The Idea of Implementing a Market-based Exchange Rate System in Ethiopia continues to be an elusive goal

By Kbour Gena
August 9, 2024

(TH) – Ethiopia’s recent shift from a restricted foreign exchange rate to a market-oriented free exchange rate system indicates a significant alteration in economic policy under Abi’s leadership. This development has garnered considerable acclaim in Western nations. Advocates of a market-driven exchange rate system contend that such an approach enables the market to establish prices based on economic fundamentals. Furthermore, they assert that a free exchange rate system is more appealing to foreign direct investors, who tend to favor market-driven mechanisms over government-regulated exchange rates.

Proponents of the market-based foreign exchange rate system assert that such a system is inherently pure and free from flaws; however, those with a deep understanding of the Ethiopian economy express significant apprehension regarding its potential to trigger rampant inflation, ultimately jeopardizing the well-being of society. Critics argue that ignoring the adverse effects of this system is unwise, particularly as inflation rates approach critical levels, suggesting that the introduction of a free foreign exchange rate could exacerbate existing economic challenges. Furthermore, the adoption of a market-driven foreign exchange rate is expected to increase the burden of servicing loans and obligations to international financial institutions, thereby placing considerable strain on both the business sector and consumers at large.

The free foreign exchange rate system, which garners both support and criticism from various stakeholders, receives endorsement from the International Monetary Fund; however, numerous countries’ experiences indicate its shortcomings. For instance, Bangladesh adopted a market-based exchange rate system in 2003 and initially saw positive outcomes, yet it now faces a significant economic crisis. Similarly, Ghana’s attempt to implement such a system in 1986 ultimately led to its bankruptcy declaration in 2003. Furthermore, Zambia, which embraced this system in 2003, has warned that it will face bankruptcy by 2022, highlighting the potential failures associated with this approach.

One significant issue associated with foreign exchange is that the dollar serves as the standard against which all other currencies are measured. For instance, an increase in interest rates in the United States not only poses challenges for the American economy and its banking system but also adversely affects developing nations that carry substantial debt. It is essential to recognize that this scenario exacerbates the plight of impoverished countries, pushing them deeper into economic distress.

Taking into account our comprehension of the market-driven foreign exchange rate system and the potential risks associated with an imbalance between the demand and supply of foreign exchange, it is evident that the overnight global market plays a pivotal role in determining the outcome, whether favorable or unfavorable.

Concerning the market-driven foreign exchange rate system, it has been suggested that such a system would enhance market stability and prevent the Commercial Bank of Ethiopia from facing insolvency. Nevertheless, even in the absence of this system, there exist numerous strategies to rescue the Ethiopian Commercial Bank from its current predicament. For instance, the government could bolster and stabilize the bank’s capital by providing working capital or issuing bonds. Additionally, these bonds could be offered in the form of shares to generate the necessary funds.

The bank should prioritize its fundamental operations to improve both efficiency and effectiveness by tackling outstanding debts and related financial responsibilities. Creating a dedicated division to specifically address these challenges could yield significant advantages. Additionally, by refining the allocation of capital and adopting various cost-saving measures, the bank can navigate through its financial troubles and establish a solid groundwork for future expansion.

The current administration, in its efforts to reverse the bank’s downward trajectory, risks repeating the mistakes of its predecessors. Both governments have demonstrated insufficient dedication to promoting the bank’s growth and stability, which has negatively impacted the overall condition of the Ethiopian Trade Bank. This scenario highlights the necessity for a more concentrated strategy to ensure the bank’s durability and viability within the competitive financial sector.

An examination of the foreign exchange rate system that has been in effect in Ethiopia for a considerable duration reveals its inadequacies. The current framework fails to adequately facilitate essential economic activities, resulting in ambiguity regarding the performance of the foreign exchange rate. It is clear that previous systems have not effectively contributed to the development of a strong and functional foreign exchange market, which is vital for the nation’s economic advancement.

In numerous developing nations, the presence of effective governance is often accompanied by challenges such as inflation and external debt management. These issues can lead to a significant reliance on foreign currency reserves, which necessitates stringent oversight by governments. Rather than merely focusing on regulatory measures, many regions are actively engaging in practical initiatives to address these economic concerns. This reality is also evident in Ethiopia, where similar dynamics are at play.

The black market for foreign currency operates as a mechanism that facilitates transactions, allowing individuals to acquire dollars and euros through informal channels. This situation often arises from the collaboration between government entities and market participants, who navigate the complexities of foreign exchange. The black market not only serves as a conduit for currency exchange but also reflects the underlying challenges faced by the formal banking system in managing foreign currency reserves effectively.

As is well known in Ethiopia, the black market for currency exchange has become a significant aspect of the economy, particularly when the official banking system struggles to meet demand. This phenomenon not only undermines economic stability but also disproportionately affects wealthy individuals, especially those engaged in import businesses. The disparity between the black market rates and official bank rates has led to a situation where affluent individuals can exploit these differences, further exacerbating economic inequalities within the country.

In a different context, some countries that have previously experienced rapid growth have adopted a similar approach to managing foreign exchange rates. By doing so, they have stabilized their economies and facilitated further development. This strategy has proven effective in ensuring that economic progress is not only sustained but also enhanced over time.

Ethiopia has historically utilized two types of foreign exchange rate management: the conventional system and the black market. The conventional system primarily focuses on essential imports such as food, medicine, and fuel, allowing these critical goods to be imported under regulated conditions. This system is closely monitored by the national bank to ensure compliance and stability in the market.

Generally, the black market operates alongside the conventional foreign exchange system, creating a significant disparity in demand and supply. In Ethiopia, the black market for foreign exchange has emerged as a response to the limitations of the conventional system, where access to foreign currency is restricted. This duality in foreign exchange management highlights the necessity for governments to effectively balance both systems to promote economic growth and ensure national security.

The foundational stage of international trade is heavily shaped by the importation of critical goods, including food, pharmaceuticals, and energy resources. These items are essential for fulfilling the basic requirements of the populace, which in turn supports social stability and unity. By maintaining a consistent supply of these necessary products at affordable prices, the government can protect public health and foster economic resilience, ultimately aiding in the pursuit of sustainable development.

At the subsequent level, a strong foreign exchange rate is vital for bolstering the national currency and drawing in foreign investments. A stable exchange rate not only boosts the economic credibility of the nation but also encourages advancements in technology, infrastructure improvements, and job creation. These elements are crucial for facilitating swift economic growth and enhancing the overall quality of life for the citizens.

The informal market often poses difficulties in the importation of non-essential goods, which can result in volatility in the foreign exchange rate. By addressing the demand for these items through regulated avenues, the government can alleviate the risks linked to currency fluctuations. This strategy promotes the utilization of formal foreign exchange systems, ensuring that essential goods are prioritized and effectively incorporated into the national economy, thereby strengthening the overall economic structure of the country.

Furthermore, the government has established a more effective oversight mechanism regarding foreign exchange rates, which is crucial for enhancing its monetary policy. By regulating foreign exchange rates through the national bank, the government can stabilize price levels, manage inflation, and ensure a more balanced economic environment. This oversight is essential for mitigating the adverse effects of fluctuating foreign exchange rates on the economy, thereby promoting overall financial stability.

The Ethiopian government recognizes that a market-based approach to foreign exchange rate management is vital for economic resilience. Implementing a practical system for managing foreign exchange rates can help address various economic challenges that may arise. By doing so, the government aims to safeguard the interests of its citizens and maintain a stable economic framework, which is particularly important in times of uncertainty and volatility in the global market.

In relation to the foreign exchange rate system, it is pertinent to highlight certain economic principles. Currently, the field of economics appears to be increasingly intertwined with global realities, necessitating a comprehensive understanding of its dynamics. Experts in the field are expected to provide insights and recommendations that are not only theoretical but also applicable to real-world scenarios, ensuring that economic policies are both relevant and effective in addressing contemporary challenges. As the importance of economics continues to grow, the need for informed decision-making becomes ever more critical.

The global economy is characterized by significant complexity, where economic research and analysis provide insights into the functioning of markets, trade, and overall economic dynamics. However, a comprehensive understanding of the global economic landscape is often elusive, as it does not fully capture the intricate realities of the world. Despite the efforts of numerous economists to develop models that explain economic conditions, the multifaceted nature of the global economy can lead to discrepancies between theoretical predictions and actual outcomes.

Recently, Ethiopia has undertaken practical measures to enhance its economic framework, particularly in relation to foreign exchange management and market access. The adjustments made in the foreign exchange system are grounded in economic modeling principles, which aim to address the challenges highlighted in previous analyses. By focusing on macroeconomic improvements, Ethiopia seeks to bolster its market position, attract foreign investment, and ultimately enhance the livelihoods of its citizens while managing its debt obligations effectively.

Our leaders have emphasized the importance of grounding their decisions in sound economic science, recognizing that a well-informed approach is essential for sustainable development. While they may articulate their strategies based on economic theories, the practical application of these principles remains crucial for achieving desired outcomes. The interplay between theoretical frameworks and real-world implementation will determine the success of economic policies and their impact on the nation’s growth trajectory.

The external currency exchange rate has emerged as a significant concern for our leaders, who appear to treat the fluctuations as trivial inconveniences without prior discussion. While they often assert that these changes mirror the economic realities we encounter, there is a noticeable lack of acknowledgment regarding the fundamental issues that drive these variations. A more open and transparent communication strategy would involve informing the public about the true significance of these changes and fostering a collective understanding of their broader implications.

It is apparent that numerous leaders struggle to effectively address the public’s concerns about the currency exchange rate. The frequent response of “I do not know” not only falls short of expectations but also undermines public confidence. Leaders must appreciate the necessity of delivering clear and constructive insights, as the populace deserves to be educated about the intricacies of the economic landscape. Rather than shying away from accountability, it would be far more advantageous for leaders to recognize the seriousness of the situation and commit to implementing tangible measures to confront the existing challenges.

Esteemed representatives, the financial assistance from international organizations should not be viewed solely as a positive development; it necessitates a thorough analysis of its consequences for Ethiopia. The general public remains largely uninformed about the complexities associated with the foreign exchange rate, which often results in confusion and misinformation. As we navigate these economic difficulties, it is essential for leaders to actively engage with citizens, offering clarity on the current situation and presenting a strategic framework to tackle the economic downturn. This proactive engagement will cultivate trust and collaboration between the government and its constituents.