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The measures deriving the sharp fall of inflation in Ethiopia

The measures deriving the sharp fall of inflation in Ethiopia

Berket Gebru 08-05-16

Reports this week cite the Central Statistics Authority as saying that Ethiopia's year-on-year inflation dropped to 6.0 percent in July from 7.5 percent the previous month, thanks to a drop in food prices. It said year-on-year food inflation slid to 4.1 percent in July from 7.2 percent in June and 8.9 percent the previous month.

That shows the efficacy of the approach used by the Ethiopian government to get the figures for inflation down over the years. From staggeringly huge numbers that nearly hit 40 percent, the figures have slowly but surely went down to 6 percent. That is a tremendous achievement. Accordingly, this article deals with the measures the government has been taking to control inflation.

The definition for consumer price inflation states, all things being equal, inflation is a phenomenon where the demand for goods and services could not be met by the current level of supply in the market. Accordingly, the solutions to the problem emanate from both the demand and supply sides. Policy responses of the government for the problem had been mainly addressing the supply side issues. To a limited extent, the response has also focused on breaking bad consumer expectation about the future of inflation in the economy.

Broadly speaking, tight monetary and fiscal policy stances coupled with supply of some of the basic consumables to buyers were the core of the disinflation policy. From the get go, sharp critics of the government's macroeconomic management, the likes of the International Monetary Fund (IMF), were unhappy about its overstretched expenditure plans. In fact, it was not only the question of high and persistent inflation that bothered such critics but the possibility of such massive government expenditure to end up crowding out the private sector was another point of discomfort.

Anyways, fiscal side policies as well are known to have bigger roles to play in bring inflation down to a desired level. Simply put, inflation is nothing but excess purchasing power chasing fewer goods in the market place. On the other hand, as the government expands its investment portfolio, large amount of cash will enter the economy in the form of investment spending. Hence in the short run, government spending will reach the hands of the consumers in the form of employment benefit or payment for other transactions. Given the nature of output production and supply in a market like Ethiopia's, which grows much slower than its demand counterpart, the additional spending of the government could be a cause for short term inflationary phenomenon. Adding the very nature of government expenditure in Ethiopia, which is primarily focused on infrastructure and other huge investment ventures with long term return to this equation would further reinforce the suspicions of the government spending fueling inflation in Ethiopia. As it stands at the moment, Ethiopia is among the leading countries in the continent in terms of allocating large capital budget and huge chunk of this to pro-poor investment expenditures. As far as the authorities are concerned, most of the spending on the government menu are investments that the country can not go without; but a relatively well disciplined and managed expenditure might reduce the potential pressure on the price of consumer commodities, they admit. To this effect, the government can be said to have taken a great leap during the past two years.

First and for most, while the late Pirme Minister Meles Zenawi was still in office, the government passed the decision to keep the level of its budget deficit well below the 3-percent-of-the-GDP ceiling. This decision also enabled the treasury to manage its expenditure on its own throughout the year. It also completely discontinued direct withdrawal from the central bank, which is termed as printing money by the industry professionals. According to experts, direct withdrawal is the worst form of deficit financing there is, since it is said to have almost a one-to-one relationship to the rate of inflation.

It does not stop there. In fact the government has shown its seriousness regarding its target of single-digit inflation by exercising fiscal discipline over the past year or so. This included turning away additional, supplement budget requests from its various ministries and agencies. As a matter of fact, the seriousness of the commitment it has made is reflected on its adoption of new budget planning format. It is called program budgeting, and it allots money based on specific programs instead of pouring funds to agencies and ministries letting them spend as they see fit.     

On the monetary side as well, the central bank, a body entrusted with the power to control monetary policy in the country, has made some firm commitments and is sticking to them. Among other things, the bank has implemented a firmly tight monetary stance since last year. Up on the recommendation of the IMF, the bank adopted quantitative anchor to gauge the growth of broad money supply. The system is said to be useful to keep the money supply in very short leash and eliminate the potential pressure it might exert on consumer prices in the market.

Apart from that, the bank also used its various monetary policy instruments to check money supply growth: commercial bank reserve requirements and interest rate adjustments are the major ones. Commercial bank reserve requirements are frequently used monetary instruments in Ethiopia, and it could increase or decrease the requirement levels depending on what it is planning to achieve. As an integral part of the country’s financial system, the level of financial leverage that banks do have at their disposal has direct effect on inflation. For instance, if the reserve requirements are relatively more relaxed, it means that commercial banks do have ample financial resources at their disposal and that they can disburse large amount of loans to their customers; increasing the amount of money in the system.

On the other hand, exchange rate is also another monetary policy instrument which is controlled by the central banks of Ethiopia. In this regard as well, the bank has taken some strong measures to keep spillover effect of the exchange rate dynamics from affecting local price levels. In reference to the situation briefly mentioned above, where the country's trade balance improvement had led to high foreign exchange reserve and money supply, central bank's quick measure to sterilize the domestic market from this effect is among the list of policies which are bringing disinflation at this time. The late PM Meles, while explaining the scenario to the parliament, said that due to the sudden favorable conditions, the unexpected build up of the foreign exchange reserve of the country also had a down side from the vantage point of controlling inflation. He said, as the reserve starts accumulating, an equivalent amount of local currency will also be entering the circulation putting high pressure on prices. This, he explained, should be treated immediately by sterilizing the effect.

With such measures taken bearing down on the economy, the country has managed to force the one time high flying inflation plummet back to earth. Keeping up the trend could lead to the inflation figures of less than five percent recently further cementing the government’s control of inflation in the economy.

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