By Asefa Belachew
I extend my gratitude to Dr. Worku Aberra for sharing his opinion pieces entitled “Devaluation and Inflation” on Borkena of August 1 and August 4. Before I provide a few reactions on his pieces, I want to mention my surprise why almost all analysts on the exchange rate, including Worku, fail to address the alternative option of “doing nothing”. As Worku indicated, Ethiopia’s economy is heavily import-dependent (to the extent of 40 percent, as he says). Given that export revenue meets only a third of the import bill, if the Government depends only on its own exports, to maintain a trade balance, GDP will have to shrink by two-third. This is a complete collapse of the economy. I think this is the scenario that the Government wanted to avoid.
I know that the Government has been consulting with some respected Macroeconomists based in Ethiopia. The advice it received was to control illicit trade (contraband) of various sorts. One of them with whom I discussed the issue extensively was leaning towards a dual exchange rate – one rate for Government purchases and another for the private sector. The challenges of administering a dual exchange rate are well known in countries that tried them. Either he desisted from pushing the proposal or the Government did not want to consider it.
In any case, there are two parameters to watch for in an exchange rate management viz., reducing (or eliminating) the gap between the official and black-market rate, and maintaining a stable real exchange rate. The latter requires ensuring the change in the exchange rate to exceed domestic inflation. Unless this is maintained the nominal depreciation alone will not be meaningful for resource allocation. This in turn requires a tighter fiscal and monetary policy, as Worku alludes. The Minister of Finance and Governor of the Central (National) Bank seem to recognize this and have gone out to assure the public that the lax practices of the past will not be followed any longer. It remains, however, that I agree with Worku that the sources of the inflation are to a large extent domestic policy laxity. Of course, this is a challenging task under the current political and military posture.
Worku maintains that “… When a currency is devalued, a country’s exports become cheaper in foreign currencies, …” and at a different paragraph he says “… When a currency is devalued, a country’s exports become cheaper in foreign currencies, …” I think this is a gross misunderstanding of how devaluation (depreciation of the Birr) works. Ethiopia is a price-taker in the international market and the world price of its imports or exports will not be affected by its actions. With depreciation, however, the domestic (Birr) value of exports will rise. An exporter who earned Birr 58 for a dollar of export earnings will now receive over Birr 100 (the auction rate had depreciated to Birr 107 while I was in the process of writing this commentary). The higher price will motivate him/her to invest in the coffee farm, for instance. I have shown how this works through the market in a short paper I distributed in September 2014 (Refer https://borkena.com/2014/09/08/reflections-upcoming-devaluation-birr/ ). Against Worku’s
1 The term “devaluation” applies when one talks about a fixed exchange rate regime. In a floating system, the terminology changes to depreciation of the birr (or appreciation of the Birr). I will use the depreciation/appreciation terminology.
statement “… depends on the product’s price elasticity of demand, …”, it is the supply response that matters when we talk about coffee. Indeed, coffee is a special case in Ethiopia because not only that it is a major export product, but its domestic consumption is also significant. It is expected that the domestic consumption of coffee will decline with the amount depending on the price elasticity of domestic demand for coffee. It is expected that there will be a positive supply response as well. The supply response increases as we move forward. While the immediate effect can be minuscule, the long term effect could be substantial.
In my view, I see some confusion in Worku’s analysis. Devaluation (depreciation of the Birr) impacts only the Birr prices. It tends to make imports more expensive in Birr terms and less of imports (importables) will be demanded. Depending on the elasticity of demand, the Birr revenue will rise by much or by a small amount. On the export side, the higher Birr price is expected to motivate exporters to look out for export opportunities. Here, what matters is the supply response.
Worku also says “…When the Birr lost 30% of its value on July 29, the country’s foreign debt and interest payments increased by an equivalent amount in a single day…” Indeed, the Birr value of the debt will rise by an amount tracking the depreciation — 30 percent (as you suggest initially), but the dollar value of the debt will remain unchanged. It poses a bigger challenge to the Government to raise sufficient Government revenue to be able to buy the dollars when the loan repayment falls due. My reading of the IMF report indicates to me that the IMF program will address the issue of the foreign debt through the Common Framework of the G20.
Let me share a personal story. I am a coffee lover like many Ethiopians. Each time I pay a visit to Ethiopia, I return with a pack or two of roasted coffee. In my last leg (early 2023), I went to pick 2 packs of one kilo coffee from one of the roasters in Addis. It cost me Birr 1000 each (US$16-17 per kilo at the official exchange rate at the time). Back in the States, Colombia Supremo which I usually buy was US$16 for 1.36 kg or 3 lb or around US$12 per kilo. If I was doing it as a business, I would not be making money. As many of us realize, Ethiopian groceries that carry roasted coffee charge close to US$20/kg. Upon my return to the States, I was not surprised when I heard the Chief Executive of the Ethiopian Tea and Coffee Authority complained in Parliament that the export of coffee did not meet the target because of the weak domestic prices.
On a different note, devaluation (depreciation of the Birr) is not costless. There will be major welfare as well as distributional costs. Significant redistribution would take place – from buyers (consumers) to producers, from non-tradables to tradeables goods producers, and it will put an additional burden on fixed income earners. But, it is important to bear in mind also that the adverse social impact will be addressed through subsidies on various goods, higher wages to low and middle income professionals and an expanded social safety nets. Government would need to take the hardship-meliorating measures quickly.
Devaluation (depreciation of the Birr) has always been the most feared policy measure in the Ethiopian Government since the early 1970s. South Korea and Ethiopia (and several other Sub Saharan African countries) were faced with similar challenges (i.e. persistent BOP deficits), including unresponsive exports performance, and options. Countries such as South Korea took aggressive open economy policies, including exchange rate devaluations (depreciation), while Ethiopia and the others remained wedded to their fixed exchange rate regimes. Very recently, as recently as a decade ago, Ethiopian Economists in the diaspora as well as those at home were discussing the same issues without reaching a closure. The time has now come for action whether we professionals in diaspora agree with it.2
Assefa Belachew; he could be reached on Assefa.Belachew@gmail.com
Editor’s note : Views in the article do not necessarily reflect the views of borkena.com
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My question to Asfaw Belachew:
How can you assume that the price of coffee, which you used to buy at 1000 birr per kilo, will remain the same after the birr depreciates to 115 per dollar? Do you not anticipate that the farmers selling coffee to exporters will increase their prices? With the rising cost of imported goods, other producers are likely to raise their prices as well due to the impact of higher import costs.