Eritrea's economy: challenging structural problems

U.S. Embassy Asmara, Eritrea, March 1998

Introduction/ comment

1. Eritrea's economic future depends on its ability to overcome fundamental social and economic problems. Human capacity building, overcoming illiteracy and expanding educational opportunities, promoting job creation, expanding technical training, rapidly increasing privatization programs, attracting foreign investments and streamlining business facilitation services are some of the challenges faced by Eritrea. Eritrea's economic struggle has been complicated this year by the acute shortage of food as a result of unusual seasonal rains. This has forced Eritrea to use limited foreign exchange reserves to purchase food.

2. The introduction of the new currency, the Nakfa, has resulted in problems with it important trading neighbor, Ethiopia. Agreement to use hard currency in trade between Ethiopia and Eritrea has also placed pressure on foreign exchange reserves in both countries. 67 pct of Eritrea's external trade is with Ethiopia. Diversifying markets and increasing trade with other nations is a goal of Eritrea. The U.S. seeks to expand its share of Eritrea's market, presently at 3 pct.

3. The government has made sound fiscal decisions which have resulted in a low current account deficit, a low rate of external borrowing, increasing per capita savings rate, and extremely low corruption. It has a clear sense of the social and economic challenges and the direction it must take. The president has said it will take time, further sacrifices and a focused commitment for Eritrea to establish sustainable economic development. End introduction.

Part I: Social and structural problems

Severe social challenges: creating a capable workforce

4. Eritrea's most pressing challenge is creating a professional, capable and educated workforce to prepare the nation for economic advancement. An 80 pct illiteracy rate and low levels of education in important technical areas from computer literacy to industrial skills are fundamental problems. The Eritrean leadership considers education and technical training top priorities, but lack of schools and teachers allows only 50 pct of all children to receive any type of education. Enrollment is increasing 24 pct annually. Nevertheless, another glaring problem is the society's emphasis on male education -- female enrollment in the rural areas remains strikingly below male enrollment. Population pressures will further complicate the government's education challenges in coming years: with most of the population under the age of 16 and the population growth rate of over 2.6 pct forecasting a doubling of the population within 26 years, the number of young children will increase in the future.

5. The 30-year war for independence from Ethiopian rule left some 30 pct of all households headed by women. The leadership is trying to help war widows by providing childcare service to allow the women to receive education and skills training.

Few jobs for now

6. Creating jobs and developing opportunities for Eritrea's youth are serious challenges. Nearly 80 pct of the population is engaged in agriculture. Diversifying the workforce must therefore be a priority. This is especially difficult in the current environment, with no export growth, few new firms being created, and downsizing by the government and most companies. The government, for instance, has taken bold measures to stem the increasing annual budget deficits. In 1995, government expenditures amounted to 338.3 million dollars, a 32 pct increase over the previous year, while total revenues amounted to 213.5 million dollars, only a 22 pct increase over the previous year. To cut the staggering budget deficits, the GSE downsized the government. At the end of 1996 and early 1997, the government laid off a large number of employees. Compounding the availability of jobs has been the decline in job opportunities with foreign organizations as well as with public and private firms which have also engaged in downsizing workforces to maximize efficiencies and cut costs.

Structural challenges

7. The creation of a modern, hi-tech and international minded banking system is proving to be a slow process. The long awaited Financial Institution Proclamation Act (94/1997), issued in April 1997 was enacted to regulate the banking industry. So far, no private outside banking firm has opened operations in Eritrea.

8. Another challenge is the need to liberalize and privatize other sectors of the economy, such as the insurance industry, one of the most regulated industries in Eritrea. The National Insurance Corporation of Eritrea maintains a near monopoly with foreign firms restricted to only 25 pct of the market and limited to traditional insurance policy issuance. With little incentive for foreign insurance firms to invest in development projects and explore innovative insurance programs, consumers are left to deal with the Eritrean insurance company and its high premiums.

Food shortage

9. Food purchases are a serious drain on Eritrea's limited foreign exchange reserves. Eritrea requires 600,000 to one million metric tons of cereal grains annually. In a good year, Eritrea is able to meet nearly one fourth of its food needs; imports from Ethiopia fill much of the rest of the shortfall. The heavy rains this year destroyed much of the harvests in both countries, however, and Eritrea will meet only about 20 pct of its food needs this year. To make up for sharply lowered imports from Ethiopia, Eritrea has purchased wheat and sorghum from the U.S., Europe and other sources. Eritrea recently signed a USD 5 million Title I agreement to purchase 30 thousand metric tons of soft white wheat from the U.S. they plan to sign another USD 5 million agreement and receive another 25 thousand metric tons of sorghum under Title III.

New currency, trade friction, inflation

10. The end of the use of the Ethiopian Birr note and the introduction of the new Eritrean currency "Nakfa" at the end of last year was a deliberate decision by the Eritrean leadership to take charge of their own monetary policy. In the long-term, Eritrea's leaders are confident they will be able to end their chronic trade deficits as their industries are reconstructed and exports increase. In the short-term, Eritrea will need to diversify its sources of supply. Heavy dependence on Ethiopia, which has experienced a poor harvest this year, and the requirement to conduct trade transactions in hard currency have led to a sharp increase in the prices of many basic food items imported from Ethiopia. Prices jumped 10 to 140 pct in one month late last year on such items as teff, sorghum, maize and tomatoes. This trend will almost certainly push the inflation rate in Eritrea much higher than the low 4 pct annual rate in mid 1997.

Part II: economic indicators

A. Increasing trade deficits

11. Ethiopia is Eritrea's largest market, taking 65.8 pct of Eritrea's exports for 1996, primarily in livestock, foodstuffs and raw (crude) materials. Although Saudi Arabia and Italy were Eritrea's largest source of imports in 1992, their combined import share for 1996 was only 29.2 pct (15.2 and 14.0 pct respectively). Goods from Saudi Arabia are re-exports from Europe and Asia. Eritrea's primary imports are machinery and manufactured goods. The importation of capital goods underscores Eritrea's commitment to reconstruction and development. The U.S. could potentially develop into one of Eritrea's major sources of imports if more energy is put into trade promotion, considering the competitive edge by the U.S. in equipment and technology important to Eritrea's growth. U.S. market share for 1995 was 3.7 pct (93.8 million Birr) but fell to 2.7 pct in 1996 (83.1 million Birr).

12. Eritrea's chronic annual trade deficit reached USD 418 million in 1996, bringing the total accumulated trade deficit since independence to USD 1.62 billion. In Eritrea's overall balance of payments, there were modest surpluses in 1993 and 1994, and negative balances in 1995 (USD 66.3 million) and 1996 (USD 75.2 million). Should trade deficits continue to mount, Eritrea may increasingly come to rely on increased external financing to pay for nation-building and reconstruction programs.

13. Table 1: Eritrea's top export markets through 1996 in millions of US dollars. (Percentages are of total exports.)

(Source: IMF and GSE)

14. Table 2: top sources for Eritrea's imports in millions of US dollars. (Percentages are of total imports.)

(Source: IMF and GSE)

15. Table 3: Import/export/trade balance in millions of US dollars.

16. Table 4: Content of exports in millions of US dollars. (Percentages are of total exports.)

(Source: IMF and GSE)