Private Sector Stimulation for Long Run Disinflation




Abraham Tekeste (PhD), minister of Finance & Economic Corporation, is content with himself. In the first quarter of the current fiscal year, the Ministry announced that over half a billion Birr had been saved from the budget allotted to 80 federal institutions. And with the news in mind, Abraham did not have any qualms telling state-run universities that no additional funding will be forthcoming for the remaining year.

If the hardheadedness of the Ministry towards government institutions, and their spending patterns, seemed surprising, it should not. What changed was not spending but extravagance. Public bodies, often notorious for overspending, were told to cut expenditures set aside for book and calendar publications and the use of field vehicles in cities.

With this version of the Revolutionary Democrats’ fiscal conservatism, the state will have salvaged over two billion Birr by the time the year is out. The volume, though, is a tiny percentage of the federal government’s current budget and quite a contrast to the amount that has been set aside for the nine regional states (and two city administrations) and capital expenditure. Both of which are well over a 100 billion Br.

For the state, an expansionary fiscal policy has been a means of guaranteeing growth. By injecting money into the economy, through various infrastructure projects, the government has been able to create jobs. And jobs have meant more disposable incomes, which in themselves contributed to the proliferation of small and medium-sized enterprises (SMEs). Through these platforms, close to one million jobs were created last year, according to Prime Minister Hailemariam Desalegn who appeared before parliament last Thursday.

But such a policy has not been without its side effects. An economy dependent on the state could be severely affected if the government starts to become prude on expenses such as capital spending. Thus, Hailemariam’s administration has been looking to the private sector to ensure that there is not too much money in circulation ever since the devaluation on October 11, 2017.

When the National Bank of Ethiopia (NBE) saw to it that the Birr would have 15pc less value, policymakers were as well worried about the inflationary pressure it could create in the economy. The regulatory body then implemented monetary policies to offset the effect.

Commercial banks were told to transfer any windfall gain they make as a result of the devaluation to the central bank and, to increase the country’s forex reserve, sell close to a third of their foreign exchange earnings to the regulatory body.

Another was increasing the minimum deposit rate by two percentage points, from what used to be five percent. The move is meant to incentivise savings, thereby reducing aggregate demand for goods and services, and thus contain price increases.

Notwithstanding the measure’s limited effectiveness in the face of the fact that only 22pc of the population is banked to begin with, the move will inevitably affect the bank’s profit margin if they continue to lend at similar rates as they used to. But, as the lending rate is fully liberalised, it will be expensive to take out loans. The policy measure would discourage private investment as over 90pc of the credit private banks dole out is for enterprises engaged in this sector, at least by a central bank report of three years ago.

The effect would be no different for businesses that export goods and services – a sector for whom the Birr sacrificed 15pc of its value. But the central bank is not one to give up, at least when it comes to tweaking macroeconomic constraints caused by monetarism with more monetary policies.

Outstanding credit growth rate was the central bank’s next victim. For the year that ended in June 2015, credit by private banks grew by an average of 40.8pc and 23.2pc the following year – 75.6 billion Br and around 93 billion Br, respectively. By limiting this amount to 16.5pc – roughly 108 billion Br – this year, the regulatory body has set out to affect monetary aggregates and reduce the money supply in the market.

But banks will be able to continue lending to businesses engaged in the export sector just as exporters would be allowed to keep 30pc of their forex earnings given they spend it on related costs. The central bank anticipates these measures to foster a component of the external sector the government hopes would be its knight in shining armour in the endeavour to shove through the trade deficit nightmare.

Despite the efforts, though, there were noticeable price increases just days after the devaluation as a result of retailers’ speculation of inflation. Driven mostly by lessons of the past devaluation, which is more than the incumbents are willing to do, business owners are adding to their product’s prices. A move not taken lightly by the Trade Practises & Consumer Protection Authority, which goes as far as shutting down enterprises that jack up their prices, 21 rebar retailers were made an example of to the business community.

These measures show that the central bank is only willing to sacrifice the private sector which even the International Monetary Fund (IMF), a body whose most recent visit made Hailemariam’s administration change its stance on currency devaluation, believes is a bad idea.

Two years ago, the international financial institution had advised more credit for the private sector, after noticing the havoc of another measure by the central bank to divert resources away from private banks. The banks have been required to invest 27pc of their gross loan disbursements in central bank bills, which had created bottlenecks for the private sector.

By May 2016, as privately owned businesses benefited from around 31pc of the total credit in the country, public enterprises have slugged more than double that amount. And as the primary beneficiary of loans by private banks is the former, limiting the credit growth would most adversely affect a sector the government is already biased against.

Limiting the money supply is one thing, but turning on the private sector for the country’s economic woes is quite another. If the former is mandatory then monetary policies, which can merely be applied without severely affecting other economic variables, are not the right cure.

But the private sector is. A more desirable means of containing inflation within the economy is through supply-side policies. The private sector in this regard could be of great help. The Revolutionary Democrats, although spenders, have not had great success at domestic resource mobilisation. The government has failed continuously to match either of the first and second Growth & Transformational Plan (GTP) targets when it comes to tax revenues, according to the IMF. While one reason for this is inefficient collection methods, the main one is a small tax base.

Credit to the private sector would only create more investment. This will increase the money supply, but the government can hit back through fiscal policies. Spending on the various infrastructure projects can be reduced. This should not necessarily mean completely halting projects but making increased use of public-private partnerships (PPP).

There is also privatisation of the various state-owned enterprises in the country. This would have long and short-term benefits. The government can instantly mobilise resources domestically by liquidating these assets. And in the long term, in the hands of the private sector, productivity would rise as a result of increased competition, thereby reducing the gap between supply and demand.

The private sector is also essential to economic diversification. With increased credit and an agreeable policy framework, it can bring about a sustainable economic well being, creating more jobs and improving exports.

In more than one way, it is apparent where the solution to inflation lies. Nonetheless, notably, the private sector as an answer to the recurrent inflationary pressure will mean a realignment of the incumbent’s policy perspective. It would mean a tightening of the belt when it comes to public expenditure while letting private enterprises breathe. It would also be a long-term solution, which would make the likelihood of its significance, in the eyes of political appointees with an election to face in a couple of years, very scant.



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


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