One of the maladies the Ethiopian economy has battled over the past decade has been inflation. This economic ailment has created noticeable changes in the purchasing power of consumers. And though it was kept below double digits between July 2012 and June 2017, the past seven months has seen inflation hit the economy with renewed vigour. Headline inflation for January 2017 and February 2018 increased to 13.4Pct and 15.6Pct, respectively. To make matters worse, food price inflation soared to 18Pct in January 2017 and 20.9Pct in February 2018.
This frenzied inflation has driven policy makers to contemplate administrative means to tame it; but it seems to be unyielding to monetary policy measures. In November 2017, the Prime Minister’s office formed a high-level committee to tackle the issue. The committee, made up of officials from various government organs such as the central bank and the National Planning Commission, aims to control food prices by taking various administrative measures.
However, previous experience proves that such administrative measures will end in failure. One case in point is the price cap levied in 2010 on some consumable items. Immediately after the cap was instated, consumer goods started to disappear from the shelves while the black market expanded, thereby driving prices up. After observing the effects of this measure, which brought more problems than remedies, the government quietly dropped the action and inflation remained in single digits for the next five years.
Many factors have been responsible for the recent price surge. These include supply problems, political instability, the recent devaluation, severe foreign currency shortages, expansionary fiscal policy and excessive borrowing from the central bank.
The supply side problem, especially for agricultural products, seems dominant since the country has found it difficult to meet increasing demand. Despite the increase in agricultural yield and increased production, farming has remained subsistence-based. Farmers sell only about 15Pct of their products on the market. Moreover, in the long supply chain that extends from farmers to final consumers, various stakeholders don’t have strong networks; this brings about frequent breakdowns. As a result, agricultural production has become prone to the vagaries of nature. Supply side problems that are similar to those seen in agricultural items also affect other goods and services.
The downside effect of the devaluation became apparent, as feared, when the central bank devaluated the local currency against the basket of major foreign currencies in October 2017. Unfortunately, the expected upsides of the devaluation remain elusive. Contrary to the promises of policymakers, the effect of devaluation has translated to increased prices of goods and services in a short period of time. Rumours of further devaluation, coupled with a shortage of foreign currencies have caused the gap between official exchange rates and parallel market rates to widen.
Right after the devaluation of the birr, the National Bank of Ethiopia (NBE) took measures hoping to control inflation. Savings interest rates were increased to seven percent, and the central bank ordered commercial banks to limit their lending ceilings to 16.5Pct of their previous year’s outstanding loans. The government also issued a stern warning to businesses, which were considering increasing prices. Nevertheless, these measures failed to arrest inflation.
Expansionary fiscal policy has made the government reliant on the central bank when faced with a shortage of funds. For example, the federal government borrowed ETB16.9 billion in 2015/16 and ETB26.6 billion 2016/17 inthe form of direct advances and bonds from the central bank. By the end of 30 June 2017, the federal government owed the central bank ETB135.64 billion.
The budget deficit for 2017/18 is ETB54 billion. Note that the deficit figure was based on ambitious tax collection targets. To widen the budget deficit, the state recently approved a supplementary budget of EBB14 billion. If we consider the government’s previous tax collection track records, the budget deficit will most likely be much higher than the projected amount.
Planning to fill this deficit by selling treasury bills alone is flying in the face of the financial reality of the country. The government resorts to the central bank for unusually high amounts of funding as the financial sector can’t cover even half of the deficit. I believe that the money-printing spree is already underway, fuelling the inflationary pressure.
What is very disappointing is that the monetary policy machinery is as defective as the NBE is not independent. Its hands are tied by legal means, making conducting independent monetary policy almost impossible. Within the limited monetary policy space afforded to it, the central bank has tried to employ policy tools—despite these tools having been contradictory on many occasions—to keep inflation at bay, but it has failed miserably.
To make matters worse, an economy that has been struggling to cope with multi-faceted inflictions is, and has intermittently been for the past three years, rocked by political turmoil. When supply and other economic problems are coupled with political instability, the level of uncertainty hovering over the economy rises. And uncertainty is a recipe for price volatility.
Comprehending the complex problems that the economy has faced will help the government identify the most effective way to tackle inflation. It is obvious that a given economy can’t function properly in an unstable political atmosphere. If the current political crisis is not carefully addressed, the troubles will permeate into every sphere of the economy. Business will slow down, remittances and foreign direct investments will fall, tax receipts will dwindle, and money-printing will increase. Under such conditions, inflation will be intractable.
Ethiopia can no longer afford instability. Serious political reforms are necessary to instil certainty in the economic sphere. Along the way economic measures, which include shaking up the constraints of supply, fiscal restraint and effective monetary policy should be considered.
When the current crises abate though political means, having a robust monetary policy regime should be contemplated as part of wider economic measures. This requires setting unambiguous inflation targets, properly designed monetary policy tools and independent institutional arrangements to implement monetary policies. Freeing the central bank from fiscal dominance, setting a clear mission and instituting accountability would help tackle inflation.
Without a clear legal demarcation between monetary and fiscal authorities and having a passive central bank, contemplating taming inflation is futile. What is even worse is trying to use administrative measures to control inflation. These only exasperate the situation. They cause shortages of goods, send prices soaring, and are a recipe for further volatility.
6th Year . March 16 – April 15 2018 . No.59