Exchange rate movements and economic growth in Ethiopia

Abstract

Despite the continuous devaluation of the Ethiopian birr, the trade and current account deficits have worsened over time. This problem is partly due to the limited diversification of exports and their structures, which mainly consist of price- and income-inelastic primary agricultural products. This research investigates how exchange rate fluctuations affect Ethiopia's economic growth, using annual data from the World Development Indicators and the National Bank of Ethiopia, covering the period from 1991 to 2024. The study employs the Autoregressive Distributed Lag (ARDL) model to assess both short-term and long-term dynamics and uses the Fully Modified Ordinary Least Squares (FMOLS) method to ensure the robustness of the results. The regression analysis indicates that exchange rate depreciation has a negative and significant impact on growth in both the short (− 0.187308, p = 0.0146) and long term (− 0.426882, p = 0.0197), aligning with the structuralist perspective that devaluation can be contractionary in economies with inelastic export structures and high import reliance. Government spending, labor force, and money supply positively affect growth, while FDI has negative effects, likely due to limited linkages, import dependence, and profit repatriation. The error-correction term suggests a quick adjustment towards long-term equilibrium, confirming the model's stability. The findings highlight that without export diversification, industrial upgrading, and targeted policies to strengthen FDI linkages, exchange rate interventions alone are inadequate to foster sustainable growth. These results provide essential insights for policymakers in Ethiopia and similar developing countries on designing coherent macroeconomic and structural strategies to achieve long-term economic growth.