Ethiopian Monetary Policy

Ethiopia has announced a surprise devaluation of the Birr of around 20% against the US dollar. This follows a 30% depreciation last year which had given them a $400 million balance of payment surplus. Blattman points us to "the reaction from a leading bank and investment firm in the country:"

Given the apparently little justification for a large devaluation from a short-term macroeconomic perspective, we see more longer-term and structural motives for the authorities’ actions. More specifically, we think there is now a conscious effort to experiment with a deliberately undervalued exchange rate (the “China Model” one might call it) and to pursue a more aggressive strategy of import substitution.

Blattman points out that the suddenness of the policy change increases uncertainty, which is not conducive to growth even if the devaluation itself would help exporters.The investment firm he cites thinks, however, that this will not happen; instead this one-off depreciation is to stem the tide of monthly depreciations that have been going on for the last year and we should see some stability now. Furthermore, while the size of the depreciation was unexpected, the firm had in fact predicted a sudden move at the beginning of their fiscal year to help export-oriented sectors from the beginning. The firm had guessed 5%, the IMF had said 7-10% would not be out of the question.

One thing I think it expresses is the president's confidence that Ethiopia will become largely self-sufficient in food production. Changing the exchange rate could be part of the government's plan to double agricultural production in the next five years, help start industries in textiles and sugar, and support current exports of leather and cut flowers.

There are two ways to look at the move from the perspective of food prices. It could signal Ethiopia's confidence that we will not have a repeat of the food price spikes we saw a couple years ago. The revaluation increases the price of food imports, so it's not something to do if you expect another imminent food crisis.  However, if you expect one a few years from now, then now is the time to build up foreign exchange reserves so you can buy more food should another crisis hit, making Ethiopia less reliant on foreign aid for food. Now is also a good time for such a move since inflation is lower.

On the other hand, as I am discussing in an upcoming case study with Erica Philips on trade liberalization in Haiti, World Bank and IFPRI economists have shown that import prices follow domestic markets more than domestic markets follow international prices (Hazell, Shields, and Shields, 2005 does this in detail; Orden 2002 mentions a US/Canada exchange rate movement of over 25% changing farm machinery prices only 5%). If so, the effects on Ethiopian food prices could be more muted than we would expect.

At the UNU-WIDER 25th anniversary conference I presented at this year, Vladimir Popov had put forward a paper proposing steady foreign capital accumulation over a medium-long term in order to spur long run growth. The theoretical model he puts forward shows that foreign exchange accumulation promotes growth by "(1) FER accumulation causes real exchange rate (RER) undervaluation that is expansionary in the short run and may have long term effects, if such devaluations are carried out periodically and unexpectedly; (2) RER undervaluation allows to take full advantages of export externality and triggers export-led growth; (3) FER build up attracts foreign direct investment because it increases the credibility of the government of a recipient country and lowers the dollar price of real assets."