Former United States (US) Federal Reserve Chairman Alan Greenspan sent shockwaves through the world economy with his coining of the phrase 'irrational exuberance.' Labelling the massive windfall profits from stock market speculation tenuously based on imprudent economic gambling brought to a close a large and steady period of economic growth and halted a rise in the Dow some thought would reach to the sky.
 

The statement from the economist who had reached celebrity status targeted the aspects of free markets that are subject to wild movements based on recurring flaws in human judgement. This type of behavioural evaluation where booms are prolonged by overreactions may now appropriately be applied to Ethiopia's banking sector.

One of the cornerstones of the recent impressive economic growth has been the construction sector, driven by massive volume of loans. Thus far, the banks have been doing good business, earning profits that surpass average margins at banks around the world by leaps and bounds. But like all runs, the reality of economic cycles may bring the party to an end.
 

The rationale for these banks to be so generous in opening their vaults seems clear after a cursory glance around the capital. Buildings are sprouting up left and right, while traffic congestion is increasing in part due to road construction detours and heavy-duty machines clogging avenues. However, upon closer examination, there is evidence to suggest that banks may not have made the most sober forecast of the economy's future.

When banks evaluate loan decisions, they must take into account the client's financial position, their own financial position, as well as the overall outlook of the market. It is this last area where the banks may be projecting an overly-optimistic picture.

The starting point for the construction business shows vast room for growth. Striking gaps between the shantytowns littering the metropolis and the recent additions to the skyline in certain areas such as Bole and on the road to Saris present a vision of the future that could even spark excitement in the most conservative observer. There is much work that could be done.
 

Machines driving the construction boom that once trickled into the country through the Port of Djibouti are now flooding the market. A trip out of town on the Debre Zeit road reveals dozers, excavators and loaders crowding the landscape on to either side of the highway. While many of these are utilised, there are an alarming number sitting idle, waiting for renters.
 

The capital to fund imports of the 152 heavy-duty machines that entered the country in the last fiscal year is coming from the massive loans coming out of the 11-plus banks operating in the country. These financial institutions seem to be gambling on this construction industry to a large extent, possibly reaching troubling proportions.
 

These large capital investments, where one dozer costs upwards of 360,000 dollars, are susceptible to market fluctuations and depreciation. Hopefully the bull market continues.

Past evidence from the domestic economy shows a history of banks jumping on the bandwagon, perhaps failing to undertake realistic market assessments.

Capital investments to develop the leading export market, coffee, often yielded disappointing results. The close to two billion Birr in outstanding loans to the sector signal anticipation of an overly positive picture, especially in the numerous coffee washing operations failing to bring positive returns.

While there is no doubt a lot of money is to be made in this commodity market, saturation will come too quickly when many investors converge to seize the bright prospects. The market mechanism to halt such a rush is prudent banks that supposedly have a team of specialised economists to make a more accurate assessment of profit potential than an individual investor can.

This process may be failing now in the construction sector as it did following the height of the Eritrean border conflict. As the port of choice for fuel importers was necessarily changed due to the conflict, new tankers were imported in droves.
 

The flood reached such an extent that the government banned new arrivals, feeling the heat from owners of older models being driven out of the market and facing losses on their unused vehicles. At this time, in 2003, the unleashing of credit went as far as to cause a regrettable case of market intervention to calm a flooded market and subsequent wastage.
 

Repercussions stemming from massive imports are still felt in the saturated heavy-duty transport market where profit margins are still quite slim, causing loan repayment troubles. But this may not be the end for banks.

A look inside the impressive skyscrapers being erected will yield some surprises as many spaces remain without renters, even as more are being constructed at a feverish pace. Projections into the future based on current growth rates will be troubling as price skyrockets signalling the potential for a bursting of the bubble. Hopefully, banks are remaining cautious enough to avoid mass defaults in the future.

International experiences cause room for concern. In terms of parallels to the current domestic situation and theories of market cycles, banks should be quite cautious about extending credit in the construction sector.

The Asian financial crisis at the turn of the century popped a lot of dreams for many companies speculating on the booming 'Tigers.' Capital flooded the markets of especially fast developing Southeast Asian economies, fuelled by astronomical predictions of growth. Projects in a variety of sectors, especially construction, were ambitiously funded with little scrutiny of the creditworthiness of the borrower and based on unrealistic projections.
 

While one may argue that hindsight is 20-20, it is important to learn from the mistakes of other countries. As fast as the money flowed in, it was quick to dry up as creditors smelled the bubble's demise and were eager to pull investments out before the competitors could get the edge.

Similarly, the US economy has faced its challenges of late with the demise of a roaring housing market. As property values began to skyrocket, homes were put up as collateral to invest further into the market, a drastic oversight of a diversified portfolio. When the times turned for the worse, banks were saddled with a number of non-performing loans, the effects of which will still be felt down the road.

This type of gambling on individual sectors is dangerous as the highs and lows are exacerbated by the lack of a cushion in spreading the risk. In both the Asian and US experiences, even the efforts of a strong central bank to tighten the reigns on the credit flows was not enough to avoid disaster.
 

Unfortunately, Ethiopia does not even have the benefit of an effective central bank that takes proactive measures. The National Bank of Ethiopia's (NBE) recent moves to marginally increase the saving rate and increase the reserve requirement are tiny means to control the monstrous inflation hitting the country. Indeed, the flow of credit and massive fiscal spending do not appear to be halted.

Economy-wide, the prospects for a bust on the massive speculation are glaring investors in the face. However, banks in particular have been quite liberal to grant loans, particularly in the construction sector. These financial institutions will be in trouble if it turns out the growth cannot sustain the levels of speculative investment.

Moreover, this sector is the backbone of the modernising economy, transferring money into the formal sector. If these pillars are in fact standing on shaky ground, the future ripple effects are frightening to imagine.