Legalizing the Black Market to Solve the Forex Shortage

In Ethiopia, shortages in the availability of foreign exchange, also known as a foreign exchange crunch, has beenone of the pressing economic agendas for quite some time, and has lead to heated discussions. In response to the prevailing shortages, the government has recently taken some measures that aim to ameliorate the problem. Two actions standout in this regard: a fast crackdown on black market operators, and controlling the foreign currency that exits through Bole International Airport and boarder areas. As a result, confiscation of large amounts of foreign currencies (at least from the perspective of individual stances) continues to be reported. In principle, shortage or surplus depend on the country’s export performance and other sources of foreign exchange including foreign borrowing and remittances. So, the question is whether such actions lead to an efficient outcome, and if they do not, whether there is a more efficient way of organize the foreign exchange market given the demand and supply situation.

In general, interventions that aim to restrict prices and quantities lead to inefficiencies; meaning that both price and quantities realized in the market are inefficient. Even if one was to carry out a complete crackdown, it is almost inevitable that a market would crop up in a different and probably more inefficient way.

Similarly, the market for foreign exchange is not much different from other markets. Immediately after some actions, we may observe that the market stays dormant with little activity and a seeming equivalence between the parallel and official exchange rates. Eventually, however, the market is likely to emerge and start functioning, probably at higher margins from the initial ones. The higher margins would correspond to the costs of higher risks of being caught. In order to see the pitfalls of crackdowns of these markets and confiscation of resources, we start by looking at the elements of demand and supply.

It would not be an exaggeration to speculate that the lion’s share of the supply of foreign exchange in Ethiopia emanates from Diasporas. Ethiopians residing in foreign countries send foreign exchange to their relatives informally. Most of the time this is done through people that travel to Ethiopia. Such individuals, most of the time, also come to the country to visit their families. Their countries of origin allow limited amounts of cash to be carried by travelers, but these ‘limited’ amounts are quite large when compared with the demands of our black market operators. For instance, an individual is allowed to carry up to USD10,000 from the United States: quite large from the point of view of the market we are discussing.

Similarly, tourists, including people who travel for business purposes who bring in cash, expatriates working in the country as well as local residents who travel abroad for various reasons and come back with some reserve foreign exchange are all sources of supply for the black foreign exchange market. The amounts exchanged per transaction in these circumstances may be relatively small. However, when individuals transactions are summed up, the total volume of foreign currency supplied by these sources would be immense.

It is also common for expatriates to enter contracts for rental housing premises in foreign exchange (usually using US dollars). In some circumstances, such rent is actually paid in foreign exchange. In addition, it is used as a means of deterrence for the effects of devaluation of domestic currency or inflation over the time span of the contract. If the transactions take place in foreign currency, obviously this finds its way onto the foreign exchange market.

The demand side of this market is largely composed of importers who do not find sufficient foreign exchange from commercial banks. Most of the time, importers bring commodities in bulk. However, it is not uncommon for importers to get access to only a portion of foreign currency they requested. That portion which is not funded by banks would need to be augmented with additional funds that would definitely come from the black market.

Ethiopians who go abroad for various reasons, including medical treatment, education and tourism also require foreign currency. The amount of foreign currency availed to these travelers are not only a fixed amount at a given time, but it also change over time. The most important thing here is that amounts of foreign exchange authorized for such needs are usually, if not mostly, insufficient to satisfy travels needs. At the end of the day, the source of financing these requirements comes from the black market.

There is also a segment in this market that takes place in complete darkness. Say, we have an individual living in Ethiopia who would like some payments to be made in a foreign country. One of the actions of this person is to seek a resident in that country who could make payments on his behalf—the transaction is concluded by the individual residing in Ethiopia making payment in local currency on behalf of such a claimant. In this case, no financial resource has moved in either direction but a transaction has been completed. I am raising this to indicate how various elements of the demand and supply would easily interact and create a market. Think of the time and effort being exerted in finding a double incidence in the market!

Wishing that I am wrong, but considering the amount of cash seized in one go these days, it seems that individuals are hoarding foreign exchange. One could guess two basic reasons for this: speculation and storing foreign exchange as wealth. Speculation could be pardoned in terms of comparisons of future returns from different options, but using cash (foreign exchange) at hand as a means of storing wealth is completely indefensible. In the latter, individuals are just keeping dead assets that could have been used tolubricate the economy. This problem is compounded by the fact that domestic agents cannot open foreign accounts.

Now, what would be an orderly mechanism that could be instituted in order to bring efficiency to the foreign exchange market? The most obvious reason for inefficiencies is the existence some form of monopoly. If this is coupled with a lack of specialization, where each financial institution is engaged in all kinds of financial activity, then the magnitude of inefficiency tends to be exacerbated. My proposition is that these two elements are present in the foreign exchange market in Ethiopia. Consequently, we need to break this monopoly.

The starting point of this intervention should be the legalization of the black market. Namely, offer permits to engage in the purchase and sale of foreign currency that caters the demand and supply that I mentioned earlier. There are many advantages, including: the transactions in this market would be recorded; currencies raised in this market could be pulled by commercial banks and used for international trade; the sector would employ personnel and would pay taxes, among others. Commercial banks would then specialize in the transfer of financial resources to facilitate international trade.

By focusing on this, the commercial banks would increase their efficiency. It is highly likely that commercial banks have a comparative disadvantage in dealing with piecemeal engagements in the small transactions that are carried out in the black market. It is even logical to question the viability (economic) of this segment of foreign exchange operations, given the levels of competition and instruments that are being used by banks, such as lotteries and gifts offered to customers who exchange currencies at the banks. Of course, the details of the institutional requirements and regulatory framework for this should be studied and implanted by the appropriate authority; in our case the National Bank of Ethiopia.

7th Year • Nov.16 – Dec.15 2018 • No. 68

Tekie Alemu (PhD)

is associate professor of economics at Addis Ababa University. He can be reached at

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