Following a promising start after independence, the Ethiopian war (1998-2000) drastically changed the performance of the Eritrean economy. GDP declined, inflation rose, the external current account worsened, foreign exchange reserves were nearly depleted and banking assents were severely compromised. The most significant change was the sharp deterioration of the public finances and rapid increase in domestic and external public debt.
Eritrea is one of the youngest nations in the world, which became officially independent from Ethiopia in 1993 after a debilitating war that lasted more than thirty years. It is located in the North Eastern part of Africa with a total area of 124,432 km2 and a coastline on the Red Sea of almost 1000 km. Eritrea, bordered in the North and West by Sudan, in the South by Ethiopia and Djibouti, and in the East by the Red Sea has an estimated population of about 4.3 million with a population growth per annum estimated to be 2.9 per cent. It has nine ethnic groups and six administrative provinces/regions.
Growth and Inflation:
Growth performance over the last 14 years was mixed, and no clear trend emerged. On average, real GDP grew by 5 per cent, driven by expansion in the non-agricultural sectors. Industries experienced the highest growth among major sectors, reaching 13 per cent on average, and its share in GDP rose to 25 per cent by 2002. On the contrary, the growth of agriculture fluctuated significantly year-by-year, largely owing to the weather conditions and Eritrea’s food security did not improve. In US dollar terms, GDP per capita remained basically unchanged over the last ten years at a very low-level by international standards.
Whatever the absolute level of Eritrea’s GDP, there is no doubt in the countries recent economic progress through Warsay Yikeallo Development Campaign that was launched in May 2002. The economic growth was stunning prior to 1997 (more than 8 per cent), a rate that many African countries were not able to achieve. Inflation, which had remained manageable (about 4 %) four years after independence, has been consistently high since 1998 reflecting the war, drought conditions, monetary expansion for deficit financing, and the depreciation of the Nacfa since 1998. Inflation however shot recently with consumer prices rising by 24 percent by the end of 2002, compared to 8 per cent at the end of 2001. This reduced to 16 per cent in the middle of 2005.
It has enjoyed a considerable growth before, but this was hampered by severe recession and financial crises due to the border conflict. During 1994-1997, the growth rate in Eritrea rose sharply varied between 1998-2003.
The government is trying to control the economy and price situation in the country. Since 2004, it has been trying to regulate the supply of petroleum products and other necessary items. In the first quarter of 2005, it began to supply essential items like: teff, sugar, oil, tea powder, sorghum, lentils, and coffee seeds by the Hidri distribution center to the needy people at fair prices.
Rural and Urban Differences:
After stability, the next priority for the Eritrean economy is redistribution. The gap between the rich and poor is vast. In the relatively developed regions of the country like Maakel, Northern Red Sea, Gash Barka, the standard of living and GDP per person is likely to be more than regions like Southern Red Sea and Anseba.
In the developed rural regions of the country, the GDP is almost 2-3 times what it is in the undeveloped regions. Many of the houses in different parts of the country (particularly in the lowland areas) are huts and mud roofed single stored structures with improvised windows. Water is drawn from the nearest well and separate piles of dried dung for fuel and straw for animal feed are heaped outside the front doors to the see the occupants through winter. Only the lucky houses have a satellite dish to pick up the multiplying number of TV channels. Most of the local community’s economic opportunity lies in farming and a small percent on employment.
Change in the tax system could help redistribution. At present, the country relies heavily on indirect taxes which are non-distributive, but easily collected than direct taxes, which are relatively harder to collect. The government has modified the Tax Proclamation of 62/1994 and issued a new one in 2001.
The government is also drawing up legislation to restructure the foreign exchange reserves management; business licensing policy and inland revenue service, making them interdependent authorities to do their own task. The purpose is to establish a tax system to reduce the unregistered economy and collect taxes more efficiently. Currently, about 10 per cent returns are audited, so tax evaders are likely to get away with it. Those who are caught are merely fined although imprisonment is implemented in some cases.
Nominal Exchange Rate in Eritrea:
The exchange rate plays a critical role in determining external debt and debt service burden, as well as sustainability of both. This is because of its direct effect on their size and its effect on comprehensiveness and growth. The equilibrium exchange rate generally reflects macroeconomic policies and development, including fiscal policies and their sustainability. It is also a function of investors' confidence. The current exchange rate system in Eritrea is close to that of a conventional peg; at least as far as official transactions are concerned. Although the rate is allowed to respond to market forces, the current arrangement bears a substantial risk of depreciation, especially because of the large external deficits and low levels of official reserves. Should such an adjustment occur, the foreign-currency-denominated debt would swell unless debt relief is secured. At the same time, a market-determined exchange rate would strengthen the country’s exports and growth.
Perhaps, the most charged economic challenge for the government is unemployment although, many work under national service for lower payment like Nfa 150 and 450, the official rate of unemployment is a low 10 per cent. There is considerable underemployment in farming, defense and service sector among others. This particularly appeared due to the deportees (about 100,000) from Ethiopia and Sudanese refugees (about 50,000) who mostly concentrated in the urban areas particularly in Asmara and its vicinity. Unemployment undermines social, economic and political support for reforms.
The Agriculture sector currently accounts for 75 per cent of all jobs but only 16 per cent of GDP. If the work force could match the sector’s contribution to the economy, 40-45 per cent jobs would have to be found elsewhere in other sectors. The authorities have produced an Interim Poverty Reduction Strategy Paper and a national food security strategy, which sets out plans aimed at increasing rural incomes and raising productivity in the country.
Private Sector Initiative and Development:
In most successful economies, it is observed that the private sector is the driving force for employment and economic development. The private sector is particularly effective when the sector is offered a conducive environment. In Eritrea, most of these fundamental conditions were introduced after independence but have recently been rolled back in a number of areas, such as finance, foreign exchange, utility services, petroleum products and trade. More generally, the authority’s dissatisfaction with the private sector has resulted in an increased role of the government in the economy, including its intervention in markets. The authorities consider that, despite a liberal business environment and large-scale privatization, the private sector has not played the role of being the engine of growth in the economy.
The Warsai-Yikeaalo Development Campaign is making a vital contribution in the reconstruction and development of Eritrean economy thereby improving the standards of living. However, they have a long way to go.
Government of Eritrea (1994) Macro Policy Document, Asmara, Eritrea: Government Press.
Ravinder Rena (2004a) Handbook for Eritrean Economy, Asmara: Asmara Commercial College (unpublished manuscript).
Ravinder Rena (2004b), “Green Revolution: Indian Agricultural Experience – Paradigm for Eritrea”, Eritrean Studies Review, Vol.4, No. 1, pp. 103-130.
Yamauchi Ayumu (2004) “Fiscal Sustainability – the Case of Eritrea,” IMF Working Paper WP/04/7(January).
By Dr. Ravinder Rena
Eritrean Institute of Technology
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