Economists Forecast GDP Growth Shrink, Inflation Bump In 2025

A new policy paper published by the Ethiopian Economics Association (EEA) predicts a three percentage point drop in GDP growth and a 10 percentage point rise in the inflation rate over the coming months.

The policy paper, titled ‘Initial reflection on the likely effects of Ethiopia’s foreign exchange rate reform on macro-economic indicators’, was authored by Yetsedaw Emagne and Tadele Ferede (PhD).

The authors considered the economic outlook based on a reunification scenario, where the official and parallel forex rates would converge, and another featuring a more gradual adjustment scenario.

This first scenario of the study aligns with a central bank statement this week, indicating that the reform’s immediate impacts include a sharp reduction in the parallel market premium, which fell from nearly 100 percent to near five percent.

“The reunification scenario, which involves a 100 percent depreciation of the Birr, results in a sharp short-term contraction in economic activity. Under the reunification scenario, economic growth of gross domestic product (GDP) contracts by more than three percentage points in the first and second quarters of 2025,” predicts the study.

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It attributes the contraction to an increase in import prices, which negatively impacts local production, consumption, and investment.

The authors argue the gradual adjustment scenario would entail a smaller contraction in economic growth.

“Unlike the gradual scenario, the reunification scenario would lead to a slow recovery of the economy. As a result, growth in exports critical to improving Ethiopia’s trade balance would remain slow in the initial periods, delaying full economic recovery. Firms that rely on imported inputs face higher costs, reducing output in the near term. In particular, the import-intensive manufacturing industry would likely suffer from the rising cost of imported and local raw materials, exacerbating the already weak performance of the domestic manufacturing industries,” reads the paper.

The authors predict the floating will exert inflationary pressure by raising the prices of both imported and domestically produced commodities.

“Early observations showed that the price increase for some commodities was faster than the fall in the value of birr against major currencies,” reads the paper.

It predicts the reunification scenario would result in significant inflation pressure beginning in the third quarter of 2024 and continuing through 2025.

“For example, inflation would rise by more than 10 percentage points in the first and second quarters of 2025, compared to the baseline. This creates a broad-based rise in the cost of living, disproportionately affecting low-income households,” it reads.

A fall in purchasing power will lead to a sharp drop in consumption, and low-income individuals would be most susceptible as they spend a  higher proportion of their budgets on basic commodities such as food, housing and energy, the authors predict.

They urge the authorities to put in place social safety nets for low-income and vulnerable households.

The economists state that simulations indicate a substantial decrease in the growth of government consumption spending, with the extent of this response becoming greater in the reunification scenario. Government spending would instead be diverted to social programs and subsidies, and debt servicing, according to the paper.

However, the authors foresee this decline growing more controlled over time.

“The government needs to balance and prioritize its spending between immediate relief and long-term investment,” reads the paper.

It also predicts a significant impact on Ethiopia’s trade balance.

“The immediate effect of the exchange rate depreciation is to raise the prices of imports compared to export prices, which tends to reduce net export values and exacerbate the current account deficit,” it reads. “The indirect effects are to increase the volume of exports and reduce the volume of imports, which will increase net  exports and improve the current account. However, these two effects differ in their timing. The direct effect of an exchange rate depreciation occurs immediately, while the indirect effects on export and import volumes typically occur with a lag. In view of this, exchange rate depreciation is likely to reduce the value of net exports and worsen the current account deficit.”

The authors note that several rounds of previous depreciation efforts failed to boost export revenues, instead making imports more expensive and feeding inflation.

They recommend working on expanding the export base through promoting value addition and diversifying export products and commodities. The paper cites import substitution as key to managing the effects of the floating, urging the scaling of investment in irrigation agriculture to ensure a stable supply of basic food commodities and raw materials for manufacturing.

“A disciplined and carefully designed opening of the financial sector will attract foreign direct investment in the sector to boost foreign exchange supply,” reads the paper.

The authors foresee that expediting the liberalization of the wholesale and retail markets could also attract more investment and consequently stabilize prices for consumers.