Last week, the National Bank of Ethiopia introduced a new rule that forces depositors make a maximum of five transactions per week. While this was intended to paralyze illegal money transfer agents and weaken the parallel market, the measure comes with a risk as it could result in a fall in business transactions and create a fear that it would lead to an economic slowdown.
“Hurting the wider business community just to cripple few illegal money operators is not fair. Of course, weakening the parallel market is a step in the right direction but adopting a radical measure will cause more problems,” said Wujrayib Yibgeta, Vice President of Addis Ababa Traders Forum.
Given the repercussions of the transaction limit, which some experts refer to as a draconian measure, it is simple to understand how desperate the government is to increase remittance flow, which averaged USD5.7 billion over the last five years.
Different actions have been taken by the government to raise remittance flow to Ethiopia. Albeit the little success so far, a very flexible exchange rate regime with annual depreciation rate of above 24% has been adopted since 2019 with the aim of encouraging senders use formal channels. The measure is complemented by moves to make cost of sending money affordable.
Though the outcome has not been successful, the government has taken steps to crack down on black market operators by putting under custody many operators suspected of running the informal channel. Politically speaking, there has also been an attempt by the government to boost the economic contribution of Ethiopian-born foreign nationals.
Prime Minister Abiy Ahmed (PhD) went as far as holding a discussion with the Diaspora community in North America, Europe, the Middle East and South Africa, while the parliament, during his tenure, approved an investment law that gives them equal privilege as local investors. Yet what was achieved is far from the target and the country’s potential.
Even though under the new administration, remittance inflow increased from USD5.4 billion in 2016/17 to USD6.3 billion in 2018/19, it has again declined to USD5.5 billion last fiscal year. This is significantly low compared to populous countries such as Nigeria, which is the largest recipient of remittance in sub-Saharan Africa, receiving approximately USD3.8 billion annually.
According to the World Bank, Ethiopia’s remittance accounts for 0.5 percent of its GDP whereas Kenya’s is 2.9 percent. These African countries receive significantly higher remittance in terms of the total bulk sent and as a percentage of GDP.
“Several measures (including allowing forex saving and demand accounts to members of the Diaspora) have been taken to encourage remittance over the past few year in reaction to the severe forex shortage. However, the response is disappointing as many of the steps have several restrictions which are not encouraging,” says Abdulmenan Mohammed, a financial analyst with almost two decades of experience.
Given the large size of the Ethiopian Diaspora residing abroad, which is estimated to reach three million, raising the formal flow of remittance does not only mean additional source of income for individual recipients but it also plays a unique role in the long term development of the country. The formal flow also reduces illicit financial flow and helps combat terrorism financing.
Ensuring the wide use of formal channels, however, requires addressing factors that adversely impact remittance flow and ease the troubles of senders. Such measures include narrowing the gap between the official and the parallel market, putting under control the growing tendency of under invoicing and the high cost of sending money.
Trade Mis-invoicing, a major contributor to capital flight, is a very common practice in Ethiopia. Though it has been neglected for long, it has a significant impact on developing economies as increased globalization means more opportunity to manipulate export and import invoices and bar forex from coming into a country. The practice is linked to remittance as the forex which could have been sent to a recipient in Ethiopia is simply transferred to an Ethiopian residing in the country of the money’s origin, with the forex receiver paying the equivalent amount to the recipient in Ethiopia in birr.
Mostly, it takes more than six months to get foreign currency in Ethiopia. Frustrated, most importers prefer under-invoicing their imports as lower amounts shorten the waiting time and buy the remaining forex from illegal money transfer operators abroad. Although such a practice has been avoided in some commodities like vehicle after the Central Bank implemented a directive outlawing under-invoiced imports, such a practice is still common as the Bank’s list of items is not exhaustive.
“Most importers still get forex from their partners abroad, while some also run an illegal network of agents who buy forex from senders abroad. There are importers who even sell forex to other businesses after satisfying their own needs,” said a Senior Executive of a Private Bank.
Lately, even members of the Diaspora who want to send a gift to their loved ones prefer paying the forex to an individual abroad, while another person living in Ethiopia pays the intended recipient in Ethiopia in birr, according to industry insiders.
With the unmatched growth of the demand and supply of foreign currencies helping parallel market operators thrive, illegal money operators use legal loopholes and employ different techniques to buy foreign currencies from senders abroad.
It is with the aim of preventing such transactions that the National Bank of Ethiopia introduced a rule than limits weekly transactions to just five, in order to weaken illegal money transfer agents and their local partners.
The measure has created a mixed feeling amongst industry insiders. “It is the right measure and it is not going to bring a problem since Presidents of banks are given the mandate to approve transactions beyond the limit case by case,” said President of Zemen Bank, Dereje Zebene.
Abdulmenan begs to differ.
“Without tackling the source of illegal money, such draconian measures cannot curb the problem. Coupled with the cash withdrawal limits imposed few months ago, it will disrupt businesses and those that rely on cash transactions will surely hoard cash,” said Abdulmenan. He goes on to argue that tackling illegal money requires identifying its sources and taking serious measures to dry it up.
Another illegal practice that indirectly pushes forex away from the formal channel uses Diaspora accounts. Some business people open Diaspora accounts that require saving money in forex, just to avoid the Bank process requiring LCs. After depositing some forex on that account, they dodge the need for LCs and access forex from the illegal channel.
Official vs. Parallel Forex Market
As clearly put by different scholars, parallel market is the result of the inability of the government to satisfy the demand for foreign currency and its interference in the exchange market. International Monetary Fund, in its special series note published on September 2020, called the parallel rate a market solution to a problem created by the exchange rate policy.
It is also believed that the real exchange rate is always reflected in the parallel market, whose forex supply comes from different sources, including illegal trade, under-invoicing and of course remittances, which represent a substantive source of supply of foreign currency to the parallel market due to the high premium it offers than the official market.
In Ethiopia, as of now, the gap between the official and the parallel market has reached as high as 32.5 percent. For instance, a dollar is now being traded for as high as 53 birr in the parallel market, over 13 birr higher than the rate in the official market.
“Under such scenario, it is normal for senders from abroad to choose the parallel market over the official. The high premium in the parallel market is hard to ignore, given the skyrocketing cost of living and the high profit that they can make even from small amount of forex,” Dereje told the Reporter.
From policy perspective, some experts argue, the overvaluation of the Birr is a major factor that makes the parallel market stronger. “I believe the government is taking the right measures – making the exchange regime more flexible and working on the liberalization of capital account in order to increase forex supply,” said a Policy Advisor to the government.
“Locals are now allowed to open a Diaspora account with an attractive interest rate, a commendable measure which will increase flow of foreign currency if it is implemented properly,” added the Advisor.
The deteriorating political situation in the country is also another factor that contributed to the expansion of the parallel market, largely because of the growing tendency of capital flight at a time when there is uncertainty.
Especially lately, insiders indicate, an increasing number of both local and foreign investors are rushing to buy foreign currencies from the parallel market fearing the unprecedented fall in purchasing power of the Birr.
“Rebuilding the confidence of investors and the Diaspora on the economy is important to increase remittance sent through the official channel, along with measures to put in place a strong financial intelligence system to weaken the parallel market,” said Worku Lemma, a Financial Expert and former President of Oromia International Bank.
“Above all, the viable way to make the parallel market irrelevant is through boosting sources of foreign currency using different policy and administrative measures,” he added.
Abdulmenan, on the other hand, calls for the legalization of the parallel market.
“Harsh measures implemented by the government drive the market underground, leading to higher parallel market rates. So I believe the parallel market should be legalized and regulated. This helps reduce the parallel market exchange rates as the market becomes competitive, narrowing the gap between the official and parallel market rates,” he remarked.
Cost of Sending Money
One of the key factors that encourage individuals use informal channels is the high cost of transferring funds through formal channels. Especially for small amounts of personal transfers, which make up the lion’s share of remittance in developing economies, remittance costs are very high.
For a remittance ranging between USD50 and USD250, wire service providers like Western Union charge between 2.3 percent and seven percent of the principal amount. Considering the higher premium offered in the parallel market, both senders and recipients tend to avoid such a financial burden.
Studies also suggest that migrants refrain from sending money home or prefer remitting through informal channels when transaction costs are high. A study conducted on transaction costs for 30 sending and 75 receiving countries for the period 2011-2017 found out that a 1 percent decrease in the cost of remitting USD200 leads to about a 1.6 percent increase in remittance.
“Given the expensiveness of wire transfer for poor migrants, commercial banks must promote free money transfer channels, including swift transfer,” says Worku, even supporting the idea that Ethiopian commercial banks should establish a multinational company that will provide money transferring services to reach more Ethiopians and encourage them send money at an affordable rate.
Following the harsh impact of COVID-19 on developed economies, where most migrants and members of the Diaspora of developing countries reside, the amount of remittance is forecasted to portray a 14 percent decline in 2021 compared to pre COVID-19 levels in 2019, according to the latest estimates published in the World Bank’s Migration and Development Brief.
Remittance flows to low and middle-income countries (LMICs) are projected to fall by seven percent, to USD508 billion in 2020, followed by a further decline of 7.5 percent, to USD470 billion in 2021. Remittance inflow to Ethiopia has also declined from USD1.6 billion in the second quarter of 2019/20 – before the emergence of the Coronavirus – to USD1.2 billion in the last quarter of the same year. Taking this into account, a brief study conducted by the International Growth Centre in July 2020 suggested the expansion and promotion of digital money transfer by reducing fees.
“The National Bank of Ethiopia has already raised the mobile money transfer limits, making it easier to receive remittance. Further integrating international remittance with mobile money would ease access to remittance funds for the urban poor, with the added advantage of maintaining physical distancing,” the study recommends.
Even more, it says it would not be timely to attempt to tighten enforcement on the parallel market, which would slow the flow of remittances. But with recent measures implemented by the central bank, this does not seem to be happening as more actions aimed at weakening the parallel market are becoming more apparent.