According to various sources, the Ethiopian government has made an agreement with the IMF to devalue its currency on a scale that would bridge the gap between the official and parallel market exchange rates. However, the sources claim implementation is facing delays due to considerations of the hostile impacts a devaluation of that scale would involve. Other sources again reported that the WFP foresees that devaluation could fuel further inflation and pile on pressure on low-income groups of the population. It signals that devaluation will worsen the already high prices of imported fuel, fertilizer, and agricultural inputs, which will in turn offset food production costs.
The International Monetary Fund (IMF) and the World Bank are two prominent international financial institutions that often work with developing countries like Ethiopia to provide financial assistance, technical expertise, and policy advice.
When it comes to currency devaluation, their push for such measures typically stems from their focus on macroeconomic stability, promoting export competitiveness, and addressing balance of payments issues. Here’s a detailed discussion on how and why they might advocate for currency devaluation in Ethiopia:
- Macroeconomic Stability: IMF and World Bank programs often prioritize achieving macroeconomic stability, which includes controlling inflation, managing fiscal deficits, and stabilizing exchange rates. Currency devaluation can be seen as a tool to address imbalances in the economy, particularly if the local currency is overvalued relative to its fundamentals.
- Export Competitiveness: Devaluing the currency can make Ethiopian exports cheaper for foreign buyers, potentially boosting export revenues. This is particularly important for a country like Ethiopia, where agriculture and manufacturing are key sectors contributing to economic growth and employment. By making exports more competitive on the global market, Ethiopia can earn more foreign exchange and improve its trade balance.
- Balance of Payments: If Ethiopia is facing pressure on its balance of payments, with imports exceeding exports and foreign reserves dwindling, currency devaluation can help correct this imbalance. A weaker currency makes imports more expensive, which can reduce import demand and encourage domestic production, thereby narrowing the trade deficit.
- IMF and World Bank Conditionality: In exchange for financial assistance or access to development loans, the IMF and World Bank often impose conditions on borrowing countries, known as conditionalities. These conditions may include implementing economic reforms, such as currency devaluation, as part of structural adjustment programs aimed at stabilizing the economy and promoting sustainable growth.
- Market Forces vs. Policy Choice: While IMF and World Bank recommendations can influence policy decisions, it’s important to note that currency devaluation should ideally be a carefully considered policy choice made by the Ethiopian government based on its own economic circumstances and objectives. Governments may weigh the potential benefits of devaluation, such as export growth, against the potential costs, such as inflationary pressures and increased debt burdens.
- Social Impact and Equity Concerns: Currency devaluation can have distributional consequences, affecting different segments of the population in varying ways. It may lead to higher prices for imported goods, impacting consumers, particularly those with lower incomes. Therefore, policies accompanying devaluation should consider measures to protect vulnerable populations and mitigate social hardships.
- Long-Term Structural Reforms: While devaluation can provide short-term benefits, sustainable economic development in Ethiopia will likely require broader structural reforms aimed at improving productivity, enhancing competitiveness, and diversifying the economy away from reliance on agriculture. IMF and World Bank support may also encompass assistance with these longer-term objectives.
In summary, while the IMF and World Bank may advocate for currency devaluation in Ethiopia as a means to address macroeconomic imbalances and promote export competitiveness, the decision to devalue the currency should be made in consideration of Ethiopia’s specific economic context, with attention to potential social impacts and the need for complementary policy measures.
Impact of Devaluation
Money devaluation in Ethiopia, like in any country, can have significant economic impacts. Here are some potential effects:
- Inflation: Devaluation typically leads to higher inflation, as the cost of imported goods increases due to the weakened currency. This can erode purchasing power, particularly for those on fixed incomes or with savings in local currency.
- Cost of Living: The increased prices of imported goods can make basic necessities, such as food and fuel, more expensive. This can disproportionately affect low-income households, leading to a decrease in their standard of living.
- Interest Rates: Devaluation may prompt the central bank to raise interest rates to combat inflation. Higher interest rates can discourage borrowing and investment, potentially slowing economic growth.
- Foreign Debt: If Ethiopia has significant foreign debt denominated in foreign currency, devaluation can make it more expensive to service this debt, as the amount owed in local currency increases.
- Export Competitiveness: On the flip side, devaluation can make Ethiopian exports cheaper for foreign buyers, potentially boosting export competitiveness and increasing export revenues. This can benefit sectors such as agriculture and manufacturing.
- Capital Flight: Devaluation can also lead to capital flight, as investors may seek to move their assets out of the country to protect their value. This can further weaken the currency and undermine investor confidence.
- Political and Social Impact: Economic hardships resulting from devaluation can lead to social unrest and political instability if not managed effectively by the government. This can create challenges for governance and hinder long-term economic development.
To mitigate the negative impacts of currency devaluation, governments often implement policies such as fiscal discipline, monetary tightening, structural reforms to improve productivity and competitiveness, and targeted social welfare programs to protect vulnerable populations.
The National Context
Ethiopia is faced with choosing between two critical evils – devaluation or dying economy while both are all the same. The ever-increasing inflation rate, skyrocketing prices, war injured local markets, decreasing export, down falling investment as well as the budget intensive infrastructure investments are not fertile grounds for the devaluation plan. Scholars are warning that the devaluation plan may wipe out the ruminant of the economy as flood water.
Editor’s note : Views in the article do not necessarily reflect the views of borkena.com
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