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The Great Recession and Developing Countries
thus accounted for nearly 9 percent of private consumption during the precrisis boom period. Also, the highly negative real interest rate in the banking sector engendered a culture of borrowing and excessive consumption. Private savings as a share of GDP fell precipitously from its already low levels (figure 5.8b). At the same time, an overvalued exchange rate meant that the robust growth in aggregate demand came from increased imports rather than from higher domestic production. While the government was highly successful in inducing strong aggregate demand growth, it was less successful in ensuring a healthy response from the supply side. The sluggishness in aggregate supply can be traced to a number of structural factors, including weak private sector capacity, an investment climate less friendly to young and upstart firms, the high cost of such services as transport and telecom, and the policy of maintaining an overvalued exchange rate. Indeed, the currency’s real exchange rate appreciated by nearly 35–40 percent between FY03 and FY08, largely because of a persistent increase in inflation. While the authorities realized the value of having a competitive exchange rate, they were hamstrung by the high and rising inflation rate and did not want to stoke further inflationary pressures in the economy. The overvalued exchange rate thus encouraged imports and depressed domestic production (figure 5.9). So, as global commodity prices rose, Ethiopia’s import bill swelled, resulting in a further widening of the trade deficit and greater appreciation of the real exchange rate. Ethiopia’s fiscal policy stance during the boom years also increased its macroeconomic imbalances. While the general government deficit was low and falling, the deficit of the public enterprises and extrabudgetary funds grew rapidly. Between FY03 and FY08, the government adjusted its aggregate spending in keeping with the level of available resources to keep the fiscal deficit in check. Spending by the general government (federal plus regional governments) fell from 23.6 percent of GDP in FY03 to 19.1 percent in FY09, while the fiscal deficit (including grants) fell from 6.9 percent of GDP in FY03 to 2.9 percent in FY08—its lowest level in a decade. But at the same time, the investment program of the public enterprises and the spending by extrabudgetary funds is estimated to have risen from 5.9 percent of GDP to 10.7 percent—the latter figure estimated to be more than the combined capital budget of the