The Birr has faced a precipitous depreciation against the US dollar over the six days last week, a period marked by policy shifts in the foreign exchange market. From August 19 to August 24, 2024, the Birr's decline has been unrelenting, uncovering the profound impact of the central bank’s recent decision to float the Birr and open the foreign exchange market.
A decisive move by the federal government to reach a deal with the IMF, the monetary policy change is designed to address chronic foreign currency shortages and align the official exchange rate more closely with the parallel market. However, the immediate consequence has been a sharp depreciation in Birr’s value, reflecting market forces that had long been suppressed under the previous fixed exchange rate regime.
On August 19, the Birr was trading at approximately 104.1 to 107.3 for a dollar on the buying side across various banks, while the selling rate hovered between 112.7 and 119.8.
By August 24, the Birr had weakened further, with buying rates ranging from 104.2 to 107.3 and selling rates escalating to as high as 119.8 a dollar.
The consistent rise in the spread between buying and selling rates, from around five percent to 15pc, demonstrated growing volatility and uncertainty in the market as banks adjusted to the new floating regime.
The trend reveals an erosion of confidence in the Birr. Its value has declined by over 10pc within a week, a rapid depreciation that reflects both the pent-up demand for dollars and the speculative pressures that the policy shift has unleashed. As the Birr floats, market participants, ranging from importers to individuals, are likely rushing to secure dollars, fearing further depreciation. The rush has exacerbated the downward spiral, creating a self-fulfilling prophecy where expectations of a weaker Birr drive its continued decline.
Notably, the spread between the highest and lowest rates across banks has continued to widen, signalling disparities in how different banks manage the transition. Some banks, possibly those with greater dollar reserves or better access to foreign currency, were able to offer more competitive rates. Others are setting higher rates to manage the risk of further depreciation or to cope with limited dollar availability.
Data compiled for 17 banks over the course of six days revealed a notable disparity in the average buying and selling rates offered by different banks. It showed the varying strategies banks employ in setting their currency exchange rates, impacting where customers might find the best deals depending on whether they are buying or selling.
Gedaa Bank (GDB) emerged as the bank providing the highest average buying rate, at 107.34 Br for a dollar, making it the most attractive option for customers looking to sell. Dashen Bank (DSH) offered the lowest average buying rate at 104.16, indicating a less favourable option for sellers.
On the selling side, Berhan International Bank (BIB) led the pack with the highest average selling rate of 119.8379 Br for a dollar, positioning itself as the most expensive option for customers buying forex. GDB, which had the highest buying rate, offered the lowest average selling rate at 112.70.
The divergence in rates suggests that the float has not yet led to a uniform market-clearing price, with the policy goal of price discovery still ongoing.
Central Bank Governor Mamo Mihretu’s decision to float the Birr was a long-overdue acknowledgement of the distortions created by the previous system, where the official exchange rate was artificially maintained, far removed from the parallel market rate. However, the speed and severity of the depreciation unveiled that the market had been expecting this move and that the Birr’s real value, as determined by market forces, was far weaker than previously acknowledged.
The depreciation is likely to have far-reaching consequences for the economy. The immediate impact will be on inflation, which is expected to surge as the cost of imports rises. Given Ethiopia’s reliance on imported goods, from fuel to foodstuffs, the weakening Birr will translate into higher prices for consumers, adding to households' already considerable economic pressures. Businesses that rely on imported inputs will likely increase their costs, potentially leading to a slowdown in economic activities as they pass on these costs or reduce operations.
The authorities’ challenge now is to manage the transition to a fully floating currency while containing economic disruption. This will likely involve interventions to stabilise the market, such as showing their firepower in foreign currency reserves to smooth out excessive volatility or implementing measures to control inflation. However, with depleted foreign currency reserves, their ability to intervene effectively may be limited.
In the medium to long term, the success of their policy shift will depend on whether they can restore confidence in the Birr and maintain macroeconomic stability. This will require not only sound monetary policy but also structural reforms to improve the trade balance, attract foreign investment, and build up foreign reserves.
The coming weeks will be crucial in determining whether the Birr can find a stable equilibrium in its new floating state or the depreciation will continue unchecked, leading to a further loss of confidence and economic hardship. For now, the Birr's rapid decline against the dollar serves as a reminder of the uncertainties of transitioning from a controlled to a market-driven economy.
PUBLISHED ON
Aug 25,2024 [ VOL
25 , NO
1269]
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