Ethiopian Review

Currently there is no clear consensus among economists on why Ethiopia is experiencing rapid inflation.

Traditionally, inflation was associated with large agricultural supply shocks due to drought, however, the current inflation has coincided with high economic growth for the last consecutive five years.
At the start of the price hiking, the Prime Minister Meles Zenawi’s Government was thinking that inflation was typically associated with economic growth and the solution was also economic growth. Indeed, economic growth has a general effect on inflation, but the Government didn’t link how the growth hikes prices.

But lately, a Government think tank came up with three points cited as factors: imported inflation is the main factor according to the think thank, which is accepted by the Government, especially high cost and large volume construction materials imported for the huge amount of activity in the sector; the second factor is inflationary expectations, with people pushing up prices by rushing out to buy goods due to fears that prices will rise further; and the increasing amount of money injected into the economy, particularly from the Government, is the third factor.

After recognising the factors, the Government began efforts to curb prices. Because the soaring prices of food items is the major challenge to the public, the Government placed priority on reducing the inflationary expectations by flooding the market with imported wheat.

But after investing over 250 million dollars, the Government realised that the strategy was only having the effect of holding up the price increases, as Girma Biru, Trade and Industry Minister told parliamentarians a few weeks earlier.

Another measure the Government took was to reduce the huge amount of money circulating in the country. Two years ago, the National Bank of Ethiopia increased commercial banks’ reserve rate from 5 per cent to 10 per cent and then to 15 per cent. However, inflation remained unaffected, despite the money supply not increasing at the same rate.

The International Monetary Fund (IMF) repeatedly advises the Government to slow down its expenditure so that it can reduce the money supply. The IMF also recommended it try and absorb excess money, leaving the method up to the Government.

“This is the right way of reducing prices” a macro economic researcher who agreed with the IMF guidance said.

Government expenditure on various development projects is the main contributor to the country’s frequent economic growth, and slowing down public expenditure without harming the country’s economic growth will be appropriate because expenditure has an effect on the money supply, says the researcher.

The Government letter sent few months earlier also demonstrates its agreement with the IMF’s guidance.

Sufian Ahmed. Finance and Economic Development Minister and Teklewold Atnafu, Governor of NBE, sent a letter to Dominique Strauss-Kahn Managing Director of IMF, stating the serious economic shock their country has been facing due to weak balance of payments and the mounting inflation. The letter sent in December 2008 also revealed the Government’s effort in mitigating the shock:
“In the monetary area, the minimum deposit interest rate was increased and reserve and liquidity requirements of banks rose to restrain domestic credit expansion and monetary growth. We intend to contain the broad money growth below 20 per cent in the current fiscal year”, the letter reads.
However, the money that had been circulating in the economy was 71.4 billion birr in January 2009, an increase of 4.8 per cent from 2007, and a 22.2 per cent annual growth.

Expansion of domestic credit had been identified as a contributing factor to the money supply growth, according to a quarterly report of the central bank.

The rising excess money supply seen in the first quarter prompted authorities of NBE to advise the country’s commercial banks in March this year to curtail their lending. In addition, the Government become very bold by announcing an intention to zero internal borrowing; if the Government manages this, it will halt the money growth by at least five to six billion birr.

“There is no uncertainty in making zero our net borrowing,” Getachew Negera, head of treasury department at MoFED, told Capital.

No one can be certain of the effect of all the policy changes until the end of the fiscal year. Even if the Government achieves its target of zeroing the net borrowing, it can not reduce the excess money supply below 20 per cent, according to the Government’s plan, the researcher told Capital, citing the nine month performance report of NBE presented last week to the parliament.

NBE’s performance within the first nine months of this fiscal year shows it is way off its targets in the monetary sphere. The bank has a plan to reduce the rate of money supply increase below 20 per cent, however, the money supply reached 80.6 billion birr in the third quarter of this fiscal year; which is a 9.2 billion birr increase from that of the first quarter and a 22.7 per cent rise from the same period last fiscal year.

The increase in loans obtained from banks and the rise in foreign reserves are the main contributing factors given by the banks for the money growth. According to the bank, loans increased by 16 per cent from last year and the foreign reserve increased by 12.1 per cent.

Foreign currency reserves have decreased to the extent that they are harming private companies, but NBE says that the reserve has increased by 12.1 percent. This is an illustration of the Government’s successful development activities that are adding money to the economy and contributing to the continuing inflation, the researcher said.

- By Yohannes Anberbir | Capital Ethiopia