The World Bank Group (WBG) has advised the Government of Ethiopia to pay attention to the overvalued currency, which measured by the Real Effective Exchange Rate (REER) has appreciated by 84 percent since the nominal devaluation of the birr in September, 2010, as it is one of the factors explaining the persistent decline in country’s export earnings in the past three years.
According to the World Bank’s 5th Ethiopian Economic Update entitled: Why so idle? Wages and Employment in Crowded Labor Market, the birr has been overvalued by about 70 percent at the moment and together with other factors the overvalued currency is casting its shadow on the export competitiveness of the country.
Ethiopia’s REER saw substantial appreciation and is overvalued, causing a steady loss of competitiveness over the past year, report stated.
Michael Geiger, senior economist at the Bank and Technical Team Leader (Co-TTL) of the report, argued at the launch of the report that the time has come for Ethiopia to consider systematic real devaluation to jump start its growth in the export sector. The report further argued that such a measure is what countries like China have done back when they were in the level of growth Ethiopia is at the moment.
“Overvaluation of the birr stands in stark contrast to the experience of East Asian countries (including China), which pursued systematic undervaluation during periods of rapid growth, but broadly in line with those of Latin American economies, which adopted overvaluation with far less success,” the report read.
Apart from that Geiger also noted that a percentage of real devaluation in Ethiopia at this moment would mean some serious gains for export earnings of the country. “A percentage real devaluation increases total exports by 0.5 percent and reduces total imports by 0.6 percent. Disaggregation of exports reveals that a one percent real devaluation increases manufacturing and agricultural exports by about 1.06 and 0.33 percent, respectively,” the report detailed further.
Nevertheless, Ethiopian authorities at the meeting did not seem to have heeded the recommendation of the Bank. Yohaness Ayalew, vice governor and chief economist for the National Bank of Ethiopia (NBE), disagreed with this policy recommendation. According to the vice governor, policy measures like devaluation has the potential of instigating high inflation rate and whatever short-term benefits accruing from the policy would dissipate eventually in medium and long-term leaving economy with high inflationary inertia.
The report also detailed how the persistent decline in goods export, which has dropped by 8.6 percent in 2014/15, has had its worst year in the past decade further weakening the current account balance with deficit standing at 12 percent and import-export imbalance at 22 percent of the GDP. Partly explained by the price and volume effect and the appreciation of the real effective exchange rate, the report underscored, the consecutive dive in exports revenue is something that warranties a conscious policy attention.
As far as Geiger is concerned, fearing inflation in the aftermath of the devaluation is less worrying for him since the objective conditions of the devaluation back in 2010 is quite different from that of today since commodity prices at present are largely in declining trend. “Back then, the international prices for goods and services was quite high fueling the already high rate of inflation in Ethiopia. But, at present, both inflation rate in local economy and the price at the international markets are at reasonable levels,” Geiger said.
Meanwhile, report also noted that tight monetary policy has contributed to keeping inflation rates at a lower level (5.6 percent in October 2016) even in the face of the recent drought conditions, which had a less than expected impact on agricultural production.
Hence, going forward, the Bank recommended that the government should take advantage of the low-inflation environment to reinforce its commitment to fighting inflation by considering the use of more indirect market-based monetary policy instruments and introduce institutional reforms.
On the other hand, government’s fiscal stance has remained cautious over that period with fiscal deficit not exceeding 2.5 percent of the GDP. According to the report, improvement in tax collection and other non-tax revenue sources has helped the government withstand the sudden spike in spending to assist drought affected areas across the country.
Analyzing the macroeconomic aspect, the report also stated that driven by strong public spending on infrastructure and favorable external environment, Ethiopia has pulled off one of the most remarkable growth narrative of the past decade with real Gross Domestic product (GDP) growth averaging 10.8 percent between 2004 and 2015. This growth is not only in excess of the growth of sub-Saharan African and other low income countries, but it translates into a 7.9 percent per capita (in dollar terms) growth putting Ethiopia on the right trajectory to reach middle-income status by 2025, report explained in detail.
Continuing its double digit tradition, GDP growth of 10.2 percent in 2014/15 budget year in the face of the worst drought the country has ever experienced in last three decades, Ethiopia’s remarkable economic progress has once again exhibited its resilience to shock and the strength of its economic fundamentals, the Bank stated.
According to the same report, agriculture together with construction and services (trade and hotel) has been the main driver of the growth in Ethiopia in spite of the expected impact on crop production due to the El-Niño induced drought condition in many parts of the country.
On the demand side, strong private consumption and overall investment (public and private) were behind the double-digit growth in 2014/15. As the drought continues to take its toll during 2015/16, GDP projection for the period also indicated retreat of the growth figures to the higher single digits (7.5 -8.4 percent), all the same a stellar achievement by African and global standards, report underscored.
According to the report, the rate of poverty reduction has also been quite impressive in the past decade with every percentage of growth estimated to cut down poverty levels by 0.55 percent across Ethiopia. Hence, the headcount poverty ratio is projected to fall to 24.6 percent in 2016, down from 27.2 percent in 2015.
Furthermore, the report pointed out that with modest labor shift from agriculture to services and construction explaining almost a quarter of Ethiopia’s per capita growth in past decade, a well-function and effective labor market in urban area would not only contribute to reducing poverty but to foster competitive export sector.
Urban employment is still high in Ethiopia but it has declined albeit slowly over the past decade (from 23 percent in 2004 to 17 percent in 2015) with foreseeable impact on poverty, the report noted. Nevertheless, the report identifies that urban labor markets has not been efficient when it comes to serving low-skilled members of the labor force.