Gov’t Fears Inflation Surge Could Trigger Social Upheaval, Commits To Fuel, Electricity Price Hikes

IMF foresees 31 percent inflation in 2025

The federal government harbors concerns that a surge in inflation following the liberalization of the foreign exchange market could trigger social unrest, according to official correspondence with the International Monetary Fund (IMF).

The concerns are set out in a memorandum of economic and financial policies attached to a letter of intent addressed to IMF Managing Director Kristalina Georgieva from Finance Minister Ahmed Shide and central bank Governor Mamo Mihretu on July 10, 2024.

“Downside risks to the program in the near-term include disruption from domestic conflict if this was to intensify; rising import costs due to new international commodity price increases; and potentially social unrest associated with higher inflation. An abrupt slowdown of global growth also presents a risk via its adverse effects on exports and potentially remittances,” reads the document. “Climate shocks could exert pressure on food security and food prices. If these risks materialize, we stand ready to adjust our policies, in close consultation with IMF staff, to ensure the achievement of the program’s objectives. The authorities stand ready to adjust policies if risks materialize.”

An IMF comprehensive country report on Ethiopia released on August 2, 2024, acknowledges the risks.

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“Following the adoption of a market-determined exchange rate, inflation is expected to peak around 30–35 percent in early 2025, but moderate to about 16 percent by 2025/26,” reads the lengthy IMF document.

The Fund forecasts that inflation will peak at 31.1 percent in 2025, up from the current 23 percent, before declining to 9.4 percent in 2028/29.

“The first-round impact of devaluation on consumer price inflation is expected to be relatively limited, given the low share of imports occurring at the official exchange rate in private consumption expenditure, and evidence that consumer prices track the parallel market exchange rate,” reads the report.

The IMF foresees price increases for food and essential commodities will be especially hard on the urban poor, and recommends the strengthening of safety net programs to absorb the shock.

The government has pledged to take measures to tame inflation, including raising reserve requirements depending on liquidity conditions and implementing credit caps.

“We will continue to tighten monetary policy as needed to anchor exchange rate and inflation expectations with the objective of ensuring price stability. Further increases to interest rates will be implemented with the objective of achieving a positive real policy rate in the first quarter of 2025,” reads the memorandum.

Headline inflation has slowed in recent months after peaking at 37 percent in May 2022, according to official figures. The state statistics agency puts the rate for May 2024 at 23 percent, which is still considerably high despite decisive measures from the National Bank of Ethiopia (NBE), including a cap on bank credit disbursal.

The federal government plans to increase fertilizer subsidies as a way to curtail inflation’s impact on the population, according to the memorandum.

“We will increase fertilizer subsidies to 0.5 percent of GDP. Even though under-fertilization remains among the most important factors behind relatively low production yields in wheat and other cereals, addressing suppressed fertilizer demand at the current price subsidy level would be prohibitively expensive,” it reads.

Officials estimate current spending on fertilizer subsidies at 0.3 percent of GDP, and the plan is to lower spending back to this threshold by the end of 2025/26, according to the document. It also reveals that spikes in international fertilizer prices over the last two years have outstripped the government’s USD 1 billion budget for fertilizer supply, leading to “relatively low production yields in wheat and other cereals.”

Still, the government envisages lifting fuel subsidies and increasing electricity tariffs, according to the memorandum.

“To contain the fiscal costs to 0.5 percent of GDP and smooth the impact of price increases on the public, we will raise fuel prices by 5 percent per month to close the price gap resulting from FX reform by early 2025. We will continue to provide targeted fuel subsidies for public transportation that will cushion the impact for vulnerable households across the country. To cap public transport subsidy costs at 0.1 percent of GDP and mitigate leakages, we will continue to rely on the current targeting mechanisms and digital solutions (rebates through mobile payment and digital wallets) and limit eligibility to city and regional public bus transportation,” reads the document.

The government will also be moving ahead with its plans to raise electricity tariffs beginning this September, in line with the framework approved by the Council of Ministers in June.

“The new framework underpins the 2025-2028 four-year tariff adjustment plan that aims to reach cost recovery. End-user electricity tariffs will be increased by on average about 10 percent each quarter to move toward cost recovery for the electricity sector, with larger price increases in the beginning. The first quarterly tariff increase will be implemented by end September 2024,” reads the memorandum.

Aside from tightening money supply to contain the inflation surge, the government is looking to provide subsidy packages in a bid to help the public cope with the adverse impact of the floating.

“Expanding the targeted cash transfer program (the Productive Safety Net Program, PSNP) by 0.4 percent of GDP will ensure expansion in the most cost effective and efficient way to support vulnerable people. Additional resources for PSNP will be provided by World Bank social safety net project financing (0.2 percent of GDP) and help cover the gaps in donor financing for the next 18 months,” reads the document.

The subsidy packages will cover fuel, food items and medicines, fertilizer, and transport. Prime Minister Abiy Ahmed (PhD) announced this week intentions to raise the salaries of the lowest-earning civil servants by up to 300 percent in a bid to safeguard vulnerable households against an impending rise in the cost of living.