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Will Ethiopia Devaluate its Currency Again?

by addisinsight

Even with the recommendation of the  World Bank that Ethiopia needs to devaluate its currency, the government seems to stand its ground this time.     

 Earlier this year, during its  5th Ethiopian Economic update, the World Bank (WB) suggested that the Ethiopian government should devaluate its exchange rate of Birr by 10% pointing out that in real terms may lead to a five percent increase in stalled export earnings and a two percent increase in growth.

This is not, however, the first time for the World Bank to suggest that Ethiopia devaluate its currency. Ethiopia last devalued its currency in 2010 by 17% but the value of Birr against the dollar and other international currencies has also been depreciating from time to time as per a floating exchange rate.

The reason for the bank to revisit this idea this time is because the current exchange rate – which is nearly 23 Birr per dollar is considered to be overvalued for the WB and other global financial institutions, including the International Monetary Fund (IMF).

The Bank also argues in its suggestion, that a massive devaluation could also help to suppress the otherwise lucrative parallel market, (black market). A devaluation of the Birr by one per cent would bring a 0.33% increase in agricultural export; a 1.06% surge in manufacturing for exports; and a 0.5% jump in service exports, respectively.

The devaluation of the Birr per US dollar officially began during the EPRDF (Ethiopian People’s Revolutionary Democratic Front) regime. Previously, the country used to have a fixed exchange rate with a rate of 2.07 Birr per US dollar. Some researchers held that, during the 1970s and 1980s, the Birr was overvalued leading to a trade and also public budget deficit.

If the misalignment between the Birr and the dollar continues, the World Bank cautions, it would further balloon the trade deficit and spark a balance of payments crises. Thus, the Bank urged the Ethiopian government to devalue the Birr against a basket of currencies, and restore export competitiveness, thereby improving the trade balance.

Nonetheless, devaluation is one of the topics that have divided opinions of experts all over the world. Some strongly argue that devaluation can be used by countries to achieve economic policy. Having a weaker currency relative to the rest of the world can help boost exports, shrink trade deficits, and reduce the cost of interest payments on its outstanding government debts.

There are others, however, arguing that it has a negative effect in terms of creating uncertainty in global markets that can cause asset markets to fall or spur recessions. Countries might be tempted to enter tit-for-tat currency wars, devaluating their own currency back and forth in a race to the bottom. This can be a very dangerous and vicious cycle leading to much more harm than good, they assert.

It is argued that investors would be encouraged to send in their wealth as they would get more Birr for the same amount of dollars if Ethiopia devaluates its Birr. Exporters would also be a lot more profitable, hence balancing the huge deficit between Ethiopia’s imports and exports which has averaged a loss of 824 million USD from 2006 to 2016.

Although, at face value these seem like good arguments, there are some serious negative consequences that might inevitably follow. Firstly, Ethiopian imports are what are called strategic imports – whether or not prices change, the import of these goods is too necessary to leave, goods such as fuel, medicine, and machineries. Therefore, devaluating Birr would just make it expensive. These would be an impediment to very important construction and development sites such as the Great Ethiopian Renaissance Dam (GERD).

According to an analysis done by Addis Fortune, a weekly business newspaper in Ethiopia, the major reason for Ethiopia’s inability to extract the possible “juice” from the Birr devaluation is due to the inelastic nature of its export supply; it is as a result of its inability to increase the volume of exports as a result of the exchange rate change. Despite having an enormous potential, supply is incapable to respond to price changes in the short-run. Thus, the assumption for the balance of payments to bridge gap at the initial stage of currency devaluation later to make a gradual recovery – economists call this the “J Curve” scenario – is practically not applicable to Ethiopia.

Secondly, inflation is a major threat. Following the 2010 devaluations, the rate of inflation has drastically increased. Some researchers estimate unsavoury prospects that for every 20pc devaluation there will be a 40pc increase in inflation.

Even though the arguments about devaluation by the bank or international fiscal organisations or even economics experts are various, there seems to be no disagreement over the fact that the Birr is overvalued against major currencies and is maintained at its current state with a huge cost. However, the difference of opinion seems to lie in the policy response.

Government officials refuse to devalue the Birr to avoid market turbulence. Studies conducted back in 2009-2010 by Access Capital, a research firm now inactive, shows that the monthly depreciation of the local currency by that time was in less than four per cent. Considering the difference in the global economic situation, it is obvious that the slump will be lower than the case in 2009-2010.

Financial experts on the other hand, argue that it does not have a guaranteed outcome that exports will dramatically increase due to devaluation. According to research done by Alemayehu Geda, economics professor at Addis Ababa University (AAU), exporters say that their biggest problem is not the lack of money, but other structural problems such as access to land, customs, tax regulations and corruption.

All this seems to prove that devaluation comes as a double-edged sword, “But it has not stopped it from happening,” states Tekie Alemu, PhD, an expert in Resource and Welfare economics at AAU reckons.

He estimates that the Ethiopian birr has been devaluating by 0.1% per day since 2010. Hence, while the Bank’s suggestion has not gone unnoticed, the government’s method of slow devaluation is a lot more acceptable. The Birr’s drastic devaluation in 2010 is an instance that should not be repeated.

In spite of all this though, a recent country office report of the Bank stated that despite a severe drought and a decline in export incomes caused by civil unrest in the past year, Ethiopia has still managed to register an impressive growth in its gross domestic products (GDP), averaging at eight percent.



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