Ethiopia : Dreamworld (By Kebour Ghenna) 

By Kebour Ghenna

Ethiopia’s recent transition from a fixed exchange rate to a market-based exchange regime marks a significant shift in its economic policy. This move has been applauded by the international community, particularly in the West. Proponents argue that allowing the currency to float will enable the market to determine its value, aligning it more closely with economic fundamentals. They also argue that a market-based regime could attract more foreign investment, as investors often prefer environments where currency values are dictated by market mechanisms rather than government controls.

However, many locals fear that this change could lead to rampant inflation, which is already a pressing issue, and higher debt servicing costs, further straining businesses and consumers alike.

The newly adopted market-based exchange rate is favored by the IMF: However, several countries that were touted as beneficiaries of this regime are currently facing significant challenges. Here are a few examples: Bangladesh, which moved to a floating exchange rate in 2003, initially saw success but is now experiencing economic difficulties. Ghana transitioned to a floating exchange rate in 1986 as part of broader economic reforms but essentially went bankrupt in 2003. Similarly, Zambia adopted a floating exchange rate in the early 1990s and declared bankruptcy in 2022.

Not a promising track record!

Obviously one of the problems stems from the fact that the dollar is the benchmark for the value of all other currencies. When U.S. interest rates rise, for example, it causes problems not only for the U.S. economy and its banking system but also for other currencies, especially those of heavily indebted countries, which will also be negatively affected. It’s not hard to see where this leads.

Suffice it to say from our understanding of market-based currency exchange, and the consequences of risk factors on supply and demand for it, that international markets will determine outcomes.

One more point: We’ve been told that this new policy will stabilize the market and save the venerable Commercial Bank of Ethiopia from collapse, as it’s reportedly in pretty bad shape. However, there are surely many other ways to address CBE’s financial distress without adopting a market-based exchange regime. For instance, the government could inject capital directly into the bank to strengthen its balance sheet or issue recapitalization bonds to shore up its capital. These bonds could be held by the bank or sold in the market to raise cash. Another option would be to establish a separate entity to take over non-performing loans (NPLs) and toxic assets, allowing CBE to focus on its core operations. Implementing stringent cost-cutting measures, including the disposal of its high-rise headquarters, could also be considered.

While the present government points to long-standing problems inherited from the previous administration, it’s clear that the current one has also contributed to the bank’s woes. Both past and current administrations have largely neglected the need for ensuring CBE’s survival and return to financial health.

Now, if the market-based exchange rate is bad, can we then say maintaining a fixed rate is the better option. The traditional means of “fixing” the exchange rate, has also not worked well for Ethiopia.

In many developing countries with deficient governance, high level of corruption, and depleted reserves the tendency is to set the exchange rate too high and impose tighter restrictions. Like in Ethiopia. This resulted in a thriving parallel black market, benefiting those with privileged access to dollars or euros, such as individuals close to the government and those receiving remittances outside the banking system. In Ethiopia, this parallel market rate has been twice as high as the fixed (official) rate. This situation not only depresses the economy but also discourages investment, particularly in the export sector, as exporters know that their earnings must be converted at the unfavorable official exchange rate.

It is essential to recognize that some fast-developing emerging countries have successfully used fixed rates to provide economic stability and foster growth. Therefore, when the administration claims that floating is the best reform for Ethiopia, this assertion should be approached with caution. 

Editor’s note :The article appeared first on Kebour Ghenna’s Personal Social Media page. 

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