not the game changer many are holding out for: speak to any Ethiopia-based business owner with international dealings and you will hear about the perennial lack of adequate access to foreign currency.

"This is heavily impacted by the rate at which the country is expanding and how much they can export," Davis says. "Unfortunately, we're still exporting mostly raw or low value-add products. So it's a double-edged sword. A lot of manufacturers need imported raw materials so they can process them and export higher-value products. But if there's no forex they are stuck. It's going to take some time until the country gets the balance right."

Already there are signs the balancing act may be getting wobbly. According to the 2016 World Economic Outlook by the International Monetary Fund, Ethiopia's projected economic growth rate of 4.5% for 2015--16 marks a significant decline from 10.2% in 2014--15. And export performance in 2015 failed to meet government targets: the country earned just under $3bn from exports, short of the target set of about $5bn, according to figures from the Ministry of Trade.

Reform is coming

While the financial services sector remains closed for now, even sceptics suggest that entry restrictions will be relaxed after the end of Ethiopia's second five-year development plan in 2020. Ethiopia's thirst for international capital is driving reform.

"The capital goods leasing and financing law was a positive decision by the government, reflecting Ethiopia's evolving and adoptive investment operating environment [during] the gradual transformation of the economy," says Negatu of the changes made in April.

The ATIA says the Ethiopian government "has been quite efficient in moving the process through all the administrative loops", and it expects to start underwriting in Ethiopia at some point during the second half of this year.

"We are here to support the country by helping to make their transactions more bankable," says ATIA CEO George Otieno. "With the ATIA in the picture, investors, lenders and other partners will take a more positive view of potential projects and transactions in the country. And our presence will help Ethiopian traders. If you look at industries such as the fast-growing floricultural sector, for example, ATI insurance could help these companies export to more countries."

Already the ATIA is seeing tremendous demand from hydropower and road construction projects, and for its bond products for public works and construction. Recent requests have included an energy sector project valued at $115m, a drip irrigation project valued at $190m and a foreign investor interested in building a textile mill.

"I think banks and private investors are keen on Ethiopia -- and for good reason," Davis says. "One hundred million people, a growing middle class, a stable government. We just need to reduce some registration requirements, and be a little more open to letting foreign investors in -- i.e. open up some key sectors -- and I think the capital will come in."

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Publication:African Banker
Geographic Code:6ETHI
Date:Aug 31, 2016
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