October’s Devaluation

Measuring its Impact on Coffee Exports

In October 2017, Ethiopia devalued its currency by 15Pct with the aim of boosting export and improving the current account deficit. Three months later, the impact appears to be positive, with export revival registered in some areas. For example, export proceeds from coffee hit a record high, reaching USD435 million in the first half of the current fiscal year, the highest increase since 2012.

Experts stress however, that the currency devaluation will eventually have a negative effect on the economy. Valuable and vital commodities such as fuel, medicine, and machinery will become more expensive to import. The effect, some economists cautioned, would widen balance of payment deficit and cause inflation. EBR’s Samson Hailu examines the issue.

This past October, the National Bank of Ethiopia devalued the birr by 15Pct. Yohannes Ayalew (PhD), vice governor of the NBE told journalists that the decision was made with the goal of “improving the current account deficit by boosting export volume and decreasing import bills.”

The Ethiopian government has been using devaluation to improve the competitiveness of the country by increasing exports and reducing import bills. This policy, which allows governments to improve merchandise trade balance deficits and outputs by adjusting the flow of expenditures, is known as expenditure-switching policy.

Before the 1970s, the idea that devaluation leads to merchandise trade balance symmetry was widely accepted. Though there are several empirical studies indicating the positive relationship between devaluation and the rise of exports, there are reports that show the opposite. Alternative theories that emerged after 1980s and 1990s, shed light on the possibility that devaluation might have a negative effect on exports, especially in developing countries.

Nowadays, experts stress that local currency devaluation only works for countries with vast export potential. “In an agrarian economy like Ethiopia’s, devaluation only increases import bills since the country is [heavily] dependent on imported industrial, petroleum, and consumer goods,” argues Alemayehu Geda (PhD), Professor of Economics at Addis Ababa University. “So, the overall economic impact of devaluation will be widening the current account deficit.”

But officials claim that the devaluation is already reversing the depressionary trend. “The effect of the devaluation can be seen through the increasing export volume and value of coffee in the past six months,” says Sintayehu Girma, director of Public Relations at the Ethiopian Coffee & Tea Development and Marketing Authority. “Our initial performance indicates that the country is on the path to achieving the target set for the entire year.”

In the first six months of the current fiscal year, Ethiopia exported 102,000 tons of coffee, surpassing the quantity sold overseas in the same period of the last fiscal year by 22Pct, according to the information obtained from the Ethiopian Revenues and Customs Authority (ERCA). The volume exported showed a five percent reduction in the first six months of last fiscal year compared with the previous period. However, the figure in the first half of the 2014/15 showed a nine percent increment.

It is not only the volume that showed an improved performance in the past six months. The earnings also rose by 25Pct to reach USD435 million compared with the previous year. In fact, the highest export revenue the country earned from coffee was recorded in the first six months of 2015/16. The previous record for the first half year, USD329 million, was set in 2015/16.

The surge in proceeds leveraged from the shipment of coffee, which accounts for up to 30Pct of the total export revenue, was aided by the recent devaluation of the birr.

Since 2011, coffee exporters were challenged by the decline in the price of coffee at the international market. Though the government incentivised them to increase the volume of exports, earnings stagnated for years.

For instance, the volume of exported coffee stood at a record 200,000 tons for the first time in 2014/15. However, export earnings did not exceed one third of the planned target. During the first phase of the Growth and Transformation Plan (GTP I) period, the government planned to generate an annual average of USD783.3million from the export of coffee. But the performance was underwhelming, reaching just 61.4Pct of the target, according to a report released by the National Planning Commission.

The devaluation seems to have changed this. Not only did the export volume and value of coffee show a dramatic increment, but more companies are also getting involved in the sector. At the end of the last fiscal year, there were 214 companies engaged in the export of coffee, while 21 companies joined them in the last six months.

Seven more companies applied for certificates of competence to be eligible for coffee export licenses, according to Food, Beverage and Pharmaceutical Industries Institute.

Coffee exporters, however, argue that the improvement in receipts is driven by the rise in global commodity prices.

“The price of coffee has increased in the last couple of years. Although the devaluation does have an effect, the price surge in the international market has a higher impact,” the general manager of a company, who wished to remain anonymous, told EBR. The company he works for has been exporting coffee for the past 15 years.

Globally, the supply shortage that started two years ago continued throughout 2017. As a result, the price of coffee has seen steady rise in the past two years. It showed an average of 17.5Pct annual growth, according to the International Coffee Organization.

Samson G. Moges, operations manager at Tarara Coffee, a coffee processing and exporting company, says that the volume of raw and roasted coffee is increasing.

“Tarara exported 17.2 tons of roasted coffee last year and earned USD107,000. This year, we are planning to export 50 tons of roasted coffee and have already shipped 34 tons,” he says.

However, Samson explains that the rise in volume is not the result of the devaluation.

“We have been nurturing our relationships with global buyers for three years. Now we are reaping the rewards of our efforts.”

Officials do not deny that factors other than the devaluation contributed to the surge. “By conducting studies, the Authority found that coffee production in Ethiopia, as well as its value and marketing chains, needs to improve on a massive scale,” explains Sintayehu. “As a result, Parliament amended two proclamations last year that govern the production, marketing and quality of coffee.”

The major areas the amended proclamations are meant to resolve are issues in the extended value chain, and the widespread illegal trade in the sector. They also aim to incentivize coffee growers and exporters.

Due to these improvements, officials are optimistic about meeting this year’s target of USD1.14 billion in export revenue from coffee.

“If we keep the current momentum, meeting the target will be possible,” says Sintayehu,  whose institution has even greater ambitions for 2019/20: a target of USD2.2 billion.

Studies conducted on the subject reveal that devaluation is an effective instrument to correct price differences in the local and international markets. Many factors such as high tariffs, over-valuation of local currency, restrictions on commodity, and capital flows could lead to price misalignments. In 2015, the World Bank estimated that one percent real devaluation would increase exports by half a percentage point. The effect is higher for manufacturing.

In a study titled Evaluation of Effect of Exchange Rate Variability on Export of Ethiopia’s Agricultural Product (conducted after the government devalued the birr by 20Pct in August 2010), Abule Mehare, lecturer at the School of Agricultural Economics and Agribusiness, Haramaya University, argues that devaluation might play a key role in eliminating the market distortions and correcting price misalignment in the short term. However, in the long run, Abule believes that in an economy like Ethiopia’s, devaluation will have a negative impact on the export of agricultural products.

Abule indicates that there are several theoretical reasons for this. In the short-term, exporters will take advantage and increase export volume. However, due to the inelastic nature of demand for agricultural products, the increase in price in the global market will eventually cease and the price of a given agricultural commodity in the local market will exceed the international price and businesses will have less incentive to export. As a result, devaluation would, in the long run,  have the opposite effect than intended.

Abule’s conclusion is supported by the theory of deteriorating terms of trade;  for an agrarian economy, export earnings from primary commodities are bound to stack or decrease after a short period of time, while import bills keep rising. This widens the balance of payment deficit.

This is exactly what happened after the government devalued the birr against major currencies in August 2010. Total merchandise export in 2010/11 increased by a whopping 37Pct to USD 2.75 billion, compared to the previous year. The rise by USD841.8 million was largely due to growth in export of coffee earnings by 59.3Pct. As a result, the share of coffee in total exports increased to 30.6Pct from 26.4Pct in 2009/10.

The export earnings from gold, live animals, and leather and leather products also rose by 64.1Pct, 63Pct, and 84.1Pct respectively, during the same period, while meat and meat products increased by 86.2Pct, according to NBE’s annual report. Therefore, the share of export of goods in the gross domestic product (GDP) improved to 10Pct from 6.7Pct in 2009/10.

On the other hand, import bills contracted slightly by 0.2Pct in 2010/11 relative to the preceding year and reached USD8.25 billion because of the reduction of raw materials and capital goods imports. Although the share of imports in the GDP slightly rose to 29.6Pct from 27.8Pct in the previous year, imports of capital goods fell by 4.5Pct to USD2.8 billion. In addition, import of consumer goods dropped by 8.8Pct during the period while raw material imports declined by 13.5Pct.

Due to the significant growth in total exports and a small reduction in total imports, current account deficits in 2010/11 narrowed by 12.1Pct compared with the preceding fiscal year.

Six years down the line, however, it seems that the policy had no positive long-term effects on the current account deficit; rather, it appears it may have further aggravated it. In 2016/17, export earnings reached USD2.91 billion, showing a 5.8Pct increment compared to the export revenue earned six years ago. Total merchandise import, on the other hand, almost doubled and reached USD15.8 billion in 2016/17. As a result, current account deficit has grown by 134.5Pct since 2010/11 and reached USD12.9 billion in 2016/17.

For Alemayehu, the widening of the external trade deficit is the result of the nature and composition of export commodities.

“Ethiopia mostly exports agricultural commodities that have high price elasticity of demand,” he said. “On the other hand, Ethiopia imports products such as fertilizers, petroleum products, and capital goods, which have low price elasticity of demand.”

Agricultural commodities account for 80Pct of the export earnings in 2016/17 (75Pct in 2010/11). Although the share of capital goods, fertilizer, and petroleum products declined from 68.4Pct of the total import bills in 2010/11 to 66Pct last year, they remain a great burden for Ethiopia.

The effects of currency devaluation on trade balance in Asian countries like China and South Korea reveals that there should be a set of necessary conditions for currency devaluation to be effective. For instance, the Chinese government has kept the Yuan relatively low against major hard currencies despite pressures to appreciate it from countries like the United States. Since China began to focus on the promotion of export of manufactured goods in the early 1990s, it has been experiencing a trade surplus.

Conversely, India has been experiencing a trade deficit for more than two decades. The value of the Indian rupee has been fluctuating and devaluation would not have a sufficient impact on the export sector because the economy is heavily dependent on imported energy and industrial goods while its export products have been primary commodities, which are price elastic in foreign markets.

Devaluation can further destabilize the economy by increasing the price of goods and services available in the market and reducing the purchasing power of consumers if it is not accompanied by appropriate policies. Ethiopia saw this after the 2010 devaluation, which was accompanied by rising inflation that reached 41Pct in August 2011.

Similarly, inflation started to rise after the recent devaluation in October 2017. The annual inflation rate increased by 12.2Pct compared with same period last year, while the monthly inflation increased by 0.2Pct between September 2017 and October 2017 according to the consumer price index released by the Central Statistical Agency. An informal market evaluation confirms that the price of imported commodities showed price surge. The same scenario was witnessed on items produced locally.

This is why experts stress that it is not possible to narrow the current account deficit through devaluation alone. Such policy interventions need to be executed with care until Ethiopia transforms into an industrial economy.

6th Year . February 16  – March 15 2018 . No.58

Leave a Reply

Your email address will not be published. Required fields are marked *

Ethiopian Business Review | EBR is a first-class and high-quality monthly business magazine offering enlightenment to readers and a platform for partners.

2Q69+2MM, Jomo Kenyatta St, Addis Ababa

Tsehay Messay Building

Contact Us

+251 961 41 41 41