Saturday, April 13, 2024

IMF Staff to visit Ethiopia amid concerns over birr devaluation


By Muluken Yewondwossen

The International Monetary Fund (IMF) has announced that its staff will be visiting Ethiopia in the coming weeks, raising speculation about a potential devaluation of the birr, the country’s currency.

Industry leaders and economists have urged the Ethiopian government to explore alternative solutions to address its severe foreign exchange shortages. This includes engaging in negotiations on multiple fronts simultaneously to meet the demands of foreign allies.

Ethiopia, grappling with acute foreign exchange challenges and seeking to stimulate economic activity, has been in discussions with the IMF for financial assistance. However, these discussions have yet to conclude, despite initial discussions about foreign exchange assistance early last year.

The IMF has outlined prerequisites for releasing the anticipated funds, including assurances and support from Ethiopian financiers and partners. Additionally, it has urged the government to narrow the gap between official and informal currency exchange rates.

Concerns have arisen among the public regarding the possibility of the government implementing a birr devaluation, a move the government has resisted for years. While the government has sought to downplay these reports and reassure the public, fears persist that external pressure and the foreign exchange shortage may prompt a change in stance.

Prominent industry commentators and investors have also warned against birr devaluation, citing potential negative repercussions. They argue that any benefits would be outweighed by disadvantages, including potential social and political unrest and economic instability.

Alemayehu Geda, a macroeconomic specialist, cited the example of Sudan in 2018, where a significant devaluation of the Sudanese pound, recommended by the IMF, led to skyrocketing inflation and a sharp decline in the exchange rate.

Similar challenges have been observed in Nigeria, Ghana, and Egypt, where currency devaluation resulted in soaring inflation rates and depreciation against major foreign currencies.

Analysts highlight the discrepancy between official and black market exchange rates, underscoring the complexity of implementing currency devaluation as a solution to foreign exchange shortages.

As Ethiopia navigates its economic challenges, the government faces mounting pressure to address foreign exchange issues while mitigating potential risks associated with currency devaluation. The forthcoming visit by IMF staff signals ongoing discussions and deliberations aimed at finding a sustainable path forward for the country’s economy.

As discussions surrounding a potential birr devaluation continue, experts have also raised concerns about the stability of exchange rates, particularly between official and parallel markets. Alemayehu, warned against attempts to harmonize exchange rates, citing past experiences in other countries.

Alemayehu expressed skepticism about the motivations behind Western pressure to weaken currencies, suggesting potential ulterior motives. He questioned the necessity of such measures unless there were underlying political agendas.

However, other Ethiopian experts argued that many goods are currently imported at prices aligned with the parallel market. Presently, the black market rate stands at 115 birr for one dollar, compared to 56 birr in the official market. These analysts believe that any attempt by the government to devalue the birr to match parallel market rates would have significant market implications.

They pointed out that approximately 70 percent of imports are conducted at official exchange rates, primarily for government purchases. Key imports such as petroleum, fertilizer, pharmaceuticals, and other essential goods are heavily reliant on official exchange rates. Alemayehu emphasized that a devaluation would lead to a doubling in prices for key commodities like petroleum, thereby driving up transportation costs and ultimately inflating food prices.

In terms of economic impact, experts projected that inflation would at least double in response to a devaluation, with subsequent effects on the government budget. Currently, the budget assumes a dollar exchange rate of 56 birr, but a devaluation would require a significant revision of these projections. Given that around 40 percent of the budget relies on foreign exchange, any adjustment would necessitate additional funding, likely through money printing.

Moreover, the decline in the tax-to-GDP ratio over the past decade has raised concerns about the government’s ability to generate revenue to cover increased expenditures. Internal conflicts within the nation further complicate efforts to boost tax collection.

Despite these challenges, proponents of devaluation argue that it is a necessary step to address the country’s foreign currency shortages. They advocate for implementing recommendations from financiers while seeking assistance from allies. However, opponents of devaluation maintain that the government must carefully weigh its options, considering the potential economic and social ramifications of such a decision.

One potential solution under consideration is the devaluation of the birr, coupled with obtaining foreign exchange assistance from external partners. However, experts caution that such a move could have significant repercussions on inflation and social stability.

Alemayehu and other experts propose an alternative approach, urging the government to advocate against devaluation and instead gradually depreciate the birr over time. Drawing parallels to Ghana’s successful devaluation of the cedi without causing inflation, they suggest a cautious approach to currency adjustment.

A key aspect of this alternative strategy involves aligning the remittance rate with the parallel market, thereby encouraging legitimate remittance flows. Additionally, exporters of non-traditional commodities would benefit from a discounted exchange rate, fostering growth in new export sectors. This approach, experts argue, would mitigate the risk of inflation while promoting economic growth.

While acknowledging the government’s challenging circumstances, experts stress the importance of effective foreign exchange management. They highlight the potential for significant revenue generation through measures such as curbing smuggling and enhancing forex management practices.

Julie Kozak of the IMF has confirmed ongoing discussions with Ethiopian authorities regarding economic policies and potential reforms. These discussions aim to support Ethiopia’s Homegrown Economic Reform Agenda (HGER II) and address macroeconomic vulnerabilities. The IMF team’s visit to Addis Ababa in October marked progress in identifying areas for IMF support, with further discussions planned in the coming weeks.

As Ethiopia navigates its economic challenges, policymakers face critical decisions regarding currency devaluation and economic reforms. The outcome of these deliberations will have far-reaching implications for the nation’s economic stability and growth prospects.

Read more