Ethiopia’s Economic Gamble: Birr battles inflation, instability, and austerity

By Beneal Walker

Addis Abeba – Historically, Ethiopia’s birr (ETB) has been relatively robust and stable when compared with other local African currencies. No longer the case, Ethiopia faces a preventable cost of living crisis manufactured by conflict, political austerity, and incompetency at the helm.

In late July 2024, before Ethiopia’s implementation of unprecedented macroeconomic reforms, $1 USD was going for about 57 birr. Currently, $1 USD is exchanged for about 132 birr on the secondary (black/parallel) market. The birr has lost nearly 100% of its value against the US dollar to date due largely to the adoption of a floating exchange rate.

Ethiopians at home are facing an increase in the cost of living as basic daily consumer goods become more expensive. Ethiopia’s goal towards this bold transition into a floating exchange rate stems from means in attempting to curb stubbornly high inflation, target stability, attract foreign investment that has dried due to conflict and instability, and overall, drive growth.

Ethiopia has been grappling with a foreign currency shortage for some time. This issue stems from a trade imbalance where the country imports more goods, like machinery, fuel, and food, than it earns through exports, such as coffee, services, and textiles. The situation is made worse due to Ethiopia’s reliance on imports to lead development and meet energy requirements. Moreover, the lack of export diversification also makes Ethiopia vulnerable to price fluctuations with limited ability to generate currency from its low-value exports.

In April of 2024, the International Monetary Fund (IMF) visited Ethiopia in hopes of securing a loan agreement deal; no deal was struck. Ethiopia highlighted that devaluing the birr was a no-go, understanding the instant implications associated with doing so. Four months later, both parties agreed to a loan agreement. It seems as if Prime Minister Ahmed Ahmed and his entourage of “yes-men” pulled an executive order. The administration has paralyzed the nation economically and socially.

In practice, these monetary reformation maneuvers are misdirected, align with burdensome peril, and may entirely miss the objective of orchestrating structural investment and stability that lead to actual real growth. The IMF and World Bank acknowledged this, highlighting the move should be done gradually.

Fix or float?

A fixed or pegged rate is the exchange rate in which a country’s central bank sets and maintains; it is usually pegged against a major currency like the USD for stability and forecasting investments. Thus, the central bank buys and sells its own currency in the foreign exchange market; in return, they purchase the currency in which they are pegged in order to build reserves.

Through this, the country is able to increase the value of their own currency in the international market, curb inflation, attract foreign investment, and apply appropriate fluctuations (inflation/devaluations) for the domestic money supply.

Consequently, a fixed rate comes with limited monetary policy flexibility as central banks do not have the ability to adjust the interest rate needed for economic growth, thus restricting the country from possessing full monetary independence and control as the country’s central bank is stocked with foreign reserves.

Alternatively, a floating rate is the exchange rate self-determined and self-corrected by the private market via supply and demand. If demand for a currency is low, then its value will decrease, making imports more expensive and forcing locals to look for domestic alternatives. This enables monetary policy flexibility for central banks as it enables them to adjust the interest rate freely for economic growth. Consequently, floating rates are unpredictable and volatile.

Evidently, they have created price shocks, devalued the Ethiopian birr, increased import prices, and fueled the current cost of living crisis within Ethiopia. It has exacerbated the inflation problem rather than addressing it as many had predicted.

Last year, Nigeria implemented similar monetary measures with the IMF; inflation skyrocketed, and Nigerians were fed up with the increase in the cost of living. Protests rang throughout the streets during August of this year, citing the #EndBadGovernance protests, where twenty-two protestors were murdered with thousands arrested.

How much a country imports and exports influences the decision on which rate regime they should pursue as well as how robust their economy is at the current moment. Being a heavy import country with the lack of manufacturing diversity and capability for daily consumer produce, with a trade deficit, high inflation, and semi-mixed economy, Ethiopia should not have committed to these reforms right away, timing did not call for it.

Ethiopia’s vision here is to play for the long run. Prime Minister Abiy’s administration completely understands that the short-term implications will induce a heavy toll on the population, but how much can the population bear at once?

The timing of these reforms raises concern and puts things into perspective. Considering the Prime Minister Abiy administration’s Memorandum of Understanding (MoU) with Somaliland, the Egypt-Somalia military standoff in response to the MOU, TPLF internal divisions, Fano offensive, kidnapping epidemic, fallout with Eritrea, war-mongering speeches, and BRICS preparation, it reveals that the administration is caught between the strategic influences of Washington and Abu Dhabi.

Having strategic marine trading routes impacted in the Red Sea by the Houthis, Somalia, and Iran, Washington is keen on what ways Prime Minister Abiy could play to have an actor on the coast. It also exposes that the premier and his administration have neither the population nor a developmentalist strategy in mind but rather their “business partner’s” interests in mind.

Ethiopia’s admission into BRICS was not blissful news to Washington. Many feared that Washington would restrict new loans to Ethiopia and force Ethiopia to devalue the birr. Fast forward to today; their cards were executed. Prime Minister Abiy is playing too many cards at once; he is attempting to strike gold no matter the costs, without carefully examining the necessary measures to foundationally develop and progress the nation; he is stunting Ethiopia’s growth, not building it.

Managed-float rate regime: Swiss Franc (CHF) use case

If Ethiopia saw fit the need to commit towards such a drastic change monetarily, then why not introduce the implementation of a managed-float rate regime, similar to Switzerland’s? It would essentially be a gradual transition rather than a polarizing move.

Switzerland opted for a managed-floating exchange rate regime after the collapse of the Bretton Woods system in the 1970s in order to have flexibility in its monetary policies and adapt to changing economic circumstances. The managed-float rate enabled the Swiss National Bank (SNB) to control inflation and stabilize the economy while permitting the Swiss Franc to fluctuate within a range against other currencies. This strategy aimed to minimize volatility that could negatively impact trade and investment while ensuring Switzerland’s competitiveness in the international market. Ultimately, the managed-float regime offered a framework for balancing needs within the realities of an interconnected global economy.

Albeit, Switzerland’s economy greatly differs from Ethiopia’s, but the principal remains the same.

Ethiopia had an opportunity to benefit from a managed-float exchange rate regime. This strategy would have effectively addressed the country’s trade deficit and currency shortages while ensuring stability gradually.

By enabling the Ethiopian birr to fluctuate within limits, the government would have control over inflation and improve export competitiveness without the volatility that comes in accordance with a floating exchange rate. This approach would enable policymakers to step in when the currency experiences significant appreciation or depreciation, protecting industries and maintaining stability in foreign exchange markets.

Additionally, a managed-float rate would have enabled adjustments in rates based on economic fundamentals, attracting foreign investment and improving trade balances over time. This approach would have geared Ethiopia with a balanced strategy for promoting economic growth and stability while reducing risks associated with a fully floating currency regime.

Another simple solution

Simple monetary reforms for green-developmentalist strategies could have prevailed as well. Rather than completely abandoning the developmentalist strategy associated with the fixed rate regime or similar alternatives, which have resulted in additional unwarranted instability, the Ethiopian banking system should have partaken towards a growth-led green framework that would enable banks to accommodate banks’ demand for reserves to combat financial restrictions.

In addition, finances should flow towards investment with green and social benefits as opposed to inflation-driving speculative investment. Through this, structural change can be enforced to reduce import dependency, promote an influx or surplus of exports, and progress out of a foreign exchange shortage.

Remaining tasks                

“Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice.”

Adam Smith, Scottish economist and philosopher

The above quote emphasizes that in order for a nation to progress from poverty-ridden status to one of wealth and “prosperity,” the most necessary and critical elements are peace, “easy” or minimal tax burdens, and a fair legal arena that operates efficiently, adequately, and in accordance with justice. If these elements coexist with one another within a nation, Smith implies that natural economic growth will occur without excessive governmental interventions.

For perspective, Ethiopia is facing various internal and external threats, high taxes (and inflation), and currently has no legal judicial framework in its constitution to enforce justice adequately, especially towards those positioned at the political helm. No matter what Prime Minister Abiy does, he continues to fail to address the main points of Ethiopia’s problems, our constitutional frameworks, and our governmental structure. AS

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Beneal Walker is a technological revolutionist and economist.