Assuming power in April 2018, the new administration led by Prime Minister Dr. Abiy Ahmed has undertaken several measures to wipe out the parallel exchange market including announcing the possible exchange rate adjustment and shuts down businesses engaged in informal exchange market. In doing so, the government managed to temporarily weaken the black market and narrow its gap with the official exchange market to as low as five cents. This was, however, short-lived as the gap between the parallel and official market has widened by almost eight Birr.
Why does the black market exist?
Most people tend to choose the black market over the legal one because the former pays better than the latter. But the reason for its existence is not as it obvious as it seems. According to Economics Assistant Professor at Dilla University, Dr. Dawit Hayeso black market is common in countries like Ethiopia, which follows managed floating exchange rate system, where excess demand of foreign currency subject to legal restriction, or to official price ceilings.
Of course, the high premium is one of the obvious reasons that encourage people to use the parallel market. For instance, a dollar is now exchanged as high as 36 Birr in black market while it is transacted for 28.06 Birr in the official market.
Dr. Dawit said that gaps in implementing economic policies that help to control black market premiums and the existing tough exchange rate restrictions are discouraging individuals and businesses from using the formal channel. In Ethiopia, where balance of payment deficits is enduring, and the central bank does not have sufficient reserves to satisfy the demand for forex at the official exchange rate, parallel markets will be well developed and organized. Preliminary assessment conducted in the area suggests that a single shop is capable enough to finance hundred thousand of foreign currency at a time. “By taking dozens of shops that are available around Merkato, Kazanchis in front of Hilton Hotel, around Main Post office, behind Ethiopia Hotel and near Gandhi Hospital, it is possible to estimate the volume of transaction in millions of foreign currencies,” said Dr. Dawit.
The rising number of people attempting to illegally smuggle foreign currency out of Ethiopia show that the parallel market is considerably huge and the country loses more than three billion dollars annually because of capital flight. “The main culprit is trade mispricing, and this is partly due to problems related to the custom system and foreign currency shortage,” said Mukemil Bedru, Business Lecturer at Addis Ababa University. He noted that the root causes of the problem, the deficit in balance of payment is one the major reasons for the rise in transactions in the unofficial market.
That had, actually, always been an issue for Ethiopia as its foreign trade is unsatisfactory as the nation exports considerably less in comparison to the bulk of imports. Particularly, the imports of the country surpass exports by five folds and the cost of imports increased from 6.1 billion USD in Ceaseless efforts to curtail parallel market 2008 to 14.7 billon USD in 2017, resulting in trade deficit. Due to a slow growth of exports, which has been hovering around three billion dollars over the past six years, the bulk of imports remain not substituted by local production.
“Multiple efforts of the government and the private sector are crucial as more than half of Ethiopia’s imported items such as fuel, fertilizer and capital goods are not easily substitutable in short-term,” said Mukemil. Fuel and fertilizer account for one-fourth of the nation’s imports, whereas capital and consumer goods contribute 40 and 31 percent of the aggregate imports respectively.
The expert further stated that the stricter and tougher forex regulation would also encourage people to be the part of the parallel market as legally obtaining US dollars has become extraordinarily difficult for individuals. Business, on the other hand, must wait longer period to access foreign currency and such rigorous controls on access to foreign exchange could lead to the growth in popularity of black market.
According to the expert, control on foreign currency, which is imposed to protect government’s limited stock of foreign currency reserves, needs to be relaxed to discourage the revival of parallel market. Dr. Dawit on his part said that the overvaluation of Birr is also one of the factors for the survival of parallel market as the Birr was estimated to be overvalued by 20 percent against dollar, even after the devaluation of Birr in October 2017.
It also attributed to the increase in money supply for the popularity of the black market in Ethiopia. “The rise in money supply, which resulted from the rise in government expenditure, helped the parallel market to thrive.” During the end of the 2016 fiscal year, broad money supply stood over 740 billion Birr, exhibiting a 29.2 percent growth compared to the same period previous year.
According to the expert, the annual growth in broad money was largely attributed to the expansion in domestic credit and increase in net foreign assets and the increased money supply caused by such factors and widening budget deficit have caused massive demand for imported goods and services. “As a result, demand for foreign currencies in official markets soared and as the official market failed to supply enough foreign currencies, black markets have thrived,” he added.
Governments across the world use various monetary and fiscal policy tools to direct their economies in the right path and prevent dangers. It is no different in Ethiopia. The government has implemented various macroeconomic policy measures in an attempt to abolish the parallel foreign exchange market and create a unified exchange market.
According to Dr. Dawit, no measure, however, so far has brought the desirable outcome in helping the country to move towards the realization of a unified foreign exchange market. Although it was not inflationary as the previous devaluations made in 2010 and 2011, the devaluation of Birr by 15 percent against major baskets of currency in 2017 has not brought satisfactory results in enhancing export earnings, which stood at 2.9 billion dollars at that time.
“The problem is devaluation would not improve export performance as Ethiopia primarily relies on export of limited agricultural commodities.” The economist stated that a new direction was put in place to allow importers to request a foreign currency based on the international prices of their import.
Prior to that, most businesses ask a forex that is very less than the real prices of the goods they want to import. Noting that the exporters satisfy more than half of their foreign currency demand from commercial banks, said Dr. Dawit adding, “the banks ought to ease procedures and implement modern services to become preferred places of foreign exchange.” Government’s intervention to enhance forex reserve Against the aforementioned backdrops, Ethiopia has enjoyed a remarkable economic growth over the past decade, primarily because of a bulge in foreign transfers and capital inflows, combined with increase in private and public investments in infrastructure.
According to Economics Associate Professor at Federal Meles Zenawi Leadership Academy Dr. Wondaferahu Mulugeta, the government has done commendable jobs to overcome forex crunch and attract anchor companies from all corners of the world through diplomatic channel. Prime Minister Dr. Abiy Ahmed’s viable approach encouraged many global companies to involve in Ethiopia’s business and investment opportunities and Gulf countries pledged to offer a significant amount of dollars for the country. In this regard, the UAE has deposited three billion USD in Ethiopia’s central bank for future business and investment undertakings thereby supplementing the country’s forex reserve.
“The coming of multinational companies is also believed to add a significant amount of foreign currency into Ethiopia’s economy,” said the expert, adding that Premier Abiy has done exemplary tasks in convincing Saudi Arabian and Chinese governments to extend their loan payment periods. The decree the government made to allow both domestic and foreign firms to buy minority shares in big public-owned companies and fully privatize other enterprises is a big step to obtain enormous foreign currency.
The growing confidence among the Ethiopian Diaspora that followed PM Abiy’s tours in the US and Europe would also encourage them to deposit more foreign currency in Ethiopia’s banks. The road ahead “Administrative measures and crackdown on parallel market are short term solutions and they drive participants into hiding for some time and as long as black market is attractive in terms of return, it will thrive,” said Dr. Dawit.
According to him, allowing more business people to have foreign currency bank accounts and encouraging members of the Ethiopian Diaspora to put more forex in local banks are so important to deter the revival of black market. In countries like Ethiopia where there is a high inflow of aid and soft loan, the benefits of comparatively stable exchange regime may be greater, the expert said, adding that the country could adopt strong exchange regime and follow a more open approach to the parallel market to reduce the risk premium, which incentivizing rent seeking through arbitrage between the official and parallel market.
The experts expressed conviction that prime attention should be given to enhance the export sector’s unsatisfactory performance to boost forex reserve in the formal sector thereby easing the access to hard currency for individuals and businesses. Improving Ethiopia’s capacity to substitute the bulging imports of consumer goods that have drained precious forex reserve is also something worth consideration to allocate the hard currency to strategic imports.
They said that the government needs to legalize the parallel foreign exchange market and incentivize private sector’s participation in the establishment of forex bureau as the black market could contribute to the flow of 30 percent of funds to the official channel. The effective execution of macroeconomic policy tools will also enable Ethiopia to restrain the revival of parallel market and form a single forex market.
The Ethiopian Herald January 8/2019
BY BILAL DERSO
