(Bloomberg) -- Ethiopia’s decision this week to float its currency unlocked more than $20 billion in financing from the World Bank and International Monetary Fund — money the government desperately needs to tackle the East African nation’s debt burden and open up the economy.
Ordinary citizens have begun bracing for the fallout — a surge in already high inflation in an economy that’s been struggling for years.
At the Merkato, the country’s main market in the capital, Addis Ababa, buyers hurried on Wednesday to purchase fast-disappearing items ranging from food to electronics
“If I wait any longer, the price could rise even more, so I decided to buy it today,” said Mohammed Yasin as he bought a television that cost almost 20% more than it did last week.
Ethiopia is the latest in a long line of countries that borrowed heavily during the low-rates era and have now been forced to enact painful reforms in order to unlock financing to address heavy debt burdens — in Ethiopia’s case, $64.3 billion. Those reforms have inevitably involved increased austerity and rising inflation — compounding hardship for some of the poorest people in the world.
“In the short-term, the economic pain will be acute, considering the negative pass-through impact of the currency devaluation on inflation as well as the potential increases in taxes aimed at driving revenue growth,” Omobola Adu at London-based BancTrust & Co. said in an emailed response to questions. “Communication and inclusive dialog with the public will be crucial to mitigate backlash.”
Prime Minister Abiy Ahmed secured the IMF funding after shifting to a market-determined exchange rate. The currency has slumped 23% since the measure was announced on Monday, sparking price growth for basic goods like cooking oil and the staple grain teff.
Annual inflation was almost 20% in June and the IMF forecasts it will average 30.1% in the fiscal year that ends in July 2025.
To alleviate the impact of the currency depreciation, Ethiopia’s IMF plan sees the government spending an extra 1.5% of gross domestic product in the first year on pro-poor programs and temporary subsidies for key imported goods like fuel and fertilizer. That suggests a softer stance from the Washington-based lender on subsidies, which it usually opposes.
Ethiopia’s “exchange-rate reform will lead to a one-off increase in prices for some imported commodities,” the IMF said in a statement announcing the deal on Monday. The nation’s central bank “may have to take further policy action by raising interest rates to ensure inflation quickly returns to a downward path,” it said.
The prospect of higher inflation is likely to weigh on Ethiopians, who are already facing the effects of adverse weather, brutal conflict and widespread unemployment.
“You can’t milk a cow that is starving — but that’s often what the IMF policies are trying to do, while offering just a bit of water in return. It’s unsustainable,” said Hannah Ryder, chief executive officer of Development Reimagined. “The ideas that come from it to ‘help’ weather debt walls not only hurt citizens, they are simply unworkable in African economies.”
Last month in neighboring Kenya, President William Ruto was forced to withdraw a controversial series of tax hikes after mass protests against the measures erupted across the country. The government is now scrambling to fill the fiscal hole in order to tap into IMF funding it needs to address its own $80 billion debt burden.
In Nigeria, President Bola Tinubu has introduced a series of IMF-endorsed reforms — partially floating the naira, curbing an expensive fuel subsidy and tightening monetary policy — that have thrilled investors. But he’s also facing the prospect of mass protests as Nigerians whose incomes have fallen grow increasingly fed up.
Liberalization Agenda
Abiy began rolling out his own liberalization agenda upon taking office in April 2018, allowing foreign capital into previously state-controlled industries from telecommunications to banking. But a deadly civil war broke out in November 2020 in the northern Tigray region, souring investor sentiment and sapping growth in what had been one of the fastest-growing economies in Africa.
In December, Ethiopia defaulted on its debts after failing to pay a $33 million coupon on a $1 billion eurobond that matures at the end of this year. Ethiopia needs an IMF program in order to renegotiate its debt under the Common Framework — the pandemic-era agreement to help poorer countries overhaul loans.
As part of the $3.4 billion IMF deal announced in Washington on Monday, Abiy needs to raise taxes to grow government revenue, sell state-owned firms and eliminate central bank funding of government spending. That agreement spurred the World Bank to pledge an additional $16.6 billion of funding to Ethiopia over the next three years.
Ethiopia’s deal boosts investor confidence, as it signals that Ethiopia will be undergoing reforms that will improve its economic trajectory, according to Bloomberg Economics’ Yvonne Mhango. The nation’s eurobond rallied almost 5% this week.
“The liberalization of its forex regime is an affirmative signal that we will see similar policy moves in other parts of the economy,” Mhango said.
A lot of commercial activity in Ethiopia already takes place at black market rates, suggesting that the inflationary impact may be more modest than expected, according to Connor Vasey, a managing consultant on Africa at London-based J.S. Held.
“As elsewhere, rising tax burdens amid an oppressive cost of living crisis will prove extremely unpopular,” Vasey said via phone. “There will be grassroots and political compromises to be made in Ethiopia.”
--With assistance from Matthew Hill.
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