Ethiopian is a low income country (World Bank [WB] 2012 ) where Agriculture plays a vital role in the economy contributing 42 percent of Gross Domestic Product (GDP), 80 percent of employment and 90 percent of total export earnings (Ministry of Finance and Economic Development [MoFED] 2011). In an effort to remove the vicious socio-economic circle, the Federal Democratic Republic of Ethiopia (FDRE) government developed a Growth and Transformation Plan (GTP) in 2009 with priority export orientated agricultural development to lead industrialization (MoFED 2010 P. 22). Despite the over ambitious plan, however, the performance of the export sector remained undeveloped which calls for sound macroeconomic policies are essential to combat the bottlenecks that constrained the sector.
Foreign exchange rate adjustment is a key macroeconomic variable that determine performance of export in a country. There are three reasons why export performance depends on the foreign exchange regime in developing countries: the export items, the functioning of financial sectors and trading with foreign currencies than with the domestic currency (Nilsson K. and Lars N. 2000). Accordingly, Ethiopia’s export sector is characterized by primary agricultural products with inelastic export demand and supply and not value added rather raw materials and intermediate goods for further processing. The consequence of primary agricultural product export is smaller marketing margin and insignificant bargaining power at the world market. The institutional capacity of the financial sector is also constrained with higher probabilities of the existence of parallel market that fails allocating resources to their most efficient use. Moreover, all trade transactions are carried out with foreign currencies, dominantly with US dollar which impact the efficiency in trade.
Devaluation is a monetary policy aimed to stabilize trade imbalance and balance of payment deficit by lowering the price of domestic currency in terms of foreign currency and/or increase in exchange rate of domestic to foreign currency (Krugman, Obstefeld and Melitz 2012). Theoretically it is usually assumed that devaluation improve export competitiveness by equilibrating trade balance and balance of payment. But, the theory may not always hold, and devaluation may not result as planned. The factors responsible for this policy inefficiency include production rigidities, lack of adequate institutional capacity that govern the exchange rate, and fluctuations (negative or positive) of exchange rates (Yehyis 1997 and Michael 2011).
In the 2009/10 fiscal year the FDRE devalued Birr by 40.8 percent against United States Dollar (USD) compared with the previous fiscal year (National Bank of Ethiopia [NBE] 2011) which is a massive change compared with 6.1 percent growth rate for the past one decade (WB 2012). The motive behind the devaluation of Birr was to improve export performance through increased export and reducing...