The Foreign Exchange Revolution That Never Quite Happened

Nov 15 , 2025.

The scene playing out in the foreign exchange market is more than a tale of distorted pricing. It is a test of policy credibility and institutional resolve.

In the 15 months since the National Bank of Ethiopia (NBE) introduced a liberalised exchange-rate regime, the commercial banks have operated in a space suspended between theory and practice. What was meant to usher in market realism has instead exposed the Central Bank’s ambivalence and the economy’s deep structural fragility.

The July 2024 directive marked a seismic shift in Ethiopia’s monetary orthodoxy, which had been in place for over half a century. By scrapping surrender requirements, enabling interbank trading, and allowing market-based quoting, the Central Bank initially appeared to have adopted a more flexible approach. But the policy’s core promise (to let supply and demand determine the value of the Birr) remains unfulfilled.

In reality, the Central Bank continues to enforce compliance, penalise non-reporting banks, and ration dollars through ad hoc auctions too small and infrequent to anchor expectations.

While the official rate has depreciated dramatically, nearly 148pc since liberalisation, the shadow of the parallel market still looms large. The gap has narrowed, yes, from over 100pc to around 19pc, but that is still twice the global norm. And when banks, mainly the state-owned Commercial Bank of Ethiopia (CBE), routinely pay far above their posted rates (on average at 150 Br) to buy dollars, the disconnect between declared and de facto policy becomes unmissable.

These high premiums signal that the foreign exchange market is not truly liberalised, but merely deregulated within a tightly managed framework. Policymakers fear the backlash that a fully free float might unleash in an inflation-crushed public. The monetary reform, nonetheless, marked a decisive shift in the country's cross-border dollar position.

Direct access to the Central Bank’s ledgers is unavailable, yet global databases offer clues. Figures from the Bank for International Settlements (BIS) put foreign-bank claims on Ethiopian residents amount to one billion and two billion dollars, almost entirely in foreign currency and overwhelmingly in dollars. The Brewed Buck is not convertible and is shunned by foreign banks. Cross-border credit, mostly comes from Asia and the Middle East, tied to trade finance or development loans.

Domestic banks’ own deposits abroad are also modest, at roughly one billion, with almost all of it in dollars. After the July reform, balances appeared to have ticked up as banks stocked correspondent accounts, but within the usual range. BIS data show that dollar claims dipped in early 2024 as foreign banks trimmed their exposure, then rose once the interbank market reopened and lenders built up their buffers.

The IMF reckons that Ethiopia’s public external debt was between 28 billion and 30 billion dollars, about 60pc in dollars, 30pc in euros and the rest in Yuan and other currencies. Private foreign debt is tiny, making official loans the bulk of the Central Bank’s liabilities. Reserves were 2.4 billion dollars in 2023/24, equal to two months of imports, with a slight rise following liberalisation. They are held mostly in dollars and euros, with a small amount of gold.

Nonetheless, the current-account deficit is shrinking due to improved coffee exports and remittances, but the capital account remains under strain. Banks now hold bigger dollar pools to serve clients, even though private import demand is weak and lending is restrained. Any rise in dollar funding on the Central Bank’s books thus likely reflects official support rather than market demand.

To ease the adjustment, the Central Bank began holding occasional foreign exchange auctions, pledging only to smooth volatility. With scant reserves, it cannot defend a level for long. Domestic liquidity tightened and interest rates stayed high, revealing no large-scale dollar pumping. BIS numbers, showing merely mild shifts, back the view that private cross-border flows remain small.

The trouble is that when banks pay over the odds for dollars, the credibility of the official rate erodes. It is a symptom of stubborn misalignment between policy and reality. As the actual price diverges from the posted one, the market assumes policymakers are failing to anchor expectations. The old habit of managing the rate breeds an artificial benchmark unsupported by supply and demand, undercutting monetary control.

Net-interest margins shrink because extra costs cannot be passed on where lending rates are capped and competition is fierce. Depreciation and volatility increase defaults among borrowers with unhedged dollar-denominated debts, prompting lenders to raise provisions and erode profits. Their liabilities stay in Birr while assets erode in dollar terms, deepening liquidity strains. Banks may try to offset the pain with fees, commissions and trading gains, but rarely enough. Persistent premiums threaten sector-wide stability, risking liquidity crunches or even failures.

The authorities could respond with liquidity lines, auctions or help for systemic banks, but such measures only buy time if shortages persist. A distorted foreign exchange market also undermines monetary policy. When expectations hinge on the parallel rate, an interest-rate hike may not curb inflation. Central banks then resort to blunt tools, including rationing, direct injections or tighter controls. Overreliance on such tactics delays reform and fuels fresh distortions.

Ethiopia’s woes echo patterns elsewhere. Restrictions, special windows, underdeveloped markets and parallel dealers all sustain premiums. Currency overvaluation, meant to tame inflation, widens the gap. Fiscal deficits funded by money creation stoke depreciation bets. Seasonal shocks and commodity swings add pressure.

Governor Eyob Tekalegn (PhD) can narrow spreads by boosting supply and talking straight, thereby anchoring expectations. If he fails, funding costs rise, credit tightens, and growth slows. Import-price pass-through keeps inflation high. Capital flees. Currency lurches force heavier intervention, depleting reserves and shaking confidence.

Capital-flow volatility adds to the jitters. Domestic bank credit is slowing as lenders turn cautious. Interbank and repo rates occasionally spike above policy rates, betraying short-term scarcity. Impairment provisions rise when borrowers struggle with more expensive dollar-denominated debts. Under forward-looking accounting rules, provisions can grow quickly, adding volatility to earnings. Banks with large forex-linked books are vulnerable. Defaults rise among import-heavy firms and other dollar-dependent borrowers.

Governor Eyob should closely monitor these indicators as sustained premiums signal the need for coordination and perhaps intervention. Banks, too, should monitor loan performance, adjust provisions and brace for earnings swings.

Ethiopia’s experience underlines the delicate balance between reform and stability. The liberalisation, although it could have come at a better time, was brave yet incomplete. Forex auctions and a market-based system mark progress but could falter without deeper change. Monetary credibility requires a transparent framework, credible inflation targeting, and a willingness to let the rate adjust in response to fundamentals.

Improving access to official foreign exchange channels, streamlining import finance, and bolstering reserves would help. So would clearer communication on the scale and logic of interventions. Policymakers should track the premium, watch its pass-through to inflation and guard financial stability, ready to act swiftly.

Yet early discomfort is no reason to backtrack. The IMF’s reform blueprint promised that letting the Brewed Buck float would attract foreign investment, unlock donor support, and allow prices to speak for themselves. These gains remain elusive, not because the idea is wrong, but because the transition is only half done. The stubborn premium between the official and parallel markets still defeats the whole policy objective.

The Central Bank is in a dilemma. It praises flexibility, yet levies fines of millions of Birr when banks miss tight reporting deadlines. Regular auctions were intended to determine prices, but the frequency is erratic as the amounts on offer small, rendering each sale a lottery that encourages hoarding rather than trade. Banks that win cling to scarce dollars. Those who lose scramble in the grey market, making the liberalisation largely more rhetoric than reality.

That, in turn, prolongs uncertainty, erodes trust in policy and keeps domestic bankers, importers and savers braced for the next lurch in the Brewed Buck.

PUBLISHED ON Nov 15,2025 [ VOL 26 , NO 1333]