17 February 2013

Ethiopia: Macroeconomic Radar Must Turn Towards Structural Issues


Disagreements over issues are rare within the core leadership of the EPRDF-led government. Even when they happen, they hardly involve differences in principles and values. Instead, they would be about procedural matters.

As much as this might have limited the evolution of the government, it has given it a rarely found consensus to execute its projects with full force. Only slight differences in approach occur between the different implementing agencies.

This is precisely why the recent disagreement over the problems related to foreign exchange between the top leadership of the government has grabbed the attention of the local policy sphere. Despite the differences in analysis, it was significant enough to send strong signals to the market.

On one side of the aisle stands Teklewold Atnafu, the powerful protectorate of the national money machine, who strongly argues that there is no foreign exchange shortage in the country. His analysis largely dwells on the expectation factor that instigates artificial forex demand. Whatever is happening in the market is artificial; the argument goes, largely driven by panic requests for foreign exchange, as evidenced by the repetitive requests filed in banks by businesspeople.

At the other extreme stand ministers with the responsibility of leading private sector development policies, such as Mekonnen Manyazewal, the rather technocratic minister of Industry with enough credibility in the market. An expanding gap in the supply and demand of foreign exchange has become a threat to the development of the country, as it delays projects, the argument goes. The ever increasing time that it takes to process Letters of Credit (LCs) is enough evidence of the bleeding effect of the gap in the exchange market.

Logical as the arguments may be, although largely dependent on their selection of evidence, they fail to be comprehensive. They ignore important elements of the whole foreign exchange equation - structural issues. Hence, they do not show the full picture of the problem.

If textbook economics is anything to go by, the foreign exchange reserve of a nation is a result of different interrelating economic factors. The factors range from export revenue to the type of foreign exchange regime. Whatever happens in the reserve of a nation is, then, a result of a shift in one or more of these factors.

As much as Teklewold and his opponents might be right in some areas, they cannot be on the ball in all areas. At the core of their incomprehensible reading of the market lies the partiality of their factoring.

Indeed, the numbers tell much of the story. The trade deficit of the nation which was about 1.5 billion dollars in 2007/08, the crisis year signified by the bankruptcy of major global financial institutions, and the financial quake felt throughout the world, grew to 5.5 billion dollars in 2011/12. This brings the four-year increment to four billion dollars with an annual addition of a one billion dollar deficit.

A clearer picture can be obtained when this number is compared with the foreign exchange reserve build-up, which grew from 263.5 million dollars in 2007/08 to 2.37 billion dollars in 2011/12. The four-year growth in reserves amounts to 2.1 billion dollars with an annual increment of 500 million dollars.

Simple arithmetic would then show that the ratio of the rate of growth of trade deficit to foreign exchange reserve is 2:1. From this, it is easy to see that the post-2008 economic realities, both global and local, have been going against reserve build-up, for they widen the trade deficit.

No argument over outcome will help change the direction of the economic wind. It would actually intensify the problem by sending confusing messages and encouraging speculation.

Though minor, this seems to be what is exactly happening in the foreign exchange market of the nation. Bank executives are heard murmuring about foreign exchange shortage; they seem to not agree with Teklewold. Business people relate all their challenges to the constriction of the forex market. As a result, the parallel market rate for major foreign currencies has continued to increase. United States Dollar (USD), the popular reserve currency, is now exchanging for over 20 Br.

The focus should have been on defining the structural challenges of the economy. Had that been the case, better results would have been achieved by now. After all, the past three years have seen massive public investment outlays, mainly in the economic infrastructure sector. Consequently, import of capital goods has skyrocketed. Since a large part of the economic undertakings are driven by public investment, the space for the private sector has narrowed.

In contrast, the global economic reality has been discouraging exports. Major export markets, including the United States, Europe and China, have been rocked by the swirling winds of the financial crisis. This has been complemented by the long overdue logistics problem at the lone export corridor of the nation.

The balance had been an expanding trade deficit. Of course, it was underpinned by an expansionary fiscal policy. A base money growth of 33.9 billion Br between 2007/08 and 2011/12 would also show that the fiscal expansion had been witnessing an underpinning monetary expansion.

It is this domino effect that seems to have been overlooked during debates at top levels of the leadership. They should have tuned their radar to these underlying structural issues instead of squabbling over the final outcome.

Undoubtedly, management of the foreign exchange regime of the nation is the jurisdiction of Teklewold. Yet, his policy bullets will not be able to hit their targets without the collaboration of line ministries commanding the powers of the real-time market players. But, even collaboration will not be effective without setting the right target in place.

Targeting structural issues would have a wide impact. Beyond generating foreign exchange, it could encourage growth and have an immediate impact on employment.

A leadership that focuses on structural issues would eventually face rising imports, declining exports, fiscal expansion and a rigid foreign exchange regime. Redressing each of these problems will not be easy.

Imbalances in the external trade front call for policy actions that could somehow limit imports and facilitate exports. Policy actions such as easing customs procedures, reducing export documentation requirements, solving the logistic hurdles and reducing cost of remitting export revenues could help boost the foreign exchange generation. A significant reduction in import expenditures could be made through fiscal restraint; a policy action highly sought for at this very time.

Although these actions might ease the burden in the short-term, they cannot bring a lasting solution to the recurring foreign exchange problem. What might change the whole game is a transition, albeit progressive, to a floated foreign exchange regime wherein more credible players could be accommodated. With more participants in the game, such a transition could lead to an improved forex build-up at any given time.

It is bringing such a debate to the table that could be thoughtful both to Teklewold and the other ministers. Taking any more time to deliberate over a symptom would not, in any way, help cure the pain.

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