Is The Ethiopian Birr Overvalued? A Sober Assessment

Abstract

The objective of this paper is to assess whether the Ethiopian Birr is
overvalued? If so, to what extent? And what are the policy options, if any, that
should be followed under such circumstances? To do this an annual data from
1984 to 2013 is gathered and an Autoregressive Distributed Lag (ARDL)
model is estimated in the context of bounds testing. Appropriate data
diagnostics pre-and-post estimation tests are conducted to ensure result
robustness, validation and tracking performance of results. The estimated
model shows that the Ethiopian Birr is slightly overvalued as indicated by the
spread between the nominal and the parallel exchange rates but importantly
between the actual and the estimated (equilibrium) real exchange rates. The
magnitude of the overvaluation is marginal (except the year when the domestic
inflation was at its peak).
The most sober policy conclusion the authors reached is that devaluing the
currency at the moment seems neither necessary nor useful as it is unlikely to
improve the internal and external (trade) balances of the country. This
conclusion is based on the following: first, the spread between the actual and
the equilibrium exchange rates is minimal; second, our calculation shows that
the response of Ethiopian exports and imports to a change in exchange rate is
very low or inelastic; and, third, a minor spread does not necessarily call for a
devaluation to improve internal and external balance in economies like that of
Ethiopia; and fourth, given the pervasive information asymmetries, the net
benefit of fine-tuning the exchange rate to correct minor spread is uncertain in
economies that are in transition.