Domestic Resource Mobilization:

Case Study on Ethiopia

By

Haile Kebret TAYE, Gashaw Tsegaye AYELE, Monica Kansiime KAGORORA

Commissioned by the African Capacity Building Foundation

Addis Ababa, Ethiopia/ July 2015

2

EXECUTIVE SUMMARY ............................................................................................................................. 4

1 INTRODUCTION ....................................................................................................................................... 7

2 OVERVIEW AND ANALYSIS OF STRATEGIES AND INITIATIVES ON DRM ................................................. 10

2.1 PUBLIC SECTOR SAVINGS ............................................................................................................................... 10 2.1.1 An Overview of the Tax structure ................................................................................................... 10 2.1.2 Relative Contributions of Tax Revenue ........................................................................................... 13

2.2 PRIVATE SAVINGS ........................................................................................................................................ 14 2.2.1 The Formal Banking Sector in Ethiopia .......................................................................................... 15 2.2.2 Savings in the Informal Financial Sector ........................................................................................ 17

3 EXTENT AND TRENDS IN DOMESTIC RESOURCE MOBILIZATION IN ETHIOPIA ........................................ 19

3.1 EXTENT AND TRENDS IN REVENUE GENERATION ................................................................................................ 19 3.2 EXTENT AND TRENDS IN SAVING MOBILIZATION ................................................................................................ 21 3.3 SPECIAL DRM SCHEMES ................................................................................................................................ 23 3.4 CAPACITY CHALLENGES ................................................................................................................................. 26

4 IMPACTS OF DRM AND FIGHT AGAINST ILLICIT FINANCIAL FLOWS ....................................................... 28

4.1 RESOURCE GAP AND ILLICIT FINANCIAL FLOW ................................................................................................... 28 4.2 ECONOMIC IMPACTS OF DRM ....................................................................................................................... 30 4.3 SOCIAL AND CAPACITY DEVELOPMENT RELATED IMPACTS ................................................................................... 32 4.4 PUBLIC SPENDING AND DRM PATTERNS .......................................................................................................... 33

4.4.1 Public Spending Patterns ................................................................................................................ 33 4.4.2 DRM Patterns ................................................................................................................................. 34

4.5 EFFORTS AND ACHIEVEMENTS IN TERMS OF DRM AND ILLICIT FINANCIAL FLOWS ................................................... 36

5 LESSONS LEARNT AND CAPACITY DEVELOPMENT IMPERATIVES ........................................................... 40

5.1 LESSONS LEARNT .......................................................................................................................................... 40 5.2 CAPACITY IMPERATIVES FOR EFFECTIVE DRM ................................................................................................... 41

6 CONCLUSIONS ....................................................................................................................................... 44

7 REFERENCES .......................................................................................................................................... 47

3

List of Tables:

Table 1.1 Sectoral Contributions to GDP and GDP Growth ..................................................... 9

Table 3.1 Trends of Government Revenue and Contribution of Tax Revenues ...................... 20

Table 3.2 Annual Resource Mobilizations and Disbursements of Chartered Banks as of June

30, 2014 (Millions of Birr). ...................................................................................................... 22

Table 3.3 Selected Indicators of Financial Inclusion, Sources, Debt and Investments ........... 23

Table 3.4 Amount of Private Savings Mobilized and Contribution to GDP/GNS .................. 25

Table 3.5 Diaspora Bonds Issued by Government and Their Characteristics .......................... 26

Table 4.1 Size of Illicit Finance and Resource Gap in Ethiopia (2003-12) ............................. 29

Table 4.2 Public Expenditure Structure in Ethiopia ................................................................ 32

List of Figures:

Figure 2-1 Share of Government Revenue Sources (average share for 2000- 14) .................. 11

Figure 2-2 Non-tax Government Revenue Sources ................................................................. 13

Figure 2-3 Trends of Tax and Non-tax revenue of Ethiopia (in million Birr) ......................... 14

Figure 3-1 Trend in Tax ratio of Ethiopia Compared to Selected Regional and Sub-regional

Averages. .................................................................................................................................. 21

Figure 4-1 Net ODA flows and Foreign Reserves of Ethiopia (2005-12) ............................... 30

Figure 4-2 Gross Domestic Savings and Gross Capital Formation/Investment of Ethiopia

(2000-12) .................................................................................................................................. 31

Figure 4-3 Aggregate Government Expenditures .................................................................... 34

Figure 4-4 Taxation Structure (Tax ratio and tax mixes) in Ethiopia ...................................... 36

4

Domestic Resource Mobilization: Case Study on Ethiopia

By Haile Kebret TAYE, Gashaw Tsegaye AYELE, Monica Kansiime KAGORORA1

Executive Summary

Economic principle suggests that effective and optimal investment influences future economic

performance. Optimal investment is achieved through a concerted effort to mobilize and

efficiently use all available financial and non-financial resources. Hence, domestic resource

mobilization (DRM) is a crucial input to economic growth of a country. There is recognition

that DRM works either as a complement or a substitute (or both) to external resources such as

aid, foreign borrowing and/or FDI flows. Unlike these external sources, however, internal

sources ensure or guarantee independence, reliability and sustainability of growth momentum.

Hence the keen interest of many countries to rely more on DRM.

Ethiopia has put a lot of effort in mobilizing domestic resources using various strategies as

evidenced by the relatively notable economic growth registered in recent years. The strategies

it followed included public (revenue generation and saving mobilization) and the private

sectors (household and firm) savings. The effort has covered both formal (banking) and semi-

formal and informal financial institutions (microfinance, credit cooperatives, and even

traditional entities like “Ekub” and “Iddir”).

These programs have boosted the saving rate from 5.2 percent of GDP in 2009/10 to 17.7

percent in 2012/13 which in turn contributed to the raise in domestic investment as a share of

GDP from 24.7 percent in 2009/10 to 33 percent in 2012/13. In terms of growth, deposits

(net) almost doubled between 2012/13 and 2013/14. During the above period total resource

mobilized (saving, demand and time deposed) increased from 10 to 14 percent.

Some of the instruments used in mobilizing saving include Expanding bank branches, and

various initiatives that boost deposit and saving. The initiatives used include traditional

deposit mobilization and special provisions such as lottery coupons, special accounts for

youth, women, and interest-free banking, Micro finance institutions, pension schemes,

housing saving schemes couched with a lot of campaign on the need and benefit of saving

have also been used. Commercial bank branches have increased from 681 at the end of

FY2010 to 1,286 at the end of FY 2012 (89% increase). The majority of the increase comes

from the state-owned Commercial Bank of Ethiopia, which increased its branch network by

167 percent during the first two years of the Growth and Transformation Plan (GTP).

And the revenue that is generated in recent years has recently improved. To just focus on

recent years, tax revenue (direct + indirect tax) grew by 24% between 2012/13 and 2013/14.

And indirect taxes grew by about 22% during the same period. In terms of trade and non-trade

1 The Authors are members of the research staff at the Horn Economic and Social Policy Institute (HESPI)

Headquarters at Addis Ababa, Ethiopia.

5

taxes, foreign trade taxes grew by 19.4% while the domestic component grew by 24.8%. The

highest growth during the same period was that of urban land use fee and fees and charges

which both grew by about 40%.

The sharp increase in tax revenues has been attributed to a number of policy and

administrative measures taken by the government to improve domestic tax revenue collection,

including strengthening the capacity of the tax collection agencies, expanding the tax

identification number system, strengthening the value added tax system, increasing tax

compliance and taking stringent legal measures against tax evasion (MoFED, 2014).

Ethiopia faces many capacity related challenges in its effort to mobilize domestic resources.

Low income base and hence tax base, inefficient tax collection system and the structure of the

economy (informal, less recorded, and fragmented) also exaggerate the attendant capacity

challenges. Further, the financial sector is underdeveloped (pervasive financial depression,

uncompetitive, inefficient and unskilled staff) despite recent improvements.

In the midst of such limited resources in the country, a sizable chunk of that resource is

believed to leak from the system in the form of illicit flows. According to the Global Financial

Integrity/GFI (2014) rankings, Ethiopia is among the top five SSA counties and 39th in the

world in terms of its contribution to illicit financial flows. Its volume of illicit financial flows

averaged 2,206 USD annually (2003 - 2012). In particular, the absolute size of the illicit

financial flow between 2005 and 2012 was very high. This probably contributed to the

resource gap since Ethiopia has had a resource gap over the years. The gap remained 20

percent for most of the years. There are even years during which the illicit financial flow

almost equaled with the resource gaps. For instance, in 2010 the illicit financial flow reached

97 percent of the resource gap.

The crucial policy recommendations are based on the observation that the potential to

mobilize domestic resources has not been fully exploited in Ethiopia. To do so the following

capacity limitations and policy deficiencies should be addressed. Chief among these are:

increasing an effective computerization of the tax collection and administration ;working

towards minimizing the extent and organization of the informal sector such that all

transactions (particularly in the rural areas and small towns) are recorded; improve the

interbank money transactions instead of banks operating as „bridgeless islands‟; limit the

rigidity and the existing inefficiency of the recently started teller machines (with both

depositing and withdrawing options); make the tax system clear and easy to implement such

that it avoids ambiguity among implementers and the general public; the staff should be

equipped with the required qualifications and are rewarded and with commensurate pay

package attached to consequences so that their engagement is incentive compatible to

minimize corrupt behavior.

The government should devise policies that would boost healthy competition among the

financial / banking institutions so that the banks and private household sectors could

effectively mobilize resources (i.e. eliminate the entry barriers, negative real interest rates

etc); and efforts to tap the potential of the huge Ethiopian Diaspora has recently increased and

has showed some positive results. But as noted in terms of its contribution in participating the

purchase of Diaspora bonds, the contribution is less than that of other countries‟ experiences

and in terms of the size of the Diaspora. Additional effort that transcends any political

6

differences is required to maximize the potential. The government‟s effort has not been

consistent in trying to convince the Diaspora why it has a stake in building the country

beyond supporting their immediate families, however important that might be; this is better

harnessed with initiatives that could be viewed as politically „neutral‟ like the Renaissance

Dam and by creating a closer network rather than the „arms-length‟ approach which seems to

have been followed.

Not enough is known regarding the extent to which an effort is made to repatriate what has

leaked as illicit financial flows due to the hidden and sensitive nature of the activity. But the

government has to make a concerted effort to repatriate what has leaked both to recoup such a

substantial amount and to discourage future activities using what is internationally accepted

means of what called money laundering, tax evasion or other international agreements, norms

and protocols.

7

1 Introduction

Economic theory suggests that in economies like that of Ethiopia where domestic resource

gap (investment exceeding saving) exists, resource mobilization to close the gap is necessary.

And given the limitation in the availability of foreign financing, domestic saving is one of the

reliable sources of finance. And due to the presumed linkages between saving and investment,

saving mobilization influences the rate and level of investment in an economy. Effective and

optimal investment in turn influences future economic performance (Eklund, 2013). In that

sense, domestic resource mobilization (DRM) is a crucial input to economic growth of a

country. Culpeper and Bhushan (2008) summed up the relationships between Domestic

Resource Mobilization (DRM), investment and economic growth as follows:

“There are compelling reasons, based both on theory and evidence, to believe that a greater

emphasis on DRM will enhance investment, productivity and growth in poor countries, thereby

making a significant contribution to development and poverty reduction that cannot be made to

the same extent and with the same impact by external resource mobilization” (Culpeper and

Bhushan 2008, p. 12)

The desire of countries to initiate and sustain economic growth is therefore one of the main

reasons why they are keen to mobilize both financial and non-financial resources from

domestic and external sources. In addition to the need to grow, there are various other reasons

that justify relying more on domestic resource mobilization. These include Shone (1996):

First, self-sufficiency and sustainability are much more guaranteed when using domestic than

foreign resources such as aid, borrowing or FDI; because even though external resources also

serve as alternative /complementary sources to alleviate temporary shortages, they come with

some political conditions and are less predictable, unreliable and unsustainable;

Second, the keen interest in both the government and the general public for improvements in

overall well-being is another driving force for countries to focus on mobilizing own resources,

even when they command limited resources. Third, it is believed that ownership of the growth

path is more ensured when relying on own domestic resources; this is because unleashing the

dynamic growth momentum by initial injection of domestic resources is more likely to

generate more hope for a brighter future. All these and similar factors induced governments to

focus on the need to initiate various strategies and for the people to concentrate on resource

mobilization with a hope of accelerating economic growth.

8

Despite the keen interest of countries to focus on DRM, there is recognition that DRM works

either as a complement or as a substitute (or both) to external resources. Capacity permitting,

therefore, all countries attempt to rely on mobilizing domestic resources as much as possible

while supplementing it with external resources. Accordingly, as will be outlined via the

efforts of relevant stakeholders later, Ethiopia has been making a concerted effort to mobilize

and rely more on its domestic sources in recent years.

There are various factors that may weaken the capacity of countries in mobilizing domestic

resources. As United Nations Conference on Trade and Development /UNCTAD (2007) noted,

countries may fail to mobilize adequate domestic resources because of their low level of

income (which in turn might be affected by low resource mobilization). This vicious circle and

the level of alignment of financial markets with the real economy are well recognized factors

in influencing the extent to which countries succeed in mobilizing domestic resources. The

impact of each factor, of course, will vary from one country to another. For instance, in

countries like Ethiopia where agriculture has significant share in the economy and with a

relatively less developed financial sector, the extent to which tax authorities could mobilize

resources is relatively hampered than in advanced economies. This is because rural economies

are not amenable to tax increases consistent with income increase (absence of tax bouncy) due

to a limited coverage and the efficiency with which tax is collected. Similarly, a weak financial

sector is subject to financial depression. Ultimately coupled with population pressure, the

challenge to make quick progress in resource mobilization is daunting. That is, with negative

real interest rates in recent years (owing to low nominal interest rates and high inflation) which

is likely to depress private savings and with weak capacity to accelerate tax collection efforts,

resource mobilization is a challenge in such economic circumstances.

Irrespective of the challenges, in general, the strategies that countries follow to mobilize

domestic resources focus on the public and the private sectors, on formal and informal

financial institutions. The depth and scope of these strategies may vary depending on the

composition of the instruments employed, the specific initiative implemented and the linkages

with the economic sectors selected.

9

Ethiopia has also been engaged in an effort to mobilize its domestic resources in the last few

decades but particularly in the last fifteen years or so as evidenced by the relatively

appreciable economic growth registered in recent years and the saving and revenue resources

mobilized as will be detailed later. For instance, as noted in Table 1.1, real GDP and GDP per

capita growth average, grew 10.4 and 7.7 percent, respectively, between 2006/07 and

2013/14. The growths took place at a time of deteriorating international and national

economic environments. All the major sectors (agriculture, industry and services) contributed

to the annual average growth performance. While the agriculture and the service sectors are

dominant in terms of their share in GDP (constituting about 40 percent each), industry grew

by an average of about 15.1 percent per annum between 2006/07 and 2013/14.

Table 1.1 Sectoral Contributions to GDP and GDP Growth

Items

2006/07

2007/08

2008/09

2009/10

2010/11

2011/12

2012/13

2013/14

Real GDP

(billions of Birr)

312.1 346.4 380.5 419.8 475.7 517.0 567.9 626.6

Growth in Real GDP 11.7 11.0 9.8 10.3 11.4 8.7 9.8 10.3

Growth in Real GDP

per capita

8.0

7.3

7.1

7.5

10.6

6.1

7.1

7.5

Share in

GDP (in %)

Agriculture 50.5 48.8 47.3 46.1 44.4 42.9 41.8 39.9

Industry 10.2 10.1 10.1 10.2 10.4 11.5 12.9 14.2

Services 39.3 41.0 42.6 43.7 45.2 45.7 45.3 45.9

Absolute Growth

Agriculture 9.5 7.4 6.4 7.6 9.0 4.9 7.1 5.4

Industry 9.6 10.3 9.6 10.8 15.8 19.7 24.0 21.2

Services 15.3 16.1 14.0 13.2 17.3 9.6 9.0 11.9

Contribution

to GDP

growth in %

Agriculture 41.6 33.8 31.7 34.9 31.1 25.4 30.9 21.9

Industry 8.5 9.5 9.9 10.6 12.1 23.9 27.8 26.4

Services 49.8 56.7 58.4 54.4 56.8 50.7 41.4 51.7

Source: MoFED (2014)

The objective of the paper is to examine, systematically, the extent to which efforts have been

made to mobilize domestic resources, identify the strategies employed to realize those

objectives, the efficiency with which they are implemented and the challenges encountered in

10

doing so. This will cover efforts related to the public sector (revenue generation and saving

mobilization) and the private sectors (household and firm savings). It also includes both formal

(banking) and semi-formal and informal financial institutions (microfinance, credit cooperatives, and

even traditional entities like “Ekub” and “Iddir”).

Following this brief introduction, the remainder of the paper is organized as follows. Section

two presents overview and analysis of the strategies and initiatives on Domestic Resource

Mobilization (DRM). This is followed by a presentation of the extent and trends in DRM in

Ethiopia. Impacts of DRM and state of illicit financial flows will be examined in section four.

Section five will highlight lessons learnt and capacity development imperatives, while Section

six presents conclusions and recommendations of the study.

2 Overview and Analysis of Strategies and Initiatives on DRM

2.1 Public Sector savings

The principal sources of domestic resources are private savings and government revenue.

Government revenue is comprised of tax revenues and non-tax revenues. Tax revenues

constitute direct and indirect taxes, while non-tax revenues come from, fees, interest earning,

bonds and state-owned enterprises. The average share of tax revenue (for 2000-14) at 80

percent makes tax the principal contributor to total domestic revenue, while non-tax revenues

constitute only 20 percent (NBE, 2014).

Private saving is composed of savings by households and firms. In order to enhance public

savings (from revenue sources and enterprise profits), the government of Ethiopia has put in

place a number of strategies and systems and attempted to enforce them more in recent years.

2.1.1 An Overview of the Tax structure

The government has constituted a tax mix incorporating both direct and indirect taxes. Direct

taxes comprise of personal income tax ( rates progressively increasing from 0 to 35%), rental

11

income tax (30%), business profit tax (5%) and other incomes tax at federal level such as

agricultural income tax, rural and urban land use fee at regional and chartered cities.

Indirect taxes are comprised of domestic taxes and foreign trade taxes, including customs

duties, excise tax, value added tax, surtax, and withholding tax. The Ethiopia Revenues and

Customs Authority (ERCA), the mandated institution for collecting government revenue,

collects customs duty only on imported items as no tax on exports is levied, except on raw

skins and hides (150%). As shown in Figure 2.1, customs duty provides significant revenue to

the government (contributed 12% of the gross domestic revenue between 2000 and 2014).

The remaining major indirect tax categories include excise tax that is levied on selected goods

such as luxury goods and basic goods which are demand inelastic, excise tax is also applied to

goods which are considered hazardous to health and may cause social problems2.

Figure 2-1 Share of Government Revenue Sources (average share for 2000- 14)

Source: Authors‟ computation based on National Bank of Ethiopia /NBE (2014)

2 The Ethiopian Excise Tax Proclamation (proclamation No. 307/2002a) sets the maximum excise tax rate at

100 percent for perfumes, toilet waters, and motor vehicles of over 1,800 c.c. All types of pure alcohol and

cigarettes are taxed at 75 percent. The least (10 percent) excise tax is levied on textile products and Television

broadcast receivers. The excise tax rates are equally levied to imported and domestically produced goods.

48%

32%

20%

Direct and

indirect

domestic tax

Foreign trade

tax

Non-tax revenue

a)

27%

21%

12%

19%

1%

20%

Direct tax

Indirect domestic

tax

Customs duty

Excise, VAT, other

import taxes

Export taxes

Non-tax revenue

b)

12

Value Added Tax (VAT) on all commodities except some food items is levied at a flat

percentage rate of 15% of the sum of cost, insurance, freight, customs duty and excise tax.

VAT was introduced in 2003 and was designed to tax services in addition to production;

granting zero-rating to exports; and giving exemptions to fewer basic products than was the

case under the sales tax system it replaced. Surtax comprise of 10% of the sum of cost,

insurance, freight, customs duty, excise tax; and VAT is the base of computation for the

surtax on all goods imported into the country. A 3% withholding tax was also imposed on

imported items and a 2% on payments made in return for the purchase of goods and services.

The resource mobilization strategy also introduced taxes (VAT, turn over tax, for instance)

expecting to increase revenue through a broader base, improved efficiency, promotion of

exports, and foster economic growth. It could be argued that the broadening of the tax base,

the associated increase in tax rate as well as the choice of tax exemptions may led to

differential effects on the incomes and expenditures of different groups of the Ethiopian

population because of variations in tax incidence and income elasticities. Further, exemptions

complicate the administration of the VAT system, erode the tax base and distort input-choice

decisions.

Non tax government revenues includes, government investment income, charges and fees,

reimbursements and property sales, sales of goods and services, and pension contributions.

Government investment income includes residual surplus, capital charge, interest payments

and state dividend. Non-tax revenue sources contributed 15.9% to total tax revenue in

2012/13, declining to 9.8% in 2013/14. This was attributed to a 57.3% decline in government

investment income (see Figure 2.2).

13

Figure 2-2 Non-tax Government Revenue Sources

Source: Authors‟ own computation from Ministry of Finance and Economic Development, Annual Report

2013/14.

2.1.2 Relative Contributions of Tax Revenue

Nominal amounts of both the tax and non-tax revenues in Ethiopia have been growing,

particularly since the 2000s (Guddisa and Mishra, 2014), with domestic direct revenue

increasingly gaining importance (Figure 2.3). Revenues from indirect domestic taxes and

foreign trade taxes, in absolute terms, have shown an upward trend. Non-tax revenues on the

other declined in 2012. This has been attributed to the transfer of most state-owned enterprises

to the private sector, that were the major contributors of non-tax revenues in the form of

residual surplus to the central treasury of the country (Delessa and Mishra, 2014). The sharp

increase in tax revenue has been attributed to a number of policies and administrative

measures taken by the government to improve domestic tax revenue collection, including

strengthening the capacity of the tax collection agencies, expanding the tax identification

number system, strengthening the value added tax system, increasing tax compliance and

taking stringent legal measures against tax evasion (MoFED, 2014).

-

2,000

4,000

6,000

8,000

10,000

Charges and Fees Govt. Invt.

Income

Reimb. And

Property Sales

Sales of Goods &

Services

Others

Mil

lio

n B

irr

2012/13 2013/14

14

Figure 2-3 Trends of Tax and Non-tax revenue of Ethiopia (in million Birr)

Source: Authors‟ computation based on WB‟s WDI data (2014)

In short, there have been upward movements in direct, indirect, and foreign trade taxes while

non-tax revenue seems to exhibit no appreciable change, at least in the last five years. This

attests to two aspects of the domestic resource mobilization effort. Namely these are the

strong effort to mobilize tax efforts (both in coverage, collection efficiency owing to proactive

enforcement derive and rate) and a relative decline in non-tax revenue due to the privatization

of public enterprises.

2.2 Private Savings

Private savings comprise household and corporate savings. Household savings dominate

savings in Africa (Ethiopia included), though not sufficiently channeled into productive use.

This is partly due to what is referred to as financial depression – low interest rate and at times

negative real interest rates which in turn frustrates the incentive to save thereby reducing

investment3. The World Bank (2013) argues that the low level of saving in Ethiopia is partly

3 During years of soaring inflation in Ethiopia (2003-2008), the real interest rates remained significantly

negative. The rate for 2003-08 respectively was -5.11; 2.97; -2.62; -4.08;8.29; and; -17.12 ( WB‟s WDI,2014).

0

10000

20000

30000

40000

50000

2009 2010 2011 2012 2013 2014

Am

ount

of

reven

ue

(mil

lio

n B

irr)

Direct domestic taxes

Indirect domestic taxes

Foreign trade taxes

Non-Tax Revenue

15

due to the negative real interest rate and demonetization. The nominal deposit rate has

remained well below inflation rate since 2003. The banking sector was, therefore, in effect

discouraging saving.

Banks are tapping to new areas of electronic and mobile banking to increase profitability and

maintain their market share. The initial focus of this expansion was on further deposit

mobilization as opposed to money transfer and other transactions (IMF, 2014a, p. 20).

In addition to public sector saving, the composition of household savings portfolio determines

availability of funds for investment, and is therefore relevant to a country‟s development

(UNCTAD, 2007). Households, especially in rural areas, rely on volatile income sources. In

the absence of accessible credit and insurance services, drawing on saved assets is a necessary

strategy for households to smooth their consumption patterns (Dercon, 2002). Household

saving instruments fall into four categories: formal, semi-formal, informal financial savings

and, non-financial savings. In what follows, these sub-categories are briefly outlined.

2.2.1 The Formal Banking Sector in Ethiopia

The Ethiopian banking sector has been expanding despite still dominance of the three public

(commercial, construction, and development) banks. By fiscal year 2013/14, Ethiopia‟s

banking industry was comprised of 19 banks of which 16 were private, and the remaining 3

state-owned. The state owned commercial bank of Ethiopia accounted for 70 percent of the

industry‟s total assets (Keatinge, 2014), and the public banks provided 77 percent of total

loans as of December 2012 (World Bank, 2013).

Further, since the enactment of the National Bank Bill in April 2011, the Government of

Ethiopia limited the private lending ability of banks due to the requirement it put on banks to

allocate 27 percent of any new loan disbursements for buying the National Bank of Ethiopia‟s

(NBE) bills; this bill earns only 3 percent interest rate (below the 5 percent deposit interest

rate floor) and it matures in 5 years. This seems to have been done so that the banking sector

would contribute to the huge projects underway in the country and probably to limit the

potential multiplier effects of money supply.

16

As was the case in setting targets in revenue mobilization and investment sectors, the GTP

has also set targets in the banking sector to boost resource mobilization and ultimately the

performance of the Ethiopian economy. Two of these objectives are to increase or provide

financial access to the excluded population by expanding access to finance to 67% by

2014/15 from the level of 20% in 2010; and increasing the gross domestic saving to GDP

ratio from 6% in 2010 to 15% in 2015.

In addition to surrendering 27% of the deposits the chartered banks received, a number of

other policy requirements have also been imposed on the banking sector. Among such

interventions is the increase in the initial capital required to establish a bank from Birr

(Ethiopia‟s domestic currency) 75 million, since June 2002, to Birr 500 million as of 11th

August, 2008 (Federal Negarit Gazeta, 2008).

This may have barred new entry hence potentially limiting the competitiveness of the banking

sector. Further, the financial sector is not open to foreign competitors to establish a safe haven

for domestic banks so that they earn high profits. This probably is done to ensure the financial

sustainability of the banks using the argument that this is more likely to protect the financial

health of the banking sector. Whether because of that or due to other factors, despite all these

interventions, the banking industry is one of the most lucrative with less fierce competition as

witnessed by the registered huge annual profits of all the banks (both public and private)4.

Part of the profit made by banks is due to the spread between the lending and deposit rates. In

2012/13, the lending rates ranged between 7.5 to 16.25 percent averaging around 11.9

percent. But the deposit rate has never exceeded 6% in any of the chartered banks.

By the end of fiscal year 2012/13 total deposits mobilized by commercial banks surged by

26.6 percent. Demand, savings and time deposits constituted 49 percent, 44.7 percent, and 6.3

percent, respectively. Due to the increase in deposits and high activity, the banking sector in

4 According to Zemen Bank‟s (a private bank) annual report (2014), in 2013/14, private banks in Ethiopia

registered 19.3 percent Returns on Equity (RoE) and 2.9 percent Returns on Asset (ROA). Zemen Bank reported

that its earnings per share for the last 5 years averaged about 45 percent per year.

17

Ethiopia has been registering a high return, reporting less than 2 percent non-performing

loans, and overall high profitability, limited competition, and high financial exclusion.

2.2.2 Savings in the Informal Financial Sector

The informal financial institution in Ethiopia is composed of semi-informal to informal

entities. These range from modern arrangements like microfinance to traditional saving and

cooperation set ups (locally referred to as Ekub and Idder). While some of the semi-formal

institutions are recently introduced the informal institutions have existed as endogenous

instruments to mobilize financial resources and to facilitate both financial and in kind

collaboration in times of need for its members.

According to Aryeetey (2004), the informal sector in Africa accounts for 80% of household

savings. Of the 20 per cent of household assets that are held in financial form, 12 per cent are

held in the informal sector and 8 per cent in the formal sector. Even though no accurate

figures are available, the size of the informal financial institutions is also believed to be

significant given the widespread use and duration of its existence in society. The popularity

and longevity of its existence in Ethiopia partly reflects the difficulties in accessing formal

saving instruments and/or the lack of trust in formal financial institutions, as well as the

inadequacy of formal saving instruments to fulfill poorer households‟ saving needs.

Due to Ethiopia‟s huge rural population, asset portfolio is also held in the form of non-cash.

For instance, many people in Ethiopia (particularly rural households) use traditional or

informal ways of saving and mobilizing resources for their needs. Hence the portfolio choice

may slightly vary between rural and urban poor households, but both practice one or more of

the following deposit instruments. These include cash saving (when liquidity and convenience

is the priority), ownership of animals (both for current use and future re-sale), and gold, silver,

or other precious metals.

Microfinance institutions have only been in operation in Ethiopia for about 8 years, but have

started to play a big role in mobilizing resources. According to the National Bank of Ethiopia,

the industry has pulled a total asset of 7.2 billion Birr (55.1 million USD11

), with 5.1 billion

18

Birr (38.9 million USD) in outstanding loans and mobilized a total deposit of 2.4 billion Birr

(18.4 Million USD), as of 2013/14.

In addition to the saving mobilization functions of the most widespread traditional

organizations (Ekub and Iddir) their contributions as sort of social-safety-nets (or insurance

schemes) also needs a brief description. The focus of Iddir is provision of collective support

for any member in times of need (sickness, death etc) using currently contributed or saved

resources by its members. It is usually formed among people living in proximate areas. It also

involves any support in person in addition to financial or in kind contributions. The focus of

Equb, on the other hand, is on mobilizing a rotating saving by its members during a fixed

time. The total collected amount is disbursed to a given member until all are given the

opportunity in turns. Equb is contributed either daily or weekly or monthly. The main

motivation of Equb is to collect large sum of money and disburse it in turn to members for

future investment based on a spot lottery or pre-agreed sequence, the turn at times determined

by the immediate need of the member.

It is at an early stage of the process, but the government has been engaged in coordinating and

making efforts to link the informal financial institutions both horizontally (among each other)

and vertically (with the formal institutions). The intention is to strengthen the financial,

technical, and organizational capacity of the institutions so that they will boost the resources

mobilization effort and learn best practices. Even though still at an early stage and hence no

tangible outcome has yet been observed, the process is in motion despite some resistance by

some members who do not want to lose the traditional functions of the informal institutions.

19

3 Extent and Trends in Domestic Resource Mobilization in Ethiopia

3.1 Extent and Trends in Revenue Generation

There has been a concerted effort to optimize revenue collection by improving the efficiency

with which tax is collected and by expanding the tax base. After introducing the value added

tax in 2003 (initially to high income business entities but later covering most business

enterprises) the government increased its tax base. It also attempted to improve the efficiency

of tax collection by strengthening both tax collecting institutions and policies that both reward

tax payers and punish tax evasion.

Non-tax revenue showed no increase or a slight decline after 2012, total revenue (including

grants), total revenue (excluding grants) and domestic tax revenues increased by an annual

average of 16, 17 and 20%, respectively, between 2000 and 2014 (Table 3.1). And yet, when

it is viewed as a ratio of GDP, it shows little or no change.

Tax bouncy is low in Ethiopia despite the improvements in some tax components over time

(introduction of VAT, revising income tax slightly upward). Whether viewed in terms of tax

bouncy (the relative increase in tax revenue due to an increase in income) or as measured by

the attendant resource gap (saving and investment), revenue generation has a long way to go

to meet the economy‟s resource needs. Further, the reason why tax revenue hasn‟t improved

when measured relative to GDP is partly some tax components (such as income, international

trade tax, for instance) were not increasing fast 5

; but more importantly GDP has been

growing in double digits and that growth was coming mainly from the agriculture sector

which is the least taxed and yet has still significant share in GDP (although the share has

dropped from 48.8 percent in 2007/08 to 39.9 percent in 2013/14). Hence the tax bouncy

turned out to be low.

5 for instance international trade taxes which accounted for about 50 percent of total tax since 2001, its growth

as a share of GDP was stagnant during the period (WDI,2014)

20

As demonstrated (Table 3.1) the dominant revenue source in Ethiopia in recent years has been

tax revenue which, on average, constituted about 79% of total government revenue. But in

terms of growth, tax revenue as a % of total revenue on average grew by about 1.9 percent

while GDP during the period grew by about 8% suggesting that despite the significant

improvements in tax collection, tax revenue failed to much the growth in GDP.

Table 3.1 Trends of Government Revenue and Contribution of Tax Revenues

Source: NBE (2014)

Tax ratio (the average share of tax revenue in GDP) 2000 to 2014 in Ethiopia is only 11%.

This is lower than that of Kenya (16.4%) and the Sub-Saharan average of about 17% for the

same period. It is only similar to that of Uganda which recorded 11.4%. The comparison

showed on Figure 3-1 also corroborates the argument that tax ratio in Ethiopia is indeed low

comparable to the indicated regional and sub-regional averages.

6 The World Banks (see Figure 3.1) and the National Bank (Table 3.1) reported different figures for tax ratios of

Ethiopia. However, referring both of the reports, we can confidently conclude that the trend of tax ratio in

Ethiopia is fairly stagnant.

Year

Total revenue (including

grants) –Million Birr

Total revenue

(excluding grants) -

Million Birr

Tax revenue as %

of GDP6

Tax revenue as %

of total revenue

2000 11,220 9,498 10.3 71.4

2001 12,805 10,177 11.0 73.1

2002 12,833 10,409 12.0 76.1

2003 15,703 11,149 11.3 73.9

2004 17,918 13,917 12.7 78.4

2005 20,147 15,582 11.8 79.6

2006 23,225 19,493 10.8 72.4

2007 29,381 21,797 10.2 79.6

2008 39,705 29,794 9.7 79.9

2009 40,422 31,924 7.0 72.7

2010 66,237 53,861 11.4 80.4

2011 85,611 69,120 11.5 85.3

2012 115,658 102,863 11.5 83.4

2013 137,192 124,077 12.6 86.2

2014 158,076 146,172 12.7 91.1

Average 52,408 44,655 11.1 78.9

21

Figure 3-1 Trend in Tax ratio of Ethiopia Compared to Selected Regional and Sub-regional Averages.

Source: Author‟s construction using WB‟s WDI (2014) database

3.2 Extent and Trends in Saving Mobilization

The other domestic resource component (in addition to revenue) is saving, mainly mobilized

through the various formal and informal instruments of financial institutions. In addition to

the state of saving in the last few years, Table 3.2 outlines the movement of saving via the

various components. As the table shows, saving deposits (net) almost doubled between

2012/13 and 2013/14; saving and time deposits contributed the most to the growth - jumping

from32 to 66 and -70 to 56% while demand deposits declined during the same period. During

the period total resource mobilized (saving, demand and time deposits) increased from 10 to

14%. According to media reports (Ethiopian Broadcasting Corporation 5 April, 2015),

however, the recent increase is much more significant. According to the report, saving as a

ratio of GDP jumped to 22% due to the various initiatives presented in section-2 of this paper.

Due to the various initiatives to mobilize resources, the same report also noted in less than

two months Birr 6.3 billion was mobilized (mainly related to the Renaissance Dam). This is

about 11.32% of total resources mobilized via saving, demand and time deposits as noted in

Table 3.2).

0

2

4

6

8

10

12

14

16

18

20

2005 2006 2007 2008 2009 2010 2011

East Asia & Pacific

(all income levels)

East Asia & Pacific

(developing only)

Ethiopia

Middle income

Sub-Saharan Africa

22

Table 3.2 Annual Resource Mobilizations and Disbursements of Chartered Banks as of June 30, 2014 (Millions of Birr).

Source: NBE (2014)

*Includes government borrowing in the form of bonds and treasury bills from commercial banks, DBE and other sectors other than NBE

Particulars

2011/12 2012/13 2013/14

Year-on-Year Growth

of “totals” (%) Public

Banks

Private

Banks

Total

Public

Banks

Private

Banks Total

Public

Banks

Private

Banks Total 2012/13 2013/14

1. Deposits (net change) 37,005 9,754 46,759 32,950 16,961 49,911 40,054 15,593 55,647 7 12

1.1 Demand Deposits 19,199 2,213 21,412 18,782 5,107 23,889 9,350 3,294 12,645 12 -47

1.2 Savings Deposits 12,049 5,917 17,966 12,938 10,857 23,794 29,851 9,685 39,536 32 66

1.3 Time deposits 5,756 1,625 7,381 1,231 997 2,228 853 2,613 3,466 -70 56

2. Borrowing (net change) 7,247 - 7,247 6,343 - 6,343 4,034 - 4,034 -13 -36

2.1 Local 7,232 - 7,232 5,076 - 5,076 2,926 - 2,926 -30 -42

2.2 Foreign 15 - 15 1,267 - 1,267 1,108 - 1,108 8,515 -13

3. Collection of Loans 18,480 16,708 35,187 22,936 18,885 41,820 26,128 25,617 51,745 19 24

4. Total Resources

Mobilized (1+2+3)

62,732 26,462 89,193 62,228 35,846 98,074 70,215 41,210 111,425 10 14

5. Disbursement 36,949 19,153 56,102 33,250 21,002 54,252 38,938 21,028 59,965 -3 11

6. Change in Liquidity (4-5) 25,782 7,309 33,091 28,979 14,844 43,822 31,278 20,182 51,460 32 17

7. Outstanding Credit* 85,722 36,740 122,462 103,585 47,619 151,204 127,634 53,693 181,327 24 20

23

Participation in the financial sector as measured by the number of borrowers and depositors

increased as noted in recent years. Consequently, both saving and investment as a percentage

of GDP have also increased steadily in recent years. What is of interest is that, though modest

by other country‟s standards and the size of the Diaspora, personal remittances has also

become an appreciable share of GDP. In short as shown in Table 3.3, all the relevant resource

flows showed a notable increase between 2007 and 2012.

Table 3.3 Selected Indicators of Financial Inclusion, Sources, Debt and Investments

2006 2007 2008 2009 2010 2011 2012

Borrowers from commercial banks (per 1,000 adults) 1.2 1.1 1.2 1.7 1.8 1.8 2.1

Depositors with commercial banks (per 1,000 adults) 66.4 74.9 78.0 90.7 103.2 111.1 136.8

Gross capital formation (% of GDP) 27.9 24.5 24.7 25.6 27.4 27.9 33.1

Gross domestic savings (% of GDP) 5.0 4.9 4.9 7.1 7.5 12.7 15.0

Gross fixed capital formation (% of GDP) 27.9 24.5 24.7 25.6 27.4 27.9 33.1

Gross fixed capital formation, private sector (% of GDP) 11.9 10.4 10.0 13.3 11.9 9.2 18.7

Gross savings (% of GDP) 13.2 22.5 21.1 17.8 23.9 28.9 27.0

Personal remittances, received (% of GDP) 1.1 1.8 1.5 0.8 1.2 1.6 1.5

Tax revenue (% of GDP) 8.4 8.0 8.0 6.7 8.3 9.4

Source: WB‟s WDI (2014)

3.3 Special DRM schemes

In addition to the various formal and semi-formal privately initiated savings, the government

of Ethiopia has also taken various measures to boost savings. These measures include

schemes to increase household savings through improving financial sector accessibility and

attracting funding from the large Ethiopia diaspora. The following strategies have been used

to promote and mobilize domestic savings:

a) Deposit mobilizing Schemes Initiated by the Commercial Bank of Ethiopia (CBE)

i. Expanding bank branches to create access to unbanked groups in society. This is

aimed at increasing access to financial services. The number of commercial bank

branches have increased from 681 at the end of FY2010 to 1,286 at the end of FY

24

2012 (89% increase). The majority of the increase comes from the state-owned

CBE, which increased its branch network by 167 per cent during the first two

years of the Growth and Transformation Program (GTP). The branch expansion in

all regions of Ethiopia has led to a significant increase in the likelihood of saving

in banks by individuals according to the Urban Employment and Unemployment

Survey 2012. Expanding bank branches is therefore a major saving-supporting

policy measure in Ethiopia. This is because the number of branches has had a

positive and significant impact on improving the access of individuals to formal

saving opportunities.

ii. CBE promotes deposit mobilization through the provision of lottery coupons for

additional new savings made by depositors and for those who opened new

accounts (with a fixed minimum amount).That is, every client who deposits Birr

1000 is allotted some lottery tickets to enable the client to participate in a lottery

for various prizes.

iii. Initiatives have been underway by CBE to boost deposits by encouraging special

accounts for youth, women, and interest-free banking in line with Islamic banking

traditions for those who oppose interest earnings due to religious beliefs.

b) Initiatives have also been underway to promote establishment and outreach of Micro

finance institutions to the majority of the rural areas. At the end of 2012, there were 31

licensed microfinance institutions (MFIs) operating in Ethiopia, representing 2.6

million clients, with deposits amounting to 5.5 million Birr. MFI savings constituted

4.5% of Gross Domestic Savings (GDS) in 2012. However, the MFI sector is highly

concentrated, with at least 5 of the largest MFIs owned by regional governments and

located in different regions. These correspond to 89 per cent of the total MFI assets and

83 per cent of the total MFI borrowers.

c) Pension schemes – the government has established pension schemes for employees of

NGOs and private companies, in addition to the government pension scheme under

25

which employees contribute 7% of gross pay and the government contributes 11% of

the gross pay. Being long term by nature, pension funds are expected to provide

reliable financing for long-term development projects that would normally face

difficulty attracting suitable investment. The insurance sector has similar potential, with

the added benefit of providing an income safety net for businesses and individuals. The

total number of employees covered with the private pension scheme reached about

360,000 (at end-December 2012). In the first year of its operation, the private

employees‟ pension scheme managed to collect about 0.5 billion Birr (0.3 per cent of

Gross National Savings /GNS).

Table 3.4 Amount of Private Savings Mobilized and Contribution to GDP/GNS

Source: Adapted from World Bank (2013)

d) Housing savings scheme - A new scheme is being implemented in the city of Addis

Ababa since June 2013. The scheme aims to encourage low- and middle-income

earners to deposit money for a given period, to meet two goals: to encourage saving as

a way of life to meet their future needs and to mobilize sufficient savings to enable

them to buy a subsidized home. The scheme provides three main choices for the

individual saver: the “10/90”, the “20/80” and the “40/60” options. Accordingly, an

individual saves ten per cent (or 20 per cent or 40 per cent) of the housing cost in

closed saving accounts at Commercial Bank of Ethiopia branches. By the time the

savings reach a predefined per cent of the estimated housing cost, the savers will be

entitled to a house depending on additional eligibility criteria.

Year Pensions

(million Birr)

Off which

private pensions

(million Birr)

pension

(% of GNS)

MFI savings

(million Birr)

MFI savings

(% of GDP)

2008 1598 0 1.1 1,489 0.61

2009 1743 0 0.9 2,223 0.67

2010 1700 0 0.7 2,555 0.68

2011 2400 0 0.7 3,696 0.73

2012 4540 550 1.4 5,474 0.74

2013 2656 586

26

e) Diaspora bonds – In a bid to attract foreign savings, the government of Ethiopia has

issued Diaspora bonds. This is a new approach, and Diaspora bonds have been issued

only twice. The purpose of Diaspora bonds is to raise savings domestically and abroad

to finance specific projects. In 2008, Ethiopia was the first country in Africa to

introduce Diaspora bonds. The “Millennium Corporate Bonds”, issued by the Ethiopian

Electric power Authority, aimed to finance national projects. Drawing on the

experiences of the first bond, the government issues a second bond in 2011, aimed at

securing financing for the Grand Renaissance Dam project as shown in Table 3.5.

Table 3.5 Diaspora Bonds Issued by Government and Their Characteristics

Millennium Corporate Bond Grand Renaissance Dam bond

Objective Raising funds for the

Ethiopian Electric Power

Corporation

Financing the Grand Renaissance Dam

Date of Issuance 2008 2011

Amount and

currency

Amount unknown USD –

EUR – other convertible

currency

Amount unknown but project cost $4.8bn USD –

EUR – GBP and Birr

Maturity (type

and value)

5, 7 and 10 years Range of 5-10 years

Interest rate Fixed: 4%, 4.5% and 5%

depending on tenor

Floating: 5y: Libor +1.25% 6-7y: Libor +1.5% 8-

10y: Libor + 2%

Special features Limited to Ethiopians with

access to foreign exchange

Sovereign instrument

Source: Plaza (2011)

3.4 Capacity Challenges

As is the case in many developing countries, Ethiopia faces many capacity related challenges

in its effort to mobilize domestic resources. Low income base and hence tax base, inefficient

tax collection system and the structure of the economy (informal, less recorded and

fragmented) also exaggerate the attendant capacity challenges. Chief among the factors that

directly and indirectly contribute to capacity limitations in mobilizing resources in Ethiopia

are the following.

27

1. One of the most important capacity challenges of resource mobilization in Ethiopia is

absence of a well-organized, transparent and coherent tax collection system. Tax

assessment and administration tend to be arbitrary, inconsistent and not well executed.

Partly this emanates from the unrecorded economic activities of in the economy owing

to the pervasive nature of the informal sector.

2. Consequently, tax compliance in Ethiopia has been very low partly due to weak

enforcement mechanisms and low consequence on evasion. A fragmented rural based

economy is difficult to effectively tax partly due to its low income level and its

amenability for tax evasion. Hence tax compliance in economies dominated by small,

fragmented and poor households like that of Ethiopia is a major challenge.

3. Another challenge in mobilizing resources through the tax regime when the share of

the informal sector in the economy is significant. Due to the unrecorded and an

accounted nature of the informal sector, it is difficult to mobilize resources from the

informal sector. The destination, size of economic activity and ownership structure is

difficult to identify. And since the informal sector both in the rural and urban areas in

Ethiopia is presumed a significant portion of the economy, it is a serious challenge to

mobilizing resources.

4. Another serious challenge is finding well trained staff with integrity. As a developing

and poor country availability of effective tax administrators is limited. And due to the

very low incentive structure, the level of integrity of the employees is compromised.

5. Public financial management – tackling endemic weaknesses on the formulation and execution

of investments of poor reporting and accounting practices, and long delays in auditing and

preparing annual national accounts. All these are manifested in poor or low public trust

particularly political trust of officials in properly utilizing public resources. This negatively

affects the extent to which people are willing to contribute to public funds and avoid evasion.

Further, public trusts in how accumulated savings are managed, audited and reported are

crucial in investors /savers in particular and the public in general to have the confidence in

actively participating in resource mobilization efforts.

6. Weak capacity of organizations engaged in the governance of the tax collection system

is also a challenge. Because of the reasons described up to this point (weak incentive

structure, inadequate training, and absence of computer and other relevant facilities)

limits the capacity and negatively affects effective resource mobilization.

28

4 Impacts of DRM and fight against illicit financial flows

4.1 Resource Gap and Illicit Financial Flow

The saving rate in Ethiopia has been low at least compared to the attendant level of

investment in the country (i.e. huge resource gap exists). The gap remained 20 percent for

most of the years. And one of the manifestations of the resource gap is the low level of credit

allocated to the private sector even by poor countries‟ standards. The credit given to the

private sector in Ethiopia in 2011 was 14 percent of GDP. This was far less than the 23

percent of GDP, on average, in SSA (World Bank, 2013).

For an economy like that of Ethiopia where domestic resources have always fallen short of

attendant investment, availability of credit is one of the binding constraints. This is

particularly the case at a time when external financial resources were inadequate (either due to

decreases in ODA, low FDI and /or low export receipts) to fill the ex-ante saving and

investment gap. In such instances, illicit financial flows have had an added negative impact on

the ability of the economy to mobilize adequate resources.

The widespread illicit financial flow is one of the factors that exacerbated Ethiopia‟s resource

gap in recent years7. According to the Global Financial Integrity rankings (GFI, 2014),

Ethiopia is among the top five SSA counties and 39th

in the world in terms of its contribution

to illicit financial flows. Its volume of illicit financial flows averaged 2,207 million USD

annually (2003-12). As could be seen from Table (4.1), the absolute size of the illicit financial

flow that was estimated in Ethiopia during the period was very high given the acute scarcity

of foreign exchange and resource gap.

7 “Illicit Financial Flows are illegal movements of money or capital from one country to another “(GFI, 2014).

Amidst the huge illicit financial flow there has been significant resource gap in Ethiopia as exhibited by the huge

gap between ex-post saving and investment. The saving rate has not kept pace with the growth in investment to

make up or fill the „traditional‟ external sources such as FDI, aid, and remittances.

29

Table 4.1 Size of Illicit Finance and Resource Gap in Ethiopia (2003-12)

Years

Illicit financial

flow

( Nominal

Millions of USD)

Illicit

financial

flow

Growth (%)

Resource gap

( % of

GDP)

(A)

Illicit financial flow

(% of GDP)

(B)

Illicit flow as a

percent of resource

gap

(B/A)*100

2003 495

-14 6 41

2004 406 -18 -17 4 24

2005 785 93 -21 6 31

2006 1,152 47 -23 8 33

2007 1,491 29 -20 8 39

2008 1,823 22 -20 7 35

2009 2,999 65 -19 9 51

2010 5,650 88 -20 19 97

2011 4,149 -27 -15 13 87

2012 3,117 -25 -18 7 40

Cumulative:22,065

Average: 2,206

Source: Global Financial Integrity Report (2014) and WB‟s WDI, (2014).

There are years during which the illicit financial flow almost equaled with the resource gaps.

For instance, in 2010 the illicit financial flow reached 97 percent of the resource gap. That is,

under an ideal condition of zero illicit flows, the country could have financed the resource gap

from own internal sources. For most of the year, the value of illicit finance was between half

and two-third of total government budget. The figure for such financial flow in 2010 (Table

4.1), for instance, was well above the government‟s annual budget.

Foreign reserves, illicit flows and inflation seem to have coincided in Ethiopia. Inflation rates

were very high in 2004-2011. And without inferring causality, these years witnessed an

accelerated growth in illicit financial flows (see second column of Table 4.1). Regardless of

the causality, a co-movement of illicit financial flows and the attendant high inflation rates

was observed; a possible reason might be because inflation often erodes confidence in the

domestic currency and the overall macroeconomic stability. Consequently, the country

witnessed a huge drop in its foreign reserve account (Figure 4-1). Importers experienced

limited access to hard currencies usable for importation, following the banks‟ rationing of the

available limited hard currency reserves. The global financial crises might have also

contributed to the shortage since foreign funds coming through export receipts and ODA had

fallen. The trend started to reverse after 2011 following a significant fall in inflation. After

30

2011 the reserve level reached the government‟s target of 2.5 to 3 months of imports (Figure

4-1).

Figure 4-1 Net ODA flows and Foreign Reserves of Ethiopia (2005-12)

Source: Author‟s constriction using WB‟s WDI (2014) database

4.2 Economic Impacts of DRM

In the face of the challenges noted above (improved but relatively low saving and illicit

financial flows etc.), the government has initiated various programs to address these

challenges. Chief among these initiatives is the Growth and Transformation Program (GTP)

which sets targets to be achieved in various sectors of the economy during specified periods.

With regard to resource mobilization, in addition to the efforts in revenue generation and

private saving noted above, it aims to boost overall savings to 15 percent of GDP through

various initiatives. These include continued public awareness creations and mass

mobilizations, making the financial services accessible, launching social insurance programs

for private sector employees, improving government social insurance coverage, introducing

saving bonds and other instruments such as housing, women, youth, prize schemes for clients

that deposit 1, 000 Birr or more and non-interest banking initiatives, to name a few.

0

5

10

15

20

25

30

35

40

45

Net ODA received (% of GNI)

Net ODA received (% of imports of

goods, services and primary income)

-2E+03

-1E+03

-1E+03

-1E+03

-8E+02

-6E+02

-4E+02

-2E+02

0E+00

2E+02

4E+02

6E+02

Reserves and related items (BoP,

million current US$)

31

The result is, according to a report by Ethiopia‟s Ministry of Finance and Economic

Development (2014), these programs have boosted the saving rate from 5.2 percent of GDP in

2009/10 to 17.7 percent in 2012/13 which in turn raised domestic investment as a share of

GDP from 24.7 percent in 2009/10 to 33 percent in 2012/13. Savings and investments show

similar growth patterns (see figure 4.2) even though the direction of causality between the two

cannot be ascertained. Bridging the gap is, however, still a big challenge that Ethiopia has to

face in the coming years. Recent performances show that saving is indeed growing at a

slightly higher rate than investment signaling hope for catching up.

Figure 4-2 Gross Domestic Savings and Gross Capital Formation/Investment of Ethiopia (2000-12)

Source: Authors‟ Graph using WB‟s WDI (2014) database

A related economic impact of the recent initiatives is the housing scheme which both helps

mobilize resources but also enables low income groups own their own housing. As described

in detail earlier and elaborated further in Box 3 in relation to the Growth and Transformation

Program (GTP), urban dwelling (particularly in the capital, Addis Ababa) being very scarce

and expensive beyond the reach of many middle class people, has been one of the major

initiatives due to the existing urgent needs. This initiative, therefore, has had economic

impact in both mobilizing resources, promote social equity by narrowing income gaps and

alleviate poverty (MoFED, 2014).

0

5

10

15

20

25

30

35

Gross capital

formation (% of GDP)

Gross domestic

savings (% of GDP)

32

4.3 Social and Capacity Development Related Impacts

Domestic resource mobilization is in part aimed at financing pro-poor public expenditures to

narrow income inequalities. In low income countries like Ethiopia, public expenditure and

revenue raising activities have a lot to do in combating poverty and correcting economic and

social injustices.

Pro-Poor Expenditure

During the first three years of the GTP, 69 percent of government expenditure was on pro-

poor sectors: education, health, water and sanitation, agriculture and road infrastructure

(MoFED, 2014). Public expenditures directed to poverty reduction were kept steady at 12

percent of GDP in 2012/13 (IMF, 2014b).

Table 4.2 Public Expenditure Structure in Ethiopia

Source: MoFED (2014)

Between 2009/10 and 2012/13, pro-poor public expenditure allocation has resulted in

significant increases in the provision of various social services. Since this coincided with the

increase in resource mobilization, it could be assumed that the domestic component of the

mobilized resources has contributed to this outcome.

Expenditure category 2010/11 2011/12 2012/13 2010/11 - 2012/13

Average performance

% % % %

Recurrent expenditure 43 41 41 42

Capital Expenditure 57 59 59 58

Total Expenditure 100 100 100 100

Pro poor sector expenditure 66 70 70 69 Education 25 24 23 24

Health 7 6 7 7

Agriculture 9 9 10 9

Water 6 8 8 8

33

Among the notable changes during this period:

3,544 primary schools were constructed;

primary gross enrolment rate increased from 93.4 to 95.1 percent;

577 secondary schools were constructed;

undergraduate enrolment rate increased from 447,693 to 553,849;

girls enrolment rate in undergraduate programs reached 30 percent;

number of health posts increased from 14,192 to 16,048;

The number of Health Centers increased from 2142 to 3100;

the ratio of population to Health Centers declined from 1: 37,299 to 1:27,706;

the number of hospitals increased from 116 to 127;

primary health service coverage reached 93.4 percent; and

huge investment is made to produce medical doctors, nurses, and health extension

workers (MoFED, 2014).

4.4 Public Spending and DRM Patterns

4.4.1 Public Spending Patterns

Some of the effective RDM reforms focused on increasing public revenue mainly through

international trade taxes and Value Added Taxes. The World Bank (2013) estimated that two-

third of recent years‟ growth in Ethiopia is gained from huge public investment while private

consumption accounted only a third of it. Since 2000, however, the budget envelope has

remained largely unchanged (as a share of GDP). The growing public investment is at the

expense of falling government consumption as overall GDP share of government spending

changes only marginally. A third of public investment is financed from domestic sources.

A series of 5-year Growth and Transformation Plans target to raise Ethiopia to a middle

income status by 2025.This requires large public borrowing and domestic resource

mobilization to finance high level of investment. According to IMFs report (2014b), for the

GTP that will end the coming 30 June 2015, Ethiopia envisaged borrowing level will reach

34

about 15 percent of GDP; two-third of it is expected to come from external sources. The

experiences in the first three years (2010/11–2012/13) of the GTP suggest that the sharply

increasing public investments are partly competing with the private sector in acquiring

domestic credit and foreign exchange. The need for enhanced domestic resource mobilization

trough taxation and private saving is, therefore, paramount.

Figure 4-3 Aggregate Government Expenditures

Source: NBE (2013/14)

4.4.2 DRM Patterns

The significant rise of revenue from value added taxes has boosted tax revenue mobilization.

This is supported by Electronic Sales Registry Machines (ESRMs) that enabled ease of tax

collection and appreciably reduced tax evasion. Over the last five years, the indirect domestic

tax share of VAT reached about half and it also accounted for the fifth of the total tax revenue

over the last half a decade (Ali, Shifa, Shimeles, and Woldeyes 2015). Council of ministers

regulation number 139/2007:

“Tax payers specified in directives to be issued by the Ministry shall be subject

to obligatory use of Sales Register Machine that are accredited in accordance

with the provisions of these Regulations, to generate sales Receipts. …”

(Ethiopian Council of Ministers, 26 January 2007, p-2).

Despite the recent slight fall in contribution following shifts to domestic indirect taxes such as

VAT, trade taxes constitute over 50% share of overall tax revenue and remains as the lead

contributor. Domestic indirect taxes and direct taxes have more or less equal share each

0

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Government Capital

Expenditure as % of

GDP

Government Current

Expenditure( % of

GDP)

Total government

Expenditures (% of

GDP)

35

contributing 20 to 30 percent of total tax revenues.

As shown in Figure 4.4, trade taxes are slightly losing their importance while direct and

domestic indirect taxes are gaining momentum. This is attributed to the acceleration of

domestic resource mobilization. The growth of indirect taxes is mainly because of the

introduction of VAT. The Inland Revenue authority of Ethiopia has made various institutional

reforms (tax brackets dependent on earned level of income, sales registry machines in almost

all enterprises initially starting from only large business entities, chief among the) to increase

the Inland Revenue collection. Tax collections are now well decentralized to lower

administrative units. Such decentralization has helped tax inspections and tax determination

relatively simpler as the lower level administrators are better informed to estimate earnings of

the business communities within their jurisdictions.

Ethiopia‟s tax system is at best de jure progressive and de facto regressive According to

KPMG Africa Limited‟s Ethiopia Fiscal Guide (2013/14), the payroll tax has 6 brackets with

increasing progressivity. The rate grows progressively from 0% (exemption) for low income

levels to 35 % for high income levels. Business income from body corporates is taxed at a flat

rate of 30%. For instance, high earning businesses seldom declare their true earnings and

hence they are under taxed i.e. tax evasions in this income group is widespread to put

progressivity of the tax regime in question (see evasion case reports in the box below).

Melaku Fenta, the then Director General of the Ethiopian Revenue and Customs Authority (ARCA),

heads up the press conference at his office on August 12, 2010 and provided the following detail:

The authority had stepped up audits of customs, tax, and investigation as well as prosecution of tax evaders in

the past year to increase the collection and enforcement of tax. The audits led to the discovery of 6.8 billion Birr

owed to it from desk audits, customs, taxes, and investigation audits, out of which 2.8 billion Birr was collected.

Fourteen companies alone owed the authority 1.2 billion Birr. The authority is working on collecting the

remaining four billion Birr owed to it. The prosecution department of the ERCA had 1,936 criminal cases in

different stages of processing throughout the year. It won 905 cases out of the 1,160 criminal charges it had

instituted, leading to prison sentences of six months to 15 years for 1,122 people. The ERCA has also taken 165

cases to the Cassation Bench of the Federal Supreme Court, involving massive tax evasion and fraud. The

authority, through its different branch offices, also confiscated goods worth 150.9 million Birr that were being

smuggled into the country and goods worth 25.8 million Birr and cash in the amount of 2.4 million Birr and 1.1

million dollars that were being smuggled out of the country. It has also confiscated gold worth 12.2 million Birr

and cars worth 182.5 million Birr that were circulating in Ethiopia illegally. The Basic Tax Administration

Process (BTAP) has taken steps to harmonize facilitation and control procedures, according to the one-year

performance report. To this end, the ERCA has prepared a list of 100 importers and 50 forwarders which have a

36

high record of tax and customs fraud and a profile of 2,245 companies who pose a high risk.

Figure 4-4 Taxation Structure (Tax ratio and tax mixes) in Ethiopia

Source: WB‟s WDI (2014)

4.5 Efforts and Achievements in Terms of DRM and Illicit Financial Flows

This section briefly highlights three cases of government effort to mobilize

resources and reduce capital flight. The boxes show the attempt to use innovative

and intensive efforts either in mobilizing resources or tackling to reduce and if

possible eliminate illicit financial flows. Box 1 attempts to show the efforts that

tax authorities are doing to limit the extent and the practice of illicit flows. In

particular, the Ethiopian Revenue and Customs Authority (ERCA) is devising

schemes as a counter measure to limit under invoicing while at the same

encouraging resource mobilization. Through a specific proclamation the authority

tried to change how it does business both in terms of efficiency, monitoring of

illicit flows and the overall performance of the foreign trade administration.

Box 2 examines the experience of introducing a bond in order to mobilize resources. It

documents the initial experience and the reasons why it wasn‟t successful initially and the

reasons why its acceptance level was low among the Ethiopian Diaspora. Following the initial

experience it then briefly outlines how the recent bond performed in terms of mobilizing

0

10

20

30

40

50

60

70

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

tax revenue ( %

GDP)

direct tax ( %

total tax revenue)

international

trade tax ( % total

tax revenue)

37

resources.

Box 3, on the other hand, outlines the resource mobilization efforts by chartered banks and

other initiatives ranging from housing schemes to other encouragement like offering prizes for

depositors. Following such efforts saving deposit jumped from birr 12.9 to 29.8 million

between 2012/13 and 2013/14. This jump is partly due to the government‟s initiative of low

cost housing scheme. This scheme required residential house seekers to open saving deposit

accounts at the publicly owned Commercial Bank of Ethiopia on a regular basis until a

minimum deposit is reached that would warrant qualification to be considered in the scheme.

BOX 3 also outlines all the other schemes utilized to mobilize domestic resources by the

dominant Commercial Bank of Ethiopia to show some of the initiatives and the success

achieved.

BOX 1: ILLICIT FINANCIAL FLOWS AND GOVERNEMNT RESPONSE

Enactment of Customs proclamation number 622/2009 and subsequent institutional improvements of

the Ethiopian Revenue and Customs Authority (ERCA) have contributed to growth of revenue from

international transactions (Federal Negarit Gazetta, 2009). According to a senior official at the ERCA,

the major institutional changes are directed to increasing efficiency and reducing corrupt and fraudulent

acts. The enormous networks of corrupt practices established among sizable number of importers and

similar clients, customs officials, and transit agents has been reduced and a number of newly entering

customs officials, most of whom women, have created inconvenience for the reestablishment of such

networks and hence untangled the perpetuating fraudulent actions. [Despite instituted strategies to

reduce it, import under invoicing remains to be a challenge] the principal sources of illicit flows are

export under-invoicing and import over understanding, as well as correct contracting practices etc]

what is explained here might be relevant to tax evasion and . Although the law stipulates import under

invoicing as an illegal act, it has now become almost a norm in real practice. Ethiopian Revenue and

Customs Authority/ERCA uses a customs valuation CD that lists the minimum international prices of

goods and services using which imports are revalued for tax and tariff determination. However,

importers or their transit agents have access to this customs valuation CDs using which they adjust

import prices accordingly. It is likely that the actual import prices are much higher than the ones in the

valuation CD and illicit financial flow of this form is huge. As a further remedy, the Authority has also

identified trade partner countries that recorded the accuracy of imported items; and documentations and

hence import values from these countries are subject to the authority‟s scrutiny. For instance,

importations from most of the EU countries are considered genuine whereas importation from countries

often with non-genuine pricing is subject to close scrutiny by customs officials. Regardless of all these

efforts, illicit flow in the import sector is still unacceptably high in Ethiopia.

38

BOX 2: DIASPORA BONDS

Ethiopia introduced the first diaspora bond called “Millennium Corporate Bonds” in 2008, making it the

first country in Africa to introduce diaspora bonds. The millennium corporate bonds were issued by the

Ethiopian Electric Power Corporation (EEPCO) to finance national projects. The first diaspora bond

issuance did not meet sales expectations, despite the efforts of the Commercial Bank of Ethiopia and the

embassies and consulates to sell them. Some risks that the diaspora faced were: i) risk perceptions on

the payment ability of EEPCO on its future earnings from the operations of the hydroelectric power; ii)

lack trust in the government as a guarantor; and iii) political risks.

Although the millennium bond was not as successful as had been hoped, the Ethiopian Government

issued a second bond in 2011. The second bond issuance was aimed to secure financing for the Grand

Renaissance Dam project. Based on the experience of the first bond, the second bond issuance

incorporated new features to make it more appealing and practical. The features that were included in

the second bond include; i) consolidation of the Renaissance bond with the Millennium bond; ii)

considerable marketing and awareness-raising campaigns by the government to encourage the diaspora

to buy it; iii) bond offering in minimum denominations of USD 50, which many Ethiopians can have

access; iv) transferability of the bond up to three people, and ability to use it as collateral in Ethiopia;

and v) covering any remittance fees associated with the purchase of these bonds by the Commercial

Bank of Ethiopia.

Performance of the new bond – amount raised as a proportion of GDP

Some lessons have been learned from the Ethiopia‟s experience:

i. the need to ensure that the bonds are marketable and will appeal to the diaspora;

ii. ability to identify and locate nationals living abroad;

iii. establishment of an entity that can attract and maintain ties with the diaspora;

iv. improvement of financial literacy among members of the diaspora to help them to become active

investors; and

v. demonstrated good governance, transparency and political stability to enhance trust by members of the

diaspora.

39

BOX 3: Resource Mobilization – Commercial Banks

*deposits + borrowing (net change) + collection of loans

Contributions of Selected Components to Total Deposit (%)

Source of deposit Contributions to total deposits (%)

2011/12 2012/13 2013/14

1. Grand Ethiopian Renaissance Dam Bond 2.16 1.77 1.96

2. Public Sector Social Security 3.45 3.99 4.38

3. Private Sector Social Security 0.30 0.91 1.54

4. Insurance Premiums 2.65 2.53 2.03

5. MFI Deposits 3.61 3.97 4.82

6. Other Deposits (primarily saving, time, and demand deposits )

7. Housing scheme Initiatives (elaborated below*)

87.82 86.82 85.28

*According to MoFED (2012/13)In the first three GTP periods, a total of 95 thousand houses were under

construction some of which are completed and transferred to users. A total of 24,068 housing units have been

transferred to users both in Addis Ababa and the regions. About 6,262 (26%) of these beneficiaries are

women. Integrated Housing Development Program In 2012/13, it was planned to construct and transfer

30,000 new housing units in Addis Ababa, and complete and transfer all condominium houses under

construction in all regions. As a result, in Addis Ababa 33,120 housing units are under construction and the

construction of 23,503 houses is 29.6% completed. In the first three GTP periods, a total of 95 thousand

houses were under construction some of which are completed and transferred to users. A total of 24,068

housing units have been transferred to users both in Addis Ababa and the regions. About 6,262 (26%) of these

beneficiaries are women. It has been planned to reduce the slum areas of Addis Ababa to 42% from the base

year level of 60% at the end of this planning period. Hence, the city government of Addis Ababa took various

development measures to downsize slums to 45%. Domestic saving: with regard to domestic saving the target

was to increase to 15 percent of GDP. Accordingly, various measures have been taken to achieve this target in

the past three years, including awareness raising of the citizens on saving culture, expanding access to

financial services, launching and implementing social insurance program for private sector employees,

strengthening Government social insurance coverage, introducing saving bonds and other saving instruments

such as housing saving program, investment equipment saving program, etc. and allocating more Government

expenditure on investments that increase capital accumulation. As a result of these measures, domestic saving

increased from 5.2 percent in 2009/10 to 17.7 percent in 2012/13. Similarly, the share of gross domestic

investment increased from 24.7 percent in 2009/10 to 33 percent in 2012/13 which is relatively high

compared to countries at similar stage of development with Ethiopia. Though the achievements made so far in

domestic savings and investment were remarkable, the gap between gross domestic savings and investment

Resources Public banks Private banks Total % change

Deposits (million Birr) 2011/12 37,004.6 9,754.3 46,758.9 2012/13 32,949.9 16,960.8 49,910.7 6.7 2013/14 40,053.9 15,592.7 55,646.6 11.5 Total resources mobilized (million Birr)* 2011/12 62,731.5 26,461.9 89,193.4 2012/13 62,228.4 35,845.5 98,073.9 10.0 2013/14 70,215.4 41,209.9 111,425.3 13.6

40

has remained high indicating that additional efforts are required to further increase growth in domestic

savings in the remaining two years of GTP.

5 Lessons Learnt and Capacity Development Imperatives

5.1 Lessons Learnt

The lessons learnt are mainly inferred from the capacity constraints outlined in section 3.4.

The first important lesson learnt in the last few years in Ethiopia has been how resourceful the

people have been if the proper policies, implementation and productive utilization of

resources are visible and verifiable. Taxes, fees, and charitable donations (in the form of

bond purchases and free donations for various projects) have been imposed on citizens; but

despite the heavy burden the people have responded well to the tasks as expected. That is,

they continue to contribute to the various government initiated projects despite the heavy

burden. These lessons are demonstrated by the various initiatives (the response to the various

saving mobilization efforts, the participation in the various bond purchases such the Diaspora

bond, the Renaissance Dam etc) described in section 3.4.

The second important lesson learnt is that the slight improvements in the efficiency with

which taxes and various charges are collected has significantly improved the tax outturns.

Despite the improvement, however, the level of tax collected has not been optimal. Hence, the

efficiency has a long way to go to eliminate the various inefficiencies in the system;

The third important lesson is that if the government makes even effort to demonstrate that the

revenue collected from taxes are being utilized to benefit them via health, education and

similar provisions and make that connection transparent than it has done so far, there room to

even mobilize more resources as everything the people do becomes incentive compatible.

A fourth lesson worth noting is related to the structure of the economy. Despite the

improvements in resource mobilization in recent years, the extent to which resources would

be mobilized is going to be limited as long as the informal sector remains out of each of tax

authorities. There is no any time tested means of incorporating the informal sector into the

41

formal sector. But there are incentive enhancing policies that both increase their capacity and

to be attracted as well to engage themselves in formal lucrative activities; and

A fifith lesson worth emphasizing is the effort that should be made to increase confidence and

fairness in the tax system. To achieve these authorities should avoid arbitrariness and unfair

practices in designing and implementing the tax administration process. The issue of

arbitrariness and unfair levy has been a serious complaint of small and multi-commodity city

traders. Bestowing confidence in such practices would make the resource mobilization

process more acceptable and predictable. These issues were discussed earlier in the context of

lack of well-trained tax collectors, inefficiency in the system and arbitrary enforcement

practices.

5.2 Capacity Imperatives for Effective DRM

The capacity imperatives for effective domestic resource mobilization efforts are many and

that cover many aspects of the capacity issues ranging from personal skills of staff to

organizational structures and an enabling policy environment.

In the case of Ethiopia the first crucial capacity imperatives for effective domestic resource

mobilization is related to the designing and implementing of appropriate policies to

broadening the tax base. Except the recent limited initiatives underway to cover more

economic activities, the tax base in Ethiopia is very narrow, owing to the economic base. It

has only been able to effectively capture income and foreign trade taxes. All other activities

have been beyond the reach of the tax system. Therefore, the potential to mobilize domestic

resources has not been fully exploited. This is partly due to the limitation of the

implementation capacity of the government and partly due to the absence of proper recording

of transactions.

Second, a related capacity imperative is the low skill level of administrative staff engaged in

resource mobilization, particularly tax collection. For the most part staff are poorly qualified,

inexperienced and according to many clients very corrupt. This led to high staff turnover due

to layoffs to minimize corrupt behavior. This is a serious problem, particularly in the foreign

42

trade tax administration as it involves imported goods with a lot at stake for importers (due to

size and ambiguity in valuation).

Third, the problem of efficiency and integrity of the tax administration is complicated by the

limited introduction of computerized systems to both expedite the process and provide

reliable information. There have been minor improvements in computerizing the tax

collection process but its spread is limited and it more often than not fails to function. This

has been a problem in almost all government offices partly due to unqualified operators and

partly poorly functioning machines. Improving on the training of staff, the computerization of

the tax administration and its effectiveness will definitely improve the resource mobilization

outcome; introduction of a computerized system is underway but it has to be expedited to

bring about noticeable changes;

Fourth, a related capacity imperative of staff is the seemingly incompatible benefit package of

staff and the asset size that they decide on. It is appreciated how difficult it is to make a policy

that takes into account the relative pay in a government structure, the incentive compatibility

of a benefit package in a specific activity and its budgetary implications for the overall salary

structure. But all these have to appreciate the inherent incentive incompatible employee

reward system. For instance, an employee is paid few thousands a month but decides on

whether to levy taxes worth million every day. This inherently creates a temptation for both

the client and the staff to find a mutually rewarding arrangement since the consequences are

minimal at best (losing a job that pays few thousands a month, at worst).This seems to suggest

that, the „stick‟ and „carrot‟ approach has to be carefully examined to make sure the setup is

incentive compatible if resource mobilization is to continue and more importantly improve its

performance.

Fifth, equity issues are important in the Ethiopian tax system, but the prevalence of

exemptions (as was stated in relation to the VAT) complicates the effectiveness of tax

administration and resource allocation. This also makes the equity issue less targeted and

creates some loop-holes in the process. It is therefore more effective if the equity related

issues are more targeted than addressed using exemptions since it both distorts resource

allocation and complicates the tax administration thereby hampering revenue mobilization.

43

Sixth, the inability of the financial sector (particularly banking) to integrate is an important

constraint for resource mobilization. As noted the number of private banks recently increased

but the inter-bank linkages and efficiency between them is still inadequate. This is

demonstrated by the recent increases in minimum capital requirement from 200 million to 500

million which creates an entry barrier; the spread between the deposit rate and the lending rate

(lending rate is more than twice the deposit rate); the negative real interest because the

inflation rate almost always exceeds the nominal at least the deposit rate; and almost absent

facility to make direct interbank transfers or money market transactions regardless of the

proximity of the banks / branches concerned. Among the branches of the same bank are slow,

though slightly improved due to the recent branch-networking that just started. The

competition and efficiency of the financial /banking sector needs to greatly improve for the

sake of effective resource mobilization.

Seventh, Ethiopia has a scattered and farm based rural economy both in geographic sense and

composition of activities. Small farm households and even more fragmented non-farm

households in the rural areas are not easy to tax or coordinate their fragmented activities to

optimize economies of scale. It is, therefore a challenge to both maximize available resources

and coordinate an optimal investment schemes. But most importantly, a fragmented rural

economy is difficult to effectively administer taxes partly due to its low income level and its

amenability for tax evasion. Hence tax compliance in economies dominated by small,

fragmented and poor households like that of Ethiopia is a major challenge.

Eighth, another challenge is related to the fragmented to the low infrastructure facilities of a

rural based economy is its low out reach of financial services. Modern financial services need

close proximity of dwellings and some level of information symmetries to facilitate deposit,

loan and other transactions. Therefore, in addition to trust and literacy, physical proximity and

easy access supported by adequate infrastructure is crucial in enhancing an effective resource

mobilization. Absence and /or inadequate of such facilities is therefore another challenge in

economies like Ethiopia.

.

Ninth, in addition to being fragmented, another challenge in mobilizing resources is the share

of the informal sector in the economy. Due to the unrecorded and an accounted nature of the

44

informal sector, it is difficult to mobilize resources from the informal sector. The destination,

size of economic activity and ownership structure is difficult to identify. And since the

informal sector both in the rural and urban areas in Ethiopia is presumed a significant portion

of the economy, it is a serious challenge to mobilizing resources.

Tenth, Low savings rates, a general lack of awareness and financial literacy, and inadequate

consumer protection are also other challenges. It is a challenge to mobilize savings in a

subsistence economy as low income implies, other things being equal, low saving. In addition

to low income, lack of exposure, trust and understanding of modern financial services is a

challenge since most people in rural areas and even in small towns depend /channel their

assets in the form of durable assets which are less liquid and hence not easy to mobilize for

investment purposes. It takes time to build the trust in the modern financial system, educate

on the public benefits of tax collection, and other collective benefits that need individual

contributions.

Eleventh, lack of effective investment guidelines as well as limited capacity to implement

investment strategies also limits the ability of urban dwellers in mobilizing sufficient

investable resources.

6 Conclusions

The main key issues that would be drawn as conclusions of the study could be summarized as

follows: the size and overall trends of domestic resource mobilization in the areas of revenue

generation and saving accumulation, the improvements made in mobilizing domestic

resources and that there is a long way to go to tap the huge potential, the capacity constraints

in resource mobilization efforts and the scope and opportunity costs of the leakages through

illicit financial flows.

First, the recent improvements in resource mobilization both in public finances (saving and

revenue generation) and private saving (of households and firms) is encouraging.

Particularly, the improvements in tax collection efforts and household saving are significant.

These should be strengthened and deepened to ensure the reliability of domestic resources and

limit the dependence on foreign sources in financing development;

Second, The government‟s effort to use the mobilized resources for socially productive and in

an inclusive manner is appreciable. It utilized the mobilized resources to improve social and

45

economic wellbeing of citizens. As noted in the allocation of government expenditures, the

government focused on health, education and infrastructure expenditures in general and on

pro-poor expenditures in particular;

Third, due to the complicated nature of the leakage of financial flows, a proven and reliable

device may not exist to eliminate it, but coherent, aggressive and practical mechanisms should

be devised to limit and discourage capital flight. This has been a significant leakage from the

system from a country with limited means. Parallel to harnessing the potential domestic

resources, therefore, a concerted effort to minimize or attempt to eliminate the leakages must

be made;

Fourth, increasing an effective computerization of the tax collection administration;

Fifth, working towards minimizing the extent and organization of the informal sector such

that all transactions (particularly in the rural areas and small towns) are recorded;

Improve the interbank money transactions instead of banks operating as „bridgeless

islands‟;

Further, to limit the rigidity and the existing inefficiency the recently starting teller

machines (with both deposing and withdrawing option) should be further encouraged

and to increase the availability of such facilities. coverage areas; more automation

facilities will definitely facilitate better mobilization of financial resources;

Make the tax system clear and easy to implement such that it avoids ambiguity among

implementers and the general public;

The staff should be equipped with the required qualifications and are rewarded and

with commensurate pay package attached to consequences so that their engagement is

incentive compatible to minimize corrupt behaviour.

Sixth, government should devise policies that would boost healthy competition among the

financial / banking institutions so that the banks and private household sectors could

effectively mobilize resources (i.e. eliminate the entry barriers, negative real interest rates

etc);

Seventh, efforts to tap the potential of the huge Ethiopian Diaspora have recently increased

and have showed some positive results. But as noted in terms of its contribution in

participating the purchase of Diaspora bonds, the contribution is less than that of other

countries‟ experiences and in terms of the size of the Diaspora. Additional effort that

46

transcends any political differences is required to maximize the potential. The government‟s

effort has not been consistent in trying to convince the Diaspora why it has a stake in building

the country beyond supporting their immediate families, however important that might be;

this is better harnessed with initiatives that could be viewed as politically „neutral‟ like the

Renaissance Dam and by creating a closer network rather than the „arms-length‟ approach

which seems to have been followed.

Eighth, not enough is known regarding the extent to which an effort is made to repatriate what

has leaked as illicit financial flows due to the hidden and sensitive nature of the activity. But

the government has to make a concerted effort to repatriate what has leaked both to recoup

such a substantial amount and to discourage future activities using what is internationally

accepted means of what called money laundering, tax evasion or other international

agreements, norms and protocols. That is, an analysis of the legal and political procedures of

any attempt to repatriate what has already crossed the border is beyond the scope of this

paper, but efforts to close loop-holes in the process and making arrangements with partner

countries should be given priority.

47

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