A forex crunch has once again afflicted Ethiopia. Given the increase in global oil prices and the country’s rapid growth, it deserves much more attention than usual, writes Amanuel Assefa (firstname.lastname@example.org), a finance and risk professional with over fourteen years of experience in the financial services industry.
Shortly after Prime Minister Abiy Ahmed (PhD) assumed office, he sent jitters through the business community when he stated the country’s foreign currency crisis would remain unresolved within the next 15 or 20 years.
There is much angst among the business community who are unable to readily obtain foreign currency to buy equipment, import consumer goods for the local market, pay for overseas medical care, or pay dividends on equity investments made by foreign investors. Many are unable to conduct their day-to-day business or implement expansion plans without significant delays and cost brought about by the shortage of foreign currency.
Ethiopia’s foreign currency reserves have barely exceeded two months of imports. But even beyond the last ten years, the country has historically run a negative balance of payments.
Why does it sound like it is different this time?
For a country the size of Ethiopia, experiencing the level of economic activity, there is no doubt that access to foreign currency is one of the key requirements for continued growth. Industrial equipment, vehicles, and chemicals that are part of the manufacturing processes need to be imported.
Foreign currency reserve levels that we have experienced in recent years, as in 2016, were also at a time when the price of oil was about 44 dollars a barrel. It has recently been trending at over 60 dollars. As the price of oil increases, the amount of foreign currency spent on oil increases. As economic activity and growth continue so does the demand for more oil.
On oer number of barrels a day equivalence, Ethiopia’s consumption has more than doubled from 30,000 barrels to 61,000 barrels between 2005 and 2014, and consumption is expected to grow at 10pc a year.
Putting all these together the country could be coming face-to-face with a more challenging environment due to foreign currency shortage compared to past years.
Foreign currency reserves allow the country to directly finance international payments imbalances caused by imports exceeding exports. It enables the nation to intervene in financial and currency markets to provide liquidity in times of crisis, influence the exchange rate, allow foreign borrowing, ease repayment of foreign currency denominated debts, and facilitate government purchases from abroad.
Building the reserves becomes even more crucial as foreign currency debt comes due and full principal amount needs to be paid down.
It is first essential to understand why the National Bank of Ethiopia’s (NBE) foreign exchange coffers are depleted. On the supply side, there are declining export revenues due to depressed commodity prices globally; lower than usual foreign remittances due to political unrest in recent past, and more foreign currency entering through informal channels due to the spread between the official and unofficial exchange rate.
On the demand side, we have an increased demand for imported consumer goods, driven by income growth and absence of local substitute, increased demand for capital goods, as a result of increased economic activity, and rising price of commodities such as petroleum.
As the government reiterated, the long-term approach to building sustainable foreign currency reserves is to bolster the export-oriented manufacturing industry to increase outflows.
The export maximising initiative is getting a lot of focus and support from the government and the policies enacted are a clear indication of the commitment to grow the country’s foreign currency earning potential. Construction of industrial parks, low rent, and tax holidays are just a few of the incentives that are being offered to entice global manufacturers to set-up operations in the country.
The building of transportation infrastructure like roads, railways, and investment in ports in the region support the main theme also. Building hydroelectric power generation capability and electricity infrastructure to neighbouring countries is another example of capital-intensive projects that are expected to produce dividends over the long-term both in revenue generation but more importantly revenue in foreign currency.
Furthermore, prior investments will start to provide some benefits, as expected ramp up in exports from the manufacturing sector come online as production at the various sectoral industrial parks pick up pace towards full capacity. Improved political conditions will likely increase remittances, at least in the short-run as optimism sweeps many who are bullish that change at the top will result in structural reforms.
But policy-makers can do more. There needs to be more focus on import substitution initiatives. The government will in parallel need to work harder in incentivising local manufacturers to produce, fast-moving consumer goods that are competitive but also meet the standard and quality expected by the local market.
One approach is to take a bit of a protectionist stance and impose a higher import tax on certain products that can be produced locally. Another is to provide incentives for existing manufacturers to be able to scale their operations and increase their output and simultaneously facilitate entry of others to enter the manufacturing sector catering exclusively to the local market.
The government ought to similarly employ stricter controls to reduce foreign currency going into the informal sector and further devaluation. The latter will come with its own challenges – increased debt service payments in Birr and increased external debt. Such measures can reduce the spread between the official and unofficial exchange rate.
After having done thorough diligence, there are further reforms that need to be taken. These are listing the Ethiopian Airlines, Commercial Bank of Ethiopia (CBE), and Ethio telecom on a foreign stock exchange as has been hinted by Abiy and enabling the telecom provider to issue a license to foreign telecom operators.
Another is to allow local banks with enough scale to list on foreign stock markets and encouraging those without scale to consolidate and do the same. Considering “non-traditional” approaches to shore up foreign exchange liquidity through currency swaps and developing the tourism sector, both up-and-down the value chain, can also help alleviate the forex crunch.
The foreign currency crisis will get worse before it gets better. But there are multiple actions that the government has in its toolkit that it can pursue to better manage its liquidity in the short to medium term.
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