The government’s decision to move beyond managed currency devaluation and accept a currency float comes as a surprise, even to me—a long-standing advocate for the liberalization of the financial sector. While the exact motives behind this move are unclear, it starkly highlights the dire state of the Ethiopian economy. This action seems to be the only choice left, effectively waving the white flag and conceding to the World Bank’s demands.
Ethiopia finds itself with few alternatives, primarily due to the poor management of the economy. By undermining the contributions of Chinese loans that fueled Meles Zenawi’s economic model, we have burned crucial financial bridges. The much-heralded BRICS alliance has not yet matured into a supportive fraternity, making Ethiopia’s recent inclusion appear more like affirmative action than genuine economic solidarity. Additionally, the ongoing war has severely depleted the country’s dollar reserves, with the cost of drones and cannons consuming vast sums of foreign currency.
What happened last couple of weeks can hardly be seen as a reform carried out in good faith; it feels more like an act of desperation, akin to raising one’s arms and surrendering, saying, “Do whatever you like.” At this critical juncture, three key issues arise: first, whether this policy shift is truly a liberalization as it has been portrayed; second, who stands to lose the most from this change; and third, what lessons we can draw from the experiences of other countries.
Is this the end of socialist controls or merely a change in management?
Fifty years ago, Ethiopia boasted a free economy with no foreign currency control. The Ethiopian dollar was pegged to the US dollar and gold, with a conversion rate of 2.10 Ethiopian dollars to 1 USD. Historical data from the Addis Ababa Chamber of Commerce shows that Ethiopia exported more to Europe, the US, Saudi Arabia, and Yugoslavia than it imported from these countries, with a negative trade balance only with Italy and France. There was no shortage of foreign currency to cover national imports.
However, the communist revolution changed everything. In 1977, the government imposed strict socialist controls over the economy, leading to numerous problems and hardships.
Many hoped that floating the currency and lifting the criminalization of holding foreign currency would mark the end of this era. Yet, despite the currency float, the socialist policies surrounding the dollar remain firmly in place.
The regulation introduced by the governor of the National Bank of Ethiopia, Mammo Meheretu (PhD) is even more stringent than those enacted under Mengistu Hailemariam (Col.) in 1977. According to the directive, unless provided by pertinent laws, or without authorization from the National Bank, a person “may not hold or carry foreign currency.” Concerning “accounts abroad” another article stipulates that no Ethiopian national, natural or juridical person residing in Ethiopia is permitted to own, possess, or operate a foreign currency account abroad.
These policies hardly represent a liberalization of the economy.
The public is expected to endure the hardship without any of the freedoms and benefits typically associated with liberalization. Nothing has changed for exporters either, who continue to face stringent conditions. The regulation mandates that exporters surrender 50 percent of their export proceeds to the bank.
Exporters are left wondering why they should hand over their earnings to the National Bank. The government did not intervene to keep the dollar low; exporters purchased everything at market price. Therefore, what justification does the National Bank have for seizing 50 percent of their export earnings? If the National Bank wants foreign currency, it should operate in a free market and purchase it using the money it prints, rather than confiscating the earnings of exporters.
The most alarming aspect is the government’s ability to alter this percentage at will. The percent share of foreign exchange proceeds to be converted immediately, may be modified from time to time by the NBE, according to the directive. This implies that the government could increase the surrender of export earnings to 80 percent once the World Bank and IMF release their funds.
Despite claims of a free-floating currency, the central bank continues to exert tight control over how exporters can spend their remaining forex earnings. The directive states, “Foreign exchange earners shall be entitled to utilize—only for their own use by the same legal entity—the foreign exchange balance in their Foreign Exchange Retention Account.”
This effectively restricts exporters, limiting their ability to reinvest or diversify their earnings freely.
Moreover, the supposed free market does not extend to local banks. As foreign banks prepare to enter the Ethiopian market, local banks find their hands tied by restrictive regulations. The directive prohibits banks from entering into loan or guarantee agreements with foreign lenders without authorization from the National Bank, thereby hampering their competitiveness and growth.
Among the most stringent regulations is Article 22.1.1, which limits banks’ holdings of foreign currency. Authorized banks, according to the directive, can only hold up to 10 percent of their paid-up capital in foreign currency cash notes as a working balance at the close of each calendar month. “Any excess holding shall be surrendered to the National Bank within five working days from the end of the calendar month,” it reads.
Given that the paid-up capital of most banks is less than USD 100 million due to devaluation, banks can only hold less than USD 10 million. Any excess must be surrendered to the National Bank, further restricting their operations.
The prohibitions detailed in the 108-page document continue, prompting a recommendation for bank CEOs to scrutinize it thoroughly.
For instance, authorized banks cannot ship foreign currency cash notes abroad, it imposes limits on cash holdings for individuals traveling to and from Ethiopia, individuals entering or leaving the country may carry a maximum of 3,000 birr, equivalent to about USD 25 at the current exchange rate, and travelers to Djibouti or other port cities in neighboring countries may carry up to 10,000 birr, approximately USD 85. Further, unless authorized by the National Bank, individuals may not transfer or pay foreign currency in cash to third parties as a donation, gift, or to settle obligations. The directive also prohibits carrying or conducting cash transactions in foreign currency within Ethiopia, except in specific cases authorized by the National Bank.
These stringent measures underscore the continuation of socialist economic controls, masked as liberalization under new management.
The burden of these policies falls most heavily on those with fixed incomes. In just one week, the salaries of Ethiopian teachers, police officers, army personnel, civil servants, and university lecturers have effectively been slashed by 100 percent, and it continues to diminish.
A university lecturer’s salary, which was about 8,000 birr six years ago and equivalent to USD 363 per month, is now worth just USD 69 and falling. An army soldier’s salary, once 3,000 birr or about USD 136 per month, has dropped to USD 26. These figures, valid as of August 6, 2024, are likely to decrease further as the currency continues to depreciate.
To maintain the lifestyle of a university lecturer from six years ago, their salary would need to increase to 41,000 birr. Similarly, the salary of a soldier or police officer would have to rise to 15,640 birr to restore their standard of living. It is inconceivable that the government will increase a private soldier’s salary to 15,640 birr, highlighting the disproportionate burden placed on those with fixed incomes.
If the criminalization of carrying foreign currency persists, a hotel waiter might have to refuse a USD 10 tip out of fear of being caught on the way to the bank. Savers see the majority of their savings eroded, while borrowers find themselves in a favorable position.
The experience of other countries that have undergone liberalization offers little encouragement.
In Sudan, for instance, the exchange rate of one USD to 55 Sudanese pounds plummeted to 1 USD to 600 pounds following the introduction of a free-floating currency system.
The most alarming aspect of Ethiopia’s current economic situation is that the government cannot borrow without the explicit permission of the World Bank and the International Monetary Fund (IMF). Recent reports indicate that the World Bank has granted Ethiopia permission to borrow USD 900 million from other sources to complete the Koysha power station. This effectively means that decisions on loan agreements are no longer in the hands of the Ethiopian Parliament but are determined by World Bank and IMF officials.
Debt Crisis: a growing 3.2 trillion birr debt
Ethiopia is on the precipice of a debt crisis, with its foreign currency debt estimated at approximately USD 28 billion. This debt was manageable when the Eurobond was issued at an exchange rate of 22 birr to the dollar, requiring the government to collect 22 billion birr in taxes to service it.
Today, with the birr trading at around 115 to the dollar, the government must raise 115 billion birr to meet its Eurobond obligations, excluding interest.
In the 2023/24 fiscal year, Ethiopia’s total tax revenue was around 700 billion birr. If the exchange rate remains stable, 115 billion birr will be needed annually for debt repayment. However, if the birr continues to depreciate, as seen with the Sudanese pound, Ethiopia’s annual tax revenues may not even cover the $1 billion Eurobond payment.
At the current exchange rate, Ethiopia’s total debt stands at a staggering 3.22 trillion birr, and it continues to grow daily. The political leadership may be tempted to overlook the implications of this mounting debt, leaving future generations to bear the burden of their decisions.
Yared Haile-Meskel is the managing director of YHM Consulting Plc. He can be reached at [email protected]
Contributed by Yared Haile-Meskel
