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Whilst the US economy teeters on the
brink of a recession and many European economies are
besieged by colossal public debt, several emerging
and a few developing economies continue to enjoy
robust growth.
Similar to other rapidly growing
economies, the Ethiopian economy carries on to
register vigorous Gross Domestic Product (GDP)
growth. Although the growth performance remains
exhilarating, the country’s economy remains in the
grip of double digit inflation, currently standing
at 40.1pc.
Apparently, the runaway inflation,
together with the high inflation expectation, has
become a serious predicament to the administration.
Indeed, in early 2011, the country was able to
achieve single digit inflation, leading everyone to
believe that this nemesis was overcome.
Nevertheless, the inflation has once
again resurfaced with a vengeance. The whole
situation is reminiscent of a family that expressed
gratitude for the survival of their home from a
powerful hurricane but failed to prepare for more
storms to come.
Inflation is an inevitable byproduct
of economic growth, just like the increased exhaust
emitted from a speedy car as it accelerates. As
economies grow faster, it is inevitable for their
engines to overheat.
The Ethiopian government has taken
several policy and administrative measures to cool
down the economy and keep a lid on the inflationary
pressure. Despite these measures, inflation has
refused to go away; its pressure has not yet been
abated.
During his annual state of the union
speech, President Girma Woldegiorgis indicated that
fighting inflation will be the chief concern of the
government in the 2011/12 fiscal year. He has vowed
that the government will do everything possible to
bring down inflation to a single digit soon.
Yet, whether it is possible to
attain single digit inflation and there is a
framework in place to attain it, it remains
uncertain.
With inflation hovering and
expectations remaining high, obtaining an easy
answer to such a million dollar question is
unimaginable.
Indeed, inflation provides an
important insight on the state of the economy and
the policies that govern it. Stable inflation
provides impetus for economic growth. There is no
doubt that stable prices are good for healthy
economic growth.
There is no economic theory that
states that an inflation rate of five per cent is
better than one of 15pc. It is the structure of the
economy that determines the threshold of healthy
inflation.
Ethiopia has a chronically supply
constrained economy with excess demand. Increasing
government investment in infrastructure, rapidly
growing private consumption, influx of foreign
capital, and remittances have all exacerbated demand
that outsprints supply at a haggle speed. Much of
the resulting growth is gulled by real estate
investment and property market.
Ethiopia's economy lacks financial
depth and highly liquid marketable financial
instruments. Domestic investment tends to get
channeled into non-productive sectors over
productive ones, which could have helped in
correcting the imbalance between demand and supply.
In a situation where there is a dearth of savings
instruments to which people can turn, prices for
consumer products tend to rise, creating ground for
an inflationary spiral.
Addressing the demand and supply
imbalance and spurring long-term growth requires
vigorous infrastructure investment.
Infrastructure is a capital stock
that provides public goods and services. It creates
an environment for productive activities and allows
wider movement of goods and people. It helps to
commercialize and diversify the economy. Squeezing
infrastructure spending to curb inflation does more
harm than good to the economy.
Correcting the rise in food prices
will also require structural changes in food
production. This, on the other hand, requires
increasing agricultural activities. Until meaningful
and radical output increasing measures have taken
root, it is hardly possible to head off inflationary
expectations.
In the face of a chronic structural
bottleneck and the need for increasing
infrastructural investment activities, a single
digit inflation target is neither attainable nor
desirable. Curbing inflation must walk hand in hand
with growth, as neither can walk alone to a useful
end.
Instead of burdening itself with the
task of achieving single digit inflation in a short
span of time, the government would rather opt for
moderate inflation ranging between 10pc and 15pc
until the gap between demand and supply closes.
There is no way to escape economic
overheating the best possible approach; would be to
pursue a path that gradually takes the economy from
an overheated to a sustainable growth track.
Quite a number of people argue that
the goal of achieving single digit inflation is an
obligation imposed by the International Monetary
Fund (IMF). Unless the country obeys this rule,
access to Balance of Payments (BoP) support will be
denied.
However, the IMF’s article of
agreement IV notes, “each member shall endeavor to
direct its economic and financial policies towards
the objective of fostering orderly economic growth
with reasonable price stability, with due regard to
its circumstances.”
The preamble expects monetary policy
tools to simultaneously attain reasonable price
targets and orderly growth. It does not specify
quantitative targets.
There is no presumption of the
suitability of a single digit target that is
universally applicable as country specific
circumstances are equally important.
A nation can endure moderate
inflation rate in the medium term without destroying
its long-term economic prospects. Japan, for
instance, experienced high to moderate inflation for
several years after World War II. Yet, it liberated
itself from that pain and went on to become an
economic juggernaut for many decades. Similarly,
inflation plagued Brazil during the early 1990s, but
it is one of the strongest emerging economies today.
The Ethiopian government has taken a
litany of measures in the past to tame inflation and
bring it to a single digit level, including
increasing the reserve ratio, capping credit,
increasing interest rate on deposit, and a price
cap. Despite all the available monetary policy and
market intervention measures, inflation has refused
to release its grip in the economy.
Although fighter monetary policy
would help to anchor expectations and help commodity
price spreading in to the wider economy, it alone is
not sufficient to completely stop the runaway
inflation as long as demand continues to outpace
supply. Economic stability and achieving acceptable,
moderate inflation is a continuous challenge that
demands comprehensive approach. The fight
necessitates holistic and calibrated policy action.
Solid and coherent monetary, fiscal,
exchange rate, trade and market intervention
mechanisms are required to arrest inflation to a
single digit level. Doing so is time consuming and
requires patience.
What policymakers are advised to do
is develop the ability to detect inflation and other
macroeconomic instability situations. These, in
turn, will entail putting in place and continually
updating state of the art methodologies and tools
for measuring, forecasting and analyzing price
movements and other sources of macroeconomic
instability. Apart from instituting a robust
monetary policy, policymakers should also revamp
existing institutions and help them build flexible
and effective capabilities. It is also essential to
create more effective sterilization mechanisms and
more productive economic bases to channel and
observe financial resources.
Above all, the best shield against a
rampant inflation is to address the structural flaws
of the economy and persistently tackle the imbalance
between aggregate demand and supply. While the
administration has so far managed to steady the
growth, the next step is to increase potential
growth and close the output gap.
Until the economy gradually moves
from overheated to sustained growth, targeting a
moderate and acceptable inflation is better than an
unattainable single digit inflation level. Running
a country after all is about making choices, and
each choice has a price. The price one is prepared
to pay determines the choice and the course one
wants to follow. The public too should understand
that moderate inflation is a price to be paid to
achieve sustainable and long-term growth. |
