Consistent overvaluation of the country's real exchange rate has contributed to poor export performance
Labelling the country's recent export performance as the worst in a decade, the recent update on the Ethiopian Economy released by the World Bank Group pinpointed a consistent over valuation of the country's real exchange rate (RER) over the past two decades has significantly contributed to the lower export performance.
All things being equal, a 10pc devaluation of the country's RER could lead to annual growth of five percent in its exports, suggests the report. Nonetheless, in the presence of macroeconomic trade-offs, the government has to weigh in other factors in using the exchange rate as a policy tool. This includes considering its impact on inflation, as well as on the import cost of capital and consumer goods, cautions the author of the report, the World Bank Group.
Suggesting increased productivity and product quality as the core drivers in making Ethiopia's exports perform better in the long run, the report also finds that Ethiopia could enjoy an improved economic growth of two percentage points with a 10pc devaluation of its RER.
The predominance of basic export commodities in the country, which tend to compete more on price than on quality, plays a role in the stronger impact of the exchange rate level of the country's currency in the performance of its exports.
The real exchange rate of the country was overvalued by around 30pc in 2009/10 and 2010/11, according to the report. This has affected the export performance of the country, as an "undervalued RER is associated with higher real export and output growth". This has been true across all countries and throughout history. On average, for each additional 10pc in RER undervaluation, the country's exports go up by 0.6pc points, and its output growth goes up by 0.88pc points a year, the economic updates says.
The overvaluation of the exchange rate hurts exports and favours imports, it says.
"Therefore, monetary and fiscal policy should aim to keep inflation low and the exchange rate policy should support a nominal exchange rate that is competitive," the group suggests. "The macro policy mix should take into account that a faster pace of nominal currency depreciation would potentially induce inflation."
The country is described as an example of "self discovery" by encouragingly creating and nurturing a high value horticulture industry and a booming air services, which have helped its rise in exports. This has contributed to the remarkable economic growth over the last decade, while creating more jobs and enabling the nation to earn "much needed" foreign currency.
Nonetheless, the type of the nations export items, which is primarily dominated by "unprocessed and undifferentiated" agricultural products, made it susceptible to the fluctuations of the prices of these commodities in the international market.
In fact, ever since the government disclosed its five year Growth & Transformation Plan (GTP), which is a year ahead of its conclusion, no sector has been more disappointing than the exports sector. There has been a sizable gap throughout the past four years of the GTP between the level of achievement and the four billion dollar annual earnings target. The problem seems to have been worsened by the recent price fluctuations, predominantly in the prime export commodities of the country.
When compared to the previous budget year, the export performance of coffee in the first ten months of this budget year has showed a decline of 8.7pc and 15pc, in the amount exported and revenue generated, respectively. The prime export commodity of the nation - coffee - has seen a year-on-year decline of 38.4pc, whereas spices, cotton and eucalyptus have seen a drop of 7.4pc, 66.2pc and 29.5pc, respectively. Indeed, the export regime of the nation is under distress, to say the least.
The overall export performance saw the country earn 2.6 billion dollars during the ten months of the budget year, registering a growth of 4.8 per cent from the last year.
It was in reference to this that the World Bank Group warned the nation that there exists underlying vulnerability in the country's export structure and recommended measures towards strengthening competitiveness. Such measures included the macro policy mix that enables the devaluation of its currency by at least 10pc - though it has been long overvalued by 30pc.
Increasing value addition, quality and branding of exports is the prime measure on the list of policy recommendations the group has made in its latest economic update. It also needs to avert constraints related to reliable power supply, credit and foreign exchange and redress the long overdue bottlenecks in the logistics sector, which still continue to be the least recommendations the nation has to consider. In its endeavour to thrive in the staggering exports sector, which has in fact contributed in many aspects of the economy, it has, however, expanded its efforts with the establishment of industrial zones in conformity with the international standard.