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The gap between official exchange rate and that of black market is widening. Banks are buying one USD for 17.85 birr while selling it for 18.21 birr as of the official rate published by the National Bank of Ethiopia on Friday August 10. The parallel market is buying one dollar for 18.5 birr surpassing Friday’ s official selling rate. Such a trend is observed for the first time since the country depreciated the birr against major foreign currencies two years ago.The observed difference in the value of exchange rate is diverting hard currency bearers from using formal exchange channels to the informal one creating room for the underground business to re-flourish.
The gap between official exchange rate and that of black market remained close to one percent for almost two years after the government depreciated the exchange rate of the birr against major foreign currencies on average by 20 percent. However, this gap widening in the past two weeks has reached close to five percent as of last Friday.
The expanding difference shows the imbalance between demand and supply of foreign currency according to experts.
The observed difference in exchange rate has already triggered speculation about possible price hikes in the near future, at least, for imported goods in the business circle of the country. If this speculation materializes, the situation will accelerate inflation which was rather decelerating during the past few months.
“ We are processing letters of credit for selected sectors of the economy on a priority basis since there is a foreign currency shortage. There is not as such directive that bans processing it,” said an executive in the banking sector on condition of anonymity a week ago.
Though the inflow of hard currency to the country from remittances, tourism and other sources has not been made public so far, it is reported that the country earned USD 3.1 billion from exports last fiscal year.
The government of Ethiopia envisions single digit inflation and five percent depreciation of the birr against major foreign currencies in this Ethiopian fiscal year.
In what was termed as massive government crackdown, the government confiscated close to USD 6 million from black market dealers in Addis Ababa in March 2008. Since then, the city has not observed such a major move despite fragmented efforts to discourage it. At that time the nation was facing a critical shortage of foreign currency.
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On September 12, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Ethiopia.1
Background
Ethiopia’ s macroeconomic performance in 2011/12 has been mixed. Strong, broad-based growth continues at a pace of about 7 percent and poverty reduction measured by poverty head count declined from 38.7 to 29.6 percent during the six years to 2010/11. However, inflation surged to 40 percent in August 2011, largely reflecting a combination of factors including loose monetary policy, and high global food prices but has eased to about 21 percent in June 2012 supported by a slowdown in global food and fuel price inflation and the implementation of the base money nominal anchor. Despite the continued robust increases in goods exports and remittances, the current account deteriorated in the first half of 2011/12 contrasting the surplus recorded in 2010/11 attributed to a frontloading of import of capital goods the previous year. The developments in 2011/12 largely reflect a recovery of imports of capital goods, an increase in consumer goods imports, and a weakening of the services balance due to a surge in service imports.
The federal government budget execution in 2011/12 has been tight based on a strong tax revenue increase when compared to the previous fiscal year, and a slower-than-budgeted execution of recurrent expenditure. However, the public sector (including state-owned enterprises) as a whole has been providing strong fiscal impulse given the state-owned enterprise substantial capital expenditures financed by borrowing from external sources and the Commercial Bank of Ethiopia (CBE). A rise in regional government deposits at CBE contributed to the funding. The 2012/13 budget focuses on sustaining growth, lowering inflation further, mobilizing revenue, and spending on pro-poor projects. The revenue target is within reach with the continuation of administrative efforts. Total expenditure is projected to grow slower than nominal GDP, but poverty-related spending as a share of GDP will be maintained.
Monetary policy in 2011/12 has largely been geared toward lowering inflation with the implementation of the base money nominal anchor. Base money at end-May 2012 declined by 0.9 percent year-on-year as the central bank has ceased providing new direct credit to the government since July 2011 and has been selling foreign reserves in recent months to achieve a base money contraction target of 4 percent for the fiscal year. However, the lowering of the reserve requirement ratio in early January from 15 percent to 10 percent weakens the tightening effect of the base money contraction. Broad money at end-May 2012 grew by 29 percent year-on-year on account of strong credit growth to public enterprises. Despite the planned National Bank of Ethiopia (NBE) financing of the 2012/13 budget, which could affect inflation expectations, the 2012/13 monetary targets focus on lowering inflation.
The NBE directive that requires commercial banks (excluding CBE) to hold bills issued by NBE is impeding financial intermediation. By creating a significant maturity mismatch in the private banks balance sheets, it has a considerable negative impact on their capacity to play their conventional intermediation role. Financial sector soundness indicators do not point to immediate concerns. However, recent developments such as the increasingly dominant market share of CBE and its growing exposure to large public enterprises, and the adverse impact of NBE directive on private banks suggest a need for a closer scrutiny of the banking system.
Absent increased role of the private sector to leverage the large public infrastructure investment and efforts to improve the doing business conditions, IMF staff project that real GDP growth will slow down to 6.5 percent in 2012/13 and over the medium term. However, the authorities project the economy to grow at double digit rates.
Executive Board Assessment
Executive Directors welcomed Ethiopia’ s strong economic growth and continued progress in poverty reduction. However, Directors noted that the authorities’ public sector-led development strategy is contributing to macroeconomic imbalances. To sustain robust growth and address the emerging risks, policies for the period ahead should focus on promoting disinflation, achieving an appropriate pace of public investment, reconstituting official reserves, and promoting greater financial sector stability.
Directors welcomed the authorities’ goal of reducing inflation. In this context, they urged the central bank to pursue a tighter monetary stance and avoid further deficit financing. Directors also underscored the importance of broadening the toolkit of monetary policy instruments, including by revamping the market for government securities, which could foster private saving and investment. Greater exchange rate flexibility would safeguard foreign exchange reserves, strengthen external competitiveness, and mitigate external vulnerabilities.
Directors encouraged the authorities to persevere with their fiscal reforms. In particular, they saw scope for further improvements in tax administration and revenue mobilization. Additional public financial management reforms and development of a medium-term debt management strategy encompassing both domestic and external debt would help achieve the fiscal objectives under the Growth and Transformation Plan and maintain fiscal sustainability. Any non-concessional borrowing should be consistent with maintaining a low risk of debt distress.
Directors stressed that effective financial sector supervision and regulation remain crucial for macroeconomic stability. In this regard they advised the authorities to consider participation in the Financial Sector Assessment Program which would help identify vulnerabilities in the financial system and suggest corrective actions as appropriate. Directors encouraged the authorities to address the remaining deficiencies in Ethiopia’ s AML/CFT regime.
Directors agreed that deeper structural reforms are essential for promoting growth. Accordingly, they underscored the importance of creating a more favorable business environment and enhancing the role of private sector in the economy. Directors also called for further efforts to improve data quality and supported Fund technical assistance in this area.
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