Ethiopia’s economic transformation
Ethiopia is undergoing economic transformation following Prime Minister Abiy Ahmed’s announcement of a comprehensive macroeconomic overhaul on July 28th.
This bold and eagerly awaited decision shifts Ethiopia to an interest rate-based monetary policy and a market-based foreign exchange rate. According to officials, the new policies aim to curb inflation and enhance banking efficiency.
As a result, the Ethiopian birr has significantly depreciated. Awash Bank reported the Commercial Bank of Ethiopia’s exchange rate at 90.00/94.50 birr per USD, down from 57.49/58.64 to 83.94/85.62 in just one week.
Prime Minister Ahmed has urged banks to align the official exchange rate of 118 birr to one US dollar with the parallel market rate. These policies could fundamentally reshape Ethiopia’s economic landscape, 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,” said Sam Rosmarin, CIO of African Bamboo.
Unlocking external financing
Following the announcement, Ethiopia secured an IMF loan of USD 3.4 billion over four years under the Extended Credit Facility (ECF), with an initial disbursement of USD 1 billion. The larger package of USD 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 also inked a USD 1.5 billion package, which includes a USD 1 billion grant and a USD 500 million concessional credit. The combined contributions from the World Bank and IMF totaled USD 5 billion in a single week.
“We will need to sustain supportive macroeconomic policies, including the elimination of monetary financing of government deficits, monetary policy tightening, and prudent fiscal management,” said Antoinette Sayeh, deputy managing director of the IMF.
Maryam Salim, the World Bank Country Director, emphasized the importance of safeguarding the vulnerable and impoverished during this economic transition and increasing opportunities for them.
Impact on Ethiopia’s Economy
The market-based currency rate is expected to promote growth, attract foreign direct investment, and increase investor confidence. While the depreciation of the birr presents challenges in terms of managing inflation and maintaining financial stability, it may also boost the competitiveness of Ethiopian exports.
The reforms could open new avenues for investment in industry, services, and agriculture. Agro-processing might see a surge in investment, given that agriculture employs over 70% of the labor force and contributes 33.3% of the GDP.
With increased access to foreign exchange, the industrial sector—which currently contributes 6.6% of GDP—could expand. The services sector, comprising 45.3% of GDP and including banking, travel, and telecommunications, might experience significant growth.
However, these initiatives must contend with underlying challenges such as political instability, climate change, and security concerns. Addressing these issues is crucial to creating a stable investment climate.
Analysts, like Davis Githinji of Sterling Capital, note that the birr devaluation will have distinct effects. Comparing the situation to Argentina and Nigeria, Githinji highlights potential cost increases when the official rate aligns with the black market rate. However, the inflationary impact might be less severe than anticipated since many goods are already priced at black market rates.
Foreign exchange losses could affect Ethiopia’s private sector. Businesses like Safaricom Ethiopia, which operates at the official market rate, will face higher borrowing costs due to increased benchmark rates. Ethiopian Airlines may attract more tourists due to the weaker birr but will incur higher costs for importing aircraft parts. Ethiopian Electric Power’s import expenses will rise, although its access to foreign exchange might improve.
Ethiopia can learn from the devaluation experiences of Ghana and Zambia. Key lessons include the importance of strong foreign exchange reserves, well-coordinated monetary and fiscal policies, and effective communication to manage market expectations.
In Zambia, devaluation led to rapid inflationary pressures and higher business costs initially. However, over time, foreign exchange availability improved, and the market stabilized. Ghana’s devaluation resulted in prolonged economic instability, increased operating costs, and inflation.
In summary, these reforms and birr devaluation present short-term challenges but hold the potential for long-term stabilization and growth. Effective macroeconomic policies and measures to mitigate immediate adverse impacts on businesses and consumers are essential for a positive outcome.
Agnes Gitau, Executive Director at the Eastern Africa Association and partner at the advisory firm GBS Africa, provides political and economic risk advisory for businesses with an interest in East Africa.