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Reflections on the upcoming devaluation of the Birr

By Asefa Belachew
September 6, 2014

Ethiopia should devalue the birr. In fact, it should have done it “yesterday”. Now that yesterday has come and gone, a quick action is necessary because of the adverse expectation engendered by the impending devaluation. Otherwise, exporters, who are rational souls, will hoard their export items with the anticipation (expectation) that their exportable produce will fetch higher prices in terms of birr once the devaluation occurs. On the other side, expectation will exacerbate the shortages in imported goods (or importables) with the hope that the importers could sell their produce at higher birr prices later. I will be surprised if this is not occurring today already.

The Ethiopian government, however, has to take action in many fronts together with the devaluation. Nominal devaluations alone will not be adequate. To ensure that the nominal devaluation translates into a real devaluation, fiscal and monetary tightening is necessary. Otherwise, prices will rise as a result of the devaluation and excess aggregate demand resulting from lax fiscal and monetary management. As tax revenue may not respond quickly, from experience, I would expect that most of the adjustment should come from a cut in government spending. Unfortunately, the recent increase in wages and salaries along with a number of huge domestically financed infrastructure projects in progress will not make this very easy. In addition, given that the next election is around the corner, it is going to invite much politically motivated expenditure which make fiscal control even more difficult.

Real devaluation, if achieved, will generate positive effect on exports and growth. One has to look carefully at the short-, medium- and long- term effects (what economists call the lag structures in demand and supply elasticities of price) of the devaluation carefully and objectively. The short-term price elasticity of supply is perhaps low (inelastic) but elasticities increase over time. It is perhaps instructive to take one of the existing export items and examine the underlying microeconomic behavior.

Coffee is the major foreign exchange earner and it has great potential for growth. Unlike many other coffee exporting countries, Ethiopia is also a major consumer. In the early 1980s, over 50% of the annual coffee production was consumed locally. During those years, considering the highly overvalued birr, coffee fetched more to the farmer if sold domestically than exported. Thus, the government put all types of barriers to the regional movement of coffee as well as other crops. The farmer, on its part, allowed the coffee to fall to the ground so that it would not meet the export quality requirement and it would be allowed to sell it domestically. With real devaluation, export coffee will be more remunerative, and the farmer could invest more resources in the up-keep of the crop. If action is taken now, in the next marketing season (December – March), the volume of exportable coffee will increase due to two factors. First, more of the domestically consumed coffee will be diverted to exports. Second, the farmer will care more to the crop now (September – November) and will invest more resources to picking the beans directly from the tree while still a red berry. Coffee harvesting is a very labor intensive task. With good prices the farmer could hire more labor as well as use the family labor intensively during the harvest season. Likewise, the drying and further processing at the farm level will be given sufficient attention. If export coffee is not remunerative in terms of birr the farmer will allow the bean to fall on the ground, thereby adversely affecting the quality. These are the short to medium-term effects.

In the medium-to-the long-term, a larger positive supply response will be unleashed. This will take a good 3-5 years to bear fruit. Old coffee trees will be up-rooted and new varieties planted. Some of the land that had been lost to Khat will be regained and more land could be brought into the cultivation of coffee.

One can tell similar microeconomic level stories about the leather and leather products industry, the oil seeds and pulses industry and similar industries. With devaluation, the production and processing of the traditional products will be enhanced and traditional market shares regained in 3 to 5 years. In addition, what is important to bear in mind is the potential for the emergence of new export products that are not known now. The potential for the export of artificial human hair was unknown until market and price conditions made such exports lucrative and countries like China and South Korea seized the opportunity in the early 1970s. Nobody would know what Ethiopia’s artificial hair (black gold) will be until the market is opened, realistic exchange rate is instituted and market intelligence support is put in place.

To ensure that the benefits of devaluation are realized however the government must take additional institutional measures on top of the fiscal and monetary measures. Two issues are particularly important in this respect; i.e. credible and private sector-friendly measures and a package of measures including research, extension, training, and export facilitation services. Economic policies in Ethiopia have always been rather unfriendly to the private sector. Even during the Imperial days, subtle measures were in place that were unfavorable to the private sector. Derg was anti-private sector due to the Socialist ideology it embraced. The EPRDF government is slightly better than Derg but it has not yet full heartedly opened the way for the private sector. It is not uncommon to hear many Ethiopians investors in Diaspora fleeing the country before reaping the benefits of their investment. Similar woos are heard from many local investors on the grounds that project proposals are stolen and given to others who obtain licenses quickly to go forward with the investment. In short the government should clarify the laws and rules governing private sector development and apply them in an objective, transparent, uniform, and fair manner. Business disputes will have to be resolved expeditiously without recourse to extra-legal patronage. Even if there is a sincere turn around on the part of government policy, however, it will take several years to build confidence on the system.

Second, the continuum of research, extension, training, and export facilitation services are lacking or the supplies are highly bureaucratic. Such services will enhance the production, collection and marketing of exportable products (or import substitute products). The emphasis here is on market intelligence and product development. An example would be useful. In the early 1970s, the former Agricultural and Industrial Development Bank (AID Bank) had a unit dedicate to such functions. The purpose of the unit was to identify products and services for which Ethiopia had the potential to produce and export. I remember one such product was castor seed (Gullo). At the time, many households had a tree or two in their compound. The excesses supply was being exported to Western Countries. Castor seeds have diverse uses in the pharmaceutical industry as well as in petro-chemical industry. It was identified as having a great potential for export diversification. The effort however lacked the extension and training aspects. Thus, the idea did not go too far since the continuum of services was not provided. Another example is Kenaf . Kenaf is a hard fiber used in the production of bags, ropes and twines. In the mid-1970s, Ethiopia imported Kenaf worth about $20 million from Bangladesh and Thailand. The former National Fiber Works Corporation encouraged the Agricultural Research Institute, a national outfit, to promote the production of Kenaf and assured to purchase all the Kenaf produced. In the late 1980s, Ethiopia had managed to source a good proportion of its demand for Kenaf from domestic suppliers. The suggestion here is to establish a mechanism to identify such opportunities and carry out the necessary activities towards some goal. This institution could be established as a public-private partnership where business (industrial) association and the government work together.

As indicated above, with the right macroeconomic and microeconomic policies, it will become cheaper for producers and consumers to purchase their good from domestic sources. I mentioned how Kenaf started to be grown in Ethiopia to supply the fiber companies. With the right policies, Ethiopia will be able to export Kenaf. In a like manner, if prices are attractive the collection of inset fiber could be increased to bridge the import gap. The government and its Advisors should not takes very static view of the world. With the right governmental attitude and policies, the private sector could play a dynamic role. Indeed, Ethiopia’s manufacturing sector uses old machinery. To sustain and increase production, investment in machinery for replacement and expansion is called for. It is indeed obvious that most machinery in Ethiopia are imported. However, devaluation will shift the incentive structure to look for more labor intensive techniques. There is a large menu of choice for machinery and equipment in the international market. With the “right” prices, investor will choose refurbished second hand machinery instead of the new brands.

In addition to the positive macroeconomic effects, devaluation favors the poor. The largest proportion of the poor live in rural areas and are engaged in agriculture. Higher birr prices to traded (or tradable) products translate into higher income. The non-farming rural population or unemployed town folks also benefit as more labor is demanded in weeding and harvesting. Temporary rural employment would rise and rural wages rise at the same time. Of course, the urban poor and those on fixed income could sustain some welfare losses which should be addressed as part of the policy package.

To conclude, this writer encourages the Ethiopian government to devalue the birr and do it periodically as macroeconomic conditions warrant. But, the devaluation should be accompanied by fiscal and monetary tightening. These macroeconomic measures should be complemented by conducive institutional support structures. Further procrastination will only make the situation much worse.

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