"Why Ethiopia Ended Half a Century of Currency Control"

" Why Ethiopia Ended Half a Century of Currency Control \r\n For the past half-century, Ethiopia tightly controlled the official value of its currency, the birr. That changed in July, when unmanageable debts and dwindling foreign reserves forced the government in Addis Ababa to liberalize the exchange rate regime. The decision, which followed similar moves by Egypt and Nigeria, allowed the Horn of Africa nation to clinch $3.4 billion from the International Monetary Fund and a further $16.6 billion from the World Bank. It also opened the door to talks with creditors on restructuring at least half of its $28.9 billion in external debt. \r\n How did Ethiopia run into trouble? \r\n The government borrowed heavily during more than a decade of low interest rates to finance ambitious infrastructure projects that were expected to boost economic growth, but the investments drained its coffers. Wasteful public spending, shocks from the pandemic, a two-year civil war in the northern Tigray region, territorial conflicts, prolonged droughts and flooding all exacerbated the problem. \r\n Ethiopia\u2019s heavy debt burden and dearth of foreign currency caught up with it in December, when it defaulted on a bond payment. In July, left with just enough foreign reserves to cover two weeks of imports, it enacted painful measures, including floating the birr to secure an IMF program that would enable it to renegotiate its debt under the Common Framework \u2014 a pandemic-era program to help poorer countries rework their loans. It also overhauled its monetary policy, using interest rates rather than controls on private credit to try to contain inflation. \r\n How did the government try to control the currency?\u00a0 \r\n The central bank set the rate at which the birr could trade at. It also controlled access to foreign exchange. This encouraged the emergence of a lively parallel currency market. An estimated 80% of foreign-currency trades happened on the street, with US dollars fetching more than double the official rate. In recent years, foreign currency became even more scarce as imports outpaced exports, and international aid flows almost dried up following the outbreak of war in Tigray in 2020. In 2022, the government restricted imports of 38 items including perfume, chocolate and juice in an attempt to limit capital outflows. \r\n How did the currency depreciation unfold? \r\n Locked out of international capital markets after the December default, the government announced that it would float the currency. The birr\u2019s official rate immediately fell by 30% against the dollar on July 29, as the government sought to close the gap between the official and parallel markets. That enabled it to tap the IMF for funding and enter into talks to rework its debt. It also allowed commercial banks to set exchange rates and non-bank entities to operate foreign-exchange bureaus for the first time, and removed most of the import bans. \r\n Days later, dissatisfied with the progress in narrowing the gap between the official and parallel-market exchange rates, Prime Minister Abiy Ahmed berated the banks for inflating the value of the birr. The National Bank of Ethiopia intervened in the market on Aug. 7, selling dollars to commercial lenders at rates close to those on the parallel market. \r\n What\u2019s wrong with Ethiopia\u2019s economy? \r\n For decades, Ethiopia clung to the idea that development should be state-led. It avoided privatization, protected its banking and telecommunication industries from foreign competition and sought to channel private savings into development projects. Abiy changed course after taking office in 2018, welcoming foreign capital to maintain momentum in what was then one of the world\u2019s most rapidly expanding economies. \r\n He also scrapped bans on opposition and rebel groups, purged allegedly corrupt officials and ended two decades of acrimony with neighboring Eritrea \u2014 an initiative that won him the 2019 Nobel Peace Prize. But he struggled to contain ethnic tensions and his attempts to sideline the Tigray People\u2019s Liberation Front, once the nation\u2019s preeminent power broker, led to civil war. The fighting stalled economic reforms and prompted the US government to impose sanctions on Ethiopia and withdraw its duty-free market access. A peace deal was agreed in 2022, but efforts to get the economy back on track have been stymied, first by the worst drought in four decades and then by floods and soaring grain and fuel prices. \r\n How are the policy changes working out? \r\n The devaluation of the birr and an influx of IMF and World Bank funds are helping to normalize the foreign-exchange market and should ultimately unlock more external financing and foreign investment. New subsidies introduced by the government should help to cushion citizens against higher living costs. Still, the currency overhaul is adding stress to the economy even as pockets of conflict linger in parts of the nation. \r\n It also remains unclear whether Abiy\u2019s administration will agree to play a lesser role in the economy and allow foreigners to own property and buy stakes in national assets. In June, Ethiopia put the sale of state-owned Ethio Telecom to foreign investors on hold, opting to give domestic retail investors priority to take up stakes ahead of a listing on the nation\u2019s new securities exchange. \r\n\r\n \r\n \r\n \t A related QuickTake on Ethiopia\u2019s two-year civil war that tore the nation apart. \r\n \t Bloomberg stories on Ethiopia allowing its currency to plunge to secure an IMF bailout and on the central bank selling dollars at a special auction. \r\n \t A Bloomberg TV interview with Eyob Tekalign Tolina, state minister in the finance ministry. \r\n \t A Bloomberg Economics Insight on whether African nations should float their currencies, with lessons for Ethiopia. \r\n \r\n "

"Why Ethiopia Ended Half a Century of Currency Control"

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