Determinant of current account balance in

Ethiopia
Research proposal
submitted
Partial fulfillment of the
requirement
For the award of BA degree
in Economics
Prepared by: Bizunesh Chiche
Id No 1845/04

Advisor name: Wondwesn W.

Debre Markos University

Collage of Business
and Economics
Department of
Economics

June 2014
Chapter one
Introduction

1.1BACKGROUND OF THE STUDY

Current account balance is the sum of the value of imports of goods and
service plus the net transfer payment (net returns on investment abroad
minus the value of export of goods and services where all these are measured
in domestic currency. (D.salvatora ,2004 as cited by Abebayehu.Y, 2014),
Developing country are characterized by low level of macroeconomics
performance of high total population, low per capital income growth, under
employment, budget balance deficit, high rate of inflation in continuous
manner, unfavorable, unfavorable terms of trade and market instability.
(Ethiopian economic association annual report,2006) .
Ethiopia is a country with population of 80 million in 2007/8. It is one of the
developing countries which face the problem of low per capital, inflation and
current account deficit and food insecure (scarcity food).The high growth rate
of the population did not match with the production of the output in the
country .(NBE annual report,2009/10).
In open economy policy markets are concerned with two macroeconomics
goal. Internal balance and external balance are fully utilized and stability of
price level is attained where as external balance is achieved when an optimal
level of current account balance attained optimal balance meant that a
countrys current account balance is neither so deeply deficit that the country

may be unable to repay its foreign debt in the future nor strongly in surplus
that foreigners are put in that position. The impact of trade liberalization is
hypothesized to render the current account more sustainable relative to the
represented pre liberalization era. The trend volume of exports rose sharply
during the post return period relative to the pre reform period. I.e. the volume
of these exported items twice less than in the perform period. The reasons
behind the decline of the output of the exported items were the major
determinants of the output of the export products. During the post 1992
period the value of imports a share of GDP increase continuously.(Ethiopia
Economic association annual report 2004).
But, the objective is for identifying what factors that determine the current
account balance of Ethiopia.

1.1

statement of the problem

A current account deficit is reflection of the strength of developing countries

economy particularly Ethiopia and it measures the available resource coming
in to the country to finance investment demand in excess national saving, on
the other hand it can also shows dangers imbalance between national saving
and domestic investment so as to the accumulation of debt.(Abush
Grime;2011).
In the case of Ethiopia there is a problem of unstable export markets
consequently, it worsening term of trade and it leads to Ethiopia exports are
concentrate on a small number of products. In terms of values the share of
major export items have been fluctuating over time due to volatile behavior of
price and unpredictable demand in the international market. On the supply
side agriculture item are influence by policy problems, war structural
constraint, natural factor(drought, disease)etc, there are an over increasing
knowing the determinant of current account balance is one of the main target
that is expected from policy makers and every individual for discarding
problems regarding with it (Abebe Gizaw,2012).

The current account balance is affected by or determine by so many things

from time to time, however there is no sustainable increase on surplus of the
curt account balance of Ethiopia. Because Ethiopia is one of the developing
countries has low level of capital stock and manufacturing industries with
regarding to this the country really on foreign trade. The country export
mainly agricultural products ,while
imports constitute different items
regarding from food to different types of manufacturing goods that are
required to transform its backward economy but the absence of stable and
expanding exports product and market because independent for the increase
in foreign exchange earnings. Therefore its necessary to knowing and
assessing the determinants of current account balance of Ethiopia.
(Gebregzabher T.2003, As cited by abebayehu.y).

RESEARCH QUESTION
1. What are the factors that determine the current account balance in
Ethiopia?
2. How to investigate the trends of current account balance in Ethiopia?

1.3 Objective of the study

1.3.1 General objective of the study
The main objective of this study is to look for what are factors that determine
the current account balance of Ethiopia.

1.3.2 Specific objectives of the study

1. To examine the determinant of current account balance of Ethiopia.
2. To investigate the trends of current account in Ethiopia.

1.4siginificance of the study

The study would be important to induce information which helps to design

appropriate and effective polices about the countrys economy and it helps to
identifying what kinds of policy be adopt in order to reduces the negative
impacts of variable on CAB in Ethiopia.

1.5 scope of the study

The research would be focus on typical determinant factors that affect current
account balance of Ethiopia for the last three decades through time series
Quantitative data and its revise and assess the regime up to the present
current account balance of Ethiopia

1.6 Limitation of the study

Time and finance constraints data collection requires more times but the time
is but the time is highly limited to get information from different source about
the current status of the situation. On the other hand to get reliable data,
requires more fund but the capacity of finance does not allow to data, requires
more fund but the capacity of finance does not allow to carrying out the study
deeply and efficiently, since it requires more expense.

1.7 research methodology

The data analyzes through using two methods of data analyzes which are the
descriptive and econometrics analyses in order to make the study productive.
When under econometrics analyses the estimation model would be made
using ordinary least square (OLS) methods with different tests. Under
descriptive analyses .it uses tables, graphs, etc for analyzing data.

1.8 Hypothesis of the study

1. REAL GDP is negatively correlated to current account balance in Ethiopia.
2. Real effective exchange rate is negatively correlated to current account
balance.
3. Consumption is negatively related to current account balance.

4. Oppenness is also relatively correlated to current account balance.

1.9 Organization of the study
This paper has five parts
The first part is introduction part, deals with briefly about the background of
the study, statements of the problem, objective of the study, significance of
the study, methodology of the study, objective of the study including both
general and specific objective of the study, the scope of the study, the
limitation of the study, the hypothesis of the study, and organization of the
study.
The second part is about related literature reviews relisted to the topics and
under this part which included both theoretical and empirical literature.
The third part is about methodology of the study which includes methods of
data analysis are, model specification, definition of variables and descriptive
data analysis.
The fourth part talks about data analysis method and presentation and
interpretation of results in both econometrics and descriptive analysis is
made.
The fifth and the last part of this paper is present conclusion and give
recommendation about the ultimate result and trend of the study in short and
precise way.

CHAPTER
2.

TWO

LITERATURE REVIEW

2.1Theoretical literature review

The current account records and imports of goods and services are by
convention entered as positive items in the current account balance and
imports are entered as a negative ,unilateral transfers are receipts, which the
residents of a country receive for free receive from abroad as negative items.
(soderston and reed,1994 cited by abebayehu y).
Since current account is concerned with goods and services, it is generally
considered to be the most important component of balance of payments.
What makes a current account surplus or deficit important is that a surplus
means that the country as a whole is earning more than it is spending and
increasing its stock of claims on the rest of the world. On the other hand,
deficit means the country is reducing its net claims on the rest of the world.
The current account is likely to be a cause of changes in other economic
variables. Such as change in the real exchange rate, domestic and foreign
domestic and relative price inflation(Pitbean,1998).
It is important mention that current account deficit is not necessarily
phenomena for country economic development. The country opportunity for
investing the borrowed recourses is more important than paying back loans to
foreigners because profitable investments wills generate are turn loans. In this
case, A deficit in current account is likely to be followed by future surpluses.
Similarly a surplus in current account is not undisputedly appositive
phenomenon economic development. For example if the surplus is a result of
low investment due to un certainty in the country it is likely to be followed by
future deficits, the important goods predominantly consumer goods like cars
and electronics, then it might be argued that deficit is more worrying then if
the imports are plant and machinery that could be important be generating
future export (Gebregzabher Tessfmariam2003, cited by abebayehu, 2013).
A current account deficits means that the concerned country is increasing its
indebtedness or reducing its claims on the rest of the world. If the country is a
net creditor it can usually afforded to do this. Whereas, if its debtors the
deficit may be regarded as a serious problems another point to bear in mind
that if country has a large deficit due to a large government budget deficit.
Then the remedial measures may lie in reducing government expenditure and
or raising taxes. If however, the deficit due to high investment then there is a

good chance that future export growth will reduce the deficit. Finally to the
country has a current account deficit, high inflation and low economic growth
then the problem is more worrying then it the deficit is a combined by high
economic growth and low inflation.(Abebe Gizaw; 2003).

2.2 Approach to current account determination

2.2.1 Elasticity Approach
The elasticity approach treats the current account balance as the sum of trade
balance and net international investment income. Exchange rate domestic
output and foreign output. In particular, it is uses to examine whether
currency depreciation can help to improve the current account balance or
no. Therefore the elasticity approach highly emphasizes the role of exchange
rate and trade flows in current account adjustment. Consequently, relative
international prices and their determinants were viewed as central to the
dynamics of the current account (siewed, 1994 as cited in Abush Girma 2004).
Alfred marshal (1968) and Lerner (1971) set the marshal Lerner condition that
indicates whether devaluation improve or worsen the current account balance
and condition postulates a stable foreign exchange market and important in
balance of payment if the sum of elasticity of demand for export unity in
absolute value however the sum of these to elasticity will have to be
substantially greater than one to make devaluation a method of correcting the
nations balance of payment. Devaluation will improve the trade balance if the
devaluating countries elasticity for imports country export exceed on the
other hand if the demand are less than one then devaluation will worsen the
trade balance would weather helps not hurt, of the sum demand elasticity
equal one.(salavator,as cited by abebayehu y,2013) .

2.2.2 Absorption approach

The absorption approach considers the current account balance as the
difference between income and absorption or equivalently the difference
between saving and investment. This approach is a macro economics
approach it investigates the effect of exchange rate change on trade balance
through the absorption channel ewer income and relative prices change by

adjusting this approach states that if an economy spends more than what it
produce i.e. Absorption exceed consumptions and spending. This approach
argues that the exchange rate is an important for current account adjustment.
(Krugman, 1987 cited by Abush grime 2004).
Mathematically
the
absorption
follows(Carbaugh,2009).

approach

can

be

expressed

as

Let Y=C+I+G+(X-M)
Y=A+B
B=Y-A
By this expression suggest that the balance of trade (B) Equally the difference
between total domestic output(y) and the level of absorption (A). Its national
output exceeds the level of absorption; the economys trade balance would be
positively. Conversely a negative trade balance suggests that an economy is
spending beyond its ability to produce.

2.2.3 Inter temporal approach

The inter temporal approach to the current account views the current
accounts(CA) as the difference between domestic saving(s) and domestic
investment (i): recall the previous national income identify on expenditures
side:
Y =C+I+G+X-M and we add the national income identify on the disposal side
(how people earn income and allocate it to different uses).Y=C+S+T,(SSaving, T-tax). This side at income is divided consumption savings and taxes,
(sequentially, it may be more first. CA=S-I and focused on macro economics
factors that determine the two variables, S and I. The intertemporal approach
recognizes that savings and investment decision result from forward looking
calculation based on the expected values of various macroeconomics factors.
It tries to explain the current account development through closer
examination of inter temporal consumption, savings and investment decision.

This approach has achieved a synthesis between the trade and financial flow
perceptively by recognizing how relative prices and how relative prices affects
saving and investment decisions (Regoff, 1995).
The inter temporal approach suggests that one could approach currents
account determination by focusing more explicitly on the development of on
in its counter part of the capital account. In an open economy, the capital
account can be affects by country characteristics that reflect macroeconomic
policies. According to literature, countries that are more open to international
trade to attract more foreign capital to finance expenditures relative to
income, contributing current account deficits. The degree of openness to
international trade may have important for long run implications for over all
current account positions (krugman,1987 as cited in Abush Girma,2004).

2.2.4 Monetary Approach

According to monetary approach currency devaluation exerts impacts on
purchasing power levels and balance of payment. (Carbugh 2009, as cited by
yamrot,2005).
According to this approach, currency devaluation may induce a temporary
improvements in nations balance of payment position. The surplus does not
last forever, the currency devaluation leads to an increase in spending
9absorption) which reduces surplus. The effects of devaluation on real
economic variables are thus temporary. Overt long run currency deprecation
merely raises the price level.

2.3, Empirical Literature Review

2.3.1 Cross-country studies on
current account
(Khan and Knight 1983), Investigated the evaluation of the current account
balance for 32 non-oil developing countries over the period 1973-1980 by
using pooled times cross section data and adopting an ordinary least square
estimation approach, their result indicate that both internal factors(the

increase is fiscal deficits and the apperception in real effective exchange

rate)and external factors, (the deterioration in terms of trade, the decline of
economic growth and the increase in foreign real interact rates are important
in explaining the deterioration of the current account of the countries under
review).
The effect of the exchange rate on exports depends on the price elasticity of
export supply because the real exchange rate should incorporate the price
effect on exports thus the higher the price elasticity. The move competition
face exports of particularly commodities on the world market in general
individual products have higher price elasticity then primary products, which
causes industrial export to respond perfectly to change in real exchange
rates. I.e. the effect of exchange rate on developing countries exports is
ambiguous (Yishak, 2009).
Many developing countries adopted import substation strategies to promote
domestic economic development. Ethiopia was one of these during derge
regime as such Ethiopias trade history has long been characterized by control
system of region exchange, trade policy, imports, quotas, high tariffs, state
controlled marketing of exports, export prohibits and export taxes. Thus trade
policy become increasingly inconsistent with some of the macroeconomic
policies followed by derge regime. (Derese,2001)
Current account and real exchange rate; the effect of devaluation on the
current account has been extensively addressed in traditional open macro
economics. In mundele Fleming model devaluation will improve the tread
balance if the marshal learner conditions are fulfilled (Devarla, 1998)
Current account and openness on the issue of openness investigate the
impact of trade restriction on current account. The studies suggest that when
non tradable are intensive in import intermediary tariff act as a supply sock in
this sector as a result resource will be reduce from non tradable to exportable
and current account improves. When the input tariff leads to a contraction of
the exportable sectors the net effect on current account is ambiguous. (Lopez
and rodic, 1989)

Real gross domestic product and current account as theoretically domestic

economic growth accelerate demand for foreign goods and services and
consequently deteriorates current account balance (Gebregzabher T, 2003 as
cited by abebayehu y2012)
Consumption and current account balance: When increase in consumption it
leads to decreasing of net saving of individual (Abebe Gizaw, 2004).

CHAPTER THREE
3.1 RESEARCH
METHODOLOGY
The study used time series data from the period 1981to20010/11 on currents
account balance, real effective exchange rate, real GDP, consumption and
openness of country.
The data for my study is obtained and collected from the national bank of
Ethiopia (NBE), The statistical agency of Ethiopia (CSA), ministry of finance
and economic development (MOFED), World bank (WB), research paper, books
magazines and other related idea to the issue. These collected data are used
to develop the model or inferential (econometrics) analysis and descriptive
analysis.

3.2 Model
specification
Current account balance is usually measured the sum of the value of imports
of goods and services plus the net transfer payment (net returns) on
investment abroad minus the value of exports of goods and services where all
these elements are measured in domestic currency (D.Salvatoer as cited by
Abebayehu Y,2013).

The specification of model shows the regression of Ethiopians current account

balance on system of macroeconomic variables, so the research specifies the
current account balance as auction of real effective exchange rate, real GDP,
consumption and openness as follows.
CAB=B0+B1REER+B2RGDP+B3OPP+B4CONS+Ei
Where CAB=current account balance
REER=Real effective exchange rate
RGDP=Real growth domestic product
Opp=openness
Cons= consumption
Ei=error term
REER is expect to have positive correlation with current account balance,
where there is devaluation of domestic currency is expect to improve CAB by
encouraging and by discouraging import. Conversely REER is also expecting
to have negative relationship with CAB, when there is appreciation of
domestic currency. Because it is expect to encourage import and discourage
export and it lead to current account deficits.
RGDP is expecting to have a negative relationship with CAB through by
encouraging import and bringing above deteriorate CAB.
Consumption is expected to have negative association with CAB.
Openness is expected to have negative correlative with CAB.

3.3 variables Description

A. Dependant variable
Current account balance (CAB)
CURRENT ACCOUNT BALANCE IS PART of the balance of payment that
contains international transactions on currency product good and services and

other net income from abroad (D.salvatora ,1990 as cited by Abebayehu

Y.2013)

B Independent variables
1.Real gross domestic product(RGDP),domestic economic growth accelerates
demand for foreign goods and services and consequently deteriorates the
current account balance an increase in domestic output growth rate has
effects of expanding the current account deficits. The increasing of real GDP
of Ethiopia which leads to increase import and export level of the country
because of domestic income increases, the government support domestic
industries to compute in the international market and the resident of the
country prefer to import from abroad. The decrease real gdp discouraging
both import and export but import of goods from abroad are huge in amount
in addition to highly price. In contrast export goods of our county are primary
products and low in volume I n addition to lowness of price.
2.real effective exchange rate (REER):can affects the current account balance
,at the value of birr increase the price of goods and services in home country
increases and become expensive price of goods and services. Therefore, is
promoting import since the residents are unable to buy domestic products?
With regard this exports are discouraged since, supplies are beneficial to sell
goods and services domestically as higher price relative to foreign prices.
Conversely, the decrease in value of birr result in price of goods and services
are relatively low and the residents are willing to buy these domestic
products while produces are not beneficial because their produces are cheap
domestically they prefer to export goods and services to abroad since the
relative price of goods are relatively high. Thus exports are encouraged one
imports are discouraged.
3. Consumption (cons): can affect the current account balance hince,when
increasing consumption net saving of individual decrease .so
I expect
consumption is negative correlation with current account balance .

4. Openness (opp): as the trade is more liberalized, the restrictions are less
and it encourages import of the country. Regarding export high openness
means reduce export.

3.4 TEST OF THE MODEL

1. STATIONARY
Theoretically time series is a collection of random variable (xt) such collection
of random variables ordered in time is called stochastic process. Stochastic is
said to be stationary if it means (x) and variance very(x) are constant over
time and values depend on the distance or lag between two time periods and
not on the actual time at which the covariance cov(x) is compute. (Guajarati,
1995).
Augmented dickey Fuller(ADF)test is the most popular unit root test to
differentiate weather the variables stationery or not and it indicates the order
to integration of variables to make them stationery. If the test is non
stationery using time difference lag(0), and so on tries to get stationery.
(Maddala,1992)
2. Test of multicollinearty
Variance inflation factor measures of multicollnearty
relationship between independent variables.

that

shows

the

3. Test of hetrosdasity
Brush pagon-Godefary test is the common measures of hetrosdasity that
shows non constant variance of non homogeneity enough the variables by
compute the compute value of chi square are critical value of accept or reject
the hypothesis.
4.

R2-Test

Shows the performance of the explanatory variables jointly explainer the

variation in the dependant variables and there is also the adjusted R 2 that is
the modification form of R2.

5 . Autocorrelation
If the assumption of the classical linear regression model that the errors or
disturbances of entering into the population regression function are random or
un correlated is violated, the problem is autocorrelation arises (Guajarati,
1995).
The presence of autocorrelation the OLS estimators remain unbiased,
consistent and they are no longer efficient. The remedy depends on the
nature of interdependence among the disturbance. (Gujerti, 1995).

6. Co integration
Engle and Granger (1987) pointed out that linear combination of two or more
non-stationery series may be stationery. If such stationery linear combination
does exist the non stationery time series are said to be co integrated and the
stationery linear combinations can be interpreted as a long run equilibrium
relationships among the variables.
When the Engle test only allows as a single co integrating relationships. And
the granger tests multiple co integrating relationships.

CHAPTER FOUR
4. DATA ANALAYISIS AND PRESNTATION
OF RESULT
4.1 PERFORMANCE OF CURRENT ACCOUNT BALANCE IN
ETHIOPIA

Current account balance is the sum of trade balance and invisible balance
(meaning that is the sum of net services (export- import) services plus
unilateral transfer of payment9aid, donation, and remittance) plus interest
dividend and profit. In spite of this fact, according to World Bank report the
current account balance of Ethiopia shows deficit for the two consecutive
years (in 2010, and 2011). Current account balance of Ethiopia is a deficit
sight still. Ethiopia has been one of the fast growing non oil dependent
countries in Africa and its economy is based on agriculture which accounts for
more than 45% of the countrys GDP, 80% of export and 80% of employment.
The highest source of the countries foreign trade are coffee, flowers, oilseed,,
pulses and live animal as well as vegetable respectively. In spite of high
growth rate of the country the current account balance is vicious circle due to
periodic drought, soil degradation, and high population density, high level
taxation, poor infrastructure and high income distribution inequality. As a
result of the above mentioned and other additional factors the Ethiopian
current account balance inclined to deficit balance account.
4.2.2 Net income in Ethiopia
Net income refers to receipts and payment of employee composition paid to
non residents workers and investment income (receipts and payments on
direct investment, portfolio investment, other investment and receipt or
reserve assets). As the net income of the country increases the people went
to save or to consume luxury goods imported from foreign nations. With
regarding to this the countrys current account balance can be affected and
worsened deficit account balance.
4.2.3 Structured of imports
It is often the case that a developing countries export destination largely
corresponding with origins of imports. In the case of Ethiopia however, such
corresponding which has been holding for long has started to lose significance
as of the past few years.
The import structure of Ethiopia can grouped into raw materials, capital goods
consumer goods and oils and fuels take the lion share. In the year 2005/06to
2007/08 was rise and its share of GDP riches 30.4% from 16.7% in 1994/95. In

over all case, capital goods are the major import items which have
$1774.4million in 2007/08. Flowers, consumer goods, Sami finished and raw
materials take the other shares in decreasing orders with a value of 1621.4,
1515.7, and 257.8 respectively as the same year.
According to the journal report; the pre devaluation and post devaluation also
the import of capital goods where the highest accounting for 34.7% and
followed by consumer goods by accounting of 29% on average. The smaller
import items are raw materials. It s not only small but also continued declining
compare to the import items. This might shows the society depend on
imported goods rather than consumed and used local manufacturing products
by imported raw materials. So, this sharp in the total value of imports and this
is contributing to worsen of current account balance of Ethiopia.
Import of goods and service comprise all transaction between residents of a
country and the rest of the world involving a charge off ownership from non
residents to residents of a general merchandise goods sent for processing and
repairs goods and service. The industrial products successes machinery,
fertilizers, chemical and luxury products. Since, Ethiopia is one of the
developing with hugest growth rate (double digit growth rate), this situation
leads to the country to import large amount of products until the country can
able to produces those goods and service. Due to this fact the countrys
current accounts balance adversely affected and aggravated for the level of
deficit account.
4.2.4 Structures and performance of Ethiopia
export sectors
As most of African counters Ethiopia is highly depends of agriculter.Even
though is sides that more than 80% of the people depend up on agriculture
and its output is not as expected because, agriculture sector characterized as
traditional in absence that the method of agriculture used is what our great
grandfather has been using, because of this and other rezones the output
agriculture is more subsistence.
During 2007/08 the largest market for Ethiopias export to Europe and it was
accounting for 41.9% of the countrys export. Among the European countries,

Germany which mainly imported coffee and flower were the largest buyers of
Ethiopian goods. The Netherlands, the biggest destination for Ethiopian flower
during the review period was the second largest market followed by
Switzerland and Italy whose main imports from Ethiopian include leather and
leather products, coffee as well as textiles and garments. The major export
items to Saudi Arabic include coffee, live animals as well as meat and meat
products. Coffee constituted the bulk of exports to Japan. Leaser and leather
products, as well as oil seed made up large portion of export to china. Meat
and meat products, pulses, live animals as well as fruits and vegetable were
the major items exported to United Arab Emirates.
On the Other hand, 14.2% of exports were detainable to African countries of
which about 88.3% went to three neighboring like countries like, Somalia, Sudan
and Djibouti. Chat was the principle export items shipped to Somalia followed by
live animals. The major export to Djibouti include chat ,lie animals as well as
fruits and vegetables, on the other hand Sudan mainly imported coffee, pulses
and natural honey and bee wax. Mean while, about 1 5.3% of Ethiopias exports
were to African nations in particularly to Somalia (41.8%), Sudan (30%) and
Djibouti (12%) and Egypt (9%). Coffee pluses and live animals were exported to
Sudan, chat and live animals and pluses to Egypt. The Americans accounted for
5% of Ethiopias exports of which 85%, mainly coffee and oilseed went to the
united state of American (NBE, Third quarter 2010/11).
Over time, Germanys and sauds shares remained almost stagnant, while that of
Japan and Switzerland have been falling on average by 5 to 7.6% yearly. But
export to Netherlands china and the united state increased substantially by
50.44 and 12 percent respectively.
Since, Ethiopia export is dominated by agricultural products among that the
most important merchandise export are coffee, leather and leather products and
oilseeds respectively and others share their own accounts for the total export of
the country. In spite of this fact, the export sector for goods are most venerable
for weather condition and give less response for exchange rate devaluation as a
result the export sector of Ethiopia not much significance contribution for
current account balance of Ethiopia until now. Meaning that, the counters export
volumes faced serious fluctuation from to time because of its export goods and
mostly depend on agriculture goods which highly depend on climatic condition of
the country.
Table 4.1 Ethiopias export share to major trading partners

Ethiopia is export share to major trading partners.

Major
trading 2002
2003
2004
partners
Germany
10.7
12.2
12.6
Arabia
8.3
7.5
6.9
Japan
8.3
9.2
10.2
Switzerland
9.4
10.2
8.8
Italy
9.0
7.6
6.3
United state
3.9
4.9
6.1
China
1.7
1.5
2.4
Nether land
0.9
1.2
3.1
Source: - Ethiopian costume Authority

2005

2006

2007

2008

14.1
6.5
7.7
6.8
5.7
4.9
8.8
3.9

13.0
7.0
8.7
5.7
6.3
5.1
7.2
4.5

10.1
7.3
6.5
4.9
6.8
5.7
5.7
6.6

10.7
7.8
3.9
6.3
5.3
7.3
5.2
7.6

Avera
ge
11.7
7.3
7.1
6.8
6.4
5.7
5.3
4.9

4.2.5 Gross Domestic product

The Economic growth (gdp at constant price) EFY is estimated to be 11.4%. As
per the estimates annual growth rates of the major sectors, i.e. agriculture,
industry and their services were 9.0% 15.0% and 12% respectively and their
shares out of the total GDP were about 41%, 13.4% and 45.6% respectively.
Over the last eight consecutive years: during 1996-2003 EFY the economy has
registered rapid growth. Accordingly, in this period the annual average growth
rate of GDP was 11.4%. The agriculture, industry and service sectors annual
average growth was 10.2%, 10.8%, and 12.9% respectively. In this period a
slight structural change observed in the economy. The agricultural sectors
share of GDP is decreasing and that of service sector is increasing. The
industry sectors share more or less constant except in the last budget year
where high growth is registered. With regarding to this, the Ethiopian
economy as this time shows higher growth rate. But there is not well
expanding and integrated of industry and home production of goods and
services is not massive. Hence, there is a higher demand of foreign goods
including large machineries for sustainable growth in the country until the
infant phase of industry over come in the country until the infant phase of
industry over come in the country and this situation brings adverse effect on
the current account balance of the country.
4.2.6 Expenditure on gross domestic
product

As per the estimate in 2003EFY:- consumption has registered about the

remaining balance (83.1%) is attributed the private final consumption. Rate of
investment has reached 25.5% of GDP and has registered 30.3% annual
average growth over the last eight years, on the other hand, import has been
31.8% of GDP and has registered 32.1% annual average growth over the last
eight years, on the other hand, imports has been 31.8% of GDP and has
registered 30.1% annual average growth over the last eight years. As a result
of higher trade deficit and it worsen current account balance of the country
through trade deficit of the country.
4.2.7 Openness
The trade liberalization of Ethiopia has almost affects the trade balances of
the country and it also leads to affect the countrys current account balance
negatively. As openness increase the import and export item of the country
increase, however that increment is unbalanced due to their nature. For
example from 2009 to 2010 there is relatively high increment in openness i.e.
14.6% and it results brought current balance deficit through high trade deficit.
Standing from this fact the increasing of openness in developing countries
particularly in Ethiopia it worsen current account balance deficit.

4.3 econometrics result and interpretation

The investigator used economics analysis or economic data in order to lend

empirical support to the economic model and obtain numerical result and
quantitative analysis. Since the important part of economic model is empirical
model. In addition to descriptive analysis in order to capture the degree of
influence of some of the determinant of current account balance as a result
econometric analysis would be apply. The investigator (the research) used
time series data to run regression covers from the year 1981 to2009/10 using
time series data. In ordered to evaluate the trend of the determinants in the
long run by affecting the dependant variables.

The estimation of the model has been made using ordinarily square method
(OLS) with different tests. If the model is not correctly specified the researcher
encounter the problem of model specification error or model specification
bias. The model may have omitted important variables or have used the
wrong functional form. To aid us in determining whether the model is
adequate on account or not we can use some of the following test. Test is
useful in econometric analysis since, the data may face some error and which
leads to wrong decision.
4.3 Result of OLS regression
CAB
RGDP
REER
CONS
OPP
CONS-

COEF
-223621.7
2821331
55096.23
3.56
6.57

STD error
94847.89
8193354
25464.92
3.01
4.63

T-VALUE
-2.36
0.34
2.16
1.18
1.42

P-VALUE
0.026
0.733
0.040
0.247
0.167

R-Squerd (R2) =0.2266

Adj R-Squared =0.1076
4.3.1 Long run model
Long run model is a model which shows the long run relationship of curre nt
account balance and explanatory variables. It can be represents from the
above regression results as follows.
CAB=6.57-223621.7RGDP+2821131REER+55096.23CONS+3.56OPP+Ei
4.3.2 Interpretation of the model
The explanatory variables
1.Real GDP
It was a negative impact on the variable of current account balance with
highly significance because of P-value. A unit ($1) increase in real GDP result

to decrease $223621.7 amount of current account balance by other things

remain constant.
This may be in developing countries, when real income of the people
increases they are encourage to consuming luxurious imported goods and it
affects current account balance negatively.
2. Consumption
In the same fashion, Consumption and current account balance Ethiopia are
negatively correlated to with highly significant manner. Economically one unit
increase in total consumption will lead to generate a current account balance
by, $550926.23 by considering other things remain constant. This can be due
to the case that, When consumption is increase it will lead bring decreasing
net saving of the individual and it affects the current account balance
adversely because saving is a primary condition for investment activities and
if there is no investments takes place in the country it worsen the current
account balance deficit by importing very simple finished products to the
country.
Openness
It is found that, it has positive impact on the value of current account balance
of Ethiopia and it is also insignificant from point view of p- value.
Real effective exchange rate
It has also a positive effect on current account balance of Ethiopia with highly
insignificance, because of p- value. I.e. p-value is less than 90%.

4.3.3 Test of the model

4.3.3.1 Stationery test (unit root cost)
Table 4.3
Variables

Test
statistics
Current account -5.056
balance
Real GDP
7.207
CONS
4.793
REER
24.022
OPP
2.326

1%
critical 5%
critical 10%
critical
value
value
value
-3.716
-2.986
-2.624
-3.716
-3.716
-3.716
-3.716

-2.986
-2.986
-2.986
-2.986

-2.624
-2.624
-2.624
-2.624

Based on the above stationery test most of the variables are stationery. Because,

absolute value of T-statistics greater than the augmented critical value.

Ramsey RESET test using powers of the fitted
4.3.3.2 Hetrosedasticity
Hetrosdacitey has serious consequences for estimator. Based on our data the
hetrosdacity is as follows
Brush-pagan/ cook-Weisberg test for hetrosdacitey
HO: Constant variance
Variables: fitted values of current account balance
Chi(1)=23.1
Prob>chi2=0.0000
Interpretation: This means that our critical value chi is greater than the
calculated value this means our data has a hetrosdasities with having
problem. i.e.o.ooo<23.1

4.3.3.3 Multicollinarity
The result shows how the variance of an estimator is inflated by the presence
of multicollinerty and between the variables mean of VIF will be
Variable
Openness
RGDP
REER
CONS
Mean VIF

VIF

1/VIF

35.27
21.52
9.23
3.26

0.028353
0.283844
0.108291
0.306287

17.32

According to the stata result of the multicolinerty test there are relationships between the
Independent variables. Openness has highly relationship with others by 35.27 and real
effective exchange takes the last one with 2.89 values. in this model the vale of VIF =17.32
which is that greater than 10 so,There is serious multicolinerty.
Autocorrelation

e of

We use Durbain- Wetson alternative tests to check whether there is autocorrelation in the
model or not is tasted by Durbain-Weston d-statistics.
If p-value is higher do not reject the null hypothesis no serial correlation
d= 2(1-p)
1.98516=2-2p
2p=2-1.98516/2
p=0.00742
d=2(1-0.00742)
d=1.98516
So if p approaches to 0 and d approaches to 2 so there is no autocorrelation and when p
approaches to one and d approaches to 0 there is positive autocorrelation and when p
approaches to -1 and d approaches to 4 their is a negative autocorrelation but in this model
d approaches to 1.98516 and p approaches to 0.00742. There is no autocorrelation.

R2-Test
This test shows that the goodness of the explanatory variables to fit or to explain the
dependent variables. So, according to the above regression results, the dependant
variables is the current account balance of Ethiopia has explained about 23.6 by its
determinants that of its independent variables. As result the model has medium fitness.

Conclusion

Ethiopias current account balance is connived in deficits sign through time, but since in
1992, birr continued to devaluate against dollar with the objective of improving the current
account balance that is to expand exports and to discourage imports and stabilizing the
economy. Even though, there are several determinants of current account balance of
Ethiopia most likely real gross domestic product, real effective exchange rate, consumption
and openness are the determinant one.
export volumes and values of trade after the devaluation of exchange rate or revaluation of
real effective exchange rate the same is true in Ethiopia but, their share of export and
import are inproprtional due to the inelastic nature of export goods and elastic behavior of
import goods that are primary agriculture products and capital and finished extensive
products respectively.
The growth of the countrys GDP and increasing income inequality also highly leads to high
demand on foreign goods for richer and this conditions enables high import than export
which deteriorate the current account balance of in Ethiopia. With regarding to this
relationship between current account and real GDP are negatively correlated. On the other
hand arise in domestic output growth may be with a greater saving rate for the save of
investment rate is strongly affect the current account balance of the country. Consumption
and current account balance are negatively correlated through the case that an increasing
in consumption leads to reduce the propensity to save and this situation aggravating of a
decreasing in the current account balance of the country.
Trade openness and current account balance negatively associated and the introduction of
economic reform (trade liberalization) has a positive impact for export earning s through
devaluation .But ,in most developing countries particularly in Ethiopia and its economy as
faster growing rate massive import than massive export is not doubt.

The ordinary least square (OLS) is taken for regression and knowing quantitative impact of
the explanatory variables on the explain (current account balance) variable through time
series data collection converging the year from 1981-2009/10. All explanatory variables are
highly significant and the above mentioned entire explanatory variables explain the model
of current account balance about 83% of its factors.

5.3 recommendations
Based on the paper result and the finding of this study the researcher
(investigator) can recommend the following.
When we have seen the current account balance of Ethiopia it is continuously
continued in deficit due to export of primary product or raw materials and
imports secondary or manufacturing products and this situation leads that
Ethiopia is a raw material export country. So, the government and the policy
makers should be focused on how to be transfer from primary exported goods
to finished item and attempt to control and promote export of finished goods
in ordered to bring the favorable current account balance and economic
growth. This can be do either further processing and change to semi finished
to finished product that export from agriculture products or adopting import
substitution factories to export promotion factories and involving massive
export items through both its quality and quantity to other countries can
insuring in the international market completion with list cost through using
cheap labor force of country or also open our door to foreign direct investment
for to open huge industry and import raw materials to their industry rather
than finished products.
On the other side, the country export must be diversified through involving
export of organized different commodities. This conditions enhancing for
international market competition by insuring the country comparative and
absolute advantage.
The investigators also recommended, the policy makers of Ethiopia should
attempt to involves on encouragement of saving of individuals and enforcing
it by using different mechanisms like, raising of value added tax rate and raise
tax on luxurious consumable products, as a result, it makes constraint
(obstacle) for consumption opportunity and it leads to raising saving and

increase tax revenue of the government, (which encourage both private and
public saving) consequently, it enables improving of current account balance
of the country.
Finally, further research can be made by deeply analyzing these, the ideas
mentioned as recommendation and related topics.

Reference

Damodar N.Gujerti, 2004 basic Econometrics, 4 thedition

Ethiopia economic association, The current state of are construction industry
Volume vi 2006/07.
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reports.
H. Fargue(1999). What determines current accounts? In a cross sectional and
panal approach IMF working paper.
Koia pilbeasm, 2006, international finance (London: pagrave Macmilan).
Maddala. G.s, 1992 introduction to econometrics with application.3 rd Ed.
National bank of Ethiopia Annual Report, 2004/05, 2007/08 and 2010/11.