Can Devaluation Work in Ethiopia?

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By Etsubdink Sileshi

What has happened and what it means:-It has been a year and half since the National Bank of Ethiopia (NBE) devalued the currency, ETB, by about 15% (in October 2017). The then vice governor and chief Economist of NBE, Yohannes Ayalew, said “In recent years, the real effective exchange rate of Ethiopia has become stronger- reducing our global competitiveness. This is attributed to two factors. One is the global economic slowdown which resulted in a decline of inflation in our main trading partners (this makes Ethiopian exports relatively expensive). And the other factor is the strengthening of the USD (this reduces the purchasing ability of non-USD countries)1.” The IMF had been pushing for exchange rate and other policy reforms. High level delegates from the fund held a meeting with Ethiopian authorities two weeks prior to the devaluation decision. According to the fund’s view, the Birr is still over valued “…policies should address most of the birr’s prior overvaluation, while ongoing reforms to strengthen the business environment will help preserve competitiveness gains… a more flexible exchange rate would help preserve competitiveness and foster export diversification, and recommended eliminating exchange restrictions ”2
Why do countries adjust the price of their currencies? How much big should this change be? And how long does it take for the benefits to pay back? How is Ethiopia’s external trade responding to the NBE’s action? Will there be unintended consequences? This article will take you through the answers to all these questions.
The devaluation of Birr means that our exports become cheaper and imports dearer. For an American consumer of Ethiopian coffee, $1 can buy more coffee now than before (the Birr price of coffee being the same). On the other hand, for an Ethiopian, here, a barrel of oil is more expensive now than it was before (needs more Birr now. Given that the dollar price of Oil is kept at the same level). Hence, in the short run, the quantity of exports and imports remains unchanged (as purchase orders are set in advance). However the price of exports declines while imports become expensive. This increases trade deficits.
However, as time goes on, the price competitiveness of Ethiopian exports attracts more consumers from abroad-volume of exports rises. For instance, if Brazil has a strong currency and Ethiopia a weaker (devalued) one, Ethiopia’s coffee of similar quality will be preferred to Brazil’s in the market. Increase in foreign produced items prices is expected to reduce demand for imports in the long run. Thus, a rising volume of exports vis-à-vis a falling quantity of imports leads to trade balance (the least it can do is to narrowing the trade deficit). Then, the answer to the first question above is that devaluation helps achieve a favorable trade balance. Moreover, in countries like Ethiopia, it helps solve the foreign currency shortage (boosts reserves). Regarding the size of devaluation (15%), it is not a random number. Central banks use tools like “the law of one price” or “The purchasing power parity” to identify if the price of an identical good is higher, lower, or equal with other countries.
The fertilizers, pesticides, herbicides and the time when the fruits of devaluation get reaped
Is devaluation of a currency always successful? The answer is no! Only countries that have done their assignments well enjoy the benefits of weak currency. Plus, a onetime devaluation and a successive ones have different results. The World Bank Group gave Ethiopia about seven recommendations back in 2014. Almost all of the requests outlined there are key to achieving the targets of devaluation in Ethiopia. The points include – increase value-addition(and branding of exports), easing binding constraints like power supply, credit, and foreign exchange, redressing bottlenecks in trade logistics, establishing Industrial Zones, revising burdensome business rules, improving regulatory quality, and ensuring real exchange rate competitiveness(the very topic we are discussing) 3.
Moreover, responsiveness to the reduced prices of Ethiopian exports (export elasticity), and that of increased costs of imports to Ethiopia (import elasticities) play an important role on the effectiveness of devaluation. According to what economists call “Marshall-Learner Condition”, the absolute value of the sum of these elasticities should be greater than one. If this criterion is met, the trade imbalance vanishes in the long run.
How long is the long run? A change in any policy will not have an automatic effect. There is a period between an implementation of a policy and its outcomes (output lag). So for Ethiopia, to reap the benefits of devaluation it takes time for commercial contracts to be renegotiated, quantities altered, inventories destocked; production lines expanded.
What the thermometer reads:-According to the quarterly bulletin of NBE (Q1-2019), total earnings from export fell by 7.4 percent compared to the same quarter of the previous year. The export volume of oilseeds, gold, fruits& vegetables, flower, live-animals and electricity declined. But those of coffee and pulses witnessed a rise. The price of most of these items decreased while there was a rise for some. Conventional wisdom tells as quantity of exports should remain constant in the short run and rise then after. The reductions in volume might have resulted from other factors like political instability.
On the import side, NBE says in the first quarter of 2018/19, total merchandise .Imports are found to be 8.7 percent lower than a year ago. The explanation given is “slowdown in import values of capital, consumer, semi-finished and miscellaneous goods”. This reduction in imports contributed to the narrowing of the trade deficits vis –a –vis the same period in the previous fiscal year4.
Can a side effect be worse than the original disease? Sometimes yes! Patients who walk in to hospitals may fall in bed if treatments go wrong. A pill, if taken inappropriately, may hurt the other organ more than the initial case of the organ that it was intended to cure. In the same token, economic policy actions like devaluation might have dire consequence if measures including the above seven points are left unattended. Rising inflation (due increase in cost of imports), forex shortage (if exports fail to generate hard currency), deteriorating trade balance may follow -offsetting the desired targets of NBE.
At this level, it may be too early to clearly identify the blessings/curses of the Birr devaluation. As the size of the mirror (time) increases, and if it is kept well-polished with rich data and proper tools of analysis the true image of the effect of this policy will be revealed.(Indeed we will continue valuing the devaluation)

The writer can be reached at etsubdink08@gmail.com