"The sustainability of the current public sector-led growth strategy was threatened by several downside risks – including, external financing of the public investment programme, declining prices for export commodities, and weather-related shocks," IMF said.
"Mitigating these risks will necessitate greater policy coherence and appropriate structural reforms going forward, to help shift the balance toward private sector-led, sustainable growth."
The fund agreed that Ethiopia's recent macroeconomic performance continues to be strong, with robust economic growth supported by higher agricultural production and large public sector and foreign direct investments.
Inflation remains contained and the fiscal stance at the general government level is cautious, although public enterprises continue to provide an expansionary impulse, IMF said.
Public and publicly guaranteed external debt is estimated to have increased to about 23% of GDP from 20.5% in 2012/13, the Fund said.
IMF said tight monetary policy has supported achieving the National Bank of Ethiopia (NBE)'s inflation objective in 2013/14. Base money, the nominal anchor of monetary policy, increased by 17.5% in April 2014, driven mainly by claims on government.
The current account deficit is estimated to have widened from $2.8bn (6.0% of GDP) in 2012/13 to $3.5bn in 2013/14 (7.1%). It was financed largely by concessional and non-concessional inflows as well as by foreign direct investment (FDI).
IMF said Ethiopia's economic outlook remains encouraging. The 2014/15 budget plan targets the general government deficit at 3% of GDP and maintains a strong pro-poor focus. Monetary policy, anchored on base money, is geared toward maintaining inflation in single digit.
The public debt to GDP ratio is expected to rise, reflecting large disbursements associated with implementation of investment projects under the Growth and Transformation Plan (GTP).
The Fund, however, underscored the need for continued fiscal prudence in order to achieve the GTP goals while reducing crowding out of the private sector.
It has called for stepped-up efforts to increase domestic revenue — by broadening the tax base, improving customs and tax administration and removing tax exemptions.
The IMF has welcomed Ethiopia's planned implementation of a new high-level oversight mechanism designed to carefully monitor the operations and financial position of public enterprises and any contingent liabilities.
The Fund said monetary restraint is required in the wake of food and energy price shocks and domestic demand pressures stemming from large public investments.
IMF also recommended strengthening liquidity management and monetary transmission through enhanced interest rate flexibility and the adoption of a broader set of monetary policy instruments.