Battling inflation is nothing new for Ethiopians. While global markets were stable, Ethiopia’s consumer good prices were wobbly. Only five years of the two decades since the 2000s have seen inflation below 10%. Now, for the first time in a decade, inflation in Ethiopia has remained above 25% for a year.
This time around, though, life has become almost intolerable for the working class, whose wages have more or less stagnated over the years, making Ethiopian workers, among the lowest paid people in the world.
Food, housing, fuel, industrial inputs, rent, and virtually every other product have skyrocketed in price. Food staples such as edible oil, bread, bottled water, and milk are quickly becoming unaffordable to most.
The government too seems to be conceding defeat, albeit slowly, in its fight against double digit inflation. In a speech last month, the minister of finance, Ahmed Shide, announced that the government expects to cushion inflation to 11.9% percent in the upcoming fiscal year, a somewhat unrealistic goal against the 37.2% inflation registered in May.
The chaos is the outcome of a series of questionable policy decisions taken by the government over the years, combined with persistent macroeconomic challenges and global market disruption. The latter has left the already weakened economy with little resilience to bounce back.
Wrong turn one: Massive devaluation of the birr
Since 2017, the government has been undergoing a major devaluation. In the past four years the value of birr has dwindled by 126% against the dollar.
Eyob Tekalign (PhD), state minister of finance, appearing on national TV, stressed the government believes the birr is still overvalued and rectifying that remains a priority. Nevertheless, the rate of depreciation of the birr has started to decline, while experts speculate it was done to tame inflation.
Devaluation was a policy measure taken by the government in hopes of addressing the forex shortage by reducing the gap between official and parallel exchange rates and increasing export revenue and foreign investments.
Devaluation is a policy measure often promoted by international financiers, primarily the World Bank and IMF, that local economists are displeased about.
It was one of the macroeconomic adjustments the government was taking as part of the $2.9 billion financing facility from the IMF, which abruptly expired at the end of last year due to delayed debt rework negotiations. The facility, among many other targets, was supposed to compensate for foreign currency shortages due to the devaluation and the eventually floating the exchange rate.
“There are two strains/factors driving inflation right now. One that is the historic issue of severely depleted forex that is aimed to be addressed by a steady devaluation of the birr contributing however additionally to the price pressures we see” says Alisa Strobel, a senior economist for sub-Saharan Africa at S&P Global Market Intelligence.
World Bank research studying the causes of inflation in Ethiopia suggests in an economy facing foreign exchange constraints, a devaluation can miss its target and set off an inflationary spiral.
“Under tight foreign exchange reserve constraints and dependence on imports, inflation can indeed offset some of the intended benefits of devaluation. The World Bank concluded that a key reason why a similar attempt in 2010 devaluating the birr (17%) did not yield the desired outcomes is that “inflation ‘ate-up’ most of the positive real exchange rate gains,” the study reads.
Forex and commodities shortage
The severe shortage of foreign currency has led to a shortage of commodities in the market. A senior executive in one of the commercial banks in Ethiopia told Quartz it’s the worst forex crunch seen, especially after the government decided to retain the majority of the foreign currency banks attain.
One of the short-term measures taken to address the shortage of goods was allowing franco valuta import of essential food commodities where importers source forex through their own means.
“I won’t tell you it’s a great policy measure,” said state minister Eyob in an interview. His ministry passed the decision in hopes of making goods at least accessible.
In the second quarter of the fiscal year, franco valuta imports amounted to 1.8 billion birr, representing 42% of total imports and 56% annual growth, according to a report from the National Bank of Ethiopia.
Although goods are available in the market, their prices have been exorbitant, resulting from expensive forex acquisition costs and increasing global prices.
“Some argue that the flow of hard currency to banks as remittance has been affected because of the new type of franco-valuta condition. One needs to look at this, however, also in a balanced manner as the parallel rate upwards trend is not just explained by the franco-valuta directive but also the general global price environment, including that of energy and significant fuel shortages that increased the demand in the parallel market tickling down as higher prices to the consumer,” Strobel tells Quartz.
Wrong Turn two: Big-budget War in Tigray
The war between the federal government and forces in the Tigray region has resulted in a wider budget deficit stemming from high military and humanitarian costs that the government attempted to finance through domestic borrowing and budget reappropriation through cutting on capital projects.
It created turmoil in the country’s foreign currency reserve. Development partners and bilateral lenders shied away from extending assistance and loans. As the minister of finance said in his speech 25% of tax and foreign aid appropriated for the budget this year did not come in, leaving the country with forex worth less than two months of export.
This unsustainable expenditure created a vicious cycle where financing it causes inflation and the inflationary pressure leads to increased expenditure.
Although prime minister Abiy Ahmed’s administration managed to cut down on excessive money printing for a while, in the light of the war in the North, it has gotten itself into massive domestic debt again. In nine months of this year alone, the government printed 66 billion birr ($1.3 billion), states a report from the Ministry of Finance.
Economists however argue that money printing alone is not the problem but where it is spent.
In nine months, government borrowing through T-bills was 167 billion birr ($3 billion). Now it makes up 20% of the government’s 1.4 trillion birr domestic debt.
“A country will squeeze out liquidity that should be available for the private sector through central bank budget financing. The less credit to the private sector, the higher the demand for borrowing in the informal financial market increases, thus fueling inflation additionally,” Strobel says.
The government is still making an effort to cut costs by reducing subsidies.
The biggest national subsidy, fuel, is planned to be lifted gradually. The subsidy spending on fuel has topped $2 billion over the years.
Experts disagree on whether the timing is correct as a slight fuel price increase has been linked with higher inflation in the past.
Strobel says in terms of maintaining greater fiscal discipline, phasing out these subsidies is desirable in the long run. However, she cautions in light of the current macroeconomic imbalance removing subsidies will ultimately lead to the drawdown of higher inflation, which is why maintaining subsidies for public transport vehicles is important.
Global crisis adds fuel to the fire
The precipitated effects of global market disruption began in 2020 with the onset of covid-19, which majorly inflated logistics costs, which is still seen in the domestic market. While the country was just getting accustomed to the new normal, the Russia-Ukraine war erupted in February
The crisis is adding fuel to the fire making importing goods extremely expensive for the government. As a major importer of fertilizer, fuel, and wheat, an extra couple of billions have to be spent.
The government says the Russia-Ukraine war will cost an additional $2 billion in import bill.
Brighter days ahead for Ethiopia?
Although things look bleak in practically every part of the economy, a glimmer of hope comes with the possibility of resolving the conflict in the North.
As the Ethiopian government indicates a commitment to a peaceful resolution of the conflict with forces in the Tigray region, development partners are loosening their reluctance to engage in program discussions. In mid-June, a delegation from the IMF visited Ethiopia and hinted at a potential future program discussion, despite having put off the idea in February.
The World Bank has also recently kicked up its loan and grant commitment to Ethiopia, extending about $1 billion in financing for several programs.
“Taking the impact of global price pressures aside, foreign exchange accumulation through the ongoing process without major delays of privatization and ongoing reform progress will be crucial,” says Strobel as a way forward.
In addition, in the short term, reestablishing the country as an investment destination and rebuilding multilateral and bilateral lender engagement is essential to obtain sufficient forex and budget finance to keep the economy going.
Ultimately, the future of Ethiopia resides in the ability to reconcile differences and ensure stability, says the World Bank in its closing passage of a country economic memorandum published recently.
Source: https://qz.com/
