Despite a recent foreign exchange reform by the National Bank of Ethiopia (NBE) and substantial dollar allocations by the Commercial Bank of Ethiopia (CBE), Ethiopian import and export traders remain reluctant to access foreign currency from banks. Between July 22, 2024, and September 30, 2024, CBE distributed over USD 282 million across various sectors, yet businesses have utilized only 28% of the available foreign exchange. This reluctance persists despite the availability of dollars at lower rates than what is typically found on the open market.
Several reasons account for this phenomenon. First, Ethiopian banks allow only spot trading, which exposes traders to significant risks due to exchange rate fluctuations. Second, the ongoing economic slowdown and inflation have weakened demand for imports, making the market less attractive for traders. Third, Ethiopia’s tight monetary policy has created cash flow issues, making it difficult for businesses to secure the necessary local currency to settle forex payments. And finally, despite substantial forex allocations, businesses have been unable to fully capitalize on these resources due to the challenges mentioned. Here is a closer look at these issues.
1. Spot Trading and Exchange Rate Fluctuations
A key issue discouraging traders from using bank-offered forex is the reliance on spot trading. Spot trading means that traders must buy or sell foreign currency at the current exchange rate, without the ability to hedge against future currency fluctuations. In Ethiopia, where the birr has seen significant depreciation in recent years, this exposes businesses to major risks.
For example, imagine an importer needing to buy $100,000 to purchase goods from abroad. At the time of the transaction, the exchange rate is 1 USD = 60 ETB, meaning they will need to pay 6,000,000 ETB. However, by the time the goods arrive and payments are due, the birr might depreciate further to 1 USD = 65 ETB. In this case, the importer will need to pay even more in birr to cover the same $100,000, potentially causing financial strain or losses.
In contrast, hedging allows businesses to lock in an exchange rate for future transactions, protecting them from unfavorable currency movements. For instance, with a hedging contract, an exporter might agree to sell $100,000 at a future date at a fixed rate of 1 USD = 60 ETB, regardless of the market rate at the time of the transaction. This provides more financial certainty, but Ethiopian banks currently do not offer such mechanisms. Without access to hedging, traders are exposed to volatile exchange rates, making spot trading a high-risk endeavor, especially in a fluctuating market like Ethiopia’s.
2. Economic Slowdown and Inflation
Ethiopia’s ongoing economic slowdown and high inflation have created additional barriers for traders. The consumer index—a measure of household consumption and economic activity—has been on the decline, which discourages importers from bringing goods into the country. Even with forex available at lower rates, many importers fear that weak consumer demand will leave them with unsold goods, making their investments unprofitable.
Inflation has eroded the purchasing power of consumers, further reducing demand for imported goods, which are often more expensive than local alternatives. As a result, traders are reluctant to take on the risk of importing goods that may not sell, especially in a market where households are tightening their belts.
Additionally, the export sector has been sluggish, further compounding the issue. With declining external demand for Ethiopian goods, exporters are earning less foreign currency, making it difficult for them to sustain operations or invest in future imports.
3. Tight Monetary Policy and Cash Flow Constraints
Ethiopia’s tight monetary policy is also playing a significant role in limiting traders’ access to foreign exchange. In an effort to control inflation, the government has restricted the availability of local currency (birr), which has created cash flow issues for businesses.
Current regulations require importers to deposit between 50% and 100% of the transaction value in birr before they can access forex from banks. This policy locks up significant amounts of capital, leaving businesses with limited cash flow to cover other operational expenses. Even if forex is available at lower rates, many traders find themselves unable to meet these high deposit requirements, preventing them from securing the dollars they need to conduct business.
For example, an importer looking to purchase $100,000 would need to deposit up to 6,000,000 ETB (assuming an exchange rate of 1 USD = 60 ETB) in advance to access the forex. With cash flow already strained by tight monetary conditions, many businesses cannot afford to tie up such large sums in forex transactions, even if the rates are favorable.
Low Utilization of Allocated Foreign Exchange
Despite the challenges outlined above, the Commercial Bank of Ethiopia (CBE) has made significant strides in distributing foreign exchange. Following the NBE’s reform of the foreign exchange management system, CBE distributed over USD 282 million between July and September 2024. The allocations were made across four rounds and targeted key sectors such as pharmaceuticals, manufacturing, and import/export businesses. The breakdown of the distribution includes:
- Medicines and medical supplies: USD 208,290,167.10
- Machinery: USD 42,777,753.94
- Raw materials and consumer goods: USD 18,153,777.53
- Service fees and miscellaneous expenses: USD 13,237,737.99
Despite this sizable allocation, the utilization rate by businesses has averaged only 28%. This low uptake highlights the disconnect between the available forex and traders’ ability or willingness to access it. Many traders are either unable to secure the necessary birr to meet pre-payment requirements or are unwilling to take on the risk associated with spot trading and fluctuating exchange rates.
The reluctance of Ethiopian import and export traders to take advantage of the dollars provided by banks, despite lower rates, stems from several interrelated factors. The reliance on spot trading without hedging mechanisms exposes traders to significant exchange rate risks, while the economic slowdown and inflation have reduced demand for imports, making the market less attractive. Additionally, tight monetary policies have squeezed cash flow, making it difficult for businesses to secure the local currency required to access forex.
Although the recent foreign exchange reform and sizable allocations by the CBE are steps in the right direction, these measures alone are not sufficient to address the broader issues. Introducing hedging mechanisms, easing cash flow constraints, and stimulating consumer demand will be crucial in encouraging businesses to fully utilize the available forex and participate more actively in international trade. Until these systemic issues are resolved, the low utilization of forex by traders is likely to persist, regardless of the rates offered.
I really have enjoyed the analysis and appreciated the examples used to help readers easily understand the issue. I want to raise a two issues. Firstly, it is true that devaluation of local currency make imports more expensive to local consumers. This when coupled with lower purchasing power of domestic consumers, it leads to decline in demand for imported goods. But I don’t see why demand for Ethiopian exported goods are declining when local currency is devalued. Contrary to this, it is expected that Ethiopian goods get cheaper to foreign consumers thereby increasing the demand for exported goods, why is demand for Ethiopian exports decline? Secondly, it is not right to introduce tight monetary policies to curb inflation? Governments are advised to decrease money supply during inflation, and thus introducing tight monetary policies is part of the that policy to stablize the economy. After all, the objective of the government is not to help businesses to fully utilize the available forex, but to stablize the economy. So, why do you suggest the government to introduce easing cash flow constraint, which is beleived to increase inflation.
Best,