Advocating transformation

Zemedeneh Negatu is the Managing Partner of Ernst & Young in Ethiopia and Head of Transaction Advisory Services. He has a wide variety of clientèle including prominent investors from Africa and the Middle East. Here in Ethiopia, he was instrumental behind the acquisition of Meta Brewery by Diageo and Ethiopian Airlines’ development road-map Vision 2025. He has extensive global experience advising clients in financial services, manufacturing, telecoms and airlines. Asrat Seyoum of The Reporter sat down with Zemedeneh for an interview on the performance of the GTP I, the renewed focus on manufacturing in GTP II and the need to establish formal equity markets in Ethiopia. Excerpts:

The Reporter: What is your independent assessment of the first Growth and Transformation Plan? What has it achieved?

Zemedeneh Negatu: First of all the announcement of GTP 1 was timely. It gave the country a very focused but a very determined view of where it should be over the next five, ten, fifteen years. As a starting point, I think it was a strong determination by Ethiopia to create this environment that says we can grow faster; we can achieve big things than we have done in the past. And it gave it a structured framework. In terms of what it has achieved, by and large it has achieved a lot. Not everything, obviously. But I think that was anticipated, in my view, from the beginning that we probably would not achieve 100 percent. No one in the world achieves 100 percent especially when you look five years down the road. But by and large, if you look at the big infrastructural targets that were set, I think a lot of them are either achieved, on track or will be achieved soon. Because the GTP gave it a framework, we now have some measurement tools to see what we have set five years ago and what we have achieved. Where the GTP target and what was achieved may not have reached equilibrium is probably in manufacturing and exports. I think manufacturing in the next GTP will achieve its goals. Export still needs a lot of work. Export is linked to manufacturing and it’s difficult to grow exports very significantly if you are primarily exporting commodities. We have to add value. If you look at the Asian tigers how they developed, it is in the back of manufacturing and value added exports. We need to keep in mind that that manufacturing also includes agro-processing. Where GTP II, hopefully, will pick up where GTP I left off in terms of achievements, I think very significant achievements will be in manufacturing and export.

What do you think needs consideration when planning GTP II? What are the loopholes should the next GTP address?

My expectation on what GTP II will focus on is definitely what I call migration to industrialization. Very significant migration to industrialization. What it essentially means is that, the Ethiopian economy, which is still heavily reliant on agriculture would start to migrate to manufacturing. The draft that had been circulating and being discussed by the public is also focused on the manufacturing sector. Secondly, it is the continuous focus on huge investment in infrastructure. GTP I has done a very good job and I think GTP II will continue on that. For Ethiopia to sustain double-digit GDP growth, it has to continue to invest in infrastructure. And the linkage of all that is the significant ramp up of exports. I think this is very critical for Ethiopia. If we look at the examples of the Asian economies, China and South Korea in particular, they developed on the back of a manufacturing especially for exports. This is the same thing in Malaysia and a lot of Asian countries. For me, and also I think this would be anticipated in GTP II, the focus on manufacturing and continuous investment in infrastructure would eventually help enhance Ethiopia’s competitiveness and export capabilities. These are sort of linked activities and I think that is what is going to happen in GTP II. Now, what would I like to see in GTP II? Capital markets, definitely. More specifically, I mean a stock market. An organized capital market is absolutely essential for Ethiopia.

We will come to that later on. You have said GTP II should focus on manufacturing and policymakers are also saying that manufacturing will be the focus. But from the draft plan and public discussions there appears to be nothing inherently different from GTP I.

Remember, GTP I was a very good policy document which addressed all the key elements that Ethiopia needs to address. What GTP II, in my view, should do is enhance what was planned in GTP I. These are five year plans and rolled out in increments. GTP I, even though it has achieved a lot is a work in progress. That means GTP II will pick up on that and continue with a shift in emphasis to manufacturing. It is not to discard what was done in GTP I but pick up from there. It is like a relay team. One will hand over to two. Where there are things that have not been completed in one will be completed in two but will be enhanced. I have not seen the full GTP II document yet other than what has been circulated in public. To me the key focus for GTP II will have to be manufacturing. The rest is the continuation of GTP I which is infrastructure.  

GTP I was supposed to bring about structural transformation. Would you characterize the last five years as transformative?

Absolutely! Had we not had GTP I, Ethiopia could not have sustained 10 percent plus GDP growth. GTP I gave Ethiopia focus and determination. This very high level of achievements of economic growth can be done if structured the right way and give focus to certain priorities. One of the priorities was the continued investment on infrastructure. Could we have the Renaissance Dam which was started during GTP I? It is a massive project. Could we have done it without an overarching framework? May be or maybe not. But I think it is more likely than not that GTP I gave it framework and it gave it the linkages it needed to the rest of the economy. In my view, the achievements have been very encouraging. As I said earlier, there are some things we have not achieved in particular the export targets. I am sure even the government will acknowledge what was achieved in terms of the export is not what was set.

Why do you think the manufacturing sector could not deliver on its production and export targets in GTP I?

I think the ramp up phase took longer. For example if you look at the industrial parks, they started coming on line in full force in the last two years. Had we had the infrastructural base for industrial parks say five years ago, we probably would have them by now. Secondly, the competitiveness of Ethiopia is still at a low level. These things take time. To be honest, five years is a very short period of time. In exports, you are competing globally. And Ethiopia is at a low end in terms of competitiveness if you look at the World Economic Forum’s competitiveness index. Thirdly, we are still by in large commodity exporters where we are totally dependent on prices determined somewhere else in the world and we have no control over. Some years we are lucky when coffee prices go up and within that five years period there were years where coffee prices were down substantially. This had an impact. And that is one of the reason that we need to migrate to value addition as opposed to exporting commodities. Coffee and sesame seeds are very good examples. If we can add value to coffee, if we can process sesame before it is exported as raw, then we will have leverage on how much we can export and how much earnings we can get. In GTP II, my expectation is that there will be a dramatic change. We will not just be exporting commodities. Where Ethiopia has done well in GTP I  in terms of hard currency export earnings is in the services area. I do not know how many people know this but Ethiopia’s single largest source of export earnings is aviation. Aviation brings in about five times what coffee export brings. In 2012/13 Ethiopia brought in USD 3.2 billion from aviation services. Coffee export was about USD 750 million. It actually shows you that there is a shift taking place in the economy. Even though Ethiopia is described as a commodity exporting country, it actually is a misnomer. Ethiopia is a very large service exporting country on the back of aviation especially the success of Ethiopian Airlines. We need to characterize and understand the fundamental shifts that are taking place in the Ethiopian economy. It has occurred under the GTP I and I think it will accelerate in GTP II.

The shift to the non-tradable service sector is the elephant in the room no one seems to be talking about. The services sector now accounts for 45 percent of the GDP. As a result some say that the transformation of the Ethiopian economy has gone to the wrong direction instead of migrating to industrialization. What is your view on this?

We cannot expect everything to be transformed completely in a span of five years. This economy has either been agriculture or service dependent. What is starting to happen is a shift from basic agriculture to agro-processing; from a service and trade dominated economy to manufacturing. But that takes time. If you look at China, it took them 30 years. They started in 1979 and it was not until the mid 90s and early 2000s that China became an overwhelmingly manufacturing-based economy. We need to understand that it is a gradual shift. That is why we need GTP II to reemphasize the shift. However, service is a critical component of any economy in the world. We need to appreciate and give value to the service industry. Professional services like ours, trading, importers, exporters and all the other services are part of the dynamics that makes an economy vibrant. I do not want to cast any negative view of the service industry. In very advanced economies like the US, the service industry accounts for about 75 percent of the economy. If you look at the emerging economies of China and South Korea, the manufacturing industry takes the bulk of the economy. In Ethiopia also the shift is taking place but it is a gradual process. It cannot be completed within the GTP I five years period. I think the shift will be very noticeable in GTP II.

One vision laid under GTP II for the manufacturing sector is the attainment of the production possibility frontier. Can you tell me what that signifies?

Regardless of the definition, what it means is, we will need to operating at the cutting edge of global competition For that to happen, Ethiopia’s manufacturers have to be innovative, adaptive, price competitive and efficient. You need to be at the cutting-edge even if you are producing some basic stuff. And I think that is where the Ethiopian manufacturers need to be at. In this regard, there is a lot of good trends we are seeing here. We see a lot of multinationals coming into Ethiopia. The industrial parks are now full. I know a number of clients of ours, big multinationals, that are waiting for Bole Lemi II to open so that they can move in because the first one is completely full. These global manufacturers bring in their know-how, their linkages to the global supply chain. They will make Ethiopia on the cutting-edge of competitiveness, especially as they partner with local Ethiopian companies. One key element to enhancing competitiveness is talent. Here again, we see encouraging trends. Ethiopia has a very large talent pool which is young, trainable, easily deployable, affordable and eager to work. Another element which I believe will contribute to Ethiopia’s competitiveness is proximity to global markets. We had done a study at EY which shows that from Addis Abeba you can reach half the global population – 3.5 billion people – in just eight hours. That is what I call perfect strategic location. When you talk of access to market, it is not only the free trade of AGOA or others but your location also matters because the further you are from your markets the more expensive it is. These are all the advantages Ethiopia has.

One of the debates with regards to giving focus to the manufacturing sector is as to which way Ethiopia should industrialize. Should it rely on foreign direct investment or local manufacturers?

My recommendation and what I think is starting to happen is we definitely need the foreign investors because, as I said earlier, they will bring knowledge, know-how, technology and more importantly market access. For example, if we look at the Chinese shoe manufacturer Huajian, for over 20 something years it was exporting to the US from China. So, it already has the built-in customers. Customers that know its product and would buy immediately. Huajian moving to Ethiopia now has access to that same customer base that an Ethiopian manufacturer would have a very difficult time accessing. However, we have to continue creating linkages between the international manufacturers who are setting up facilities in Ethiopia and the Ethiopian private sector. It could be some point of the value chain. If you are a manufacturer of shirts, the Ethiopians could produce the buttons or other pieces. It could also be equity share. Share holdings between Ethiopians and foreign investors. I think this has to happen. Are we starting to see this? We recently had a couple of instances that we are aware of that people we have been working with who have signed up joint ventures with international investors. That is the way to go in the future. Have local participation. The law does not require it. Which is fine. It is a smart law. You do not want to force foreign investors to take local companies just because the law says so. However, the smart ones are starting to create partnerships with Ethiopians. That is the way to go about it. The Chinese did that in China. If you see a lot of big Chinese companies in the 80s and 90s, they created joint ventures with multinational companies. Today the Chinese have built up their expertise and I think that is the way I would expect these things to develop in Ethiopia in the future.

Do you see a lot of FDI coming into Ethiopia in the next five years?

I am glad you asked me this. At EY we just released our global report called the Africa Attractiveness Survey. It is a fantastic report. We have been publishing it globally for five years. This year, one of the star performers in terms of FDI was Ethiopia. For two reasons. One, Ethiopia is now among the top ten FDI destinations in Africa. In terms of the number of FDI projects, Ethiopia was ranked 14 in 2013. This past year, it moved up to number eight. But most importantly, and this is the key finding, almost one out of five jobs (18.5 percent) created by FDI in Africa in 2014 was accounted for by Ethiopia. Out of 54 countries in Africa. That means Ethiopia’s FDI policies creates jobs. There are a lot of countries in Africa who get big headline that says big FDI dollar came in, but those FDI numbers do not create jobs. You could have, for example, five billion dollars going into an oil and gas deal to build a refinery or a pipeline. But that USD five billion only employs maybe a 100 people? One other key finding we have in our research is that, this year, FDI in Ethiopia will top USD 1.5 billion [annually]. Only six years ago in 2008 it was around USD 100 million. And we expect an average of a billion and half FDI each year for next three years. In a span of six years an increase of 15 times is a very strong performance. But, there is a lot of global competition and therefore, Ethiopia has to stay focused to sustain those kinds of numbers. By the way, there are a lot of very large deals in the pipeline which will hopefully be announced in the next several months.

Most of the FDI flow to Ethiopia in the past decade are mostly from recently industrialized countries like China, India and Turkey. But some are of the view that with regard to technology transfer it will be to the disadvantage of Ethiopia to copy from the copiers. What is your view on that?

In the first wave of FDI that started coming to Ethiopia say seven years ago, a lot of it came from the newly emerging economies. However, what we have seen in the last three or four years is a gradual balancing between emerging economies and western investors. And we have some very good examples to show that. Last summer, the big American private equity fund KKR invested USD 200 million to buy a flower farm, Afroflora, in Zeway. KKR is the company that essentially invented private equity in America in the 1980s. These are very smart people. That investment in Afroflora was their first investment in Africa and they chose Ethiopia. That is American money. KKR is the bluest of the blue-chip of American companies. We now have other top US companies like GE opening up offices in Ethiopia looking for manufacturing facilities in the country. And then we have companies from Europe like Diageo, Heineken, SABMiller and in the next few months Unilever which will be opening a factory to produce consumer products. So what you are starting to see now is that even though the first movers into Ethiopia were investors from the newly emerging economies, in the last few years we are starting to see a balance. Some of the big deals that will be announced in the next 12 months are actually western investors, in particular American investors. However, we also need to appreciate the value of investments from newly emerging economies. They are much more adaptable to an emerging economy. Although that is also starting to change because the Americans have also become very adaptive to emerging economies such as Ethiopia.

Going back to the issue of stock markets you raised earlier. Recently, the National Bank of Ethiopia is making preparations to start a secondary bond market. Do you think secondary bond market should take priority over stock market?

I think they could go parallel. It is a good thing that the bond market will be launched. It is about time. Especially now since Ethiopia’s bonds are traded globally – the Euro Bond. It is only natural and timely that we should have a domestic one. However, Ethiopia unequivocally, absolutely needs an organized equity market. Let me put this in to context. We have the fourth largest economy in Africa and we do not have a stock market. Countries with much much smaller GDPs than Ethiopia have equity markets. I do not think it is logical for Ethiopia not to have an equity market. Is it the panacea for everything? Of course not. But it is one of the bucket of market options that we need to have. Our economy is becoming sophisticated. It is a sizable economy by African standards. On a PPP (purchasing power parity) basis, it is 139 billion dollars and on a nominal basis around 55 billion dollars. That means it is starting to become relatively large and gradually, sophisticated. Investors need alternative sources of capital. Almost every Ethiopian young person that I meet wants to become an entrepreneur today. I think this fantastic. An amazing attitudinal change I have seen in Ethiopia in the last fifteen years. But every single one of them need capital. You cannot just use your Iqub or borrow from your friends to get seed capital. So Ethiopia definitely needs an organized equity market. We already have some semblance of equity trading even though it is not formal. People who own shares in banks in Ethiopia trade. They exchange shares. But it is not organized. So there is no transparent way of determining the value of these shares of these banks for example. There are hundreds of thousands of shareholders in private banks in Ethiopia today. They are illiquid. The banks will try to find a match between a buyer and seller but it is very inefficient and secondly you do not know if the value you get is transparent. Remember, a lot of people are forming share companies in Ethiopia today in a very unregulated market. So it is better for the government to organize a stock exchange where the rules, financial reporting, the corporate governance is clearly laid out by the government. That way people know what they are trading and under what conditions. Ethiopia might be the only country one in the world, with a GDP of this size, that does not have a stock market. Therefore, I encourage the government to really consider this in GTP II. I have a very strong position on this because we have been working on establishing s stock market in Ethiopia for years, going back to 2001. By the way, during the reign of the emperor, Ethiopia used to have a stock market in the late 60s [the Addis Ababa Share Dealing Group, which was abolished in 1974]. I think the timing is right and the government, and I hope, agrees with me. China has a very big stock market. Every Asian country Ethiopia is learning from in terms of fast economic development, have stock markets. Therefore, we need to have a stock market as well.

One more reason for Ethiopia to having a stock market is the lack of alternative equity sources such as private equity and venture capital that could fund startups with dynamic ideas but lack finance.