The gross domestic product (GDP) growth rate slumped to 4.0 percent in 1998 from eight percent in 1997 after a border squabble boiled over into violence last May.

Woldai Futur, chief economic adviser to the finance ministry, said the fall could be explained by ``the adverse effects of the border conflict on investment and trade.''

The mobilisation of 200,000 soldiers, heavy spending on new military hardware and the loss of revenues from the port of Assab have combined to depress the economy.

Fighting on the border resumed in early February after an eight-month lull and diplomatic efforts to resolve the conflict have failed to made headway.

Foreign currency reserves have been depleted from the equivalent of seven months of imports before the conflict started to about three months now, said Abraham Kidane, economic adviser to the central Bank of Eritrea.

Western diplomats said they expected the proportion of gross domestic produce (GDP) spent on defence to at least double in 1998 from nine percent in 1997.

Without naming a precise figure, Futur said defence expenditures had increased ``substantially.''

He said Eritrea had suffered a severe blow with loss of revenue from Assab after Ethiopia switched its shipping trade to Djibouti last year.

``Ninety percent of the port's business involved Ethiopia, that has stopped,'' he said.

A buying spree of foreign weaponry and aircraft have helped deplete foreign currency reserves from the equivalent of seven months of imports before fighting began to about three months now, said Kidane.

Such spending is partly offest by foreign currency remittances from the large Eritrean diaspora across the world. Remittances totalled around $300 million in 1997, then fell slightly last year, but renewed patriotic fervour is expected to boost the figure this year to around $400 million.

Nevertheless, the Eritrean nakfa has depreciated from 7.2 to the dollar to an official rate of 7.66. On the black market, however, the dollar can be exchanged for 9.0 nakfa.

Inflation rose in 1998 to an estimated average of nine percent from two percent in 1997, Kidane said, although a bumper harvest helped keep a lid on food price increases.

Despite the war the government has continued its development and infrastructural programmes, including work on the Massawa airport and port, helped by grants and loans from bilateral donors, including Italy which has pledged $100 million over the next three years.

Neway Gebre-ab, chief economic adviser in Prime Minister Meles Zenawi's office, also told reporters that there was no sign of new foreign investments into the Horn of African country as investors waited to see how events unfolded.

But putting on a brave face, Neway said Ethiopia's economy had suffered only limited damage from the war, having benefitted from near record food crops and a fall in global fuel prices.

He said a major burden was some 300,000 people displaced from northern border areas and living on government handouts.

``The impact of the conflict on the overall economic performance is very limited,'' said Neway, adding that Ethiopia financed the war from its own internal resources.

``Some countries promised and have withheld bilateral assistance -- a very unfortunate signal,'' he added, without specifying which the countries, or the sums, involved.

Neway said foreign capital which had shown interest in investing in Ethiopia appeared to have adopted an attitude of ``wait and see'' since the conflict with Eritrea erupted.

``A few of them tend to look at the conflict as a brief interlude, but I would not be surprised if there are some delays,'' he said.

Ethiopia's defence budget in 1998/99 stood at $126.3 million from a total $1.61 billion state budget.

Neway said Ethiopia's recent overall economic performance had been encouraging. It had maintained a gross domestic product (GDP) growth rate of six percent in 1993 to 1998 and inflation in that period has stood below five percent.

Independent economists said GDP was likely to take a beating from the war and statistics at the end of June 1999 would show that. They added that inflation was in check because of a bumper food harvest in the last year. Good weather at the start of 1999 also points to an above-average harvest this year.

Neway said Ethiopia's export earnings had risen to $600 million in 1997/98, double the level of the early 1990s, but were expected to decline in 1998/99, mainly due to the collapse of the coffee price in world markets. Coffee accounts to over 60 percent of Ethiopia's foreign exchange earnings.

Asked about a report that Ethiopia and Eritrea each spend around $1 million a day for the war, Neway said, ``the estimate is on the high side.''

Neway said the decline in the birr currency in the last two months did not reflect dwindling economic fortunes. The birr stood at 7.915 on the dollar on Monday compared with 7.517 in the week ending February 1.

The border war first erupted over disputed territory in the Badme region last May, and while fighting subsided the following month, both sides used the lull to build massive reinforcements of troops and weapons along the frontier.

Speaking at a news briefing here, Justin Thundu, acting head of the OAU press and information department, said OAU is "very keen" for a peaceful solution of the conflict, as both parties have indicated their readiness in favor of a peaceful settlement through the OAU framework agreement.

Thundu told reporters that a similar visit to Eritrea by an OAU team took place last month to convey the OAU's concern over the on-going fighting, despite the acceptance by both sides of the OAU framework agreement for resolving it, and to press for the implementation of the agreement by working out the necessary modalities.

The OAU team has conveyed similar concern to Ethiopian authorities before going to Asmara, he said.

Ethiopia accepted the OAU framework agreement in November last year while Eritrea accepted it in February this year. The border conflict escalated into fierce fighting in June 1998 and renewed in February and March this year.

Meanwhile, Thundu said OAU Secretary-General Salim Ahmed Salim is due to leave Addis Ababa, capital of Ethiopia, later Monday for Port Louis, Mauritius, to attend a two-day ministerial conference on human rights in Africa which opens Thursday. Salim will proceed from Port Louis to Antananarivo, Madagascar, where he will attend the inter-islands peace conference on Comoros from April 19-23 in the capital of Madagascar.

"This conference on the crisis in the Comoros is sponsored by the OAU. We hoped the gathering of all concerned parties will come out with acceptable solutions to all the problems of the islands within the Islamic Federal Republic of the Comoros," Thundu said.