Birr in Tumble, Reform Rhetoric Meets Bitter Economic Realities

Jan 25 , 2025.

Grand ambitions have long driven Ethiopia’s successive leaders, but they remain weighed down by deep structural vulnerabilities. But, nowhere is this more evident than in the monetary policy front, where policymakers let market forces guide Birr’s value against a basket of major currencies.

The bold policy measure, introduced after 50 years, initially reduced the gap between the official and parallel exchange rates from more than 100pc to around five percent. Yet, barely six months later, the gap has climbed toward 25pc, raising doubts about whether the reform will be truly maintained. It should be no surprise if the liberalisation slide reinforces concerns that the economic policy goals remain hostage to the authorities' reluctance to accept short-term pain mainly due to worries about a weaker currency rooted in the country’s debt position.

Nearly 45.8pc of Ethiopia’s external obligations are denominated in dollars; each depreciation of the Birr drives up debt-servicing costs when converted into local currency. Although external debt rose by two percentage points in the 2022/23 fiscal year - a modest expansion - currency swings alone added 133.84 million dollars to the overall burden. Debt-service payments for last year were 2.21 billion dollars, with nearly half going to external creditors. The balance is consumed by domestic-debt servicing, which has climbed toward a billion dollars, reducing the money available for development programmes in areas like education and health.

Foreign currency reserves remain too thin. Although they have improved considerably compared to the years before the forex regime liberalisation, they cover about 2.3 months of imports, short of the three months the International Monetary Fund (IMF) advises for economies in Ethiopia’s position. The balance of payments showed a small surplus of 59.4 million dollars in the fourth quarter of 2023/24, but this bright spot conceals deeper weaknesses.

The current account deficit widened from 826.3 million dollars the previous year to 1.1 billion dollars during the fourth quarter of last fiscal year, in large part because the trade gap swelled by 30.8pc. Exports rose by 27.3pc, reaching 1.3 billion dollars, helped by stronger earnings from coffee, live animals, gold and electricity. Yet, during the same quarter, imports grew even faster, by 29.9pc, to 5.1 billion dollars, as demand for capital goods, fuel and other essentials climbed in an economy seeking to industrialise and meet rising consumer needs.

However, those headline export figures hide structural constraints.

Coffee exports earned 34.3pc more than before, but revenues from oilseeds fell by 5.6pc, and khat exports plunged by 39.4pc. The bigger picture is also discouraging. External debt claimed 179.8pc of exports, above the 150pc threshold considered risky for low-income countries. This mismatch between debt obligations and forex inflows uncovers a long-running problem. One or two star exports cannot carry a country of over 100 million people.

Efforts to limit non-essential imports have had limited success. The economy still needs machinery, fuel, and pharmaceuticals to keep infrastructure projects and daily life running.

Such strains become more apparent when looking at the federal government’s broader debt position. By June 2024, total public debt reached 68.9 billion dollars, equivalent to 32.9pc of gross domestic product (GDP). At first glance, that number may not seem alarming for a growing economy. The trouble emerges in the details. Domestic debt of 39.97 billion dollars, having grown by 12pc in dollar terms in one year, comes from Treasury bills, government bonds and direct advances from the central bank. It created a large rollover risk in a capital market that is still nascent.

State-owned enterprises (SOEs) account for over one-third of domestic debt, adding to the government’s liabilities and leaving less room for private borrowers.

External debt, at 28.89 billion dollars, created its own difficulties. About 65pc of this is concessional, with terms easier than market rates. But, many SOEs have variable-rate loans due to the large share of these debts in dollars. Birr's depreciation can only heighten repayment costs. Servicing external debt amounted to 1.27 billion dollars last year, nearly matching the 1.48 billion dollars in fresh disbursements, a scenario that makes it challenging to build up foreign exchange reserves over time.

At 11.3pc, the external-debt-service-to-export ratio exceeds the 10pc threshold, which is considered a warning sign. Reducing non-concessional borrowing, matching the currency of debts with that of major exports and developing more sophisticated debt-management skills will all be essential.

Officials have tried to keep inflation in check and defend the Birr, setting high interest rates and imposing large reserve requirements. Commercial banks are compelled to buy government bonds, diverting funds that might otherwise support private investment. These measures prop up the Birr in the official market but at the cost of higher borrowing expenses for everyone else, with an outcome that stifles growth.

Federal authorities insist that they still maintain a market-determined exchange rate. Yet, the renewed divergence between the official and parallel rates is not in their favour. Interventions persist behind the scenes. The state-owned Commercial Bank of Ethiopia (CBE) often quotes lower rates for foreign currencies than private banks do, acting more like an arm of policy than a commercial lender.

However, there are signs of progress. Foreign direct investment (FDI jumped by 49.4pc in the fourth quarter of 2023/24, while private-sector long-term financing rose by 24.4pc. Nonetheless, short-term capital flows reversed from a surplus of 23 million dollars to a deficit of 195.3 million dollars, a shift that may signal the jitters of lenders who can withdraw funds at the first sign of trouble.

Public-private partnerships (PPPs) may help them tap private capital for infrastructure projects. However, investors complain about a tangled and unpredictable regulatory environment, frequent policy shifts, unreasonable tax law enforcement, and a cumbersome logistics sector. The federal government still places SOEs at the front of the line for credit, crowding out private firms that might be more nimble exporters.

The economy needs to diversify beyond commodities like coffee and livestock to raise more revenue. Better roads, smoother customs procedures and more reliable power could encourage greater investment in manufacturing and agro-processing. This would allow Ethiopia to wean itself off high levels of borrowing gradually. Policymakers hope that multilateral lenders will offer some breathing room. The 3.4 billion dollars from the IMF, 3.75 billion dollars from the World Bank and relief from the G20 Common Framework for debt restructuring are in the pipeline. But, success depends on convincing these creditors that reforms are genuine.

Ambition without discipline, however, can easily turn into peril. Previous administrations' drive to build roads, dams and industrial parks might have fuelled growth, but it has also heightened vulnerability to exchange rate shocks and global interest rate rises. The large stock of dollar debt from previous years remains a drag on the economy. Debt re-profiling can ease payment pressures in the short term, but it does not fix deeper problems like an underperforming export sector and uneven policy enforcement in a country under political spells that have led to ongoing violent conflicts.

A more realistic exchange rate could spur exporters and attract foreign investors, although it would likely push up prices in the short run. A fully floating Birr might drop quickly, lifting inflation and triggering public discontent. Yet letting the currency drift into a grey zone between official and parallel markets simply drives people toward unofficial channels. When policymakers trumpet reforms, then reverse course the moment the Birr trembles, they damage the credibility they need to bring in new capital. That wariness can spark the very flight of funds the authorities are trying to avoid.

PUBLISHED ON Jan 25,2025 [ VOL 25 , NO 1291]

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