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Ethiopian Birr Stabilizes, Business Owners Eye Risks
By Ruth Ayalew and Katherine Shamraj | Wed Aug 28 2024
Ethiopian business owners are adapting to rapidly shifting dynamics following the July 29, 2024 float of the Ethiopian Birr (ETB) by the National Bank of Ethiopia (NBE). Dropping a crawling peg (an exchange rate system where a country's currency is adjusted periodically in small amounts at a fixed, pre-announced rate) with rigid capital restrictions, which caused chronic forex shortages, was one of the conditions put forth during negotiations with the International Monetary Fund for a $3.4B debt deal, to support Ethiopia’s Homegrown Economic Reform (HGER) Agenda aiming to address macroeconomic imbalances, restore external debt sustainability and foster private sector-led growth. This arrangement is also expected to catalyze additional external financing and credit. Additionally, the World Bank pledged up to $16.6B over three years in support of Ethiopia’s aspiration to become a middle-income country.
Renew Capital brought together members of the Isua Network, the Ethiopian women-in-business network, in Addis Ababa on August 22, 2024 to learn about how they are adapting to the change and to provide a legal overview of the impact of the float.
- Banks can now buy and sell foreign currencies at freely negotiated rates. They are no longer required to surrender foreign currency to the NBE and may allow residents to hold foreign currency accounts inside Ethiopia.
- Import restrictions on 38 product categories have been lifted and the forex market for imports has been broadly liberalized.
- Interest rate ceilings on borrowing from foreign countries have been removed for private sector companies and banks.
- Ethiopia’s securities market is now open to foreign investors.
- Special Economic Zones companies may retain 100% of their foreign earnings in a foreign currency.
In the medium and long term, this is a landmark move for Ethiopia’s economy. The previous system led to significant shortages of foreign currency, distorted import and export markets and difficulty attracting foreign capital into the economy. The changes enacted are expected to breathe life into the economy, especially in the form of foreign investment and credit, free up reserves previously used for maintaining the currency peg and enable market forces to attain equilibrium without government intervention.
In the short term, business owners and consumers are concerned that Ethiopia’s trajectory will echo that of recent currency liberalizations, including Nigeria in 2023 and Egypt in 2024, which respectively resulted in 70% and 60% devaluations of the local currencies against the U.S. dollar. This rapid devaluation affected the already high inflation rates and in Nigeria, triggered a cost of living crisis. Indeed, the ETB has fallen 47% against the dollar in the four weeks since the float. This brings the official ETB-USD exchange rate to within 5-10% of the parallel market rate. Previously, dollars sold on the parallel market fetched a premium as high as double the official bank rate.
Uncertainty for Businesses
While most Ethiopians share concerns about inflation and cost of living, business owners are navigating an even more challenging landscape. The uncertainty of how markets and the government will react is top of mind for many. As is often the case in these situations, float-related fears led some businesses to hoard dollars and shops to raise prices immediately on essential goods, such as cooking oil, by as much as 25%. Authorities shuttered dozens of shops accused of price gouging and confiscated inventory, adding fuel to the fears of business owners.
Exporters, whose access to foreign currency makes them a target of regulation, are seeing incremental changes. Prior to 2023, exporters were allowed to retain only 20% of the foreign currency they earned through exports, the remaining 80% was surrendered to the National Bank of Ethiopia for forced exchange into ETB. In 2023, the allowed retention increased to 40%. The 2024 directive nudged it to 50%. While these changes provide some relief for exporters, there remains uncertainty, as the government can still adjust the regulations at any time.
Navigating Contracts
One area where business owners may consider taking action is around contracts. Whether a contract is denominated in a foreign currency or in ETB, the value of existing contracts has changed overnight. Recognizing this challenge, Renew Capital invited Tsegamlak Solomon, Founder and Principal of the Addis Ababa-based law firm Tsegamlak Solomon & Associates, to address this topic at the latest Isua Network event.
The key takeaway for business owners was that the time to renegotiate contracts is now. Everyone doing business in Ethiopia is navigating this change together and there may be more opportunity and willingness to renegotiate within the first few months of this shift than later on.
- Review all contracts. Do any contracts contain a force majeure clause that includes unforeseen government changes? If yes, business owners should be prepared to renegotiate any such contract.
- Evaluate the impact of the contract currency. Regardless of whether payment terms are delineated in ETB or a foreign currency, the reality on the ground has changed. Business owners should consider their own position and the counterparty’s to identify a solution that may suit both.
- If negotiation is not possible, consider arbitration. Ethiopia’s Civil Code does not support court intervention in contracts, so strictly legal options are limited. However, the law does encourage parties to go through arbitration to determine a fair price that benefits both parties. Cases of onerous contracts – where one party is burdened with more costs than the other – are the most likely to be successful in this arena.
One question raised by Isua members included whether there were any limitations to contracts being denominated in a foreign currency or a combination of ETB and a foreign currency. Mr. Solomon indicated that the chief constraint is that some contracts, such as employee contracts, may be set in a foreign currency, but must be paid out in ETB. Otherwise, business owners are free to use a variety of mechanisms. These include setting forex thresholds whereby pricing is reviewed once thresholds are reached or indexing different parts of the agreement to different currencies as desired.
However the contract is designed, the most important point is to ensure that all contract elements, especially those related to forex, are crystal clear. This includes whether the contract follows the exchange rate on the date of signing or the prevailing rate of the NBE at the moment of payment.
It is still early days and much remains in flux as the markets adjust. Isua business owners expressed both concern and optimism over the reforms. The question which remains is whether and how much this first critical step is followed by true market liberalizations in the coming months and years.
Renew Capital is an Africa-focused impact investment firm that backs innovative companies with high-growth potential. Renew Capital manages investments made on behalf of the Renew Capital Angels, a global network of angel investors, foundations and family offices who seek financial returns and sustainable social impact. For the latest on investing in Africa, subscribe and follow us at our social links below.
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