The precarious birr

Once again, the embattled Ethiopian Birr has experienced a significant decline against the mighty US Dollar. The latest round of devaluation resulted in shaving off 15 percent of the purchasing power from the Birr vis-à-vis the  Dollar. The latest move aside, NBE has two other devaluations under its belt. For all its achievements in registering double-digit economic growth in the past 15 years, Ethiopia is still unable to improve its foreign currency shortage. All major devaluations were taken in the name of shaking this persistent and annoying evil. Nevertheless, devaluation has some serious tradeoffs. While high inflationary pressure and risk of swelling the country’s external debt threatens macroeconomic stability, the gains in the external trade sector are quite vital, 

On Tuesday, the National Bank of Ethiopia (NBE) announced a jump in the official Birr/Dollar exchange rate from 23.3 to 26.9 (15 percent devaluation) which took effect as of the next day. Interestingly, the parallel market have made an adjustment of their own in the parallel rate in the form of an increase from about 27 Birr/Dollar to 34. With the shadow of the September 2010 devaluation still hanging over its head, the latest measure is yet to show that its thorny side would not outweigh its benefits, explores Asrat Seyoum. 

Ethiopia’s major export items and export value in 

years (In million dollars)

The narrow street from Meskel Square to Ambassador Cinema, which is one of the oldest movie theaters in Addis Ababa, is perhaps among few perplexing spots in the city. It is dotted with some regular office facilities like banks, a hospital and clinics and a church, but most importantly small grocery stores and souvenir shops. 

Yet again, looks can be deceiving; most of the small shops along this street also double as exchange bureaus. This becomes evident when a couple of youngsters stop a passersby a number of times to ask if you have currency exchange needs. Some could even appear to be overzealous in their attempt to find customers as they quote daily USD/Birr exchange rates or even start negotiation as they chase potential customers up the street.

For all practical purposes, the street is currency exchange central; and yet with questionable legality. Indeed, it is the location for a thriving parallel currency market in the capital.

On the other side of the street, only few meters away, is the National Bank of Ethiopia (NBE) situated in its high-rise edifice and making decisions which indirectly employees the entire army of streetwise businesspersons who wag the nation’s currency market. But, it was NBE’s turn to shake the currency market last week with a significant (15 percent) devaluation on the official exchange rate of Ethiopia. 

On Tuesday, the Bank announced a jump in the official Birr/Dollar exchange rate from 23.3 to 26.9 which will take effect as of the next day. Interestingly, the currency operators down the street took the news to heart and are rumored to have made an adjustment of their own in the parallel rate in the form of an increase from about 27 Birr/Dollar to 34.  

Economists say, exchange rate is the rate at which a local currency, in this case the Birr, is exchanged for a currency of choice, in his case the mighty Dollar, in the market. Simply put, an exchange rate is merely a price, an important one at that, of a certain foreign currency expressed in terms of the local currency, they also state.

Hence, like any price its true market value is determined by the demand for and supply of that foreign currency in the local economic setting. An exchange rate determined by the mighty market forces of demand and supply is closer to what the economists refer to as real exchange rate.

But, official or nominal rates are those which are employed in the day-to-day transaction. The recent NBE move effected a change on the official exchange rate.   

An official exchange rate is determined depending on the foreign exchange regime that prevails in the country. Depending on the relative control a central bank like NBE has on the exchange rate, there could be fixed, floating or mixture of the two, sometimes referred to as managed floating or crawling-peg, exchange rate regimes.

As implied by their names, strictly fixed exchange rate regimes seek to determine rates by making direct policy or market interventions in the markets while floating refers to free moving rate depending on the market conditions. According to NBE’s documents, Ethiopia’s choice of forex regime is the third on: managed floating.

Simply enough, this type of regime is about embracing market deterministic forces yet with added twist of curbing the extreme volatilities of market with market intervention.

Coming out of a deeply stringent fixed forex regime employed during the time of the Derg, the current government’s exchange rate policy has accepted in principle the role of the market in determining exchange while keeping a lid on the market movement. Not only in principle, but the Bank has put in place an institutionalized inter-bank foreign currency trading platform to determine rates based largely on the market forces, but the banks are required to trade in currencies after accepting an indicative rate from NBE at the start of a trading day.

Nevertheless, a young macroeconomist and researcher at a government institution, who requested anonymity since he is not authorized to speak on the matter, questions the very nature of NBE’s floating exchange rate regime.

“Officially, Ethiopia’s exchange rate regime is termed managed floating. However, it is difficult to accept that definition as the National Bank determines the exchange rate by fiat [by announcing indicative exchange rates] rather than intervention through the market [by increasing or decreasing supply of local currencies by buying and selling currencies in open market operation],” he told The Reporter.

In fact, even those countries which claims to have fixed exchange rate regime are now moving more to open market currency manipulation than deciding it by fiat, he argued further.

Regardless, the Ethiopian monetary authorities have taken two major devaluation measures in the past. One is among the first policy moves the newly inaugurated Ethiopian Peoples’ Revolutionary Democratic Front (EPRDF) took in 1992 where the official exchange rate of the nation jumped from 2.07 Birr/Dollar to five, while the other one took effect in September 2010 and had the rate jumping from 13.6 birr/dollars to 16.3 birr/dollars amounting to 16.7 percent.

The primary logic behind devaluation is the claim that it is somehow overvalued. International organizations like the International Monetary Fund (IMF) had been claiming this for a very long time. Here is where things get a bit complicated.

Over/undervaluation refers to an implicit reference point with which to compare the real exchange rate of a country. Apparently, there is none. But, here is how it is conceived. Real exchange rates are assumed to have a long run level (Real Effective Exchange Rate (REER))which will serve as equilibrium to bring about balance and harmony in countries’ external trade sector (import and export balance).

“Distortions in the forex market and a widening gap between the parallel and official exchange rates are indicative as to the buildup of pressure in the forex market and possible misalignment from the ideal equilibrium REER,” the macroeconomist explains. 

According to the macroeconomist, the decline in real exchange rate observed in the immediate aftermath of the 2010 devaluation has dissipated in less than year and REER appreciating back to its pre-devaluation period thanks mainly to persistent inflation 2011-2012 period. Hence, most professionals agree that Ethiopia was due for devaluation merely a year after the 2010 devaluation.

So who cares if the Birr is devalued? Well, “we all should”, according to the professionals, since its direct effect is in making Ethiopia’s exports more expensive and imports cheaper. This results in persistent current account deficit the likes of which Ethiopia has been grappling with for years.

According to NBE’s own data, the country’s estimated external trade balance in 2015/16 was around 14.58 billion birr while current account balance including transfers stood at 7.56 billion. An obvious impact of such trade balance crisis is shortage of foreign currency local market affecting individual consumers.

NBE, on the other hand, has picked up the noble cause of boosting export sector performance while at the same time narrowing down the persistent external imbalance by implementing the devaluation measure. The pundits greatly differ on this point. For one, there are many who question the very basics and if indeed the effect of REER is the factor behind the deteriorating export sector.

Costantinos Berhe (PhD), lecturer at Addis Ababa University School of Graduate Studies, has doubts if devaluation will be enough to revive the nose-diving export sector in Ethiopia.

“The staggering devaluation of the birr on October 10, 2017, which was evidently taken to enhance export performance, represents an important recognition by the NBE that its policy setting had been a factor in inhibiting Ethiopia’s external performance. However, by itself, this move falls short of addressing the problem,” he told The Reporter in an email interview.

Constantinos argues further that leaving aside a set of macroeconomic measures to be undertaken in the national economic and fiscal policy frameworks, outside of the jurisdiction of the NBE, devaluing the birr alone might prove to be disappointing since the most important factor for export sector underperformance is not currency policy but structural challenges stifling the sector.

“To revitalize exports the government needs to focus on increasing industrial supply capacity, cutting trade costs, improving producer services, improve on trade agreements and simulations with conventional trade models,” he contends.

Nevertheless, the success of devaluation in boosting exports is not also a sure thing. Both the macroeconomist and Constantinos agree that response of the export sector to devaluation measures is not that straightforward.

According to the standard economic literature, for a nation to take full advantage of the devaluation measure, in terms of high export revenue and low overall imports, it has to first take a look into the nature of its export and import basket at the national level.

Economies with export basket for which there is no easily available alternatives in the global market and imports with the exactly the reverse quality would stand to gain more for devaluation. “Ethiopia is importing goods for which there are no native alternatives and exporting raw materials demand for which tends to be less sensitive to change in price,” Constantinos says, reaffirming this concern.

Here, the question remains, is the export sector going be as responsive as it is expected to be? The macroeconomist as well has doubts as to the outcome of the devaluation. As far as benefiting the exporters, he estimates that the birr price exporters receive increases by 60 percent since they fix most of their price in USD in the international markets. “However, in general, exports are rather less sensitive to devaluation; in fact, one can hardly expect any change in export in case of slow currency depreciation,” he argues.

Nevertheless, the macroeconomist is optimistic about correction of the external balance. He indicates that external balance could still be corrected due to the impact the policy measure has on imports. “In general, Ethiopian imports are very sensitive to the devaluation of the Birr. In fact, import decreases by 0.65 percent for a one percent decrease in the Birr/Dollar,” he explains.

And he argues that the move could still result in decrease of the balance of payment gap although most of that adjustment takes place through the reduction of imports; not because of boost in export.

What is for sure is the impact of the devaluation policy on inflation and the country’s external debt stock. Pundits estimate a one-to-one increase in prices of imported goods and devaluation in local economy. The macroeconomist further asserts that large devaluations may feed into expectations and self-fulfilling high inflation regimes.

Commentators like Abdulmenan Mohammed, in his recent social media commentary, has illustrated how the recent move could creep into consumers’ personal budget and how the unrelated services like house rent could also be affected by this dynamics.

Some even claim that the market is already ripe with businesses which are reacting by racking up prices on merchandises which are in stock.      

While at the same time the local currency value of the country’s foreign debt stock is also at risk following the devaluation measure. At the end of the day, all the negative impact that follows devaluation is more reason for the government to use the small window of opportunity to capitalize on the reviving export otherwise the fast climbing inflation which is just a step behind the devaluation would erode any gains made in the currency exchange market.