BY AGNES GITAU
Ethiopia is undergoing a profound economic transformation as a result of Prime Minister Abiy Ahmed’s announcement of a comprehensive macroeconomic overhaul on July 28.
This bold and eagerly awaited decision moves Ethiopia to an interest rate-based monetary policy and a market-based foreign exchange rate.
This, according to officials, aims to reduce inflation and boost banking efficiency. The outcome has been a significant depreciation of the Ethiopian Birr. Awash Bank reported the Commercial Bank of Ethiopia’s exchange rate at 90.00/94.50, but it dropped from 57.49/58.64 to 83.94/85.62 in just one week.
PM Abiy has urged banks to align the official exchange rate of 118 Birr to $1 with the parallel market rate. These policies could potentially alter Ethiopia’s economic environment, thereby influencing trade and foreign investment.
“The Ethiopian government has taken a necessary step to liberalise its exchange rate, moving away from a patronage-based system to encourage exports and formal remittances,” opines Sam Rosmarin, CIO of African Bamboo.
OPPORTUNITY TO UNLOCK EXTERNAL FINANCING
Following this announcement, Ethiopia received an IMF loan of $3.4 billion for four years under the Extended Credit Facility (ECF), with an initial disbursement of $1 billion.
We will need to sustain supportive macroeconomic policies, including the elimination of monetary financing of government deficits, monetary policy tightening, and prudent fiscal management.
Antoinette Sayeh
The larger package of $10.7 billion includes debt restructuring, grants, and loans. Hon. Eyob Tekalign, Ethiopia’s State Minister of Finance, stated that the IMF agreement paves the way for a long-overdue debt restructure to take place in three to six months.
Ethiopia and the World Bank inked a $1.5 billion package, which included a $1 billion grant and a $500 million concessional credit. The World Bank and IMF contributed $5 billion in total in a single week.
According to Antoinette Sayeh, deputy managing director of the IMF, “We will need to sustain supportive macroeconomic policies, including the elimination of monetary financing of government deficits, monetary policy tightening, and prudent fiscal management.”
The World Bank Country Director, Maryam Salim, underlined how crucial it is to safeguard the weak and impoverished throughout this economic transition and to increase possibilities for them.
REFORMS IMPACT ON ETHIOPIA’S ECONOMY
It is anticipated that the market-based currency rate will promote growth, draw foreign direct investment, and increase investor confidence.
Although the depreciation of the Birr presents issues in terms of managing inflation and maintaining financial stability, it may also increase the competitiveness of Ethiopian exports.
The changes may open up new avenues for industry, service, and agriculture investment. Agro-processing could see an increase in investment, given that agriculture employs over 70% of the labour force and contributes 33.3% of the GDP.
With more foreign exchange access, the industrial sector—which presently contributes 6.6% of GDP—could expand. Services, which make up 45.3% of the GDP and include banking, travel, and telecommunications, might expand significantly.
Despite these bold initiatives, it is worth noting that the underlying dynamics that are likely to impact Ethiopia’s business climate, such as political unpredictability, climate change, and security concerns. In order to create a stable investment climate, these issues must be resolved.
Analysts, such as Sterling Capital’s Davis Githinji, commenting on Ethiopia say the Birr devaluation will have distinct effects. The analyst compares Argentina and Nigeria and points out possible cost increases when the official rate matches the black market rate.
Nonetheless, the inflationary effect might not be as bad as anticipated because many goods are already priced at the black market cost.
Foreign exchange losses will be a problem for Ethiopia’s Private sector, among them businesses such as Safaricom Ethiopia, which operates at the official market rate.
Higher benchmark rates will also lead to increased borrowing costs, which will impact their profitability. Ethiopian Airlines may profit from more tourists as a result of the reduced value of the Birr, but it will incur higher costs for importing aircraft parts. And although Ethiopian Electric Power’s import expenses would increase, the company’s access to foreign exchange might improve.
The country can learn from the devaluation experiences of Ghana and Zambia. The necessity of strong foreign exchange reserves, well-coordinated monetary and fiscal policies, and efficient communication to control market expectations are among the most important lessons learnt.
In Zambia, devaluation resulted in rapid inflationary pressures and higher business expenses but as time went on, foreign exchange availability improved, and the market steadied. The devaluation of Ghana resulted in sustained economic instability, higher operating costs, and inflation.
In summary, Ethiopia’s economic reforms and Birr devaluation pose short-term challenges but hold potential for long-term stabilisation and growth.
Effective macroeconomic policies and measures to mitigate immediate adverse impacts on businesses and consumers are crucial for a positive outcome.
Agnes Gitau is the Executive Director at the Eastern Africa Association and a partner at the Advisory Firm GBS Africa where she provides political and economic risk advisory for business with an interest in East Africa.
@AgnesGitau
