A global nexus: Regulatory reform and an ambitious national development programme further connect the country with global trade flows

Located at a juncture point between Africa, the Middle East and Asia, Djibouti’s geography has become its principal economic advantage. Easy access to international trade routes via the Gulf of Aden and the Red Sea, as well as its border with fast-growing yet landlocked Ethiopia, make it an ideal continental hub to transport goods. New ports, railway links and road improvement projects are being integrated to enhance economic efficiencies and provide a more solid platform to bolster expansion in other sectors. These factors combined have led to two consecutive decades of GDP growth.

Fast growth rates, however, can mask some of the country’s main challenges, such as high unemployment, persistent poverty, and insufficient access to education and health services for a large proportion of its citizens. Furthermore, the hot climate and arid landscape make it particularly vulnerable to the effects of climate change. Lacking in significant agricultural resources, Djibouti remains exposed to abrupt rises in the price of food and other commodities in international markets.

By improving the conditions for transport and logistics, however, the authorities hope to support the development of other sectors, and encourage economic efficiencies to be passed on to small and medium-sized enterprises (SMEs). This will require continued investment in infrastructure, easing of business regulations and addressing gaps in human resources.

DEVELOPMENT DRIVE: A handful of key factors have been jointly driving Djibouti’s economic performance. GDP grew by 6.8% in 2017, according to figures from the African Development Bank (AfDB), which projected a 6.9% expansion in 2018 and 2019. According to IMF statistics, nominal GDP stands at $2.19bn in 2018, and is predicted to reach $2.38bn in 2019 and surpass $3bn by 2022. One major force behind this growth has been the burgeoning economic activity in neighbouring, landlocked Ethiopia, which has posted an annualised growth rate of 10% for the past decade. The country depends heavily on Djibouti to mobilise its heavy import and export traffic, which have been sustained by years of high growth rates. With Djibouti handling 95% of Ethiopia’s inbound traffic, the spill-over effect has been significant to the country’s maritime activity. The volume of containers handled by Djibouti increased from 600,000 twenty-foot equivalent units in 2010 to 987,000 in 2017, according to UN statistics.

Beyond trade towards Ethiopia, the rising tide of Chinese investment across Africa and the Middle East as part of the Belt and Road Initiative has seen it channel financing resources into large-scale transport and logistics assets. In Djibouti’s case, this has led to the development of port infrastructure and a new railway link to Ethiopia. Chinese economic interests are also underlining the creation of several free trade areas to support growth in regional transit of goods.

Its strategic advantage for port operations, coupled with the rents it receives from military bases, are allowing to leverage its geographic position and attract foreign direct investment (FDI). However, Djibouti’s natural conditions, with fewer than 1000 sq km of arable land and very limited rainfall, make the long-term case for diversified-development more challenging. “As the transport sector becomes increasingly automated, its ability to create jobs is now limited,” Mamadou Ndione, senior economist at the World Bank, told OBG.

This underscores the need for economic diversification as a means to establish inclusive, long-lasting development. So far, Djibouti’s economic growth has been based on capital-intensive activities with a limited impact on employment creation, something the authorities hope to change over the coming years.

PLANNING AHEAD: As a means of improving conditions on the ground, policymakers are enacting a series of economic and development measures. Most of these are included within the government’s national development strategy: Djibouti Vision 2035. Launched in 2014, the plan’s central goal is to transform Djibouti into a middle-income economy, and a regional transport and logistics centre. It aims to triple per capita income, create an additional 200,000 jobs by 2035, and achieve annual growth rates of between 7.5 and 10% over the same period. Achieving this will depend on how well policymakers can harness current investment flows and GDP growth to secure economic diversification.

The implementation of the overall initiative will be divided over several five-year plans. The Strategy for Accelerated Growth and Employment, the first of these plans, was launched to cover the priority policy measures during the 2015-19 period (see analysis).

GDP COMPOSITION: Planners hope this long-term policy approach will change the make-up of the Djiboutian economy. The strong emphasis on transport operations has elevated the services sector to a prominent position, accounting for 77.1% of the country’s GDP, according to the AfDB’s 2016 report “African Economic Outlook”.

Within the services sector, two subsectors account for over half of GDP. Transport, logistics and communications, account for 28.4% of GDP; while commerce, retail, auto repair, and tourism, hotel and restaurant services, constitute 22.6% of GDP.

With the tertiary sector accounting for such an important slice of national output, the secondary sector contributes 19.3% of GDP, followed by the primary sector, representing just 3.6% of the Djiboutian economy. This is unusual when compared with other African economies, which tend to have larger agriculture sectors. A small agricultural output presents added challenges in terms of food availability, raising Djibouti’s dependence on imports and exposing the country to commodity price shocks. However, the less developed agriculture sector also has some advantages, registering a smaller degree of informality compared to the many other African countries.

Djibouti’s public sector makes up another critical part of national GDP, representing 17.3% of the economy. Construction remains an important economic driver, accounting for 11.1% of GDP in 2016, despite its dependence on foreign inputs. Manufacturing activities comprised a mere 2.7% of GDP, the same weight it had in 2011, according to figures by the AfDB. Fulfilling the aim of increasing industrial output is therefore one of the government’s primary goals over the coming years, a mission that will face a number of structural obstacles, such as the high cost of energy and labour relative to other countries in the region.

BUDGET: Although efforts to diversify remain a key priority, government spending is likely to continue to contribute to economic growth in the medium term. In December 2017 the government approved a 2018 budget of DJF126bn ($709m), a 5% increase on the 2017 budget. Deficit-reduction efforts have proved effective, although multilateral partners have warned Djiboutian authorities of the rising weight of debt, resulting from the loans used to finance infrastructure development. The actual size of the fiscal deficit, however, depends on the metrics employed. In a 2016 meeting with the IMF, Djiboutian authorities did not include two large infrastructure projects which depend heavily on borrowing – the rail link and water pipeline, both connecting Djibouti to Ethiopia – on their budgetary assessment, according to the IMF’s 2016 Article IV consultation, which was published in April 2017. Without the inclusion of these commitments, the country’s fiscal deficit reached 0.4% in 2016, down from 0.9% in 2015. A further reduction to reach a surplus of 0.3% of GDP was expected in 2017. However, if the two infrastructure projects are included in the budget analysis, the fiscal deficit rises to 16.3% in 2016, down from 21.7% of GDP in 2015.

Relative to other countries in the region, Djibouti has been able to sustain considerable tax revenue as a percentage of GDP. According to a 2016 report by the IMF, tax revenue over the 2000-14 period accounted, on average, for 19% of GDP. Tax and Customs revenue collection efforts are expected to improve over the coming years, as the authorities implement a programme to improve e-government platforms, ease bureaucracy and digitalise a series of public administration procedures. A four-year, $15m World Bank financing programme is under way to accelerate government efforts in digitalisation (see analysis).

HANDLING DEBT: Current economic expansion is being led by large investments in transport infrastructure paid, to a large degree, through borrowing. The majority of the country’s debt obligations, however, are tied to a number of costly but necessary infrastructure projects. Djibouti’s portion of the new rail link between Addis Ababa and Djibouti was estimated at around $570m out of a total cost of $2.5bn. It is expected, though, that the long-term economic benefits will be significant, as the railway will boost the volume and curb the stream the stream of trucks across the border. Another large-scale project is the water pipeline that transports groundwater from Ethiopia into Djibouti, budgeted at $490m and financed by China’s Export-Import Bank. Additional loans from the Kuwait-based Arab Fund for Economic and Social Development, and the Saudi Fund for Development, at $36m and $25m, respectively, were taken to pay for the construction of the port of Tadjourah, inaugurated in mid-2017. In general terms, most transport and energy infrastructure expansion plans are also likely to be funded by supranational or foreign actors.

External financing for these projects is expected to feature prominently on the country’s debt sheets for the years to come. However, its strategy to specialise in transport and logistics makes these large-scale investments a necessity. “In many African countries, debt is not used for investment but for current expenses. But in the case of Djibouti, these loans have been invested in concrete projects, which generate capital,” Ndione told OBG. “The only issue would be whether the financial income is enough to pay the debts.”

The loans are nonetheless expected to push Djibouti’s debt up over the coming years. Between 2013 and 2017 total government debt rose from 48% of GDP to 87% of GDP. Despite the productive nature of the debt, its accumulation does pose a challenge for medium-term budgeting. “Because Djibouti is a small country with a $2bn economy, a loan of $500m is already a quarter of the GDP,” Ndione told OBG. Additionally, Djibouti’s publicly guaranteed debt reached $1.6bn in 2016, according to figures by the IMF, and it was expected to climb to over $2bn in 2018.

Although there is no question that the loans are essential for the country to fully leverage its geographic attributes, their value also underlines the necessity of accompanying these financial commitments with government measures that can unleash private sector development and sustain long-term economic growth. “A combination of strong growth and fiscal reforms are therefore necessary to generate enough resources for the government to service its debt,” the IMF stated in its country report on Djibouti, published in July 2016.

GEOPOLITICAL ECONOMICS: Beyond transport and commerce, Djibouti’s location has brought it a geostrategic importance that goes far beyond the country’s physical size. A handful of nations, including the US, Japan, China, Italy and France, have located military outposts in Djibouti as a means to secure trade routes and direct regional anti-terrorism operations. The presence of these military bases has become an additional source of income for the state budget, with the UN citing the US and Chinese bases bring in $63m and $20m each year, respectively. Camp Lemonnier, the only permanent US base on the African continent and Djibouti’s largest, houses 4000 military personnel and covers over 40 hectares. In addition to the military base, the US also runs a centre for regional drone operations from another facility. Japan recently established a military support facility in a 12 hectare plot and with a resident 170-member force. China inaugurated its Djiboutian military facility in August 2017, its first overseas military base. Although little information about the new outpost has been made public, the Chinese government stated that it would work as a logistics centre and have the capacity to host up to 10,000 troops, according to international media reports. In 2017 local and international media reported that another regional power, Saudi Arabia, was also finalising plans to establish its own military base in the country.

Leasing out space for military bases brings both benefits and challenges. Despite the financial advantages of hosting the military presence of international forces on its soil, the constant movement of military aircraft through the Djibouti-Ambouli International Airport has put greater pressure on runway maintenance. In addition, it has restricted the airport’s operational space, thus challenging the expansion of the civilian transport sector (see Transport and Logistics chapter). The string of nations with a military presence in the country, however, attests to Djibouti’s important geopolitical role in a polarised region of the world.

CHALLENGING POVERTY: Although its commercial and geopolitical importance bode well for Djibouti’s future economic development, poverty remains a key obstacle for the country’s policymakers. Despite the recent increase in FDI, as well as the focus on largescale infrastructure projects, little impact has been seen in terms of comprehensive poverty eradication. A study conducted by the AfDB in 2014 found Djibouti’s extreme poverty rate to be 23%, a 1% reduction relative to 2002 rates. According to the IMF’s Article IV consultation, roughly 41% of the population is poor.

Compounding the challenges, the country’s geographic position has also made it a recipient of economic migrants and refugees originating from nearby countries. Djibouti is home to around 60,000 asylum seekers and migrants, many of them war refugees arriving from neighbouring Yemen.

Despite the government’s overall receptiveness, the influx has put a strain on housing and other public services, exacerbating existing disparities. “In terms of education and health, for instance, government policy has improved things on the ground,” Ndione told OBG. “But beyond the capital, the rest of the country remains isolated, with insufficient transport links, limited employment and higher poverty rates.”

DIVERSIFICATION: One clear option to accelerate employment creation is to focus on the development of labour-intensive sectors, such as manufacturing and tourism, though the fact that it remains a small market with limited domestic demand makes economic diversification more challenging than in countries with larger populations. One key factor, however, that will likely contribute to better employment opportunities are the planned free trade zones.

The biggest of these, the $3.5bn Djibouti International Free Trade Zone, is expected to take a decade to fully develop and could create up to 350,000 new jobs once fully operational. “Despite the higher manufacturing costs, Djibouti can do light manufacturing and assembly,” Ndione told OBG. “The economic zones could attract new companies and investment, but they can also encourage other industries that already exist outside the zones to move there to improve their competitiveness on a global scale, and become more closely integrated into global value chains.”

The tourism sector also represents untapped territory for economic growth. Despite the variety of desert landscapes, volcanoes and a Red Sea coastline, Djibouti remains a frontier destination for international tourists, with the majority of foreign visitors coming for business rather than leisure. Djibouti Vision 2035 aims to attract 500,000 tourists annually by 2030. (See Tourism chapter). This would certainly accelerate job-creation efforts, but several constraints remain. In addition to lagging hospitality infrastructure, barriers such as costly entry visas and substantial travel taxes charged for handling passengers with connecting outward flights are some of the challenges for tourism expansion moving forward.

ENERGY EQUATION: Another potential diversification avenue is linked to the country’s intrinsic energy needs. Although it has significant potential for the development of renewable energy sources, especially in terms of wind and geothermal generation, they are still in their infancy. A 300-MW solar power plant is currently under construction at a cost of $390m, and the country’s unharnessed geothermal generation potential could reshape the energy mix, with studies for the implementation of a handful of geothermal electricity generation projects under way in the Lac Assal region (see Energy chapter).

Currently, the country has a total of 126 MW of installed generation capacity, although just 67% of that capacity is ready to be used at will, according to World Bank figures. Generation is done through thermal power plants, run on imported fuel oil and diesel. Since 2012 a transmission line to Ethiopia also allows Djibouti to import hydroelectricity from its neighbour.

Renewable energy is a landmark economic opportunity for the country and could determine the success of current diversification efforts. Besides balancing electricity imports from neighbouring Ethiopia and reducing the carbon footprint of fossil fuel-powered electricity generation, the diversification of generation sources might also help mitigate one of the private sector’s most pressing complaints: the high cost of electricity. Although a law covering independent power producers (IPP) was published in 2014, slow implementation and an unclear regulatory framework have persisted since its introduction.

BUSINESS ENVIRONMENT: Although the large-scale investments in infrastructure are an opportunity for the country, in order for these projects to benefit domestic firms, measures to improve Djibouti’s business environment need to remain a government priority. Considerable progress has already been made in this regard, with Djibouti jumping 55 places to rank 99th out of 190 economies for ease of doing business in the World Bank’s “Doing Business 2019” report. This represents a significant improvement from the country’s 2018 standing of 154th, making it one of the top-10 most improved economies. Furthermore, alongside India, it is the only country to make the top-10 most improved list for the second year in a row.

The climb in ranking comes on the back of six reforms, including the establishment of a one stop shop for business start-ups; streamlining property transfers via stricter deadlines for property registration and the digitisation of the land registry; strengthening access to credit by making a wider range of assets acceptable as collateral; improving minority investor protections by requiring greater disclosure of transactions; easing contract enforcement with the creation of a dedicated division within the court of first instance to resolve commercial cases; and making insolvency proceedings more accessible for creditors.

Many of the improvements have come through better communication between the government and private sector actors. Policy was streamlined through the 2014 establishment of the High National Council of Public-Private Dialogue. Additionally, further improvements arose out of the National Meeting on Fiscal Policy in 2016, which provided a forum for the private sector and the government to discuss the tax burden on local firms. One resulting resolution was the cost reduction of operating licences for entrepreneurs, which were immediately lowered in 2016 and then eliminated for three years. The next challenge will be for the government to enlarge the tax base, which continues to depend to a large extent on small domestic firms. The creation of free trade zones as well as additional tax exemptions for foreign investors has established parallel systems of taxation. “Only 3000 firms, typically domestic companies with an operating licence, end up absorbing the brunt of tax payments,” Zahra Omar Ahmed, head of information and economic studies at the Djibouti Chamber of Commerce, told OBG.

A key step was taken in 2017, with the enactment of the guichet unique, a one stop shop designed to accelerate the opening of new businesses, organisation of work and building permits, and payment of taxes. It aims to streamline and simplify processes for national and foreign companies and individuals to process all relevant legal formalities in one place. Set up by the Djiboutian Industrial and Commercial Property Office, in conjunction with the National Investment Promotion Agency and the tax office, the guichet unique has made it easier for entrepreneurs to set up new companies.

Another measure with the potential to improve the performance of Djiboutian SMEs is the creation of a collateral registry, set up by the Central Bank of Djibouti in early 2018 as a centralised listing of all assets used as loan collateral by SMEs and individuals (see Financial Services chapter). Regulatory authorities have also eased rules for the retrieval of assets by banks in case of non-payment. “Djibouti is working on an integrated information system to facilitate administrative procedures,” Mahdi Darar Obsieh, general manager at Djibouti’s National Investment Promotion Agency, told OBG. “Better coordination between 15 public institutions will be ensured, which will complement the efficiency of the single window and make Djibouti more attractive.”

OUTLOOK: Building on consecutive years of robust headline growth, Djibouti has been able to leverage its geographic position, and specialise in transport and logistics operations. This has brought integration with global commerce routes and an increase in infrastructure investment. However, this strategy has yet to prove a reliable mechanism for poverty-reduction.

One way to ease the transfer of the economic advantages of large-scale FDI is to improve the operating environment for domestic firms, which often find regulations cumbersome. Crucially, this could help unlock the employment-creation aspect of the current infrastructure development surge. Another key aspect for the country’s long-term investment attractiveness will be the evolution of energy prices. The follow-up to Djibouti’s greatly improved transport connections may be a reduction in local production costs as electricity prices remain an obstacle. The country is well placed for continued growth over the coming years, which could be aided by a better interconnection between the domestic business sector and the foreign investments reshaping Djibouti’s transport infrastructure network.