From Crisis to Control Ethiopia’s Inflation Story

The National Bank of Ethiopia’s (NBE) latest report reveals encouraging progress in the fight against inflation. In April 2024, the country witnessed a significant decrease in inflation rates compared to previous years. Year-on-year inflation fell to 23.3%, marking a substantial ten percentage point decline from the prior year. While food inflation remains relatively high at 27.0%, non-food inflation has experienced a remarkable drop to 18.0%. Many attribute the decline to the slowdown in money supply growth. The report suggests that inflationary pressures will continue moderating, with a projected year-on-year inflation rate of approximately 20% by June 2024. These developments signal positive strides in Ethiopia’s efforts to achieve macroeconomic stability, EBR’s Eden Teshome reports.

In a bold and decisive move, the National Bank of Ethiopia (NBE) has unveiled a comprehensive package of monetary policy measures to tackle the country’s long-standing struggle with high inflation. The announcement, made on August 15, 2023, comes as a response to the persistent inflationary pressures that have plagued the Ethiopian economy for over a decade, with the inflation rate reaching a staggering 29.3% as of June 2023.

“Inflation has been one of the most difficult macroeconomic challenges facing Ethiopia over a period of many years,” stated the NBE in its press release. “The Ethiopian economy and population have lived with inflation for a very long time, as seen from the average inflation rate of 16% per year registered over the past decade.” Ethiopia has grappled with high inflation rates for years, with an average annual inflation rate of 16% over the past decade. In recent years, inflation has surged even further, exceeding historical averages and persisting longer than anticipated. The consequences of high inflation are far-reaching, affecting the real income of individuals on fixed salaries and exacerbating the challenges faced by the most vulnerable segments of society.
High inflation has had a severe impact on ordinary Ethiopians’ lives. It erodes the real income of those on fixed salaries and disproportionately affects the most vulnerable segments of society.

“High inflation erodes purchasing power, disrupts price stability, and poses significant challenges to economic growth and stability.” says Atlaw Alemu (PhD), an associate professor of economics at Addis Ababa University.

Selam Mulugeta, 24, recently joined the workforce with dreams of building a better life for herself and her family. Armed with determination and a University degree, she embarked on her professional journey.

However, as Selam soon discovered, the reality of life as a newcomer in the workforce was less glamorous than she had envisioned. She secured a job that paid her a monthly salary of ETB 15,000, a decent amount on the surface. Little did she know the challenges that lay ahead with that income.

One of Selam’s most pressing concerns was finding a suitable living place. She spent countless hours searching for an affordable house rental that fit her limited budget. Unfortunately, the rapidly rising rental prices in the city made it increasingly difficult for her to find a decent place to call home. After much searching, she finally found a small place she could afford, but it still consumed a significant portion of her salary.

With her housing situation settled, Selam faced the next hurdle: feeding herself and meeting her daily needs. She quickly realised that the cost of groceries and other essential items was higher than anticipated. Balancing her limited income with the rising food prices became a constant juggling act. “Each month, it becomes increasingly difficult to make ends meet. The rising costs of housing, groceries, and daily expenses make it a constant struggle.” Says Selam.

The negative consequence of inflation isn’t unique to individual citizens; businesses have also been severely affected. The overall impact has made businesses less favourable, with costs consistently growing while income differs. Solomon Muluneh, a seasoned entrepreneur in Ethiopia’s bustling capital, Addis Ababa, is uncertain as he contemplates his next business move. With inflation rapidly eroding the value of his hard-earned capital, he fears that his carefully planned investments may falter under soaring prices. As he walks through the city’s vibrant marketplaces, his once-confident strides now face hesitant steps, each purchase accompanied by a nagging question: Will the unrelenting inflation render his business endeavours futile, undermining his dreams of growth and prosperity?

Solomon’s story encapsulates high inflation’s profound impact on the investment landscape and the delicate balance entrepreneurs must navigate to keep their businesses afloat in uncertain times.

“Persistent inflation creates a climate of uncertainty, which can be detrimental to long-term investments. Businesses face significant challenges when it comes to accurately forecasting costs, pricing strategies, and profit margins. The fluctuating prices make it difficult to plan ahead and make informed decisions. This uncertainty can discourage businesses from making substantial long-term investments, as they grapple with the unpredictability of inflation’s impact on their operations.” Explains Atlaw.

According to the NBE’s analysis, a confluence of factors has contributed to Ethiopia’s inflation woes, including supply-side constraints, cost-push factors, inflationary expectations, and expansionary fiscal and monetary policies.

To highlight the significant impact of external shocks, a press release from the National Bank of Ethiopia (NBE) draws attention to alarming price increases observed between mid-2020 and mid-2022 due to a surge in Global oil prices by a staggering 140%. These prices further surged by 12.9% in 2024 alone. In March, oil prices peaked at USD 87.10 per barrel, marking the highest level since November 2023, and averaged USD 86.79 per barrel for the entire month.

The fertiliser market also experienced a dramatic surge, with prices skyrocketing by nearly 200% between 2020 and 2022. This dynamic market witnessed a six-cent decrease in the Black Sea Urea Price, settling at US USD330 per ton, while the US DAP Spot Price (Gulf) surged by 5.77% in 2024.

Furthermore, freight prices witnessed an astonishing surge of around 300% during the same period. The monthly container freight rate index worldwide showed a gradual increase, reaching over 3,900 U.S. dollars in February 2024, the highest value on record. However, there was a slight decrease in freight prices during March and April. These figures vividly depict the challenging market conditions, with rising oil, fertiliser, and freight prices significantly stimulating the economy.

While these external factors played a significant role, the NBE acknowledged that expansionary fiscal and monetary policies implemented in response to the succession of shocks also contributed to the inflationary pressures.

To comprehend the underlying causes of Ethiopia’s inflation, the NBE conducted extensive research, which revealed a combination of supply-side constraints, cost-push factors, inflation expectations, and macroeconomic policies as key contributors. Factors such as internal conflicts disrupting food distribution networks and steep increases in global commodity prices, including fuel and fertilisers, have substantially impacted inflation levels.

Furthermore, the country’s response to several shocks, including the COVID-19 pandemic, conflict, and drought, resulted in relaxed fiscal and monetary policies. While these measures aimed to address the challenges posed by the shocks, they inadvertently exacerbated inflationary pressures. Consequently, the NBE acknowledges that a coordinated effort is required to tackle inflation comprehensively.

The NBE emphasises that a lasting solution to Ethiopia’s inflation crisis necessitates coordinated efforts across multiple areas and stakeholders. Supply-side measures to enhance food production and productivity are paramount, considering the dominant role of food prices in the consumer price index. Initiatives such as expanding cultivated acreage, promoting irrigation, encouraging cluster farming, and investing in low-land agriculture are vital to ensuring food security and stabilising prices. Similar efforts are required to boost output in other critical sectors, including cement, housing, household supplies, and transport services.

Addressing structural challenges is equally crucial. Improving transport networks, logistics systems, and the competitiveness of retail and wholesale trade will enhance supply chain efficiency and foster price moderation. Fiscal policy must complement these measures. The Ethiopian government has committed to limiting the budget deficit, thereby reducing the reliance on domestic financing, including borrowing from the NBE.

The NBE has taken significant steps to combat inflation and restore macroeconomic stability in the country. These policy measures aim to bring inflation below 20 % by June 2024 and further reduce it to single digits by June 2025.

To achieve these goals, the NBE has introduced several key measures. One such measure is limiting credit growth to 14 % for the current fiscal year ending in June 2024. Commercial banks are aligning their loan portfolios with this aggregate credit ceiling. This step will help to manage liquidity and prevent excessive credit expansion, which can contribute to inflationary pressures.

Moreover, the NBE has reduced its direct advances to the government compared to previous years. Last year, the bank gave the government 60 billion birr as advances. The policy direction will likely significantly reduce inflation at the end of the current fiscal year. The approach emphasises the importance of using such advances as a last resort, ensuring that government borrowing does not exacerbate inflationary tendencies.

In addition, changes have been made to the NBE’s Emergency Lending facility, which provides liquidity support to banks facing financial challenges. The interest rate at this facility has been increased from 16% to 18%, encouraging responsible borrowing practices and discouraging overreliance on emergency funds.

Another vital measure implemented by the NBE is reducing exporters’ foreign exchange surrender requirement. Under a new directive, exporters must now surrender 50% of their foreign exchange proceeds to the NBE, allocate 10% to their respective banks, and retain 40% for their accounts. This move aims to enhance liquidity in the foreign exchange market while promoting the growth of the export sector.

The near-term outlook for Ethiopia’s inflation remains challenging, with global and domestic conditions presenting a mixed picture. While some relief may come from favourable weather conditions, declining global commodity prices, and moderation in headline inflation among trading partners, inflationary pressures persist. International prices for commodities such as oil and cereal grains have shown recent upward trends, emphasising the need for cautious and restrained policy measures.

Ethiopia, a nation brimming with potential, currently faces the vexing challenge of inflation. The root causes of this economic woe are a growing population outpacing agricultural output and the lack of proper policy, which require a multi-pronged approach to arresting inflation and achieving a stable macroeconomic environment.

The primary culprit behind Ethiopia’s inflationary woes is the imbalance between supply and demand—a burgeoning population hunger for more food, industrial raw materials, and exportable goods. However, agricultural productivity, the backbone of the nation’s economy, needs to catch up. This shortfall creates a demand-pull inflation, driving prices skyward.

Environmental degradation and a changing climate add fuel to the fire. Droughts, erratic rainfall patterns, and soil erosion all contribute to diminished agricultural yields, further straining the already stretched supply chain. That’s why boosting agricultural productivity serves as an engine for combating inflation. While revitalising manufacturing and the service sector is essential, the agricultural sector’s role stabilising the market is paramount.

Ethiopia needs to invest heavily in agricultural infrastructure, such as irrigation systems, storage facilities, and transportation networks. This measure is crucial to increase farm productivity and reduce post-harvest losses.

Embracing modern farming techniques, including high-yield crop varieties, precision agriculture, and sustainable land management practices, is crucial.

Providing farmers access to affordable credit further allows them to invest in necessary inputs like fertilisers and improved seeds. Additionally, crop insurance can mitigate the risks associated with climate change, fostering more significant investment and production.

While agriculture is the cornerstone, other non-monetary interventions are also necessary to tame inflation and achieve macroeconomic stability. In this regard, macroeconomists advise on the merits of diversifying the economy. Over-reliance on agriculture makes the nation vulnerable to external shocks. Encouraging the growth of manufacturing and service sectors can create alternative sources of income and foreign exchange.

Fiscal Discipline is also crucial. The government must implement sound budgetary policies prioritising spending on growth-enhancing initiatives like infrastructure development and education. The approach fosters long-term economic growth that improves the quality of citizens’ lives. A disciplined approach to monetary policy is also crucial. While the National Bank of Ethiopia needs to manage interest rates effectively to control inflation without stifling economic growth, managing the money supply is essential, as it is at the centre of the mission to arrest inflation.

Ethiopia’s battle against inflation demands a multi-pronged approach. The nation can create a sustainable and inflation-resistant economy by prioritising agricultural rejuvenation, fostering economic diversification, and implementing prudent fiscal and monetary policies. These policy reforms will pave the way for a stable macroeconomic environment where prosperity can flourish and be fairly shared. Ultimately, success hinges on a concerted effort from the government, the private sector, and all stakeholders working together to build a more resilient and vibrant economy for the future.EBR

12th Year • July 2024 • No. 131