THE DETERMINANTS OF ETHIOPIA�S BALANCE OF PAYMENTS: AN EMPIRICAL ANALYSIS

Abstract

ABSTRACT Ethiopia has been gradually depreciating its currency, birr to make its products competitive and to stimulate them to the global market. Though Ethiopia has persistently depreciated its currency for the last twenty years, it has experienced chronic difficulty balancing its payments. Initially using the elasticity, absorptive, and monetary approach, the study attempted to investigate the determinants of Ethiopia’s balance of payments. Then, by interlinking the most statistically significant predictors of the elasticity, absorptive, and monetary approach into one regression equation, the study used ordinary least square (OLS) analysis techniques to investigate the determinants of Ethiopia’s balance of payments for the period 2000-2018. Negating the elasticity approach, the results of the OLS analysis failed to explain the relationship between currency devaluation and Ethiopia’s balance of payments. However, the variable, open trade policy (that is, lower tariffs, quotas, and subsidies) indicated that even in trade liberalization policy that the country followed, Ethiopia’s balance of payments showed a significant deficit. Based on the absorptive approach, the data indicated a positive relationship between domestic investment expenditure and Ethiopia’s balance of payments. That is, from 2000-2018, Ethiopia’s domestic investment expenditure exceeded its national income (GDP). Finally, contrary to the assumptions of monetary approach, the data indicated that marginal increase in foreign exchange reserves created significant negative effects on Ethiopia’s balance of payments. Overall, the study indicated the significant determinants of Ethiopia’s balance of payments included open trade policy, domestic investment expenditure, and foreign exchange reserves. According to the availability of data the study is limited to 18 years (2000-2018).The policy implies that dis-equilibrium in Ethiopia’s balance of payments could be reasonably handled through the generation of potential new businesses, validation of the new products in the global market, and the proper management of accumulated convertible foreign exchange reserves generated from exports, foreign assistance, and remittance. Keywords Balance of payments, Currency Devaluation/Appreciation, Elasticity, Absorptive, Monetary determinants