The Bitter Pill’s Back, With Little Hope of Cure




Almost all multilateral finance institutions were in tandem warning Ethiopian authorities about the Birr, which weighted against a basket of major currencies is overvalued. The IMF has its experts zooming in their estimates in private conversations that the Birr is up by 40pc, but the officials say it is overvalued by 30pc.

When a currency remains overvalued, no doubt it disadvantages exporters, making the cost of goods and services in the domestic market expensive for them to get competitive in the overseas markets. It also encourages imports, thereby leading to a widening gap of a balance of trade.

Understandably, experts in the multilateral financial institutions have been preoccupied for a couple of years now urging microeconomic policymakers in Ethiopia to consider devaluation of the Birr as a prudent policy response. They argue that such measures would not only encourage exports but also address the deficit in the balance of payment and contain, to a certain degree, public debt.

Reluctantly, authorities at the central bank, early last week, did exactly that, a day after President Mulatu Teshome (PhD) signalled possible currency adjustments, during his annual address to members of the joint legislative houses, held on Monday, October 9, 2017. The President emphasised the need to reduce the galloping trade deficit as a fundamental macroeconomic objective for the current fiscal year, after referring to the stagnant export earnings in the past three years as the primary ill.

Indeed, the Administration of Prime Minister Hailemariam Desalegn has put its money where its mouth is. Only on the morrow, Yohannes Ayalew (PhD), vice governor of the National Bank of Ethiopia (NBE), announced to the media – albeit in complete exclusion of the private press – that the Birr was devalued by 15pc. As of October 11, it has been selling in the official market at 26.9 Br for the Dollar.

It was, however, part of a series of measures the Central Bank authorities have taken in the absence of their Governor, Teklewold Atnafu, who is attending an annual fall meeting hosted by the Bretton Woods Institutions, in Washington D.C.

Hoping to beef up exports, the Central Bank increased the retention rate of foreign exchange by exporters from 10pc to 30pc, while it instructed all commercial banks to transfer 30pc their forex earnings to the Central Bank. Rightly concerned with the resurgence of inflation, mostly of speculative nature, they have increased the threshold on the interest rate on deposits by two percentage points to seven percent.

The move was both a surprise as it was not.

For the Revolutionary Democrats, whose monetary policies have been just as rigid as their fiscal ones, the value of the currency has always been in their own hands. In the parlance of financial economics, it is known as “dirty floating,” a currency market operating under a more managed exchange rate system where it has merely been allowed to function as an instrument of demand and supply. It is under the firm thumbs of Central Bank authorities, making the state’s monetary policy not just tight but contrived.

Governments in developing and underdeveloped economies often use dirty float system as a buffer from external economic shock. However, in an economy which suffers from a meagre reserve level of foreign exchange, and its officials are busy couponing whatever is available, the system responds too slow when the currency falls under pressure, and the parallel market offers better, thereby diverting funds away from the Central Bank. It is hardly surprising should Ethiopian macroeconomic policymakers remain reluctant to abandon the forex regime or devalue the Birr whenever well-meaning bits of advice come from “the tyranny of experts” at the Bretton Woods.

The fear remains that devaluation leads to inflation, which is understandable. Ethiopia had experimented before, most recently seven years ago, when the Central Bank devalued the Birr by 17pc. In a few months, inflation had galloped to nearly 40pc. The purchasing power of citizens decreased, and the country’s cost of foreign debt repayment swelled. In the words of the late Meles Zenawi, it was a “last and inevitable pill to swallow” for the better of the economy`s future.

More importantly, it remains debatable whether devaluation then had improved exports, although the Administration believed the country had gained an additional 1.4 billion dollars owing it to devaluation. In the budget year that saw the previous devaluation, export earnings had increased by about 15pc, while the year before it was over twice that amount. And a couple of years down the road, it had already started faltering.

In 2012/13, export earnings would dip, get back up the next year and finally stagnate under three billion dollars for three years. Inversely, import bills continued to steadily increase, currently standing at almost 17 billion dollars, widening the nation’s balance of payments.

The cons – and substandard pros – are not lost on the policymakers who opted for the latest devaluation. It is only that they have a narrow field of vision. They are restricting themselves to macroeconomic policies that are neither long-term nor original impact. They are trying to fetch change without taking a step back to evaluate the big picture. In dealing with the economy, they are failing to address the apparent structural shortfalls, that is too much demand for forex and too little supply of it.

At the heart of the upsurge in demand is a state with an ever-expanding fiscal policy, resulting in a massive deficit in the balance of payment. The public debt, reaching at nearly 55pc of GDP in 2016, is the largest in a decade, although the country had seen three times higher public debt in 1994.

Much of this debt no doubt is used to pay for the importations of capital goods used in the building of the nation’s physical infrastructure. But a focused approach to addressing the deficit in the balance of trade requires the introduction of austerity measures in the form of tightening the public purse. The President, in his address to the joint assembly early last week, has alluded to this effect, although not forcefully and assertively as the problem demands. Yet, his pointing out that there will be no new project launched this fiscal year exposed the contradiction an administration has between its claim of an economy advancing to claim further heights and one that is put under a measure of austerity.

Among the streams of revenues the country generates, exports find themselves at the bottom of the list, preceded by remittance as well as loans and grants. Ethiopia had earned more from foreign workers’ money transfer to home last year than exports, reaching four billion dollars. But 78pc of these earnings are lost to the informal market.

A marginal move in cutting the value of the Birr by 15pc will do little to exporters that are hoped to benefit from last week`s measure, and bring a significant increase in forex.

It is too tiny a pebble to fill the massive hole that has been created by the enormous burden of being an import-dependent nation. Much has remained neglected because of the government’s dodged preference to adjust the economy instead of creating an economic environment that not only encourages competition but harbours it.

The measure by the Central Bank may improve exports but only in the small run and fractionally. It is unfortunate to believe that it would serve as a magic bullet when a slew of other roadblocks persist. Devaluation will not fix the bureaucratic aggravations exporters face or ward off corruption in land or credit allocations. It also does not address repeated power cuts or help reduce exporters’ operation costs in a country that lacks roads or the appropriate information technology (IT) infrastructure.

If pundits are sceptical of the export side of the argument as similarly flawed in justifying the devaluation, there are reasons for it. Earnings from exports had never claimed more than 10pc of Ethiopia’s GDP since 1980, with a notable exception in 2014 when it recorded 10.4pc.

Neither is the timing the devaluation made without a questionable track. Agriculture produces, which government forecasting to reach 345.6 million tonnes, comprise 60pc of all exports, according to the IMF’s 2016 report. Such commodities are harvested and exported during what is known as the Meher season, which begins around December. Exports also show a steep climb starting from this month, as evidenced by charts in the online economic indicator, Trading Economics.

If the aim was to increase exports without upsetting prices in the domestic market, then the timing makes little sense. The Administration wants to see exporters sell more without having much to export. In the absence of resolve to address supply-side constraints and logistical nightmare, the current measure in devaluing the Birr is defocused at best, if not a miscalculated in its expected results.

The unintended results are however surfacing immediately after the announcement of the devaluation. The market, in the form of the parallel currency market, has already reacted, sending the rate of Birr against the Dollar up by 20pc late last week. Prices of imported commodities have seen a sudden increase; for instance, the cost of rebars has jumped by 35pc. The bitter pill is indeed back, with no remedy to heal the wounds in sight.

A significant monetary policy though would be addressing the central problem of demand and supply. The crux of the issue has always been rationing as the only possible means of tolerably providing for forex needs. A radical solution would be liberalising the foreign exchange regime to floating, which would unavoidably lead to a sharp depreciation of the Birr for a while but can stabilise the market and create competitiveness in the long run.



Published on Oct 17,2017 [ Vol 18 ,No 912]


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