19 October 2017

Ethiopia: Carefully Managing Possible Devaluation Impacts


Last week, the National Bank of Ethiopia (NBE) announced the devaluation of Ethiopia's currency by 15 per cent, effective as of October 11, 2017. While the move, the first in seven years, aims to boost export earnings which have stagnated in the past couple of years, due attention should be given to preventing repercussion effects, particularly inflation.

Ethiopia, for the last time devalued its currency in 2010 by 17 percent. In the following years, the country experienced double digit inflation till the policies adopted by the government finally stabilized the situation.

Since then, major international financial institutions such as the World Bank have been repeatedly advising that Birr was overvalued and devaluation would enable the country to increase exports and boost economic growth. In addition, they said, yet another devaluation would help Ethiopian exports to become more competitive in the international market.

True, Ethiopia has not earned from its exports, as much as it targeted in the past couple of years. While it was planned to earn 4 billion USD form export, the country has earned some 2.9 billion during the 2017/18 fiscal year.

One of the major reasons, economists attribute to the stagnation of export earnings, is the strong value of the birr against other currencies, which prevented the nation's exports from being competitive in the international market.

True, Ethiopia's exports have been stagnant over the past couple of years. And this has significantly affected the foreign exchange earnings that are urgently needed to realize the nation's ambitious economic transformation plans. Hence, this calls for policy measures to be taken to better the situation.

Devaluing the currency seems to be a timely measure in this regard. Because, when the value of the Birr is weaker than other currencies, Ethiopia would be able to sell its commodities with lower price in the international market. This would make its exports competitive and will in turn pave the way to generate increased foreign exchange.

Yet, increasing export is not the only outcome of devaluation. Besides making exports cheaper, the generally held view by economists is that devaluation of a currency also makes imports more expensive and increase aggregate demand. In addition, (cost push and demand pull) inflation is more likely to occur. Generally, devaluation is likely to contribute to inflationary pressures because of higher import prices and rising demand for exports.

The good thing is NBE seems to be prepared well to prevent higher level of inflation. One thing that prevents such phenomenon, according to the Bank is the high return of investment in Ethiopia. "Since investment return is high in Ethiopia; the devaluation will not cause an inflationary pressure and adversely affect import," said Dr Yohannes Ayalew, Vice Governor and Chief Economist of the bank during a press conference.

Moreover, the bank also said it raised the main interest rate to 7 percent from 5 percent to stimulate savings as well as to counter inflation resulting from the devaluation.

While the impact and effectiveness of these measures will be seen through time, due attention should be given to controlling short term artificial inflation that may arise because of expectations. The inflationary situation , particularly on commodities that do not have direct relationship with export, import or with foreign currency have to be monitored carefully.


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