Ethiopia is undergoing a significant economic transformation following Prime Minister Abiy Ahmed’s announcement of a comprehensive macroeconomic overhaul on July 28th. This ambitious decision shifts Ethiopia to an interest rate-based monetary policy and a market-based foreign exchange rate, aimed at reducing inflation and enhancing banking efficiency. The move has led to a substantial depreciation of the Ethiopian birr, with Awash Bank reporting a sharp drop in exchange rates from 57.49/58.64 to 83.94/85.62 within a week.
Prime Minister Ahmed has urged banks to align the official exchange rate of 118 birr per US dollar with the parallel market rate. These policies have the potential to reshape Ethiopia’s economic landscape, influencing trade and foreign investment.
‘The Ethiopian government has taken a necessary step to liberalise its exchange rate, moving away from a patronage-based system to encourage exports and formal remittances,’ said Sam Rosmarin, CIO of African Bamboo.
Unlocking external financing
Following these reforms, Ethiopia secured an IMF loan of $3.4bn over four years under the Extended Credit Facility (ECF), with an initial disbursement of $1bn. The larger package, totalling $10.7bn, includes debt restructuring, grants, and loans. Ethiopia’s State Minister of Finance, Hon. Eyob Tekalign, stated that the IMF agreement paves the way for a long-overdue debt restructure to occur within three to six months.
Additionally, Ethiopia and the World Bank agreed on a $1.5bn package, comprising a $1bn grant and a $500 million concessional credit. The World Bank and IMF contributed a total of $5bn in a single week.
‘We will need to sustain supportive macroeconomic policies, including the elimination of monetary financing of government deficits, monetary policy tightening, and prudent fiscal management,’ said Antoinette Sayeh, deputy managing director of the IMF. World Bank Country Director Maryam Salim emphasised the importance of protecting the vulnerable during this economic transition.
Economic impact and opportunities
The market-based currency rate is expected to spur growth, attract foreign direct investment, and boost investor confidence. While the depreciation of the birr presents challenges in managing inflation and maintaining financial stability, it also enhances the competitiveness of Ethiopian exports.
These changes may open new avenues for investment in industry, services, and agriculture. Agro-processing could see increased investment, as agriculture employs over 70 percent of the labour force and contributes 33.3 percent of the GDP. The industrial sector, currently contributing 6.6 percent of GDP, could expand with more foreign exchange access. Services, which comprise 45.3 percent of the GDP and include banking, travel, and telecommunications, might also see significant growth.
However, political unpredictability, climate change, and security concerns remain underlying factors that could impact Ethiopia’s business climate. Addressing these issues is crucial for creating a stable investment environment.
Insights from other countries
Analysts like Sterling Capital’s Davis Githinji have noted that birr devaluation will have distinct effects. Drawing comparisons to Argentina and Nigeria, Githinji highlights potential cost increases when the official rate aligns with the black market rate. However, the inflationary impact might be less severe than anticipated since many goods are already priced at the black market cost.
Foreign exchange losses pose a challenge for Ethiopia’s private sector. Companies like Safaricom Ethiopia, operating at the official market rate, will face higher borrowing costs impacting profitability. Ethiopian Airlines might benefit from increased tourism due to the birr’s lower value but will incur higher costs for importing aircraft parts. Ethiopian Electric Power will see higher import expenses, though its access to foreign exchange might improve.
Ethiopia can learn from Ghana and Zambia’s devaluation experiences. Key lessons include the necessity of strong foreign exchange reserves, well-coordinated monetary and fiscal policies, and effective communication to manage market expectations.
In Zambia, devaluation initially led to rapid inflation and higher business costs, but foreign exchange availability improved over time, stabilising the market. Ghana experienced sustained economic instability, higher operating costs, and inflation due to devaluation.
Ethiopia’s economic reforms and birr devaluation present short-term challenges but hold potential for long-term stabilization and growth. Implementing effective macroeconomic policies and measures to mitigate immediate adverse impacts on businesses and consumers is crucial for a positive outcome.
Agnes Gitau is the Executive Director at the Eastern Africa Association and a partner at the Advisory Firm GBS Africa, where she provides political and economic risk advisory for businesses interested in East Africa
