Ethiopia’s Currency Gamble

Behind Ethiopia’s ambitious currency float lies a story of haste and technocratic illusion that doomed reforms

Over the past three years, Ethiopia has grappled with a volatile mix of economic shocks and internal strife.

Hyperinflation, heavy tax hikes, skyrocketing costs for essentials like food, electricity, and fuel, and ongoing conflicts in Amhara, Oromia, and remnants in Tigray have eroded living standards, displaced millions, and fueled widespread discontent.

The U.S. State Department’s 2025 Investment Climate Statement highlights these challenges, portraying Ethiopia’s environment as one fraught with severe risks. Recent macroeconomic reforms—the July 2024 floating exchange rate and a $10.5 billion IMF-World Bank package—aimed to stabilize finances.

For three years prior, the government had hesitated, wary of the IMF’s conditionalities, as the nation’s debt ballooned to $36 billion. By the time Addis Abeba relented in July 2024, signing a $3.4 billion IMF Extended Credit Facility over four years, the economy was in critical condition.

The IMF bailout program, tightly tethered to the G20 Common Framework’s equal-treatment principle, struggles to revive an economy burdened by a major devaluation and a debt crisis represented by a $1 billion Eurobond default in December 2024.

Bitter Reform

With no choice left, Ethiopia embraced the IMF’s core conditionality in July 2024: a market-driven exchange rate. The birr devalued overnight by 30 percent and declined further to 100 percent in just 10 days as central bank controls were dropped.

Astonishingly, the government congratulated citizens on enduring this harsh reform, expecting IMF and World Bank support and an $8.4 billion debt restructuring agreement with official creditors in March to stabilize the economy.

Yet the dream of unification evaporated within days, as the parallel-market premium returned to 20–30 percent by mid-2025, driven by inadequate reserves and rampant arbitrage.

The flaw in Ethiopia’s strategy was launching without the requisite ammunition. A successful floating exchange-rate regime demands substantial foreign-exchange reserves—typically 6–12 months of import cover—to serve as a stabilization buffer.

Central banks must intervene to smooth excessive volatility, prevent speculative attacks, and signal market confidence during transition periods. With reserves at merely 2.4 months of imports, the NBE was essentially disarmed, unable to absorb shocks or counter speculative runs.

When the birr depreciated sharply post-float, the NBE had no capacity to support the currency through strategic interventions or to satisfy legitimate import demand, creating a self-fulfilling panic.

The IMF’s $3.4 billion was structured to gradually build reserves over four years, not to provide immediate market liquidity, a critical timing mismatch that doomed the float from inception.

Without this reserve cushion, the market interpreted the float not as liberalization but as abandonment, triggering capital flight and hoarding behavior.

Exchange-rate liberalization presupposes institutional integrity that Ethiopia manifestly lacked. A floating regime requires transparent price discovery, competitive banking, and regulatory enforcement, conditions impossible under systemic corruption.

State-owned and regime-affiliated banks, including the Commercial Bank of Ethiopia, Cooperative Bank of Oromia, Siinqee Bank, and Awash Bank, operated dual systems featuring official windows for optics and clandestine channels for arbitrage profits.

These banks colluded to exploit spreads, routing transactions through Merkato’s informal networks to Dubai, Somaliland, and beyond.

The parallel-market premium became a “corruption tax,” with the difference between official and black-market rates representing pure rent extraction by politically connected actors. Ethiopia’s captured regulatory system protected incumbent rent-seekers, ensuring the parallel market would persist regardless of official policy.

Ivory Towers

Ethiopia’s pursuit of exchange-rate unification epitomizes the fundamental misconception that correcting a single price, however critical, can heal a systemically diseased economy. In this theory, the exchange rate is seen as a ‘master price’ that influences resource allocation, trade flows, and inflation transmission.

Yet, it does not operate in isolation. It functions within a complex macroeconomic ecosystem where monetary policy, fiscal policy, and financial sector governance form an intricate web of mutual dependencies.

The IMF’s orthodox prescription—to let the market determine the birr’s value—rests on theoretical elegance divorced from Ethiopia’s institutional reality. Yes, an overvalued exchange rate distorts price signals, encouraging imports while penalizing exports, ultimately draining foreign-exchange reserves and generating unsustainable current-account deficits.

The textbook solution ignores a stubborn empirical truth: in Ethiopia’s case, and in numerous similar developing economies, past devaluations have systematically failed to deliver the promised export booms or reserve accumulation.

Ethiopia’s exchange-rate history reads like a chronicle of dashed hopes. Previous devaluations—undertaken with solemn IMF assurances that “getting prices right” would unleash export competitiveness—produced meager results at best and catastrophic inflation at worst.

The reasons are structural, not monetary. Ethiopia’s export base remains narrow and supply-constrained, dominated by commodities like coffee, gold, oilseeds, and cut flowers whose production responds sluggishly to price incentives.

A cheaper birr does not automatically create new coffee plantations, expand oilseed cultivation, or resolve logistics bottlenecks that plague exporters. Meanwhile, import-dependence—particularly for fuel, intermediate industrial inputs, and capital goods—ensures that devaluation’s immediate impact is inflationary, raising production costs and eroding any competitive gains from currency depreciation.

However, imported items such as electronics and vehicles didn’t see a price surge proportionate to the scale of the birr’s devaluation because before the float, black-market rates were already in use.

The anticipated surge in foreign-exchange reserves has not materialized because export volumes fail to respond, while import bills soar in birr terms, widening rather than narrowing the external imbalance.

The post-July 2024 experience confirmed what critics like Professor Alemayehu Geda predicted: devaluation without structural transformation produces inflation without adjustment.

Ethiopia’s export performance did improve following the massive birr depreciation but binding constraints are non-price factors. Coffee exporters face washing-station shortages, antiquated processing methods, and logistical nightmares transporting beans from highland farms to Djibouti’s port.

Flower growers confront unreliable electricity supply, limited cold-chain infrastructure, and punitive aviation cargo costs. Textile manufacturers struggle with cotton supply disruptions, skills shortages, and trade-financing gaps.

No amount of currency depreciation overcomes these structural impediments.

Structural Bottlenecks

Meanwhile, the import bill exploded in birr terms as fuel costs soared, driving transportation expenses and production costs across the economy. Import-dependent manufacturers saw their costs spike while demand collapsed as consumers’ purchasing power eroded—creating stagflation rather than export-led growth.

Understanding exchange-rate dynamics requires grasping fundamental interdependencies—what economists call the macroeconomic policy trilemma—and the broader consistency requirements across policy domains.

A stable exchange rate cannot be achieved through monetary policy alone if fiscal policy runs rampant deficits financed by money creation or if the financial sector facilitates capital flight through corrupt channels.

Ethiopia’s National Bank attempted monetary tightening and exchange-rate flexibility simultaneously. Yet the government continued deficit spending on politically motivated projects, including corridor development, palace construction, and military operations.

This spending required either domestic borrowing that crowded out private investment or monetary financing that fueled inflation. The result is policy incoherence: the NBE’s tight-money stance fights against unbridled military expenditures and vanity projects, with the birr exchange rate caught in the crossfire.

Add to this a financial sector actively undermining official policy through black-market operations, and the notion that ‘getting the exchange rate right’ could stabilize the economy becomes absurd.

Achieving macroeconomic stability demands dynamic understanding: recognizing that monetary policy, exchange-rate policy, interest-rate policy, inflation, money supply and demand, investment and saving, and unemployment are interconnected elements.

Raising interest rates to defend the currency and control inflation may stabilize prices but also choke off investment, raising unemployment and reducing future productive capacity. Devaluing to encourage exports may improve competitiveness.

However, it also increases the cost of servicing foreign-currency debt, worsening fiscal balances and potentially triggering capital flight that overwhelms any export gains.

The optimal policy mix requires balancing these trade-offs through careful sequencing and coordination across monetary, fiscal, and structural domains, precisely the sophisticated judgment that Ethiopia’s technocrats failed to exercise.

Speculative Spiral

Ethiopia’s obsessive pursuit of exchange-rate unification produced a darkly comic outcome: rather than closing the gap between official and parallel rates, the country now operates with more than four distinct exchange rates simultaneously.

One is the official bank rate quoted by most commercial banks, nominally market-determined but heavily influenced by NBE guidance. Another is the forex bureau rate—typically 10–15 percent above the official rate—used for small-scale transactions and remittances. A third is the parallel-market rate in Addis Abeba’s Merkato and other informal trading hubs—20–30 percent above the official rate—where genuine price discovery occurs.

Finally, there are the “special rates” operated by politically connected banks—including the Commercial Bank of Ethiopia, Siinqee Bank, Cooperative Bank of Oromia, and Awash Bank—which buy foreign-currency in Dubai, the United States, Somaliland, and China at varying rates, often routing transactions through shell companies and trading networks to exploit arbitrage opportunities.

Each of these banks maintains dual operations, official windows for compliance and optics, and clandestine channels for high-volume transactions that evade official reporting. The result is not a unified exchange-rate regime but a fragmented, multi-tiered system in which the rate one receives depends entirely on connections, transaction size, and network access.

The dog finally caught its tail, only to find it had split into four, each wagging in a different direction.

Ethiopia’s merchandise exports declined from $4.1 billion in 2022 to $3.6 billion in 2023 and $3.8 billion in 2024, underscoring that the core problem, the inability to generate foreign-exchange earnings through productive activity, remained untouched.

Even if the parallel-market premium were somehow erased overnight—through draconian enforcement or a miraculous reserve surge—macroeconomic instability would persist. Inflation would continue, driven by unproductive spending and recurrent supply shocks.

Debt distress would remain, given the $36 billion overhang and weak export base. Capital flight would persist as long as property rights remain insecure and corruption thrives.

Exchange-rate unification pursued in isolation from structural transformation embodies the ultimate policy illusion: the belief that adjusting one price—however pivotal—can replace the hard political work of building competent institutions, enforcing the rule of law, diversifying production, and establishing credible policy frameworks.

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While this commentary contains the author’s opinions, Ethiopia Insight will correct factual errors.

Main photo: Mamo Mihretu, former governor of the National Bank of Ethiopia, with IMF Managing Director Kristalina Georgieva in Addis Ababa, February 2025. Source: Social media.

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