In-depth: Ethiopia’s bond bust: A decade from darling to default

By Abdii Biyenssa @ABiyenssa

Addis Abeba – A decade ago, Ethiopia’s debut on the international bond stage sparked a frenzy among investors with its inaugural $1 billion Eurobond issuance—a daring move with a 10-year maturity and an enticing 6.625% coupon rate.

The bond, set to mature in December 2024, was met with a ravenous appetite as bids soared to $2.6 billion, more than double the offering.

The Financial Times lauded it as “one of the largest and most exclusive, yet among the most promising bonds issued by African nations.”

Investor confidence has remained robust, with the East African nation reliably fulfilling its obligation of an annual interest payment of $33 million for a continuous period of eight years since 2015.

In December 2023, circumstances took a significant turn when Ethiopia disclosed its intention to defer its coupon payment, an action that profoundly altered investor confidence and reverberated through the financial community.

On top of placing Ethiopia under intense scrutiny as it became the third African nation in recent history to enter into default, this turn of events has left the global market in suspense, pondering the implications for future investments in Africa’s second-populous nation.

Yet, experts stress the importance of determining whether Ethiopia’s recent shortfall in fulfilling its external debt obligations falls under the category of “technical default” or “contractual default.”

Henok Fasil (PhD), a macroeconomist and a consultant at the World Bank office in Ethiopia, provides a precise definition of a technical default, which occurs when Ethiopia fails to fulfill the financial obligations stipulated in its debt contract due to a missed bond payment.

Nonetheless, Henok explains that this initial breach permits a “grace period,” affording the country an opportunity to rectify the payment before a formal declaration of full contractual default is made.

The macroeconomist further clarifies that a contractual default transpires once the grace period concludes without the outstanding payment being made, thereby enabling creditors to pursue legal actions. “For Ethiopia’s bond, there is a 30-day grace period, after which it would become a full contractual default if the amount is unpaid. Ethiopia is currently in a technical default, which temporarily suspends enforcement actions.”

“However, this situation may escalate to a hard contractual default should the 30-day grace period elapse without the settlement of the missed bond payment,” Henok adds.

Pandemic, conflict push Ethiopia to the edge

Analysts have highlighted that the sovereign default of Ethiopia in December 2023 was primarily induced by an array of grave economic difficulties. Among these, the repercussions of the COVID-19 pandemic and a protracted civil war stand out as the most significant factors.

The COVID-19 pandemic in particular had a severe adverse effect on Ethiopia’s economy, leading to economic disturbances that mirrored the challenges faced by numerous countries worldwide. These disturbances have undermined Ethiopia’s ability to satisfy its financial obligations.

Ethiopia is currently in a technical default, which temporarily suspends enforcement actions.”

Henok Fasil (PhD), consultant at the World Bank office in Ethiopia

Merid Tullu, an authority in the field of economics, indicates that the factors contributing to Ethiopia’s slide into sovereign default are complex. “Foremost among the causes is stagflation, marked by substantial inflation and unemployment,” he contends.

Merid notes that the political upheaval in Ethiopia has significantly aggravated the nation’s economic woes, as the continuous unrest within several regional states has been a major contributing factor to the country’s ongoing challenges.

“The scarcity of security intensifies these issues, with the war in Tigray having an especially severe effect on the country’s economic framework,” he remarked.

The economist also highlighted that the protracted political instability in Oromia, lasting over four years, has cast a shadow over economic activities. He elaborated on the significance of this instability, considering the region’s crucial role in the Ethiopian economy, where approximately 60% of investments are situated.

“Given that Ethiopia’s economy is heavily reliant on the Oromia region, the ramifications of the political unrest have been far-reaching, creating a misalignment between demand and output,” he explained, highlighting the extensive impact of the turmoil on the nation’s economic equilibrium.

Merid also underlined that the economic fallout from political instability in the Amhara region, an important center for tourism, has adversely affected Ethiopia’s ability to generate revenue from this sector. “Consequently, this has reduced the availability of foreign currency that could be allocated towards servicing the nation’s external debt.”

Gemechu Daba, serving as an adjunct lecturer within the Department of Economics at Addis Ababa University, posited that the principal catalyst for sovereign default is often the burgeoning burden of national debt.

Yet, the lecturer hypothesizes that the changes observed in the international market have contributed to escalating inflation, thereby exacerbating challenges for Ethiopia in meeting its external debt commitments.

Two months prior, Mamo Mihretu, the governor of the National Bank of Ethiopia (NBE), disclosed to parliamentarians the considerable influence of international developments, particularly the conflict between Russia and Ukraine, on the economic climate.

Mamo indicated that the cost of three essential imports for Ethiopia—petroleum, fertilizers, and pharmaceuticals—has soared, more than doubling in the past three years. This surge has propelled the nation’s annual import expenditure to an unprecedented high, culminating in an alarming $17.1 billion in the last fiscal year.

Balancing debt relief, default

Since 2020, Ethiopia has been actively seeking to renegotiate its debt under the G20’s Common Framework for Debt Treatment, designed to establish more sustainable debt conditions for low-income countries. The initiation of these negotiations, however, was hindered by ongoing conflicts.

In August 2023, Ethiopia received a one-year postponement on debt repayments from China. Following this, in November 2023, Ethiopia’s government creditors, with the exception of China, agreed to a suspension of debt services.

During a recent parliamentary session, Mamo informed the members of parliament that Ethiopia had obtained over $1.5 billion in temporary debt relief as the nation worked diligently to prevent a default on its financial commitments.

The IMF, World Bank, and Paris Club countries collectively make up 75% of Ethiopia’s total external debt, which amounts to $28 billion.

Ethiopian authorities have also expanded their efforts eastward to secure the release of funds committed by developed countries like China. In mid-October 2023, the Ministry of Finance announced that its delegation had prompted a positive response from the executives at the China Exim Bank.

At present, Chinese financial entities have halted the issuance of loans that amount to over $758 million. Furthermore, the Chinese government is currently retaining an additional $576 million that was earmarked for Ethiopia.

Despite these efforts, the country was unable to avoid defaulting on its December coupon payment of $33 million.

In a communiqué issued the previous month, the Ethiopian government expressed its willingness to engage in dialogue with bondholders regarding potential mitigation strategies concerning the extension of maturity and the restructuring of repayments for its singular $1 billion international bond.

The statement articulated that Ethiopia’s choice to postpone the December coupon payment on its outstanding Eurobonds, albeit for a comparatively modest sum, is driven by a commitment to equitable treatment of all creditors. “Failing to do so could compromise the progress of current negotiations with other creditors,” the ministry noted.

Experts also emphasize the importance of engaging in comprehensive debt restructuring and extending maturities with bondholders and bilateral official creditors through mechanisms like the G20 Common Framework, which is essential for reducing near-term repayment pressures.

Henok recommends the implementation of structural reforms aimed at enhancing tax administration, addressing factors that inhibit private sector growth, and liberalizing critical sectors such as telecommunications and banking. “This expands the tax base and raises revenues.”

Agreeing with Henok’s assessment, Merid points out that it is crucial for Ethiopia to enter into strategic discussions with its international creditors to seek an extensive reorganization of its debt. “The negotiation process involves convincing creditors to accept partial debt forgiveness in return for reduced debt servicing commitments.”

Merid explains that this method is designed to allow Ethiopia to show a sincere commitment to managing its debt responsibilities, which could open the door to future borrowing and attract foreign investment. “Such negotiations also help to clarify the internal challenges that affect Ethiopia’s capacity to fulfill its loan responsibilities.”

Analysts also indicate legal avenues, such as invoking the force majeure clause in light of the civil war situation, may be considered to justify non-payment. “Creditors could be convinced to postpone legal action based on an argument of exceptional circumstances,” Henok adds.

A precarious leap into economic uncertainty

Experts emphasize that Ethiopia’s failure to meet its debt payments and subsequent default carry a range of short- to medium-term consequences. These include an immediate limitation on Ethiopia’s access to international capital markets and concessional external financing, pending the recognition of debt obligations and the establishment of terms for future repayments.

Analysts point out that Ethiopia’s failure to fulfill its debt payments may precipitate further downgrades in its credit rating as the perception of the country’s sovereign risk deteriorates across various debt asset classes.

Subsequent to Ethiopia’s inability to fulfill a $33 million coupon payment, Fitch Ratings adjusted the status of Ethiopia’s sole international government bond to “default” from its previous rating of “near default” as of December 27, 2023.

Nevertheless, this constituted merely a small indication of the extensive challenges that lay beneath the surface.

In early November 2023, Fitch Ratings, a prominent credit rating agency, declared a reduction in Ethiopia’s long-term foreign currency issuer default rating (IDR). The nation’s IDR was adjusted from ‘CCC-‘ to ‘CC’, reflecting an increased level of risk concerning the fulfillment of its financial obligations without succumbing to default.

Sovereign default significantly hampers a nation’s economic expansion and obstructs foreign investment.”

Gemechu Daba, adjunct lecturer at Addis Ababa University

The downgrading of Ethiopia’s rating by Fitch is attributable to a marked decrease in liquidity and considerable financing deficits, which have elevated the risk of an impending default.

Additionally, in October 2023, Moody’s, another credit rating agency, lowered Ethiopia’s foreign currency rating from ‘Caa2’ to ‘Caa3’. The rationale for this downgrade centered on the high risk of default on debt denominated in foreign currency within the private sector.

On top of the downgrading of credit ratings, Henok believes that the impending $1 billion Eurobond maturity in 2024 will be more challenging to address without debt relief, given the depleted reserves and the inability of domestic banks to roll over debts.

“Overarching across outcomes is lost credibility plus higher borrowing costs once markets reopen to Ethiopia, hampering future development and posing risks of getting caught in a debt trap again,” he notes.

Scholars assert that other creditors with pre-existing exposure might expedite their claims against Ethiopia by invoking cross-default provisions. Additionally, there could be legal ramifications should creditors pursue litigation in international courts.

With the contraction of external borrowing avenues, analysts fear that Ethiopia might be compelled to reduce its imports, increasingly relying on domestic production and the depletion of its reserves, which adds to the uncertainty of economic recovery.

When it comes to loans secured from private entities, Merid elucidates that there are no legal consequences enforceable under international law or adjudicable in international courts in instances of loan defaults. “Consequently, this has deterred international investors and financial institutions from providing loans or participating in foreign direct investment with Ethiopia, due to concerns about the government’s capacity to fulfill its financial commitments.”

On the other hand, Gemechu contends that sovereign default significantly hampers a nation’s economic expansion and obstructs foreign investment. He states, “This has profound economic repercussions for Ethiopia, rendering the prospect of borrowing money in the future prohibitively expensive or even unattainable.”

Gemechu further asserts that the looming sovereign default carries the immediate threat of the Ethiopian government finding itself incapable of financing essential needs and vital infrastructure development. “This encompasses the potential failure to fund critical projects such as hydropower initiatives, road construction, educational institutions, healthcare facilities, and telecommunication networks,” he explains.

Echoing a similar sentiment, Merid emphasized that the anticipated sovereign default is likely to have significant long-term consequences, as a prolonged default could detrimentally affect vital sectors including education and health, as well as broader social and cultural advancement, owing to the lack of crucial foreign assistance. AS