VZCZCXRO6721
RR RUEHROV
DE RUEHDS #2983/01 2771417
ZNR UUUUU ZZH
R 041417Z OCT 07
FM AMEMBASSY ADDIS ABABA
TO RUEHC/SECSTATE WASHDC 8062
INFO RUCNIAD/IGAD COLLECTIVE
RUEHGV/USMISSION GENEVA 4036
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 ADDIS ABABA 002983 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON ETRD EINV EAGR ET
SUBJECT: ETHIOPIA: INFLATION AT RECORD LEVELS 
 
 
¶1. SUMMARY: Except during episodes of drought and macroeconomic 
shocks, Ethiopia historically has seen low rates of inflation. 
However, the recent rise in inflation, especially food inflation, 
during times of good agricultural output run counter to historic 
trends.  The Government of Ethiopia (GOE) has taken measures 
including instituting a surtax and raising civil service salaries to 
combat the effects of rising prices, but the effects are 
questionable.  END SUMMARY 
 
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UNUSUAL INFLATION 
----------------- 
 
¶2. Food items (mainly cereals) constitute over 60 percent of the 
weight in the computation of Ethiopia's Consumer Price Index (CPI). 
Historically, bumper crops lead to low inflation while droughts and 
other shocks that lead to reduced agricultural output raise grain 
prices and put pressure on inflation.  Thus, trends in the CPI 
largely depend on productivity in agriculture and its seasonality 
which is less controllable by fiscal and monetary policy stance. 
 
¶2. The CPI in the past two years was however in paradox to this 
historic trend.  Official statistics indicate that, on the average, 
agricultural value added grew annually by 14 percent in the past 
three years while annualized moving average CPI inflation rose 
steadily, reaching 18 percent in July 2007.  People on a fixed 
income bear the brunt of the inflation. In an effort to curb the 
rise on prices, the GOE has been trying to understand its causes and 
taking counter measures.   The GoE's principal policy responses 
include 1) levying a surtax and using the proceeds to purchase 
subsidized wheat for distribution to the urban poor and 2) raising 
salaries of civil servants.  The surtax appears to have been 
inconsequential as prices are still on the rise while the impact of 
the salary revision remains to be seen as it was implemented very 
recently. 
 
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POSSIBLE CAUSES OF THE PRICE ESCALATION 
--------------------------------------- 
 
¶3. Different explanations are given by the GOE, opposition parties, 
the IMF, and individuals for the steady rise in the inflation rate. 
The GOE argues that the prevailing inflation came about due to 
demand side pressures. According to the GOE, factors contributing to 
excess demand include an increase in farmers' income,  a shift in 
production by some farmers towards production of cash crops mainly 
for exports (thus shifting from producers to consumers of cereals 
and increasing demand), hoarding grains for speculation,, merchants 
expecting higher profit margins, the export of cereals, and an 
increase in the prices of imported commodities. 
 
¶4. Some institutions and individuals also focus on the demand side. 
They argue that GOE intervention in grain marketing, hoarding, 
reliability of the official growth statistics (particularly, 
agricultural value added data which are based on pre-harvest 
estimates and subject to biases), monetary expansions (especially 
massive investment in infrastructure) and government spending are 
some of the factors behind the pressure in aggregate demand. Still, 
some studies have suggested that inflation in Ethiopia is a supply 
side problem and the prevailing inflation is a result of 
expansionary output and price policy of the GOE that induces demand 
to trigger economic growth. 
 
-------------------------------- 
MEASURES TAKEN TO CURB INFLATION 
-------------------------------- 
 
¶5. An IMF mission that visited Ethiopia in February 2007 observed 
profound imbalances in the economy such as rising inflation; 
significantly high real negative interest rates. The mission advised 
the government to pursue demand dampening measures and growth 
enhancing structural reforms to ensure macroeconomic stability and 
sustain growth. 
 
¶6. The GOE has attempted to curb inflation in a piecemeal manner by 
banning exports of cereals, levying surtax on selected imported 
goods and using the proceeds to distribute subsidized wheat to low 
income urban dwellers, taking administrative measures on speculating 
merchants, making adjustments to interest rates and reserve 
requirement ratios of commercial banks, and increasing civil service 
salaries.  Assuming that the rise in the inflation was a result of 
cereal exports, the GOE banned exports of certain grains early in 
¶2006.  The National Bank of Ethiopia (central bank) raised the 
minimum deposit interest rate from 3 to 4 percent and the reserve 
requirement ratio of commercial banks from 5 to 10 percent in July 
¶2007.  The GOE also warns merchants against hoarding grains and 
speculating for higher prices. 
 
¶7. On April 11, the GOE imposed a 10 percent surtax on selected 
imported goods generate funds to stabilize the domestic grain price. 
 
ADDIS ABAB 00002983  002 OF 002 
 
 
 Essential imports such as fuel, fertilizers, medicine, trucks, 
passengers' buses and other investment goods are exempted from the 
surtax. Hence impacts of the tax on investment and the on low and 
medium income groups is assumed to be minimal, according to the 
Finance Ministry.  The GOE plans to collect billions of Birr from 
the surtax and use this money to subsidize grains to low income 
urban dwellers.  Some economists disagree with the GoE arguing that 
by increasing the cost of some imports, the surtax risks further 
feeding inflation. 
 
¶8. Additionally, the GoE recently increased salaries of civil 
servants.   The salary increment ranges from a minimum increase of 
17.5 percent for mid-level officials to 36.2 percent for high and 
low salary bands.  It also includes up to a 70 percent increase for 
medical doctors and university professors.  Similar adjustments will 
follow to employees of public enterprises.  The GoE also raised 
pension payments including a 60 percent increase from USD 11 to USD 
17.70 per month rise in the minimum pension. The total cost of the 
salary revision is estimated at $200 million per annum. 
 
¶9. Analysts see this as a nominal, cost of living, wage increase 
rather than a real wage improvement that should come as a result of 
the continuous structural transformation of the economy. They view 
the current salary adjustment will exacerbate the existing 
inflation, due to businesses raising prices.  Prices of some 
consumer goods have already gone up following announcement of the 
salary increase.  Analysts recommend that the GOE pursue its reform 
agenda in liberalizing and transforming the structure of the economy 
in the areas of finance and telecom and expanding its tax base from 
the current coverage of 13 percent of GDP to at least the African 
average of 29 percent. 
 
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RESULTS- SURTAX NOT HAVING 
DESIRED EFFECT; IMPACT OF 
SALARY INCREASE TO BE SEEN 
-------------------------- 
 
¶10. Despite various measures taken to abate rising prices, inflation 
remains a threat to the livelihoods of low income Ethiopians, 
macroeconomic stability, and long term investments.  Annualized 
headline inflation has steadily risen over the past two years, 
increasing from 3.9 percent in January 2005, to 18 percent in July 
¶2007. Despite surtax food inflation increased from an annualized 
rate of 3.8 percent in January 2005 to 13.7 percent in January 2006, 
14.8 percent in January 2007 and 20.2 percent in July 2007.  The 
impact of the recent salary revision of civil servants is feared to 
aggravate the pressure on prices leading to built-in inflation. 
 
¶12. COMMENT: The ever increasing inflation will undoubtedly 
negatively impact long-term investment through eroding confidence of 
investors and putting macroeconomic stability in danger.  People 
whose income is fixed in nominal terms are bearing the burden while 
the recent revision in salaries and wages may aggravate the price 
hike.  Emphasis should, thus be given to improving production rather 
than further creating demand which has significant impact in 
sustaining growth and fuelling inflation.   The measures taken so 
far appear piecemeal and their impact in reducing inflation is not 
visible.  Improving supply rigidities and increased private 
investment would enhance production of goods and services that will 
counter balance demand pressure.  END COMMENT 
 
YAMAMOTO