and β∈ []1,0 is the degree of indexation as defined earlier. The expenditure shares in 2004 were according, φ _m_ = 481.%, φ _n_ = 506.%, φ _exd_ = 3.1% .

The short-term impact of a nominal exchange rate devaluation is expected to be an increase on government expenditure on tradable goods and services and on interest payments (added expenditure associated to the local currency cost of foreign debt servicing)<sup>23</sup> . At the same time, to the extent that currency devaluation raises the aggregate price level, it would lower real wages, which is the main component of Djibouti’s’ government expenditure. A nominal exchange rate devaluation could also affect government spending if it causes a change in discretionary fiscal policy such as raising salaries of public sector employees to protect their real earnings from a devaluation-induced rise in prices of consumption goods, a policy which can be reflected by an additional increase in government expenditure on non-tradable services. For the purposes of this paper, this possibility is captured in the wage indexation method outlined in the discussion on ~ ~ revenue, where the growth rate of the price of non-tradable goods, _P n_ = βτ _E_ .

**_Based on a nominal devaluation of 30%, a pass-through of 60% and indexation of 30%, the resulting growth rate of real government expenditure is -2.43%._** This can be divided between nominal expenditure rising by 11.79% and aggregate price level increases by 14.22%, with the resulting real growth rate reflecting the difference. The resulting real expenditure level is

(8) Real expenditure (deflated by the GDP deflator with 2004 as the base year) was DF 40.1 billion in 2004. With a growth rate of -2.43% in lieu of a 30% devaluation, the new expected level of real government expenditure is DF 39.1 billion.

# **_4.1.3. Estimating the Real Fiscal Savings from a Nominal Exchange Rate Devaluation_**

In early 2005 which is the base year for the purposes of the analysis, real fiscal savings was DF 1.37 billion or 1.16% of GDP. The predicted levels of real fiscal savings after a 30% devaluation with 60% pass through, assuming no indexation, which is equation (8) less equation (11), is DF 6.61 billion or 4.6% of GDP<sup>24</sup> . Tables 3 summarizes estimates of fiscal savings under a matrix of 30%, 60% and 100% devaluation assuming 0% and 30% wage indexation.

**Table 3 Djibouti: Gross Fiscal Savings From various Devaluation Scenarios (DF bn/percent of GDP)**

|**Devaluation**<br>**Rate**|**0%**<br>**Indexation**<br>**50% pas**|**30%**<br>**Indexation**<br>**s-through**|**0%**<br>**Indexation**<br>**60% pass**|**30%**<br>**Indexation**<br> **-through**|**0%**<br>**Indexation**<br>**70% pas**|**30%**<br>**Indexation**<br>**s-through**|**0%**<br>**Indexation**<br>**100% pas**|**30%**<br>**Indexation**<br>**s-through**|
|---|---|---|---|---|---|---|---|---|
|**30.0%**|6.61|6.28|6.00|5.61|5.40|4.93|3.57|2.91|
|**% of GDP'05**|5.40%|5.13%|4.90%|4.58%|4.41%|4.03%|2.92%|2.38%|
|**60.0%**|11.85|11.19|10.64|9.84|9.42|8.50|5.78|4.45|
|**% of GDP'05**|9.68%|9.14%|8.69%|8.04%|7.70%|6.94%|4.72%|3.64%|
|**100.0%**|18.84|17.73|16.81|15.49|14.79|13.24|8.71|6.51|
|**% of GDP'05**|15.39%|14.49%|13.73%|12.65%|12.08%|10.82%|7.12%|5.32%|

_Note: Values are in constant Djibouti Franc terms with the base year of 2004. Source: Authors' calculation based on EDAM 1996_

> 23 In Djibouti, only a small fraction of government expenditure (0.5%) goes to service external debt.

> 24 This is expressed as a share of predicted GDP in 2005 which is estimated by the WEO at DF 122.4 billion.

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