Ethiopia: foreign exchange constraint and market liberalization dilemma

As Ethiopia’s constrained foreign exchange market continues to worsen, foreign firms as well as those involved in importing have found it difficult operate. Citing deteriorating macroeconomic conditions, French Telecom Orange retracted bid to take a 45% stake in state owned Ethio-Telecom, with a customer base of 70 million subscribers. Previously Ethio-lease, the only foreign firm operating in the equipment and machinery leasing in the country exited. Days later, Bank of Ethiopia (BoE) Governor Mamo Mihretu dismissed claims of regulatory changes affecting their decision.

Although Ethiopia has announced finalizing rules for banking liberalization, increasing challenges with foreign currency availability may derail plans. The country, the second-most populous in Africa, has been a target for foreign investors eyeing opportunities in its financial sector. In an interview with John Everington, Mamo Mihretu discussed progress on debt restructuring, the fight against inflation, and plans to attract foreign investment.

Regarding the country’s banking sector, Governor Mihretu described it as healthy and stable, with plans to deepen its modernization and open it to foreign investment. Ethiopia is finalizing a legal and regulatory framework to enable foreign banks to operate in the country, with the intention of allowing them to acquire shares in existing financial institutions.

However, these plans have been held up due to debt overhang at State Owned, Commercial Bank of Ethiopia as well as dollar/euro denominated sovereign debt obligations. A recent agreement with bilateral creditors on an interim debt-service suspension in mid-November and talks on restructuring a $1 billion Eurobond maturing in 2024 has provided some respite. In addition, Ethiopia has agreed to a repayment holiday with its main Chinese creditor.

Governor Mihretu emphasizes the positive discussions with the International Monetary Fund (IMF) and the potential agreement soon. This however has been an agonizingly slow process, dragged by disagreements over restructuring plans proposed by the IMF, the most contentious of which is the devaluing the Birr to converge it with the parallel market exchange rate of approximately $105 per dollar. Ethiopia’s officials fear a sudden drop in the value of the birr will be destabilizing, particularly without funding to stabilize the transition first.

Governor Mihretu assured that Ethiopia is comfortable with its foreign currency reserves. The announced debt-service suspension is expected to bolster macroeconomic stability, supported by the IMF’s economic reform program. But many firms see the FX market as a considerable bottleneck. This is not a good market for importers or those seeking to expatriate profits legally.

French wine maker Castle has had to reinvest its proceeds in Ethiopia rather than keep profits liquid in Birr. Although this has been difficult for investors seeking to reap profits, it does mean the rate of profit reinvestment is higher now among firms in general, adding to inflationary pressures.

The National Bank of Ethiopia aims to encourage investments by introducing reforms, such as the opening of offshore accounts for strategic foreign investors. Governor Mihretu emphasizes the government’s commitment to updating the regulatory environment to attract more investment in the coming months.

Looking ahead, the National Bank of Ethiopia has outlined a three-year strategy focusing on achieving price stability. Tackling inflation is a top priority, with monetary measures already implemented to address supply-side shocks and international price increases. The central bank anticipates a move toward 20% headline inflation by June 2024.

While the IMF expects core inflation in Ethiopia to decline in the medium term, the foreign exchange picture will remain constrained as long as structural issues that reduce the quantity and quality of exported goods as well as foreign direct investment remain. This is of course a longer-term perspective.

Given the circumstances, some economists counter liberalization efforts of the financial sector on grounds foreign banks will likely seek short term profits by running up unsustainable debts and diverting funding away from long term investment needs of this developing economy. This line of argument focuses more on long term investment to increase efficiency and competitiveness in the export sector instead, but most private foreign firms have little appetite for long term investment, particularly given the of political and and macroeconomic challenges. These are all things that will mean the government will continue to control the so called “commanding heights” of the economy.

Foreign banks with an eye towards quick rewards would love to be able to expatriate profits quickly rather than reinvest in more loans towards productive sectors. The fear is a government facing financial duress now may be forced to liberalize too quickly, thus risking long term economic stability, and exposing the country to complicated financial instruments that could reck the economy in case of a sudden capital flight.