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Money TalksStrong USD presents new challenges for Ethiopia’s economy

Strong USD presents new challenges for Ethiopia’s economy

Long gone are the days when international headlines were dominated by economic triumphs in both the global north and south. It all started with the COVID-19 pandemic, which shocked the entire global economy and brought business activities to a standstill.

The conflict between Ukraine and Russia exacerbated the already tumbling global economy, and its effects are still being felt in some industries, such as logistics, as evidenced by the rise in shipping costs. Not only do the two countries supply a sizeable amount of the raw materials used to make fertilizer for both developed and developing economies, but their dispute also led to an economic shock on a scale unseen in the previous ten years, at least following the global recession in 2009.

Since the start of the conflict, natural gas prices in Europe have increased by 127.6 percent, and coal prices by 96 percent. Six months into the Russia-Ukraine conflict, prices for natural gas and coal on international markets exceeded all previous records.

European countries get 40 percent of their gas from Russia, which they have all sanctioned for its actions in invading Ukraine. Consequences such as sanctions for the war ended up with higher bills for energy and food all over the world, with European countries taking the heat. In the Eurozone, energy inflation reached 41percent, while food, alcohol, and tobacco inflation reached 12 percent.

Inflation in Eurozone countries reached 10 percent in September, a point higher than the previous month but nearly seven percent higher than the same period the previous year. Given that their policymakers predicted such repercussions from the war, this may not be surprising. However, what has perplexed economists and policymakers across the world is how the USD has been gaining ground against major currencies since last month.

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Several currencies, mainly the ones in Europe, like the Euro and GBP, saw their values depreciate against the USD. The all-time superior euro lost value against the USD and depreciated by 0.047 cents on September 28, 2022. Two days ahead of that, the GBP weakened, reaching almost the same level as the USD. On September 26, 2022, one USD was exchanged for GBP 0.93.

With their currencies getting stronger, the US can enjoy cheaper imports, but the weakening European currencies are well observed as inflating import prices for the Europeans and weighing hard on their countries’ economies.

Poorer economies, such as Ethiopia, will feel the heat as they continue to rely on the USD, the currency used in the majority of trades, and import commodities priced in USD.

The National Bank of Ethiopia (NBE) has been following the international exchange rate situation closely. Fikadu Digafe, vice governor and chief economist at the NBE, disclosed that such forms of changes in the global market would also have bigger impacts on countries like Ethiopia, with a major dependency on USD for international trade.

“The overvaluation of the USD is affecting the European economy highly. This can also be dangerous for us as the Europeans’ demand for our products like coffee might decrease,” Fikadu said.

Most of Ethiopia’s imports are from China, with the USD becoming the main currency for trade. But the resources for that come from incomes such as the sale of coffee with euros that has to be changed into USD, affecting the coffee income, Fikadu explained.

“For an item that might cost USD 10, we will have to make a payment of USD 15 or more in situations like this. Our country makes most of the trades, including fuel, with USD,” he added.

This is also echoed by an economist and a consultant closely following Ethiopia’s economy.

Ethiopia’s dependency on the USD for import trade with earnings partly including the euro and the GBP would destabilize the country’s economy, according to him.

“When we import an item from a USD trading country by exporting two bouquets of flowers to Europe and getting paid in euros, this means that we will now have to send three bouquets of flowers to cover the same amount of expenses,” the economist said, adding “The higher import bill would widen the balance of payment deficit.”

He also foresees the shock a strong dollar could bring in local exchange markets. For him, the recent widening of the gap between the parallel and official markets to previously unseen levels, reaching more than 100 percent, was more than just a reflection of local economic dynamics, of which the international exchange market is a component.

“Exporters or anyone who has notes in euros and other currencies would exchange them to USD in the parallel market. Such moves would further widen the gap between the two,” he said.

For a price-taker nation and a small economy like Ethiopia’s, there seems to be nothing to do to ease the pressure. But if continued, officially devaluating “the overvalued” Birr at once and narrowing the gap between the official and parallel exchange markets might be the only option available.

“There is no better way of reducing the gap between the official and parallel markets in the Ethiopian scenario. The ultimate solution seems to be devaluation, but this would greatly increase the import bill,” the expert said.

Fikadu wants to remain an optimist, though. He believes a strong USD might have advantages for Ethiopia if there is a chance to import goods with the weakened euro and service debts in euros.

The debt bulletin from last fiscal year shows a composition of 12 currencies that Ethiopia borrowed from different sources for the public sector, all of which are USD denominated, with a total outstanding balance of USD 27.9 billion.

“Imagine the relief it could bring if Ethiopia serviced its debt in euros and goods were imported in euros,” Fikadu underscored.

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