External Sector Under Currency Discrimination

Currency devaluation, unlike other policy tools of governments, is not supposed to leave without being dramatic or traumatising people. This is perhaps what goes on in the minds of businesspeople and consumers in Ethiopia. People are worrying and at times questioning to what extent they would lose or gain from the unexpected policy shift of the National Bank of Ethiopia (NBE).

Those who are in the export sector are pondering whether the benefits they currently enjoy would stay with them beyond the short-run, a period that is unknown. They ask to what extent domestic prices for their inputs would give them time to reap the gains of the policy shift.

Will it stay long enough? Alternatively, will it respond soon and grab the fruits of the devaluation within a few months?

The same goes to those who send remittance. They may be encouraged to remit extra hard currency to their relatives, hoping the purchasing power of a dollar is better than what it was a few days ago. However, it would not stay for long, as domestic prices will increase because of the pressure it may face from imported products.

In the home of consumers, a rise in the cost of living and erosion of their real wage should no doubt be a reason for worries, if the current inflation aggravates further. The hope is only if the domestic industry responds positively to expensive imported products. However, this is not more than a pipe dream given the current socio-economic situations of the nation.

For any government, constructing a policy is one of its jobs. However, when it exercises its duties, the policymakers need to think thoroughly or sometimes need to think out of the box, given that they are playing with people’s livelihoods. Especially in a country where there is an absence of reliable independent institutions that score and identify the devil behind a newly crafted government policy, the job of policymakers should not only be designing a strategy that targets addressing problems; instead it should include considering all possible scenarios and alternatives. Considering this, policymakers at the central bank have failed the test. Here is why.

The country has been losing its competitiveness, maybe because of ever-increasing domestic prices or overvaluation of the official currency. Thus, addressing the causes that affect competitiveness should be a shared interest.

However, what is the rationale behind giving a subsidy in the form of devaluation of the currency, for example, for an exporter that only exports raw coffee beans?

It is not the prerogative of coffee exporters to sell all the beans the country grows to the global market. They are licensed to do just that. If every exporter has been exporting in compliance with the law, whether or not the central bank devalues the currency, the hard currency generated from such trading is the same.

Therefore, what is the purpose of making a policy that benefits such trading that only supports exports of raw beans without any value added? Can this encourage small holding coffee growers to produce more?

To a certain extent, this could be the case; but it is insignificant. The same goes to imports.

Is there any rationale in the minds of policymakers that justifies charging domestic producers who import capital inputs with the same exchange rate as those who bring in luxury products?

Much of our domestic producers, including those in the manufacturing industry, are dependent on importing raw materials for producing value-added products. Most certainly, depreciation of the Birr against a basket of major currencies, unless they manage to source them locally, will swell their expenses. With the current infrastructure the nation has, and the productivity level the industries exhibit, substitution of imports may not happen soon.

Thus, what should be done with the recent devaluation of the Birr to achieve the desired outcomes?

We follow a managed quasi floating exchange rate regime, with many opportunities for policymakers to control the currency market in the interest of the nation. That is, with such room the central bank has at its disposal, I do not see the wisdom of sticking to the existing currency regime. Instead, it would be worthwhile to consider the introduction of multiple exchange rates applying to different sectors but depending on their productivity.

If an industry is engaged in exporting value-added goods, it should get a preferential exchange rate where the Birr has been devalued. However, if it exports primary products and raw materials, it shall obtain an overvalued currency. In the same token, importers of inputs for investments should be rewarded with an overvalued currency as opposed to those who bring in luxury items.

Policymakers at the central bank can easily alter how businesses behave than with tired fiscal policy instruments such as duties and tariffs. The alternative could be through exchange rate discrimination. They can also boost competitiveness among sectors driving businesses to where they can gain policy driven benefits. This can be accomplished with high impact in taming domestic inflation.

However, if the central bank continues with the current single exchange rate regime, sectors that are critical for import substitution but are dependent on importing capital inputs, will lose some of the gains they were enjoying from the fiscal policy side. In the absence of such encouragement, domestic manufacturers are left with limited choices but to jack up prices for their products or cut manufacturing costs.

I am afraid that for a nascent manufacturing industry operating in a business environment that is unfavourable, it will be challenging for them to wither the wind. To survive, they need to either charge higher prices for their products or look for another subsidy from the state.

Neither is the single exchange rate policy crafted in a way that encourages industries to move beyond exporting primary goods and raw materials. Those that export such items without adding value will continue with the same trend, enjoying the benefit, at least for a few months, until prices for exportable primary goods and raw materials in the domestic market escalate. That is, with such policy of the central bank, the economy falls into a vicious circle but with much loss to consumers.

By Sharew Erkehun
Sharew Erkehun is a public policy analyst. He can be reached at sharewerk@gmail.com

Published on Oct 28,2017 [ Vol 18 ,No 913]



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