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Ethiopia will float its currency in a long-delayed reform designed to ease chronic foreign currency shortages and attract foreign investment, a move that is expected to be a prelude to a multilateral funding deal.
The country’s central bank on Monday removed restrictions on the foreign currency market as part of efforts by Prime Minister Abiy Ahmed’s government to secure more than $10bn in funding from the IMF and World Bank and to restructure debt after defaulting in December.
“The reform introduces a competitive, market-based determination of the exchange rate and addresses a long-standing distortion within the Ethiopian economy,” the central bank said in a statement. This included a “shift to a market-based exchange regime”.
Ethiopia, east Africa’s largest economy, has a managed floating exchange rate system that has caused a severe shortage of dollars critical for imports and the repatriation of profits by foreign investors.
Commercial Bank of Ethiopia, the country’s largest lender, quoted the birr at about 75 to the US dollar on Monday, indicating a devaluation of about 30 per cent from Friday’s official rate of about 57 birr.
Professor Alemayehu Geda, an economist at Addis Ababa University, feared that with inflation running at 20 per cent, a weaker currency would “shoot up” prices even further by raising the cost of imported goods. When Nigeria sharply devalued its currency last year it stoked inflation to 30-year highs.
But Charlie Robertson, head of macro policy at FIM Partners, a frontier and emerging market investment house, said the devaluation might not create an inflation surge because Ethiopia had been effectively operating for years at the parallel exchange rate of 110-120 birr to the US dollar.
The float might also be staggered and fuel prices subsidised during the transition, he said.
“This is going to open up Ethiopia to portfolio investment and bring back exporters’ money hoarded offshore,” Robertson said, adding that he expected further reforms designed to make the country more attractive to portfolio investors. “I don’t think overnight it will attract FDI, but it makes Ethiopia more attractive in the medium term,” he said.
Lenders and investors have been pushing Ethiopia to float the Birr in order to ease foreign currency shortages. The central bank said the outgoing system had led to “the emergence of an unanchored parallel market exchange rate together with high inflation”, while Eyob Tolina, state minister for finance, said its replacement would correct “decades-long distortions” and remove constraint on the economy.
Abiy initiated a series of pro-market reforms after taking office in 2018 as part of a plan to open up an economy that had been state-controlled for decades. The process was undermined by a brutal two-year war in the northernmost region of Tigray that formally ended with a truce almost two years ago.
Ever since, Addis Ababa has been seeking to lure foreign investors back to the country. Foreign donors withdrew billions of dollars during the war, while the US ended Ethiopia’s tariff-free access to its markets, worsening an already crippling foreign exchange shortage.
As part of the reforms, Ethiopia said last month that it would allow foreign banks to set up local subsidiaries and foreigners to acquire shares in domestic lenders. Abiy has previously told parliament that he expects talks with the Washington-based lenders to unlock more than $10bn in financing in the coming years.