Foreign Currency Crunch: Why is it Happening Every Now and Then? Featured

Yonas Gebrekidan 38, whose name has been changed, is one of the printer cartridge importers in Addis Ababa. He has been doing this business for the past five years. As the business has been expanding, he has lately opened shops in regional towns. But recently, his business has been seriously challenged. “Business has come to a ground halt” he said. “The banks have not been allowing enough foreign currency to import the necessary materials we need.”

Like Yonas, many businesses in the import sector are facing hard time to acquire foreign currency.

This is not the first time when such problems happen in Ethiopia. The same problem was in the economy four years back. However, this year’s has been different for government has been less forward about it. The shortage and the confusion stirred by speculators and brokers, who have been taking advantage of the situation, have been around since May 2012.

For a country like Ethiopia which is a net importer and whose export earning depends mainly on primary products, trade deficit and foreign reserve shortages are expected, Eyob Tesfaye (PhD), a macro economist, who used to be the director general of the Financial Institutions Supervision Agency, said.

There are many questions in the minds of many actors in the economy as to why the country finds itself in the vicious cycle of acute foreign currency crunch every now and then. Why is that the National Bank of Ethiopia (NBE) unable to manage even the limited amount of foreign currency the nation has acquired efficiently so that business doing in the country becomes a little bit predictable? Why was it unnecessary for the NBE to discuss the issue publicly for the last nine months? Before anything else, the subject is purely an economic issue. Why did the Budget and Finance Standing Committee or the Office of the House Speaker failed to call Teklewold Atnafu, Governor of the NBE, to explain the situation? Back in 2009, he had appeared before the parliament for same.

So far, the NBE was unavailable to discuss the issue with the Media. No other government Why did the Budget and Finance Standing Committee or the Office of the House Speaker failed to call Teklewold Atnafu, Governor of the NBE, to explain the situation? Back in 2009, he had appeared before the parliament for same. official also dared to speak about it openly. Even if it came late, it was Prime Minister Halemariam Desalegn who raised the issue while answering questions by parliamentarians recently, although he denied the problem. He said, the shortage has been caused by speculators who thought the country will be in trouble to import goods upon the death of the late prime minister. However, while the country is stable now, as it was before the death of Meles Zenawi, opening letter of credits hasn’t become that easy.

As the NBE opted to keep silent about it, the situation has created information vacuum. This gave market speculators leverage to manipulate the gap. Was this much secrecy, denial and media blackout that creates information asymmetry in the market the right way of dealing with the issue?

There is a visible fear factor around this issue. Ethiopian Business Review has tried to get the opinion of several banks, including the bankers association. However, none of them were willing to talk on the issue. Perhaps this comes from the possible fear of the Central Bank, the big brother. We have also tried to get answers from different departments of NBE including the governor’s office but all of them declined to comment. And their faces visibly change and they show apparent signs of discomfort anytime we mention the word “foreign currency reserve”, during our frequent visits.

Foreign reserve and balance of payment

A reserve currency, also called an anchor currency, is a currency that is held in significant quantities by numerous governments and central banks as part of their foreign exchange reserves. These currencies are pricing currency for global trade-particularly to commodities such as gold, oil and coffee. According to the Global Finance, the primary reserve currency used worldwide is the US dollar, followed by the Euro, the British Pound, the Japanese Yen, and the Swiss Franc. The Chinese Yuan is also increasingly becoming a global trading currency. The modern exchange market, as tied to the prices of gold, began in 1880.

Foreign-exchange reserves: foreign currency deposits and bonds held by central banks, commonly includes foreign exchange, gold, and others. These are assets central banks use to back their liabilities such as the issuance of local currencies and various reserves deposited with the central bank.

Balance of payment is a statistical record which shows all the economic transactions which occurs between residents of a country and the rest of the world. It shows the extent of a country’s technical development and hence competitiveness in the world market.

The amount of foreign exchange reserves that a country has is used as an indicator of the ability to repay foreign debts.

Table1: Selected countries and their foreign exchange reserve holdings in dollar and gold in 2011.Sourcre:Global Finance
Rank Country Reserve in USD
1 China 3,236,000,000,000
2 Japan 1,259,000,000,000
3 Saudi Arabia 541,100,000,000
13 Algeria 183,100,000,000
18 USA 148,000,000,000
61 Egypt 17,660,000,000
77 Botswana 8,674,000,000
87 Kenya 5,298,000,000
109 Ethiopia 2,665,000,000
150 Sudan 295,000,000

Total foreign exchange holdings worldwide went from almost 2 trillion in 2000 to more than10 trillion dollars in the first quarter of 2010. The top 11 countries, including China, Japan, Saudi Arabia, Russia, Taiwan, Brazil, India, South Korea, Hong Kong, Switzerland, and Singapore hold a majority of the total world foreign currency reserves.

Ethiopia is the 109th nation, from a list of more than 169 countries surveyed. Even though its standing is better than a sanctioned Sudan, neighboring Kenya has twice its amount.

In 2000, reserves held by advanced economies was almost double the amount held by emerging and developing economies—at 1.2 trillion and 0.7 trillion dollar, respectively. By the first quarter of 2010 these figures had reversed, with emerging and developing economies holding almost double the amount held by advanced economies—at 5.5 trillion and 2.8 trillion dollar, respectively. In 2011 this ration remained stable, with emerging and developing countries holding 6.7 trillion and advanced economies 3.4 trillion dollar, according to the global economic indicators data base.

Foreign currency and balance of payment in Ethiopia

Both Ethiopian and Egyptian economies have been hit by foreign currency shortages recently. However, the similarities end here. When it comes to handling the crisis, the Central Bank of Egypt (CBE) openly declared the problem and seeks solutions; its Ethiopian counter part chose silence.

According to Reuters, foreign cash reserves held by CBE dropped in November, to 15.035 billion dollar. Before the revolution the reserve was above 20 billion dollar.

Mohsen Adel, the vice president of the Egyptian Association for Financing and Investment Studies, predicted that the reserve may rise again with support from the African Development Bank as well as anticipated deposits from Qatar and Turkey. Whether the National Bank of Ethiopia is trying to follow such approaches to minimize the impact of the problem on the economy isn’t clear for officials of the bank were unavailable to discuss on the issue. The bank was not even willing to give information on its foreign currency holding.

Since Ethiopia started professionally documenting its international trade, it experienced chronic balance of payment problems. With the exception of 1973, the country’s balance of payment has been negative. The major factor in the deteriorating balance of payments was the worsening situation of merchandise trade. The trade deficit that existed during the imperial years continued to grow after the revolution, despite the introduction of import controls.

The situation persisted even after the change of government in 1991, and the subsequent market liberalization. Since then the country’s import has consistently increased. The trend has accelerated in the last decade. However, the growth in export sector has not matched the pace. This has exacerbated the need for foreign currency. This has been the main reason behind the low level of foreign currency reserve in the country, according to macro economists.

The amount of reserves that a country should hold is not uniform, although one common benchmark is holding enough to cover external debt for one year. As a rule of thumb, NBE holds enough to cover imports for three months.

Graph 1: Ethiopia's reserve of foreign exchange and gold from 2004 to 2011 in US dollar.
Source: CIA fact book
Compiled and Illustrated by EBR

Graph 1 gives the dollar value for the stock of all financial assets that are available to the central monetary authority for use in meeting a country’s balance of payments needs as of the end-date of the period specified.

Even though the foreign currency reserve of the country steadily grows it is still unable to satisfy the growing demand from the import sector.  This is best explained in the growing trend of balance of payment deficit of the country.

This entry records the country’s net trade in goods and services, plus net earnings from rents, interest, profits, dividends, and net transfer payments (such as remittances) during the period. These figures are calculated on an exchange rate basis, i.e., not in purchasing power parity (PPP) terms.

Graph 2: Balance of payment position of Ethiopia from 2004-2011.
Source: CIA world fact book
Compiled and Illustrated by EBR

As we can see from Graph 2, the country’s balance of payment shows deficit in the years.

This entry provides the total value of goods in dollar on FoB (freight on board) and imports on CIF (cost, insurance, and freight) basis. These figures are calculated on an exchange rate basis, i.e., not in purchasing power parity (PPP) terms.

The import of the country is growing dramatically. It has reached 8.25 billion dollar from a low base of 1.25 billion dollar in ten years, while the export grow only to 2.75 billion dollar. The gap between the two is expected to continue in the foreseeable future, as the country continues to import massive capital products in its drive to transform the economy. The growing rate of imports of finished goods in the country has also contributed to the situation.

Graph 3: Import-export performance of Ethiopia from 1998-2011, in billions of dollars.
Source: CIA world fact book
Compiled and Illustrated by EBR

Unpredictable fluctuation

Different reasons can be attributed for the prevailing foreign currency shortage in the market. One of the bankers that Ethiopian Business Review has discussed the issue with, sites huge government imports as one of the possible reasons for the situation.  “The amount left is not enough for the private sector”, the banker said.

The macroeconomist agrees with this. According to the Growth and Transformation Plan (GTP), about 60% of expenditure of projects will be paid in hard currencies. The government’s decision to sell foreign exchange to suck the local currency suffocating the economy as part of its strategy of curbing the galloping inflation was also a reason to the economist. Even though this venture by the NBE is necessary to tame the inflation, the central bank could have avoided this by controlling broad money supply in the economy.

A fundamental issue that should be taken into account while studying the financial situation in the country is the institutional independence, capabilities, strength of the central bank. Even though the international trend mainly give central banks the role of stabilizing price, exchange rates and supervision of commercial banks, NBE engages in activities as a commercial bank too: It sells foreign exchange, opens LCs, opens and operates current accounts, provides other banking services. This lack of focus on its primary mandates, in combination with the lack no skilled labor and technological infrastructure contributes to the prevailing foreign exchange market unpredictability and mismanagement. “Banks that operate in the economy, including the NBE don’t have scientific foreign exchange management systems” say industry observers.

No matter what caused the shortage of foreign currency, the problem will lead to lesser economic activities. This is evidenced by the large number of importers lined up to open LCs. According to the information Ethiopian Business Review About 60% of the projects in the Growth and Transformation Plan (GTP) will be paid in hard currencies has collected, it takes more than three months to open LCs in most banks. At the moment, most banks use different criteria to prioritize request for foreign currency permits. The tools used to prioritize ranges from the level of loyalty of the customer to the sector that they are engaged in. Import of medicine and related products and manufacturing and export oriented businesses garnering special treatment.

Importers like Yonas, who trades consumable and intermediary products, cannot afford to wait for the dust to settles. One of the ways that they are trying to go around the problem is to use multiple Telegraphic Transfers (TT). TT is an advance payment system for transactions less than 5000 dollar. Even this takes several weeks.

One of the bankers, that Ethiopian Business Review has discussed the issue with, down plays the severity of the situation. “I think those who have applied for a letter of credit couldn’t deliver the local equivalent, if all of the requests were to be approved”. The banker anticipates that many clients have applied for LCs in several banks to increase the chance of getting the foreign currency permit.

Ethiopia has lost 24.9 Billion dollar in Capital Flight in 40 years; 3.4 Billion in 2010 alone

When will the foreign currency shortage be solved?

Earnings from export, remittance, aid, loan, foreign direct investment and privatization are the main source of foreign currency in the country. These sources have proved to be insufficient to cover the cost of its growing imports. As a result Ethiopia’s trade balance would continue to be negative until such time comes that a large amount of its export earnings comes from industrial goods. Officials at the NBE and Sufian Ahmed, the long serving minister of finance and economic development, had made it clear in 2009 that Ethiopia will achieve a positive trade balance only by joining the bloc of middle income countries and the economic transformation associated with it. The journey towards becoming a middle income country would take more than a decade from now. That was why Sufian said at that time, the foreign currency shortage in the country will not be solved in my life time.

The 2007 Gross National Income (GNI) per capita classification of the World Bank categorizes countries as low income if their per capita is 935 dollars or less; lower middle income if their per capita is between 936 and 3,705 dollars; upper middle income if the per capita is 3,706 dollars to 11,455 dollars and high income if the per capita is 11,456 dollars.

According to the Bank, the current GNI Per Capita of Ethiopia is 370 dollars. With the continuation of the double digit economic growth, the figure is expected to reach 698 at the end of the GTP period, 2015. If the above classification remains as it is, it would take the country a decade or so to raise its GNI per capita to the lower middle income category. When Ethiopia attains this status it is expected that the country would have an improved balance of payment position.

The way forward - liberalization

Ethiopia has one of the ill developed foreign currency management systems. Scientific management of the meager foreign currency resources seems visibly missing. As a result, erratic foreign currency availability has become a defining feature of business doing in the economy. This situation, in combination with the prevailing market imperfections, is making it tough for the economy to enjoy even the minimum level of market certainty.

One of the most valuable, but missing commodity in Ethiopian economy is a timely available market information. And NBE is not the place to go to get one. This is clearly evidenced by the fact that the bank is yet organizing the third quarter annual report of the previous fiscal year. In light of the fact that several ministries and agencies in the country were able to provide our editorial team an up to the minute information, NBE’s sluggish speed and blockage of information on the foreign reserve of the country triggers many questions.

In light of such information asymmetry in the market, brokers and speculators are having a field day. Rumors have it that by the time of preparing this article the enticement that is paid to secure a letter of credit has reached above two birr for every dollar that will be granted. The same rent seekers and corrupted people that the government vows to crush are prospering because of the confusion that was created due to the information vacuum apparently present in the market. There is a long running rumor that some private banks are misappropriately favoring their shareholders to take advantage of the situation.

As official statements on the issue have become rare and conjured, speculators and brokers have become the main source of information on matters of foreign currency in the country.

NBE should put its act together and inform the public about the situation the country has found itself in. Banks must follow a transparent and ethical way of handling the crisis. NBE must strengthen itself capacity to give remedy to the present crisis and prevent it from happening every now and then. It must lead the way by replacing the old rule of thumb and start implementing a scientific foreign exchange management. It should then assist other banks to follow its step.

Certainly it should focus on its basic mandates as the central bank and get out of the routine banking operations. NBE’s lack of focus is explained by many economists as the main reason for its inefficiency to use appropriate monitory instruments to execute its prerogatives. Lack of institutional independence also a factor in this regard.

As a means of increasing the foreign currency resource in the short run, the government should work to increase the remittance earnings of the country through formal structure.

According to the Bank, the current GNI Per Capita of Ethiopia is 370 dollars. With the continuation of the double digit economic growth, the figure is expected to reach 698 at the end of the GTP period, 2015.

It should also work more to increase export earnings, because this is what makes the real difference in the long run. In the meantime the country should manage to get some grant or loans to solve the problem”, macro economist advise.

This year’s chronic foreign currency problem is in part the result of last years under performance of the export sector. The country achieved only 69pct of what it planned for the year in terms of earnings. The government must strengthen its financial intelligence instruments to curb the high capital flight. According to a report from Political Economy Research Institute of the University of Massachusetts, Ethiopia has lost 24.9 Billion dollar in Capital Flight in 40 years. The country has lost 3.4 Billion in 2010 alone. In light of the fact that the country’s export in the year was 1.73 billion dollar, and balance of payment deficit was a little over 1.9 billion dollar, the need to work on the issue is ever evident.
Special measures must also be taken to attract foreign direct investment.

A fundamental strategic solution that Eyob Tesfaye (PhD) recommends is the full liberalization of the foreign exchange market, where the results of the game is dictated by all actors, including the government. Although this would be a hard pill to swallow for the developmental state government at least in the short run, it is the ultimate solution.

Mikias Merhatsidk

EBR staff writter

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