Table 2A in the Annex shows the baseline simulation results from the calibrated model. The results are investigated in turn for the external sector, government sector, prices and exchange rates, and some additional items of interest. The external sector shows an improvement of the current account balance, largely due to a rapid depreciation of the local currency. Private unrequited transfers are assumed to be constant in percent of GDP. Net income flows declined, due mainly to increasing interest payments on rising external debt. The capital account projection declines slightly, despite increasing external borrowing needs following the deterioration of the trade balance.

Similarly, items under the government sector (second section of Table 2A) are expressed in percent of GDP. Total tax revenue is on a declining trend, owing in part to falling domestic production and income. Since the tax base is not growing at the desired level, the government is unable to collect enough revenue to finance its expenses, even though the effective tax rate is almost constant throughout the projections. The share of non-tax revenues is constant at 6.5% of GDP. Current and capital expenditures are both assumed to be constant at 23% and 5.9% of GDP (their actual values in the baseline year), respectively.

Even though the interest rate on foreign debt is assumed to be low, at 1%, interest payments are increasing continuously throughout the simulation process due to rising stock of external debt. The fiscal balance stays negative around 3.5% of GDP due in part to persistence under a narrow tax base. In a context of limited financial deepening and domestic financial markets, only 1 percentage point of this deficit is assumed to be financed domestically; as a result, the government of Ethiopia borrows externally on concessional terms to close the financing gap.

The third section of Table 2A focuses on price and exchange rate movements and related items. Note that the composite price index is trending upward while foreign exchange rate declines, reflecting a nominal depreciation. As expected, the depreciation should lead to an improvement of the trade balance following the decrease of imported goods. The last section of Table 2A (additional items of interest) shows a slight increase in the growth rates of real GDP per capita, reflecting low savings and investment rates. In effect, at 0.9% of GDP, private savings are very low in Ethiopia, even by developing countries’ standards.

Interestingly, the ratio of external debt to GDP increases markedly, mainly due to persistently large fiscal deficits in the post-HIPC era. Paradoxically, one of the main objectives of the HIPC Initiative was to reduce the stock of external debt and interest payments accruing to low-income countries, ultimately averting the risk of another sovereign debt crisis. On the basis of the projections, debt cancellation alone may not bring a permanent solution to the external debt burden confronting the majority of low-income countries in SubSaharan Africa. As governments cannot raise more tax revenues or borrow domestically to bridge the evergrowing financing gap, they are naturally inclined to rely more and more on external sources of financing.

The projection for Ethiopia shows that the share of external debt in GDP is expected to rise from 18%in 2011 to 66% in 2030.<sup>17</sup> This impressive accumulation of projected external liabilities (at least according to projections) in the post-HIPC will result in higher external interest payments, ultimately curtailing the number of resources that the government can deploy to support growth and poverty reduction.

Another interesting feature of the model, which has significant policy implications, is its ability to estimate the number of years it would take under the baseline scenario to double real per capita income in Ethiopia.

> 17 For Ethiopia, World Bank (2006) estimates the net value of external debt in percent of GDP as 29% in 2010 under the worst-case scenario. The estimation is based on the assumption of less favorable terms of borrowing. But given that the definition of debt and the estimation methodologies are different from what is presented here, they are not comparable.

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