Ethiopia’s Currency Liberalization: What It Means for the Economy and Investors
For over fifty years, Ethiopia tightly controlled the value of its currency, the birr. This longstanding policy shifted dramatically in July when the government, grappling with unsustainable debt levels and shrinking foreign reserves, was compelled to liberalize the exchange rate. The move, similar to recent actions by Egypt and Nigeria, enabled Ethiopia to secure $3.4 billion from the International Monetary Fund (IMF) and an additional $16.6 billion from the World Bank. This critical decision also set the stage for negotiations to restructure at least half of the country’s $28.9 billion external debt.
How Ethiopia Found Itself in Economic Trouble
Ethiopia’s financial woes stem from years of heavy borrowing at low-interest rates to finance ambitious infrastructure projects aimed at spurring economic growth. However, these investments severely drained the country’s finances. Additional pressures from inefficient public spending, the global pandemic, a two-year civil war in the Tigray region, territorial disputes, prolonged droughts, and severe flooding compounded the economic strain.
By December, the heavy debt burden and lack of foreign currency reserves reached a breaking point, leading to a default on bond payments. With foreign reserves only sufficient to cover two weeks of imports, Ethiopia took drastic measures in July, including floating the birr to secure an IMF program. This program was essential for renegotiating the country’s debt under the Common Framework, a global initiative to help poorer nations restructure their debts during the pandemic. Ethiopia also revamped its monetary policy, shifting from credit controls to interest rate management as a tool to combat inflation.
The Former Approach to Currency Control
Under the previous system, Ethiopia’s central bank tightly regulated the exchange rate of the birr and controlled access to foreign currency. This rigid control led to the rise of a parallel currency market, where an estimated 80% of foreign-currency transactions took place, often at rates double the official exchange rate. As imports consistently outpaced exports and international aid dwindled following the outbreak of war in Tigray, foreign currency became increasingly scarce. In 2022, the government attempted to curb capital outflows by restricting the import of 38 items, including luxury goods like perfume and chocolate.
The Impact of Currency Depreciation
Facing exclusion from international capital markets after the December default, the Ethiopian government announced the flotation of the birr. On July 29, the official exchange rate of the birr plummeted by 30% against the dollar as the government moved to narrow the gap between the official and parallel market rates. This devaluation was crucial in unlocking IMF funding and initiating debt restructuring talks.
Additionally, the government allowed commercial banks to set exchange rates and enabled non-bank entities to operate foreign-exchange bureaus, while removing most import bans. However, progress was slower than expected in narrowing the gap between official and parallel exchange rates. Prime Minister Abiy Ahmed responded by publicly criticizing banks for inflating the value of the birr. Consequently, the National Bank of Ethiopia intervened on August 7, selling dollars to commercial banks at rates aligned with those on the parallel market.
The Broader Economic Context
For decades, Ethiopia adhered to a state-led development model, shunning privatization, protecting key industries like banking and telecommunications from foreign competition, and channeling private savings into government projects. However, since taking office in 2018, Prime Minister Abiy Ahmed has pursued a different path. He welcomed foreign capital to sustain the momentum of what was one of the world’s fastest-growing economies at the time. Abiy also initiated political reforms, lifting bans on opposition groups, tackling corruption, and securing a peace deal with neighboring Eritrea, which earned him the 2019 Nobel Peace Prize.
Despite these efforts, Abiy struggled with internal ethnic tensions, leading to a civil war with the Tigray People’s Liberation Front. This conflict, along with external sanctions, particularly from the US, stymied economic reforms. The situation was further exacerbated by the worst drought in four decades, floods, and rising global grain and fuel prices.
Assessing the Impact of Policy Changes
The devaluation of the birr and the influx of funds from the IMF and World Bank are helping to stabilize Ethiopia’s foreign-exchange market, which could ultimately unlock more external financing and attract foreign investment. The government’s introduction of new subsidies aims to shield citizens from rising living costs. However, these currency reforms are adding strain to an already fragile economy, with ongoing conflicts in some regions.
It remains uncertain whether the Abiy administration will reduce its role in the economy, allowing greater foreign ownership of property and stakes in national assets. In June, the Ethiopian government postponed the sale of the state-owned Ethio Telecom to foreign investors, opting instead to give priority to domestic investors before a planned listing on the country’s new securities exchange.
Conclusion: Opportunities and Challenges for Investors
Ethiopia’s decision to liberalize its currency represents a significant shift in economic policy, offering both opportunities and challenges for investors. While the devaluation of the birr and the government’s reforms may pave the way for greater foreign investment and economic stabilization, the country’s political and economic landscape remains complex and fraught with risks. Investors looking to capitalize on Ethiopia’s potential should be prepared for a volatile environment as the nation navigates these profound changes.
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