over future nominal devaluations partly stems from the lack of central bank transparency and credibility surrounding the course of exchange rate policy.

The country could cushion the negative effects of policy uncertainty by pursuing a systematic approach to exchange rate policy (Stone _et al_ ., 2009). An institutional reorientation towards greater central bank credibility underpinned by improved policy coherence and consistency, transparency in exchange rate management, and more independent operations is crucial in tackling uncertainty for investors and ensuring macroeconomic stability (IMF, 2008; Stone _et al_ ., 2009). Accordingly, the course of future actions has to be consistent with any exchange rate changes that Ethiopia may undertake and there needs to be a more proactive communication about policy intentions and decisions. Provided that these policy and institutional frameworks are put in place, it is less likely that devaluation will give rise to significant uncertainty about the policy direction for the currency.

# **<mark>7.    Conclusions and Policy Implications</mark>**

<mark>A competitive real exchange rate would help provide an environment conducive to manufacturing-led structural transformation, sustained growth acceleration, and improved external balance. Ethiopia’s real exchange rate has witnessed rapid appreciation over the past year and the overvaluation of the birr currently stands at about 32 percent. The overvalued currency has manifested itself in, among others, the acute foreign exchange crunch, currency rationing, persistent trade and current account deficits, and slow pace of structural change. Empirical analysis using Ethiopian data provides fairly strong evidence to support the proposition that a real devaluation would be able to stimulate exports, improve the external balance, and bolster economic growth as well as promote industrialization-driven structural transformation.</mark> <mark>In other words, a birr devaluation will play an important role by fostering expenditure-switching effects and long-term development (i.e. the growth of efficient export-oriented and import-substituting industries). Nominal exchange rate devaluation will not necessarily cause inflation. However, devaluation would involve key macroeconomic trade-offs including the higher cost of imported capital equipment and increase in external debt stock and servicing when expressed in local currency.</mark> <mark>However, a nominal devaluation or faster depreciation must be accompanied by a tightening of the monetary policy stance to contain inflation. A competitive or undervalued real exchange rate could be achieved and sustained only if it is backed by an appropriate monetary and/or fiscal policy framework. Somewhat tighter monetary and fiscal policies may be required to maintain macroeconomic stability and ensure that the gains from devaluation are not neutralized by price surges. If necessary, a policy of devaluation should be complemented with other policy adjustments to circumvent major trade-offs. Furthermore, for a devaluation to be effective, foreign exchange controls might need to be phased out to allow market forces to come into play in determining the exchange rate.</mark> <mark>A more depreciated real exchange rate would be a major step forward, but it is not a panacea. Because exports are also constrained by binding capacity as well as business environment constraints, supply side factors must be tackled simultaneously. High cost of doing business is among the key obstacles hampering export development in Ethiopia (World Bank, 2014, 2015). Therefore, a one-off exchange rate adjustment is insufficient to redress the structural bottlenecks that hinder exports and a more comprehensive policy package would be needed to enhance the supply response to devaluation. This would include measures to address critical constraints in the still-challenging business environment (e.g. trade logistics, access to finance and land, infrastructure deficit, burdensome customs regulations, skills gap) (World Bank, 2015). Structural reforms targeted towards enhancing export growth and export diversification are particularly indispensable.</mark> 18