The IMF Report on Ethiopia is at War with Itself

Yonas Biru, PhD

The IMF report suggests the foreign exchange (forex) “performance has been in line with program commitments and all quantitative performance criteria (QPCs) were met, with an overperformance in the net international reserves target.”

In the meantime, it states “The supply of foreign exchange is picking up, helping alleviate acute foreign exchange shortages. Nonetheless, some unmet foreign exchange demand persists as economic agents are still adjusting to the new foreign exchange (forex) regime.” 

The reason the supply and demand for forex are out of sync cannot be explained by the failure of the business community to adjust to the floating forex regime. The problem is due primarily to the government’s tight monetary policy that restricts the supply of the Ethiopian currency – birr. 

To explain the conundrum to non-economists, it is akin to limiting the business community’s access to birr and suggesting there is enough forex, but the business community’s demand for it is low. The presence of an oversupply of forex relative to demand for it does not reflect success in the forex reform. It reflects low demand for forex created by the policy that limited the volume of birr in the economy. 

A reputable Ethiopian economist who lives in Ethiopia put the conundrum succinctly, stating: “The overperformance of the supply-side of the forex is created by the government-imposed underperformance of the demand-side calculus.” 

An important question is that if birr is in short supply relative to dollar, how come the supposedly market driven forex rate does not respond to the enigma of the market order. If the IMF’s report is correct about the overperformance in the net international reserves target, a shortage of birr relative to dollar must have prompted the value of dollar to depreciate and that of birr to appreciate. But that was not what happened. At one point the black market was 142 birr for a dollar when the official market was 120. The government arrested black market dealers and pushed the black-market rate down. 

Furthermore, the government dealt with rising inflation with proverbial whips and chains, arresting shop owners and closing their shops, for raising commodity prices to fend off the adverse impacts of the forex reform. The IMF report acknowledges this, noting: “local authorities in Addis Ababa took measures to address perceived unwarranted price hikes and hoarding of goods, including temporary shop closures.” Pay attention to the word “perceived unwarranted.” This is the usual IMF double talk, acknowledging the use of the proverbial whip and chain, but afraid to say it was unwarranted. 

The report sheepishly suggests the government’s whips and chains helped curb inflation, highlighting “headline inflation declined to 17.2 percent supported by easing food price inflation (particularly staples).” In the meantime, it suggests the inflation will “peak around 29 percent in mid to late-2025.” 

This is puzzling for two reasons. First, only an increasing inflation can peak, not a declining inflation. Second, the data IMF peddles runs contrary to independent inflation monitors who estimated post forex floating inflation at 30% to 44%.  For example, the price of injera per piece (a non-tradable staple) hovering between 17 and 20 birrs, before the reform and currently ranging between 35 and 40 birrs, a 100 percent increase. The price of cement is up by 42%.

There are many other areas of conundrum. The report, for example, states: “continued tight monetary policy and elimination of monetary financing of the government will be key to durably reducing inflation. Expanding social safety nets is critical to mitigating the impact of reforms on vulnerable people.”

Indeed, tight monetary policy reduces inflation. But it also adversely affects both the supply and demand sides of the economy. For example, the report notes, “growth in industry has suffered from supply bottlenecks particularly in construction.” But it does not mention the fact that the primary bottleneck is the tight monetary policy. 

Construction developers cannot complete their projects because banks are restricted from providing them with badly needed loans. In the meantime, they cannot sell their completed projects (such as single-family homes or condominiums) because buyers cannot get loans for the same reason. The same is the case with manufacturing, another component of the industrial sector where there are unmet demands for similar reasons. 

Expanding social safety nets is another area of conundrum that the supposedly overperforming forex space creates. The question that imposes itself is: Where is the money coming to expand social safety nets to mitigate the downsides of the forex reform?

The report assumes the government’s ambitious, comprehensive and sustained tax mobilization reforms will finance social safety nets and support development spending needs. In the meantime, it acknowledges the government’s tight monetary and fiscal policies “will constrain economic activity in the near term.” Part of the fiscal policy requires reducing public expenditures. The report does not explain how additional tax revenues can be realized where both public and private economic activities are constrained? 

In this regard, an important point the report failed to address is the tax to GDP ratio in Ethiopia ranges between around 7%, down from 15% in 2015 that was at par with the rest of Sub-Saharan African countries. 

Inexplicably, the report only scantily mentions the ongoing conflicts in the Amhara, Oromo and Tigray regions.  On a scale of low, medium and high, it categorizes the ongoing conflicts as medium. Noting Amhara and Oromo regions are the country’s “main crop producing areas”, it blows sirens as an early warning signal to mitigate the risks of “economic disruption, increased humanitarian needs, and increase in prices of staples.” 

Surprisingly, its policy recommendation is to “Ensure clear communication, facilitate humanitarian aid, and accelerate peace talks.” Surely, the authors of the report must know about a UN report that “the UN-backed $3.24 billion humanitarian response plan for 2024 is only five per cent funded.” As to the communication between the government and the warring groups, there is a loud and clear communication. 

For example, the government has made it clear, the Amhara fighters (Fano) must disarm to end the war. On Fano’s part, one of the top leaders has communicated publicly that the only negotiation his group will consider is one in which the government renders full power to the Amhara. It is, therefore, mind boggling to read the IMF report that recommends accelerating non-existent peace talks between the conflicting parties.

The report is tone deaf and blind about two proverbial 800-pound gorillas. First the off-budget expenditures on the Prime Minister’s vanity projects, most notably his $15.4 billion palace and its posh environment that competes with the safety net needs. Second is forced displacement of hundreds of thousands of people to clear room for the Prime Minister’s pet projects in Addis Ababa and the so-called Sheger City. 

The authors of the report understand the daunting challenges. As such, they throw doubt on the government’s 8% economic growth projection, noting serious economic headwinds that the nation faces. However, they still push the government to stay the course, despite the serious downside risks. 

Chiefs among the downside risks are: (1) “persistent inflation” that is expected to “peak around 29 percent in mid to late-2025,” (2) “depreciation expectations”, (3) “Potential exchange rate pressures could generate volatility and impact volumes and market development”, (4) “policy slippages and commodity price volatility”, and above all (5) “security risks or social unrest.” 

Evidently, the noted “security risks or social unrest” emanate primarily from shortage of resources for social safety net. According to the United Nations, currently, more than 68% of Ethiopians live in poverty. The social safety net needs are enormous and there is no explanation how the government can meet the demand, considering the above-noted UN report that laments only 5% of the estimated $3.24 billion humanitarian aid has materialized.

The day the government declared its forex reform on July 29, 2024, it promised to increase the salary of public servants to mitigate the negative economic impacts of the reform.  Last week, it announced the planned salary increase is indefinitely postponed. Moreover, subsidies for key commodities such as fuel and food are limited and there is no reason to believe they will be sustained even at the current rate, considering the IMF requirement of maintaining a policy of “substantial fiscal tightening.” 

Despite the stated security and other equally serious risks, the IMF report warns the government “Inconsistent implementation or reversal of key fiscal or exchange rate reforms could result in larger financing gaps or withdrawal of development partner or creditor support.” It is the policy equivalent of holding a gun on the temple of the government.

The risks of the economic hardships are borne by the poor. The security risk that social unrest entails poses an existential threat for the nation’s survival. The only potential lifeline the IMF policy touts is international aid, but it is neither guaranteed nor likely to meet the nation’s safety nets resource needs. Ethiopia faces unmitigated and unmitigable security and survival risks. There is an economic crisis that neither the Ethiopian government nor the IMF can sugarcoat. 

A friend who read my draft wondered aloud: “Why is the IMF producing a report like this, with contradicting information? Is it to caution the government without sounding off an alarm? Or is it aimed at setting the stage for plausible deniability, if the reform runs aground?”

Editor’s note : Views in the article do not necessarily reflect the views of borkena.com

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