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Analysis: Ethiopia’s birr plunges as currency crisis worsens, posing serious challenges for economy

Ethiopia is one of the nations dealing with a sharp decrease in the value of its currency. Since January 2022, the birr, has depreciated against the US dollar by a stunning 39% (Photo: static.vecteezy.com)

Addis Abeba – The local currency, the birr, has been experiencing a long-standing decline in value against major international currencies, most notably the US dollar. However, the current state of affairs has reached unprecedented levels, with the exchange rate soaring to unparalleled heights. With the official rate currently hovering around 55 birr per dollar, the scarcity of hard currency has now driven the black-market value of a dollar to exceed 110 birr. This exorbitant premium of over 100% marks a significant occurrence in the nation’s economic history.

Ethiopia is among the countries globally grappling with a substantial decline in its currency’s value. Recent data from the Troubled Currencies Project, which tracks exchange rates in black and spot markets, reveals that the Ethiopian birr has depreciated by nearly 40% against the US dollar since January 2022.

“The economic mismanagement has destroyed the country,” Steve H. Hanke, a renowned professor of applied economics and director of the Troubled Currencies Project, tweeted a month ago.

Ethiopia has also been ranked 13th among countries with struggling currencies, according to the currency watchlist compiled by the Troubled Currencies Project. The project, initiated by the Cato Institute, a public policy research think tank based in Washington, highlights that several African countries, including Zimbabwe and South Sudan, are among the top ten nations where currency depreciation has occurred rapidly over the past year. During the period since January 2022, the Zimbabwean dollar experienced a staggering 95% depreciation against the USD, while the South Sudanese pound depreciated by 55%.

Hanke suggests that various countries struggle to maintain a stable domestic currency for a range of reasons, including political mismanagement, civil war, and economic sanctions. Ethiopia serves as a prime example of Hanke’s analysis, as it aligns perfectly with the conditions he describes. In recent years, the country has been significantly affected by a conflict that has caused havoc in different regions, including the northern part of the country. As a result, its foreign currency reserves have been depleted significantly. According to a report published in May 2022 by Cepheus Growth Capital, an investment management firm, Ethiopia’s foreign currency reserves have reached a critical level of $1.3 billion.

Besides highlighting the gravity of this precarious situation, experts have raised concerns about the foreign exchange reserve, stating that it is not only unfavorable but also a cause for alarm. Tewodros Makonnen (PhD), a country economist at the International Growth Centre (IGC) Ethiopia, stated that the instability and conflict have obstructed foreign currency inflow by limiting tourism and foreign direct investment. IGC, founded in 2008, is an economic research center based at the London School of Economics.

Africa’s second-most populous country has been grappling with foreign exchange shortages for a long time. However, the issue has recently worsened due to development partners withholding promised funds. During the presentation of the budget proposal for the current Ethiopian fiscal year, Finance Minister Ahmed Shide emphasized that a significant portion of the pledged funds from development partners had been suspended. Over the past two years, external assistance has accounted for less than 22% of the planned amount, contributing to the foreign currency crisis.

Ethiopia takes 13th place among countries with challenged currencies (Photo: cato.org)

The existence of dual exchange rates has encouraged remittances to flow mostly through unofficial routes. Remittances to Ethiopia last year totaled 7.1 billion birr, according to a report by the National Bank of Ethiopia (NBE). But based on the World Bank’s 2017 estimate, a maximum of 78% of total remittances are sent through informal channels.

Insiders argue that the disparity between the formal and parallel markets is primarily caused by the increasing demand for buying and selling hard currency on the parallel market. Fikru Yadeta (name changed upon request), a key figure in the illicit black-market trade near the Ethiopian National Theatre, revealed that the black market is seeing a surge in buyers, especially importers, who are unable to fulfil their foreign currency requirements through regular banking channels. Fikru stated, “These buyers are willing to pay a substantial premium to meet their forex needs.”

The severe shortage of foreign exchange has become a critical issue for importers across various sectors. Industries such as manufacturing, agriculture, and construction have been particularly hard hit by this crisis. Unfortunately, even those involved in importing essential items like drugs and medical equipment have not been spared from its impact. For the past five years, Biruhtesfa Pharmaceuticals Import PLC has been importing medicines and medical equipment from abroad and distributing them to wholesalers. However, the company has faced challenges in obtaining an adequate amount of hard currency to sustain its operations in recent years.

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Abebaw Gessesse, a pharmaceutical regulatory affairs consultant at Biruhtesfa Pharmaceuticals, revealed, “It has been two years since we initiated the process of opening a letter of credit at the Commercial Bank of Ethiopia.” Since then, the company has been unable to secure a letter of credit worth $50,000.

In addition to the surge in demand, the black market is further fueled by rampant speculative practices, which are triggered by instability and conflict. According to Tewodros, a former junior research officer at the NBE with over 15 years of experience, “When the official market functions poorly, the role of the black market becomes detrimental.”

Fikru agrees with this analysis, recounting how the exchange rate in the black market skyrocketed to unprecedented levels within a few days after the Ethiopian National Defense Force seized Mekelle in late November 2020. “Many rushed to convert their financial assets, mostly denominated in the local currency, which resulted in a spike in the parallel market,” he recalls.

Regardless of the sources of the problem, experts indicate that the impact of currency depreciation is being felt by everyone in the form of higher prices. This is because importers, who purchase forex from the black market at inflated costs, eventually pass on their losses to consumers through increased prices.

A report by the Ethiopian Statistics Service reveals worrisome statistics, with the average annual inflation surpassing 20% since 2019. In May 2023, the Consumer Price Index (CPI) showed a staggering 30.8% increase compared to the same period last year. Essential food items such as tomatoes, onions, potatoes, meat, milk, and eggs have experienced the highest price surges, while non-food items like clothing, footwear, construction materials, and fuel have also seen substantial price hikes.

To address the foreign currency shortage, the government has implemented several measures. In October 2022, over 1,000 bank accounts were frozen, and shops suspected of involvement in the black market were closed. This was followed by the banning of 38 non-essential import goods by instructing commercial banks to stop issuing letters of credit for items like cigarettes and whiskey. However, experts emphasize the importance of focusing on comprehensive economic reforms, rather than just addressing immediate issues.

The homegrown economic reform agenda was one of the major initiatives launched in 2019 by the administration of Prime Minister Abiy Ahmed (PhD). It aims to establish sustainable solutions to forex imbalances by removing policy distortions in the forex market and allowing the exchange rate to be determined based on economic fundamentals. However, many of these tasks remain incomplete due to the COVID-19 pandemic and internal conflicts in the northern part of the country.

Approved by the National Macroeconomic Committee chaired by Prime Minister Abiy Ahmed (PhD), the second homegrown economic agenda focuses on the reforms expected to be implemented in the next three years (Photo: ena.et)

“If these reforms had been fully implemented, the current macroeconomic situation would be different,” Tewodros argued. 

Despite this, the government is preparing to resume the second phase of the homegrown economic reform agenda. Two weeks ago, consultations were held between the government and the executive committee of the Development Assistance Group (DAG) regarding the economic reforms expected to be implemented in the next three years.

Sources close to the matter have revealed to Addis Standard that negotiations between the government and Bretton Woods institutions include discussions about the need to devalue the local currency. Experts from the World Bank and the International Monetary Fund (IMF) are pushing for a higher devaluation, while government officials are skeptical due to concerns about inflation and increased government expenditure. The last devaluation of the birr occurred in October 2017, amounting to approximately 15%.

Of course, any devaluation of the birr will be painful for the entire nation, according to the expert. “But regardless of the pain, we must bite the bullet and proceed to address the currency rate misalignment in a sustainable way.”

Currently, Ethiopia maintains a controlled exchange rate for its local currency, gradually weakening it against major world currencies. However, the World Bank and the IMF have been urging a shift to a floating exchange rate to effectively dismantle the parallel market and establish a stable exchange rate regime. According to an article published on the official website of the World Bank in January 2023, Dilip Ratha, a lead economist at the World Bank, and his colleagues identified existing capital restrictions and the prevalence of multiple exchange rates as factors contributing to the decline in capital flow into Ethiopia through formal channels.

Acting quickly is crucial, according to Tewodros. “As the gap between the official and parallel markets continues to widen, the available options for the government are becoming scarce.” AS

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