Key Issues on Ethiopia's Road to Debt Restructuring

Ethiopia is restructuring its $1 billion international bond as part of its overall strategy for debt restructuring. The government of the nation has been escalating its efforts to address increased financial pressures. A number of key issues are shaping this process of restructuring.

Why is Ethiopia Restructuring Its Debt?

The imperative for debt restructuring in Ethiopia has been triggered off by stringent foreign currency shortages, slow government revenues, and civil war stretching in the northern region of Tigray. Early in 2021, Ethiopia announced an intent to restructure its debt under the G20 Common Framework initiative—a program designed to offer rapid debt relief to developing nations facing financial distress.

Chad, Zambia, and Ghana have also applied for debt restructuring under the same framework. In the case of Ethiopia, though, this process was delayed by the Tigray conflict, which only came to an end late in 2022, and by slowing down the implementation of requirements outlined by the IMF, which provided for abandonment of the currency peg, removal of capital controls, and a shift into an interest rate-based monetary policy framework.

On July 29, Ethiopia floated its birr currency in a drastic move that helped the country clinch a $3.4 billion, four-year IMF loan program. The deal didn't only give an immediate shock of much-needed finance but also opened avenues for renewed efforts in debt restructuring.

What Are the Expected Outcomes?

The country's external debt reached $28.9 billion as of March. In the deal, the IMF acknowledged a $3.5 billion financing gap that Ethiopia is expected to cover after its debt restructuring. The Government is banking on $4.9 billion in debt relief—arguing the figure is based on proposals from official creditors, though it did not indicate how long it would take.

Of these restructuring steps, one big element is the proposed 20% principal write-down on Ethiopia's $1 billion bond. Under this proposal—designed to ensure comparability of treatment by the Common Framework between the commercial and official creditors—bondholders have turned acrimonious, saying that this write-down does not reflect the economic fundamentals of the country and that the government is not negotiating with them in "good faith.".

How Will That Dispute Be Resolved?

One of the keys to the dispute is whether or not this is a liquidity problem for Ethiopia, essentially a short-term cash flow issue, or a longer-term solvency crisis. Critics point to the dwindling export and tax revenues in Ethiopia, combined with declining foreign exchange reserves, as an indication that, even though the country's debt as a share of GDP is relatively low at 40.3%, it has a solvency problem.

"A compromise could be a middle way between the haircut proposed and an extension of the repayment period," Kevin Daly, portfolio manager at abrdn, which owns the bond in question, said. The International Monetary Fund's debt sustainability analysis is based on the fact that over an extended period, Ethiopia has had key indicators normally used to judge solvency continually breached, notably the external debt-to-exports ratio.

The divergent diagnosis of Ethiopia's financial health could result in a really long, contentious negotiation. The holders of the bonds have warned that too-conservative assumptions and light-touch fiscal effort may lead to further delays in the restructuring process.

How Are the Reforms Working and What Are the Next Steps?

The birr currency has fallen drastically to 103.97 against the dollar this year alone and is closing in on the black market rate of 115-120. Delays to hit the first target of merging the official and black market rates have been due to the reluctance of commercial banks coupled with an already building pressure from inflationary effects on saga commodities.

In response, the government closed those businesses that raised their prices without justification and augmented imports of significant goods in the marketplace. The IMF recommended that tighter monetary policy and other such measures might be needed in the near future to keep inflation under control and to stabilize the economy.

The resolution of these following issues would lie at the heart of debt restructuring for Ethiopia as it sets into motion the process and will ultimately shape its economic future while restoring financial stability.