Ethiopia devalues the birr and switches to a market-based foreign exchange system

The National Bank of Ethiopia (NBE) has decided to loosen restrictions on the amount of foreign currency held by commercial banks and exporters and to let market forces determine the value of its currency, the birr. These actions are part of a series of steps to increase the supply of dollars and stimulate economic activity in a nation beset by severe shortages of hard currency and rising inflation.

The World Bank and International Monetary Fund (IMF) are putting more and more pressure on Prime Minister Abiy Ahmed’s administration to float the nation’s currency and carry out important foreign exchange market reforms in order to be eligible for over $10 billion in new funding.

The proposed stock market will now be accessible to foreign investors, non-bank foreign exchange bureaus will be established to facilitate the buying and selling of foreign exchange, and limits on the amount of US dollars that visitors may bring into and depart from the nation will no longer apply, according to a statement released by the NBE on Monday.

The bank stated, “The reform addresses a long-standing distortion within the Ethiopian economy and introduces a competitive, market-based determination of the exchange rate.” “A larger package of economic reforms is being implemented and accelerated over the coming months, of which Ethiopia’s foreign exchange reform is just one component.”

Following the lifting of trading restrictions, the value of the birr dropped by 30% versus the dollar, hitting 74.73 on July 29 from 57.48 on July 26. This was reported by Reuters.

The reform package seeks to promote sustainable, inclusive, and broad-based growth while reestablishing macroeconomic stability and bolstering private sector activity. It is based on the nation’s Home-Grown Economic Reform Plan (HGER 2.0).

A move to a market-based exchange regime, where banks are now permitted to buy and sell foreign currencies from/to their clients and among themselves at freely negotiated rates, is one of the major new policy changes outlined in the foreign exchange reforms announced today (July 29). The central bank added that the NBE would only make limited interventions to support the market in its early stages and if necessary due to disorderly market conditions.

Exporters and commercial banks will now keep foreign exchange in order to significantly expand the amount of foreign exchange available to the private sector, so doing away with the need to surrender it to the NBE.

While capital account outflows are still restricted, import restrictions—which had barred 38 product categories—have been lifted, enabling a more extensive liberalization of the foreign exchange market for the import of goods and services.

The foreign exchange retention rules for exporters have been improved, allowing them to retain 50% of their foreign exchange proceeds instead of 40%. The rules governing banks’ foreign exchange allocation, which were based on a waiting list system for various import categories, have been abolished.

Additionally, the NBE has made it easier for residents to open foreign currency accounts based on remittances, transfers from overseas, foreign exchange-based salaries or rental income, and other specific cases. Residents can also use these accounts to pay for foreign services. The NBE has also streamlined the rules for foreign currency accounts, particularly those held by foreign institutions, foreign direct investors, and the diaspora.

The removal of interest rate ceilings that previously applied to banks or private companies borrowing from overseas, the opening of the Ethiopian securities market to foreign investors with later-specified terms and conditions, and the reorganization of various regulations regarding the amount of foreign currency that visitors may bring into or take out of Ethiopia are additional measures.

Companies located in special economic zones are also entitled to exceptional foreign exchange rights from the central bank, which include the opportunity to keep all of their foreign exchange profits.

According to the NBE, “the reform in the exchange rate system being introduced today is critically necessary, but it is also challenging in several respects.”

“An unanchored parallel market exchange rate, along with high inflation, has emerged as a result of the current foreign exchange rate system, despite its initial intention to help ensure a stable exchange rate and low inflation,” the statement continued.

A three-year agreement worth roughly $2.9 billion under the Extended Fund Facility (EFF) and Extended Credit Facility (ECF) was approved by the IMF Board on December 20, 2019, to assist Ethiopia in implementing the Homegrown Economic Reform Plan, preserving macroeconomic stability, and raising living standards.

The violence in Tigray’s northern region, however, forced a suspension of the initiative; talks only began following a peace agreement in November 2022.

Following a financial crisis brought on by the Covid-19 outbreak and the two-year conflict in Tigray, Addis missed a $33 million coupon payment on its Eurobond last year, joining Zambia and Ghana in defaulting on their external debt.

The Finance Ministry of Ethiopia reports that as of March 31, 2024, the country’s public debt was $65.82 billion, while as of June 30, 2023, the total external debt had increased by 0.5% to $28.38 billion from $28.24 billion.