Ethiopia’s process of financial liberalisation needs proof that profits can be repatriated to expand the country’s pool of foreign direct investment (FDI) beyond a small group of specialist investors. 

Reforms to the country’s centralised, state-driven model have accelerated under prime minister Abiy Ahmed, who has been in power since 2018. Kenyan telecoms operator Safaricom secured the country’s first foreign mobile money licence in May. In September, the central bank authorised convertibility of the birr into hard currency for strategic projects in energy and mining, which was the single biggest obstacle for the repatriation of profits generated by Ethiopian subsidiaries. And, in 2024, the country plans to launch its first stock market since the communist revolution of 1974. 

However, these moves have yet to spark foreign investment interest. 

Ethio Lease, the only foreign financial services company currently in the country, announced in November that it is pulling out of the country due to restrictions on foreign exchange.

The promising features of Ethiopia include a population of 120 million, a median age of less than 20, rapid gross domestic product (GDP) growth and low urbanisation rates, says Mathias Althoff, vice chief investment officer at the Tundra Fonder frontier markets investment firm in Stockholm. “We are looking for this kind of structural growth,” he says. 

But hurdles remain before Ethiopia makes it onto Tundra Fonder’s investment radar. Clear rules on repatriating profits and dividends need to be in place, with a track record of operating in practice, Mr Althoff says. The planned stock market will not be enough. “We want companies with a long record of producing profit growth during difficult cycles.” 

Though Tundra Fonder does not have any exposure to Safaricom, foreign multinationals could provide a quicker way to play the country’s potential than investing in local businesses, Mr Althoff adds.

Generational reforms

Internal political stability is an essential requirement if liberalisation is to succeed. Civil war broke out in the country’s northern Tigray region in November 2020 and continued until a peace agreement was signed in November 2022. Human Rights Watch said in June that ethnic cleansing in the region has since continued. 

Ethiopia is likely to overtake Kenya to become the third-largest economy in sub-Saharan Africa in the next two years, says Magdi Amin, managing partner at African Renaissance Partners (ARP), an east Africa-focused venture capital fund. Unlike sub-Saharan Africa’s two largest economies, Nigeria and South Africa, Ethiopia has yet to become a major destination for venture capital and has “huge untapped potential”, he says. 

ARP invested in Ethiopia in 2023, taking a stake in Kubik, a plastics recycling business. More Ethiopian investments are in the pipeline in logistics, he says. Mr Amin would also be interested in Ethiopian fintech and payments providers if financial liberalisation continues. The fund is patient and willing to hold strongly performing companies for six years or more. 

Mr Amin worked in Ethiopia for the World Bank between 2005 and 2008. By then, there were already the beginnings of reform of the old state-run economy, and the pace of change has accelerated in recent years, he says. There have been marked improvements to road networks and schools across Ethiopia, and the country is now able to export low-cost electricity. 

But there remains a “lot of caution” among lower-level state officials about the reform process, Mr Amin says. “Generational” reforms have been carried out, which reflect “a substantial shift of thinking,” he explains. “This isn’t a country that’s driven by state directive.”

About 40 million Ethiopians now have digital wallets, the use of which is compulsory for purchases of petrol. “These dynamics are not reversible,” Mr Amin says. Still, he adds, Ethiopia needs a track record of successful venture capital exits before it can attract a broader range of international investors. 

Ticket sizes

If large investors face a profit repatriation problem, venture capital interested in Ethiopian start-ups also face limitations, argues Tigist Araya, CEO and co-founder of the Araya Venture Lab in Addis Ababa.

The lab, set up in 2022, supports start-ups that address value-chain bottlenecks in agriculture, health, education and real estate. It holds a stake in SantimPay, a fintech that provides payment solutions for Ethiopian businesses.

Currently, there is a $200,000 minimum capital  requirement for any local venture fully owned by foreign investors, or $150,000 for joint ventures with local partners. That “wouldn’t make sense for early stage start-ups”, as they cannot productively absorb such sums, Ms Araya says. Smaller minimum levels are needed, and she is hopeful that a review by regulators will lead to more flexibility.  

Besides, it needs to become easier to start and close a business, and there needs to be an understanding of the appropriate ticket sizes for start-ups, she argues.

Preferential treatment

Partial opening of the economy has been carried out with the interests of state-owned enterprises (SOEs) front of mind.

Ethiopia remains “very protective” of SOEs, which “have played a central role in driving the high investment and GDP growth rates over the past decade”, wrote the IMF in 2020. They receive “clear preferential treatment”, says Irmgard Erasmus, an economist with Oxford Economics in South Africa. The IMF wants the problem to be tackled, but the government to date has not been willing to take that on board, she says. 

State-owned banks are among the beneficiaries, meaning the local private banking sector remains very small, Ms Erasmus says. She sees a risk that foreign bank entry would simply crowd out the local banking sector. Likewise, telecoms companies will want to see a clear roadmap of how the operating environment is going to improve before they will be persuaded to enter, she adds. 

Reversion to the old closed, state-dominated model remains possible, with the country’s sovereign debt burden a potential trigger, Ms Erasmus says. Fitch Solutions estimates that Ethiopia’s foreign exchange reserves were worth less than one month of import cover in the second quarter of 2023. The country faces a $1bn eurobond maturity in 2024 and in November reached an agreement in principle with bilateral creditors on debt-service suspension.

“The sword of sovereign debt default is hanging over their heads,” Ms Erasmus says. The most realistic way for Ethiopia to avoid a default, she says, is to agree to IMF prescriptions including devaluation of the birr to secure a support programme. 

The government is reluctant to do that because of the inflationary impact of devaluation, but Ms Erasmus says she is “cautiously optimistic” that a staff-level IMF agreement can be achieved in the first quarter of 2024.  

The government, Mr Amin argues, is pursuing a long-term reform process, rather than responding to sovereign debt pressures. The next steps, he says, should include regulations to facilitate local currency private equity funds which could attract foreign and diasporic investment.

The government’s digital ID scheme also needs to be fully implemented, which will ease corporate customer onboarding and know-your-customer processes, he adds.

Ms Erasmus says that the current sovereign debt context does not provide a good entry point for FDI. By 2025, she says, there may be a debt resolution which could offer a better opening. 

David Whitehouse is a freelance journalist and editor at large of The Africa Report in Paris.

This article first appeared in the December 2023/January 2024 print edition of fDi Intelligence

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