Ethiopian Action for Unity and Democracy

By Seid Hassan

Devaluation is associated with fixed or pegged exchange rates systems whose value is not being determined by the normal (free) mechanics of supply and demand. In general, devaluation reflects the existence of serious macroeconomic problems (imbalances) and also reflects weaknesses of the government which is devaluing its currency. When it comes to Ethiopia, the economic weakness is reflected by several of the resource gaps: the savings-investment gap, the balance of payments gap which in 2009 escalated, total exports and imports amounting $1.657 billion and $7.093 billion, respectively, according to the CIA World Fact book. Ethiopia is also afflicted by other gaps such as a continuous budgetary gap, a skilled human resource gap, a significant agricultural (food security) gap, a dire foreign exchange gap, technology gap and most importantly a good governance gap[1]. By just looking at the solvency issue, that is, the balance of payments and budgetary balance gaps and the alarming foreign exchange shortages, one is led to believe that the birr is overvalued and devaluation is necessary. When I wrote the popular article titled as the “The Causes of the Soaring Ethiopian Inflation Rate,” a few years ago and suggested that the birr was overvalued, some of my readers were perplexed by such an expression, informing me that I was wrong. They did so partly because they thought I was agreeing with the government that devaluing the birr would serve as a panacea for the structural problems that the Ethiopian economy was facing and partly because they thought the theoretical possibilities were applicable to Ethiopia. All that I was saying was this: using standard economic reasoning and rationales of devaluation, the fact that there is a parallel market (black market) with the birr buying less dollars/euros means that the birr was overvalued. The fact that the government has been facing foreign exchange shortages and is unable to meet the lowest required foreign exchange reserves (which is supposed to be not less than a 3-month import coverage, but the actual coverage at times being less than six weeks of import coverage) and the fact that the IMF has been warning the government that it would face financial difficulties implies that the birr could collapse, sooner or later. Moreover, the fact that even some domestic firms were suspending their operations and unable to import the necessary intermediate inputs from overseas due to the lack of foreign exchange also indicate a balance of payments disequilibrium (that is, the exchange rate between the birr and other currencies has become untenable). It also means that, with disequilibrium in the exchange rate in existence, the government will be unable to carry on its new 5-year “Growth and Transformation Plan.” It is for these already existing realities and inherent weaknesses why I argued the birr was overvalued long ago. I also believed that were it not for the continuous influx of donor assets (estimated to be $3 billion in 2009) and remittances (the National Bank of Ethiopia reporting total remittances just for the first two quarters of 2009 being $1798.8 million), the value of the birr would have been much lower than what it was then and what it is now as well.

Regarding the political aspect of the weakness, in general, devaluation comes as a result of the realities of economic mismanagement and the push (many people like to call it- coercion) by the International Monetary Fund (IMF). In general, a greater portion of a country’s citizens whose government bows to IMF’s pressure is considered to be a weak one. Second, since those firms who are engaged in the production of exportables tend to benefit the most from the devaluation of the birr, it indicates the increasing lobbying power of those firms (groups) which are able to turn policy decisions towards their favor. In the Ethiopian case, given that several of the TPLF- controlled conglomerates organized under EFFORT and REST (in collaboration with Sheikh Mohammed Al-Amoudi’s MIDROC Ethiopia) have seized the state, it is only them who stand to benefit from the devaluation. The fact that powerful elements are able to gear government policies towards their favor in turn reflects the weakness of the government which is supposed to look after for the interests of the country and the general populace. … [read more]

Experts at Access Capital, a well-known economic research firm in Ethiopia, were taken by surprise when they learned about yesterday’s 20 percent devaluation of Ethiopian currency exchange rate.

In an analysis released today, the firm said: ” The magnitude of the adjustment is a big surprise, not least because most macroeconomic indicators did not show a need for a sharp devaluation at this particular time.”

IMF, on the other hand, came out in favor of the devaluation, saying, “it will help bolster Ethiopia’s competitiveness.” In June this year, the IMF recommended a 10-percent devaluation of the birr.

The following is a summary of Access Capital’s analysis:

In a very bold and unexpected move, Ethiopia’s central bank devalued the Birr by 20 percent on September 1, 2010. The magnitude of the adjustment is a big surprise, not least because most macroeconomic indicators did not show a need for a sharp devaluation at this particular time.

Given the apparently little justification for a large devaluation from a short-term macroeconomic perspective, we see more longer-term and structural motives for the authorities’ actions. More specifically, we think there is now a conscious effort to experiment with a deliberately undervalued exchange rate (the “China Model” one might call it) and to pursue a more aggressive strategy of import substitution. Both these efforts can be seen as being in line with the main objectives of the authorities’ recently released draft Five-Year Growth and Transformation Plan.

The impact of the exchange rate adjustment will be quite adverse for several segments of the business community, but most of the encouraging trends observed with the steady depreciations of the past year—strong export growth, slower import growth, and improving foreign exchange availability—will all be reinforced.

Looking ahead, we think that after a nearly two-year period of rather sharp movements in the rate, economic policymakers will henceforth seek to provide an extended period in which the Birr rate is relatively stable and predictable. Thus, despite the authorities’ demonstrated ability to surprise, we would venture to say that the regular monthly depreciations of the past will be discontinued from here on and that the exchange rate will stay within a very narrow range for the coming year.

Click here to read the full report.

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