Ethiopia: Ripe and Open for Business

Individuals readily queue at the door to the visa office at the arrival terminal in the Bole International Airport in Addis Ababa. One individual presses the Ethiopian border guard about the timeliness of the process and the absence of concern for travelers’ time. The guard simply responds: “How do we plan for this [inflow]?” The airport is currently inundated by more than 5 million persons per year with rapid growth expected in the near future. A slightly aged airport facility, the building embodies the rapid change overtaking a country long-discounted and ignored by private investors.

This is not the country consumed by constant stories of famine-struck families and dry fields. It is a country emerging as the East Africa darling for investment. By many standards, Ethiopia is a new entrant to the investment discussion. But the country, situated in a socio-economic hotbed neighboring conflict-ridden Somalia and isolated Eritrea, recently passed Kenya as the largest economy in the East Africa block. The country is in the midst of a sustained economic boom that could push it to the forefront of Africa’s political and economic landscape.

Economy Rising

The Ethiopian economy continues to make strides unfettered by the loss of longtime leader Meles Zenawi and increasing tension from Somalia-based Al-Shabaab. The country grew by 9.7% from 2012 through 2013 (fiscal year ending in June 2013), only slightly off the 11% projected by the Ethiopian government. A drop in commodity prices, particularly coffee, during the economic year is part to blame for the dip.

Real GDP is expected to grow by 7.5% in 2014 and 2015, according to a recent statement in Addis Ababa by the International Monetary Fund (IMF), going against the Ethiopian government’s projections of 11% for both years. A huge public infrastructure spending agenda and a bump in commodity prices should propel the country toward achieving those lofty numbers.

The country remains a top-five coffee exporter. It enjoys annual gains in agriculture productivity marginally above 5%, as officially reported by the Agriculture and Transformation Agency, and boasts Africa’s largest livestock population at more than 50 million head of cattle. The country expects to be a net exporter of energy in the next few years following the completion of the Renaissance Dam in 2015. New wind and geothermal projects, underlined by a recent US$4 billion agreement with U.S.-Icelandic firm Reykjavik Geothermal, only sweeten the outlook for the power sector in Ethiopia. The story is positive one, says a representative at the Commercial Bank of Ethiopia, but we know that country still must do more to meet its economic goals.

Turning East

The country still lingers as an untapped mass of opportunity and potential. Manufacturing languishes annually at a constant 4% of GDP, more than half the equivalent share of neighboring East African giants Tanzania and Kenya. A bump in the sector could dramatically propel the economy back to double-digit growth. The Ethiopian government’s Growth and Transformation Plan (GTP) includes a conspicuous adoption by the government of an East Asian manufacturing model, similar to those employed in Vietnam and China, which is currently spelling early success for the sector.

Week after week, new delegations arrive in Addis Ababa from expected partner countries, including China and India, and unexpected partners, including Poland and Turkey. A recent investment by Swedish clothing retailer H&M indicates multinational brands recognize the progress to date made by Ethiopia. The Ethiopian Ministry of Finance and Economic Development (MOFED) has said it expects the country to reach US$1 billion in exports for the textile and garment industry by 2016. The numbers are realistic, says Fassil Tadesse, president of the Ethiopian Textile and Garment Manufacturers Association, but the country still requires greater foreign investment to modernize machines and factories.

Recent reports about labor costs skyrocketing, he says, are overstated. Mr. Tadesse may be correct, but it may not be labor costs that most concerns investors. The Central Statistics Agency (CSA) reported Ethiopian inflation at 8.5% year-over-year in October, a bump from 6.9% in September.  A recent report by the IMF projected that annual average consumer prices could decline to 9.6% in 2014. All indicators point to a potential single-digit inflation in the near-term. But critics debate if these inflation figures can be sustained with food prices still relatively volatile.

Public spending, paired with uncontrolled inflation, according to the IMF’s recent report on Ethiopia, could dampen private sector growth. An aggressive infrastructure spending agenda on roads, mega-dams and other related projects will continue to impede the private sector’s access to credit and neutralize the government’s ability to achieve its long-term growth agenda. Local business leaders consistently complain behind closed-doors that lack of available capital underscores their ability to boost capacity. Yet officials in the Development Bank of Ethiopia generally off-the-record assert confidence that the situation will improve, not based on any substantial facts but on well-established confidence in the country’s leadership.

Adopting the Chinese formula for growth can pose challenging for a cash-strapped country, according to a U.K.-based pan-African investor, and it shows with the underlying debt figures and the country’s credit issues. External debt continues to aggressively grow, estimated to be more than US$20 billion by the fiscal year ending in 2015, up from the US$12 billion in 2011. Internal debt numbers remain opaque, according to a MOFED source, but are seeing similarly rapid increases. The African Development Bank and the IMF both assert that the country remains a relatively low-risk country for debt distress. Yet growing complaints from local business over the lack of available debt underscores a more alarming situation.

Foreigners Filling The Void

The vibrant halls of packed hotels and the mix of foreign languages sparkled with the local Amharic in-between reveals the changing business and investment climate. It is definitely more suitcases and dollars in this hotel, says German investor Paul Kruger as he consumes his dinner during the Jupiter Hotel’s Thursday night jazz, and definitely differs from the days of famine during my first visit. The arrival of more foreign capital could not be timelier as credit tightens in the country.

But most foreign investors prefer large-scale mining companies with  few focusing on small and medium-sized enterprises (SMEs) in the country where EBITDA (measure of company performance or earnings before interest, taxes, depreciation and amortization) levels barely exceed US$1 million. Most of the sub-Saharan Africa deals with reported values in 2012 remained small, with many deals falling in the US$0-5 million range, according to the 2013 East Africa Private Equity Confidence Survey by Deloitte and Africa Assets. But, with most investors preferring to be minority investors, investing more than US$2 million in a company with a sub-US$1 million EBITDA generally bumps up against investor restrictions. Operators in the fast moving consumer goods (FMCGs) space of the economy consistently speak to the growth potential of economy despite lagging results in today’s production, advocating that investors must assess the opportunity more than past results.

Local manufacturers of household and personal care products, particularly soaps, detergents and paper products, express excitement about the underlying figures in the sector. Soap and detergent manufacturing has nearly doubled in the past four years. Two major producers in the country have implemented expansion projects that could bump capacity to more than one million tons. Similar expansion projects are being considered by paper and plastic manufacturers to meet growth north of 15 to 20 percent. A continued surge in incomes and ascension of more Ethiopians into the middle class underpins the potential for these basic goods and related products.

Achieving the country’s promising economic agenda necessitates improvements in agricultural downstream production, as agriculture still accounts for more than 45% of GDP. Speaking at the 3rd annual conference of the Grains, Oilseeds and Spices Exporters Association  on November 14th, Ethiopia Minister of Trade Kebede Channie emphasized the sector growth to date, noting that grains, oilseeds and spices accounted for more than US$700 million in exports. This amounted to nearly 25% of total exports, according to Mr. Channie. Improved processing in the sector, through comments from conference participants, consistently reared its ugly head as an underappreciated priority issue for the sector.

The GTP lists commercialization of smallholder farmers as a major source of agricultural growth. Only increased processing throughout the entire agriculture industry can generate greater returns for smallholder farmers and the overall economy. Coffee production, for example will only grow between two to three percent for the fiscal year ending in 2014 as lower prices linger over the sector and lessen farmers’ incentive to grow the crop. Not only would an uptick in processing and packaging boost dollar value in the market but it would also ease farmers’ price concerns.

Greater access to export credit and seeds could further transform the sector. According to the Ministry of Agriculture, greater production is required in sugar and corn, probably explaining the increased land purchases by foreign investors for commercial development of those products among other crops. Critics argue that low land prices and government disregard are driving the land purchases. It is more likely a combination of all three things in different proportions driving the situation, with disregard by a statist-orient government being the least prevalent factor.

Strong Infrastructural Base

Ethiopian authorities have put forth great efforts to eliminate systemic bottlenecks. Downtown Addis Ababa resembles an incessant construction site. The Ethiopian government spent more than US$3.5 billion on road infrastructure between 2002 and 2012, according to the Ministry of Finance and Economic Development, with another US$4 billion or more expected in the next 10 years.

Building construction and dam construction projects only add to Addis Ababa’s image as a “cement dumpsite,” according to Seleste Alemayehou, a Canadian-Ethiopian comparing the city to her adopted home city of Alberta. Cement prices accordingly remain above US$100 per ton. Nigerian cement giant Aliko Dangote is constructing a US$400 million plant with annual capacity of 2 million tons in the Origomia Region to accompany Derba Midroc Cement, which is owned by the Ethiopian-Saudi billionaire Sheikh Mohammed Al Amoudi and has a production capacity of 2.5 million tons per year. Prices are expected to drop over the longer term which will ease financing concerns for construction.

A power surplus by 2015 bids well for the country’s image and socio-economic standing on the continent. It is still unclear what the surplus means for Ethiopians as export prices for power, for example US$1.00 to Somalia or US$0.45 to Djibouti, incentivize producers to find ways to export rather than provide locally. Yet manufacturers still believe the potential for electrical stability, despite export concerns, is real and a true opportunity for the next decade. High costs and regular outages today in neighboring countries sets the stage for Ethiopia’s emergence from the crowd.

Telecommunication in the country is a challenge as Ethiopia is home to Africa’s remaining major telecom monopoly. Mobile usage has increased. Yet connectivity and efficiency, including cost, troubles foreign investors and locals alike. A deal for a Chinese-built 4G broadband network is a step in the right direction. But the greatest challenge is not 4G implementation but rather the expansion of 3G to the country’s most untapped parts. A digital gap, until then, will persist between Addis Ababa and the rest of the country. Anxious telecom investors should not expect the sector to open anytime soon as Ethio Teleco annually provides more than US$300 million to the government budget for other infrastructural spending.

The GTP projects that spending on infrastructure will amount to more than US$60 billion, or 41% of GDP by 2015. Transport and trade logistics continue to greatly benefit from this spending. Ethiopian Airlines already carries two-thirds of Africa’s air freight and recently made plans to expand its cargo capacity and range, particularly in West Africa. High speed rail and multi-lane highway projects will further solidify the country’s growing image as an African trade hub.

Very few doubt that, if successful, the GTP could transform Ethiopia.  Still this is Ethiopia and the costs associated with its development engenders many critics. Aggressive spending and economic steering will remain a point of conflict. But the one true reality is that Ethiopia has arrived to the national stage. Any investor waiting for a more ripe country will struggle to find one.

 

Kurt Davis Jr., Director and Co-Founder of Crescimento Inteligente in Mozambique, previously served as Senior Associate with Schulze Global Investments, Associate/Counsel with Swicorp, S.A., a fund manager with US$1.4 billion under management for the Middle East and North Africa, and Private Equity Consultant with Kukula Capital, a venture finance and private equity firm in Zambia. He serves as Private Equity Advisor to Precise Consult International in Ethiopia and is also a contributor to Ventures Africa and Africa.com.

Kurt Davis Jr
Kurt Davis Jr