By Magidu Nyende and Luka Okumu,
ERITREA’S monetary policy has mainly been geared to accommodating the public fiscal deficits.
Broad money supply increased sharply to 119% of GDP in 2011 and 2012. Due to exceptionally high deficits in the previous years, the authorities had to resort to central-bank financing. Credit supply to the private sector grew at much lower rates, between 1% and 4%, over 2009-11.
Inflation, which has stood at double-digit rates over the last decade, was a high 12.3% in 2012, the same rate that was estimated for 2013 and is projected through to 2015, owing to scarcity-induced foodprice increases.
In February 2013, the government liberalised the foreign-currency regime in order to ease foreign-exchange shortages. The corresponding proclamation allows institutions and individuals to open foreign-currency deposits and to use foreign exchange for international transactions without limitation. Although the Nakfa (ERN) has been pegged to the US dollar at ERN 15 per USD 1 since 2005, the black-market exchange rate reportedly exceeds the official rate by a wide margin of up to 240% or more.
Considering this overvaluation of the official exchange rate, a comprehensive reform package is needed to reverse the negative effects the policy is having on the country’s economy and development efforts. Under the new regulations, the government relaxed some controls on the declaration and accountability of all the foreign currency brought in and taken out of the country. It is hoped that the current foreign-currency inflows through investments, revenues from the gold mines and official development assistance will strengthen the currency.
Further development of the mining sector will make a substantial impact on the performance of the economy over the medium term thanks to emerging investment opportunities in oil and gas.
Although it is still early to notice key changes in the economy, the government’s decision to liberalise the foreign-currency regime is a welcome reform measure. If fully implemented, it could unlock the foreign-currency shortages and exchange-rate overvaluation; these will induce private investment, hence boost growth and create employment in the country.
DEBT POLICY
According to the Eritrean authorities and IMF staff estimates and projections, the level of Eritrea’s public debt is estimated to remain unsustainable at 111.1% of GDP in 2013 after having reached 118.3% in 2012.
At the end of 2013, the central government’s domestic debt stood at 85.9% of GDP and external debt at 25.7% of GDP. Increases in revenues from mining activities, notably at the Bisha mine, high gold prices and the related increases in the tax base are lightening the debt burden. Nonetheless, the second round of UN Security Council sanctions and the decline in remittances from Eritreans in the diaspora has weakened the country’s financial position.
According to the IMF, Eritrea is classified as a Pre-Decision Point country for HIPC initiative eligibility. Moreover, Eritrea has so far not committed to concluding an IMF Staff Monitored Program, thereby foregoing the opportunity to reduce its external indebtedness through the HIPC initiative and the MDRI mechanism.
The country needs to build broad partnerships and multiple pathways to tap different financial sources in order to address its debt problem.
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Magidu Nyende and Luka Okumu are authors of the 2014 African Economic Outlook – Eritrea Report that was sponsored by AfDB, OECD and UNDP
