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C O N F I D E N T I A L ASMARA 000347 
 
SIPDIS 
 
SIPDIS 
 
LONDON FOR AFRICA WATCHERS 
PARIS FOR AFRICA WATCHERS 
 
E.O. 12958: DECL: 04/11/2016 
TAGS: PREL PGOV PINR ECON EAID EFIN ET ER
SUBJECT: ERITREA'S ECONOMY ON THE ROPES; DOES THE GSE HAVE 
THE WILL TO SAVE IT? 
 
CLASSIFIED BY:  AMB Scott H. DeLisi, for reasons 1.4 (b) 
and (d). 
 
¶1. (C) Summary: With telephone outages the norm, 
electricity essentially rationed, and imports cut to next 
to nil, Eritrea faces an economic crisis.  Since the end of 
the war with Ethiopia in 2000, Eritrea has maintained a 
heightened state of national security. For the Government 
of Eritrea (GSE) everything, including the country's 
economic stability and viability, is secondary to ensuring 
the protection of the nation-or so the government asserts. 
For the past four years, economic policy has reflected the 
political policy of "no war, no peace", resulting in high 
defense spending and continued conscription of a large 
percentage of the labor market into national service.  This 
focus has left Eritrea with a debt that is unsustainable 
and an economy crumbling to bits.  One possibly positive 
note to come from this is that at the IMF meeting in March, 
the Eritrean authorities expressed a willingness to engage 
more deeply with the Fund, seeking to initiate the process 
that will lead to HIPC and other debt relief programs. 
However, whether the GSE has the political will to enact 
the reforms necessary for IMP and HIPC support is a 
proposition that many here question.  It is also possible 
that the severe economic problems the country faces could 
be a further incentive to the GSE to bring the border 
stalemate to closure but, again, much will depend on the 
GSE's political will and its own assumptions about how much 
more hardship the Eritrean people can bear.  End Summary. 
 
ERITREA'S ECONOMY: AN OVERVIEW OF THE NUMBERS 
--------------------------------------------- 
 
¶2. (U) Eritrea is one of the poorest countries in the 
world, with per-capita income of USD 157 in 2005 and a rank 
of 161 out of 177 countries in the 2005 UN Human 
Development Index.  Various sources estimate that the 2005 
real GDP for Eritrea is approximately 770 million USD. 
(Note: Changes to the exchange rate in 2005 from 19.5 to 15 
Nakfa to the USD affect the conversion on nominal GDP 
leading to an overstated GDP estimate. End Note.) GDP 
growth is estimated at 4.8 percent, up from 2004 yet due 
mostly to the government appreciation of the Nakfa and the 
strangling of imports.  In the 2005 Article IV 
consultations, the IMF estimated the net present value of 
the total government debt at 164 percent of the GDP, with 
domestic debt representing 111 percent and external debt 53 
percent of the total. 
 
¶3. (C) Inflation is eating away at any small growth in GDP. 
The head of the PFDJ-owned Housing and Commerce Bank, 
Berhane Tekeste, recently told PolOff that inflation was 
running over 20 percent. The World Bank reports pegged the 
CPI at 21.5 percent for 2004, significantly above the sub- 
Saharan average, yet the 2005 IMF estimates the CPI for 
2005 is 12.4 percent. Locals report significant increases 
in local prices, commenting that one year ago a candle was 
50 cents Nakfa and now it is five Nakfa, if you can even 
find one in the store.  Moreover, the prices of general 
food stuffs are becoming prohibitive for the average 
Eritrean.  A sixty Nakfa (USD 4) loaf of bread, petrol at 
roughly Nakfa 120 (USD 8) a gallon, and coffee at 50 Nakfa 
(USD 3.30) per pound instead of the pre-war price of 17 
Nakfa make life almost too costly to live for many here. 
 
TRADE, WHAT TRADE? 
------------------ 
 
¶4. (U) Eritrea's once burgeoning trade with Ethiopia and 
Sudan crashed with the end of bilateral relations with both 
countries.  A positive current account balance is a thing 
of the past; World Bank estimates the 2004 balance was a 45 
million USD deficit. Since a high of nearly USD 200 million 
in 1997, Eritrea's exports of goods and services have 
declined dramatically to an estimated USD 12 million in 
¶2005.  Exporting predominantly agricultural items in the 
past such as livestock and sorghum, Eritrea historically 
had a small textile industry and a small salt industry as 
well.  Yet, as previously mentioned the termination of 
trade with Ethiopia and Sudan decimated the export 
business. 
 
REVENUE? FROM WHERE? 
-------------------- 
¶5. (C) As exports are minimal, from where does the 
government revenue come?  According to the IMF, total 
government revenue was USD 370.2 million with 72 percent 
coming from tax revenue, presumably including an estimated 
USD 100 million paid by Eritreans living overseas.  The 
remaining come from grants and other non-tax revenues. 
What fuels the economy according to Mathewos Woldu of the 
Ministry of National Development, are tourism, agricultural 
and fishing industries; money from the diaspora (both the 
official tax and remittances) and borrowing. In reality, it 
is the diaspora and borrowing that keeps the economy alive 
today. 
 
SPENDING, SPENDING, SPENDING 
---------------------------- 
 
¶6. (C) With a growing debt, where does the money go?  Debt 
service is nearly 25 percent of revenues.  Estimates for 
defense spending vary from 17 percent to nearly 50 percent. 
In a speech given in 2005, President Isaias, stated that 
half the GSE expenditures are for national security. 
Without a transparent budget and the understanding that 
hardware purchases such as tanks and weapons may not be 
reflected in any published numbers, President Isaias's 
statement may reflect a reality.  The remainder of 
expenditures are essentially on wages for government 
employees and on materials.  Mathewos told PolOff that the 
debt burden is the greatest economic challenge faced by the 
government. 
 
¶7. (U) Of importance is the growing oil bill for the 
nation.  With an estimated USD 108 million spent on 
petroleum products, increases in the global oil prices will 
significantly squeeze Eritrea.  With gasoline costing USD 8 
per gallon and electricity cuts a regular occurrence, the 
price of oil is a constant issue in Asmara.  In the 
monitoring and assessment of avian flu, the government's 
delay in allocating funds for gasoline for the Ministry of 
Agriculture vehicles to travel in response to reports 
stalled the initial efforts to respond.  As Eritrea has no 
oil production, much of the imported oil comes from Libya. 
There are rumors in Asmara that the tab is rapidly growing 
and has not been paid in some time. 
 
NO WAR, NO PEACE, NO LABOR MARKET 
--------------------------------- 
 
¶8. (U) No one knows the exact number, however an estimated 
600,000 Eritreans are believed to currently be in national 
service, approximately 40 percent serving in the military 
and the remaining 60 percent working for extremely low 
wages in government ministries and government-owned 
enterprises.  Many in the second group are demobilized on 
paper, however, they can be recalled to the military at any 
time.  With the requirement for national service, which 
could include working in the fields during harvest, 
construction on infrastructure projects or other hard 
labor, individuals are not able to participate actively and 
freely in the labor market.  Many have had their education 
or technical training cut off or limited and, with the 
University closed and post-secondary education controlled 
completely by the government, the future viability of the 
labor market remains in question.  In fact, when one 
considers the national service cadres may constitute 
between 15-20 percent of the total population and a much 
higher percentage of the available work force pool over the 
age of 18, the labor market faces serious strains as does 
the labor pool for agricultural production.  While the GSE 
may claim success with the World Bank-funded demobilization 
project, the World Bank Country Director in Eritrea is 
quick to point out that meeting the technical requirements 
does not always mean a program is successful.  National 
service seems to have a steady flow of intake, so while 
national service members may not be doing military service 
on paper, those who are not are Eritrea's ready reserves. 
 
DEBT SUSTAINABILITY 
------------------- 
 
¶9. (U) With regards to the debt, heavy government 
involvement in the economy and the artificially low setting 
of treasury bill interest rates has kept the domestic 
portion of the debt low.  Basically, the GSE is able to 
delay repayment of these domestic loans, most taken out 
during the conflict with Ethiopia.  Furthermore, GSE has 
been able to fob off members of the Diaspora holding this 
debt by offering them land in Eritrea and facilitating the 
means to construct new houses in the homeland.  As for the 
external debt, grace periods began expiring within the last 
few months, and the pressures of these will be felt 
acutely. 
 
¶10. (U) The bottom line is that Eritrea can not continue to 
sustain the debt.  At the IMF Executive Board Meeting, 
Eritrea announced its interest in engaging in a fund- 
sponsored program that would lead to debt relief 
initiatives.  Cutting it close to the 2006 deadlines, 
Eritrea will need to move swiftly if it is truly serious 
about its commitment to the program and process.  Yet, when 
pressed about what the complications might be for Eritrea, 
the Ministry for National Development's Mathewos was loathe 
to give a specific answer.  The concern among many 
observers is that the requirements for transparency, 
demobilization and reducing defense spending may prove too 
much for the GSE to swallow. 
 
COMMENT 
------- 
 
¶11. (C) In a striking departure from earlier positions, the 
GSE now claims to be ready to engage international partners 
seriously on the economic reforms that can lead to HIPC 
qualification.  However, even with the GSE's stated 
interest in the debt relief program, they may hold these 
programs hostage to border demarcation - or may feel 
themselves unable to consider reforms absent resolution of 
the border issue.  With demobilization and defense spending 
reduction among the IMF list of concerns, the GSE may balk 
as long as they feel the national security of Eritrea is at 
risk.  The border and economic reform are inextricably 
linked for the GSE.  Progress on either, or both, will come 
down to whether the GSE has the political will and 
commitment to make progress a possibility.  In the past, 
the Eritrean leadership has shown a willingness to allow 
its ideological vision of "one nation, one party, one 
people," to trump pragmatism on economic decision-making. 
Given that history, it is not a stretch to think that the 
GSE may be willing to let Eritreans tighten their belts and 
suffer a while longer before agreeing to fundamental 
changes in economic policy or philosophy.  End Comment. 
 
DeLisi