Wed. Jul 24th, 2024

Ethiopia may allow birr to weaken to secure IMF board agreement by year end

Ethiopia’s Finance Minister Ahmed Shide addresses the parliament on the draft budget for the 2023/24 Ethiopian fiscal year, in Addis Ababa, Ethiopia, 8 June 2023. (REUTERS/Tiksa Negeri)
Ethiopia’s Finance Minister Ahmed Shide addresses the parliament on the draft budget for the 2023/24 Ethiopian fiscal year, in Addis Ababa, Ethiopia, 8 June 2023. (REUTERS/Tiksa Negeri)

Authorities are confident they can ride out a short-term inflation spike from a weaker currency, economists say.

Acceptance by Ethiopian policymakers of the need for a gradually weakening birr is likely to lead to IMF staff and board-level agreements by the end of this year, Connor Vasey, managing consultant at J.S. Held, tells The Africa Report.

Vasey spoke from Kenya following a recent visit to Ethiopia. His conversations with policymakers there left him convinced that a consensus in favour of gradual depreciation had emerged. “There has been a wrestling match to win over the old guard” which has led to the internal agreement and the remaining steps to securing agreement with the IMF are “procedural,” he says.

staff-level agreement is likely to be achieved by a new IMF mission to Ethiopia within the next two months, Vasey says. He has a “high level of conviction” that will be quickly followed by board-level agreement leading to an IMF programme being in place by the end of the year.

Finance Minister Ahmed Shide told parliament on 11 June that the current official exchange rate will stay in effect for the next fiscal year.  The fact that there is little international trading of the birr means that the government won’t need to publicly backtrack on such statements, Vasey says. Ethiopia “has driven a hard bargain to have a gradual adjustment” and won’t need to be explicit about implementing such a “dripfeed” solution, he adds.

READ MORE Ethiopia needs devaluation as step towards a free-floating birr

Ethiopia went into default when it missed a Eurobond coupon payment in December 2023. The maintenance of a debt-service suspension agreement reached with Paris Club creditors in November depends on Ethiopia getting a staff-level agreement with the IMF. An end-March deadline for such an agreement was put back until the end of June, and Bloomberg News reported that official creditors were willing to allow a further deadline extension.

IMF board agreement will need creditors to provide financing assurances. Vasey says that is unlikely to be a major hurdle. Creditors “have shown a level of goodwill” towards Ethiopia, he says, meaning little prospect of a protracted Zambia-style standoff.

Ethiopia has limited options

The reality is that Ethiopia’s options are limited. In the absence of the debt-service suspension, the country would have to find $100 million in debt service payments every month, says Patrick Heinisch, an economist at Helaba Bank in Germany. The IMF “will insist on some form of aligning the official exchange rate more with the parallel market rate,” Heinisch says.

Though a weaker currency will contribute to inflation through higher import prices, there will also be countervailing inflation-dampening effect, says Melka Girma, an economist in Addis Ababa. The current peg against the dollar has done little to reduce inflation, and higher prices for imported goods will promote import substitution, he says. “Managed exchange rate regimes are associated with slower productivity growth” with Ethiopia being a case in point, he adds.

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Policymakers accept that a weaker currency will mean an increase in inflation, Vasey says. That increase will come from a lower starting point due to the slowdown in inflation which has been achieved. Annual inflation dropped from 29.4% in January to 23.3% in April, the lowest for nearly three years. The central bank has said that inflation in June will be close to its 20% target.

The parallel market price of the birr against the dollar, which is about 100% more than the official rate, already drives inflation to some extent, Vasey says. He notes that many rural Ethiopians grow their food, which reduces their vulnerability to higher prices. The lack of organised political opposition, Vasey adds, leaves the government confident that it can weather the consequences of a short-term inflationary spike.

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