Export Uplift Unlikely In Short Term: Study

Lofty expectations for a surge in exports following the liberalization of the foreign exchange market are unlikely to prove true in the short run, according to a study published by experts at the Ethiopian Economics Association.

The depreciation of the Birr following the forex reforms is theoretically expected to result in an export boom by making exports cheaper and discouraging more expensive imports. However, experts at the Association say the anticipated short-term benefits of export expansion through currency depreciation may be limited due to the inelastic nature of Ethiopia’s export demand.

A study conducted by the Association warns that due to rising input costs for exports (both imported and domestically produced) due to depreciation and domestic inflation, the positive impact on competitiveness could be reversed.

“Given these factors, it is unlikely that export revenues will experience a significant uplift in the immediate term. Conversely, the country’s heavy reliance on essential imports, for which domestic substitutes are scarce, exacerbates the negative impact of currency depreciation. As the cost of these imports rises, the trade deficit is likely to deteriorate in the short run,” reads the report, dubbed ‘Insights on Ethiopia’s Exchange Rate Reform.’

The study forecasts exports will remain stagnant due to the country’s continued reliance on raw agricultural commodities, which are prone to fluctuations in high-priced imported inputs such as fertilizers, as well as domestic inflation and security issues.

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Depreciation is expected to reduce the demand for imports by increasing the costs of imports in terms of local currency and enabling the substitution of previously imported goods.

A depreciated currency makes imports more expensive, discouraging domestic consumption of foreign goods.

This can help to reduce the overall import bill and improve the trade balance. As imported goods become more costly, consumers and businesses may opt for domestically produced alternatives and foster import substitution-oriented production, stimulating domestic production and job creation.

A depreciated currency can contribute to narrowing the trade balance deficit by boosting export earnings. As a result of depreciation, a decline in import spending is expected due to higher prices, which also helps to reduce the trade balance deficit.

The other key factor is the overvaluation of Birr in real terms, making the country less competitive in the international market. The study places the overvaluation at 23 percent, while the International Monetary Fund (IMF) had it at 29 percent.

The study points out this significant strengthening of the Birr has hindered export growth, undermined the country’s competitiveness, and posed risks to external stability. In essence, Ethiopian goods have become relatively more expensive on the global market while the overvalued Birr also contributed to a surge in illicit trade as goods like gold and livestock are increasingly diverted to informal channels as exporters find it more profitable to avoid formal export procedures.

The study also notes that Ethiopia’s share of global agricultural products trade has shrunk from 0.13 percent in 2014 to 0.11 percent in 2021.

The economic experts foresee the exchange market liberalization could, however, offer benefits in securing grants and credit, stimulating investment, facilitating accession to the World Trade Organization (WTO), and improving overall trade competitiveness, among other things.

Still, they warn the floating could exacerbate inflationary pressure, aggravate the trade deficit, and result in a heavier debt burden as well as an oligopolistic forex market.

The report notes that depreciation is less effective when a country’s debt is denominated in foreign currency, which more than half of Ethiopia’s debt is. The debt burden has sharply increased in local currency terms following the liberalization, resulting in additional pressure on the government’s finances.

The experts behind the study recommend enhancing production capacity and addressing supply-side issues as key to making the most of the reform. Ensuring peace and stability, improving the overall business environment and reducing transaction costs, stimulating import substitution, and enacting sound fiscal and monetary policy are also among the list of recommendations.

The federal government expects the extended credit facility agreement with the IMF and other financial packages from the World Bank to boost its forex reserves, which, as of May 2024, were sufficient for around one month of imports. Still, the study notes the war-affected economy continues to grapple with shortages and a growing external debt problem, amounting to approximately USD 28 billion.

Ethiopia has secured a temporary debt service suspension from the Paris Club contingent on the IMF program. The government highlights that the recent forex reform is domestically driven and not an IMF-induced program. However, critics argue that the country’s severe macroeconomic challenges, which necessitate substantial foreign financing, have left the government with little alternative but to adopt the IMF’s proposed exchange rate and broader macroeconomic reforms.