IMF says Ethiopia’s monetary policy ‘highly distorted’; headline inflation drops by 0.5 to 40.1 percent in September, as food inflation rises by 28.4 percent By Keffyalew Gebremedhin
The Ethiopian Central Statistics Agency (CSA) on 11 October reported that overall inflation in Ethiopia in September 2011 remained as high as 40.1 percent. At the same time, food inflation has risen to 51 percent. With an increase of 24.2 percent, non-food inflation has stuck at 24.7 percent.
The main reason for the rise in food inflation is due to the increase in the cereal index that jumped by 61.9 percent in September, compared to last year in September, according to CSA. This has pushed the general Consumer Price Index and the related food components, especially of related food components such as the rise of the cereal especially, wheat, maize, barely, sorghum, pulses, meat, butter, coffee & tealeaves, pepper whole, potatoes, tubers and stems and others.
At the regional level, the highest inflationary pressure was felt in Benishangul-Gumuz at an increase in September of 58.7 percent, SNNP 46.8 percent, Gambela 45 percent and Oromia 42.9 percent. The relatively lowest rates of increases were recorded in Addis Abeba at 25.8 percent, Dire Dawa 29.5 percent and Tigrai 32.3 percent. These speak to the fact that the problems are rooted in the availability of goods and services, a reflection of the structural and macroeconomic problems the country is stuck in.
Around the Ethiopian New Year, food prices reached unaffordable levels, as newspapers reported. For instance, live lamb that is usually the tradition in Ethiopia in homes with good income cost ETB 3,000 ($ 175), chicken ETB60 to ETB 90 ($ 4-5), kilo of butter ($7-8), which automatically exclude from the celebrations ordinary citizens. A university lecturer with a monthly income of about ETB 4000 ($235) related to people recently that people of his income category, which is relatively higher in Ethiopia, are compelled to skip certain traditional necessitates and festivities such as Christmas, Easter or the New Year, because of such prohibitive prices. At the same time, some people get richer and faster, as proportion of the population that is growing poorer is expanding faster.
Talking of inflation, the IMF yesterday released its joint assessments with World Bank of Ethiopia’s poverty reduction strategy, as provided under the requirements in Article IV. In a report entitled Joint Staff Advisory Note on the Growth and Transformation Plan 2010/11–2014/15 on 12 October 2011, it dealt with the growth and transformation plan (GTP). The Advisory Note, however, does not indicate decisions by the Executive Board that met on 26 August to consider the state of the Ethiopian economy in the context of Article IV of the country’s agreement with the IMF.
The provisions under that Article mandate the IMF “to exercise surveillance over the economic, financial and exchange rate policies of its members in order to ensure the effective operation of the international monetary system.” Last spring, the Meles regime was not pleased with criticisms of the IMF mission to Ethiopia, especially the handling of macroeconomic policy.
The fact that the Fund has now released this Note, notwithstanding opposition by the Ethiopian Government of release of the report is an indication of the consensus within the Board to go along with Staff conclusions and recommendations. In this regard, recall that TRANSFORMING ETHIOPIA discussed this matter on 29 August in the article IMF report chiding Meles’s economic & financial polices not to see light of day.
The major observations and conclusions in the Advisory Note have been categorized under macroeconomic polices, structural reforms and sectoral polices required and human development and gender governance and gender issues. For purpose of this article, Note’s conclusions and recommendations under macroeconomic policies have been summarized hereunder.
• High inflation is undermining poverty reduction efforts. Single-digit inflation projections in the GTP appear unrealistic as long as a loose monetary policy and a heavy dependence of the public sector financing on bank credit continues. Present policies are contrary to the stated policy intention in the GTP that “prudent monetary and fiscal policy ensures that inflation remains single digits.” High inflation is not only constraining growth, but also represents a heavy tax burden on the poor and is eroding the gains made under the donor-funded social protection and social safety net programs.
• A highly distorted monetary policy represents a severe drag on growth and is undermining macroeconomic stability. The lack of a nominal money anchor*/is contributing to a misallocation of resources and use of inflation hedges such as real estate and commodities.
• The external position continues to be vulnerable. Despite a strong trade performance in recent months, in part reflecting the impact of credit restrictions on imports, progress in export diversification has been limited. It will be a challenge to achieve the rate of expansion of agricultural, manufacturing, and service (particularly electricity) exports envisaged in the GTP without reforms to improve private sector access to credit and foreign exchange and a more favorable business environment. Undertaking the ambitious public investment in the GTP will likely lead to a surge in imports of capital and intermediate goods.
• Fiscal policy appropriately focuses on strengthening domestic revenue mobilization and increasing pro-poor spending. While fiscal deficits at the general government level are contained at broadly sustainable levels, the off budget spending and deficit financing needs of the public sector are very large and crowd out the credit needs of the private sector.
• The mobilization of much higher domestic savings needed to finance the GTP is not likely. Unless nominal interest rates are allowed to rise and monetary policy is freed from public sector dominance, public sector financing needs are likely to overwhelm the ability of the financial system and the economy in general to supply savings, especially in an environment of highly negative real interest rates.
• Financing the GTP through external non-concessional borrowing would significantly increase the risk of debt distress, working against the need to attract financing on the best possible terms. External borrowing levels that are consistent with maintaining a low risk of distress rating would be significantly lower than envisaged in the GTP. Disbursements of external borrowing are projected to average US$2.3 billion (71⁄2 percent of GDP) annually over the GTP period, of which about US$500 million would be non-concessional over the next three years and US$585 million on average over the medium-term.
• Staffs advise a more cautious implementation of the GTP and greater structural reform. In the current overheated environment and with much of the financing yet to be identified, the government could achieve more of its objectives by slowing the pace of public investment, rebalancing of the growth drivers in favor of the private sector, and focusing on steps to improve the investment climate, and deregulate trade and the foreign exchange regime.
*/A nominal anchor for monetary policy is a single variable or device which the central bank uses to pin down expectations of private agents about the nominal price level or its path or about what the Bank might do with respect to achieving that path (Krugman, 2003). Generally, the two kinds of nominal anchor; quantity- based nominal anchor and price-based nominal anchor. The quantity based nominal anchor targets money while the price-based nominal anchor targets exchange rate or interest rate.