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BusinessHas depreciating Birr missed its mark?

Has depreciating Birr missed its mark?

On February 3, 2022, the official exchange rate of birr against the US dollar surpassed the 50 birr mark, depreciating by 0.11 percent every day. Birr’s value also dwindled against other baskets of currencies, especially over the past couple of years.

IN-DEPTH

 

It took only two years (between 2019 and 2022) for the depreciation of birr by 18 birr, compared to the four years it took (between 2015 and 2019) to reduce its value by 11 birr. In fact, the downward trajectory of birr’s value started in 2012, when the exchange rate was at 10 birr per USD.

After the massive 15 percent devaluation in a single round in 2017, birr has kept on losing its value, depreciated constantly by a fraction of cents every day, especially over the past three years, though officials previously admitted that the 15 percent devaluation was wasted.

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When the three years Homegrown Economic Reform (HGER) was launched three years ago, Prime Minister Abiy Ahmed’s administration was desperate to turn around the distorted economy it inherited from the previous developmental state model. To rebalance the state domination and achieve structural changes in the economy, the government had planned to liberalize the exchange market by now.

Another reason behind the consecutive devaluation over the past couple of years is due to the World Bank and the IMF’s recommendation to “find the right value of birr.” The institutions said that birr was overvalued, which is discouraging exports.

The major target of the continuous devaluation was to incentivize exports and discourage imports, of which, both remain the Achilles heel to the Ethiopian economy.

However, three years down the road, the impacts of devaluing birr, is rather putting the economy in disarray.

“The devaluation completely missed its initial targets because neither exports increased, nor imports were discouraged. Rather, we have the negative byproducts of the devaluation, which is a skyrocketing inflation,” said Alemayehu Geda (PhD), professor of economics at Addis Ababa University.

For Alemayehu, 90 percent of Ethiopia’s import cannot be discouraged, because they are critical imports like fuel, medicine and strategic items.

“Basically, the devaluation is the wrong policy for Ethiopia. Over 60 percent of industrial input in Ethiopia is imported. Only consumable durables, which are considered a luxury, might be discouraged. But vehicles are not a luxury now,” said Alemayehu.

Imported inflation is currently fueling inflation in Ethiopia, as the devaluation continues. Apart from the impact on individual’s purchasing capacity, the devaluation of birr has also caused the government’s expenditure and project costs to balloon. If it continues, inflation is expected to force the government to ask for another round of a supplementary budget or even print money and inject it in projects and SOEs.

However, Fekadu Digafe, vice governor and chief economist at the National Bank of Ethiopia (NBE), argues that the fast deperciation has positive impacts.

“The depreciation was not fruitless. It resulted in growth of exports. Since we started to consequently devaluate three years ago, Ethiopia’s export has been growing by 20 percent on average, up from the downward trend registered before that. Last year alone, export grew by 600 million birr (21 percent),” said Fekadu, adding, inflation during depreciation is inevitable but the trade-off is still acceptable.

But exporters say the impact of the devaluation is indifferent to them.

“Due to the depreciation, our suppliers and farmers increased the price of commodities. Price of coffee at farmers’ site doubled since the last year alone. So, we buy inflated commodities and export it. Our profit margin even shrunk, instead of growing,” said Tameru Tadesse, a coffee exporter.

Tewodros Shiferaw, who engages in various businesses, also says the exchange rate adjustment missed its target, putting the economy in a vicious circle.

“First of all, the depreciation was not intended to encourage exports. It was started three years ago, because the World Bank and IMF placed devaluing the currency as a precondition to disburse loans to finance the reform agenda,” said Tewdros.

The birr still trudges along, while the real value of it is still unknown. Three years ago, the Central Bank said the exchange rate would be changed from fixed to float with three years, after birr’s value reaches around 60 birr against the USD.

The central bank needs a reserve of not less than USD 10 billion before liberalizing the exchange rate. But the forex reserve currently stands around USD three billion, which covers only two and half month’ worth of import. Since the liberalization of the exchange rate market is impossible at this moment, keeping the fast depreciation of  birr seems meaningless for many.

“If the central bank makes the exchange rate float, value of birr jumps to over 300 birr per dollar, overnight. The government should not think about floating now,” stressed Alemayehu.

The exchange rate crisis in Ethiopia currently is similar to the scenarios Sudan, Zimbabwe, Somalia, Egypt and Argentina all went through. For instance, Sudan’s pound was at 29 against USD, while it was 45 in the parallel market. When the government equalized the official rate with the parallel market, the parallel market rather jumped to 55 and then to 350. The devaluation resulted in excessive inflation spikes, which in turn resulted in a public uproar that culminated in a regime change.

“I wonder if the World Bank and the IMF recommended devaluation for Ethiopia to repeat Sudan’s case and bring a regime change in Ethiopia,” questioned Alemayehu.

“Both the IMF and government know devaluation will not boost exports. The value of your commodities in the international market can determine the exact value of your currency. The bottleneck to Ethiopia’s export is the lack of industrial input, power outages and bureaucracy. The exchange rate is just one of these factors,” added Alemayehu.

Data evidence also indicates that devaluation and exports are less related in Ethiopia’s case. Over the past decade, between 2012 and 2022, the value of birr against dollar increased from 10 to 50 birr. However, export earnings remain at USD three billion on average, over the decade, though it has reached a record-high level of 3.6 billion dollars, still far from the 13 billion dollars import bill of the country.

Experts agree that finding the exact value of birr is difficult, especially under the influence of inflation.

“50 birr for a dollar is neither big nor small. The exchange rate is depreciated based on Real Exchange Rate Equilibrium. Nominal exchange cannot be the right indication. Yes, the value of our products in the international market can indicate to the real value of birr. However, it is still difficult to find the real value of birr because of inflation, even if we continue lower its value,” said Fekadu.

“But Ethiopia’s birr is still overvalued, compared to other currencies. Birr is still expensive. The current 50 birr is still far from the real value of birr, but that does not mean Birr would necessarily continue to depreciate,” added Fekadu.

Countries like China succeeded in encouraging exports by keeping Yuan undervalued, despite confrontations from the US.

Although Fekadu says the government will decide whether devaluing birr should continue or not, experts say the devaluation will definitely continue, since the government is still waiting for loans from the Bretton Woods Institution.

“I am sure it will go at least up to 70 birr. I also fear that we will face the similar crisis countries like Zimbabwe, and Somalia faced. The real value of money is based on export performances. Export grows mainly by working on the supply side. The major problem behind this crisis is because the central bank is led by incompetent people. The government’s economic advisors also do not know how to create value in the economy,” said Tewodros.

Currently, the NBE and the Ministry of Finance are conducting assessments on the outcome of the HGER.

“The HGER will end by December 2022. When it was launched, things were normal. But then COVID-19 and the conflict distracted its implementation. Therefore, there are obviously many targets that were missed. So, we are undertaking assessments, to determine whether we can continue with the initial plan or not,” said Fekadu.

Ethiopia’s economy has been experiencing a bulging demand that could not be met by the supply side. And achieving productivity in industries and agriculture, eventually can boost exports, and also reduce imports and inflation. Even though the government expects an 8.7 percent GDP growth for the year, the World Bank capped it at 4.3 percent in its recent forecast.

Alemayehu stressed that the central bank has to float only for remittances.

“If the exchange rate is floated only for remittances, all the Diasporas will send money via banks, because the official and parallel exchange rates are equal. But for export and other forex sources, floating would only backfire. We have been telling this to the government at least for the past five years. Floating with less than two months’ worth of reserve coverage would be a suicide,” Alemayehu concluded.

[speaker]
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Video from Enat Bank Youtube Channel.

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