New Forex Regime Won’t Address Macroeconomic Ills

Apr 26 , 2019
By Haben Mehari

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It has recently been announced that the government has a long term plan to float the Birr. This though will not address macroeconomic problems such as the foreign currency shortage, only import substitution will, writes Haben Mehari (haben.mehari@aiesec.net), an entrepreneur and a graduate student at Addis Abeba University.

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There was a recent announcement of the government’s long-term plan to make the Birr a fully floating currency, fueling public discussion on the merits and disadvantages of the concept.

The issue is not as easy as that. Ethiopia’s chronic shortage of foreign currency has been apparent for a while. Recently, infusing a little bit of exaggeration, Yinager Dessie (PhD), governor of the National Bank of Ethiopia, told members of parliament that the level of foreign exchange will cover only two and a half months of imports and that if things do not change, the country will soon be forced to allocate all of its forex to imports of medicine and fuel.

Back in 2000, export revenues were able to cover over half of the expenses of imports, an amount that has decreased to about a fifth by the last fiscal year, according to the central bank.

Floating the exchange rate regime would mean allowing forex market forces of supply and demand to determine the daily prices of the currency. Most of the world’s biggest economies follow this system, including the United States, Britain, most of Europe, Japan and India. As can be expected, it is usually countries that have large exports that have benefited as demand is boosted externally and locally. Also, low exchange rates for the local currency help lure more foreign investment.

Egypt floated its currency in 2016 amid a crippling shortage of dollars and dwindling investments. The Egyptian pound lost half its value and sent inflation above 33pc. After about a year’s time though, economic expansion has accelerated to its fastest pace in seven years and non-oil exports and tourism are growing at double-digit rates.

Also, in 2016 Nigeria decided to float its currency against the dollar in a move to control its currency crisis that was created due to lower oil prices. The currency was fixed at 197 Naira to the dollar but its black-market rate stood at 370 Naira. After the first day of trading following the float, the value of the Naira dipped by 31pc. It is currently standing at 360 to the dollar.

Our currency is currently trading at 28.58 Br to the dollar, while the parallel market rate is at least a third higher than its value in the formal market, depending on the location and volume. If we decide to move to float the currency, the value of the Birr will at least be equal to its black-market price.

This is not to say that it will only be all bad news.

Remittances that Ethiopia receives make up about a quarter of the nation’s foreign exchange earnings, comfortably exceeding export revenue. At the very least, the floating of the Birr will make all of these transactions go through the formal channels as the incentive the informal channel provides would be removed, improving the forex reserve.

But if we want to grow the economy, we cannot rely solely on the remittances of our diaspora community. We need to reverse our current account deficit by lowering imports and increasing exports. Import substitution, which may seem like a tired argument by now, is still the best way out of our current economic conundrum. We need to produce enough goods right here in the country to lower our import bills.

From medicines and wheat to manufacturing and construction inputs, the nation does have the resources to produce these goods and commodities if we can improve private sector participation.

In the 1950s, South Korea saw growth primarily driven by import substitution, supported by significant aid inflow and by making significant investment in local economic development. This included a dedication to infrastructure and human capital development - basic literacy levels more than tripled from 22pc in 1945 to the early 1960s.

This focus on import substitution created possibilities to improve utilisation of capital for export expansion in subsequent periods. This idea is also not new for our country, and Emperor Haile Selassie’s regime, as well as the EPRDF, have been quite obsessed about it. The fact that it has not been realised only means that a different approach toward it should be tried. It is only then that we will be able to bring the shortage of foreign currency to heel, not through floating the currency.

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PUBLISHED ON Apr 26,2019 [ VOL 20 , NO 991]

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