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Box 5: Ethiopia’s macro-economic context in a nutshell
5.1 Policy barriers
5.1.1 Macro-economic gaps
Inflation has been above 10% p.a. for most years since 2010, and it has been rising since 2017, to over 20% p.a. in 2021.
Ethiopia experiences constant forex shortages. For instance, at the time of writing banks have been instructed to stop lending, because this fuels the black market for forex where rates are substantially higher than the official exchange rate.
These problems that affect SMEs as well as their (potential) financiers are based on three persistent problems: 1. Exports < imports 2. Savings < investment needs 3. Tax collection < government spending
Box 5: Ethiopia’s macro-economic context in a nutshell
Any country can expand its national income if it can export more goods and services than it imports. By the accounting logic of national accounts, this represents a net-capital export. Equivalent, if a country imports more than it exports, it contracts its national income. This represents a net-capital import. This describes the macroeconomic situation of Ethiopia. If net-exports (i. e. exports minus imports) are negative, a floating currency of the country would depreciate; this makes imports more expensive and exports less expensive (hence exporters more competitive). However, Ethiopia does not allow its currency to depreciate as much. Therefore, there is a forex-shortage in the country and hence a black market for forex. Countries which have a high savings rate, such as common in South-East Asia, can finance their capital stock that way (rather than through negative net-exports).
5.1 Policy barriers (cont.)
5.1.2 Liberalisation
Throughout the 20th century, Ethiopia pursued a state-centred, highly interventionist economic policy. This largely suffocated private sector development. (Pinto, 2019)
During the 2010s, the government introduced an SME-policy and agency, FEMSEDA. This agency was recently replaced by FeSMMIPA and FeUJCFSA (Pinto, 2019). However, the main spirit of economic policy was still shaped by the previous philosophy. Fanta (2012) finds that reforms that allowed private Ethiopianowned banks to operate since about 2000 did not have any effect on SME-access to finance.
USAID notes that “[t]he formal private sector in Ethiopia has very little capacity and involvement in the
Ethiopian economy. […] The private sector has a relatively low 27 per cent contribution to the economy, and creates a meagre 5.5 per cent of the formal workforce. [..] the private sector in Ethiopia has one of the lowest rates of formal business creation in the world. Comparatively, Ethiopia has very low private sector investments in the country; 8.8 per cent compared to a sub-Saharan average of 18 per cent”1
1 Cited from an USAID-presentation on the case of expansion of the Warehouse Receipt System (WRS) in Ethiopia. Year, event, and target group of the presentation are not indicated. From references used it, can be dated to be from 2019 or 2020.
5.1 Policy barriers (cont.)
5.1.2 Liberalisation (cont.)
Furthermore, in the agricultural sector SMEs have played a relatively smaller role because the GoE has given priority to cooperatives. While this desk review has not looked into the role of cooperatives, it is apparent that they have been supported massively by GoE, e. g. through the cooperative promotion agency promoting formation of primary cooperatives from kebele level upwards. Since 2018, the government has adopted a new approach which emphasizes liberalization, in particular: Opening the telecommunications market (ongoing; MTN received the first foreign telco-license in May 2021). Opening the financial sector for foreign-owned financial institutions from 2023.
Foreign firms are restricted from entering the m/e-banking and e-commerce market of Ethiopia, it is still only open for domestic investors. (NBE-Directive No. ONPS/02/2020)
Ethiopia’s Ten Years Perspective Development Plan (2021 – 2030) states under the strategic pillar “Private sector's leadership in the economy” to enhance access and quality of infrastructure to attract quality foreign direct investment.
The current credit information system in Ethiopia is operating sub-optimally. The World Bank (2015) reports that financial institutions are constrained by the contractual environment and do not exploit the public credit reference bureau well. Another study advises to allow private credit reference services to expand the scope of information (as well as of its users). The World Bank suggests to enhance the regulatory, legal, and supervisory framework of the NBE that underpin the establishment and supervision of a private credit bureau. “Faced with a dearth of information, financial institutions impose unduly large collateral requirements in order to minimize their exposure and risk.” (World Bank, 2020:46) Leasing as an alternative financing instrument fits perfectly in the Government’s vision to increase access to finance to agri-related SMEs with insufficient collateral. The vision is reinforced by the fact that the policy makers have found it relevant to further amend the actual capital goods leasing proclamation 103/1998 as amended by the 807/2013 proclamation by aligning it to international best practices. Leasing as an innovative financial product for agricultural SMEs, purposely for the financing of agricultural machinery, increases the quantity and quality of lending for eligible lessees (private agricultural service providers, aggregators, processors, farmers, cooperative unions).
5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)
5.1 Policy barriers (cont.)
5.1.3 Legal environment (cont.)
The existing commercial laws of the country do not properly and clearly address m-banking and e- banking at large. Ethiopia is just in the process of enacting legislation that deals with e-commerce which covers enforceability of the validity of electronic contracts, digital signatures, and electronic transactions. Drawing on experiences from Kenya and Uganda (among others), consumer protection concerns will inevitably emerge as a topic; from the current desk-review, it is not a topic that affects (agri-) SMEs.
The regulatory body faces challenges in terms of timely approving innovative products. It took about seven months to get a license for mobile and agent banking for one commercial bank.
To reduce transaction costs of loan contracts, NBE created a movable collateral registry which became operational this year. NBE obliges banks to secure a minimum of 5% of total disbursed loans against movable inventory only. Besides, banks can also lend to MFIs that have greater liquidity requirements, which can be counted towards the portfolio disbursed against movable inventory. (MCR/01/2020)
Bureaucracy in company registration and getting a license, instability in tax policy and high tax rate have a negative significant effect on financial performance of small business enterprises. (Gelaye, 2020).
5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)
5.1 Policy barriers (cont.)
5.1.4 Infrastructure
As of the end of FY 2018/19, Ethiopia had 138,127 km (85,825 miles) of all-weather roads – about 39% of the required road network in the country.2
The new rail system began commercial operations in 2018. It comprises 656 km railway network that links the capital city Addis Ababa to the port of Djibouti.
However, road network constraints in the rural economy are still felt.
“According to the World Health Organization (WHO), Ethiopia has the highest rate of traffic fatalities per vehicle in the world. Roads in Ethiopia are poorly maintained, inadequately marked, and poorly lighted.”3
2 International Trade Administration: “Ethiopia - Country Commercial Guide”, accessed Aug 2021: https://www.trade.gov/knowledgeproduct/ethiopia-road-and-railways 3 Country Reports: “Traffic and Road Conditions in Ethiopia”, accessed Aug 2021: https://www.countryreports.org/country/Ethiopia/traffic.htm
5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)
5.1 Policy barriers (cont.)
5.1.4 Infrastructure (cont.)
Moreover, the IT-infrastructure is still very inadequate. Ethiopia has one of the lowest mobile phone and fixed broadband penetrations of East-Africa (data.worldbank.org). This is mirrored by high rates of per minute tariffs in telephone or communication services.
Table 2: Comparative mobile banking status (Global Findex database 2018).
Ethiopia Kenya Rwanda Sub-Sahara Africa
Mobile money accounts (in %, age 15+) 0.3 73 31 21
Made or received digital payments in the past year (%) 12 79 39 34 Paid utility bills using a mobile phone (out of adults who paid utility bills) 0 82 44 23 Used a mobile phone or the internet to access a financial institution account in the past year (out of adults with a financial institution account, age 15+)
1 57 13 24
5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)
5.1 Policy barriers (cont.)
5.1.4 Infrastructure (cont.)
Availability and quality of IT infrastructure is one of the challenges which impacts the agent banking business. Interruption in services of telecommunications due to technical or nontechnical issues and non-availability of any parallel system as alternative may cause disruption in service availability. Similarly, congestion in network may become a bottleneck in providing quality of service to agent banking users.
Furthermore, electric power breaks up frequently. The inconsistent availability of power supply in the country, particularly in rural areas, is one of the challenges for the implementation and continuous availability of mobile and agent banking services. The utility disruptions, software or hardware failures can cause a lack of service availability and information loss.
In some places there are inadequate water supply and waste (disposal) management systems. (Gelaye, 2020)
All of these translate into costs for SMEs which affect their ability to compete in the market.
5. Findings I: Barriers to Agricultural Finance for SMEs in Ethiopia (cont.)
5.2 Demand-side barriers
5.2.1 Management capacity & governance structure
Some characteristics of the SME-management are positively correlated with access to finance: Age of the firm Experience of the manager Whether firms are managed by the owner (owner-manager) or not.
Several studies note that SMEs often lack of the required human resources and management systems along the HR cycle.
Particularly when SMEs grow, they encounter challenges in setting up financial and operational management systems. Financial management gaps are most acutely felt, because the enterprise runs into liquidity problems and, viz-a-viz lenders or investors, lacks financial records that state its business case.
5.2 Demand-side barriers (cont.)
Lack of management skills and experience and the application of poor accounting practices hinder the SMEs’ ability to formulate a qualified demand for capital and to raise finance. For instance, Dalberg (2018) notes
“financial reporting, accounting, governance and growth strategy” as TA-needs of agri-SMEs in East Africa (from the perspective of the FIs, they do not see these as profitability drivers, though).
The application process for a loan is difficult for SMEs (slide 43 lists some of the documents required). 6% of small and 5% of medium sized companies indicated “application procedures were complex” as a reason for not applying for a loan (World Bank, 2015). Conversations from the stakeholder workshop gave examples of agri-SMEs that do have well prepared business documents (such as validation of assets etc.), but nonetheless see their loan application rejected (because of the type of collateral); this shows that narrow focus on collateral over-shadows demand-side issues.
These are interlinked with operational management and business planning (‘strategic management’). When the team expands, the entrepreneur needs to make sure that everybody knows their roles and performs them, and receives feedback on their performance, even if the manager-owner is not around.
5.2 Demand-side barriers (cont.)
Accordingly, SMEs also regularly miss the governance structure required for an enterprise that has outgrown its owner-manager taking any decision alone. Conversations at the stakeholder workshop affirmed that an overbearing role ‘owner-CEOs’ is a bottleneck for some agri-SMEs, particularly when they have successfully outgrown the micro-size.
5.2.2 Socio-cultural context
Some entrepreneurs (SME-operators) reported that they can not access credit due to their religion (Islam), which prohibits interest-charges. In Ethiopia, like all around the world, women-owned businesses have less access to credit than their male counterparts. In the Economist’s Women’s Economic Opportunity index, Ethiopia occupies the 123rd rank out of 128 countries. Most growth-oriented women entrepreneurs fall into a ‘missing middle’ trap, in which they are served neither by commercial banks nor by microfinance situations. (World Bank, 2020)
5.2.3 Perception of financial institutions
SMEs prefer to obtain their finances from family loans, iquub, or personal savings as an alternative to credit from banks or MFI.
5.3 Supply-side barriers
5.3.1 Collateral requirements
By international comparison, Ethiopia has one of the highest collateral requirements in the world – at time over 200% of the loan amount.
The World Bank (2020) reports that its Women Entrepreneurs Development Programme triggered reduction of collateral requirements by some MFIs (!) from 200 to 125%.
So far, practically all collateral is demanded in form of fixed assets (and/ or land titles), which most SMEs hardly possess. AACCSA (2020) reports that about 60% of small enterprises pledge land/ buildings or personal assets as collateral. Only for larger enterprises are other forms of collateral (equipment, receivable accounts) accepted, complementary not substituting to land / buildings.
Oshora et al (2021) also note that MFIs demand clients save compulsory 15% to 20% of the loan amount over six months. This is effectively another form of collateral and both a huge increase of capital cost and a substantial drain of liquidity for the SME.
5.3 Supply-side barriers (cont.)
5.3.2 Credit history
In line with theory – credit history reduces credit risk – studies show that firm’s previous engagement with banks are positively correlated to their access to credit, therefore it is more difficult for unbanked SMEs to enter the market.
5.3.3 Excessive upfront documentation
Commercial banks require SMEs to provide a lot of documents upfront, many of which are costly to generate in the first place, for example: Audited accounts (usually) at least 2 years Certificate of incorporation Taxation compliance (TIN number) Business plans with financial projections etc.
Box 6: Loan application processes
SMEs surveyed by AACCSA (2020:chapter 5) report that the process of applying for a loan is very lengthy. On the one hand, the procedures are complex and require ‘a pile of paper work’ (p. 241). On the other hand, the valuation of collateral offered is perceived to be neither consistent nor transparent. Furthermore, in the course of the loan application additional expenses (including stamp duty, city council charges, other service charges) occur that sum up to 8% of the loan amount. In sum, these procedures regularly range from 3 to 12 months; DBEapplicants report up to 18 months.
5.3 Supply-side barriers (cont.)
5.3.4 Technical (staff) capacity
CIMMYT (2015) identifies capacity building needs: Weak management information system (MIS) Lack of standard software Skilled manpower, e. g. loan appraisal, market research In future, IT-skills will be critical for banks to provide secure services and control vulnerability if they computerize their systems, particularly if they engage in e- and m-banking.
