Agriculture plays a vital role in the Ethiopian economy, contributing 42 percent of Gross Domestic Product (GDP), 80 percent of the employment and 90 percent of total export earnings (Ministry of Finance and Economic Development %5BMoFED%5D 2011; Diao et al. 2010). In 2009 with an effort to remove the vicious socio-economic circle, the government of Federal Democratic Republic of Ethiopia (FDRE) developed a Growth and Transformation Plan (GTP) with a priority to export orientated agricultural development led industrialization (MoFED 2010 P. 22). Despite the over-ambitious plan, however, the performance of the export sector has remained undeveloped which calls for sound macroeconomic policies that are crucial to combat the bottlenecks constraining the sector.
Foreign exchange rate is a key macroeconomic variable that determines performance of export in a country. The causes why export performance depends on the foreign exchange regime in developing countries include: the characteristics of exportable goods, the effectiveness of financial sectors and trading with foreign currencies rather than with the domestic currency (Nilsson and Nilsson 2000). Accordingly, Ethiopia's export is characterized by primary agricultural products with inelastic export demand and supply, concentration of market and products, and little value addition. The result of primary agricultural product export is a smaller marketing margin and insignificant bargaining power on the world market. The financial sector is also constrained with higher probabilities of the existence of parallel markets that fail at allocating resources to their most efficient usage. Moreover, all trade transactions are carried out with foreign currencies, predominantly with US dollars (USD) which inhibit trade efficiency.
Devaluation is a monetary policy that lowers the price of domestic currency in terms of foreign currency, thereby increased exchange rate of domestic currency per a unit of foreign currency. Theoretically, it is usually assumed that devaluation equilibrate balance of payment, thereby improves export competitiveness. However, there are possibilities that devaluation might worsen the balance of payments instead of improving it. Primarily, the Marshal Learner (ML) condition, a necessary but not sufficient condition, for balance of payment improvement may not hold (Melesse 2011). According to the ML condition "exchange rate stability results when the sums of the absolute value of the elasticity of import demand and the elasticity of export supply exceed unity" (Krugman, Obstefeld and Melitz 2012; Daniels and VanHoose 1999). Furthermore, the price rigidities which in turn depend on the features of export items, production flexibility, and the time horizon considered determine the impact of devaluation on export performance.
The ML condition affects price elasticity as the export supply of the country is mainly primary agricultural products. This effect causes less responsiveness...