Commentaries | Oct 26,2024
The foreign exchange market plunged into volatility last week in the aftermath of the Central Bank's decision to float the Birr, leading to sharp disparities in exchange rates among commercial banks. The spread between buying and selling rates varied widely — from as low as 3.4pc to as high as 16.5pc — uncovering inconsistent responses from banks to the new market conditions.
Over six days, the Birr depreciated dramatically against major currencies, including the U.S. Dollar. The shift reflected the market turbulence caused by the policy change allowing the Birr to float freely, marking a historic shift in Ethiopia's monetary strategy. The move was designed to introduce broader economic liberalisation efforts targeting chronic foreign exchange shortages and tests the Birr's value against market realities.
The floating of the Birr predictably led to rapid shifts in exchange rates as banks adjusted to supply constraints and rising demand for foreign currency. Previously, the Birr was heavily managed, creating a persistent gap between official and parallel market exchange rates. Central Bank Governor Mamo Mihretu sought to close that gap by letting market forces set the exchange rate. However, the wide variance in rates between banks and the volatility observed unveiled the consequences of a free-floating currency besieging the market.
One striking outlier was Amhara Bank (AMB), which consistently maintained the lowest spread at 3.4pc at one point, despite fluctuations elsewhere. Such a narrow spread is unusual during heightened market uncertainty, especially in the early stages of a floating currency regime. Banks typically widen spreads to respond to potential risks associated with rapid depreciation. AMB's decision to maintain a tight margin may reflect a strategic effort to attract more foreign currency transactions by offering better rates than competitors, albeit at higher risk to its balance sheet in a volatile environment.
At the other spectrum, Awash Bank adopted a conservative, risk-averse strategy with a spread of 16.5pc, the highest observed. The wide margin could tell the Bank's anticipation of further depreciation of the Birr or liquidity constraints demanding a cushion against unforeseen exchange rate shifts.
The sharp differences between these two banks, and the wider variability in spreads, revealed a forex market in a highly fluid state with no consensus on pricing strategies. Broader uncertainty and lack of confidence in predicting Birr's future trajectory are evident.
The rapid escalation in buying and selling rates over a short period unveils banks' difficulty in managing forex portfolios in a floating currency system. The Birr's depreciation has been swift but uneven, as shown by the wide differences in rates across banks. The unevenness exposes certain banks struggling to adjust to newfound volatility, while others may be speculating on future weakness by keeping selling rates substantially higher.
Between September 16 and 21, the Birr's value against the U.S. Dollar showed a clear downward trend, with disparities across banks. Average buying rates for the dollar increased from 107 Br to 116 Br, while selling rates moved from around 119 Br to as high as 126 Br. AMB offered the highest buying rate, peaking at 116 Br to the dollar, while the lowest came from Abyssinia Bank at above 103 Br. For selling rates, Dashen Bank posted the highest at 126.44 Br, while Abyssinia again offered the lowest at 115.43 Br.
Averages across 17 commercial banks surveyed revealed a buying rate of 110.3 Br and a selling rate of 122.7 Br, with a substantial spread of 11.2pc between the two.
Awash Bank stood out not only for its high spreads (five percentage points above the average) but also for consistently offering some of the highest selling rates, particularly from September 18 onward when rates crossed the 125 Br threshold. Abyssinia Bank maintained the lowest buying and selling rates throughout, revealing a cautious approach by its executives to protect their customers from excessive fluctuations while trying to preserve market share.
The divergence in bank behaviours, particularly in managing spreads, was notable. The disparity between risk-averse strategies like Awash Bank's and more aggressive, market-share-driven approaches like AMB's revealed a forex market still finding its footing amid economic headwinds.
The pronounced variability in spreads and exchange rates showed the problems inherent in transitioning to a floating currency system. While the Central Bank's move sought to align the official exchange rate with market realities and address chronic forex shortages, the initial instability brought forth the need for robust risk management among banks and clear guidance from regulators. It makes the ability of banks to adapt to market-driven exchange rates crucial in stabilising the forex market and supporting the economic policy reform. Prolonged volatility could undermine confidence in the financial system and stunt the economic goals the liberalisation seeks to achieve.
PUBLISHED ON
Sep 22,2024 [ VOL
25 , NO
1273]
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