accounts, with fiscal deficits typically contained to less than 4 percent of GDP, these central government accounts do not include the accounts of state‐owned banks, SOEs and other government agencies. Because many of these entities operate with financial deficits, failure to include them in government accounts results in an understatement of the public‐sector deficits. According to the IMF,<sup>90</sup> the net borrowing requirement of the non‐financial public sector amounted to 8.6 percent of GDP in 2017/18, of which 3.3 percent of GDP corresponded to external borrowing.<sup>91</sup> A priority in the sequencing of reforms is therefore to prepare consolidated financial accounts that provide a more complete picture of the financial situation of the public sector broadly defined, and pursue the path of public finance consolidation on the basis of the broader definition of the public sector.

Fiscal consolidation of the overall public sector should be pursued to limit the potential macroeconomic destabilization effects of financial liberalization. Because financial repression allows to indirectly finance fiscal or quasi‐fiscal operations without collecting the corresponding fiscal revenue, the liberalization of the financial sector will reveal large direct fiscal costs. To maintain macroeconomic stability while liberalizing the financial sector, important efforts would be needed to raise government revenue through tax policy and tax administration reforms, phase out subsidies (e.g., wheat, cooking oil, petroleum), further prioritize public projects, and strengthen SOE governance by hardening their budget constraint. The immediate tax policy measures to consider include the rationalization of tax incentives and exemptions and the strengthening of both the existing presumptive taxation (turnover tax) and excise taxation.<sup>92</sup> Consideration could also be given to the introduction of property taxes. The hardening of the budget constraint of SOEs will require to dramatically improve public financial management and SOEs’ corporate governance, disclosure, and transparency.

# 4.3. Reforming public financial institutions

Moving away from financial repression would require a series of institutional reforms of Ethiopia’s public financial institutions. New or revised proclamations and directives need to be enacted to, among others, (1) strengthen the independence and supervisory functions of the NBE; (2) phase out the 27‐percent rule and reform the DBE; (3) design a sustainable financing mechanism for DBE’s lending operation; and (4) eventually open the banking sector to foreign participation.<sup>93</sup> Strengthening the independence of the NBE from the government. The government should consider amending the NBE Establishment Proclamation to strengthen the NBE institutional, management, and operational independence from the government. There is ample empirical evidence that central bank independence brings about lower inflation, which ensures a more stable environment for economic growth and employment creation. More independent central banks reduce the possibility for governments’ interference to monetize their debts or to discretionary channel resources to other publics

> 90 IMF (2018). Ethiopia: Staff Report for the 2018 Article IV Consultation. IMF, Washington D.C.

> 91 This borrowing requirement, although high, has substantially declined from 13.7 percent of GDP in 2014/15, owing to stricter controls on SOE operations to contain external imbalances.

> 92 World Bank TA is being provided in these three areas.

> 93 Other elements of a financial sector reform roadmap would include a new banking act, reform plans of the CBE and DBE, the establishment of a new regulatory framework for the insurance sector, and the development of a stock exchange and corporate bonds market.

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