The National Bank of Ethiopia’s recent shift to a market-based foreign exchange rate system has intensified eagerness over the effectiveness of this reform in curbing the hardened black market’s influence. Despite the policy’s goals of enhancing transparency and stability, the persistent gap between official and black market rates highlights the challenge of eliminating informal currency trading. Deutsche Welle (DW) reports that in Addis Ababa, one dollar exchanges for 120 to 140 birr, the euro for 125 to 130 birr, and the British pound for about 150 birr. This article examines the black market’s response to the new policy and assesses its potential to alleviate its negative impact on Ethiopia’s economy.
The National Bank of Ethiopia (NBE) has recently transitioned from a fixed foreign exchange rate system to a market-based approach. This adjustment is intended to let the Ethiopian birr better represent its market value, correcting long-standing distortions and fostering economic stability, private sector expansion, and sustainable growth. However, a major challenge remains: the disparity between official and black market rates. It is unclear whether this change will fully address foreign exchange supply problems and eradicate the black market, which persists by supplying currency where official channels are inadequate.
“Previously, businesses faced several significant challenges, including the retention of only 40% of generated foreign currency, foreign currency shortages, and high service fees. This limitation severely impacted operational efficiency, leading importers to engage in coffee exports as a means to generate the necessary foreign currency,” explained Tadese Melaku, Manager Coffee Trade at Horra Trading. He further noted that this shortage also led coffee exporters and others to sell their foreign currency at prevailing rates to various buyers. Transactions conducted through the parallel market has its own challenges and it remains unregistered on financial profiles.
As noted by Tilahun Girma, a seasoned Finance Consultant and respected commentator across multiple media outlets, observed that exchange rate misalignment caused official rates to misrepresent true supply and demand for foreign currencies. This overvaluation of the Birr made exports costlier, reducing formal export channels and increasing contraband activities, such as smuggling gold and live animals. Persistent foreign currency shortages led to difficulties accessing currency through official means, giving rise to a parallel market where foreign exchange transactions, especially for imports and remittances, occurred at significantly higher rates than in the official market.
He added that traders and diasporas turn to the parallel market for foreign currencies due to the higher return compared to the official market, which struggles to meet demand because banks prioritize currency allocation. This gap has led to significant flows of remittances and foreign currency into the black market, with exporters under-invoicing and selling currency illicitly. To stay competitive, exporters often sell products below the cost of purchased dollars, offsetting losses by selling foreign currency to importers or starting import businesses. These illegal transactions increase business risks and create discrepancies between invoiced and customs trade values, inflating duty-paid valuations.
Will the National Bank of Ethiopia’s shift to a market-based foreign exchange rate resolve the issues mentioned, or will the black market continue to prevail? While the reform seeks to restore macroeconomic stability, enhance private sector activity, and promote sustainable growth, its success in fully eliminating the parallel market is still in its early stages and will depend on the effectiveness of its implementation and the market’s response.
According to Andualem Goshu, Assistant Professor at Addis Ababa University, he anticipates that the parallel market will eventually disappear. He identifies two key measures necessary for this elimination, first, allowing the exchange rate to float will enable traders to access foreign currency as needed, thereby reducing reliance on the black market. Second, it is not sufficient to merely float the exchange rate, ensuring a steady supply of foreign currency is also crucial. While loans from the IMF and World Bank offer a temporary solution, Andualem suggests that the government should consider banning the import of non-essential goods to help maintain a stable foreign currency shortage.
On top of that, Tadese estimates that the parallel market will gradually diminish as the gap between the official and black markets continues to close. According to him, intermediaries and traders gain more than importers or exporters. Therefore, importers and exporters are likely to move towards the official market to improve their bank profiles and performance and to obtain profit and loss reports from banks. He notes that the parallel market involves additional legal challenges and difficulties in accumulating sufficient foreign currency. The transition to a market-based exchange rate is expected to drive these buyers towards official channels, making transactions more straightforward and legal.
“The gap between the official market and the parallel market is likely to narrow as the official market better aligns with actual supply and demand,” said Tilahun. “Transitioning to a market-based rate will increase transparency and allow rates to more accurately reflect economic conditions, potentially reducing shortages. This shift is expected to enhance foreign currency transfers through the formal market by exporters, remitters, and foreign direct investors, and to minimize the under-invoicing of exports.” He also noted that if commercial bank rates become competitive and foreign currency availability improves, traders might prefer the official market. The reduced risk in the official market could attract those who previously relied on the parallel market, where transactions involve a higher risk of default.
He added that market-based rates can introduce volatility, potentially impacting economic stability due to speculations and manipulation by market hoarders. Short-term disruptions might occur as the market adjusts, and foreign currency reserves may deplete initially during this transition. However, over time, a market-based system could achieve a more balanced supply and demand, stabilizing reserves. Initially, exchange rates may be highly volatile, leading to a potential spike in inflation as the cost of imported goods rises. Despite these challenges, markets may stabilize in the long run, resulting in more predictable exchange rates.
The NBE’s overhaul of Ethiopia’s foreign exchange system, including the shift to a market-based regime and various policy changes, aims to reduce market disruptions. The end of surrender requirements, removal of bank allocation rules, and introduction of non-bank foreign exchange bureaus enhance market flexibility and liquidity. Removing restrictions on franco valuta imports and simplifying foreign currency account rules improve accessibility. Allowing residents to open foreign currency accounts and lifting interest rate ceilings support investment and savings. Additionally, opening Ethiopia’s securities market to foreign investors promotes economic integration, leading to a more fluid foreign currency market.
Tilahun asserts that selective foreign exchange interventions, such as auctions, are essential for stabilizing the volatile exchange rate gap between commercial banks and curbing speculation. These measures are expected to build confidence in the official market, increase bank liquidity, and decrease reliance on the black market by enabling importers to open LC accounts. Improved bank liquidity is likely to attract foreign investors and foster the development of a capital market in Ethiopia, benefiting both local and international stakeholders. Over time, these reforms are anticipated to stabilize the economy.
As the reform is new for the nation’s economy, it creates confusion in society. After over a decade of a fixed exchange rate, NBE’s bold reform has lifted the fog obscuring the Ethiopian economy. For businesses to adapt and for the government to ensure the reform’s effectiveness, both must navigate these changes with clear strategies and robust support systems.
Experts argue that IMF and World Bank loans offer only a short-term fix for the foreign currency shortage. A long-term solution requires shifting from an agriculture-based economy to a manufacturing focus and moving from import reliance to export emphasis. As the Indian saying goes, “To ruin your country, focus on imports; to build your country, focus on exports.” The country must meet consumer demand with affordable products, promote import substitution, and shift exports from raw materials to value-added products to create jobs. While many businesses prefer the profitable service sector, encouraging manufacturing is crucial for national development. Foreign investors should be welcomed but must contribute to the foreign currency supply rather than hoard it.
Based on insights from experts, the official market is poised to outpace the parallel market in the long run. Achieving this shift will hinge on the successful implementation of reforms and the proactive stance of business leaders in discouraging illegal activities. Effective execution of these measures, coupled with a strong commitment to operating within legal frameworks, is essential for the official market to gain a dominant position and stabilize the economic landscape.
