The Ethiopian Business Environment in Light of the Homegrown Economic Reform Program
By Tsegamlak Solomon | Thu Sep 03 2020
Below we attempt to outline some of the most straightforward and honest assessments of the barriers that have historically choked the private sector and foreign investors in Ethiopia, and what the government is doing about it. After building one of the most active SME investment firms in Ethiopia, our companies have experienced every one of these challenges, and then some. So after we present the top five challenges holding back the private sector and the remedies Ethiopia’s progressive government is implementing to address them, we offer some color to bring these to life. These are real challenges, with real consequences, but if the government can implement these reforms from the top, down to each employee, then the skies are the limit for Ethiopia!
In 2015, the World Bank published its 2015 Enterprise Survey on Ethiopia, which outlined information about the biggest obstacles that private sector companies face in the country. The survey summarized twelve business environment categories, including: corruption, crime, finance, firm characteristics, gender, informality, infrastructure, innovation and technology, performance, regulations and taxes, trade and workforce. As a result, the RENEW team compiled 10 takeaways and published a blog titled “10 Things You Should Know About Ethiopia’s Business Environment” to address a number of insights from this survey.
Five years later, Ethiopia has taken a number of measures and adopted an economic reform program known as the ‘Homegrown Economic Reform Agenda’ (the “Reform Program”). The Reform Program highlights the importance of the private sector to the national economy and a key part of the growing business environment. In light of the reform, here is our updated findings that the country is currently undertaking to make the business environment more appealing to foreign investors.
Access to Finance
The World Bank asked 848 companies in Ethiopia to rank the most prevalent obstacles that they face while doing business in Ethiopia. From the list of 15 common obstacles presented, access to finance was identified as number one.
The Reform Program recognizes that access to finance is a major challenge; as such it listed improving access to finance and developing capital markets as one of the requirements for the safeguarding of macro-financial stability. In order to tackle this problem, the Reform Program proposes the development of a competitive and well-functioning T-bills market; upgrading the financial market infrastructure; establishing a secondary bond market and a stock exchange market; and supporting the development of mobile banking.
Spearheaded by the National Bank of Ethiopia, the access to finance reform sets different short term, medium term and long-term goals. These include creating a unified secured transactions legal framework, introducing and operationalizing collateral registry systems, and developing and implementing a credit scoring mechanism, among others.
As a result, subsequent to the adoption of the Reform Program, the Government has adopted the Movable Property Security Right Proclamation No. 1147/2019, which allows financial institutions to hold movable properties as collateral for providing loans. The types of items that could be collateralized include inventories, agricultural products, incorporeal assets, security rights in warehouses receipts and many others. This is expected to expand the reachability of bank loans to SMEs.
Ethiopia is moving a lot of projects forward with regard to economic reform and access to finance. At first, it won’t be perfect. We expect a lot of changes and amendments until the government works out the kinks. But these are steps in the right direction. Of course, only when Ethiopia opens the banking sector to foreign investors will the country see access to finance and foreign currency really improve.
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Challenges in Relation to Customs Clearance
As per the 2015 World Bank Survey, it takes on average 19.2 days to clear import from customs, about 3 days longer than the SSA region’s average, and the proportion of inputs and/or supplies that are of domestic origin are significantly higher than SSA - 82.5% versus 66.1%. This may be a result of a shortage of foreign currency and protectionist trade policies.
To address these issues, a year before the adoption of the Reform Program, the Ethiopian Customs Commission was established as an autonomous government entity independent from the former Ethiopia Revenues and Customs Authority. After its establishment per Proclamation No. 1097/2018, the powers, duties and organization of the Commission were further defined by Regulation No. 437/2018. The Customs Commission is headed by a commissioner and is accountable to the Ministry of Revenues. The objective of the Commission is to provide equitable, expeditious and quality service by establishing a modern customs administration system among others. Using its power, the Commission has issued different directives to this end. These measures in effect are expected to improve the country’s ranking in relation to customs clearance and administration.
The Commission has been given the responsibility of leading the Reform Program in relation to trading across borders. The Commission is accountable for launching pilot electronic single window systems, implementing simplified customs procedures, implementing pre-arrival clearance and many others. These were all set in an effort to reduce the lead-time in customs clearance and improve the country’s ranking in that regard. So far, the Commission has taken different steps including, but not limited to, launching a single window customer service system, reducing the number of documents required for import/export; and introducing a web based internal customs management system.
This is very good news. It starts at the top. But if the person stamping the documents and interfacing with the private sector doesn’t believe their job is made possible from the tax revenues generated by the hard work of the private sector, the full benefits of these programs will not be realized. And with other countries engaging more with Africa, some of which do not have the same adherence to the rules of good business as those in the West, the game could get exponentially more messy. But if the top is truly committed to making the flow of goods and services in and out of the country seamless, then there's a good chance these programs will take hold. If the desk officers believe in this work, we will see thousands of small businesses grow into big companies that create hundreds if not thousands of jobs.
Tax Administration and Payment
From the 2015 Enterprise Survey Data, RENEW learned that although the amount of time senior management spends dealing with the requirements of government regulations in Ethiopia is higher than that of SSA (11.9% versus 7.6%), the remaining indicators are all lower. Examples include the number of days it takes to acquire an operating license (5.4 versus 19.1), number of visits required to meet with tax officials (1.6 versus 2.2), and the percentage of firms identifying tax rates as a major constraint (22.8% versus 33.2%).
In light of this, the government has taken a number of tax reform measures that will have a direct impact on improving the country’s ranking. This includes implementing an e-filing and payment system; reducing VAT refund time; enabling payments through banks, etc. One of the biggest changes is that through the new VAT Proclamation (VAT (Amendment) Proclamation No. 1157/2019), companies with annual gross revenue of less than ETB 70 million (close to 2 million USD) are no longer required to report VAT monthly, but can now report quarterly.
These are all very good measures. ERCA, the tax authority, has a reputation of conducting audits and always finding something, so be ready. But the VAT payment is a notable hat-tip to SMEs from the government, giving the heartbeat of the economy some better cash flow, and a lot less hassle each month (now quarterly) to pay their taxes.
Electricity and Access to the Grid
Per the 2015 World Bank Survey, generator use is much higher in Ethiopia than SSA (48.9% versus 26.5%), which is to be expected given that the country is quickly industrializing but in need of more power. In fact, electricity was listed as the second highest obstacle that firms face in Ethiopia. It takes companies 194.3 days to obtain an electrical connection upon application, versus the 33.0 days for the rest of SSA.
The Ethiopian Electric Utility has been given the mandate to handle the reform measures in relation to improving access to electricity. Among these mandates are availing effective tariffs and changes online; reducing documentary requirements on the first application form and ID card; reducing the time it takes for connection and other related tasks. As a result, the Ethiopian Electric Utility has undertaken the following major measures:
Eliminating the 10% guarantee deposit requirements for post paid bill customers and introducing a bank guarantee system for customers using bank payment and those using more than 10 megawatts;
Reducing time of site visit and cost estimation to 5 days from the date of application for a request ranging upto 150 kw; 7 working days for requests between 150 kw - 3 mva; 10 working days for requests between 3 mva - 10 mva; and fifteen working days for requests greater than 10 mva;
Reducing the number of documentations required to apply for connection; Introducing the new tariff system online and having a system to inform customers about their bill before it gets printed.
Those who give you power, wield power. We have personally sat for hours, days and weeks in run-down government office buildings waiting for a meeting to beg the person across the desk to hook our transformer to the grid. Getting a transformer alone can take six months to a year, and then the steps to get a connection can kill any new factory’s chances for survival. This is a very real problem, and until Ethiopia eliminates the steps, it will remain a problem at the top of the list as one of the main chokeholds for Ethiopia to industrialize. A piece of advice for investors; add a 6-month cushion to deal with power issues alone or find a way to go off-the-grid.
A Closed Business Environment
The 2015 World Bank Survey indicates that the proportion of private domestic ownership in a firm versus the private foreign ownership in a firm (95.9% versus 3.8%) shows that RENEW and the IAN are part of a very small percentage of foreign investors doing business in Ethiopia.
Under the Reform Program, private investment has been given greater emphasis. The private sector has been presented in the program to succeed the government in leading the economy, which has been dominated for a long time by public investments. In order to bring its percentage of enterprise ownership down, the government has adopted a new investment proclamation and investment regulation, repealing the decades-old law. The new investment law loosened some of the major restrictions on foreign investment. Parts of these measures include the adoption of a negative listing approach, which resulted in the reduction of the number of sectors that were closed for foreign investment. In addition, the new investment laws introduced an accelerated investment permit issuance, renewal and cancelation procedure; favorable grievance handling and dispute settlement mechanisms; and an extended one-stop-shop service, among others.
The negative listing approach is a welcome change and opens up many sectors to foreign investors. However, foreign investors should still be ready to make their case clear and compelling to DARA, one of the main groups that approves investments. We recommend hiring a very good local lawyer to help you work through the approval process and be ready to use kind persistence. After decades of approving certain types of investments for foreigners, government employees will need (and welcome) your patience.
In summary, Ethiopia is opening up for business. If you are interested in learning more about investing in Ethiopia, please reach out to us (firstname.lastname@example.org) or come by our office in Addis.
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