Outlook for 2011-12

• The ruling Ethiopian People's Revolutionary Democratic Front is expected to remain firmly in power following its emphatic victory in federal and regional elections in May 2010.
• The opposition was, in effect, removed from parliamentary politics by its landslide election defeat in 2010. Its divided nature and inability to raise significant funds will make it easy for the government to keep it marginalised.
• Ethiopia will continue to support the government of Somalia, and it will retain its position as the key US ally in the volatile Horn of Africa.
• Barriers to business caused by the government's state-led development model will hinder private-sector growth, but the stable political outlook following the 2010 elections will make the investment climate more attractive.
• Real GDP growth is forecast to rise to 9% in 2010/11 (year ending July 7th), owing to a favourable agricultural performance, and 9.5% in 2011/12, helped by higher foreign investment and improvements in the power supply.
• Inflation is forecast to rise to 22.7% in 2011, as a result of global food and fuel price rises and a large currency devaluation in September 2010. It is expected to stay high in 2012, at around 11%, owing to structural constraints.
• The current-account deficit is forecast to average 4.9% of GDP in 2011-12, owing to the structural trade deficit.

Monthly review

• The foundation stone for the Renaissance Dam was laid on April 2nd, reviving tensions around "water politics". If built, it will be one of the largest dams in the world, producing 5,250 mw initially, and 10,000 mw by 2017.
• Six of the nine Nile riparian countries have signed an agreement to change the distribution of control over the Nile. This has angered Egypt and Sudan; colonial era agreements currently entitle them to over 90% of the Nile's water.
• The Ugandan president, Yoweri Museveni, has said that the accord will not be ratified until Egypt elects a government, giving it a chance to reverse the stance of the Mubarak regime.
• In early April the US State Department released its annual Human Rights Report, which again criticised the human rights situation in Ethiopia. The Ethiopian government has dismissed the report in its entirety.
• The government started to sell staple foods directly to consumers as shortages emerged following the introduction of state-imposed price ceilings in January.
• The year-on-year inflation rate reached almost 30% in April, up from 16.5% in February, owing to higher food and fuel prices.

The ruling Ethiopian People's Revolutionary Democratic Front (EPRDF) is expected to remain firmly in control at all levels of government following its emphatic victory in the parliamentary election in May 2010. The EPRDF has a 99% majority in Ethiopia's House of People's Representatives (lower house), as other candidates won just two seats. Although the opposition ran a dismal campaign, the scale of the victory mostly resulted from the passage of restrictive laws governing the media, civil society and political funding. The hegemony of the EPRDF will probably ensure political stability, but recent turmoil in North Africa has stoked government fears about civil unrest, and the opposition has accused the government of arresting 200 of its members in March. The party will hope that the recently introduced public-sector pay rises and price ceilings to limit inflation will help to quell any potential unease.

The prime minister, Meles Zenawi, has said that he will stay as party leader until 2015, and the Economist Intelligence Unit expects that he will tighten his grip on power. His position was strengthened in September 2010 by the appointment of loyalists as the chairmen of two of the four parties that comprise the EPRDF coalition. Moreover, the appointment of a new cabinet in October was taken as an opportunity to promote younger supporters to replace older allies who might otherwise have tried to position themselves to succeed Mr Meles. It is unclear whether he is strengthening his position with the intention of running for re-election in 2015 (he is only 55 years old) or to enable him to choose his own successor. At the moment, Mr Meles appears to be the only candidate capable of holding together the EPRDF's multi-ethnic framework, using his authority and force of personality.

Following the landslide victory of the EPRDF in the May 2010 election, the ruling party will consolidate its control while the opposition will enter a period of reflection, trying to come up with strategies to force the government to open up the political space over the next five years. The next elections are not due until 2015, but the opposition has a lot of work to do to make itself competitive at the polls. The largest opposition alliance, the Ethiopia Federal Democratic Unity Forum (known as Forum, or Medrek in Amharic), has announced plans to transform from a coalition into a political front and has appointed a new chairman. One of its six constituent parties, the Unity for Democracy and Justice, has spoken of plans to merge with two smaller opposition parties, the All Ethiopian Unity Party and the Birhan for Unity and Democracy Party, which would enlarge the alliance. However, most of the opposition parties are still having difficulty agreeing on anything. The divided nature of the opposition, as well as its inability to raise significant funds domestically, will make it relatively easy for the government to keep it marginalised.

Instability in the volatile Horn of Africa will cement Ethiopia's position as the key ally of the US in the region, and relations with Eritrea and Somalia will continue to dominate the foreign-policy agenda. The protracted border dispute with Eritrea remains at an impasse and attempts at a diplomatic solution have failed. Ethiopia adopted a more aggressive stance in March, when it called for the removal of the current regime. It is unclear whether the government is trying to deflect attention from domestic dissatisfaction or whether it sees an opportunity to act unilaterally. There is a risk of conflict, although continued deadlock is the most likely scenario. Somalia will also remain a source of tension and Ethiopia will continue to offer support to the government of Sheikh Sharif Sheikh Ahmed.

Water politics will shape Ethiopia's relationship with Egypt and Sudan, and tensions might increase in the coming months. Colonial era agreements currently grant the two countries access to 90% of the Nile's water but Ethiopia has stoked tensions by announcing plans to build a huge, 10,000-mw dam on the river. It recently signed a provisional agreement with five other Nile riparian countries-much to the anger of Egypt and Sudan-to redistribute control over the river. However, it will not ratify the agreement before the Egyptian elections, in order to see if the new regime will be more open to renegotiating the current arrangement. The Nile is an important source of water, electricity and jobs for all the countries involved and the situation has ample potential to deteriorate.

The main challenge facing Ethiopian policymakers will be to harness the recovery in global demand and sustain the rise in domestic demand while addressing the return of high inflation and other macroeconomic imbalances. Despite concerns about governance and the lack of a functioning opposition, the country's strategic importance means that donors will continue to provide support. The Ethiopian government will loosely adhere to an IMF-style policy framework in order to uphold donor funding, although it will continue to bar foreign banks and will maintain its monopoly in the energy and telecommunications sectors. It performed well under the 14-month, US$235m exogenous shocks facility with the IMF that concluded in November 2010, but a successor IMF programme in 2011-12 is unlikely, as the authorities are keen to maintain economic independence.

The government has gradually expanded the role of the state in the economy, and interventionist action will be a feature of public policy over the forecast period, although it could have detrimental economic consequences. A five-year economic plan, the Growth and Transformation Plan (GTP), adopted at the end of 2010, prioritises a strong role for government, and price ceilings on 20 basic goods were introduced in January to combat inflation. This policy will not prove productive; the government has since had to start selling goods itself, as shortages emerged when sellers stopped importing goods because it was not profitable, and inflation has continued to rise regardless. It may eventually have to relax these price ceilings or at least stop enforcing them. The sometimes conflicting agendas of maintaining a strong governmental influence on the private sector while attracting foreign investment will continue.

The government will loosen its commitment to a tight fiscal stance despite the risk of macroeconomic imbalances after several years of rapid growth. Spending will rise quickly, as an impatient government will continue to espouse a state-led development model that places the emphasis on public investment rather than private-sector growth. Domestic revenue performance will improve at a decent rate, although it is coming from a low base relative to GDP, even by African standards. The revenue agency, the Ethiopian Revenues and Customs Authority, will continue to implement measures to broaden the tax base, improve compliance and reduce evasion. A windfall tax on bank profits arising from the 16.7% devaluation of the currency in September 2010 will bolster government coffers in fiscal year 2010/11 (ending July 7th). Overall, we expect the budget deficit as a percentage of GDP to edge slightly higher, to 2.5% in 2010/11 and to 2.3% in 2011/12, as a public-sector pay rise of over 30% will ensure that the government balance cannot match its performance in 2009/10. The deficit could be exacerbated depending on the scale of government involvement in importing commodities and if they are sold at a loss in an effort to maintain the price ceilings that the government introduced in January. The deficit will be financed through a combination of external debt and cheaper domestic debt as high inflation causes negative real interest rates on Treasury bills.

Inflation has escalated significantly in 2011 and will be the main challenge for monetary policy. In an important change to monetary policy at the end of 2010, the National Bank of Ethiopia (NBE, the central bank) said that it would stop financing public spending and would adopt a low reserve money growth target. This is aimed at tackling the problems of excess liquidity and demonetisation. The NBE will try to tackle price rises by limiting money supply growth in order to reduce core, non-food inflation. Its task will be made difficult by several factors, including a lack of sophistication in financial markets, which weakens the link between interest rates and prices, and the large impact on inflation of other factors, such as the weather, the exchange rate and import costs. Foreign-exchange reserves are expected to remain at two to three months of import cover, as the government prefers to spend resources on development rather than build up reserves beyond this level.

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Economic growth will accelerate as the economy recovers from a slowdown caused by the fragile global economic environment. Growth in agriculture will continue to underpin the economic expansion as agriculture and agro-industry benefit from the movement of subsistence farmers into the commercial economy, helped by the expansion of road, power and market networks. Drought in some areas will limit the speed of this expansion in 2011. Industry will be helped by an improvement in power supply; the addition of three hydroelectric power stations in 2010 more than doubled capacity to around 2,000 mw. All three have been producing below capacity owing to teething troubles, but output will improve over 2011-12, boosting economic activity. Barriers to business caused by the government's state-led development model will hinder private-sector growth, but the stable political outlook following elections in 2010 will make the investment climate more attractive. Based on these factors, we forecast real GDP growth of 9% in 2010/11. This will increase slightly to 9.5% in 2011/12 as foreign investment rises and the electricity supply stabilises.

After averaging 8.1% last year, the lowest rate since 2004, price increases will accelerate in 2011 on the back of rising global food and fuel prices, as well as the 16.7% currency devaluation in September 2010. The inflation rate quickened to 29.6% in April and government-imposed price ceilings on some goods have not been successful. The government introduced price ceilings on 20 basic goods in January in order to dampen inflation, but the impact of this policy will be muted because of a lack of implementation and subsequent shortages as traders stop importing goods for sale at the unprofitable lower prices. International price rises for oil and food and continued inefficiencies in supply chains from ports in Djibouti, Kenya and Sudan will add to price pressures. We forecast that inflation will average 22.7% in 2011 and that structural constraints will keep it high, at around 11%, in 2012.

The birr will continue to be managed closely by the central bank, which maintains a policy of gradual depreciation interspersed with sharper downward adjustments. The IMF classifies this as a crawl-like arrangement and supported a 16.7% devaluation in September 2010, which it says brought the birr in line with fundamentals. However, we expect that the government will continue to wield the exchange rate as a policy tool in 2011-12, devaluing the currency to improve export competitiveness. The pattern of gradual depreciation and intermittent larger adjustments is likely to continue. We forecast that the currency will weaken from an average of Birr14.40:US$1 in 2010 to Birr17.90:US$1 in 2011 and Birr19.60:US$1 in 2012.

Ethiopia's structural trade imbalance will keep the overall current account firmly in deficit during 2011-12. Trade activity will quicken in line with faster economic growth, although import growth will outpace export growth, leading to a wider nominal trade deficit in both years. Robust economic growth, high global food and fuel prices and growing demand for capital goods for infrastructure projects will drive up import costs while exports will receive a boost from a more competitive exchange rate. The services account is forecast to switch from deficit to surplus owing to the projected start-up of electricity exports to neighbouring countries in 2011. The country's dependence on concessional borrowing from donors and private remittances will continue (current transfers are around twice as large as export earnings) and growth in transfers will mitigate the expanding trade deficit. Overall, the current-account deficit is forecast at 5.5% of GDP in 2011, falling to 4.2% in 2012 as the prices of imported food and fuel fall.

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Ethiopia's plan to build a huge hydroelectric dam on the Blue Nile near the Sudanese border has revived tensions around "water politics" in the wider region. The cornerstone for the Renaissance Dam (formerly named the Grand Millennium Dam) was laid at a ceremony attended by the prime minister, Meles Zenawi, on April 2nd. Once completed, it will be the largest hydroelectric dam in Ethiopia and one of the largest in the world, with plans to produce 5,250 mw initially, rising to 10,000 mw by 2017. The scale of the project could make it the most significant development for decades between the nine Nile riparian countries. Building dams on the river has always been politically sensitive, and Egypt and Sudan have been the most vocal in opposing such projects in the past; Egypt has even gone as far as equating dam-building to acts of war against the Egyptian state. The country is heavily dependent on the river, using it for almost all its water needs.

Although Sudan and Egypt have dominated Nile negotiations in the past, a series of events over the past two years suggests that their dominion is coming to an end. Under the terms of colonial-era treaties signed with the UK in 1929 and with Sudan in 1959, Egypt and Sudan are entitled to over 90% of the Nile's waters, and Egypt has veto rights over any upstream developments. This lopsided agreement has been unchallenged for the better part of a century, largely because countries upstream of Egypt did not have the resources to build dams on the scale that Ethiopia is now planning. Moreover, with water and electricity demand growing in line with expanding economies, and high oil prices becoming a hefty burden for the state, governments have begun to seriously consider ways of exploiting the renewable resource that flows through their countries.

The Nile Basin Initiative (NBI) was established in 1999 by the nine Nile riparian countries-Egypt, Sudan, Ethiopia, Uganda, Kenya, Tanzania, Burundi, Rwanda and the Democratic Republic of Congo (DRC)-to facilitate dialogue on how to use the Nile's resources. However, Egypt's water rights have always been an obstacle for upstream countries, and in 2010 five NBI members-Ethiopia, Uganda, Rwanda, Kenya and Tanzania-signed a Co-operation Framework Agreement (CFA) that would change how control over the Nile was distributed. It would remove Egypt's veto and redistribute water rights on the Nile. In February 2011 Burundi became the sixth member to sign the agreement, allowing it to be ratified by the parliaments of signatory countries.

Egypt and Sudan have both rejected the accord, threatening to withdraw from the NBI while also lobbying other members to rescind their backing for the agreement. Egypt sent delegations to the DRC and Uganda, and the DRC has subsequently reversed its stance, after previously being an advocate of the new framework. In mid-May a large Egyptian delegation, including the interim prime minister, Essam Sharaf, is due to arrive in Addis Ababa to discuss the matter with the Ethiopian government. The situation has been further complicated by the tumultuous political events in early 2011, with the Egyptian president being overthrown and Southern Sudan voting to secede from Sudan.

The situation is precarious and the final outcome is not yet clear, although it appears likely that a new agreement will redistribute control over the Nile's water away from Egypt and Sudan. Six of the countries upstream have successfully forged a fairly united front against Sudan and Egypt. In an attempt to find a more inclusive solution, the Ugandan president, Yoweri Museveni, stated that the new accord would not be ratified until Egypt elected a new government, giving it a chance to reverse the stance of the Mubarak regime and become a signatory to the CFA. The threat of Egyptian military action against countries building on the Nile has prevented projects from reaching fruition in the past, but the country's military might is no longer as effective a deterrent. Egypt recently demanded that Ethiopia share the technical and environmental studies for the Renaissance Dam, but Ethiopia rejected the request, stating that it will only deal with Egypt through the CFA. Egypt may need to adopt a more pragmatic approach or risk being frozen out of future discussions.

That said, while it seems unrealistic to expect that Egypt and Sudan will retain rights to 90% of the Nile waters-the two countries remain vehemently opposed to any changes-they may resort to other tactics to maintain the status quo. There have been complaints that Egypt has been exerting pressure via the US and others on creditors not to finance construction of the Renaissance Dam project-a tactic that appears to be working at present. In response, Ethiopia has pledged to fund the US$4.8bn project by itself if necessary, but this is unrealistic. China has reportedly provided financing for feasibility and technical studies, but this accounts for only a small fraction of the project's cost. Both Egypt and Sudan have been invited by Ethiopia to become partners in the project and share costs, stating that it will benefit them through flood control and higher electricity production in the region, but both countries have rejected this suggestion and the dispute over control of the Nile risks becoming the defining issue between these countries in the coming years.

In early April the US State Department released its annual Human Rights Report, which again criticised the human rights situation in Ethiopia. The report has in the past provoked an annual rebuttal from the Ethiopian authorities, often countering the US report on an almost point-by-point basis. However, this year the Ethiopian government dismissed the report in its entirety, citing numerous repetitions from the 2009 report and claiming that it contains unfounded allegations of human rights abuses from earlier reports.

The reaction from the Ethiopian government is not surprising. There is broad consensus among analysts that the political environment in the country has deteriorated significantly since the 2005 general elections. The US report cites numerous cases of intimidation, detention, torture and unlawful killing of opposition members. Large-scale arrests of opposition members are well documented, as was seen around the 2010 elections and the rounding-up of hundreds of opposition members in March (April 2011, The political scene). The government has resorted to jamming the radio frequencies of foreign radio stations, including Voice of America and Germany's Deutsche Welle, a charge that was admitted to by Mr Meles, in the run-up to the May elections. The virtual monopoly on power now enjoyed by the ruling Ethiopian People's Revolutionary Democratic Front (EPRDF)-it captured all but two seats in parliament and nearly all regional and district offices in the 2010 general elections (May 2010, The political scene)-has put Ethiopia's multiparty democracy credentials in serious doubt.

Yet, despite the heavy criticism levelled at the human rights record of the Ethiopian government, international donors continue to support the government. The US remains Ethiopia's largest bilateral donor, giving almost US$1bn per year, while annual UK state aid for Ethiopia is over US$500m, making the country the largest recipient of British aid (April 2011, Economic policy). In addition to uninterrupted aid flows, there has been no high-level response from the US government regarding the Ethiopian government's recent more aggressive stance against Eritrea (April 2011, The political scene). Ethiopia has stated explicitly that it will provide support to opposition groups looking to overthrow Eritrea's current regime. The US ambassador to Ethiopia, Donald Booth, has simply stated that the US shares interests with the Ethiopians in tackling the security threat posed by Eritrea in the region.

Donors claim that the level of aid for Ethiopia reflects its substantial needs, as well as the progress that it has made in recent years, and there is some truth in this, but the strategic political importance of the country plays a large role. There has been good economic progress in recent years; Ethiopia boasts the highest economic growth of non-oil producing countries in the region and has made significant progress in the areas of health and education, making the government a good development partner, despite its authoritarian tendencies. However, the most significant reason behind the continued international support is that Ethiopia is a key ally in the volatile Horn of Africa region. It is this role that will ensure that critical human rights reports and poor democratic systems will not deter other countries from co-operating with Mr Meles' government.

The government started to sell staple foods directly to consumers as shortages emerged following the introduction of state-imposed price ceilings in January. The government took a radical policy approach to limit rising inflation by setting price ceilings on 20 basic goods from January 6th (February 2011, Economic policy). The price ceilings are estimated at between 5% and 45% lower than current market prices for goods including bread, meat, rice, sugar, pasta, cooking oil, and some fruits and vegetables.

In early February Mr Meles warned retailers that if they did not make the market work under the new prices the government would begin selling directly to consumers (March 2011, Economic policy). Many retailers have since refused to sell products covered by the new ceilings, saying that it is not profitable, especially given rising global commodity prices. As a result, in March Mr Meles announced that the market had failed and that the government would sell staples such as sugar and edible oil through government-owned shops. Long queues subsequently sprang up at government shops, where the goods went on sale for prices in line with the ceilings introduced in January.

The Ministry of Trade claims that the government ceilings allow sellers to make a profit of between 4% and 6%, which it says is more than adequate for sellers to make a living. The shortage of goods and long queues indicate that the system is not functioning efficiently, and the price ceilings have not lowered prices. Indeed, the year-on-year inflation rate for April accelerated to almost 30%. The authorities claim that the government shops are a temporary measure until the market stabilises and private sellers begin to function within the system again. Even if this were to eventually happen, it is likely to take some time, and until then Ethiopia will have Soviet-style food lines and shortages. The government appears unwilling to back down, however, and clearly still believes that it is taking the right approach. It even introduced new price ceilings for animal hides and skins being sold to tanneries in the country in late April, saying that the high price being charged to factories was hindering the development of the sector.

Fears of rising inflation since the start of the year have proved well-founded, as the year-on-year inflation rate reached almost 30% in April. The rate was 29.5% in April, up from 25% in March and 16.5% in February. This is similar to the April 2008 figure of 29.7%; a year in which inflation spiked to average 44.4% over the 12 months. Unfortunately for consumers, it appears that the comparison with 2008 may continue to prove apposite, as price pressures are likely to remain high for the rest of the year. Drought in some regions has lowered domestic food production, exacerbating price increases driven by rising global food prices. Meanwhile, a 14% rise in petrol prices was recently announced, prompted by higher international oil prices; both factors that are reminiscent of the commodity price surge that drove inflation in 2008. Although the government is clearly aware of the damage that such high inflation can do to the economy, some of its policies have added to price pressures. The steep devaluation of the currency in September 2010 increased imported inflation, while the price ceilings that were introduced in January in an unrealistic attempt to limit inflation have actually led to shortages of goods, which will push prices higher. The Economist Intelligence Unit forecasts that inflation in 2011 will average 22.7%, before easing to 11% in 2012 as commodity prices fall back.

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Please see graphic below

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Land area

1,221,900 sq km

Population

75m (mid-year estimate for 2010)

Main regions

Population in '000 (1999 official estimates)

Oromia: 21,694 Afar: 1,188

Amhara: 15,850 Benishangul-Gumaz: 523

SNNPR: 12,132 Dire Dawa: 306

Somali: 3,602 Gambella Peoples: 206

Tigray: 3,593 Harari Peoples: 154

Addis Ababa (capital): 2,424

(Addis Ababa and Dire Dawa are municipalities)

Climate

Temperate on plateau, hot in lowlands

Weather in Addis Ababa (altitude 2,450 metres)

Hottest months, April-May, 10-30°C; coldest month, December, 5-23°C; driest month, December, 5 mm average rainfall; wettest month, August, 300 mm average rainfall

Languages

Amharic, Orominya, Tigrinya, Afar, Somali and others; English and Amharic are mainly used in business

Measures

Metric system; also 1 gasha = 40 ha, 1 kend = 0.5 metres, 1 frasoulla = 17 kg

Currency

The birr (previously the Ethiopian dollar) = 100 cents; the single legal exchange rate is determined by a weekly auction

Time

3 hours ahead of GMT

Public holidays

January 7th (Christmas), January 19th (Epiphany), March 2nd (Battle of Adowa), May 28th (Downfall of the Derg), September 11th (New Year), Good Friday, Easter, Eid el Fitr, Eid el Ahda, Maulid; the Ethiopian calendar has 13 months

Official name

Federal Democratic Republic of Ethiopia

Form of state

Federal republic

Legal system

The federal constitution was promulgated by the transitional authorities in December 1994; in May 1995 representatives were elected to the institutions of the new republic, which came formally into being in August 1995

National legislature

The Federal Assembly consists of the House of People's Representatives (lower house; 547 members) and the Council of the Federation (upper house; 108 members); the nine regional state councils have limited powers, including that of appointing members of the Council of the Federation

National elections

May 2010 (federal and regional); next elections due in May 2015

Head of state

President-a largely ceremonial role, appointed by the Council of Peoples' Representatives; currently Girma Wolde-Giorgis (president since October 2001)

National government

The prime minister and his cabinet (Council of Ministers)

Main political parties

The Ethiopian People's Revolutionary Democratic Front (EPRDF) won all but two of the seats in parliament in the election in May, 2010; it evolved from the coalition of armed groups that seized power in May 1991; the Tigray People's Liberation Front, the Amhara National Democratic Movement, the Southern Ethiopia People's Democratic Movement and the Oromo People's Democratic Organisation; Opposition parties include Unity for Democracy and Justice (UDJ), the United Ethiopian Democratic Party-Medhin (UEDP-Medhin), the United Ethiopian Democratic Forces (UEDF) and the Oromo Federalist Democratic Movement (OFDM)

Prime minister: Meles Zenawi

Deputy prime minister & foreign affairs: Hailemariam Desalegn

Key ministers

Agriculture & rural development: Tefera Deribew

Customs: Melaku Fenta

Defence: Siraj Fegisa

Education: Demeke Mekonnen

Federal affairs: Shiferaw Teklemariam

Finance & economic development: Sufian Ahmed

Health: Tewodros Adhanom

Justice: Berhanu Hailu

Labour & social affairs: Abdulfata Abdulrahman

Mines: Sinkenesh Ejgu

Science & technology: Desse Balke

Trade: Abdurahman Sheikh Mohamed

Transport & communications: Diriba Kuma

Urban development & construction: Mekuria Haile

Water & energy: Alemayehu Tegenu

Central bank governor

Teklewold Atnafu