Ethiopia is embarking on a significant economic transformation aimed at rectifying long-standing imbalances within its economy. A pivotal step in this journey is the National Bank of Ethiopia’s (NBE) recent decision to adopt a market-based determination of the national exchange rate. This move signals a renewed commitment to fostering a more resilient and competitive economic environment.
For years, Ethiopia has grappled with a range of economic challenges, including inflation, currency devaluation, and trade deficits. These issues have hindered sustainable growth and have disproportionately affected various sectors of the economy, leading to disparities in wealth and access to resources. Recognizing the need for comprehensive reforms, the Ethiopian government is taking deliberate steps to address these imbalances.
The NBE’s shift to a market-based exchange rate system is a cornerstone of Ethiopia’s economic strategy. Previously, the exchange rate was heavily regulated, with the government playing a dominant role in setting rates. This approach often led to distortions in the market, contributing to a black market for foreign currency and limiting the competitiveness of Ethiopian exports.
According to the governor of NBE Mamo Mihretu, by allowing the exchange rate to be determined by market forces, the NBE aims to enhance transparency and efficiency in foreign exchange transactions. This new framework is expected to bring various benefits to the nation’s economy including attracting Foreign Direct Investment, diminish black market, inhibits illegal trade and enhance the nation’s foreign currency reserves.
In addition, a more predictable exchange rate environment can attract foreign investors who seek stability and clarity in their financial dealings.
It also boosts exports with a market-driven exchange rate; Ethiopian products may become more competitively priced in international markets; potentially increasing export volumes and revenues.
By aligning the exchange rate with market dynamics, the government hopes to reduce the fiscal burden associated with maintaining an artificially pegged currency.
The NBE’s decision is part of a broader set of economic reforms aimed at promoting sustainable development. These reforms include efforts to improve the business environment, increase access to finance, and enhance infrastructure development. The government is also focusing on diversifying the economy, which has traditionally been reliant on agriculture, by promoting sectors such as manufacturing and services.
While the move to a market-based exchange rate is promising, it is not without challenges. The transition may lead to short-term volatility as the market adjusts. Additionally, managing inflation and ensuring sufficient foreign reserves will be critical to stabilizing the economy during this period of change.
Ethiopia’s renewed efforts to address economic imbalances through the adoption of a market-based exchange rate represent a significant step forward. By embracing market mechanisms, the NBE is positioning the country for a more sustainable and equitable economic future. As these reforms unfold, the international community will be watching closely, hopeful that Ethiopia can navigate the complexities of this transition and emerge stronger as a result.
According Zemedeneh Negatu, a distinguished Ethiopian-American business leader, global strategist, and investor , the measure taken by the government will bring significant development for Ethiopia’s financial landscape, increases the volume of export trade and make the financial industry more competent at the international market.
Fitch Ratings, an international financial think thank group, on its part, announced that the measure signaling a cautious optimism toward Ethiopia’s economic restructuring. The opening up of the financial sector to foreign companies and introducing of floating exchange rate encourages both importers and exporters to enhance their business by easing shortage of foreign currency in Banks. In addition, it supports to serve the nation’s debt as per the schedule. Moreover, it reduces the nation’s dependency on foreign financial institutions for its development endeavor.
The move reflects Ethiopia’s renewed efforts to address long-standing economic imbalances, starting with the NBE’s recent market-based determination of the national exchange rate. This policy, introduced in July 2024, led to over 50% depreciation of the official exchange rate, aligning it with the parallel market and alleviating distortions that had hampered trade. The NBE also introduced an interest-rate-based monetary policy, setting a 15% policy rate to stabilize inflation and enhance the effectiveness of monetary policy.
The changes follow Ethiopia’s new four-year agreement with the International Monetary Fund (IMF) under the Extended Credit Facility, which immediately disbursed 1 billion USD as part of a 3.4 billion USD package to support Ethiopia’s economic adjustments. The arrangement, alongside anticipated funding from the World Bank totaling 3.75 billion USD, is expected to reduce Ethiopia’s reliance on domestic financing and enable a shift toward market-based auctions for Treasury bills.
Fitch also noted Ethiopia’s intention to phase out non-market-based local financing, which had contributed to financial repression and inflation. In a related move, the NBE converted 242 billion Birr in direct advances to long-term government securities, easing rollover risks. The NBE’s initiative to conduct regular open-market operations is a key step in creating a sustainable fiscal framework.
The government’s shift toward managing its debt more sustainably is evidenced by a narrowing of its fiscal deficit from 2.5% of GDP in 2023fiscal year to 2% in 2024 fiscal year. Fitch projects a slight increase to 2.7% in 2025 fiscal year due to government spending on essential social programs and public sector wage increases.
Despite the positive trajectory in local currency management, Ethiopia’s external debt challenges persist with the foreign-currency International Depository Receipt (IDR). Ethiopia is restructuring 15.1 billion USD of external debt through the Common Framework, which began in 2021 and includes both bilateral and commercial debt. A standstill agreement with major Chinese creditors and the Official Creditor Committee (OCC) granted Ethiopia relief on debt service for 2023 and 2024. Progress toward an agreement with the OCC is expected by the end of 2024, a crucial step before Ethiopia begins negotiations with private creditors.
The International Monetary Fund also outlined conditions for further positive rating action, indicating that a resolution of Ethiopia’s foreign-currency debt restructuring and successful implementation of economic reforms could lead to further upgrades. The alignment of official and parallel exchange rates has boosted gold exports, contributing to an expected rise in international reserves from 1 billion USD in the 2024 fiscal year to an anticipated 4.5 billion USD by 2026.
However, challenges remain, particularly in institutional transparency, which impact Ethiopia’s credit profile. Fitch’s scores highlight governance concerns, particularly in terms of rule of law and corruption control, underscoring the need for continued progress in these areas to solidify Ethiopia’s path to economic stability.
According to the IMF, the nation faces a delicate balancing act as it seeks to achieve sustainable growth and meet the conditions of international creditors. The journey is ongoing, but Fitch’s assessment reflects growing confidence in Ethiopia’s reform agenda and economic potential.
Tewodros Tassew, an economist working in the World Bank Ethiopia Branch said that floating the currency is a necessary step for the economy that will allow Ethiopia to gradually move away from aid and towards global markets as a source of foreign exchange and investment.
He further said that trade with the foreign world through export is essential to boost the nation’s foreign currency reserve which plays key role in importing industrial inputs and capital goods.
Currently, agriculture, though it is subsistence, contributes more than 75% for foreign currency earnings. The export products are mostly exported in their raw form with no value addition which again reduces their competency in the international market. Therefore, exporting goods by adding value further enhances the nation’s foreign currency earnings.
As to him, Coffee, which is a traditional export product, is still exported in its raw form; this again deducts the amount of the nation’s foreign currency earnings. Therefore, exporting roasted and grinded coffee, which has been flourishing in some parts of the country, should be enhanced. Ethiopia exports oil seeds. Paradoxically, it imports edible oil by spending millions of Dollars which is not reasonable. Hence, halting such practices should be a priority. Expanding manufacturing can be taken as a way out for linking agriculture with industries and boosting value-added agricultural products.
As mentioned above the floating of currency is critically vital to enhance the nation’s hard currency reserve through stimulating export and value addition on agricultural products.
BY ABEBE WOLDEGIORGIS
THE ETHIOPIAN HERALD THURSDAY 14 NOVEMBER 2024
