Fiscal, Monetary Policies Mismatch to Blame for Forex Woes

Last week, Ethiopia got a vindication of a sort of its gains over the years in its pursuit of economic growth. A London-based magazine, “World Finance”, has joined the foray listing it second in the five fastest growing economies in the world, next to Bhutan’s 11.1pc. Neither is the prospect of economic growth, projected by the World Bank’s “Global Outlook”, is grim for Ethiopia and countries listed in the magazine.

Despite the nuanced dispute over the size of growth, Ethiopia’s economy has been growing consecutively over the last decade, unprecedented in its economic history. In large part fueled by state investments in public infrastructure, this growth has not been without challenges that are difficult to address, as they are structural in nature.

The contradiction is in Ethiopia’s economy thriving under paucity. It is an economy starved of inputs in many fronts; but, none is as painfully limiting as the crunch in foreign exchange availability. The nation’s foreign exchange reserves barely exceed covering more than two month’s of imports.

The deficit in the balance of trade, with bills overwhelmingly dominated by imported capital goods for mega projects, gives no indication of subsiding. Neither is such situation buttressed with improvements on the export front, despite official aspirations for more in export earnings. This has created a situation where cost of imports is so high, because businesses incur costs at a rate of the parallel market, while forex revenue is reported at a lower rate offered by the inter-bank market, under strict control of the National Bank of Ethiopia (NBE)

Regardless of the terminal imbalances though, the source of the real issues lies in the mismatch between policies on the fiscal and monetary fronts. Lack of coordination between Teklewold Atnafu, governor of the central bank, on the one hand, and Abraham Tekeste (PhD), minister of Finance, and Yinager Dessie (PhD), commissioner of the National Planning Commission, on the other, illustrates how they have lost focus of the macroeconomic policy objectives.

Members of the macroeconomic team, chaired by Prime Minister Hailemariam Desalegn, their responsibilities should be to see a stable macroeconomic environment where inflation is tamed, employment is high and broader expansion of the economy, in gross domestic product (GDP), is achieved. Coordinating and harmonising fiscal and monetary policies thus has an overriding strategic imperative.

It is of little surprise to see a government such as the EPRDF, whose legitimacy to rule mainly comes from its performance mandate, aspires to pursue an expansionary fiscal policy. Growing by an average of 10pc since 2007/08, the current budget for the federal government reached at a record 274 billion Br.

A prudent fiscal policy requires a government follows policies in determining the imposition and collection of taxes and public expenditure. Despite modest growth in mobilising tax revenues, growing from 11.8pc of the GDP last year to 11pc a decade ago, neither Abraham nor Yinager appears to have the desire to put a limit to the state’s appetite for more expenditures.

There is not much Teklewold can do in the monetary policy front, which is more difficult and less effective in the absence of prudent policy on the fiscal side.

Monetary policy is about fixing exchange rates and interest rates. It is also determining the quantity and value of money in circulation; print money and control how much can be available with the banks collected from their depositors.

Ironically, what appears to be a symptom from ineffective policy responses both in the fiscal and monetary fronts is under treatment without addressing the real issue. The structural paucity in forex comes from the state’s constant demand to pay for its mega projects, if not servicing the nation’s oil bills. Yet, authorities at the central bank are desperate in breathing a sigh of relief injecting forex only to the state-owned Commercial Bank of Ethiopia (CBE).

Two weeks ago, the central bank advanced one billion dollars to the CBE, a banking giant in the local arena. It is not the first time that the Bank seemed to have gotten preferential treatment by the central bank, which is thought to be equally responsible for all the 18 banks operating in the market. Three months ago, CBE received two billion dollars, in addition to one billion dollars it had obtained a year ago.

The Administration and the central bank may have been put off the pressure from the many importers who are in a queue for over six months to access forex. Nonetheless, it borders to irresponsibleness to do it at the expense of the fledging private commercial banking industry.

Four years ago, the regulator reduced the reserve requirement for banks to five percent, after realizing that it would be almost impossible for banks to keep up with payments on top of other obligations to the central bank. But this came after private banks were being charged 17pc on loans they took out from the regulator to offset crunch in liquidity. It was their own money they kept as reserve that was been given back to them at a very high interest rate. They found it crippling.

Now it looks like the private banks are going to go through another bout of a liquidity crisis. They are hesitant to go to the central bank for help to avoid the hefty interest rate. Not only are they going to be charged an arm and a leg for their own money. They feel shortchanged by the directives and decisions made by the regulator, which was supposed to have their best interest in mind.

To combat the liquidity crisis, the private banks will need cash flow, but for it to be extended to them with extremely high interest rates is not only unfair, it does not support their prospect for growth.

Understandably, the decision to bankroll the CBE with a billion dollars in much wanted foreign currency was a tough pill to swallow for private banks. They are condemned to sit back and watch as their customers and their deposits fled to the CBE. Since there is a foreign currency shortage and businessmen are desperate to get their hands on some much needed forex, customers did not think twice before going down to their nearest CBE to seize the opportunity.

Many businesses have been struggling to stay afloat in the time when banks were turning them away or putting them on long, if not frustrating, waiting lists for foreign currency. The CBE requires that customers who open Letters of Credit (LC) with it pay 100pc in cash in advance get access to forex. This causes customers to withdraw even more money from private banks and deposit it with the CBE.

Some private banks have even started to ask their customers to not withdraw high amounts of money, as they do not have enough cash in their vaults. When they were beginning to recover and find their footing, they got hit again. And the cycle will continue.

The private banks are going to have a stressful time remaining competitive in the financial sphere, skewed by policy in favour of their competitor. But it should not be lost on anyone that they need support and nurture from the regulatory bank in order to grow and flourish.

The way private banks handle foreign currency might be questionable, as some even have compromised managers receiving kickbacks for facilitating the process. The practice might also be frowned upon by the regulatory bank and the way it is handled by the private banks lacks transparency. However, it is no reason to bar them from having the same opportunity as the state-owned bank.

Governor Teklewold should consider the impact of his one-sided decision to only provide a state bank with huge amounts of foreign currency. In a way, he is waging a losing battle, defocused from where his attention matters most: macro economic stability. As a regulator, it is his responsibility to make fair and just decisions that benefits the entire financial sector and the economy at large.

The Administration is mounting the pressure on the monetary policy side, unable or unwilling to fix what is broken in the fiscal policy front. The collateral damage is thus the private commercial banks. But that is only in the short term. Eventually, the Administration will be caught up by its own lethargy when inflation spikes, unemployment soars and tax revenues dwindled.



Published on Apr 14,2017 [ Vol 17 ,No 884]



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