Featured | Sep 09,2024
Three weeks into the floated exchange market, policymakers and business owners convened to chart a course on the prospects and pitfalls of navigating the uncharted territory. Policymakers expressed optimism while businesses with disrupted operations voiced concerns over substantial risks, with soaring costs, inflating credits, structural vulnerabilities, and illicit activities threatening stability.
A comprehensive discussion at Inter Luxury Hotel, Tito St., underscored the delicate moment the country is passing through amid macroeconomic reforms.
According to Abebayew Duferaw, deputy director of Foreign Currency Monitoring & Reserve Management at the central bank, the reforms will address currency shortages, promote economic growth, and foster a more competitive and transparent foreign exchange market. He noted that adopting a market-based monetary policy is crucial to resolving long-standing macroeconomic constraints.
Exporters can now retain 50pc of their foreign exchange proceeds, up from the previous 40pc. The waiting list system for banks' forex allocation is also eliminated, allowing easier access for importers while banks can freely negotiate foreign currency exchange rates with customers.
"We were bold with most of the reforms," said Abebayhu, while acknowledging ongoing concerns.
However, he also expressed lingering concerns, revealing that the central bank had revoked permits for several importers who requested under-invoiced LCs from 10 commercial banks, warning of the risks associated with foreign currency diversion. He also mentioned upcoming revisions to directives, including changes to Franco Valuta regulations.
"It is risking foreign currency diversion," he warned.
He advised importers to take heed and disclosed that controlling mechanisms are being enhanced with commercial banks to bolster the monitoring and supervision spectrum.
Businesses, however, revealed a series of difficulties they have faced in the past weeks. Unsettled payments, rising costs, market volatility, unpredictability, and bureaucratic inefficiencies are stifling their operations.
The reform has immediate consequences for importers and manufacturers such as Yesimashewa Eshetu, who is now facing higher costs and is on the brink of bankruptcy. He disclosed that manufacturers who had already calculated their cost build-up before opening LCs are encountering major losses due to the reform and ensuing inflated costs.
He said liquidity limitations at banks are preventing them from borrowing working capital and is frustrated that unsettled suppliers' credit initiated before the reform hit his company hard. He is struggling to cover unexpected additional costs.
"How will these scathing problems find a solution?" he inquired.
On behalf of the Ethiopia Publishers & Printers Association, Haymanot Asfaw, described a market in turmoil, with suppliers withholding products amid soaring inflation and uncertainty.
Some see the long-term potential. Gizat Worku, general manager of the Ethiopian Coffee Association, sees potential long-term benefits for exporters after they recover from the losses they have encountered. He believes that a currency exchange float is a step forward to encourage exports and increase foreign currency inflows. However, Gizat noted that inflated domestic commodity costs and their mismatch with international prices are issues that need to be addressed.
"The floating will benefit exporters in the long run," he told Fortune.
Abebe Shimeles (PhD), an economic advisor to the Ministry of Finance, noted that the reforms were made without external influence, to achieve robust macroeconomic stability through quantitative goals by maintaining an exchange rate that unifies with the parallel market.
"Short-term shocks were expected," he said.
Abebe cited policy, market, and government failures that have repressed the economy into one of the lowest poverty lines. He said major challenges include inflation, the informal economy, the expansion of the parallel market, and the debt burden. According to Abebe, GDP growth has been hampered to 6.1pc, despite multiple domestic and external challenges over the past four years.
He revealed that a nominal increase of the parallel rate by one percent reduces the annual growth rate by 0.4pc while remittance inflows have been negatively impacted. Abebe's research shows that every one percent premium in the parallel market reduces remittance inflows by nine percent. He said the average annual growth rate of exports is 5.9pc, garnering the country around three billion dollars. Meanwhile, consumer prices respond to changes in parallel exchange rates.
"We have one of the most complex economies," he said.
He pointed out that payment imbalances, capital account outflows, and illegal trading remain challenges that require policy measures, with proper studies being undertaken at the Ministry.
Given the government's lack of budget to finance investment, the new reform is expected to enhance the private sector and attract foreign direct investment. Ethiopia's foreign currency reserve is far below the optimal five-month import coverage, with reserves only sufficient for a few weeks. In the 2022/23 fiscal year, foreign currency earnings amounted to 24 billion dollars, including notable contributions from services, remittances reaching 6.8 billion dollars, foreign direct investment falling short at 200 million dollars, and 3.6 billion dollars generated from export earnings.
The central bank's strategy aims to bolster foreign currency reserves to cover two and a half months of imports by 2026, with a meaningful reduction in inflation, targeting a drop to eight percent.
For some, the reform is far from smooth sailing.
Getachew T. Mariam, a public research specialist and coordinator at the African Financial Integrity & Accountability Program, said businesses are confused and compelled to navigate their costs, revenues, and profits in an uncertain environment. He said fiscal discipline in government finances, controlled expenditures, and effective regulations need to accompany the reforms.
He foreshadows short-term shocks in the coming months, potentially extending up to a year.
"It is going to be a really tough time," he cautioned, noting that floating alone does not solve structural imbalances in export trade where underlying domestic challenges threaten businesses.
He called for a shift in how businesses operate, warning that selling at a loss and relying on the currency for importation cannot continue as usual.
"There needs to be a new marketing strategy and market projections," he said. "New winners and losers will emerge."
The concerns specific to Ethiopia encompass the manufacturing sector that remains underdeveloped, highly dependent on imports and contributes largely through cheap labour and electricity. Last year alone, the country imported non-durable consumables worth 16 billion dollars.
Yirga Tesfaye, an economic researcher, noted diversifying exports beyond commodities is important, tapping into sectors like mining and energy, to thrive in the export market. He also advocated for banks, businesses, and traders to use hedging strategies to protect against rate risks and adverse currency movements through financial instruments.
"This is crucial for market stability," he told Fortune.
Yirga outlined that the free-floating foreign exchange management system allows for automatic adjustment in currency value, enabling responses to external shocks with full monetary policy independence. He said that floated rates reduce risks related to supply and demand, making exports cheaper and imports more expensive, which can help adjust trade imbalances.
However, Yirga stressed the necessary conditions for the success of the float: a robust financial sector with well-capitalised banks and sufficient foreign exchange reserves, along with the central bank's intervention when needed. He pointed to countries like South Korea, which successfully implemented similar reforms by heavily proliferating their manufacturing sector, enhancing production before focusing on quality and standards, enabling them to withstand shocks.
Experts indicated that comprehensive reforms are indeed imperative if economic stability is to be restored and sustainable growth achieved. If implemented wisely and thoroughly, the reforms could help Ethiopia overcome its economic difficulties and chart a course toward a more optimistic future.
Eshetu Fantaye, a veteran finance expert, supported the reform, stating that it is an overdue undertaking that should have been implemented five years ago.
"It has sustained our faith in the country," he said.
While questioning whether the market and infrastructure are prepared to absorb the coming shocks, Eshetu noted the importance of transparency from the central bank and advocated for a hands-off approach, limiting the regulator's involvement to controlling overtly volatile financial activity in the market.
He noted that commercial banks have been thrust into the deep end, likening them to infants with no swimming abilities diving into a pool, with the central bank acting as a lifeguard. He underscored the need for commercial banks to improve their capabilities in hedging and risk management to benefit both exporters and importers.
PUBLISHED ON
Aug 18,2024 [ VOL
25 , NO
1268]
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