Currency Unification Problem Structural Reckoning, Not a Policy Failure

Currency Unification Problem Structural Reckoning, Not a Policy Failure

Feb 7 , 2026. By Eyob Tesfaye (PhD) ( Eyob Tesfaye (PhD) - etesfaye48@yahoo.com - is a macroeconomist and policy analyst. )

The exchange rate reform was bold and necessary. However, its incomplete results should not be read as a failure, but rather as a reminder of how deep the constraints run. Unification demands patience, reserves, and realism. The discipline required to see it through is now the harder test, writes Eyob Tesfaye (PhD), etesfaye48@yahoo.com - is a macroeconomist and policy analyst.

The decision to unify exchange rates was meant to close a long and disreputable chapter in Ethiopia’s economic management. Multiple rates had distorted prices, entrenched rent-seeking, and suffocated private enterprise.

The reform launched in early August 2024, backed by the IMF, promised a clean break from this. A market-determined Birr, a transparent foreign exchange allocation, and renewed investor confidence were the policy targets.

Eighteen months later, the promise remains only partially fulfilled. The official bank rate trades over 150 Br to the dollar; the parallel market trades over 180 Br. A premium of roughly 17pc persists, stubborn enough to fuel arbitrage and scepticism, modest sufficient to tempt premature celebration.

It should prompt neither triumphalism nor despair, but a sober reckoning with structural constraints and the policy mix required to overcome them.

The persistence of the premium is not a mystery of policy incompetence. It is the predictable outcome of an economy where prices can adjust faster than quantities, where exports are concentrated in a few commodities with rigid supply, and where reserves remain thin relative to the task they are tasked with.

In such circumstances, exchange rate unification is not an event but a process. It requires buffers larger than orthodox benchmarks, alternative sources of foreign exchange beyond exports, and institutional reform deep enough to change incentives.

Ethiopia’s experience places it squarely among a group of developing economies for which unification is a marathon, not a sprint.

Start with exports, the channel through which devaluation is supposed to work its magic. Coffee and gold together account for roughly 64pc of export earnings. Both are notoriously unresponsive in the short run to price signals.

Coffee trees take four to five years to mature. Ageing plantations, climate volatility, and limited processing capacity constrain yields. Gold production is dominated by artisanal mining, plagued by smuggling and long lead times for industrial projects.

Empirical estimates put export supply elasticities for coffee at 0.15 to 0.25 and for gold at 0.10 to 0.15. An 89pc devaluation delivered only a modest increase in export volumes over several years, far below what standard models assumed.

Imports, meanwhile, are equally inelastic. Petroleum products, fertiliser and capital goods together account for more than half of the roughly 18 billion dollars in annual imports. Farmers cannot substitute fertiliser, power stations cannot improvise fuel, and infrastructure cannot be built without machinery.

When exports and imports fail to respond meaningfully to prices, the exchange rate is left doing what it cannot do alone, closing the balance-of-payments gap. This is the “double inelasticity trap” that haunts the reform.

In such a setting, reserves become the decisive variable. They are not merely a cushion against shocks but a signal of credibility.

Evidence from Ethiopia’s own post-reform experience shows that reserves dominate all other measurable determinants of the premium. Each additional month of import cover reduces the gap by more than eight percentage points. Ethiopia has rebuilt reserves from crisis levels of less than one month before reform to around 5.5 months today. That is real progress. It is also insufficient.

The conventional rule of thumb, enshrined in decades of IMF literature, holds that three months of import cover is adequate for exchange rate stability. This benchmark is misleading for structurally constrained economies such as Ethiopia. Where exports respond sluggishly, and imports are essential, adjustment takes longer.

The central bank should intervene over years, not quarters. It has to absorb commodity price swings without signalling panic. Markets, fully aware of these realities, demand a thicker buffer before believing that the rate is truly unified.

International experience supports this conclusion.

During its exchange rate unification in the 1990s, Vietnam maintained reserves consistently above 4.5 months of import cover. Bangladesh crossed the four-month threshold before its parallel premium collapsed. Ghana reached roughly 4.2 months at peak convergence.

These were not coincidences but an understanding that credibility requires excess capacity, not simply adequacy.

For Ethiopia, the credible threshold lies closer to 4.5 and five months than to the orthodox three.

However, reserves cannot be conjured from thin air, and Ethiopia’s export structure limits how quickly they can be built through trade. This is where alternative sources of foreign exchange become critical. Foreign direct investment (FDI) and remittances are not ancillary to unification. They should be central to it.

Vietnam’s experience is instructive. In the early 1990s, its export base was narrow and agricultural. Rather than waiting for diversification to materialise, Hanoi aggressively courted FDI. It offered explicit guarantees for repatriating profits, streamlined approvals from weeks to months, and invested heavily in industrial zones.

FDI inflows to Vietnam grew from less than half a billion dollars in 1992 to more than two billion dollars by 1997, equivalent to 30pc and 40pc of export earnings. Those inflows provided the foreign exchange needed to sustain unification while exports caught up.

Bangladesh took a different route, one perhaps more relevant to Ethiopia. Facing extreme export concentration in garments, Dhaka focused on remittances. In 2001, formal remittances were about two billion dollars. By 2015, they exceeded 15 billion dollars.

Crucially, much of that increase reflected formalisation rather than new migration. By narrowing the gap between official and informal rates, expanding access through mobile platforms, and guaranteeing reliability, Bangladesh shifted billions from hundi networks into banks. Reserves exceeded four months of import cover, and the premium shrank to low single digits.

The Philippines offers a third model, through comprehensive diaspora engagement. Overseas Filipino workers were treated not merely as senders of money but as stakeholders in financial stability. Dedicated institutions, consumer protection, and tailored products lifted remittances from six billion dollars in 2000 to 28 billion dollars by 2015. The peso benefited from a stable and predictable inflow stream.

Ethiopia has similar potential as its diaspora of three to four million people sends an estimated 6.2 billion dollars annually through formal channels, about 4.8pc of GDP. Another two to three billion dollars is believed to flow informally. Capturing even half of that would add one billion to 1.5 billion dollars a year to reserves, a material contribution to the buffer Ethiopia needs.

Yet policy has often relied on moral suasion rather than incentives. Experience elsewhere has shown that migrants respond to prices, convenience, and trust, not to exhortation.

FDI, too, remains underexploited, where annual inflows were around 1.6 billion dollars, barely 1.2pc of GDP, despite Ethiopia’s population size and strategic location. Investors cite delays, regulatory uncertainty, and concerns over exit.

Vietnam’s lesson is that confidence compounds quickly once early entrants succeed. Clear rules and fast execution matter more than generous tax holidays.

Structural constraints are not the only obstacles. Institutional weaknesses amplify the premium by creating arbitrage opportunities that distort behaviour. A 17pc gap between official and parallel rates is not trivial. It offers returns that legitimate business struggles to match.

Importers with access to official foreign exchange can earn extraordinary profits simply by reselling. This diverts entrepreneurial energy into rent-seeking.

The banking system plays an uncomfortable role in this dynamic. Foreign exchange allocation remains discretionary and opaque. Letters of credit are rationed, processing times vary wildly, and information systems are fragmented.

False demand proliferates as firms submit multiple applications across banks. The Commercial Bank of Ethiopia (CBE), which dominates the industry, has only recently been stabilised after non-performing loans (NPL) equivalent to roughly a third of GDP were transferred to a state asset management vehicle. That intervention prevented systemic collapse, but balance-sheet repair is not the same as functional reform.

Without modern treasury operations, transparent pricing, and credible governance, banks cannot efficiently intermediate foreign exchange.

History is unforgiving on this point.

Chile’s first attempt at liberalisation in the early 1980s collapsed because banking reform lagged behind exchange rate reform. Only after cleaning up banks did convergence hold. Mexico and Poland tell similar stories.

Ethiopia’s unification will not endure unless banking reform moves from firefighting to transformation.

What, then, is the most realistic path to completion?

It should begin with accepting that complacency, not time, is the enemy. A comprehensive strategy should combine several elements.

Reserve accumulation should be elevated from a supporting objective to the central anchor of policy. Ethiopia should target 4.5 to five months of import cover, not as an academic benchmark but as a credibility threshold. That requires sustained inflows from remittances, FDI, and concessional finance, as well as restraint on non-essential imports.

The remittance policy should be redesigned around incentives. Competitive exchange rates within a narrow margin of the market, mobile platforms that reach rural households, reliability guarantees, and bilateral arrangements with labour-hosting countries are proven tools. Bangladesh’s experience shows that formalisation is possible at scale.

Clear repatriation rights, predictable regulation, and fast approvals in FDI management matter more than promotional rhetoric. The industrial parks can provide a base. But, they need to be matched with investor confidence.

Financial sector reform should be treated as macro-critical. Transparent foreign exchange intermediation, modern systems, and governance reform are prerequisites for unification, not luxuries to be addressed later.

Lastly, governance matters. Trade misinvoicing, capital flight, and weak enforcement quietly drain foreign exchange reserves. No reserve strategy survives persistent leakage.

Nonetheless, none of this will deliver instant gratification. International experience shows that a five- to seven-year horizon is realistic for structurally constrained economies. If Ethiopia builds reserves decisively, mobilises alternative inflows and reforms institutions, the premium can fall below five percent by the middle of the decade. Below that level, arbitrage fades, expectations stabilise, and the currency becomes functionally unified.

PUBLISHED ON Feb 07,2026 [ VOL 26 , NO 1345]