SUPPORT ETHIOPIA INSIGHT TODAY!
While the government touts success in managing macroeconomic reforms and curbing inflation, it’s too soon for a victory lap—economic reality tells a more murky story.
O
n 28 July, Ethiopia made a historic decision to adopt a market-determined exchange rate, lift most current account restrictions, and modernize its monetary policy framework. This paved the way for bailouts from the International Monetary Fund (IMF) and World Bank as the country confronts escalating economic challenges.
The decision to allow market forces to dictate the value of the birr was set against a backdrop of soaring inflation, hard currency shortages, and increasing external debt. While transitioning to a floating exchange rate may improve market efficiency and resilience, it also carries substantial risks for vulnerable populations, who could experience increased price volatility and diminished purchasing power.
As Ethiopia embarks on this transformative path, important questions remain: Will this decision lead to long-term benefits, or will it burden the struggles faced by everyday Ethiopians even further? The stakes have rarely been higher.
Economic Context
Ethiopia, with a projected population of 120 million in 2024, experienced impressive economic growth, averaging 10 percent annually from 2007 to 2017. This reduced extreme poverty from 61 percent to 31 percent. The country has also made notable strides in health and education, meeting a number of the Millennium Development Goals.
However, recent years have been marked by economic instability, characterized by inflation rates exceeding 35 percent. This crisis has been exacerbated by global supply chain disruptions, the lingering effects of the COVID-19 pandemic, serious droughts and flooding, and ongoing conflicts, particularly the war in Tigray and insurgencies in Amhara and Oromia.
These challenges threaten to reverse the development gains made in recent years; further diminishing Ethiopia’s standing in the Human Development Index (HDI).
Prolonged conflicts have undermined agricultural production, a key pillar of the economy, displaced millions and worsened food insecurity. The toll includes lost lives, damaged infrastructure, and depleted resources. The extensive devastation, especially in northern Ethiopia, cannot be quickly addressed due to ongoing unrest in Amhara, internal TPLF divisions, and unmet commitments of the Pretoria Agreement.
Military expenditures related to the Tigray conflict surpassed $1 billion, with projections indicating further increases as violence continues to afflict Amhara and Oromia. This military focus intensifies already critical humanitarian needs, with an estimated 20 million people requiring food assistance by November 2024.
The Fano insurgency in Amhara is escalating, with major factions in Gojjam and Gondar launching increasingly daring attacks on urban centers. In response, Ethiopia’s military has initiated major operations against the rebels, disregarding calls for a peaceful resolution from human rights organizations and international partners.
As Ethiopia grapples with a troubling mix of state contraction and militarization, essential sectors such as education, healthcare, trade, and infrastructure are suffering from a diversion of resources. This shift in budgetary priorities not only hinders long-term growth but also exacerbates poverty.
In conflict-affected regions, educational institutions are often damaged or repurposed for military use, disrupting learning. In Tigray, over 550 schools remain under armed group control. In Amhara, student enrollment stands at only two million, far below the target of seven million, primarily due to ongoing violence.
Alarmingly, only 5.4 percent of students passed the 2024 Grade 12 national exam, with just 36,409 qualifying for university admission from 684,405 candidates. These statistics highlight the severe challenges facing the education system.
This loss of educational opportunities leaves a generation unprepared for the workforce. As fewer skilled workers enter the job market, youth despair intensifies, raising the risk of anti-social behavior and radicalization. The absence of stable livelihoods can drive disillusioned youths towards rebel groups, further destabilizing the country and deterring investment, thus perpetuating a cycle of violence and underdevelopment.
The public investment-led growth model that once propelled the economy reached its limits, exposing vulnerabilities in sectors previously viewed as growth pillars. Economic instability has also deterred foreign investment.
A depreciating currency exacerbated challenges for businesses reliant on imported materials, leading to rising costs and operational difficulties. Trade route disruptions due to violence have stagnated exports, particularly in vital sectors like coffee, which plays a crucial role.
Moreover, the suspension of official development assistance (ODA) due to ongoing conflict has left the fiscal deficit primarily financed through rising domestic borrowing, particularly from the National Bank of Ethiopia (NBE), further exacerbating inflationary pressures.
The compounded effects of overlapping shocks have relegated the country to a low growth trajectory, causing a sharp decline in investment and forcing the government to implement austerity measures to meet international debt obligations. The debt-servicing budget for this fiscal year has risen to 139.31 billion birr , exceeding last year’s allocation and surpassing the combined budgets for health, education, water, energy, and agriculture.
Consequently, Ethiopia is regressing from two decades of economic and social progress, with the poverty rate now at 68.7 percent, according to a UNDP report. Ethiopia ranks 175th out of 191 countries on the Human Development Index (HDI) and 145th out of 166 in progress toward achieving Sustainable Development Goals (SDG) targets.
According to the Ministry of Finance, Ethiopia will need an estimated $20 billion over the next five years for recovery and reconstruction, with $5 billion required in the first year.
In response to the crisis, the government has felt pressured to comply with IMF demands, shifting from a fixed to a floating exchange rate system. This change is intended to stabilize the economy by addressing immediate challenges while also embodying a broader vision for building a resilient economic framework capable of withstanding future shocks.
However, successfully implementing this floating exchange rate—alongside necessary structural reforms—will depend on the government’s ability to restore investors confidence, promote stability, and prioritize sustainable development within a challenging political landscape.
Post-Flotation Impact
As anticipated, the policy change led to an extraordinary depreciation of the birr, plummeting by approximately 100 percent within a month. The parallel market now reflects an exchange rate of 140 birr per dollar, compared with the rate of 57.8 just one month prior.
This transition to a floating exchange rate has elicited mixed responses from economists and the broader populace, varying from cautious optimism to considerable anxiety. The rapid devaluation has immediate adverse consequences, notably raising the prices of essential imports such as food, fuel, fertilizer, and medical supplies.
The volatility associated with this exchange rate adjustment is likely to intensify the existing inflationary pressures. Reports indicate that several businesses in Addis Ababa and beyond have faced shutdowns due to allegations of price hiking.
In early October, the government announced a price increase for gasoline and diesel, raising the cost to 91 birr per liter and 90 birr per liter, respectively. This represents an increase from the previous prices of 82.60 birr for gasoline and 83.74 birr for diesel. In Jigjiga, fuel prices surged even higher, reaching 100 birr per liter.
BACK OUR INDEPENDENT JOURNALISM!
Ethiopia’s black market dollar exchange rate has risen steeply to 140 birr, significantly surpassing the official rate of 117 birr established by the National Bank of Ethiopia (NBE), primarily due to currency shortages and economic instability.
Though the gap briefly narrowed following the July float, ongoing external pressures and dwindling foreign reserves have continued to push black market rates upward. The NBE’s 2 percent limit on the foreign exchange rate difference has proven ineffective, leading an increasing number of businesses and individuals to rely on the black market.
The depreciation of the birr has also worsened Ethiopia’s trade imbalance by reducing the value of exports and raising import costs. This could deplete foreign reserves and diminish the benefits of the currency float, while increasing government spending and the local cost of servicing foreign debt, potentially exacerbating inflation.
The government’s decision to increase the prices of essential utilities such as electricity, water, education, and healthcare is exacerbating the challenges faced by low-income populations. These growing pressures prompted the central bank to further raise interest rates, which negatively affects small businesses and undermines individual livelihoods.
Low-salaried government workers may face greater livelihood risks due to rising inflation. Recently, the federal government announced a budget of 91.4 billion Br (845.7 million dollars) to increase salaries for over 2.4 million civil servants, following a half-billion long-term loan from the World Bank as part of a $1.5-billion IDA package. While the finance minister noted the loan would support social safety nets for vulnerable households including civil servants, many mid-range civil servants are dissatisfied with the proposed increases.
While the government claims to have implemented initiatives aimed at alleviating economic distress—such as announcing substantial pay increases for civil servants and providing temporary subsidies for fuel, fertilizers, medicines, and edible oil—these measures are likely to have limited efficacy. Exacerbating the situation, widespread discontent is palpable across Ethiopia, leading to concerns that rising inflation could catalyze renewed social unrest.
The fiscal implications of the IMF-mandated reforms—including cuts in government spending and stricter credit controls—are likely to further complicate the already delicate relationship between the Ethiopian government and its citizens. While the specifics of governmental expenditure management remain unclear, a contraction in spending, particularly in Ethiopia’s peripheral regions, is anticipated.
Notably, despite Addis Ababa representing only six percent of the national population, it receives a disproportionate 24 percent of the federal budget, largely due to several ongoing mega projects in the capital that may not significantly benefit the struggling economy. This allocation has raised serious concerns among critics regarding government priorities, equity, and representation, as well as the potential neglect of rural areas.
Defining Crossroads
Ethiopia faces significant economic and political challenges that demand stability, unity, and effective governance. Proposed macroeconomic reforms aim to enhance resource mobilization, streamline public spending, enforce fiscal discipline, and promote productivity and job creation.
While external financing from the IMF and other donors may provide a temporary boost to reserves, it is unlikely to stabilize an economy plagued by deep-rooted conflict, maladministration and rapid birr depreciation, which adversely affects millions of people.
The current leadership, insulated from the economic hardships faced by ordinary citizens, risks widening the cracks in societal stability if they fail to provide tangible relief in these trying times.
Without targeted welfare initiatives such as the Productive Safety Net Program—now halted in many rural areas due to funding shortages—as well as the creation of more jobs and the implementation of effective monetary policies, vulnerable populations may face significant hardships.
The situation has the potential to expose a complex interplay of political turmoil, economic distress, and social instability. A nation’s future therefore hangs on whether Ethiopia will sink or swim in this unforgiving economic sea.
HELP US DELIVER ETHIOPIA ANALYSIS!
Query or correction? Email us
Main Image: Ethiopian Birr; 11 March 2009; Rustinpc
This is the author’s viewpoint. However, Ethiopia Insight will correct clear factual errors.
Published under Creative Commons Attribution-NonCommercial 4.0 International licence. You may not use the material for commercial purposes.
