It is well recognized that traders, economists, and analysts await trade announcements because the balance of trade is seen as an indicator of Gross Domestic Product (GDP) of a given nation, country’s economic well-being, and its potential for growth. Obviously, currencies and equities can fluctuate when trade statistics are released, presenting trading opportunities. National Bank of Ethiopia has intervened in foreign exchange markets in order to achieve a variety of overall economic objectives such as controlling inflation, maintaining competitiveness or maintaining financial stability.
Keeping this in mind, The Ethiopia Herald had a short stay with Getinet Abera, an economist graduated from Addis Ababa University to have a piece of information about the utilization of foreign exchange pumped to the economy.
He said, “Currency floating switches demand from imports to domestically produced goods by increasing the relative prices of imports and export industries. As the step helps the nation become more competitive in international markets by stimulating domestic production of traded goods and inducing domestic industries to use more domestic inputs, the measure the Ethiopian government has taken is legitimate and acceptable amid some challenges.”
As to him, of course, an exchange rate is the price of one currency expressed in terms of another currency or group of currencies. For developing economies such as Ethiopia that actively engage in international trade, the exchange rate is an important economic variable. Movements in the exchange rate influence the decisions of individuals, businesses and the government as well. Collectively, this affects economic activity, inflation and the balance of payments. There are different ways in which exchange rates are measured. Over the years, there have been also different operational arrangements for determining Ethiopia’s exchange rate. The Ethiopian dollar is now freely traded in foreign exchange markets.”
According to Getinet, in the long-run, Ethiopia needs to maintain its international competiveness for which nominal exchange rate adjustment will be an important instrument. The precise objectives of policy and how they are reflected in foreign exchange market intervention depend on a number of factors, including the stage of a country’s development, the degree of financial market development and integration, and Ethiopia’s overall vulnerability to a range of alarms.
He further stated that the balance of trade influences currency exchange rates through its effect on foreign exchange supply and demand. On the side of the government, three immediate objectives of intervention have been important: to influence the level of the exchange rate; to dampen exchange rate volatility or supply liquidity to foreign exchange markets; and to influence the amount of foreign reserves.
According to Getinet, it is found that expected floating of the domestic currency, while relatively high, does not play a major role in sustaining the dollarization of transactions. Conversely, preferences for the use of foreign money are strongly influenced by people’s perception that foreign money is already widely used in the economy. What matters here is aptly injecting foreign currency into the intended target helps the nation making a difference in terms of socio-economic progress.
He said, “Obviously, currency is a medium of exchange for goods and services. In short, it is money, in the form of paper and coins, usually issued by a government and generally accepted at its face value as a method of payment. It is the primary medium of exchange in the modern world, having long ago replaced bartering as a means of trading goods and services. In the 21st century, a new form of currency has entered the vocabulary and realm of exchange. Currency is simply one, tangible form of money.”
Many countries in the African continent have been affected by a slowdown/ downtrend, in their already very low levels of economic and social development, as a consequence of both internal and external factors. These factors are, among others, the foreign debt burden, the insufficient achievements in financial resource mobilization, price and exchange rates distortions, the high dependency on exports of few commodities, and unfavorable weather and internal security conditions. In order to interpret the causal links underlying this negative performance in the Ethiopian case, a time-series analysis has been carried out on various indicators of the real and monetary economy, Getinet said.
He further stated that foreign exchange market intervention is driven by broad macroeconomic objectives so as to control inflation or maintain internal balance, to maintain external balance and prevent resource misallocation or preserve competitiveness and boost growth as well as to prevent or deal with disorderly markets or predicament. To achieve these objectives, the National Bank of Ethiopia might seek to target the level of the exchange rate, dampen exchange rate volatility or influence the amount of foreign reserves.
The economic objectives of intervention will influence its targets, for instance the under a floating exchange rate regime, if the concern is with inflation, the estimated pass-through from exchange rate changes to inflation is relevant, and the behavior of the nominal exchange rate will be monitored with a view to preventing sharp changes or volatility.
If external balance is the primary concern, the real exchange rate and the current account, and factors that may influence these variables, such as the terms of trade or capital flows, will be monitored. If the concern is with financial stability and crisis prevention, then market conditions can be highly informative incorporating concepts like how fast the exchange rate changes; the size of exchange rate volatility; transaction volumes; and the exposure of different market participants, he opined.
The purpose of National Bank intervention is to influence the exchange rate as excluding national bank operations that are not intended to influence the exchange rate can rule out a number of transactions that might have no underlying stabilization policy goal, such as small technical transactions, foreign reserve purchases financed by foreign currency borrowing, or transactions that are similar to those of other economic agents and are related to underlying economic activities, for instance using foreign reserves to purchase a piece of equipment on behalf of the government.
In some cases, national bank does not consider as intervention transactions that are mainly intended to regulate the amount of foreign reserves, particularly if they are automatic or based on rules, rather than discretionary, he added.
He said even when the exchange rate is floating, national bank sometimes prefers to intervene in the foreign exchange market rather than conduct an open market operation to achieve a monetary policy objective. Understanding the motives for and characteristics of national bank operations in the foreign exchange market under these conditions is of considerable policy interest, whether the operation is labeled intervention or not.
Besides, national bank foreign exchange transactions can affect the exchange rate even if this is not the primary intention. For example, in pursuing its policy of reserve accumulation, the National Bank of Ethiopia has been trying to limit the impact on the exchange rate by entering the market only when large supplies of foreign currency become available.
However, the transactions are large, so it is likely that the impact on the exchange rate is significant, even if this is not the primary purpose. Reserve accumulation can also affect the exchange rate because of its impact on sovereign ratings and spreads. True, the national bank finds some positive impact of reserve accumulation on sovereign credit ratings. A traditional reason for such intervention is that the government wishes to control the allocation of foreign reserves. Another reason is to insulate the foreign exchange market from the impact of very large foreign exchange flows that is to dampen exchange rate volatility.
He further said that the forex market refers to the decentralized market for the trading of currencies which determines specific foreign exchange rate for every currency. Here, sorting out the pros and cons of joining the forex market with reference to the foreign exchange management regulations and foreign exchange management plays a very crucial role in currency trading in the global forex market as it controls and manages all the exchanges in every currency.
In sum, exchange rate intervention remains popular among many emerging market, small/medium and open advanced economies. The relative values of currencies are influenced by the demand for them, and that demand is influenced by trade. If Ethiopia for instance exports more than it imports, which is known as a trade surplus, there is a high demand for its goods, and thus, for its currency. The economics of supply and demand dictate that when demand is high, prices rise and the currency appreciates in value. In contrast, if the country imports more than it exports, which is known as a trade deficit, there is relatively less demand for its currency, so prices should decline. In the case of currency, it depreciates or loses value.
BY MENGESHA AMARE
The Ethiopian Herald August 18/2024
