World Bank report urges Ethiopia to accelerate structural reforms

By Muluken Yewondwossen

In a recently released report by the World Bank, titled Country Climate and Development Report (CCDR), it is stated that Ethiopia’s transition to a market economy has been hindered, and its external competitiveness has been undermined by a state-led growth model that heavily relied on imports and public investments. The growth model was characterized by pervasive price distortions and an overvalued exchange rate.

The report emphasizes the need for the government to expedite structural reforms to build a climate resilient economy. Ethiopia has been grappling with significant macroeconomic imbalances, financing challenges, a depletion of external reserve buffers, foreign exchange shortages, a growing parallel market premium, and high inflation. Failure to address these issues in a timely manner could lead to an increase in poverty exacerbated by the effects of climate change. The report highlights that efforts to reduce poverty are being impeded by compounding shocks from conflicts, droughts, and rising food prices.

The emergence of the capital market is identified as a crucial step toward developing a climate-change-mitigating economy. The report, released on February 27, indicates that Ethiopia needs to allocate at least USD 27.6 billion over the next 25 years to tackle climate change challenges effectively.

The research suggests that structural changes and macroeconomic stabilization will not only enhance climate resilience but also promote economic growth. It states, “Ethiopia’s current economic situation features serious macroeconomic imbalances, few jobs, and widespread poverty, insecurity, and vulnerability. Without addressing the causes of these problems through a program of macroeconomic stabilization and structural reforms, it will be difficult to undertake actions to build climate resilience.” Implementing these reforms will also help propel the stalled structural transformation of the Ethiopian economy and its transition to a market economy, contributing to inclusive growth and poverty reduction.

The report emphasizes the essential role of the private sector in addressing these challenges. It notes that climate investment needs are significant, considering the resource shortages. The CCDR estimates that sector-specific climate investments, focusing on agriculture, livestock, sustainable land management, urban infrastructure, roads and bridges, and water storage, will amount to USD 27.6 billion by 2050. This represents 3.6 percent of cumulative GDP until 2050, with frontloading of investments necessary to protect against the worst impacts of climate change.

While acknowledging the difficulty in fully ascertaining the volumes of climate finance mobilized by Ethiopia, the report estimates that it ranges from USD 0.6 to 3.2 billion per year, with indications of a decline. The report suggests that in the near term, mobilizing more domestic resources and unlocking access to grant and concessional resources through structural reforms should be a priority.

The report also highlights the importance of grant and concessional finance as the most significant and least expensive source of external finance for climate-related purposes. It recommends that Ethiopia implement stronger policies to support performance-based allocation (PBA) formulas, which will determine resource envelopes from multilateral institutions. Additionally, financial sector reforms are crucial to improve stability and depth, strengthen regulatory frameworks, and address the relationship between state-owned enterprises (SOEs) and state-owned banks. Opening the banking sector to foreign investment, establishing deposit insurance, and increasing insurance market penetration are also key areas for reform. Developing capital markets will further facilitate the issuance and exchange of climate finance instruments such as green bonds, supporting private capital mobilization in the medium term.

The report concludes by emphasizing the need to reform Ethiopia’s social safety net programs to effectively respond to climate shocks and strengthen adaptive capacity, with a priority on the lowlands.

As Ethiopia tackles the challenges of climate change and seeks to build a resilient economy, it is crucial for the government to implement the recommended structural reforms, mobilize resources, and engage the private sector to achieve sustainable and inclusive growth while addressing poverty and vulnerability.

The CCDR aims to support Ethiopia in achieving its development goals while navigating the challenges posed by climate change until 2050. Modeling analysis conducted for the CCDR reveals that climate change will impose substantial costs on the economy, with costs increasing rapidly after 2030.

The report identifies several channels through which the adverse impacts of climate change will materialize. These include more frequent and severe flooding, reduced crop and livestock yields, variable hydropower production, infrastructure damage, and losses in human health and productivity.

If Ethiopia maintains its current policies, characterized by a significant state presence in the economy and slow progress on structural reforms, known as the constrained growth (CG) scenario, the report projects average annual losses to GDP and household consumption ranging from 1 to 1.5 percent annually in the period of 2024-2030. These losses are expected to reach the upper end of the range in a dry and hot climate scenario.

Furthermore, the report highlights that impacts will rapidly increase from 2030 onwards, with average deviations from GDP and household consumption reaching as high as 5 percent during the 2040s. The cumulative economic loss is projected to rise from about 10 to 14 percent of 2022 GDP between 2023-2030, to approximately 20 to 30 percent of average decadal GDP between 2030-2040, and even higher thereafter.

“If current policies are maintained, poverty will also increase due to the impacts of climate change in the absence of macroeconomic and structural reforms,” the report warns. Analysis conducted for the CCDR demonstrates that climate change will lead to larger increases in poverty over the next 25 years without the implementation of structural reforms. Under the CG scenario, poverty is projected to increase by 0.5 to 1.7 percentage points by 2050. However, with the implementation of structural reforms, the increase in poverty would be much smaller, ranging between 0.1 to 1 percent.

The report argues that undertaking macroeconomic stabilization and structural reforms will mitigate the adverse impacts of climate change on economic growth. It emphasizes that structural reforms will enhance resilience and reduce the cost of adapting to climate change. The agriculture sector is highlighted as an example, where implementing reforms would lead to a significant increase in agricultural output, even in the face of climate change. This would result in an excess production that surpasses domestic demand by the end of the decade, generating a substantial marketable/exportable surplus from 2030 onwards.

However, the report cautions that structural reforms alone will not be sufficient. Additional measures will be required to adapt, including a shift away from a center, state-driven development approach. These measures encompass additional policies and incremental investments aimed not only at increasing productivity but also at reducing the costs associated with climate change impacts.

As Ethiopia grapples with the challenges posed by climate change, the report underscores the importance of implementing structural reforms and additional measures to build resilience, adapt effectively, and mitigate the adverse effects on economic growth and poverty levels.

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