Introduction: Shifting from a Fixed to a Market-Based Exchange Rate
For over a decade, Ethiopia’s economy has been guided by a fixed exchange rate, but now, the National Bank’s bold move to a market-based system is stirring up excitement and uncertainty. As this new chapter begins, the ripple effects on pricing, especially for everyday essentials like food, are set to reshape the way people live and work. With the whole economy on the edge of change, the impact of this reform on wallets and businesses is a pressing question. The IMF predicts that rising prices for food and essential goods will be especially burdensome for the urban poor. Addis Insight will explore how this historic shift is set to transform agriculture and product pricing.
The Vital Role of Agriculture in Ethiopia’s Economy
Ethiopian agriculture is vital to the nation’s economy, providing livelihoods and contributing significantly to GDP. It is the main food source for both urban and rural areas. To reduce imports, Prime Minister Abiy Ahmed’s reforms included a planting campaign. The 2022 irrigation-based summer cultivation produced 25 million quintals of wheat, leading to a halt in imports. Wheat exports now enhance foreign exchange earnings, provide farmers with extra income, diversify the export base, and support rural development. However, despite ongoing instability and climate impacts, the sector has received little attention. Food inflation has only decreased by 5.3% this July, and there are concerns that the National Bank of Ethiopia’s recent interest-rate policy may deter investment in agriculture and technology. The shift to a market-based exchange rate brings uncertainty, with questions about whether it will worsen existing issues or promote growth. The IMF predicts that inflation could rise to 30–35% by early 2025.
Technology and Smallholder Farming: Challenges and Opportunities
“Agricultural productivity is closely linked to the adoption of technology, but the recent shift to a market-based foreign exchange rate is likely to worsen issues related to importing machinery, pesticides, and fertilizers,” explains Atlaw Alemu (PhD), renowned economist. He notes that with the ongoing devaluation of our currency, foreign currency has become both expensive and scarce. It remains uncertain when a stable supply of foreign currency might be restored. Although the government has promised subsidies for fertilizers and pesticides, providing support for machinery will pose a greater challenge.
Impacts on the Agriculture Sector and the Broader Economy
He added that our agriculture is primarily smallholder-based, with most farmers engaged in subsistence rather than commercial farming. Many of these farmers work with only small plots of land, which restricts their productivity and yield. To overcome this challenge and provide their product to the market, they need support through technologies like mini tractors to boost yields on their limited land. Increasing output would allow them to sell for profit and transition to commercial farming. Additionally, supporting and incentivizing the local production of fertilizers and pesticides could improve agricultural productivity while reducing costs and conserving foreign currency.
Currency Volatility and Its Impact on Imports
In the short term, transitioning to a market-based exchange rate often increases volatility and currency fluctuations, leading to higher import costs and inflation if the currency depreciates, as seen in early 2000s Turkey. However, a weaker currency can enhance export competitiveness, as Japan experienced. Central banks may need to adjust policies to manage these effects. In Ethiopia, the recent macroeconomic reform has caused significant price increases, a 20-liter bottle of oil rose by 1,000 ETB, a 5-liter bottle by 200 ETB, and sugar by 10 ETB per KG.
The Initial Economic Impact: Inflation and Speculation
“Every initial stage of any policy impacts the economy,” noted Tilahun Girma, Finance Consultant and Associate Director at Feyssel and Associates. He highlighted that the recent policy reform caused a temporary inflation spike, with expected stabilization over time. Although the IMF generally opposes subsidies, their press release suggested selectively subsidizing essentials like food, fertilizer, and fuel to shield vulnerable groups from the reform’s impact, which shows its significant inflationary effect. Farmers and suppliers are holding back products in anticipation of price increases. Unlike countries with inventory tracking, our traditional market allows local merchants to adjust prices freely. Currently, exporters face shortages due to this speculation, and substantial inventories are held at various ports. Government intervention is crucial to regulate practices, ensure supply, and provide necessary subsidies. Addressing the supply chain from farmers to consumers and incentivizing the official market over the parallel market are essential for economic and currency stability.
Uncertainty for Fixed Income Earners and the Inflationary Future
Atlaw Alemu (PhD), renowned economist and Dean of the Department of Economics at Addis Ababa University notes, the shift to a market-based exchange rate will inevitably increase prices, though the duration and extent remain uncertain. Those on fixed salaries and with minimal incomes are particularly vulnerable to the inflationary effects of this reform. The market’s stabilization timeline is unclear, potentially extending into next year or beyond. I estimate that inflation will rise as foreign currency prices and the cost of imported goods increase. While some argue that goods previously imported using parallel market rates are now priced according to the official rate, this approach seems impractical due to our insufficient foreign currency reserves to support importers. Consequently, the parallel market rate is likely to rise due to a shortage of foreign exchange, exacerbating the issue as our economy does not generate enough foreign currency.
Differing Views on the Liberalization of the Currency Market
Conversely, Million Kibret, Managing Partner of BDO Ethiopia, argues that the liberalization of the currency market has a significant impact on import pricing. Prior to the liberalization, traders relied heavily on the parallel market, where the exchange rate fluctuated around ETB 110-120 per dollar. which is now closer to the official bank selling rate. Therefore, unless traders seek to increase their profit margins, imported goods should not experience a price increase. Furthermore, Kibret posits that increased availability of dollars to importers in a transparent manner would stimulate competition among traders. This competition, in turn, would drive down prices. He also points out that the recent permission for franco valuta imports would boost supply volume, further contributing to a potential price decline.
Volatility and Opportunities in the New Economic Environment
Samson Tizazu, Co-founder and Deputy General Manager Business Valuation and Export Import Consulting Firm called Proma Partners, anticipates that a market-based exchange rate will increase volatility, posing challenges for importers who must navigate uncertainty and potentially rely on black market rates. He suggests that government support and diaspora involvement could alleviate some volatility, aiding financial planning. Tizazu also notes that this new environment offers opportunities: importers with strong financial management and hedging strategies could remain competitive with attractive pricing despite fluctuating costs. Increased import expenses might encourage local production, reducing reliance on foreign products and bolstering local industries. However, he warns that rising costs and volatility could strain cash flow, disrupt supply chains, and complicate foreign currency acquisition, potentially affecting operational efficiency for Ethiopian importers.
Government Measures to Support Citizens and Stabilize the Economy
To cushion these effects of the historic macroeconomic reforms and stabilize the economy, the government has rolled out promising measures to support citizens. To alleviate the impact on vulnerable populations and ensure economic stability, officials have pledged to subsidize fuel prices and increase civil servant salaries. These steps aim to ease the transition for the public and help people adapt to the sweeping changes.
Addressing Food Inflation and Enhancing Agricultural Productivity
Kebede Lakew, Public Relations and Communication Manager of the Ministry of Agriculture, states, “To address food inflation, the Ministry is set to boost productivity this summer by enhancing 20.4 million hectares to achieve a yield of 615 million quintals.” He added that the Ministry will employ effective fertilizer distribution, high-quality seeds, mechanization, and cluster farming technology to improve smallholder productivity. Measures to reduce harvest losses include using drones and small machines to protect crops from weeds and pests, and treating soil acidity with limestone. With substantial rice production across Ethiopia, these efforts aim to enhance productivity and yields. He emphasized that macroeconomic reforms focus on increasing the productivity of exportable goods to ensure macroeconomic stability.
The Ministry of Trade’s Role in Facilitating Essential Goods Distribution
To tackle the price surge caused by recent macroeconomic reforms, the Ministry of Trade and Regional Integration has facilitated the distribution of essential goods. Between July 27 and 29, 2024, 752 of the 1,649 heavy vehicles carrying sugar, oil, rice, and other basic food items began distributing products in various parts of the country. Minister of Trade and Regional Relations Dr. Kasahun Goffe stated on the ministry page that the remaining vehicles are expected to complete their deliveries by August 1, 2024, ensuring that these essential goods reach the market promptly.
Short-Term Subsidies and Long-Term Growth Prospects
Kibret advocates for short-term subsidies to soften the blow of currency liberalization, but sees a long-term path to growth built on an open environment for foreign investment. He believes attracting foreign investors, with their financial muscle and institutional expertise, will boost production and economies of scale, ultimately driving down prices for consumers. He further emphasizes the importance of capital markets, not just for encouraging savings and channeling funds productively, but also for fostering peace and stability. He argues that widespread participation in capital markets instills a desire for a peaceful and stable environment, critical for business success. He also stresses the need for a proactive monetary policy based on interest rates. This allows the central bank to closely monitor the economy and adjust rates to control inflation or stimulate growth. Looking toward the future, he suggests, even with potential constitutional amendments, allowing the purchase and sale of agricultural land could pave the way for large-scale farms, potentially transforming the agricultural sector.
Balancing Inflation, Prices, and Economic Stability
Tizazu noted that the shift to a market-based exchange rate is likely to drive up prices for essential goods, as many of these rely on imports and importers may pass on higher costs to consumers. However, government subsidies and efforts to attract diaspora investment could help stabilize prices and mitigate the impact on consumers. The effectiveness of these measures in maintaining affordability will become clear over time.
Influence of Government Policies and Foreign Investment
He also highlighted that the government’s recent subsidies and price control measures, combined with the National Bank of Ethiopia’s monetary policy adjustments and a favorable approach towards foreign investors like Alibaba, will significantly influence the long-term stability and cost trends of imported goods. Imported goods may remain expensive unless the local currency appreciates, but foreign investments and subsidies could ease the transition to price stability. The government’s focus on managing inflation will be crucial for preserving consumer purchasing power and ensuring an economy that effectively adapts to market fluctuations.
A Future of Economic Transformation and Global Competitiveness
As challenging as this transition is, it sets the stage for Ethiopia to achieve macroeconomic stability, drive high and stable economic growth, control inflation, and develop a globally competitive economic system. However, it will be crucial to closely monitor the application of these reforms and their impact on the economy, learning from both the successes and setbacks experienced by other countries. This period of transformation could redefine Ethiopia’s economic landscape, offering a chance to overcome past hurdles and seize new opportunities for prosperity on the global stage.
