Devaluation in Ethiopia: Why it Doesn’t Boost Export?

The World Bank argues that the Ethiopi¬an currency is unduly expensive in terms of foreign currency such as the USD. In the eco¬nomic jargon we call that over-valuation of exchange rate. In lay man terms, the World Bank advice says that ETB19.60 Ethiopi¬ans are giving when somebody comes with USD1 is too small. So, it means giving them ETB22 (10Pct increase) or ETB24 (20Pct in¬crease), instead for the same dollar. If that is the case, the World Bank argues that Ethio¬pian importers will be discouraged because it will be expensive to them in terms of the local currency.

In addition, the World Bank says, export¬ers will be encouraged because they will get more money in terms Birr for the same USD1 export item they send abroad. Not only that, the Bank continues narrating, investors and those who send money to Ethiopia will be attracted by this and will send more mon¬ey and invest a lot. When that happens, the country will be able to narrow down the gap between imports (which is close to 11 Billion USD) and exports (which is just under USD3 billion).

No question this is a huge foreign ex¬change deficit; however, despite this pres¬sure from the World Bank, the Ethiopian government is moving with its exchange rate policy (referred by economist as managed floating). This policy allows the government not to completely leave the exchange rate to be determined by the ‘free’ market.

With these in mind, I argue that the cur¬rent government policy towards exchange rate is right and the World Bank policy or pressure is wrong for the following basic reasons.

First, Ethiopian imports are what can be described as strategic imports which are not amenable for reduction because they will be expensive in local currency following the advised devaluation. The breakdown of our imports shows that about 70Pct of our im-ports are capital & intermediate goods, fuels and related imports which Ethiopia will be importing whether they are expensive.

This demonstrates the wrong presump¬tion of the World Bank. In fact if imports came to be expensive in local currency they will lead to inflation which the government has tried its best to abate it in the last two years. Moreover, since the government is a major actor in the economy its own import price will be very high and will enter into budget deficit which invariably leads to inflation in Ethiopia.

The second consequence of devaluation in today’s Ethiopia is its inflationary effect. Myself and my former student’s empirical research and forecast on Ethiopian inflation shows (and actually proved right in the last devaluation) that a 20Pct devaluation in Ethiopia will have an effect of about 40Pct increase in inflation. Given the Ethiopian traders capacity of passing such an increase in price to consumers which is found in the same study, this will have a detrimental impact on the welfare of the population, especially the poor.

In addition, given the low level of foreign inflation this might even lead to appreciation of the Ethiopian currency and possibly contraction of business activity due to rise of cost of inputs and low real demand that may emanate from this policy. This is what critical economist call “contractionary effect of devaluation” which was very common in Latin American countries in the 1980s and 1990s.

My other argument against the devaluation ad¬vice relates to the fact that Ethiopian exports will not dramatically increase or may not increase at all because of devaluation, as the World Bank presumes. This is because the fundamental problems behind Ethiopian exports is not a need for a rise in price (not that devaluation here acts as a rise in price because exporters get more money in terms of birr for the same export) but rather major hindrances to supply and production and exporting.

Based on the survey based research conducted by me and my colleagues on problems of Ethiopian exporters by looking the cases of 100 exporters, we found that their fundamental problems are access to land, customs, tax regulations, tax rates and admin¬istration as well as corruption. More than 70Pct of the exporting firms rated access to land as the major obstacle for their operation.

In addition, a more structural problem to Ethiopi¬an exporting firms is the lack as well as inadequacy of infrastructure. Though encouraging improvements are reported in road, air transport and telecommu¬nication services, about 70Pct of the exporting firms reported such infrastructure as well as telephone and communication deterioration as major problems.

The other important factor is access to finance, which is constraining firms from operating at full capacity. Exporting firms exhibit considerable level of inefficiency with an average capacity utilization rate of around 55Pct.

These show that Ethiopia’s balance of payment problem is more of structural than financial. I think addressing these, not devaluation, is the key to leap¬frog on Ethiopia’s exports. Similarly, the World Bank suggestion seems to send a signal that the Ethiopian government could wake up just one day in bright morning and change the exchange rate. This percep¬tion incredibly damages the policy credibility of the government.

Thus, if needed the government need to stick to its managed floating policy stance and make changes in piecemeal and predictable manner as it is current¬ly doing; otherwise, inter alia, business people may began planning in USD instead. The government could also lose some policy power –Zimbabwe be¬ing a case in point that lost total monetary policy control today.

6th Year . November 2017 . No.55