Devaluation of Birr and it's effect in the economy

The Reporter

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Dr. Wolday Amha has been president of the Ethiopian Economic Association (EEA). for the past six years. He would be vacating the post today. The outgoing president spoke to Asrat Seyoum of The Reporter on the economic implications of the devaluation of the birr.

Excerps:

Beyond the current case of devaluation in Ethiopia, what is the basic concept of the policy prescriptions in  economics literature? 

According to the textbook definitions of the devaluations policy prescriptions in the economics, it is nothing but a conditions whereby the country tries to encourage exporters and do the reverse to the importers. In the free market set-up, the question of currency valuation is not a matter for the government. Rather, it is the market for imports and exports that determines it. If I were an exporter in Ethiopia, let us see how I can benefit from the devaluation. Imagine that I was selling coffee in the internationalPublish Post market. If 800 kg of coffee were sold, charging one dollar for a kilo then I will be receiving some 10800 birr, according to the old exchange rate. 

However, the new rate will result in a receipt of 13200 birr, without any change to the export volume or price of my product. Now, as a rational exporter, my next move would be to go for more gains in the export market, which, if others follow it, would be a benefit to the country.

On the other hand, the policy also would discourage importers, as the price of imports would rise for us. Yet, it should be noted that the policy does have its own disadvantages and, at the end of the day, it would be one of those cost-and-benefit-weighing decisions.

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Positive and Negative effects of Devaluation of Birr

Considering all the benefits and the cost, can we confidently say at this particular juncture that the policy benefits the country?

In effect, the devaluation directly touches those products that are tradable in the international market. The sectors that are not as such traded in the international arena are not likely to feel the effect. 

The stylized facts in the Ethiopian economy had been the same in the past: which are fewer export commodities and more imports every year. As a result, the balance of payment is always under pressure from this severe imbalance.  Devaluation is a policy designed to correct this deficit in the balance of payments. It is easy and simple to implement. So developing countries use it to correct the shortfall in the in external sector. 

If you are asking me how successful the policy prescriptions, in Ethiopia, at present is, as an economics I would be required to conduct a proper study on the matter. In a nutshell, the economic literature states that the success of devaluation, in general, depends on the respective elasticity of both the import and the export. These figures do require  proper study.   

Some of the professionals in your discipline are expressing their fear that the policy would bring the risk of imported inflations with it. How do you explain the risk? 

I think we are already witnessing the phenomena in the market. For instance, some of the products, are actually experiencing a price increase of up to 30 percent, while some are hording the products, speculating soar prices in the future. At some of the markets the price has been raised in the products that landed in the country prior to the policy of devaluation came into effect. Increasing the price on the already existing stock is a very speculative behavior, and hence hurts consumers.

Personally, I feel that the price increase is not the direct effect of the devaluation; rather it is the panic and shock playing their speculative role in the already vulnerable market. Some had unexpected bonanza, while the others lost big time. What I meant by the already vulnerable market is that at the moment the market is already high in price from the problem in the letter of credit (LC) administrations in the import sector. The government is rationing the LC to the imports, which creates an artificial price hike in the imported goods.  Of course, the devaluation by itself, could be inflationary to the economy. 

We are dependent on the import of fuel, fertilizers and other machineries. So it would be naïve to think that the devaluation is not inflationary. But the cumulative effect could really hurt the economy. What I suggest is that the government should at least try to relieve the artificial inflationary tendency by correcting the LC problem in the country. Hence, it would be the net gain of the policy that really matters. 

On the other hand, what we should not forget is that the policy of devaluation has a psychological dimension whereby the devaluing country is perceived as being economically weak. It is hazardous, as it would erode the confidence in the currency and shifts tendencies to store value in other ways. It jeopardizes the credit-worthiness of the nation.

You have explained that apart from the export-encouraging effect of the policy, it also discourages imports. However, we depend on the import of some strategic goods ourselves. Hence, in a way, are we not making it expensive on ourselves?   

I think it has to be clear that discouraging imports is not is not an end by itself, since, as you have motioned it in your question, we do need the import. The aim of the policy also anchors instituting import-substituting industries to fill in the demand gap for goods that we use to import. 

What I learnt during my years as an economist is that the Ethiopian economy is in  transition from a simple, harvest dependent one, to gross import demanding one, hence, making the import play a vital role in the economy. Of course, it would take time to do that and until then the government should fight inflationary tendencies with ardent policy measures. And to begin with, it would help to remove the artificial inflation that we talked  about earlier. As a measure setting the right track for import substitution, the devaluation would really help.

It is known that both the International Monetary Fund (IMF) and the World Bank are staunch supporters of the devaluation move. Did their rationale for suggesting the policy differ from what you have explained above? 

No, actually the policy justification is the same. They say that if developing countries are to grow, they should devalue and encourage their export. We started the policy as early as two decades back. However, apart form all the justifications, we have to meet their demand to get their support.  

The devaluation came in the immediate aftermath of the announcement of the Growth and Transformation Plan. However, some say that the plan is not realistic. What is your view on this issue? 

We at the EEA believe that it is not right to debate whether the plan is achievable, ambitious or otherwise. What is critical is to point out the resource base that would bring about such a growth. The economy of this country has been dead for more that half a century. As far as doubling the output is concerned, we should look at it from the point of view that what were our initial points. It is always easy to grow 100 and pus percent as long as we start at the lower point. A small push would result in a big leap. Even in my field of specialization, in microfinance, the number of people seeking credit now is not even comparable with what it was five years ago. I believe the culture of thrift is growing in the economy; hence saving rates as well.  The focus of the government in the plan should be on the resource that is available locally. We should mobilize the saving potential of the country to finance our five-year plan; still it would be difficult to attain the finance at least for a year or so.