African Economic Outlook 2014: Eritrea’s Private and Financial Sector

The low level of financial development in Eritrea has continued to limit investment opportunities in sectors like agriculture, mining, tourism and fisheries, which have potentially high regional spill-over effects to spur economic transformation and foster inclusive and sustainable growth.
The low level of financial development in Eritrea has continued to limit investment opportunities in sectors like agriculture, mining, tourism and fisheries, which have potentially high regional spill-over effects to spur economic transformation and foster inclusive and sustainable growth.

By Magidu Nyende and Luka Okumu,

A combination of restrictive government policies, shortages of foreign exchange, declining remittances and heavy government borrowing from the banking sector has severely inhibited private-sector activity and development in Eritrea. Consequently, the private sector remains small, underdeveloped and crowded out by the state’s growing role in the economy. 

The private sector is also constrained by an underdeveloped financial and banking sector characterized by low access to credit and poor saving incentives. The problem of low access to financial services, especially credit, is undermining the private sector’s efforts to participate in the government’s privatization programme. It has also curtailed the growth of both formal and informal trade along the border areas, thus lowering the potential impact of regional spill-over effects.

In the World Bank report Doing Business 2014, Eritrea was ranked 184th out of 189 countries.

To improve the business climate, the government has invested in developing human skills and major physical infrastructure, including the establishment of the Massawa free-trade zone. It has further taken measures to provide a more business-friendly environment through easing the conditions for business registration, approval of plans and establishing a project in the free zone, as well as easing access to and use of foreign exchange.

Recently, the government has selectively sought investment in the mining, energy, fisheries and tourism sectors.

In 2013, it adopted Proclamation No. 173/2013 allowing privatization of state-owned enterprises as well as institutions and individuals to hold and use foreign exchange for international transactions without limitation.

Similarly, state manufacturing companies were being turned into share companies. These measures are hoped to boost trade and investment.

Financial Sector

The Eritrean financial system remains significantly underdeveloped with a limited supply of financial services, which fall far short of demand, including project finance for both the public and private sectors.

There are currently six financial institutions comprising the central bank (Bank of Eritrea), one commercial bank, one housing and commerce bank, one development bank, one insurance company and one foreign-exchange bureau. As a result of the shallow and narrow financial system, the average level of credit extended to the private sector is quite low and the government pursues administered interest rates, which discourages private savings and increases the cost of borrowing. When not subsidized by the government, the borrowing rates have tended to be prohibitively high at around 30%.

Moreover, under the regional financial integration arrangement with COMESA, Eritrea remains one of the countries still unable to meet the essential precondition of attaining macroeconomic stability, partly due to its underdeveloped financial system.

The low level of financial development in Eritrea has continued to limit investment opportunities in sectors like agriculture, mining, tourism and fisheries, which have potentially high regional spill-over effects to spur economic transformation and foster inclusive and sustainable growth.

Several institutional and risk factors contribute to the financial development gap. High macroeconomic and regional security instabilities and threats prevent the implementation of well-intended government programmes. This is the context in which needed key economic reforms such as the gradual privatization of enterprises are being pursued by the government to generate an enabling environment for private-sector development.

Public Sector Management, Institutions and Reform 

The government is moving towards implementing reforms pursued under the Proclamation for the Establishment of Regional Administrations No. 86/1996. These initiatives aim to improve governance through the decentralization of fiscal and administrative functions. The reforms are aimed at strengthening the roles and responsibilities of the regions (zobas) and sub-regions (sub-zobas) in order to achieve results in a more effective and transparent manner.

To improve and strengthen fiscal management, several structural measures have been considered. These include: the adoption of an IMF-designed chart of accounts; modernization through computerization of the inland revenue and customs divisions; strengthening of enforcements; and adoption of a robust risk-based management system. These measures are further accompanied by successive reforms to the budget and treasury systems aimed at ensuring that budget financing by zobas and sub-zobas is fully tracked and accounted for on a timely basis.

While achievements have been significant, a substantial reform agenda is still pending. Its implementation will be essential for addressing the remaining weaknesses in public financial management (PFM) and the entire planning process both at sector and national levels, especially in terms of developing evidence-based development plans.

Additional challenges include the shortage of adequately trained human resources, lack of basic infrastructure, scarcity of equipment and required software.

These capacity constraints are preventing the country from further improving its PFM through the introduction and adoption of robust systems, such as a performance or a programme-based budget system, and its long-term planning through the rollout of a three-year Medium-Term Expenditure Framework (MTEF).

Failure to introduce an MTEF will undermine the effective monitoring and evaluation of sector-development plans.

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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