Yohannes Ayalew (centre), chief economist and vice governor of monetary stability at the National Bank of Ethiopia (NBE) and Getahun Nana , vice president of financial institutions supervision.

Following its unexpected move to depreciate the Birr against the dollar and a basket of major foreign currencies by 20pc, the central bank of Ethiopia will not be making any interventions for some time to come, it assured the public, during a press conference it held on Friday, September 3, 2010.

Teklewold Atnafu, governor of the National Bank of Ethiopia (NBE), was conspicuously absent at the press conference meant to quell the unpredictability of the market and foster consumer confidence. Yohannes Ayalew, chief economist and vice governor of monetary stability, explained the rationale of the rather unprecedented depreciation of the Birr, flanked by Getahun Nana, vice governor of financial institutions.

"The depreciation was implemented to bring the exchange rate close to the real exchange rate and attain a level of equilibrium," said Yohannes. "This will increase the external competitiveness of local goods and increase import substitution to bring the trade deficit down."

While, macroeconomic experts were aware that, there would be some adjustments made in the exchange rate, they were surprised by the magnitude of the devaluation.

"Virtually all indicators did not show a need for a sharp devaluation according to our reading of the data," read a review released by Access Capital after the central bank's announcement.

Starting in 2009, the central bank had depreciated the Birr three times to bring it to what most economists considered an appropriate level. This was shared by the assessment of the International Monetary Fund (IMF), which called for a modest adjustment of seven per cent to 10pc.

The previous exchange rate was at around the right level, economists had thought, based on the balance of payments and the unexpected performance of the export sector in the last budget year, which brought it a record two billion dollars in foreign exchange.

This was further supported by the national foreign exchange reserve, which, despite reaching an alarmingly low rate in 2008, has since bounced back to reach 1.9 billion dollars, enough to cover 2.1 months of imports.

The exchange rate was in alignment with the equilibrium level, with minor adjustments needed to reduce the queue times at banks to access foreign exchange, according to Access Capital's review based on the combination of factors indicated.

The government would make an adjustment of five per cent in the first quarter of the new fiscal year, Access Capital's "2010 Macroeconomic Handbook," had predicted. Yet, the central bank's announcement of its devaluation of the Birr by 20pc was a lot larger.

"We clearly misjudged the magnitude of the devaluation on the expectation that the authorities would, at most, move to close the prevailing gap with the parallel market," the review read.

With these indicators showing the exchange rate of the Birr being more or less at around the equilibrium rate, the move by the central bank is seen by many economists as an aggressive mechanism to improve the competitiveness of locally produced goods in the export market by deliberately undervaluing the Birr.

This approach, known as the China Model, makes locally produced goods cheaper in the local market allowing for more import substitution and enhancing them in the international market. This seems to be in line with the government's Five-year Growth and Transformation Plan. The plan mainly focuses on import substitution and is highly focused on the export sector, Sufian Ahmed, minister of Finance and Economic Development (MoFED), said right from the beginning, when announcing the plan.

Export promotion is a high priority in the long-term, the exchange rate adjustment signals, if one takes a look at China's economic success story, which has been sharply criticised by the West, according to Zemedeneh Negatu, managing partner at Ernst & Young.

"Brazil is another country which has used its currency rate properly to make itself competitive in the international market," said Zemedeneh, who lived in Latin America in the 1990s.

There are more monetary and fiscal policies to come, Yohannes, the chief economist at the central bank alluded but refrained from going into detail, other than to say that they were "prudent."

This was also the signal Prime Minister Meles Zenawi sent in a clear manner during the discussion held with the private sector last week. The government is ready to utilise all policy measures to ensure that the goals of the five-year plan are seen through to their end.

There seems to be a coordinated effort by the government to see the long-term goals come to fruition, including changes in import tariffs, one policy tool that is on the horizon, as the Prime Minister indicated.

Currently, the difference between import tariffs on finished products and raw materials is not that significant. For instance, the difference between the tariffs on chemicals used to produce soap and the actual soap is around five per cent.

The introduction of changes in tariffs on imported items to be used as inputs for local production will encourage the manufacturing sector and further allow for import substitution to take place, said Zemedeneh.

Although many economists agree on the long-term goal of the depreciation of the Birr, the short-term effect of it will contribute to inflation, some think. The inflation rate, in 2008, reached an average yearly rate of 36.4pc, which it brought down, to 2.8pc at the end of last fiscal year.

"This will increase inflation in two ways," said Tewodros Mekonnen, a macroeconomist at the Ethiopian Economists Association (EEA). "One is through inflation due to expectation, and the other is through imported inflation."

The market, following the announcement by the central bank, was in disarray, with trading of imported items practically coming to a halt. The expected inflation is already evident, as some traders increased prices on metal and electronics items they had in stock, in reaction to the announcement.

Increase in the price of imported items like fuel, vehicles, raw materials, and machineries will in the short-term have inflationary tendencies, according to Tewodros, whose effect will trickle down to the final consumer.

The inflationary pressure of these import items is not that high, contended Yohannes. The measures being taken will not create more inflationary pressure than is expected from the demand side, he stressed. "Although some imported items may increase in price, the overall impact on the inflation index is very limited," he said.

At the height of the inflation rate in Ethiopia, prices in both food and non-food items increased, which was further exacerbated by the spike in fuel prices in the international market. With the current market price of fuel remaining at around 70 dollars per barrel, down from a high of nearly 150 dollars per barrel two years ago, and a bumper crop harvest around the corner, the inflation rate might not be so bad.

Access Capital's forecast that the inflation rate would be a little over 10pc for the next year seems to be in line with this, as well.

However, the market is not reacting as economists at the central bank expected it to react, hence the need for the press conference on Friday, in which Yohannes tried to explain the nature of the economics and the effect that speculators in the market have on the price of certain items. Since the exchange rate has reached equilibrium, it will be some time before the central bank makes such an intervention in the market again, it signalled to the public.