The views, statements and opinion in the article reflects that of the writer’s , NOT borkena.com ‘s
By Teweldemedhin Aberra
The Dollar Rationing System
Before the introduction of the new freely floating foreign currency market, Ethiopia did not have an official currency market. Instead, a foreign currency rationing system was in place. The government rationed the available foreign currency to those in need, such as importers and travelers, based on a set of rules designed to allocate the currency fairly according to its intended use.
Rationing is a non-market mechanism for distributing commodities and comes with a multitude of challenges. Although it is intended to be a fair method of distribution during sudden shortages, it can exacerbate shortages if not quickly replaced by normal market mechanisms. For example, during World War II, England rationed commodities such as food, fuel, and clothing, which, although necessary, led to widespread shortages and black markets. Similarly, during the COVID-19 pandemic, some countries had to ration essential goods like medical supplies, toilet paper, and sanitizers temporarily. Market economies implement rationing only in extreme instances and on a temporary basis.
Prolonged rationing regimens give rise to black markets for the rationed commodities, as beneficiaries of the rationing scheme can profit by selling their rations instead of using them for the intended purpose. In the case of the former foreign currency rationing system, importers and travelers who managed to secure a significant amount of foreign currency could sell it on the black market at a substantial profit. At one point, you could make about 60 Birr on each dollar obtained from the government.
This substantial profit naturally tempted government officials involved in the allocation of dollar rations to collaborate with black market operators to share in the profits. The government tried to institute a collection of measures to tackle the black market, including the extreme practice of searching the wallets of Ethiopians traveling abroad to find dollars they might have bought on the black market. Unsurprisingly, these measures failed, as operating against such a powerful market force is very difficult.
In rationing regimens, when consumers receive commodities at subsidized prices, someone has to bear the cost of the subsidy. In Ethiopia’s former currency rationing system, the entities that generated the dollars were responsible for paying the subsidy. This included the government, which raised dollars from aid and loans, exporters, and individuals who voluntarily surrendered their dollars to banks in the form of dollar notes or remittances through official channels.
These sources of dollars were forced to sell their dollars at a 60 Birr loss per dollar compared with the black market price, which was the only real currency market at the moment. This loss was so significant for exporters that their export businesses were usually not profitable. As a result, the
government had to convince them to continue operating by providing very cheap and easy loans and other incentives. Most export commodities, such as livestock, generated more revenue for exporters when sold in the local market rather than when exported. This also created a bizarre black market where export commodities were sold locally. Consequently, there was little incentive for exporters to invest in improving and expanding their production, as they were primarily motivated by the government incentives rather than the money they made from exports. The result of this was directly reflected in the stagnant export volume, even as the economy grew during the more than three decades that the currency rationing regimen was in operation.
Thus, the rationing system exacerbated the foreign currency shortage in two ways. On one hand, it encouraged the waste of limited foreign currency resources, and on the other hand, it discouraged exports. It is a system that should have been abandoned a long time ago, and it would be extremely irresponsible to maintain it.
Inflation and Currency Market
The widely cited argument against the introduction of a foreign currency market is that when the dollar rationing is stopped, commodities bought in dollars will automatically become more expensive and contribute to the already high inflation in the economy. This is expected as a one-time adjustment when the official currency market balances.
If the official currency market has sufficient freedom for buyers and sellers to buy and sell dollars, the official and parallel exchange rates will converge.
It is widely understood that most importers used to price the goods they sell based on the black market value of dollars, even if they might have obtained the dollars from the rationing system at below-market prices. Hence, no large swing in imported commodity prices is expected as the price of dollars in the official market and the black market converge.
However, there is still a risk that the price of dollars in both the official and black markets could quickly surge together due to the introduction of the official foreign currency market. One reason is the so called ‘self-fulfilling prophecy’ phenomenon, where prices increase when market players strongly believe the price will increase. In the case of the dollar market, if market players believe that its price will skyrocket, buyers will want to purchase dollars before the price increases, and sellers will want to hold on to their dollars because they expect to get a better price in the future. This will drive demand and restrict supply, in turn increasing the price. However, this phenomenon is self-limiting for dollars as a commodity, as dollar holders can’t keep holding their dollars indefinitely. At some point, they will have to start selling their dollars to participate in the Ethiopian economy that operates in Birr.
A more serious risk is entities taking loans in Birr to buy dollars. If, for example, the government takes on debt to buy dollars from the currency market, it will quickly drive up the price of dollars, as the government can take on as much Birr debt as it wants. The solution for this is for the government to institute tight fiscal discipline. The national bank can also take actions to control the expansion of the money supply. It is very important to note that this mechanism of price increase is not unique to dollars; if the money supply expands even when the exchange rate for dollars remains constant, inflation will increase for commodities.
In any case, imported goods account for 15% of the GDP, which means the increase in the price of imported goods will only contribute a fraction to overall inflation. The solution for inflation is reducing
the money supply, and that applies both to foreign currency and products/services produced locally.
In summary, inflation for imported goods and locally produced goods is tackled together, and the dollar as a commodity is not different. The measures that address general inflation will also address dollar price inflation.
Timing
The ideal timing for this reform was when the Derg regime was overthrown in 1991 and the EPRDF abandoned the rationing system for household consumables such as cooking oil and soap. The EPRDF had every opportunity to introduce a currency market since then but somehow did not.
Some argue that the reform should not be introduced in the current unstable security situation in Ethiopia. This argument is flawed because there is no logic that supports maintaining a wasteful policy is somehow good for security. On the contrary, the economic benefits from this reform will create more resources to tackle security problems. The time for the reform is now.
Conclusion
The introduction of the currency market is a long-overdue and necessary measure, the delay of which denied the economy the opportunity to expand foreign trade and connect the country to the global system of finance, capital, and technology. The government should be applauded for undertaking such a critical reform despite its political cost associated with removing a widespread rationing system that effectively subsidized imports. The government should work with the IMF and World Bank to address short-term challenges and monitor the transition. The capital flow control measures included in the reform should be vigorously enforced to ensure that dollars bought in the currency market do not flow out of the country. With the former, complex, and wasteful dollar rationing system no longer in place, the government will find it easier to enforce capital flight controls and ensure that all excess dollars are sold back to the market.
Editor’s note : Views in the article do not necessarily reflect the views of borkena.com
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