OREANDA-NEWS. Ethiopia's (B/Stable) 2016-2017 budget illustrates the federal government's conservative fiscal stance despite the disruption from the severe weather conditions that the country has experienced for over a year, Fitch Ratings says. However, we expect state-owned enterprises (SOEs) to retain their large role in public investment, and for SOE debt to continue rising.

Parliament approved the federal government budget for FY17 (July 2016 to July 2017) last week. Based on projected real GDP growth of 11.1%, it targets a budget deficit of around 3% of GDP, in line with both the government's self-imposed fiscal guideline and with our estimate for FY16. Based on our more conservative growth forecast of 7.5% for FY17, measures in the new budget would result in a 3.3% of GDP deficit. Given the authorities' track record of fiscal prudence at the federal government level over the last ten years, we think the risk of fiscal slippage is low.

The budgetary impact of the El-Nino-induced drought and subsequent floods appears limited. The authorities do not forecast any major impact on revenue, which is expected to rise by 25% from FY16's initial budget, faster than expected nominal GDP growth. Revenue growth is not held back by the drought because the primary economic effect of extreme weather falls on non-taxed subsistence farming. On the spending side, the 38% rise in regional transfers compared with FY16's initial budget largely reflects greater fiscal decentralisation.

Some drought-related expenditure (for example, external purchases of cereals) has been met by tapping reserves accumulated in the oil stabilisation fund. A large part of the cost is covered by international donors through budgetary grants (which the authorities expect will account for 7.5% of revenues in FY17) and through direct assistance to the affected populations.

The new budget largely maintains the government's heavy focus on capital spending (40% of expected spending, in line with previous budgets), which has been a significant growth driver in recent years, and pro-poor spending (7.3% of spending, primarily on education).

Our analysis of Ethiopian public finances extends beyond the federal budget. We consider the general government deficit (which incorporates regions), although this has also been prudent as regions are not allowed to run deficits.

More importantly, some quasi-fiscal activities are traditionally carried out by SOEs across large sectors of the Ethiopian economy, ranging from energy and transportation to retail distribution, sugar production, or construction. SOEs are heavily involved in the authorities' ambitious public investment programme, primarily in energy and infrastructure.

Data transparency on a number of SOEs is weak, but their financing needs have exceeded that of the government in recent years (they were estimated at 7.4% of GDP in FY15 by the IMF). We therefore monitor the evolution of SOE debt as an indicator of broader public finance sustainability and view it as a contingent liability for the sovereign. At end FY15, SOE debt was estimated at 29% of GDP against general government debt of 27.3% of GDP, and Fitch expects their debt will continue rising over the next two years.

Our next scheduled sovereign rating review is due on 7 October 2016.