Floating Exchange Rate Sparks Concerns Over Exchange Rate Risk in Ethiopia
Ethiopia has recently launched a comprehensive macroeconomic reform program to tackle long-standing economic challenges and transition to a more stable and competitive economy. A central aspect of this reform is the adoption of a Floating Exchange Rate System, intended to address foreign exchange distortions. However, critics within the banking sector warn that this system is increasing foreign currency risk, commonly referred to as exchange rate risk.
Foreign currency risk arises from fluctuations in exchange rates between two currencies, potentially leading to financial losses for businesses, investors, or individuals exposed to foreign currency transactions.
Previously, Ethiopia operated under a tightly controlled, fixed foreign exchange regime. While this system created significant market distortions—manifested in wide gaps between official and black-market exchange rates—it also provided some degree of predictability. Businesses often faced currency shortages, delays, and challenges importing goods. The new floating exchange rate aims to mitigate these distortions by letting the market determine foreign currency values, though it introduces new risks tied to rate volatility.
Banks argue that the 14% credit cap, which restricts the amount of credit they can extend, is compounding liquidity challenges. They claim this limitation prevents them from accessing sufficient cash reserves to meet the rising demand for foreign currency.
According to an anonymous finance expert, importers are particularly vulnerable to currency fluctuation risks due to delays of up to three months in receiving their foreign currency allocations. During this time, the value of the currency often appreciates, increasing costs for importers.
“We’re left waiting up to three months to receive our foreign currency, with our funds blocked,” said Mohammed Ababor, a medical importer. “Even a small fluctuation of one birr significantly impacts us because we import in large volumes. These delays are a real struggle.”
He further suggested that the approval process for foreign currency requests, which currently takes up to 15 days, should be expedited to reduce the burden on businesses.
As Ethiopia navigates these economic reforms, it is crucial to address the challenges businesses face to minimize disruptions and ensure sustainable growth. Proactively resolving these issues will strengthen both the financial sector and society as a whole, maximizing the benefits of the reforms for all stakeholders.
