SALALE UNIVERISITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS

RESEARCH SUBMITTED TO THE DEPARTMENT OF ECONOMICS IN THE

PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF
BACHELOR OF ART DEGREE IN ECONOMICS

DETERMINANT OF PRIVATE INVESTMENT IN ETHIOPIA: TIME SERIES

ANALYSIS

Prepared By: LIYA TESHOME

ID Number: 0034/13

Advisor: MR, TESGAYE

JANUARY, 2024

FICHE, ETHIOPIA
Contents
.............................................................................................................................................................................. 1
CHAPTER ONE...................................................................................................................................................5
1.INTRODUCTION..............................................................................................................................................5
1.1 BACKGROUND OF THE STUDY............................................................................................................5
1.2. Statement of the problem............................................................................................................................7
1.3. Research question......................................................................................................................................8
1.4. Objective of the study...............................................................................................................................9
1.4.1. General objectives...............................................................................................................................9
1.4.2. Specific objectives...............................................................................................................................9
1.5. Scope of the study......................................................................................................................................9
1.6. Significance of the study............................................................................................................................9
1.7. Limitation of the study...............................................................................................................................9
1.8. Organization of the study.........................................................................................................................10
CHAPTER: TWO...............................................................................................................................................11
2. Review literature.............................................................................................................................................11
2.1 Definitions.................................................................................................................................................11
2.1. Theoretical literature reviews...................................................................................................................11
2.1.1. Basic Concepts of Investment...........................................................................................................11
2.1.2. Importance of investment..................................................................................................................13
2.1.3. An overview of investment theory.....................................................................................................13
2.1.4. Historical development of investment policy in Ethiopia..................................................................15
2.1.5. Private Investment Development.......................................................................................................16
2.1.6. Private Sector Development..............................................................................................................17
2.2. Determinates of private investment in Developing countries...................................................................18
2.2.1. Inflation.............................................................................................................................................18
2.2.2. Interest rate........................................................................................................................................19
2.2.3. Availability of Finance......................................................................................................................20
2.2.4. Sales and profit..................................................................................................................................21
2.3. Empirical literature reviews......................................................................................................................21
CHAPTER: THREE............................................................................................................................................25
3. Methodology...................................................................................................................................................25
 3.1 Research design.........................................................................................................................................25
3.2 Source and types of data............................................................................................................................25
3.3 Method of data analysis.............................................................................................................................25
3.4 Model specification...................................................................................................................................25
3.5 Description of variables.............................................................................................................................26
CHAPTER FOUR...............................................................................................................................................28
4. Discussion and data analysis...........................................................................................................................28
4.1 Descriptive analysis...................................................................................................................................28
4.1.1 General overview on economic conditions of Ethiopia......................................................................28
4.1.2. Performance Requirements and Investment Incentives.....................................................................31
4.1.4. Challenges of the Investment.............................................................................................................35
4.1.5. Policy discussion...............................................................................................................................36
4.2. Econometrics analysis..............................................................................................................................37
4.2.1. Estimation technique.........................................................................................................................37
4.2.2. Stationary test....................................................................................................................................37
CHAPTER: FIVE...............................................................................................................................................46
5. Conclusions and Recommendation.................................................................................................................46
5.1 Conclusion................................................................................................................................................46
5.2. Recommendations....................................................................................................................................47
Least of Tables

Table 4.1: ADF unit root test, sample for (1994-2024) stationary at level……………………...38

Table 4.2. ADF unit root test for stationary at 1st difference …………….……………………...38

Table 4.3 Regression analysis……………………………………………………………………39

Table 4.4 summary of analyses result……………………………………………………………41

Table 4.5 analysis the outcome of the parameters………………………………………….……42

Table 4.6 Variance inflationary factor (VIF) for testing multicollinearity ………………….......43

Table 4.7 Link test for model specification……………………………………………………...45

1
Acknowledgement
Above all I would like to express our endless love and gratitude to my omicent GOD .And to all my
familys and my friends .
Secondly, I would like to extend my heart full gratitude to my research advisor Mr Tsegaye for his
guidance, suggestions and constructive comments.

2
Abstract

Ethiopia has recently embarked on policies that aim at rebalancing the role of public and private sector
in the economy. To do so, the country has been giving a due emphasis on the development of private
sector. This paradigm shift is basically to encourage private investment and ultimately make private
sector the engine of growth. Taking this policy shift in to account, these study conduct as time series
analysis of private investment in Ethiopia covering annual dataset from 1980-2014. It systematically
examines the major determinants of private investment by undertaking various techniques of tests such
as multicollinearity, autocorrelation, normality and model specification test. As the finding indicates
that real GDP growth rate, real lending interest rate, inflation and gross fixed capital formation have a
significant effect on private investment; whereas real effective exchange rate has insignificant effect
on private investment.

Regarding the results, the study provides evidence that real GDP growth rate, inflation, real lending
interest rate, real effective exchange, and gross fixed capital formation both in a short-run and long-run
significantly affect the level of private investment. Hence, to promote the performance of private
sector to a higher level, it is essential to take measures that can improve real GDP in general and real
income of people in particular, and make public investment in basic infrastructures (gross fixed capital
formation) and institutions that are crucial to attract private investment. Besides, ensuring stable
Investment environment (such as consistent investment policy and requirements/regulatory
frameworks/, and macroeconomic and political stability), and addressing bureaucratic inefficient and
poor governance problems are necessary to build lasting confidence of private investors.

3
ACRONOMY

CSA Central statistical agency

EPRDF Ethiopian People Revolutionary democratic Front

UNCTAD United Nations Commission for Trade and Development

FDI Foreign Direct Investment

GDP Gross Domestic Product

RGDP Real Gross Domestic Product

EEA Ethiopia Economic Association

EIA Ethiopia investment agency

EIC Ethiopia Investment Commission

EIG Ethiopian Investment Guide

LDC s Least Developing Countries

NBE National Bank of Ethiopia

OLS Ordinary Least Square

WB World Bank

MOFED Ministry of finance and economic development

ODA Official development assistance

4
CHAPTER ONE

1.INTRODUCTION
1.1 BACKGROUND OF THE STUDY
The private investment is the main engine of growth in market economics. It thrives and delivers
sustained growth when number of factors combines to produce conductive environment for the private
sectors to develop. Privet investment is crucial pre-requisite for economic growth because it allows
entrepreneurs to set economic activity in motion by bringing resources together to produce goods and
services (IBID).Rapid and sustained growth is facilitated by virtuous circle whereby entrepreneurship
and investment leads to higher productivity, and which makes possibility to invest large sums in the
future. In cause of this process, job is created and new technology is introduced, especially through
international trade and investment linkages. Economic growth could be realized through a proper
development policy. One of which could be promoting demand countries social institution in which
the private sectors is not involved.The growth rate of investment is much greater in developed
countries than that of least developed countries. The reason for this is that investment needs skills,
certainty, updated information and appropriate policy to go with the existing circumstances, which are
common problem of LDCs. Private investment is relevant to economic growth in developing countries
like Ethiopia.

Regarding trends of private investment performance in Ethiopia, the overall performance in a country
since the era emperor’s regime shows allow rate of growth, which fluctuation through time. According
to IMF (2005), large infrastructure investments are needed not only to support the creation of rural-
urban linkages and rural growth, but also to create an enabling environment for private sector
development. The issue weather government expenditures (particularly government investment
increase or decrease private investment: i.e., crowding in versus crowding out private investment has
been a recent debate among macroeconomists. It is said that inadequate provision of physical
infrastructure, has been a primary cause of poverty and unemployment in developing countries like
Ethiopia. (Sackey, 2007)

5
Economic literatures prove that investment is, both empirically and theoretically, the key determinant
to economic growth. Economic growth refers to an increase in a country’s production or income per
capita. It is usually measured by gross national product (GNP) or gross national income (GNI), used
interchangeably, an economy’s total output of goods and services. Investment is the source of
manufactured goods that will be used to produce other goods. It is the major foundation of
enhancement in the level of literacy, improvement in technology and increase in the capital stock
(Hashmi et al 2012). A rate of investment is one of the key factors that differentiate developed
countries from developing countries. In high-growth countries investment is high, where as it is low
in low growth countries. The implication of low investment is that the productive capacity of the
economy fails to increase. This in turn leads to lower rates of growth and job creation, and fewer
opportunities for the poor to improve their livelihoods (White, 2005). As of Sackey (2007) countries
with high standards of living are those who have shifted the economic structure from traditional and
less diversified to a more diversified one. Commitment to investment is the central issue in the
process of structural diversification. For developing countries like Ethiopia the basic question in
their economy is increase the production and hence improve the standard of living of their people so
that there will be dramatic change in their economic, political and social conditions. For this purpose
different alternatives are on the table. Investment promotion is one key instrument and primary engine
of economic growth (Mustefa, 2014). As a result due attention has been given to development of
private sector in developing countries to help improve economic growth (Ouattara, 2004). Reliable
and continuous increase in domestic private investment also helps in reduction of poverty.
Understanding the status and determinants of private investment is essential for successful and
effective implementation of sustainable development goals (SDGs). According UN World Investment
Report (UN, 2014b) SDGs will require huge levels of both public and private investment in all
countries. Even if public finances are considered as central to investment in SDGs, they cannot meet
all SDG-implied resource demands. So far, various studies were conducted to identify the
determinants of private investment. In view of that, the primary aim of this systematic review is to
investigate the main factors affecting private investment in developing countries, particularly Africa.
This review may helpful in providing relevant information about policy options for concerning body
such as government, policy makers, and other institutions working to improve private investment.

6
1.2. Statement of the problem

Privet investment is an engine for creating innovation, economic growth and poverty reduction.
Domestic investment in Ethiopia shows progressive trends with speedy starting from announcement of
liberal policy in 1992. Nevertheless, the gap between domestic investment and saving has remained
wide thereby reinforcing the need foreign direct investment in development of the economy
(UNCTAD, 2002).Although the investment climate has improved greatly in recent years, there are still
many aspects of investment promotion where improvements are urgently needed. In other words, even
if the situations or investment has improved from the previous period, the participation of private
sector is not satisfactory. Conducive Government Policies: In recent years, the government has
adopted a robust growth and poverty reduction strategy, focusing on infrastructure development,
commercialization of agriculture, improvements in access to basic services, as well as on private sector
development, including the creation of appropriate regulatory and institutional frame works to support
private business. (Economic Brief, 2010).

A Nov. 2020publication by the World Bank, Ethiopia Economic Update, shows on average the share
of total national investment from its GDP in the years between2016-2018 was 22.9%. Growth and
Transformation Plan (GTP), Ethiopia’s latest lead economic development plan, aspires to make
investment contribute some 31.5% to the nation’s GDP by the end of 2022 . In line with this, and
following the government’s incentives in the form of various investment policies and trade laws and
regulations, many sectors are now seeing new foreign entrants with new innovation and technology.
Ethiopia’s public investment rate is the third highest in the world, but private investment rate is the
sixth lowest. The current ‘big push’ of public investment-led development has delivered positive
results in the past but the development of a strong, vibrant private sector is needed to sustain high
growth. (World Bank, 2021).

A more difficult relationship to discern is that between public and private investment. Crowding in of
private investment is defined to occur when increase public investment is associated with increase
private investment. This may arise because of public infrastructure provision affects return on private
investment positively, hence enhancing the incentive to carry out such private investment.

7
Crowding-out occurs when the opposite in the case. Some empirical literatures inclined with the
crowding- in effect are Oshikoya (2001); finding that public investment in infrastructure is
complementary to private sector investment. Opposing to this, Clements and Levy (2011); suggest that
public investment is crowding-out private investment. Finally, Ghura and Goodwin (2000); suggests
that public investment have mixed effect on private investment in different cases, which are investing
in information equipment, credit market and generally on non infrastructure have a crowding-out
effect; otherwise the effect is opposite. Therefore the researchers support that this mixed effect case.
And; according to, Ashebir Tsegaye (2012) the determinants of private investment in Ethiopia case
were: inflation rate, RGDP growth rate, government expenditure, and real effective exchange rate.

Given the above fact; researchers were initiated to conduct a study by considering the gap between
determinants of private investment and the available good climate. That means there are other basic
factors that determine private investment; like Gross fixed capital formation and real lending interest
rate. On the other hand, most of the paper done in this area; in the past, does not include recent data.
The researcher believes that even if the overall prevailing determinants of private investments are
diverse and complex, it’s necessary to identify the major one and to investigate them properly to
achieve the expected growth of investment or to fill the gap between the determinant of privet
investment and the available good climate and suggest measures to be taken to promote private
investment in the economy.

This research plays a unique role on showing the determinants of private investment to productively
use in the growing economy of Ethiopia by letting the community to be involved in the creating the
change.

The researcher tries to fill the gap or solve the problem of Ethiopia by letting the peoples know more
about the importance of private investment and use this opportunity to change the countries current
problems and this research show and explain how can the determinant of private investment could help
the country to be productive by realizing the effects of each.

1.3. Research question

The researcher is eager to answer the following questions, in order to meet the research objectives;

 What are the factors that determine private investment in Ethiopia?

 What are the benefits of private investment in Ethiopia ?

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1.4. Objective of the study

1.4.1. General objectives

The main objective of this study is to investigate the determinants of private investment in Ethiopia.

1.4.2. Specific objectives

The researchers want to identify the following specific objectives

 To examine factors that determines private investment in Ethiopia.

 To analyze the benefits of private investment in Ethiopia

1.5. Scope of the study

Investment is a broad topic; however this study intends to look only on private investment. Even
though the determinants of private investments; controlling for non- macro-economic factors, which
have an intense effect on it. The study will focus on the determinants of private investment in Ethiopia
from 1994-2024 by using the determinants variables of : Inflation rate, real interest rate , Real
effective exchange rate, Real gross domestic product(RGDP) growth rate, with regard to private
investment in Ethiopia.

1.6. Significance of the study

It is not new for all that investment would provide an important role for countries economic growth
which further leads to development. The paper would have its own importance for policy makers to
improve the level of private investment. In addition to this; the paper would consider as basis for
further research literature in this area.

1.7. Limitation of the study

As has already been pointed out in this study, investment is an engine to economic growth. The
apparent limitations of the study are that it concentrates on macroeconomic variables and uses
aggregate data. This means that there are other important factors, other than macroeconomic factors
that explain the relatively good economic growth in Ethiopia. This controversy itself is a topic for
further research and is not addressed in this study. A study that utilizes more disaggregated data and
seeks to explore sectorial private investment may arrive at different results.

9
1.8. Organization of the study
This section of the study set a foundation of the study. Chapter one the background of the study,
Statement of the problem, Research question, objectives of the study , scope and limitations; and
Chapter Two discusses, and reviews related private investment literature. The Methodology (Chapter
Three) discusses the research framework assumed and justification of the methods to ascertain
their suitability given the expectations of the study. Chapter Four focuses on research findings and
the study ends with Conclusions and Recommendations (Chapter Five).

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CHAPTER: TWO

2. Review literature
2.1 Definitions
 What is privet investment ?

Before explaining about private investment let us define what is investment. Investment is a core
reason for ones country economic growth.

Investment is defined as the commitment of current financial resources in order to achieve higher
gains in the future. It deals with what is called uncertainty domains. From this definition, the
importance of time and future arises as they are two important elements in investment.

This proposal is more concerned on private investment so we should elaborate it.

A private investment, also commonly referred to as an alternative investment, is a financial asset

outside public market assets such as stocks, bonds, and cash. Qualified investors often access private
investments through an investment fund.

Private investment, from a macroeconomic standpoint, is the purchase of a capital asset that is
expected to produce income, appreciate in value, or both generate income and appreciate in value.

2.1. Theoretical literature reviews

“Peoples can choose either to spend their time picking apples or planting apple trees. In the

first case there are more apple today; in the second more apple tomorrow.” Steven

2.1.1. Basic Concepts of Investment

An investment is simply any vehicle in to which funds can be placed with the expectation that they
will generate positive income or that their value will be preserved or increased. The reward or returns,
from investing are received in either of two basic forms current income increased value. For example,
money invested in a bank saving account provides current income in the form of periodic interest
payments; similarly, buying apiece of raw land is an investment, because. The land is expected to
11
increase in value between the time it is purchased and the time it is sold. In short investment funds
placed within the expectation value the time between purchasing and sold.

Investment broadly, defined as a flow of expenditure devoted to product, producing goods and
services, which are mostly not intended for immediate consumption where this project may take the
form of adding to both physical and human capital as well as investors. (Dictionary of modern
economics).

The relevance of investment to economic growth in developing countries has received a particular
attention among researchers and policy makers only after 1990s. While the government to concentrate
on improving to social over heads capital and poverty alleviating goals is based on two reasons. First
there has been growing empirical evidence the relative efficiency of private over public investment in
the productive sector. Second, there is physical complementary between private and public investment
(world development report).

Given the above fact proposition we can understand that investment is one of critical element which
determines the level and pace of economic growth. Investment helps to introduce technology change
and the quality of resource, which in turn improving productivity (Ethiopian economic association,
2005/06).

Investment in the Keynesian system defined in desired business investment, expenditure were one of
the major factors that Keynes through were responsible for change in income. Keynes believed that
consumption was a stable function of disposable income, consumption was primary induced
expending; meaning expenditure that depends directly on income that be lived that investment was the
most highly variable of the autonomous components of aggregate demand believed that variable
investment spending was primary responsible for income instability (Foreign, 2005).

According to the classical economists, investment is interest elastic, this important from the point of
view of monetary policy because if this the case investment could be increased sufficiently enough by
increasing the money supply particularly in a slump, a resource to the easy money policy would have
been sufficient to review the economy and ensure full employment. Keynes .challenged this faulty
classical view which held that the investment was influenced more by income rather than by interest
rate except marginally. During depression when the marginal efficiency of capital suffers a near

12
collapse, no amount of lowering of the interested rate would help review the investment in the
economy. (Vals, 2006).

2.1.2. Importance of investment

Individual investor can participate in the growth and prosperity of the country, by investing the
security market more importantly even small investors can share the growth investing small amount of
money over long period of time. If you are for a long term intensified group of societies, you will
proper financially and which help economic system work even better long term investment helps to
create new jobs and new economic opportunities.

2.1.3. An overview of investment theory

The theories of investment date back to Keynes , who first called attention to the existence of an
independent investment function in the economy. A central feature of the Keynesian analysis is the
observation that although savings and investment must be identical ex-post, savings and investment
decisions are, in general, taken by different decision makers and there is no reason why ex-ante
savings should equal ex-ante investment. The next phase in the evolution of investment theory gave
rise to the accelerator theory, which makes investment a linear proportion of changes in output. In the
accelerator model, expectations, profitability and capital costs play no role. Keynesian theory has
traditionally favored the accelerator theory of investment while disregarding the role of factor costs. A
more general form of the accelerator model is the flexible accelerator model. The basic notion behind
this model is that the larger the gap between the existing capital stock and the desired capital stock, the
greater a firm’s rate of investment. The hypothesis is that, firms plan to close a fraction of the gap
between the desired capital stock, K*, and the actual capital stock, K, in each period. This gives rise to
a net investment equation of the form of:

I = δ (K* - K-1)………….. (1)

Where I = net investment, K* = desired capital stock, K-1 = last period’s capital stock, and δ = partial
adjustment coefficient. Within the framework of the flexible accelerator model, output, internal funds,
cost of external financing and other variables may be included as determinants of K*. The flexible
accelerator mechanism may be transformed into a theory of investment behavior by adding a
specification of K* and a theory of replacement investment. Alternative econometric models of
investment behavior differ in the determinants of K*, the characterization of the time structure of the

13
investment process and the treatment of replacement investment. In the flexible accelerator model, K*
is proportional to output, but in alternative models, K* depends on capacity utilization, internal funds,
the cost of external finance and other variables.

Jorgenson and others have formulated the neoclassical approach, which is a version of the flexible
accelerator model. In this approach, the desired or optimal capital stock is proportional to output and
the user cost of capital (which in turn depends on the price of capital goods, the real rate of interest, the
rate of depreciation and the tax structure). In the “Q” theory of investment (which is also in the
neoclassical framework) associated with Tobin , the ratio of the market value of the existing capital
stock to its replacement cost (the “Q” ratio) is the main force driving investment. Tobin argues that
delivery lags and increasing marginal cost of investment are the reasons why Q would differ from
unity. Another approach known as “neoliberal” emphasizes the importance of financial deepening and
high interest rates in stimulating growth. The proponents of this approach are McKinnon ; The core of
his argument rests on the claim that developing countries suffer from financial repression (which is
generally equated with controls on interest rates in a downward direction) and that if these countries
were liberated from their repressive conditions, this would induce savings, investment and growth. Not
only will liberalization increase savings and loanable funds, it will result in a more efficient allocation
of these funds, both contributing to a higher economic growth. In the neoliberal view, investment is
positively related to the real rate of interest in contrast with the neoclassical theory. The reason for this
is that a rise in interest rates increases the volume of financial savings through financial intermediaries
and thereby raises investible funds, a phenomenon that McKinnon calls the “conduit effect”. Thus,
while it may be true that demand for investment declines with the rise in the real rate of interest,
realized investment actually increases because of the greater availability of funds. This conclusion
applies only when the capital market is in disequilibrium with the demand for funds exceeding supply.

It is clear from the discussion in this section that private investment depends on three broad categories
of variables: Keynesian, neoclassical, and uncertainty variables. Variables that may be included in the
Keynesian tradition include growth rate of GDP, internal funds and capacity utilization. The
neoclassical determinants of private investment include Tobin’s Q, real interest rate, user cost of
capital and public investment ratio. There are three uncertainty variables. The first is variability
(variance, moving standard deviation or moving coefficient of variation) of the user cost of capital,
real exchange rate, inflation rate, distortions in the foreign exchange market (proxies by the black

14
market premium) and real GDP. The second uncertainty variable is the debt/GDP ratio and the third is
debt service as a ratio of exports of goods and services.

Rostow argued that advanced countries had all passed the stage of “take off”. In to self sustain growth
and under developed countries where still in either the traditional society or the “ precondition” stage
had only to follow a certain set of development to take off in their turn in to self sustain economic
growth. The principal strategies of development necessary for only take off was the mobilization of
domestic and foreign saving in order to generate sufficient investment to accelerate economic growth
(Todaro, 2000)

2.1.4. Historical development of investment policy in Ethiopia

According to the document of the Ethiopian investment agency, there are many reforms, investment
condition, and exemption of various duties. These have radically changed the Ethiopia’s investment
today. The revised Investment Code of 2015, as well as the Investment Proclamation provide
incentives for development-related investments, and have gradually removed most of the sectorial
restrictions on investment; Ethiopia's investment code prohibits foreign investment in banking,
insurance, and financial services. The remaining state-controlled sectors include telecommunications,
power transmission and distribution, and postal services with the exception of courier services.
Manufacturing of weapons and ammunition can only be undertaken as joint ventures with the
government.

Other areas of investment reserved for Ethiopian nationals include: broadcasting; air transport
services; travel agency services, forwarding and shipping agencies; retail trade and brokerage;
wholesale trade (excluding supply of petroleum and its by-products as well as wholesale by foreign
investors of their locally-produced products); most import trade; capital goods rentals; export trade of
raw coffee, chat, oilseeds, pulses, hides and skins bought from the market; live sheep, goats and cattle
not raised or fattened by the investor; construction companies excluding those designated as grade 1;
tanning of hides and skins up to crust level; hotels (excluding star-designated hotels); restaurants and
bars (excluding international and specialized restaurants); trade auxiliary and ticket selling services;
transport services; bakery products and pastries for the domestic market; grinding mills; hair salons;
clothing workshops (except garment factories); building and vehicle maintenance; saw milling and
timber production; custom clearance services; museums, theaters and cinema hall operations; and
printing industries. However, the GOE has indicated an interest in bringing foreign private sector

15
expertise to some of the above sectors. Ethiopian-Americans can obtain a local resident card from the
Ministry of Foreign Affairs that allows them to invest in many sectors closed to foreigners. Foreign
firms can supply goods and services to Ethiopian firms in the closed sectors.

The 2012 amendment to Ethiopia’s investment proclamation introduced provisions for the
establishment of industrial development zones, both state-run and private, with favorable investment,
tax, and infrastructure incentives. The amendment also raised the minimum capital requirement to
US$200,000 per project for wholly-owned foreign investments and US$150,000 for joint investments
with domestic investors (or US$100,000/US$50,000 respectively in the areas of engineering,
architectural, accounting and auditing services, business and management consultancy services, and
publishing). A foreign investor reinvesting profits/dividends may not be required to allocate minimum
capital.

Inflation rates, while still high, stabilized over 2012. The GOE has taken an active role in managing
inflation through a series of measures including strict monetary and fiscal policies limiting the growth
of broad money, resulting in year-on-year inflation undergoing a steady series of declines and
stabilization periods, dropping from 39.3% in November 2011 to 15.6% in November 2012. The GOE
remains vigilant about combating inflation; however, structural inefficiencies such as a state
monopolized multi-modal logistics system and an oligopolistic wholesale sector will likely continue to
keep Ethiopia’s inflation rate in double digits.

Ethiopia does not have discriminatory or excessively onerous visa, residence, or work permit
requirements for foreign investors; however, investors may face bureaucratic delays in obtaining these
documents.

2.1.5. Private Investment Development

The mobilization of private investment is essential for development, while public expenditure whether
by developing countries government or through official development assistance (ODA) provided by
developed countries governments is requires it has become clear that the demand for finance out strips
that which the public sector can provide. Report on international conference on financing for
development (UN, 2002).

The Monterey consensus, Recognized that a substantial increase in ODA and other resource including
private investment will be required if developing countries are to achieve the international agreed

16
development goal and objectives. Including those contained in the united national millennium
declaration. Mobilizing investment in developing countries can contribute direct to economic growth
the challenge for developing countries and their development partner to identify the best way to
influence the condition reads to increased levels of private investment. This guidance documented
focuses on the role of ODA can play in helping developing countries to mobilize private investment.
However on handing private investment should not focus on attracting foreign perfect investment
(FDI) alone. While FDI to developing countries has increased significantly in the last 20 years the bulk
of investment is domestic (World Bank, 2004 E.C.).

Profitable private investments, where they do not rely on protection generally contribute to economic
development, through the productive use of capital. In addition, they may contribute to environmental,
social, or corporate governance improvements traditionally this contribution to these key components
of suitable development has been through the use of minimum environmental and social standards.
The international fiancé corporation (IFC), as part, of the world bank group has invested consider by
in the development of such standards they have become intrinsic part of contribution significantly of
the understanding of environmental and social influence and the processes through which the adverse
impact can be minimized.

2.1.6. Private Sector Development

There are different prospective on how private sector development might contribute to poverty
reduction and sustainable economic growth. The private sector was considered to play a crucial role,
creating opportunity for employment and income generating, with emphasis than on the policy needed
to make market explanation (work,) the processed of structural adjustment sough to restrain the re
orient government intervention in the markets to ensure that the private sector ranging from small
farmer comparatives to lager national and multinational companies operated more freely (foster and
Weston 2006).

Private sector development, the performance of private sector activities, is now seen as crucial to
economic growth and poverty deduction (reduction) in developing countries. It is there for important
to understand how donors think they can promote a vibrant private sector. There have been various
discussions in policy circles, including among donors. Where and how to support private sector
development in developing countries Regulate, structure and Implement of competition law (Tempo
and Willemetvelde, 2008).

17
The main obstacle to private sector development in transition economies is the shortage of private
business capital. The formal private sector only gradually absorbs workers released from the state
sector is that it takes time for entrepreneurs to create productive new private businesses and for the
competitive economy to select highly productive businesses through national selection on the other
hand, once the entrepreneur find a productive businesses activates opportunities, he can immediately
attain the optimal size of the business. There is no limitation on the growth of the businesses for the
individual entrepreneur. In the individual entrepreneur often faces partialities not only in finding a
highly productive business opportunity but also in financing the businesses investment.

2.2. Determinates of private investment in Developing countries

The relevance of privet investment developing countries has received particular emphases among
researchers and policy makers in the 1990s. this leads growth strategy, towards base the private sector
a leading role while allowing the government to concentrate on improving social over head capital and
poverty alleviation goals is based on two reasons, first there has been growing empirical evidence on
the relative efficiently of private over public investment in the in the productive sector. Second there is
physical complementary between private investment and public infrastructural investment.
Nevertheless promoting private investment is a complex task because the factors affecting it are
intricate and delicate, the specification of the private investment and saving determinates can be drawn
from empirical literature on investment behavior or with appropriate consideration of the structural
features of an economy among these are direst focal policy. Such as tax, public investment, and
financial variables such as interest rate and credit how. Hence the term work for private investment
combines not classical investment determinates with borrowing constraints, public infrastructure and
uncertainty variable, the foreign debt to output ratio and political and business regulations. (Yasaba,
2003 E.C).

2.2.1. Inflation
The evidence for friend mans statement is straight forward whenever a country inflation rate is
extremely high or a sustained period of time; its rate of money supply growth is also extremely high
(inflation and the monetory transmission mechanism 2005). Accordingly friend mans proposition
actually says that upward movements in the price level are a monetary phenomenon only if this is a
sustained process. Inflation is defined as continuing and a rapid rise in the price level. Most

18
economists, whether monetarist or Keynesian. Will agree with friend mans’ proposition that one alone
is to balance.(pirre L.siklos 2011)

Inflation too, has significant role in affecting the level of domestics investment as well as private
investment from its very definition, inflation is the rise of all or almost average price of goods and
services, or put the other way round, if it is the fall of the general purchasing power of the monetary
units economic literatures emphasized on stable price level as a goal of economic policy. (Inflation
theory and policy by Jeffrey a Frankel 2010)

Underlined the desirable feature of price stability because he explained, inflation create uncertainty in
the economy and usually lower the economic growth in the inflationary environment, planning is
hardly attained as it complicates decision making for consumers, business and even government, when
the price of one good rises, that price increases may or may not be part of a large inflation. Remember,
inflation is an increasing on the overall price level. We measure inflation by looking at a large number
of goods and services and calculating the average increases in their prices during some period of time
(CASE AND FAIR, 2007).

Real estate and other tangible investments, including gold, other precious Metals and collectibles such
as art work and antiques. are generally more responsible to the rate of inflation than to any Thing ales,
housing prices and the price of commodities like coffee, oil, meat, corn and sugar are component of
consumer price index when consumer price starts to rise the return on real estate and other tangible
investment starts to rises as well as, but when inflation comes back down to more normal level, returns
on real estate and other tangible investment also decaling. (Lawrence and Michael, 2008).

And public investment and financial variables such as interest rate and credit flows. Hence the frame
work or private investment combines no classical investment determinate with borrowing constraints,
public infrastructure and uncertainty variable, the foreign debt to output ratio, and political and
business regulations.(robert J borro 2016 )

2.2.2. Interest rate

The real interest rate measures the opportunity cost of holding inventories. When the real interest rate
rises, holding inventories becomes more costly, so rental firms try to reduce their stock therefore, an
increase in the real interest rate depresses inventory investment. The real interest rates that prevailed

19
during most of this decade are one possible explanation for this change in business strategy (Mankiw,
2000).

Bond and other forms of fixed income security ; preferred stock and bond fund are highly sensitive to
movements in interest rate, infarct interest rate are the single most important variable in determining
the bond price behavior and return to investors. Because interest rate and bond price move in opposite
direction, so interest rate are unfavorable for outstanding bonds already held in an investor portfolio.
Of course high interest rate enhance the attractiveness of new bonds be causes they offer high returns.
(Lawrence and Michael, 2008).

The impact of interest rate can be seen by its power to influence capital stock by changing the
expected portability of various investment expenditure interest rate has special role in the analysis of
the net present value of investment, the higher purchasing of additional capital goods Keynesians
explain the impact of interest rate in deferent manner by using the concept efficiency that expected
how of return is less than the market interstate, the project is regarded as profitable for Keynesian and
investment project will be pursued by if its expected profitability exceeds the cost of borrowing to
finance the project at a higher interest rate borrowing cost toward projects satisfy this criterion (foreign
2005.)

The user cost of capital is an important factor in investment decisions by the private sector. When the
user cost is generally raised by increasing the cost of bank credit through raising interest rate or by
increasing the opportunity cost of retained earnings, which is the other main source of investment
financing, private investment declines (Steven v. Mann , 2010). Findings of various empirical studies
are not, however, consistent. The negative influence of interest rates on investment is confirmed by
certain studies in developing countries (interest rate risk management by Antony corny 2012) .
However, studies by others (Siddhartha Jha 2014) have shown that, in the repressed financial markets
in developing countries, credit policy affects investment directly through the stock of credit available
to firms with the access to preferential interest rates, rather than through the interest channel). Thus
institutional set up of the financial markets is an important factor for the transmission mechanism of
the impact of monetary policy and credit policies on private investment.

In the classical system, the components, of commodity demand consumption, investment, and
government spending play their explicit role in demining the interest rate the equilibrium interest in
the classical theory was the rate at which the amount of funds individuals desired to lend was just
20
equal to the amount other desired to borrow. In classical system, the suppliers of bonds where the
firms, which financed all investment expenditures by the sale of bonds and the government, which
might sell bonds to financial spending in excess of tax revenues for a given expected profitability ,
investment expenditures varied inversely with the interest rate. At high interest rate, toward project
will be profitable, net of interest cost, and investment will increase, (foreign).

2.2.3. Availability of Finance

Firms face financing constraints limit on the amount they can raise in financial markets. Financing
constraints can prevent firms from undertaking profitable investment, when a firm is unable to raise
funds in financial market, the amount can spend on new capital goods is limited to the amount if it is
currently earning financing constraints influence the investment behavior of firms just as borrowing
constraints influence the consumption behavior of households, borrowing constraints caused
households to determine their consumption on the basis of current rather than permanent income,
financing constrains cause firms to determine their investment on the basis of their current cash flow
rather than expected profitability. (Mankiw, 2000).

In many developing countries firms fire to generate adequate sale financing. In addition on the amount
of resource available for investment financing in these countries are so much eliminated because of
low income and low savings. This is further exacted based by the absence and inefficiency of capital
must, which mobilize saving and direct them in to productive investment. Finance is therefore, an
important constraint to promote investment in developing countries. In these countries where financial
markets are repressed, credit policy affect investment directly through the stock of credit available to
firms than through the interest rate channel. In general, because the total amount of financing is
limitedly, it would seem legitimate to hypothesize that the private investment is restricted by the level
of available bank credit. (Abinet, 2006).

2.2.4. Sales and profit

The level of sales could be as affecting expectation of future output and thus affecting the desired
capital stock, not that output and sales differ by the amount of inventory accumulation similarly. High
profits may provide an indicator demand for the firms product, and thus of future output.
Alternatively, it is often argues that firms prefer to use retained profit to financial investment, rather
than borrow. The preference might result from the expense of having to rise outside funds relative to
using inside funds. However, it has to be remembered that in using its retained protest to finance
21
investment rather than borrow. The preference might result from the expense of having to rise outside
tends relative to them to the firms owners.

2.3. Empirical literature reviews

Thomas, (2005) in his study of 86 developing countries examined data on terms of trade, real
exchange rates, property rights and civil liberties and concluded that while factors including credit,
availability and the quality of physical and human infrastructure are important influences, uncertainty
in the investment environment was negatively related to private investment in sub-Saharan countries.
Employing the variability in real exchange rates as an explanatory variable in regression analysis, in
his cross-country study on the macroeconomic environment and private investment in six Pacific
Island countries observed a statistically significant negative relationship between the variability in the
real exchange rate and private investment.

Duncan et al. (2011) argued that although variability in the real exchange rate is a reasonable proxy for
instability in major economic variables as fluctuations in inflation and productivity. Generally, fiscal
and monetary management are reflected in the real exchange rate, which is not a good measure of the
uncertainty attached to policy or the insecurity of property rights and enforcement of contracts or the
level of corruption. It has been observed that these non-economic factors appear to have significant
influence on investment in the Pacific Island countries. However, admitted that no quantitative or
qualitative evidence is available of their size or their impact. In the absence of such evidence, any
study on private investment is to be necessarily restricted to the conventional variables. It has been
observed by many researchers that monetary, fiscal and exchange rate policies for correcting
unsustainable macroeconomic imbalances are bound to affect private investment. There are two ways
by which restrictive monetary and credit policies included in stabilization packages affect investment.
These are the rise in the real cost of bank credit and the opportunity cost of retained earnings from
higher interest rates. The user cost of capital is increased by both mechanisms, leading to a reduction
in investment. (IBID)

Van Wijnbergen (2014) however noted that credit policy affects investment directly, because credit is
allocated to firms with access to preferential interest rates rather than through the indirect interest rate
channel. Thus the effect of monetary and credit policy on investment and the means of transmission
depend on the institutional structure of financial markets.

22
TunWai and Wong incorporated features of the neoclassical model into investment models for
developing countries. Their approaches take into account the relevant data problems and structural
features Journal of Economics and Sustainable Development.

That caused a gap between the modem theory of investment and the models that were specified for
developing countries. Blejer& Khan (2013) focused on the role of government policy and derived an
explicit functional relationship between the principal policy instruments and private capital formation.
Using the model they were able to assess the extent of any “crowding out”. The second extension that
did was to make a distinction between government investment that is related to the development of
infrastructure and government investment of other kinds. Those researchers found a positive
relationship between the share of private investment in total investment and the ratio of total
investment to income. They also found that the larger the share of private investment, the higher the
average growth rate of the economy. These patterns indicate the relevance of private investment
behavior in developing countries and call for the testing of formal models of private capital formation
in individual countries.

Two principal conclusions emerged from (IBID) tests of formal model for 24 developing countries.
The first was the possibility of identifying well behaved empirical function for private investment in
developing countries. This challenged the traditional view that standard investment theory is not
relevant for developing countries. The second conclusion was the establishment of a direct empirical
link between government policy variables and private capital formation.

Asante (2000) estimated a private investment equation that tried to assess the determinants of private
investment in Ghana. Among the independent variables were the incremental capital output ratio, the
lending rate, the exchange rate, credit to the private sector and public investment. His preliminary
results showed among other things a “crowding out” effect of public investment.

Ariyo and Raheem’s (2014) country estimation of the determinants of investment consisted of public
investment rate of growth of GDP, domestic credit to the private sector and interest rate as arguments
in the private investment function. “Their results show that all variables were statistically significant
and evidence of the existence of crowding in”.

Bazoumana (2004) analyzed the determinants of private investment in general. He found a significant
relationship between private investment and its explanatory variables. Public infrastructure investment

23
was found to be positively related with private investment GDP, credit to the private sectors and terms
of trade has a significant negative impact in private investment.

Bayraktar and Fofak (2007) derive a formal specification of a private investment function in Sub-
Saharan Africa. Using the Tobin’s Q theory and the neo-classical theory of investment, their results
point to the significant role played by aggregate profitability shock, and by financing of investment in
determining the level of private investment in Africa.

Khan and Reinhart (2005) carried out a study on private investment and economic growth in
developing countries. The conclusion from their study was that both private investment and public
investment have different effects on the long-run economic growth rate. Private investment was seen
to play a much more -significant role in the growth process than domestic public investment. The only
shortcoming in this study is that it failed to consider the complementary effects of public investment
on private investment. Such public expenditures like construction of roads, building of schools,
electricity and telecommunication do have a strong effect on private investment.

Asante, Y. (2000) studied the Determinants of Private Investment Behavior in Ghana using data for
the period 1999 to 2002. This study revealed that public investment as a ratio of GDP, growth rate of
real credit to the private sector, the real exchange rate, the real interest rate, lagged private investment
as a ratio of GDP; all have positive and significant impact on private investment. Public investment,
growth rate of real credit to the private sector, the real exchange rate, is all significant at the 1% level.
On the contrary, measure of macroeconomic instability, political instability represented by coup
dummy, and inflation all has a negative impact on private investment in Ghana. The main strength of
this study is that, it incorporated many macroeconomic variables that are expected to affect private
investment in the context of a developing country. The only weakness of the study is that it used a
short time period coupled with the many explanatory variables. Given the short period of the study and
the many explanatory in the model, the degree of freedom will be very low and that may impose
constraints in the model estimation process.

24
CHAPTER: THREE

3. Methodology
3.1 Research design
The researcher detect and show the framework of research methods and techniques that the
researcher choose to conduct the study. This proposal aims to show what determines private
investment and how private investment is important for Ethiopia.

This research is mainly focused on one country that is Ethiopia and it more explains and see with
macroeconomic glasses using qualitative and quantitative data that are simple to analysis. Due to the
data that are going to be used to conduct the study the research design is going to be flexible enough to
avoid irrelevant delays.

3.2 Source and types of data

The study conduct basically using secondary data. An attempt would make to gather a 30-years data
(i.e. from 1994 to 2024, since there is poor performance of investment GDP growth rate in the year
1994) on some important variables. The data would gather from various sources such as National
Bank of Ethiopia (NBE), MOFED, EIA, CSA of Ethiopia, and WB data basis, and from other relevant
and reliable sources.

3.3 Method of data analysis

The methodology would uses in an attempt to learn more about the determinants of private investment
activities in the country, is econometric regression using OLS method over the period 1994 to 2024.
This model is select for its simplicity, and is also expect to fulfill the assumptions of efficiency,
consistency and unbiased and the researcher will employ descriptive analysis; after collecting
secondary data the researchers would summarize using tables, charts and other appropriate statistical
tools.

3.4 Model specification

For the purpose of this specific study, the researchers have used the theory of accelerator principle.
The principle uses the researchers to specify private investment. the principle states that an increase in
25
productive capacity requires an expansion of capital stock, which in turn causes for a higher rate of
spending .Therefore, the rate of investment spending depends on change in output.

As the literature proposed, there are key macroeconomic variables that play an important role in
explaining private investment behavior in Ethiopia.

“Factors that influence the ability and motives of private investors to implement their project or to
investment equally determine the speed with which private investors respond to the gap between
planned and actual investment” (Getachew, 2012). In our cause these determinants are RGDP growth
rate, real lending interest rate, inflation rate, real effective exchange rate;. In addition to this the
purpose of including the explanatory variables which affect private investment and which are not
included here; i.e. error term (ᵋ) is used.

When we put it in mathematical form, we get:

Pri =β0 +β1RGDPt + β2RLIRt + β3INFt + β4REERt +Et

Where

Pri-private investment

RGDP-real gross domestic product growth rate

RLIR-real lending interest rate

INF-inflation

REER-real effective exchange rate

t- on all variables represents time t and ᵝ0,ᵝ1……constant and coefficients respectively.

3.5 Description of variables

Private investment is the proxy for the performance of private sector in the economy, and it is
dependent variable, which depend on some explanatory variables for our case.

Real GDP growth rate is one of the most commonly used variable as explanatory variable, to measure
its effect on private investment. According to Fielding (2017), explain that private investments
positively related to real GDP growth rate of a given country. This is because countries with higher

26
income level inclined to allocate more of their wealth to domestic saving, which could be then used to
help in financing private investment.

Real lending interest rate is a proxy for cost of capital. The perceived negative relationship between
real lending interest rates and private investment is a long debated issue which pulls in a number of
prior studies. Pablo et al, notes that, these rate of return of an investment – approached by literature
through a real lending interest rate as a representative of the cost of capital is a possible determinant of
private investment. Here, it’s worth to make two distinctions: the interest rate would have a negative
impact in the level of private investment made by domestic agents if the investment is financed in the
local credit market. However, an increment in interest rate could have a positive effect in the capital
flow from abroad, like it usually happens in emergent markets.

Inflation is the third variable that the researcher uses in the study as a proxy to measure macro
economics stability of the country. Models like the Tobin-Mundell model argues that higher
anticipated inflation lower the real interest rate which then causes to be made portfolio adjustment
away from real money balance to real capital which then expected higher inflation to raises real
investment (Ghura & Goodwin, 2000).

Real effective exchange rate is another explanatory variable, is also used as a proxy to measure
macro-economic stability. In most literatures the effect of real effective exchange rate, either
devaluation or appreciation of local currency on private investment is ambiguous. real depreciation of
local currency increases domestic goods relative to the real cost of new capital goods which then
increase the investment in non-tradable activities; and it make exportable product more competitive in
the World market.

Table 1 reletionship between private investment and the determinant

Explanatory variables There relationship with private investment

Real GDP growth rate Positively related

Real leading interest rate Negatively related

Inflation Positively related

Real effective exchange rate Positively related

27
CHAPTER FOUR

4. Discussion and data analysis

4.1 Descriptive analysis

4.1.1 General overview on economic conditions of Ethiopia

Ethiopia’s economic growth for the 2012/13 fiscal year was 9.7 percent as stated by the Ministry of
Finance and Economic Development. According to a press release by the Ministry, the annual growth
of major sectors: agriculture, industry and service sectors were 7.1, 18.5 and 9.9 percent respectively
and their shares out of the total GDP were about 43, 12 and 45 percent respectively.
Over the last ten consecutive years, the country’s economy has registered rapid growth, according to a
press release from the Public Relation and Information Directorate of the MOFED. The average
growth rate of the GDP was stated to be 10.9 percent. The agriculture, industry and service sectors
annual average growth was 9.3, 12.2 and 12.4 percent respectively.
In the last three years of the Growth and Transformation Plan (GTP) period, the economy has
registered robust growth. During that period, the annual average growth rate was 10 percent.
Agriculture, industry and service sectors have 7, 16.9 and 11 percent annual average growth rate
respectively.
According to a World Bank 2015 report, the economic growth was driven by services and agriculture
on the supply side and public investment on the demand side.
The report says that the service sector is now larger than agriculture in terms of value added.
Over the past decade, the economy has been undergoing a shift from agricultural production towards
an increased reliance on services.
Between 2003/04 and 2013/14, the value added contribution of agriculture fell from 51 to 44 percent
while the services sector increased from 38 to 45 percent. The value added growth of the industrial
sector remained unchanged at 9 to 10 percent.
It also says that public investment has become the growth engine in recent years. Over the past 3 years,

28
the public investment share in contributing to growth has increased from 31 to 63 percent. In other
words, almost two-thirds of the 8.5 percent growth in 2014/15 can be attributed to public investment.

Ethiopian investment guide, 2015, suggests that Enormous efforts have been implemented in major
key sectors to achieve Millennium Development Goals (MDGs). As the result, Ethiopian economy
witnessed sustainable double digit broad based growth. In 2010/11, real GDP growth was 11.4 percent
moderately higher than the year earlier.

Ethiopia’s economy is based on agriculture, which accounts, in 2010/11, for about 41.10 percent of the
gross domestic product (GDP), 90 percent of foreign currency earnings, and 85% of employment.
Generally, the overall economic growth of the country has been highly associated with the
performance of the agriculture sector.

Coffee is critical to the Ethiopian economy. It earned US$ 841.8 million in exports in 2010/11. Other
important export products (2010/11) include gold, oil seeds, chat, flowers, live animals, pulses, leather
and leather products, meat and meat products, fruits and vegetables.

The industrial sector, which mainly comprises small and medium enterprises accounts for about 13
percent of GDP. Similarly, the service sector comprised of social services, trade, hotels and
restaurants, finance, real estate, and transport and communication etc. accounts for about 46 percent of
GDP in the year 2010/11.

Real GDP grew by an average of 10.4 percent in year 2010/11, which places Ethiopia among the top
performing economies in Sub-Saharan Africa despite world economic meltdown and global financial
crisis. All sectors contributed to this relatively high economic growth. Accordingly, agriculture,
industry and services grew by an annual average of 9, 15 and 12.5 percent, respectively during the
indicated period. During, 2008/09, 2009/10 and 2010/11, the general annual inflation was 36.4, 2.8,
and 18.1 percent respectively. It was predominantly due to the hike in price of food items. At the end
of 2010/11, the average marginal exchange rate in the inter-bank foreign exchange market was Birr
16.53 to US$ 1 as compared to Birr 13.68 to US$ 1 in 2009/10.

Ethiopia’s economy continue to register strong and robust growth the real GDP grew by 10.3 percent
in 2013/14, showing growth acceleration compared to 9.7 in 2012/13 and 8.8 percent in2011/12. The
share of services and industry sectors in the economy is increasing in contrast to that of agriculture
which is declining. For example, in 2013/14 the shares of services, agriculture and industry stand at 46
29
percent, 40 percent and 14 percent, respectively, in contrast to 45percent, 43 percent and 12 percent,
respectively, in the preceding year. The annual growth in the industry sector was quite significant
(21.2 percent) mainly driven by exuberant performance the construction sub- sector. Growth rates of
the agriculture and service sectors were estimated to be 5.4 percent and 11.9 percent respectively.
Concerning the sectors contribution to the 10.3percent real GDP growth, 5.3 percentage points (51.5
percent) is attributable to the service sector, 2.7 percentage points (26.2 percent) to the industry sector
and 2.3 percentage points (22.3 percent) to the agriculture sector.

With regard to sources of the growth, the economy still depends on very few subsectors. For instance,
64 percent of the real GDP growth is contributed by three sub-sectors, namely, crop production,
construction and wholesale and retail trade. The share of manufacturing sector in total GDP remains
low at 4.4 percent. This indicates that the structural transformation is very slow; agriculture still takes
the lion’s share (73 percent) in terms of employment followed by service sector (20 percent) and
industry (7 percent). The employment in the service sector increased from 13.3 percent in 2005 and to
20 percent in 2013, while the share of the sector in total production increased from 38 percent to 45
percent in the same period.
On the expenditure side, the share of private consumption expenditure has declined from 72.5 percent
in 2012/13 to 69.5 percent resulting in the increase of the share of gross domestic savings from 19.2
percent to 22.5 percent in the same period. This could be attributable to the efforts geared towards
introducing different saving instruments such as bonds and savings for housing scheme.

Average saving interest rate remained unchanged at around 5.4 percent just a little above 5 percent the
minimum (floor) rate set by the central bank while average Lending rate was 11.8 percent. Bond yields
and Treasury bill rates remained low at 3.67 percent and 1.26 percent respectively.

Inflation continued to be contained in single digit range. By end of the first quarter of 2014/15
inflation was lowest since April 2013. Year-on-year Inflation was 5.4 by at the end of October 2014
which is a significant decline compared to its level in the same period last year of 8.5 percent. The
major decline in inflation is observed in food and non-alcoholic beverages category which decreased
from 7.8 percent to 2.9 percent over the same period. Non-food inflation decreased only moderately
from 9.1 percent in October 2013 to 8.3 percent in October 2014. Inflation in Ethiopia is mainly
determined by the agricultural production, as food and beverage category takes 53 percent of the

30
household expenditure. In addition, the high import dependence of the economy that Ethiopia is
importing essential intermediate inputs, capital goods, fuel and raw material

made the country prone to imported inflation. Accordingly, good harvest and favorable price
conditions mainly in Ethiopia’s trading partners have helped the inflation to remain in single digit,
besides the coordinated fiscal and monetary policy effort.

4.1.2. Performance Requirements and Investment Incentives

Ethiopia does not formally impose performance requirements on foreign investors. The 2003
amendment to the Investment Proclamation outlines investment incentives for investors in specific
areas. New investors engaged in manufacturing, agro-processing activities, or the production of certain
agricultural products, who export at least 50% of their products or supply at least 75% of their product
to an exporter as production inputs, are exempt from income tax for five years. An investor who
exports less than 50% of his product or supplies his product only to the domestic market is income tax
exempt for two years. Investors who expand or upgrade existing enterprises and export at least 50% of
their output or increase production by25% are eligible for income tax exemption for two years. An
investor who invests in the ”developing regions” of Gambella, Benishangul Gumuz, South Omo, Afar
or Somali Region will be eligible for an additional one-year income tax exemption. An investor who
exports hides and skins after processing only up to crust level will not be entitled to the income tax
incentive. A special loan fund through the Development Bank of Ethiopia (DBE) provides land at low
lease rates for priority export areas such as floriculture, leather goods, textiles and garments, and agro-
processing related products. An investor can borrow up to 70% of the cost of the project from this
special fund without collateral upon presenting a viable business plan and 30% personal equity.

Investors are allowed to import duty-free capital goods and construction materials necessary for the
establishment of a new enterprise or for the expansion of an existing enterprise. In addition, spare parts
worth 15% of the value of the capital goods can be imported duty-free. This privilege may not be
granted if comparable capital goods or construction materials can be produced locally and have
competitive prices, quality, and quantity. Imported duty free capital goods can no longer be used as
loan collateral. Travel agencies/tour companies have increased duty-free privileges for the importation
of goods such as vehicles, provided they are used solely in tourism activities.

31
The Ministry of Agriculture's (MOA) Agricultural Investment Support Directorate offers grace periods
of up to seven years on land rents. The Directorate is currently focused on land deals in the remote
regions of Gambella, Benishangul Gumuz, Southern Nations, and Afar.

4.1.2.1. The Private Sector in Investment

We have seen earlier that the GDP share of the private sector was 84.8 per cent in nominal terms in
2008/09, of which agriculture accounts for 49.9 per cent. Excluding agriculture, the private sector
share in GDP is 34.9 percent, with a 6 percent share of GDP coming from industry and the balance of
28.9 per cent from service sectors. Within industry, the private sector share from manufacturing and
construction is 2.7 per cent and 2.6 per cent, respectively. In the service sectors, private sector has a
share of 14.6 per cent from trade, 3.2 per cent from hotels and restaurants and 6.9 per cent from real
estate, and business services. At constant prices, however, the GDP share of the private sector was
80.1per cent in 2008-09, of which the share coming from agriculture was 42.3percent.This leaves the
share of GDP coming from private industry at 6.8 per cent and services at 31.8 per cent. These shares
are higher than those at current prices. With in industry, the private sector share comes mainly from
manufacturing (3.3%) and construction (2.8%). On the other hand, the private share in GDP from
services is mainly from the activities of trade (13.6%), hotels and restaurants (3.4%) and real estate
and business services (8.2%).

The sectors composition of gross fixed capital formation25 (GFCF) in Ethiopia during the 5 years
ending in2008-09; as data on investment are available only at current prices, these are presented here.
The table shows that the bulk of investment made in 2008-09 was in private corporations, with a share
of 40.5 per cent. In fact, general government, which had been the leading investor until 2007-08 with a
share of 35.9 per cent, was overtaken by private corporations in 2008-09 as the largest investor among
the institutional sectors in Ethiopia. However, if we consider the public sector in totality, it is still the
main sector of investment, at 53.9 per cent in 2008-09, though its share has fallen from a high of 66.3
per cent in 2006-07. The private sector share in total investment in Ethiopia during 2008-09 was 46.1
per cent, of which the investment share of household sector was a mere 5.6 percent. In terms of rates
of investment26 too, the picture of investment among institutional sectors remains the same. The rate
of investment of private corporations in 2008-09 was 9.1 percent, as against the investment rate of 8.5
percent for general government. The public and private sectors’ rates of investment in 2008-09 were
32
12.1 percent and 10.3 percent, respectively. Between 2007-08 and 2008-09, the investment rate of
public sector fell from 14.2 percent to 12.1 percent, while in the same period, private sector investment
rate rose from 8.3 percent to 10.3 percent of GDP.

The steepest fall in investment rate in this two-year period was in public corporations, which declined
from 6.1 percent to 3.6 percent. Private sector investment grew at an average annual rate of 34.7
percent between 2004-05 and 2008-09; this compares with average annual growth of 30.7 percent in
the public sector. The average annual growth was highest in private corporations’ at 35.4 percent,
followed by general government with a growth rate of 33.2 percent.

4.1.2.2. Foreign Direct Investment

It is an undeniable fact that Ethiopia has made a considerable progress in economic and social
development since 1995 as a result of the implementation of favorable policies and strategies that are
instrumental in improving the national economy.

The Rural Development Policy and Strategy, the Industrial Development Strategy, and other sectors
policies and strategies have initiated a new push towards creating frameworks conducive to economic
and social development.

The Rural Development Policy and Strategy, which is under implementation in the country, underlines
that agriculture-centered development will bring about fast economic growth, enable its people
become beneficiary of economic growth, and lay solid foundation for industrial development.

The Industrial Development Strategy focuses on export manufacturing with priority given to textile
and garments, leather and leather products, agro-processing, and small and micro-enterprises.

The Government of Ethiopia in recognition of the role of the private sector in the economy has revised
over four times the Investment Code over the last twenty one years (2003-2023) to make it more
transparent, attractive and competitive. Major positive changes regarding foreign investments have
been introduced through Investment Proclamation No.769/2012.

As a result of the implementation of the above mentioned policies and strategies, agricultural and
industrial production, investment and export trade are growing steadily from year to year both in terms
of variety and volume. Export earnings from gold (64.1 percent), fruits and vegetables (0.1 percent),
live animals (63.0 percent), chat (13.7 percent), pulses (6.0 percent), coffee (59.3 percent), flower (3.0

33
percent), meat (86.2 percent), oil seeds (-8.9 percent) , leather and leather products (84.1 percent) and
other (94.7 percent) have been increased in 2010/11. The World Bank has also witnessed the double-
digit economic growth registered in the last several years. This achievement is the highest among the
non-oil producing economies of Africa.

Due to the investment-friendly environment created in the country, the inflow of foreign direct
investment (FDI) has been increasing over the last twenty one years. Accordingly, out of the total
investment projects licensed between 1994- 2022, FDI’s share is about 15.80 percent. However, the
overall trend of investment in 2022 both the total number of projects and capital invested have shown
slight increase.

Ethiopia remains an untapped and unexploited market for investors. China, India, Sudan, Germany,
Italy, Turkey, Saudi Arabia, Yemen, the United Kingdom, Israel, Canada and the United States are the
major sources of FDI.

The Ethiopian government has formulated the five year Growth and Transformation Plan (GTP) to
carry forward the important strategic directions in maintaining a fast growing economy in all sectors.
Accordingly, Ethiopia’s economy is projected to grow at an average growth rate of 11.2 percent.
(IBID)

4.1.2.3. Regional Share of Private Investment in Ethiopia

This section presents the summary of regional share of investment by region during the last 22 years
period of incumbent government, Ethiopian People Revolutionary Democratic Front (EPRDF). Nearly
half of the capital investment is in Addis Ababa (45.8%) followed by Oromia (26.1%), Amhara
(7.5%), Multiregional (7.2%), Tigray (6%) and SNNPR (4.87%). This distribution portrays that
around 70% of the investment is concentrated in Addis Ababa and Oromia region.

Spatial economics have various justifications why such agglomeration happens. Firstly, though, there
is cheap rent land in regions, investors prefer Addis Ababa to minimize the transportation cost. The
outermost ring investment would consist of either land-intensive or cheaply transported items. The
import-export in Djibouti route, cargo airport and domestic market is very favorable in Addis Ababa
and Oromia special zones, which is very applicable in the context of location theory. Secondly, most
of the wealthier persons are concentrated in Addis Ababa, which create high nearby demand. The
1995/96to 2004/05 consumption and expenditure survey of Ethiopia portrays that only Addis Ababa,

34
Harari and Diredawa persistently show high levels of income at all times (MOFED 2005). Thirdly,
there happens small cost of production in the presence of educated and uneducated labor market
pooling that can favor technology spillover. Alfred Marshal sets this as one of the external economies
that agglomerated firms create. Studies also show that agglomerations are minimal or nonexistent in
small towns

4.1.4. Challenges of the Investment

Investment is increasing across period in the country. However, there are basic hindering challenges
which some of them are presented in this paper. Firstly, some of the investors are nominal and do not
invest trust-worthily.

Some others start building and stop after a certain period; and others fence and rent the land: other
than the intended purpose, which the case is getting worse as the concerned authority did not took
immediate measure for such occurrences. As presented on Reporter Magazine Amharic Version, 2006
E.C, based on the assessment made by Urban Renewal and Land Bank Office, long period fenced 109
investment plot of lands were found in Arada, Bole, Yeka, Nifas Silk Lafto, Gulele and Lidetasub-city
administrations. However, its macroeconomic level detail cause and effect analysis needs further
research. Secondly, one of the basic factors for development is the favorability of investment
environment. The Federal Anticorruption Commission conducted a study through “Selam
Development” research organization. The study was on Foreign Direct Investors to Ethiopia about
their corruption experience in government services. The survey finds out that, most of the investors do
not have trust on government for the reason that offices are corrupted. Except Latin America and
Antarctica, the sample contains 350 companies representing 42 countries. The finding from the 350
companies shows that: 20% of them stated government procurement contracts are made non-
transparently 71% of them believe it is difficult to run business in the country because of corruption
and very complex and procedural procurement 67.4% of them stated in order to break the bureaucratic
problems, they give corruption for government top officials and workers thinking as there is no other
alternative solution.

These investors were asked to rank the top corrupted government offices and it was found that 18.9%
put Ethiopian Revenue and Customs Agency 8.3% Transport Authority 7.4 % Land Administration
6.5% Ethiopian Electric Power Corporation (IBID).

35
This is a big homework for the country, which is an obstacle for attracting FDI. Of course, as
compared to previous periods, there is a good start from the government in capturing corruption
particularly in the Ethiopian Revenue and Customs Agency officials. Thirdly, for sustainable
development domestic mobilization of saving for investment is critical. In this regard, MOFED (2005)
reported that though the government has increased capital expenditure to public investment, the
growth rate of private investment is relatively small which it is not stimulated as expected. Moreover,
the investment is surrounded with problems such as:

The private sector investment is favoring the service sector investment, rather than agriculture and
industry and fails to make sector-wise link in the economy

Per capital saving is very small as compared to the per capital income growth. However, still it is very
challenging because the economy is dominated by the hand to mouth subsistence agriculture. As a
result, there is large gap between domestic saving and investment which it makes to need foreign
finance.

The high inflation rate is discouraging the amount of income (interest) that can be obtained through
saving.

The private investment is largely dominated by the FDI, but not the domestic investment.

4.1.5. Policy discussion

Ethiopia has achieved considerable success in implementing its development strategy, but sustaining it
is increasingly challenging. Recent macroeconomic stability, with robust economic growth and single
digit inflation, is not fully entrenched in the presence of negative real interest rates, an overvalued
exchange rate, and low reserve coverage. Growth has also fluctuated in the context of global and
domestic shocks and the country remains vulnerable to terms of trade shocks. Export diversification
and competitiveness lag behind those of other African countries.

Achieving high growth rates set out in the GTP requires continued investments and resource
mobilization. The GTP envisages a significant part of investment to be undertaken by public
enterprises with average annual borrowing over the five year period of some 15 percent of GDP, of
which some two-thirds is to be borrowed externally. With binding external financing constraints,
critical investments need to be financed increasingly from domestic sources, implying a need to
mobilize substantial domestic savings. The current level of domestic savings is insufficient to finance
36
the high public investment. The in the short run is limited. At the same time, the government’s policy
of keeping the real interest rates negative is not conducive to saving and distorts financial
intermediation. Experience in the first three years of the GTP suggests that large scale public
investment financed domestically squeezes the availability of credit for the rest of the economy. Thus,
an adjustment in policies to establish better balance between the public and private sectors is
warranted. There is also a risk that the investment levels envisaged under the development strategy
may run up against the absorptive capacity of the economy.

Policy discussions focused on sustaining high economic growth while preserving macroeconomic
stability and debt sustainability. Key recommendations include (Ι) rationalizing and prioritizing public
sector investment, especially for state-owned enterprises; (ii) real and external sector reforms to
support structural transformation; (iii) strengthening financial sector policies to promote inclusiveness
and market development, bringing real interest rates to positive levels, and ensuring more flexible
exchange rates and higher exchange reserves; and (iv) improving the business environment and
expanding the private sector’s role in the economy. The implementation of these recommendations
would facilitate financial development that should enable less distortionary financing of the GTP that
is consistent with debt sustainability.

4.2. Econometrics analysis

4.2.1. Estimation technique

The researchers stressed on ordinary least square methods which used to point the time series data in
the good path. Even the above is clear guarantee, the introduction of different techniques become
necessary to test those of the above are in the normal track or not. To get those of consistent estimation
of relationship between this dependent variable, private investment with their own respective
explanatory variables; the data series must be tested for stationary or non stationary. In doing so the
non stationary conditions should be changed to stationary condition. This is because, if a time series is
non stationary, we can study its behavior only for the time period under consideration. Each set of time
series data will be for a particular episode. As a consequence, it is not possible to generalize it to other
time periods (Gugarati, 2004).

It is possible to change non stationary time series to stationary form through the process of
differencing. That is by differencing log value for the successive period lags until the trend become
dumps.

37
Formally, stationary can be checked by finding out if the time series contains a unit root. The Dickey
Fuller (DF) and Augmented Dickey Fuller (ADF) test can be used for this purpose. But for our case
the Augmented Dickey Fuller (ADF) become the best and used to identify the existence of unit root.
Since it is the most appropriate type of unit root test and it is mostly used by some empirical studies.

4.2.2. Stationary test

This section reports the stationary test of the study. The source of all data used here are national bank
of Ethiopia, World Development Indicators and Ethiopian Investment Agency. The series
econometrics study is not complete without performing stationary test on the variable used study. The
regression runs on non stationary time series variables produce spurious result, which are meaningless.
Therefore, it is important to make sure that variables are stationary. This means that a stationary time
series has three characteristics mainly finite mean, variance and auto covariance over time (Guajarati,
1995). Unit root test method is used for stationary test of this study. For this purpose ADF tests for
unit root are applied for each variables used in the analysis.

Table 4.1: ADF unit root test, sample for (1994-2024) stationary at level

variables Test static's 1% critical 5% critical 10% critical p-value

value value value
Lnpri 1.164785 -3.626784 -2.945842 -2.611531 0.9973
Lnrgdp 3.820310 -3.626784 -2.945842 -2.611531 1.0000
Lnrlir -1.716364 -3.626784 -2.945842 -2.611531 0.4147
Lninf -4.197190 -4.234972 -3.540328 -3.202445 0.0110
Lnree -1.743783 -3.626784 -2.945842 -2.611531 0.4014
Inflation rate is stationary at level but other variables except inflation rate are non-stationary at level
according to this test.

Table 4.2. ADF unit root test for stationary at 1st difference

Variables Test static's 1% critical 5% critical 10% critical P-value

value value value

38
 Dlnpri -4.638200 -3.632900 -2.948404 -2.612874 0.0007
Dlngdp -3.381533 -3.632900 -2.948404 -2.612874 0.0185
Dlnrlir -6.610011 -3.632900 -2.948404 -2.612874 0.0000
Dlninf -8.553593 -3.639407 -2.951125 -2.614300 0.0000
Dlnreer -5.202156 -3.632900 -2.948404 -2.612874 0.0001
According to the test all variables are stationary at 1st difference.

MacKinnon approximate p-value for Z (t)

Reject H0*_ at d_ is 1st difference stationary test

4.2.3 Regression Analysis

Long run analysis

Table 4.3.: regression analysis

Variables coefficient Standard error Test –test p>t

Lnrgdp 1.836016 0.122977 14.92978 0.0000

Lnrlir 1.518082 0.353327 4.296540 0.0002

Lninf -0.089086 0.078876 -1.129440 0.2686

Lnreer -2.152522 0.326790 -6.586869 0.0000

Constant -13.23673 2.392274 -5.533114 0.0000

OLS regression Number of obs = 36

F (4, 32) = 94.40s

Prob > F = 0.0000

R-squared = 0.9219

Adj R-squared = 0.9121

Root MSE = 3.7e+09

39
The model summarized as follows:

lnPri = -13.23673 + 1.836016RGDP + 1.518082RLIR - 0.089086INF -2.152522 REER+Ei

SE (2.392274)) (0.122977) (0.353327) (0.078876) (0.326790)

+Ei

The result analysis based on economic criteria as shown the above specified model can be seen as
follows:

 Determinant factor which have significant positive effect on private investment (PRI) is
real GDP growth rate. A 1% increase in RGDP results in a 1.836016 percent increase in
private investment. This increase in RGDP is believed to have raised the effective
demand in the economy through increased disposable income. Such increased in
effective demands for goods and services have stimulated more private investment in
the economy over the period under study.
 From the findings, there is a positive relationship between real lending interest rate and
private investment, the coefficient of real lending interest rate is 1.518082 which
implies that a one percent increase in real interest rate will increase private investment
by 1.518082 percent.

 Inflation is statistically insignificant with negative sign. With the P-value of 0.2686
and coefficient of -0.089086.

 From this finding, there is a negative relationship between real effective exchange rate and
private investment, the coefficient of REER is -2.152522 which imply that a one percent
decrease in real effective exchange rate (REER) will increase private investment by 2.152522
percent.

 The F – statistics test: the test is conducted to determine if the independent variables in the
model are simultaneously significant or not.

40
 k–1=4–1=3
n – k = 36 – 4= 32

From the result, since Fcal > Ftab i.e. 62.35 > Ftab
Therefore we reject the null hypothesis Ho and accept the alternative hypothesis H1 and conclude that
all slope coefficients are not simultaneously equal to zero i.e. the independent variables are
simultaneously significant.
 T-test is used to determine of the significance of the individual parameter stimulated t-value
in the regression result with the t-tabulated at n-k degree of freedom (df) and at 5%
significance level.
HO: βi = 0 (not significant).
HI: βi = 0 (statistically significant).
Note: The null hypothesis assumes equality of each of the coefficients of the parameter (βi) to be zero
(0) which means that each of the variables does not have significance impact on private investment,
but the alternate hypothesis (H1) assumes none of the coefficients of parameter (βi) to be zero which
means that each of the variables has significant impact on private investment.
Decision rule
Reject H0, if Tcal > Ttab and accept, if otherwise
From our data, n = 36 and k = 4
df = n – k = 32 at 1%, 5% , and 10% significance level are show below.

The result of the analysis is summarized in table 4.4 below:

Variable T calculated 1% 5% 10% Decision rule Conclusion

RGDPgr 2.38 2.58 1.96 1.62 Reject Ho Significant⃰⃰⃰ ⃰

RLIR 2.04 2.58 1.96 1.62 Reject Ho Significant⃰ ⃰

INF 3.09 2.58 1.96 1.62 Reject Ho Significant⃰ ⃰ ⃰

REER 1.20 2.58 1.96 1.62 Accept Ho Insignificant

41
 GFCF 10.62 2.58 1.96 1.62 Reject Ho Significant⃰ ⃰⃰⃰ ⃰

Significant⃰⃰⃰ ⃰_ significant at 5% and 10% significant levels

Significant⃰ ⃰ ⃰_significant at both significant levels

From results obtained in the regression, the result is expected to follow a prior expectation of
magnitude and sign. Thus,

table 4.5 below, analyses the outcome of the parameters

Variable Expected Obtained Correlation

RGDPgr Positive Positive Conform

IR Negative Positive Not conform

INF Negative Negative conform

REER Negative Negative Conform

 R2 is used to test the goodness of fit from the regression results; the value of R 2 is
0.9219implies that in the long run, 92.19% of the variations in private investment is explained
by the independent variables (real GDP growth rate, real lending interest rate, inflation rate,
real effective exchange rate).

Here after the researchers try to test whether the given model are free from major estimation problem
that is multicollinearity, autocorrelation and test like normality and model specification.

42
A. Multicollinearity

Multicollinearity is the term which is used in order to show the linear relationship between the
explanatory variables not the dependent and independent variables. Multicollinearity problem arises
from the use of large values of explanatory variables in the model, when the numbers of variables
exceed the number of observation. A high multicollinearity results a parameter instability, wrong
decision and model specification; and insignificant individual test statistics. There are a certain rule
used to detect the multicollinearity there are tolerance statistics and variance inflation factor (VIF),
step by step regression, examination of bigger value and condition index and farrar-glibber test. The
researchers use the first rule of multicollinearity test. The decision rule is when the mean of variance
inflation factor is below ten (10), then the presence of multicollinearity problem become less and less.

Table 4.6 variance influence factor (VIF) for testing multicollinearity

Variable VIF 1/VIF

RGDP 1.84 0.544572

IR 2.65 0.376654

INF 1.31 0.761061

REER 2.28 0.439166

Mean VIF 2.02

Source: STATAs results

Test for correlation matrix

It is other test to avoid the problem of multicollinearity on the model specification of this specific
study. The correlation between each independent variable should be less than one and the correlation
alone each variables are exactly equals to one, since they are correlated correctly and which shows that
there is no multicollinearity problem in our model specification. See the result from the appendix part.

43
B. Autocorrelation test

“If the residual are correlated among them (this correlation is called autocorrelation), one has to look
for the pattern of this correlation. One statistics that is often used is the Durban Watson statistics”
(Gujarati, 2006). The Durbin Watson shows that there is no autocorrelation; therefore we accept the
Null hypothesis (Ho), when (du < d < 5 – du). Or dl < d< du. The study illustrated that computed
Durbin-Watson d-statistic (4, 32) = 2.053612; after 1 st difference. Then this value is needs to
compare with that of d-statistics from Durban-Watson table. The value dL (lower limit of d-statics) =
0.971 and the du (the upper limit of d-statistics) = 1.589, so for this test, (1.589 <2.053612<3.411). Or
(0.91 < 1.03 < 1.589); by taking the autoregressive estimation test to correct autocorrelation problem.
(Therefore; accept the null hypothesis of no autocorrelation, and the researchers definitely conclude
that model could be free from autocorrelation problem.

C. Test for normality

Test for normality means that determining whether the data is measured by normal distribution or not.
This test of normal distribution may take place by non graphical (Shapiro-Wilk W test for normal
data) method of test the decision rule behind the Wilk W test for normality states that if the p-value
error term is greater than at the chosen level of significance, 1%, 5%, 10%, indicates that, the error
term are normally distributed (Gujarati, 2006). Table 4.4 below, shows the result or Shapiro- Wilk W
test for normal data test for normality. Because, the value of error terms in the stated table, shows that,
the p-value (0.57049) is greater than 0.05. As a result the researchers conclude that the error term of
the specified model, are found to be normally distributed.

Shapiro-Wilk W test for normal data

Shapiro-Wilk W = 0.973701, with p-value 0.57049

Source: own computation of Gretel results

D. Test for model specification

Testing the model is very important to check out whether one or more relevant variables are omitted
from the model irrelevant variables are included in the model. There are different methods to detect

44
specification error of the model. The link test and Ramsey rest test for omitted variables are commonly
used methods in the test. The researchers use the link test for this purpose.

The link test for specification of the model creates two variables of prediction (-hat and –hatsq). The
decision rule behind these two variables states that hat’s p-value is expected to be statistically
significant but the variable hatsq should be statistically insignificant (p-value > significant level)
which tells the model is specified correctly. The p-value of the –hat lies at 1% level of significant
(0.000%) where as the squared prediction (-hatsq) is indicating insignificant which is 65.15%>5%.

Table 4.7; link test for model specification

logPI | Coef. Std. Err. t P>|t| [95% Conf. Interval]

-------------+----------------------------------------------------------------

_hat | 0.72631 0.60265 1.205 0.2370 -0.50125 1.95388

_hatsq | 0.01407 0.03086 0.456 0.6515 -0.04879 0.07693

_cons | 1.29718 2.88787 0.449 0.6563 -4.58522 7.17958

45
CHAPTER: FIVE

5. Conclusions and Recommendation

5.1 Conclusion
The existence of economic growth which is the objective of every society is achieved with the efficient
allocation of the existing resource in appropriate manner. One of the important factor for such
economic growth and efficient allocations of resource is the development of private investment.

Private investment in the derg regime was not that of much attractive. Many structural and economic
problems were relevant during due to the shift in resources ownership from private hand to
government. This implies private sector was discouraged during the regime. The current government
of Ethiopia; however, developed a policy in contrast with that of the derg regime. That is encouraging
private investment and liberalizing the market through the appropriate policy is the main concern of
the government. Moreover, many policy instruments to encourage investors to participate in the
diversified sector of the economy (service, agriculture, manufacture …) are also the main concern of
the current government. Even if the private investment is encouraged by the current government of
Ethiopia, its distribution is not equitable. The descriptive result shows that private investment in
Ethiopia is mainly distributed in one city administration Addis Ababa and the two regions amhara and
tigray holds 63% of private investment some periods. The study offers an econometric analysis of
macroeconomic factors that can be potentially affect or determine private investment in the short run
and long run perspectives. Both theoretical and econometrics analysis are taken to identify a private
investment function for the last 36 years (1980-2016).

Accordingly, the result of econometrics OLS regression analysis shows that rising of real GDP growth
rate per share of each person’s per capital incomes; which have a crucial positive effect on private
investment through a way of increasing market demand for goods and services. On the other hand,
high and protracted inflation rate could undercut private investment by signaling macroeconomic
instabilities, and thereby weakening investors’ desire and ability to invest. Likewise, unpredictable and
in efficient investment climate (which could be due to reasons such as frequent changes of investment
policies and requirements, inefficient bureaucracy prolonged poor governance rampant corruption

46
among others) would deteriorate investors confidence and appetite. As per econometrics regression
result shows that all the explanatory variables in our case have a significant effect on private
investment after 1st difference of logarithmic value of private investment, real effective exchange rate .

5.2. Recommendations
In the light of the finding above, the researcher has advanced or developed the following
recommendation or suggestion:

The government should give attention to the growth of real GDP. This is because real GDP is a great
significant factor which determines private investment,

A mere development or growth of investment should not be the concern of the government. But it
should also look and do for the equitable distribution of private investment among all regional states of
Ethiopia rather than concentrating those plants in a single place,

Low value of local currency constrained private investment. The positive relationship of real effective
exchange rate and private investment suggests that the real effective exchange rate encourages private
investment or vice versa. So this finding may suggests that the government decision of devaluating of
the local currency should be continue. Since depreciation of local currency attracts private investment
in the country,

Enhance the real GDP growth rate through rising the per capital income of people by creating various
employment opportunities and income generating means,

The government should create a fertile investment environment by ensuring consistent investment
policies and requirements, by creating clear and efficient bureaucracy and good governance at all
levels, and by opening more investment opportunities for private investors,

Lastly, the researchers suggest the need to conduct a comprehensive study on private investment in
Ethiopia by adequately accommodating the essential qualitative and quantitative factors or
determinants of private investment for proper policy actions and decisions.

47
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50
Appendix
. gen logPI=ln(PI)

. reg logPI RGDPgr RLIR INF REER GFCF

Source SS df MS Number of obs = 35

F( 5, 29) = 64.98
Model 71.2249716 5 14.2449943 Prob > F = 0.0000
Residual 6.35693435 29 .219204633 R-squared = 0.9181
Adj R-squared = 0.9039
Total 77.581906 34 2.28182076 Root MSE = .46819

logPI Coef. Std. Err. t P>|t| [95% Conf. Interval]

RGDPgr .040381 .015223 2.65 0.013 .0092466 .0715155

RLIR .0559265 .0303014 1.85 0.075 -.0060468 .1178998
INF .0907097 .0305849 2.97 0.006 .0281565 .1532629
REER .0023077 .0021687 1.06 0.296 -.0021279 .0067433
GFCF 13.16762 1.210312 10.88 0.000 10.69225 15.64298
_cons 5.138693 .5790087 8.87 0.000 3.954487 6.322899

. tsset Year, yearly

time variable: Year, 1980 to 2014
delta: 1 year

. dfuller logPI, lags(0)

Dickey-Fuller test for unit root Number of obs = 34

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) 1.078 -3.689 -2.975 -2.619

MacKinnon approximate p-value for Z(t) = 0.9950

51
 ___ ____ ____ ____ ____ (R)
/__ / ____/ / ____/
___/ / /___/ / /___/ 12.0 Copyright 1985-2011 StataCorp LP
Statistics/Data Analysis StataCorp
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Special Edition College Station, Texas 77845 USA
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Single-user Stata network perpetual license:

Serial number: 93611859953
Licensed to: STATAforAll
STATA

Notes:
1. (/v# option or -set maxvar-) 5000 maximum variables

. dfuller RGDPgr, lags(0)

Dickey-Fuller test for unit root Number of obs = 34

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -4.621 -3.689 -2.975 -2.619

MacKinnon approximate p-value for Z(t) = 0.0001

. dfuller RGDPgr, lags(1)

Augmented Dickey-Fuller test for unit root Number of obs = 33

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -4.212 -3.696 -2.978 -2.620

MacKinnon approximate p-value for Z(t) = 0.0006

52
. dfuller INF, lags(0)

Dickey-Fuller test for unit root Number of obs = 34

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -3.978 -3.689 -2.975 -2.619

MacKinnon approximate p-value for Z(t) = 0.0015

. dfuller REER, lags(0)

Dickey-Fuller test for unit root Number of obs = 34

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -1.776 -3.689 -2.975 -2.619

MacKinnon approximate p-value for Z(t) = 0.3922

. dfuller GFCF, lags(0)

Dickey-Fuller test for unit root Number of obs = 34

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) 0.635 -3.689 -2.975 -2.619

MacKinnon approximate p-value for Z(t) = 0.9884

53
. estat vce, correlation

Correlation matrix of coefficients of regress model

e(V) RGDPgr RLIR INF REER GFCF _cons

RGDPgr 1.0000
RLIR -0.1966 1.0000
INF -0.1873 0.9602 1.0000
REER 0.0162 0.3919 0.2759 1.0000
GFCF -0.2680 -0.2014 -0.2865 0.3726 1.0000
_cons 0.0660 -0.6346 -0.5500 -0.8874 -0.4370 1.0000

54