BAHIR DAR UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS
Impacts of exchange rate on export earning of
Ethiopia
Prepared by :
1, Befkadu shumet
2, Behailu Assefa
3,Belay Beyene

Submitted to instr. Surafel Melak

May, 2004 EC
Bahir Dar,
Ethiopia
 Executive summary
This study is conducted to give clear understanding on arguments between that exchange
rate variation has significant effect on the export earning of Ethiopia or not. The study has
discussed questions that whether the export sector of Ethiopia is promising or not, and does
exchange rate matter on the country’s export sector. To briefly investigate these questions,
the study has employed a forty years observation of sample periods to analyze the time
series data using OLS Econometrics estimation techniques. And the study justifies that
exchange rate variation has no significant effect on the country’s export sector. Moreover,
though the country’s competitiveness has decreased as the time goes, the export earning
has improved from time to time and possible to say the export of the country is promising
due to the contribution of other factors other than exchange rate variation.

Acknowledgment
First and for most, we would like to thank God for being with us
in completion of this study. We also express our heartfelt
gratitude to our adviser, instructor, Surafel Melak, Dean of
Business and Economics College at Bahir Dar University,
devoting his golden time for us from the beginning up to the
end.
Finally, we say thanks all who supported us by providing the
required data, and by giving us their constructive suggestions
and advice in doing this research. Our appreciation to all is
great!

Table of Contents
ACKNOWLEDGMENT ………………………………………………

ACRONYMS ………………………………………………………………

1. INTRODUCTION……………………………………………………………….

1.1 Background of the study……………………………………………………………….

1.2 Statement of the problem……………………………………………………………

1.3 Objectives, significance, and scope of the study………………………………………..

1.3.1 General objective ……………………………………………………………………

1.3.2 Specific objectives…………………………………………………………………….

1.4 Limitation of the study…………………………………………………………………...

1.5 Frame work of the study …………………………………………………………………

1.6 Methodology…………………………………………………………………………….

1.6.1 Type and source of data……………………………………………………………….

1.6.2 Model specification and data analysis………………………………………………….

1.6.2.1 Model specification…………………………………………………………..

1.6.2.2 Data analysis…………………………………………………………………….

2. LITERATURE REVIEW……………………………………………………………………

2.1 Theoretical Review…………………………………………………………………..

2.2 Empirical Review……………………………………………………………………..

3. METHODOLOGY………………………………………………………………………
3.1 Model Specification……………………………………………………………………….
3.2 Econometric Tests………………………………………………………………………

4. ANALYSIS OF DATA……………………………………………………………………
4.1 Descriptive analysis………………………………………………………………..
4.2 Empirical analysis…………………………………………………………………….

5. CONCLUSION AND RECOMMENDATION……………………………………………

5.1 Conclusion……………………………………………………………………………..
5.2 Recommendation………………………………………………………………………...
 Acronyms
BOP: Balance of Payment
IMF: International Monetary Fund
MOFED: Ministry Of Finance and Economic Development
NBE: National Bank of Ethiopia
OLS: ordinary least square
SAP: Structural Adjustment Program
WB: World Bank
 Chapter one
1 Introduction
1.1. Background of the study

A ccording to the law of comparative advantage, if one nation has

comparative advantage on a certain goods and services with respect to other
countries in production of two commodities, there is a mutual benefit through
export of commodities which are comparatively advantageous and import of
commodities of comparatively disadvantageous. This creates trading among
nations (Manuer, 1995).

International trade does not carried out using a single currency just like what
is done in domestic trade, because international trade is conducted at least
between two nations. This mismatch in currency needs to consider price of
one’s currency in terms of other’s currencies what we call it the concept
exchange rate, which is used to compare the price of one country’s currency
with other’s currency. (Salvator, 1990).

Even though exchange rate is not the only means for the price at which
different countries currency units are exchanged, its valuation plays an
important role for the export of a nation. Assuming other things remaining
constant, the change in exchange rate has pro and cons on the export sector
and in turn, it affects the economic growth of a certain country. (Mankiw,
2004)

When a country’s currency appreciates or rises in value, the country’s goods

abroad become more expensive and foreign goods in that country become
cheaper holding the domestic prices in the two countries constant. Conversely,
when a country’s currency depreciates relative to other currencies, its goods
abroad become cheaper and foreign goods in that country become more
expensive. (Mishkin, 2004)

Since Ethiopia has become more open and one participant of international
trade, its currency has been expressed in terms of other nation’s currency and
the country’s export was affected by the valuation of exchange rate from time to
time. This in turn affects its economic growth as well.

Though there is a decline in net export from the experience of the past few
years due to high increment in import trade component, other things
remaining constant, Ethiopia’s export has shown an increase due to the
devaluation of its currency, it would be worse too much for its export and
further for its economic growth.(Befkadu and Berhanu, 1999/2000)

The year 1992 was a very important period in Ethiopia that has shown a
deliberate exchange rate variation to promote the country’s export sector. This
increase in exchange rate is still continuing. One dollar was exchanged by birr
2.07 before 1991 E.C. and again in 1983 E.C the transitional government
devalued the exchange rate of birr from 2.07 per dollar to birr 5 per dollar.
This value of birr has also decreased to birr 8.85 in 1993 further. Then
currently 17 birr is required to get one American’s dollar. (Befkadu&Berhanu,
1999/2000)

1.2. Statement of the problem

Since 1970’s after the collapse of Bretton wood system, Ethiopia was following
a fixed exchange rate system for the two consecutive decades, that means the
country has not used exchange rate variation as a major policy measure of
regulation to affect export volume and earnings, rather the country has been
used export diversification and tax abolition of export goods (except coffee).
But, after the devaluation of birr in 1997 due to the structural adjustment
program (SAP) that was supported and launched by WB and IMF, the
Ethiopian birr was devalued to increase the volume and earnings of export
sector and exchange rate began to float and managed by the government.
(Befkadu&Berhanu, 1999/2000)

Previously, two different studies have been conducted about Ethiopian export
sector and trade balance of the country. (Yamrot: Jemal, 2005). They have used
macro-economic time series data obtained form NBE. Variables such as real
GDP, real exchange rate, real private consumption, real world GDP, foreign
exchange availability, tariff and real private sector credits are used in the
analysis of both the above studies. Based on the findings of these studies, real
GDP, real private consumption, real exchange rate and foreign exchange
availability can significantly affect the export sector of Ethiopia.

However, these studies are not in-line with the current situations due to the
reason that the studies cover the time from 1991 to 2003 as a sample for the
other reason after this period; there is a huge variation in exchange rate.

In addition to this, coffee, which served as a major export item for a long period
of time, has to be used as an important variable to affect export of Ethiopia.

So, the present paper differs from the previous studies by the following
important unique features.
Firstly, it covers a longer sample period from 1971-2010,
Secondly, it includes world price of coffee as one important variable and will
look its effect on the export sector of Ethiopia.
Thirdly, this paper makes itself unique in looking the effect of the wide
variation of exchange rate on the export of Ethiopia after the previous studies
have been conducted.

1.3 Objective, significance and scope of the study

1.3.1 General objective
The general objective of the paper is to examine the impact of the change in
exchange rate on the export sector of Ethiopia.

1.3.2 Specific objective

This paper specifically focuses

-To identify the role at which exchange rate plays in the economy,
-To look at the trends of export earnings of the country.

To do so, the following research questions are derived.

i. Does exchange rate matter on the Ethiopian export sector?
ii. Is the Ethiopian export sector promising?
This particular paper will be very important in adding some information about
export of Ethiopia from the existing knowledge. In doing so, the findings of this
research will serve as a tool of information and also act as a positive brunt or
power in motivating other researchers to conduct further study in the area of
this paper or in other crucial economic studies.

The paper will bound itself to the assessment of the change in exchange rate
impact only on the export sector of Ethiopian economy. Hopping 40 years time
coverage is sufficient enough to assess the impact of exchange rate
determination on export of Ethiopia, the study to be analyzed extends from
1971 to 2010.

1.4 Limitation of the study

Even though the paper is completed timely, it does not mean that the study is free
from any limitations .The variation and luck of the required data from different
sources; in availability of sufficient enough time and finance all together have
resulted to the study to have less scrutiny. Hence, we advise other researchers to go
further by filling this gap.

1.5 Frame work of the study

This research paper will have the following frame works.
 Chapter one -------------- introduction
 Chapter two -------------- literature
 Chapter three ------------ methodology
 Chapter four ---------- analysis of data
 Chapter five ----------- conclusion and recommendation

1.6 Methodology
1.6.1 Type and source of data
For the purpose of analyzing this study, macroeconomic time series data will
be used. All the data will be obtained from different publications of annual
report of national bank of Ethiopia. This will include annual report of real GDP,
foreign exchange rate, the world price of coffee, domestic consumption and the
volume of export reported throughout the sample periods of the study.

1.6.2Model specification and Data analysis

1.6.2.1Model specification
For the investigation of this study, we use export as a dependent variable and
other five independent variables (GDP, REER, WPC, oppn and dcon) having the
following relationship in logarithm form i.e.

lnx=B0+B1lnrgdp+B2lnreer +B3lnwpc+B4lnoppn+B5 lndcon+ui where,

 X is export
 rgdp is gross domestic product (Real)
 reer is real effective exchange rate
 wpc is world price of coffee
 oppn is openness of the country and
 dcon is domestic consumption. While ui refers to the error term B o stands
for an intercept And B1, B2, B3, B4, B5 are the coefficient of the
explanatory variables.

Here one an easily observe that the functional specification is logarithmic since
it is a better way of expressing the change in the probability of export due to a
percentage change instead of one unit change in each explanatory variable.
 Real GDP: is a type of GDP which shows what would have happen
to expenditure on output if quantities had changed but price had
not. As domestic income increases, the export level of a certain
country rises.(Mankiw, 2004)
 Real exchange rate
It is the relative price of goods and services of one country to other countries.
As the value of a certain country's currency depreciates, the price of goods and
services are relatively low and residents in that country are willing to buy the
domestic product, while the domestic producers are not beneficial since their
products are cheap domestically. As a result they prefer to export their
products abroad where there is a relatively higher price. The vice-versa holds
true for appreciation. Hence, exports are encouraged and imports are
discouraged while the domestic currency began to depreciate.(Mankiw, 2004)

 World price of coffee: it is the price at which coffee is internationally

marketed other than the domestic market. As the domestic goods and
services become more expensive in the international market and become
cheaper domestically, local producers would be eager to sell their
products abroad since they have a better chance to be benefited
comparatively. Hence when world price of coffee rises export tends rise
(Salvator, 1990).
 Openness
Openness in trade refers to the degrees to which countries or economies
permit or have trade with other countries or economies. It is the most
basic measure of trade intensity. And it can be expressed as a ratio of
export plus import to GDP .When a certain country becomes more open
and open to the rest of the world, more export and import will be
expected relative to less opened nations.
(www.ins.fr/en/methods/default/asp )

 Domestic consumption
It is the municipality use of domestic products by domestic consumers. When
domestic demand for domestic products rise, selling in local market becomes
profitable than selling abroad and such pull of domestic demand erodes the
availability of goods and services for the world market ( Jemal, 2005). This
shows that when domestic consumption increases, export tends to decline.

So that based on the above descriptions, the explanatory variables are expected
to have the following sign.
Table expected sign of explanatory variables
Explanatory variable Expected sign
Real GDP Positive (+)
Real exchange rate Positive (+)
World price of coffee Positive (+)
Openness Positive(+)
Domestic consumption Negative (-)

1.6.2.2 Data analysis

Since the quantitative data that will be used in the analysis of the study are
time series and raw data, it will be a must to process to change them in to the
form that is suitable to coincide with econometrics model that will be used in
the analysis and the raw data will be changed in to a usable manner. The
whole or part of the processing will be assisted by SPSS-12 and other software
applications like STAT-11 version, plus this, econometrics model of ordinary
least square method (OLS) will be used.
 Chapter two

2 Literature reviews

2.1 Theoretical review

Does exchange rate variation determine the export earning?

The existence of exchange rate variation is important to balance (improve) the

given balance of payment deficit or usually surplus ( Salvatore, 1990),though
countries usually do not bother about their surplus, since it is usually not
difficult to live with. Exchange rate variation has played a major role in
determining the export earnings. The determination of exchange rate variation
on export earnings has been briefly described on the elasticity approach
(Manuer, 1995).

According to this approach the given BOP of a certain country can improve if
exchange rate variation has change the domestic demand for import elasticity
and foreign demand for export of that nation. This implies that a certain
country has devalue its currency to export more or to increase foreign demand
for exportable goods and services and to decrease domestic demand for
imports , but this might be diverted from the expectation. It may not show any
change in response to price change .At this time, devaluation causes a
decrease in export earnings and an increase of import expense which worsen
the trade balance account and the vice- versa holds true for over valuation.

Moreover, exchange rate variation may not bring any change in trade balance
account when a given variation has bring equal demand for domestic import
and demand for foreign export, though it bring good export earning only in one
perspective.

In addition as (Manuer, 1995) stated that the success of exchange rate

variation (devaluation) in improving trade balance depends up on the sum of
elasticeties of demand. That means the summation of elasticity of demand for
export and import in absolute term determine the profitability of policy
assuming supply of export and import of a nation is usually infinity elastic (at
least elastic). According to this condition, if the summation of elasticties of
demand for import and export of a certain country is more than unity,
devaluation would improve trade balance (increase export earning and decrease
import). At this time, it is better to take this exchange rate policy. It would
boost the country’s export earnings.

If the sum of elasticity of demand for import and export of a certain nation in
absolute term is less than one, better to give up to use devaluation policy
because it would worsen the trade balance deficit or deteriorates export earning
of a nation. Moreover, devaluating countries can increase export earning if a
country is in a position to have a larger exportable surplus and export capacity
otherwise exchange rate variation could bring insignificant change or leads to
an adverse effect on export earnings.

Another model called IS-LM (Mankiw, 2004) stated that exchange rate variation
of a certain country has changes the price of domestic good relative to foreign
goods and in turn affect the net export of that country. This leads to the IS-
curve to shift up ward /inward/.
This implies that when a certain nation depreciates its currency, the price of
that currency will lower the price of goods and services relative to foreign
goods. This increases export earnings of a nation. This incremental in export
earning leads to high output, income and employment opportunity to external
sector. This makes the IS-curve to shift out ward.

A change in exchange rate affects LM-curve to shift, i.e. when exchange rate
rises, it has an impact on the domestic money supply to rise, and in turn shift
interest rate down. So that it leads to depreciation of domestic currency which
enables to rise the nations export (Mishkin, 2004). This implies that an
increase in exchange rate brings further depreciation of the domestic currency
to the motive of rising export. This could be applicable until the IS and LM
curves equate each other.
Has export earning a quick response to the change in exchange rate?
Or can the change in exchange rate quickly affect export earnings?

When exchange rate of a country is devaluated then the price of its export will
fall and the price of imports rises. Initially, one might expect little to happen to
the amount of exports and imports demanded as consumers take time to
change their preference from import goods to domestically produced goods. In
addition, foreign consumers will take time to adjust from domestic goods to
foreign export. If this was the case, the BOP might be expected to worsen as the
value of exports would decrease and the value of imports would increase.

After a while, the situation improves as deficit gets smaller and then moves to
surplus. In the longer time period, once consumer preferences have adjusted to
the changes in import and export prices, then the amount of export and import
will change.
Generally, the response of export earning or effect of exchange rate an export
earning is explained by “J” curve effect.

Surplus
0 time
Deficit

Fig 1 j-curve effect

Does exchange rate variation have the same impact on all countries?

A Marshal learner (ML) condition stated that the supply of import and export is
infinitely elastic in export sector of a devaluating country and the elasticity of
demand for import and export should be greater than one in absolute term.
Countries which provide this condition are advisable to use devaluation policy
to affect its export earning via exchange rate. Countries which are governed by
this Marshall Learner condition have flexible supply of import and export
(Manuer, 1990). Flexible supply in a sense mean that imports and exports are
able to be changed easily when price changes. This fact is visible in countries
which broadly depend on industrial products for their export.

However, for countries which export agricultural products, the Marshall learner
condition is not applicable (Soni,1995), because those agricultural products
have inelastic supply curve. This is because of their nature of production
process involved in the occupation. Sowing, waiting and then harvesting or
collecting agricultural products require more or less rigid time schedule. This
makes world supply of agricultural products less sensitive to price changes.

Moreover, the devaluating country can promote its export if it is in a position to

increase export capacity. This implies that though exchange rate variation
(devaluating) has positive effect in promoting export, the devaluating country
must assess the capacity of producing that exportable goods and services
before taking any exchange rate policy measure.

In addition exchange rate variation can be a remedy for balancing the BOP if a
single country has take exchange rate policy measures among its trade
partners. Otherwise, the exchange rate variation (devaluation) has not any
effect in increasing export earning, and in turn, BOP balance. Plus this, even
though devaluation raise export earnings, countries which are highly indebted
are not advisable to devaluate its currency since devaluation make worsen its
foreign debt burden. (Manuer, 1995)

So that a change in exchange rate variation brings significant change or could

brining an effect if a nation exports industrial products, if a nation has lower
foreign debt and if it lonely devaluate its currency among its trade partners.
2.2 Empirical review

The aim of this section is to review empirical findings of the study on the
correlation between the real exchange rate and export sector.Yamrot (2005)
attempted to investigate the real effect of exchange rate on trade balance of
Ethiopia, using data source of NBE’s various annual report covering the
sample period starting from 1970 – 2001, with econometrics analysis of OLS
estimators.

The study has used variables like real GDP, tariff, foreign exchange rate
availability and real exchange rate as an explanatory variable to explain the
trade balance of the country. The study gave more emphasis to exchange rate
expecting the rise in exchange rate could increase exportability and decrease
its importable goods and services. Finally, Yamrot has found that real
exchange rate positively affects the trade balance, implying that when real
exchange rate rises, trade balance also increases by decreasing price of export
and it makes goods and services cheaper in foreign market.

The study which was carried out by Tadese (2005) tries to investigate the effect
of exchange rate on trade balance of Ethiopia before and after the reforms. He
has used nominal exchange rate, foreign export price and openness as
explanatory variable to explain trade balance of Ethiopia.

The finding of this paper is that nominal exchange rate is estimated to be 0.03
providing that exchange rate devaluation is slightly sensitive to the change in
export of a county.

Another research conducted by Jemal (2005) has shown the effect of

devaluation on export sector of Ethiopia by comparing the pre and post
devaluation periods. The study has covered a sample period running from 1970
to 2002. Explanatory variables like country’s real GDP, real private
consumption, real effective exchange rate and real private sector credit have
been used in the study to explain export earning of the county. After these
variables have been regressed using OLS econometric method, real exchange
(devaluation) has, in fact, increased export earnings as proposed in the
hypothesis.
According to Wondimunegn (nd), on “Ethiopia’s reform and export
performance”, he found that the change in exchange rate has little or no effect
on Ethiopia’s export sector. Using generalized method of moments estimator
econometrics technique, the findings of the coefficient on the real exchange
rate were positive (0.09) and statistically in significant. In this study only world
income was found to positively affect export performance of Ethiopia.

The study conducted by Rodrick (2009) for the World Bank report also shown
that real under devaluation has positive effect on economic growth and export
expansion, but this effect is significant only for developing countries with low
per capita income like Ethiopia.

The study conducted by Goldare (1989 ) has identified the determinants of

India's export performance with the relation to price competitiveness are
important determinants of export performance since the estimated coefficient of
this variable was positively and statistically significance (berhanu,2004).

A study conducted on “The output and inflationary impact of devaluation in

developing countries”, theoretical and empirical evidence from five African low
income countries ( namely, Ghana ,Kenya, Malawi, Senegal, and Zambia),
found that trade balance is not very responsive to real exchange rate
( fani,1994 in yamrot )

Generally, based on the above empirical evidences, real exchange rate has been
found positively significant in a research conducted by Yamrot (2005), Jemal
(2005) and Rodrick (2009). But, unfortunately, it is found to be slightly
significant to the change in export of Ethiopia based on the findings of Tadese
(2005) and Wondimunegn (nd). They showed a disparity in their findings.

In sum, the findings of those researchers have shown that reer (real effective
exchange rate) has positive impact on export sector coinciding to the
conventional theory of exchange rate. However, based on Marshal Learner
condition these studies imply that the country has elastic supply of import and
export. It is also meant that the country is exporting more industrial products
than agricultural products. However, these all issues are beyond the fact
observed in the soil of developing countries like Ethiopia.

And for those findings indicating real exchange rate has negative impact does
not fit with conventional theory of exchange rate. There is an implication that
the variation in exchange rate (devaluation) brings nothing to export earnings.
Also they have null impact in influencing the nation's income. It is this idea
which conflicts with the IS-curve.

In addition to this, all the above empirically reviewed literatures are conducted
a few years back from now, hence not recent. So, what will be the findings of
this recent particular paper?
 Chapter three

3 Methodology

In this study only time series, quantitative macro economic data are used.
These secondary data are its collected from the National Bank of Ethiopia’s
various annual report, from MOFED (Ministry of finance and economic
development), and from Ethiopian Economic Association bulletins. A forty year
observations a sample period sampling from 1990-2010 including the two
interior years has been used for the analysis of one explained and five other
explanatory variables.

The study used economic analysis of OLS estimators using stata- 11 software
to regress the explained variable over the explanatory variables.

3.1 Model specification

For the investigation of the data, export as a dependent variable and real GDP,
real effective exchange rate, world price of coffee, openness of Ethiopia and its
domestic consumption totally five independent variables are used. These
independent variables have the following relationship with dependant variable
in logarithmic form. i.e.,
Lnx=lnrgdp+lnreer+lnwpc+lnoppn+lndcon+ui
X= export
rgdp= the real gross domestic product
Reer= the real effective exchange rate
wpc= world price of coffee
Oppn= openness of the nation
dcon= domestic consumption
Ui= is the error term and when
Bo is an intercept, ß1, ß2, ß3, ß4, and ß5 stands for being coefficient of the
explanatory variables.
Real GDP: is a type of GDP which shows what would happened to expenditure
on output, it quantities had changed but price had not. As
mankiw(2004) were stated when domestic income increases the export
level of a certain country also rise.
 Real effective exchange rate: it is the exchange rate of a monetary zone
measured at the weighted sum of the exchange rates with trading
partners and competitor. The real effective exchange rate includes price
indices and trends.(www.insc.fr/en/methodology/default.asp?)
In mankiw, 2004, real exchange rate is also explained as the relative
price of goods and services of one country to the other countries. as the
value of a certain country currency depreciates the price of goods and
services are relative low and residents are willing to by the domestic
product while the domestic producers are not beneficial because their
products are cheap domestically. As a result they prefer to export their
goods and services abroad.

This is because the relative price of goods and services are relatively high in
abroad. Thus, exports are encouraged and imports are discouraged and the
vice versa holds true for the case of appreciation or over valuation of domestic
currency.

World price of coffee:- In Salvatore, 1990, world price of coffee is expressed as it

is the price in which coffee is marketed internationally other than the domestic
market. In this study FOB price is taken as world price of coffee. As domestic
goods and services become more expensive in the international market and
cheaper domestically, Domestic producers would become eager to sell their
products abroad since they have a better chance to be benefited comparatively.
Hence when world price of coffee rises, export also tends to rise.

Openness:- In trade it refers to the degrees in which countries or

economics permit or have a trade with other countries or economies. It is
the most basic method of trade intensity. Openness of country can be
expressed as the ratio of export plus import of the nation to it gross
domestic product. When a country becomes open and open again to the
rest of the world, more important and exports are expected or there would
be better flow of imports and exports.
Domestic Consumption is the municipality use of domestic products by
domestic consumers. When domestic demand for domestic products rise,
selling in local market become more profitable than selling abroad and,
such pull of domestic demand erodes the availability of exportable goods,
 and services for the world market.(Jemal, 2005). This shows that when
domestic consumption rise export tends to decline. The study has
operationally used consumption expenditure as domestic consumption.

We need to note from the above model that the very basic reason for
expressing the relationship between dependant and in dependant variables
in the form of logarithmic is simply to see the change in the elasticity. It is
to express what a unit change in the explanatory variables would bring
about an average change in the explained variable would bring about an
average change in the explained variable.
3.2 Econometrics tests
In order to assure the validity of the OLS estimation, checking the validity or
nature of time series data is very important. For this purpose stationary test
conducted. For valid estimations of OLS, the time series data itself has to be
stationary; otherwise, using OLS estimation technique with a non stationary
time series data would be senseless. Thus, to make sure that stationeries
condition has been fulfilled unit rout test is under taken.
Moreover, the study has employed diagnostic tests like multicollinearity test,
hetroskedasticity test and autocorrelation test to show the validity of the model
that the study used.
 Chapter four

4 Analysis of data
 4.1 Descriptive Analysis
Real effective exchange rate trends of Ethiopia
Exchange rate is not a recently introduced phenomenon in Ethiopia. It was about sixty years ago
that has been started while birr was used. Looking the trends of the exchange rate in pre and post
1991 is very crucial for better understanding of exchange rate trend in Ethiopia by using graph.

reer
400

350

300

250
Figure 2: real effective exchange rate trend

200
The pre 1991 real effective exchange rate
As it is observed from the above graph, the trends of real effective exchange rate starting from
1970 to 1990, the country’s competitiveness has improved; it range between 200-354. But, by
150
that time no devaluation has been taken rather overvaluation taken after Breton wood has been
started in 1971. Moreover, the competitiveness of the country has reached peak on that period
due100
to the reason that Derg has been under taken policy improvement from socialist to mixed
economy.

The50post 1991 real effective exchange rate

After EPRDF has taken power the country’s competitiveness has decreased though continuous
devaluation has taken place. The real effective exchange rate ranges from 99.79-150, and the real
0
effective exchange rate has decreased as the country has devalued its own currency from time to
0 5 10 15 20 25 30 35 40
time.
This may be because of the reason that its export is mainly agricultural products and the country
is one of the low income countries as identified in empirical findings.
Structure of Ethiopia export
Now a time, Ethiopia follows an open economy and engages in international trade with the rest
of the world. It passed many years with different types of governments as well as market
systems. The Haile Selassie’s export-led development strategies and the Derg regime’s import
substitution strategy were put their influence on the economy of the country.
The current government follows agricultural led development strategy (ADLI) and free market
system to improve country’s competitiveness in the world market.

As it can be seen clearly, Ethiopian export is dominated by agricultural products. Among this,
the most dominant merchandize export item is coffee. Its share to the total merchandize export
varies from time to time. For example, since 1998/99, there was the persistent decline of the
share of coffee in the total merchandize export though it was the major source of visible export
earnings of the country. In addition, its share to the total volume also declined through time, and
even there was a period that has been registered negative growth rate. This is due to other export
items such as hide and skins, oil seeds, pulse, flower, and other items increased their share in the
total volume and value of the national export.
Among these export items, flower and oil seeds have shown remarkable change in percentage
share of export.

The following table shows the percentage share of export items.

Particulrs 2005 2006 107% share 2007 200810 2009

106 108%shar 9% 110%
% e share share
share
Coffee 354.3 35. 424. 35. 524.5 35.8 375.9 26.0 520.3 26.4
4 2 8
Oilseeds 211.4 21. 187. 15. 218.8 14.9 356.1 24.6 358.5 17.9
1 4 8
Leather 75.0 7.5 89.6 7.6 99.2 6.8 75.3 5.2 56.4 2.8
and
 leather
products
Pulses 37.0 3.7 70.3 5.9 143.6 9.8 90.7 6.3 130.1 6.5
Meat and 18.5 1.9 15.5 1.3 20.9 1.4 26.6 1.8 340.0 1.7
meat
products
Fruits 13.5 1.3 16.2 1.4 12.8 0.9 12.1 0.8 31.5 1.6
and
vegetable
s
Live 27.6 2.8 36.8 3.1 40.9 2.8 52.7 3.6 90.7 4.5
animals
Chat 89.1 8.9 92.8 7.8 108.3 7.4 138.7 9.6 209.5 10.5

Gold 64.7 6.5 97.8 8.2 78.8 5.4 97.8 6.8 281.4 14.0

Flower 21.8 2.2 97.0 5.4 111.8 7.6 130.7 9.0 170.2 8.5

Others 87.8 8.8 63.6 7.7 106.3 7.2 91.3 6.3 112.5 5.6

Total 1000.3 100 91.8 1,4657 100.0 1,447. 100. 2,003. 100.
9 0 1 0
Table1፡ values of major export items source፡ Ethiopian revenue and
customs authority

From the above discussion, one can easily understood that Ethiopia’s export item is diversified
from time to time. Its export earnings increased through time even though its growth rate has
been fluctuated. This implies that an export earning of Ethiopia is still promising.

.
 exp
30000

25000

20000

Figure 3: Ethiopian export earnings trend

Moreover, as we can easily observe from the above graph, after 1991, the export earning has
15000
doubled itself, as the time goes on. And around the years 2003 the export earning was not
rewarding because of the political instability of a country related to election, but after that, it
shows an improvement in the export earning of the country.
10000

Nature and Trends of Export Earning

Export is one of the major source of foreign reserves in nations of the world. Exporting
different
5000 commodities to other nations is desirable, so that countries try to increase its
earnings through different techniques or instruments. i.e., export diversification, devaluation
of exchange rate, increasing the volume of exportable commodities etc. Since Ethiopia is a
nation which has a desire to boost its export earnings by improving the given sector. To
enhance0 this sector, Ethiopia has used different instrument such as diversification of its
0 5 10 15 20 25 30 35 40
export commodities other than traditional exportable commodities [ coffee, hide and skin ]
like that of horticulture, flower and oilseeds, etc.
In this study ,based on the information collected from a total of 40 years observation
[1970-2009], the export sector of country in somehow has positive trend, but there were
some periods that have shown a drastic fall, due to some historical events. For instance, the
export earnings of the country has fall down from 1062.2 to 937.5 in the period between
1990 and 1991. This is because of the political instability due to the conflict between Derg and
Ethiopian People Republic of Democratic Front [EPRDF].
And then after the new reform, the export earnings of the country have shown great improvement
up to the Ethio-Eriterean war. After that the sector has improved, though it falls down because of
internal political instability which is related to the 2005’s election. But after that export sector
has recovered and drastically changed in recent years.
This drastic change relates with many factors like consecutive growth of the economy, enhancing
capability of export commodities and diversification of exportable items. According to the
information collected, the real effective exchange rate which shows the competitiveness of a
certain nation due to the exchange rate variation has shown a fall from time to time, though the
export sector (earnings) increased. This means that the country’s exchange rate policy has
reduced the country’s capability to compete with foreigners, but there are other factors that offset
this effect and improving the earnings of the sector.
Some of the factors are real GDP, world price of coffee and domestic consumption. When we
look at their trend with the relationship of the export earnings, real GDP has increased from time
to time with almost a constant percentage change as the export earnings of the country has
increased. The real GDP as well as the export earning reach its peak in a recent year (2008 and
2009) due to the country has registered two digit number growth rate.

The openness of the country has also shown improvement, especially after the new reform
(1991) as the data testified. But, it has been fallen down in 2004, due to political instability in the
country. And after that it has shown great improvement up to now. This enables the country to
freely trade with other countries and can increase the export earnings. It has almost the same
trend with export earnings. (See the graph below)

oppn
0.6

0.5

0.4

0.3
Figure 4: openness of the economy

When we observe the trends of world price of coffee (the amount of money gained from export),
it has shown a better improvement though the rate of growth is not similar. (See Appendix 4)

As it is clearly observed from the data, domestic consumption was not stable throughout the
sample periods. It has reached on peak in 1999, the time when export also has fall down due to
the prevalence of drought and Ethio-Eriterean war. (See the graph below)

dcon
100
98
96
94
92
90 dcon
88
86
84
82
0 10 20 30 40 50

Figure 5: domestic consumption trend

4.2 Empirical Analysis

The study has been checked several tests like stationery, multicollinearity, autocorrelation and
hetroskedasticity. All the variables are stationed, there is weak relationship between the variables
and can be tolerated, no autocorrelation and hetroskedasticity problem has been solved by
robusting the variables so that the model becomes free from some defects. (See appendix 1, 2, 3,)
for autocorrelation, muticollinarity and stationary tests respectively.
An important question raised at the beginning of this study was whether the change in exchange
rate really affects the export earning of the country or not. Different empirical results have shown
different views. Some empirical finding indicated that the variation of exchange rate has no
effect on export earnings of the country. And some other results have found that the variation of
exchange rate has an effect. The finding of this paper looks like the following.
Variable Coefficients t-valve p-value
Cons 0.078 1.60 0.120
dlnwpc 0.233 2.98 1.005
dlnrgdp 0.680 2.14 0.040
dlndcon -3.749 -2.74 0.010
dlnoppn 0.710 1.49 0.147
dlnreer 0.122 0.13 0.899
R2 =0.5320 f(5,33)=14.88(0.0000)
Table 2: OLS estimation result

As we observe from the above table, all the explanatory variables of the model can explain the
explained variable by 53%. All the variables except openness and real effective exchange rate
are statically significant. As world price of coffee increased by 1%, the export earnings would
increase by 23% on average. This is due to the reason that coffee plays a dominant role in total
receipt of Ethiopia. Real GDP is also significant and as it is increased by1%, the export earnings
would rise by 6% on average. This is because as income of residents (producers) increased, the
capability of the producers to produce exportable commodities also rises and can produce as well
as export to foreign markets.
Domestic consumption also fits with the hypothesis proposed in the proposal. It negatively
affects export earnings. In contrary, this study proved that real effective exchange rate is
statically insignificant. This result coincides with low income countries such as Malawi, Ghana,
Zambia and Nigeria as stated in the empirical finding and also coincided with empirical study
conducted by wondimunegn (nd) and Tadese (2005).
The very basic reason for this may be because of the ineffectiveness of the Marshal Learner
condition in Ethiopia and perhaps because of the commitment of other partner countries to
devalue their own currency while Ethiopia devaluates its own.
 Chapter Five
5 Conclusion and recommendation
5.1 Conclusion
Ethiopia has shown that a visible spiracle of development among the most banana republic
nations. This is specially happening after the previous decades. In the sense of development it is
very important to upgrade all of the economic sectors of the nation. Export is one of the very
important economic sectors of Ethiopia which is predominantly lead by supply of agricultural
products.
The findings of this study have proved that around 53% of Ethiopia’s export sector is influenced
by economic variables of real GDP of the country, its world price of coffee, the real exchange
rate, the domestic consumption and its openness.
Except openness and real effective exchange rate, all the above macro economics variables can
significantly affect export sector of Ethiopia. This implies that the supply side matters more than
the demand side. So, the real effective exchange rate is ineffective to influence export earning of
Ethiopia.
 5.2 Recommendation
-This study recommends that the government or other policy designers should not stick with the
exchange rate variation for the motive of influencing export earnings of Ethiopia. To be effective
for this, the country has to transform its export items from agricultural to that of the industrial
products to go in line with the Marshal Learner condition.

-Exchange rate policy has employed to have large impact in overall economy, if the country’s
economy is developed. But here in Ethiopia, it has no effect since the country’s economy is not
developed. So it is advisable to critically look devaluation policy. Rather, the government has to
rapidly boost the growth of the country as it is observed in the previous years.

-The Ethiopian government has changed exchange rate variation for the last two decades to
increase the competiveness of the nation in the international market. But this study advises the
responsible body to revise again this exchange rate policy, since further devaluation would
worsen or exacerbates the existing inflation so that its impact would hurt domestic residents due
to high price of goods and services.

-Ethiopian producers [peasants] are less responsive to exchange rate policy changes and its
impacts. So that, producers are almost inelastic for the change in exchange rate. Plus this, their
land hold is constant and their product per annum is probably the same whatever the exchange
rate moves ups and downs for influencing them. So that devaluation policy becomes nonsense.
For the betterment of this, the government has to work hard in improving the technology and in
providing inputs for the agricultural sector to raise its productivity and via this to boost up export
earnings of the country.

Hence one must note that the export sector of Ethiopia is most influenced by the supply side
factors or variables like real GDP, domestic consumption and world price of coffee but not
mostly affected by the demand side variables like exchange rate policy.
APENDEX

Appendix -1 Test for autocorrelation

Estate ovtest

Ramsey reset test using powers of the fitted values of dlnexp

Ho= model has no omitted variables

F(3,30)=0.60
Prob > F =0.6200

Appendix-2 Test for multicollinearity

Estate vif

Variable Vif 1/ vif

dlnwpc 1.27 0.788495
ddlnoppn 1.25 0.798224
dlnreer 1.12 0.896484
dlndcon 1.09 0.915034
dlnrgdp 1.01 0.994572

Mean vif 1.15

Appendix -3 Test for stationary

Variables Test statistics (lags=0)

dlnexp -6.744
dlnwpc -11.557
dlnrgdp -5.426
dlncon -7.739
dlnoppn -5.995
dlnreer -7.891

Appendix 4 The raw data

year Exp wpc rgdp oppn reer dcon

1970 438 179.6 7567.9 0.181 240.63 87.5
1971 458.6 164.7 7804.5 0.187 217.92 86.3
1972 611 200.3 8015.3 0.201 220.69 84.7
1973 773.8 166.1 8194.8 0.224 241.75 83.5
1974 638.5 117.5 8287.3 0.233 215.3 90.1
1975 710.5 297.7 8343.4 0.224 239.24 90.8
1976 785 408.9 8428.7 0.236 263.48 93.2
1977 809.1 514.5 8381.2 0.253 274.68 96.1
1978 881.1 541.6 8583 0.245 259.65 94.4
1979 1130.4 631.8 9208.9 0.295 263.88 93.8
1980 1072.4 524.3 9324.5 0.272 258.51 92.4
1981 1007.2 480.3 9315.4 0.267 259.15 94.1
1982 1064.9 195.9 10253.8 0.248 278.41 94.5
1983 1164.9 590.4 9608.2 0.299 275.49 91.9
1984 1057.1 466.3 8676.9 0.241 328.36 97.2
1985 1217.7 664.8 9536 0.265 354.49 91.4
1986 1186.8 524.3 10874.8 0.244 287.99 92.4
1987 1205.4 439.2 10869 0.24 264.33 87.5
1988 1422.8 626.4 10906.1 0.235 248.24 91.6
1989 1295 405.1 11349.6 0.199 244.3 92.2
1990 1062.2 2668.5 10938.2 0.18 292.01 96.6
1991 937.5 168.3 10534.6 0.152 240.33 97
1992 2222.5 537 11798.8 0.252 314.69 94.4
1993 3223 718 11999.2 0.328 148.98 95
1994 4898.1 1799 12644.4 0.379 146.68 92.6
1995 4969.7 1724 13987.1 0.36 124.37 93
1996 6730.6 2307.4 14640.3 0.417 123.63 92.3
 1997 7116.9 2889.5 14429.1 0.411 123.22 92.3
1998 6878 2112.7 15294.1 0.429 141.55 97.9
1999 8017.6 2133.6 16112.3 0.45 113.22 99.1
2000 7981.5 1520.1 17354.4 0.445 105.91 97.4
2001 8027.4 1393.8 17632.2 0.495 113.02 98.2
2002 9778 1418.3 16941.5 0.524 108.85 97.7
2003 11611.8 1926.6 18909.9 0.533 103.07 92.2
2004 7329.8 2900.1 20131.8 0.35 100.69 92.9
2005 8683.5 3075.2 21494.8 0.355 99.79 93.1
2006 10422.3 3730.5 23002.1 0.359 108.48 93.3
2007 13549.1 4848.5 249036 0.359 112.56 93.6
2008 15088.1 3916.7 335380 0.364 113.99 93.9
2009 24638.1 6652.8 383364 0.369 148.26 94

The data used for regression

Year Lnexp lnwpc lnrgdp lndcon lnoppn Lnreer
1970 5.75067 5.19073 8.93167 4.47164 -1.70926 5.48326
1971 5.78044 5.10413 8.96246 4.45783 -1.67665 5.38413
1972 6.11678 5.29982 8.98911 4.43912 -1.60445 5.39676
1973 6.39493 5.11259 9.01126 4.42485 -1.49611 5.4879
1974 6.17003 4.76644 9.02248 4.50092 -1.45672 5.37203
1975 6.2899 5.69609 9.02923 4.50866 -1.49611 5.47747
1976 6.46583 6.01347 9.0394 4.53475 -1.44392 5.57398
1977 6.50832 6.2432 9.03375 4.56539 -1.37437 5.61561
1978 6.61325 6.29453 9.05754 4.54754 -1.4065 5.55934
1979 6.83583 6.44857 9.12793 4.54116 -1.22078 5.57549
1980 7.59035 6.26206 9.1404 4.52613 -1.30195 5.55493
1981 6.65686 6.17441 9.13942 4.54436 -1.32051 5.55741
1982 6.23363 5.2776 9.2354 4.5486 -1.39433 5.6291
1983 6.83475 6.3808 9.17037 4.5207 -1.20731 5.61855
1984 6.61285 6.14483 9.06842 4.57677 -1.42296 5.79411
1985 6.84875 6.49949 9.16283 4.51524 -1.32802 5.87068
1986 6.69679 6.26206 9.2942 4.52613 -1.41059 5.66293
1987 6.65105 6.08496 9.29367 4.47164 -1.42712 5.5772
1988 6.8055 6.43999 9.29708 4.51743 -1.44817 5.5144
1989 6.60232 6.00413 9.33694 4.52396 -1.61445 5.4984
1990 6.4239 7.88927 9.30002 4.57058 -1.7148 5.67679
1991 5.76331 5.12575 9.26242 4.57471 -1.88388 5.48201
1992 6.85541 6.286 9.37575 4.54754 -1.37833 5.75159
1993 7.25806 6.57647 9.3926 4.55388 -1.11474 5.00381
1994 7.94987 7.49499 9.44497 4.52829 -0.97022 4.98825
1995 7.86607 7.4524 9.54589 4.5326 -1.02165 4.82326
1996 8.26917 7.74388 9.59153 4.52504 -0.87467 4.81729
1997 8.32884 7.96884 9.577 4.52504 -0.88916 4.81397
1998 8.199 7.65572 9.63522 4.58395 -0.8463 4.95265
1999 8.28344 7.66557 9.68734 4.59613 -0.79851 4.72933
2000 8.26013 7.32653 9.7616 4.57883 -0.80968 4.66259
2001 8.25954 7.23979 9.77748 4.58701 -0.7032 4.72756
2002 8.32896 7.25721 9.73752 4.5819 -0.64626 4.68997
2003 8.55181 7.56351 9.84744 4.52396 -0.62923 4.63541
2004 8.8997 7.9725 9.91006 4.53152 -1.04982 4.61205
2005 9.06918 8.03113 9.97557 4.53367 -1.03564 4.60307
2006 9.2517 8.2243 10.0433 4.53582 -1.02443 4.68657
2007 9.51408 8.48642 12.4254 4.53903 -1.02443 4.72349
2008 9.62166 8.273 12.723 4.54223 -1.0106 4.73611
2009 10.1121 8.80279 12.8567 4.54329 -0.99696 4.99897
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