Economic commentary: PM Abiy’s Inflation Test

By Guest Contributor

Addis Abeba, August 11/2021 –Inflation has become emblematic of the Ethiopian economy. Prices have gone awry the last three years that the popular perception is “there seems to be no one stopping them from increasing”. The last parliamentary speech of Prime Minister Abiy Ahmed and the time it took him to explain the scourge is a showcase to the magnitude of the problem. Often challenged in explaining economic issues, the premier was seen having difficulty to put a wholesome picture of what is happening.

What was interesting, even more than Abiy’s rather fragmented economic theorisation, is the emotion and repetitiveness of the members of parliament (MPs) in describing the gravity of the problem. As much as it was about their public responsibility, it was about personal experiences. No doubt wage earners, including MPs, are significantly affected by the inflationary pressure.

It is all vivid out in the market. A kilo of meat is now sold at 450  – 800 ETB. An egg costs 9 ETB, while 5 litres of edible oil costs anywhere between 675  and 750 ETB. A package of diapers (80 pieces) is sold between 670 to 720 ETB, while a package of locally produced children’s milk is sold at 430 ETB. A kilo of sugar costs 90 ETB, while a kilo of wheat flour costs 45 .

Official statistics show that the monthly inflation rate stands at 24.5%. While the monthly inflation for food items is 28.7%, the rate for non-food items stands at 19%. There is no aspect of life that has not seen price increment, with basics such as rent, education and health experiencing an increment in the rate of 50 to 100%.

There is no aspect of life that has not seen price increment, with basics such as rent, education and health experiencing an increment in the rate of 50 to 100%.

No theorisation will help ease the burden. If there is anything positive about PM Abiy’s parliament speech, it was the admission that inflation is the utmost challenge in the economy. However, his understanding of the problem and his suggested solutions involve serious flaws.

PM Abiy attributed the current inflationary pressure to structural and transient factors. As structural causes, he mentioned that low productive capacity and productivity are the major drivers of inflation. He uses the popular demand and supply analysis to tell MPs that supply challenges are the major factors behind price build-up. His analysis focused on low agricultural productivity, undeveloped industrial base, and supply chain disruption.

Notably, he repeated his popular line saying, “A country that could not produce enough wheat cannot claim to be sovereign”. As it has become typical with him, he oscillated between conspiracy theory and selective evidencing to justify how challenged his administration is to contain the inflationary beast. 

But one line that I found to be the most inappropriate of all is that where he said, “Even if we do all of these things [measures], we will not drain the inflationary pressure out.”

Ditching the Real Causes

Abiy’s style of public speech, especially when he speaks about challenging stuff, is presenting himself as a common man. His wording is such that he detaches himself from his post and tells a story of a helpless citizen. With that, he ditches an obvious fact that he is a statesman with an arsenal of policy instruments. No different was his latest speech on inflation.

Mentioning a wide variety of factors, from global commodity prices to business malpractices, he told MPs that it is not all on to him and his government. It may be true that some of the factors leading to inflation may be imported. However, it does not mean states have no ability to attend them. Abiy’s inflationary theorisation has dumped serious contributors to the inflationary build-up that is pushing urban dwellers, wage earners, rural poor, pensioners, and many other sections of the population down the hill.

Abiy’s inflationary theorisation has dumped serious contributors to the inflationary build-up that is pushing urban dwellers, wage earners, rural poor, pensioners, and many other sections of the population down the hill.

The topmost factor is depreciation of Birr against major currencies. Abiy’s wholesale buying of IMF policies and written commitment to progressively float the local currency remains the major culprit that led to significant price build-up. There are two points to note here. First is the fact that Ethiopia is an import-dependent country. Its import bill is eight-fold of its export earnings. What is even more astonishing is the fact that import continues to rapidly increase while export remained stagnant over the last 14 years. It is obvious that under such a structural situation, currency depreciation will translate into price increment as depreciation entails higher import prices.

Second is the fact that the current depreciation, unlike previous regimes, has been fast and incessant. Over the last three years, Birr has gone down from $1:23Br to $1:45Br in official markets. This seems to be the fastest ever weakening of the local currency.

Yet another seemingly inferior but important factor is the issuance of a 200 Birr note. Higher denominations often regularize inflationary perception. Markets peg prices to higher denominations and hence lead to further price build-up. This is exactly what happened with the latest demonetization. Lower value denominations, such as 5 ETB, are slowly losing value as prices crawl up and stick to higher denominations. Economic activities, such as street side car parking, are now denominated in 10 ETB rather than 5 ETB. It may be true that the demonetization has helped bring cash back to the banks, but it is obvious that the 200 Br denomination fed the inflationary pressure.

Restrictive withdrawal limit and complete banning of cash transfers has slowed down business transactions.

Related to the demonisation is the series of restrictive banking rules that the NBE issued in the past two years. Restrictive withdrawal limit and complete banning of cash transfers has slowed down business transactions. It reduces business activity between Addis Abeba, Ethiopia’s economic capital, and regional cities and towns. This further complicated agriculture and other merchandise trading. It is puzzling why Ethiopian policymakers often associate cash transactions with backwardness. There actually is enough evidence that an economy can be developed, and cash based. An example is Germany. Although Germany is largely cash-based, it remains a sophisticated and a net exporting economy with an upbeat industrial base.

Hence, that paradigm of associating cash with backwardness and crimes is unproven. More so when such thoughts lead to laws that push the business cycle downhill. Yet another important factor that Abiy ditched in his inflationary analysis is government consumption. Although he noted that his next government (he seems to be sure about his electoral win) will have ministers driving their own car and travelling without their extended security details, the actual practice and the precedent he himself has set is one of conspicuous consumption and luxury.

It has become normal to see government agencies spending millions to refurbish their offices, in the name of “ergonomics”. What is even worse is the fact that most of these refurbishing works are overpriced and awarded without proper bidding. So much is being spent on something that does not add value to the economy. The fact that such short-term investments feed into the inflationary cycle seems to be missed from the minds of the policymakers.

Furthering the problem is the type of investments that Abiy’s government takes as priorities. Parks, recreational facilities, and museums do not add productive capacity to the real economy. If anything, what they do is instigate more consumption and spending. The type of jobs these investments create are also low-paying and low-skill ones, adding little to the competitiveness of the economy.

It is puzzling to see officials bragging about these short-cycle investments as great achievements, while they run an economy deprived of serious investments in key sectors, such as energy, logistics, finance, and agriculture.

The 28 Billion  ETB supplementary budget that was approved in April 2021 shows that direct advance has increased after the conflict.

True, the government has reduced direct financing of the budget deficit. Establishment of a competitive treasury bill market was a very wise decision. However, the deficit build-up following the Tigray conflict seems to have pushed the government back to its default state. The 28 Billion  ETB supplementary budget that was approved in April 2021 shows that direct advance has increased after the conflict. The IMF’s projection is that the conflict has driven the budget deficit to 3.3% of GDP, higher than the long standing 3% threshold.

Abiy’s firm line on corruption indicates that he may soon go tough on corrupt officials. Yet, this will not drain the inflationary impact of corruption unless it is followed with serious systemic instruments and checks.

Corruption has gone systemic. It has become impossible to get public services without paying bribes. This has produced public servants living a life way beyond their means. The chain of brokers that have attached themselves to the public sector has made life unbearable for normal people. At the same time, these chains increase the cost of doing business and hence contribute to the significant build-up of prices in the market.

This speculative structure is so powerful that it swings prices like crazy. Anyone who follows the real estate market in Addis Abeba can easily get what that means. No economic logic could describe the volatility in the real estate market in Addis except the collusion of corrupt officials and the chain of brokers under their guardianship.

The chain is so inhuman that it even gambles with the lives of people. Brokers and their collaborators smuggle medicine from the public health system and sell it in underground markets, and channel publicly imported edible oil to Merkato. Sitting at the top of these chains are officials who pretend to be “reformers”.

Any analysis of inflationary pressure in Ethiopia cannot be full without looking at the impact of conflict on prices. In his parliamentary address, Abiy deliberately downplayed the impact of conflict on inflation. Yet, his line that the government has invested 100 billion ETB in Tigray tells history.

Beyond disrupting production and supply chains, the conflicts in the country, be it the all-out war in Tigray or localized conflicts in Benishangul Gumuz, Oromia, Somali and Amhara regions involve huge spending in military mobilization. No doubt this will put pressure on the federal budget, pushing it to use tools, such as direct central bank advances, that are inherently inflationary. Besides, feeding IDPs and resettling people consume huge resources. And these compete with other priorities in the fiscal space. No doubt conflict also creates uncertainty, affecting production and consumption patterns.

It, therefore, is easy to see that the conflict cycles the country finds itself in bring considerable inflationary pressure in the economy through both direct and indirect channels. Hence, managing the conflicts is crucial to fight inflation.

Who Gets Hurt

Although Abiy said little about who is being hurt by the inflation, possibly so as to avoid political backlash, he indirectly has indicated that the urban poor is suffering the most. His line about fuel subsidies and the need to review who is benefiting from the subsidy indicates that he believes the poor are suffering the most. 

Although Abiy said little about who is being hurt by the inflation, possibly so as to avoid political backlash, he indirectly has indicated that the urban poor is suffering the most.

Price build-up often affects people with fixed income and those unable to hedge the risk through other means. Under Ethiopia’s current reality, this entails the 27 million people living under absolute poverty, the 1.4 million public servants, the 350,000 pensioners, the 17% people working in the informal sector and the 20 million unemployed working age population. Notable additions to this mix are the 8 million people living under the PSNP and the 1.8 million IDPs.

This, however, does not mean that middle incomers and the rich are saved. It is only that they, at least, have the means to buffer themselves from the challenge. Not so with the above mentioned sections of the population. 

Much as Abiy and his officials tout about prosperity, their real assignment in bringing inclusive economic growth will hugely depend on their success in fighting inflation. Demonising past economic models cannot take them any further. With whatever amount of electoral legitimacy they are set to get will come the responsibility of creating economic opportunities for the massive poor and vulnerable population of the country. 

What are the Solutions?

Abiy’s statement that it will be hard to drain out inflation is unwise. The state has multiple instruments to contain inflation. It can usher it into the economy or drain it out as it wishes. Of course, attending the structural constraints of the economy may take time. But that is not all about fighting inflation.

Abiy was on point on issues of land consolidation, low land wheat farming, importing of consumables, new financing windows for the private sector and stringent regulation. But most of these are long-term shots. 

I believe slowing down the depreciation of Birr and postponing its floating is an immediate step that Abiy’s government should take. One cannot have the cake and eat it too. Reviewing the public investment framework away from short-cycle investments to investments that add value to the productive capacity of the real economy will also be important. It will be very difficult to fight inflation under a spending paradigm driven by consumption and luxury.

It will be very difficult to fight inflation under a spending paradigm driven by consumption and luxury.

To his credit, Abiy was successful in easing financial repression. However, restrictive monetary policy measures that hinder business transactions and increase cost of doing business need to be reviewed. The National Bank of Ethiopia (NBE) should be pushed to find other ways to fight crime and malpractices.

Abiy’s pride in increasing credit to the private sector can only be sustained if the much-talked credit is put into productive sectors. Current practice shows that the case is far from that and hence a need for closer scrutiny of credit approval within banks.

Managing the many conflicts in the country and ensuring the rule of law will have huge positive externality to the fight against inflation. Reinstituting production and supply chains will not be possible under a conflict dynamic that continues to wreak havoc to livelihoods.

Closely aligned with conflict management is attendance of the weak fiscal stance worsened by costs of military mobilization. Looking at the economic costs of ongoing conflicts and analyzing foregone benefits may help in bringing some sanity to the prevalent political madness. 

The fight against corruption cannot be separated from this whole matrix. Abiy needs to take serious measures on his corrupt officials and their chain of brokers if he is to stabilize the economy. It is indeed hard to ease price build-up while hot money obtained through corruption scrambles to find the next portfolio of opportunistic return. 

At policy level, it is time to anchor fiscal and monetary policy on inflation. We seem to have reached a point where fighting inflation is decisive enough for the political and economic stability of the country.

Understanding its urgency and facing the real causes is the only way out. This is not time for theorisation and scapegoating. It rather is one of action and boldness. AS

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Editor’s Note: Addis Standard withheld the identity of the author upon request.