The Likely Outcome of Ethiopian Birr Devaluation
By Tsehai Alemayehu, PhD
It appears that the Ethiopian authorities are at seriously considering the World Bank’s most recent advice to devalue the Birr. There are in fact indications that the decision to devalue might already have been made. Reading the media reports of the recent press conference held by the government spokesman I was left with the distinct impression that only the magnitude and the timing of devaluation remain to be determined.
The memory of the last series of devaluations is still fresh in the minds of Ethiopian consumers and businesses. It is doubtful that the authorities have forgotten the lessons of that very recent episode either. Yet they appear incapable of resisting the promise of substantial enhancements in the growth trajectories of exports and GDP by the main promoters of devaluation, namely the World Bank. At the presentation of its most recent recommendations for devaluation, the bank claimed that a 10% devaluation would increase Ethiopia’s exports by 5% and add 2 percentage points to the economy’s growth rate.
Given the lackluster performance of the country’s exports and manufacturing output during the first 4 years of the GTP, one can understand why the government might be willing to revisit currency devaluation in hopes that it will deliver on the promises of economic theory this time around. It remains, however, that such a move is more likely to reignite another episode of high inflation than lead to increased exports or GDP. One need not be an expert in the minutiae of international finance to understand why this will be the case. A cursory review of the structure of Ethiopia’s exports can vividly demonstrate the futility of actively managing the birr’s exchange rate with the hope of significantly enhancing the competitiveness of exports.
Table 1 below reports the contributions of Ethiopia’s major export commodities to total export revenues both in terms of US dollars and as a percent of total export revenues. The data is for FY 2012/2013 and is from the National Bank of Ethiopia website. During FY 2012/2013, these 13 product categories account for 97.6% of total exports by value for. The biggest of these (coffee) accounts for 21.3% and the smallest (meat –excluding live animals) accounts for 2.1% of total exports. The suggestion that devaluing the birr can significantly increase exports is based on one or more of the following assumptions: (1) there exists unutilized domestic productive capacity for exports or that such productive capacity can be quickly ramped up if devaluation leads to sufficiently attractive domestic currency prices for exportables, (2) when relative prices change following devaluation, the market will quickly redirect to the export market those exportables previously sold to domestic consumers and that the authorities will deem such redirection socially desirable, and (3) there are no other obstacles (issues in logistics, the bureaucracy, the banking system, etc.) hindering the efforts of market participants from taking full advantage of the increased prices of exportables which devaluation will bring about.
None of these assumptions appear to be realistic when viewed in the context of the list of products which are the mainstay of Ethiopia’s export business. Granted that some of these categories lump together a broad range of products, we can still contemplate what must take place for the devaluation of the birr to translate into larger quantities of these products being delivered to the export market. At least in theory, because devaluation will increase export prices when expressed in domestic currency, producers should deliver to the export market larger quantities of textiles, leather products, live animals and meats in short order. The reality is likely to be much different.
Take for example garments and textiles which should be among those exportables which should be most responsive to devaluation. In the Ethiopian reality where textile mills often run short of basic raw materials (cotton and yarn) even at current production levels, it would be difficult to believe that businesses would orchestrate capacity increases in the medium term just because prices are more attractive. This would also be true for leather products and meats that often face similar supply bottlenecks.
With regard to vegetables (a category which seems to consist primarily of chat) and flowers, it would take somewhat longer for the expected supply response to materialize in the aftermath of any devaluation, if it did materialize. In the best of circumstances, it would take from several months up to a year for increased supply following devaluation. Many of the other exportables, including the three most important products (coffee, gold and oil seeds), have to overcome even more significant challenges given their peculiar production processes. Oilseeds and pulses are primarily produced on rain fed farms and hence require a full year for a single crop cycle. Coffee requires an even longer time from planting to the first harvest. And the production of gold needs substantial investment and a much longer time frame to expand current operations sites and even more time and capital to identify and bring online new deposits. As such even if all other requirements are met, given their peculiar production process, devaluation is at best a slow fix but more likely a non-fix for the export of this group of commodities.
Given the oft reported shortage of cotton to meet the needs of local textile manufacturers, it is assumed here that the cotton export reported here must be an anomaly and not likely to represent a real option for export development. Likewise, although the revenues from scraps are significant, export of scraps cannot be viewed as a reasonable and sustainable product on which a nation can rely.
The remaining exports are too meager to warrant further analysis regardless of whether or not they might be responsive to devaluation. I am thus hard pressed to understand the bases for the World Bank’s optimistic assessment of the prospects of Ethiopia’s exports following the devaluation of the birr. Perhaps in a decade when and if the country achieves a substantially different mix of exports, devaluation can become a valuable component of the country’s policy arsenal.
In fact, except in countries where manufactured exportables constitute a large part of domestic product, devaluation is rarely viewed as an export promotion tool, much less a tool for growing the economy. Instead, devaluation is often thought of as a sledge hammer nations resort to when they suffer from prolonged deficits in the balance of payments and when all other avenues have been exhausted. In part, that is because devaluation increases the prices of all traded goods, and as a result triggers a spate of inflation.
Table 2 is extracted from the reports of the National Bank of Ethiopia and shows the US dollar values of major imports. To evaluate the World Bank’s claim that devaluation will lead to increased economic growth, one needs to examine the structure of imports. The World Bank seems to put all of its faith on the outcomes predicted by economic theory. That theory tells us that devaluation which raises the domestic prices of imported goods will curb a country’s appetite for imports and encourage domestic investment to produce import substitutes at home. But it is critical for us to go beyond the general guidance of theory and study closely the mix of goods imported by Ethiopia so we can make a reasoned assessment of the likelihood for any surge in import substituting investment in Ethiopia.
A quick look at Table 2 shows that the single largest import category labeled “Other” likely consists of defense related equipment. The bulk of the rest of the country’s imports are capital goods and other critical inputs required for the proper functioning of the economy. If devaluation were to lead to the expected decline in these kinds of imports, the economy would be forced to slow down, not accelerate as the World Bank promises, except in the unlikely event that domestic substitutes come on line rather quickly. However, there is no evidence to support the notion that Ethiopia has the capacity, active or latent, to produce domestic substitutes for the range of products enumerated here.
Even when one looks at imports that may be deemed as purely consumer goods (Table 3), one would be hard pressed to make the case for beneficial devaluation. First of all, together this sub-group accounts for only 12.5% of total imports, with 75% of the expenditures here going towards food, grains and pharmaceuticals. These are products anyone would find difficult to see cutback.
And we have yet to consider the numerous problems Ethiopian businesses deal with every day. As an avid follower of the Ethiopian economic and business scene, I have come to know and appreciate the obstacle course businesses in Ethiopia have to navigate daily as they seek to secure credit, to ship exports, to clear their imports, to procure raw materials, to pay taxes, to access reliable IT services, etc. It was only a couple of weeks ago that the president of The Huajian Group, one of the most celebrated FDI firms in Ethiopia, was complaining to members of the foreign media that he was so frustrated with the logistics system of the country that he was considering of starting up his own trucking company instead of pursuing his expansion plans. And this week came news that Ayka Addis, another FDI firm considered by many to be the pacesetter in the textile and garment business in Ethiopia, was not meeting its production and export targets because it was unable to secure the cotton that it needs.
If the goal is to enhance the competitiveness of Ethiopia’s exports, the government’s energy is best directed at addressing the problems which often hamstring business so that the country’s latent competitive advantage could become real. No amount of tweaking of the exchange rate can make up for the disadvantage of dealing with these hurdles. The right policy for what ails this sector can be found if one listens carefully to the daily travails of the nation’s businesses and commits to fixing them, one issue at a time.
Should the government instead go along with the World Bank’s counsel, it will lose the moral high ground from which it has been successfully championing the cause of price stability. As is often the case in many transitional economies, price discovery in Ethiopia often amounts to throwing a dart in the dark and hoping that it sticks at the right spot. When in doubt, retailers raise their prices and see if anyone will buy. Those who are uncomfortable with regularly updating their prices have resorted to listing their prices in foreign currency. In such an environment, announcing even a relatively small devaluation on the scale recommended by the Bank will likely trigger a new era of high inflation with little positive gained in return.