The recent war in Ukraine, which triggered a sudden increase in oil and food prices in the global market combined with persistent drought and armed conflicts within Ethiopia have further worsened country’s economic woes. The Governmentof Ethiopia has recently introduced a franco-valuta imports permit to curb inflationary pressures, ease acute foreign currency shortages, and meet its debt servicing obligations.
This article explores the merits and ramifications of franco-valuta imports on the Ethiopian economy. It also outlines policy options available for the Government beyond or instead of franco-valuta. The basic tenet of the article is that the country’s economic challenges are systemic and demand coherent and fundamental action centred on a paradigm shift in development policy.
In the absence of effective coordination, robust financial institutions and flexible or floating exchange rate policies, Franco-valuta may exacerbate import under-invoicing and tax evasion and encourage financial outflows and illicit currency trading.
The Ethiopian economy at a glance
Ethiopia is one of the poorest countries in the world and the second most populous naton in the African continent, after Nigeria. About 36 million people—or 30% of the country’s population—lived on less than US$ 1.90 a day in 2016 (latest available data), while per capita GDP was US$936 in 2020.
Domestic circumstances and international factors shaped by unforeseen global events continue to define Ethiopia’s socio-economic landscape. On the domestic front, the lack of a unified national agenda remains a key binding constraint to the country’s growth and development prospects.
This is rooted in the politicisation of ethnic identity, which fueld political instability and ethnic rivalry, which recently led to a full-blown armed conflict in several parts of the country. Economically, this has restricted factor mobility and forced the nation to divert meagre financial and human resources to less productive ends.
The Ethiopian economy is also vulnerable to external shocks. Global economic uncertainties, fueled by the COVID pandemic and the war in Ukraine, pose one of the biggest and most recent challenges to Ethiopia’s economy. The economy also suffers from decreased demand for its agricultural exports and a lack of market access for exports, particularly to the USA.
As a result, Ethiopia’s trade imbalance has widened, with imports outstripping exports. Climate change and the associated impacts of drought and locust infestation in the country have also subdued agricultural output and domestic food production, resulting in high inflation.
According to various authoritative sources (2), the Food inflation stood at 41.9 per cent in February, up from 39.9 per cent the previous month. The overall inflation rate also increased to 34.7% in March of 2022 from 33.6% in February 2022.
A high and rising cost of living is a fertile ground for social and political unrest. It will also erode the modest gains in poverty reduction attained in the last couple of decades in the country. Within these contexts, on April 2022, the Government has indefinitely expanded permits for franco-valuta imports introduced in 2021. These raise various policy questions.
Is franco-valuta suitable to manage the current economic challenge and arrest the high and rising cost of living in the country? Is it the only option available for the Government? Does the policy choice lead to the intended outcome or bring more ills to the economy?
Franco-valuta in historical context
Franco-valuta is a rare policy instrument designed to curtail foreign currency crunches, tame inflationary pressures, or ease systemic socio-economic vulnerability. Usually, franco-valuta grants restricted licenses to importing enterprises and tax holidays for exporting firms.
The primary motivation is to ease foreign currency shortages while curbing inflationary pressures. This is done by facilitating imports of commodities with high domestic demand, which cannot be met domestically due to supply-side constraints.
However, Ethiopia has been known for overusing franco-valuta as a short-term solution to economic problems, particularly since 1974. Pre-1974, Ethiopia followed managed floating or flexible exchange rates systems (National Bank:2000).
Then, the country’s external debt was manageable, its external sector healthy, and its international reserves were adequate to cover several months of imports. Thus, there was no need for exchange rate manipulation or desperate policy measures like franco-valuta.
Franco-valuta was first introduced in the country in the 1980s by the military regime of Ethiopia (1974-1991). The military Government followed a socialist economic system and a highly regulated fixed exchange rate regime, leading to severe foreign currency shortages and necessitating franco-valuta as a policy instrument (National Bank of Ethiopia:2000).
Subsequent Governments of Ethiopia have repeatedly introduced franco-valuta for different purposes and under various socio-economic contexts. For example, in the late 1990s, the Government of Ethiopia implemented franco-valuta to facilitate imports of machinery and durable consumer items, including used clothes (see Council of Ministers Regulation No. 8/1996).
However, the decree, which came into effect in April 2021 and was extended in April 2022 by the Ministry of Finance, is unique in that it exclusively focused on daily necessities such as edible oil, sugar, wheat, rice, milk, and flour (See Ethiopian Monitor, 10 April 2022).
Why Franco-valuta will not work?
Traditionally, when exports could not finance imports, the balance must be met from foreign direct investment (FDI), Official Development Assistance (ODA), borrowing or drawing on international reserves. However, the country’s debt burden is already high, while FDI and ODA inflows have also declined in recent years.
According to data from national and international sources, Ethiopia’s public debt has soared from US$ 19.74 billion in 2016 to US$ 63.85 billion in 2020, propelling the country’s debt to GDP ratio from about 26% to nearly 60 per cent during the same period (World Bank Open Data: 2022). At the same time, Ethiopia’s international reserves have historically been low or negligible over the years. They stood on average at about US$ 3 billion in the past two decades, accounting for less than 20% of the country’s annual import bills (UNCTADstat:2022).
The trends primarily reflect the continued weakening of the national currency, weak production and supply (export) capacities and the country’s expansionary monetary policy. Such economic woes are systemic and hungry for more profound and transformative reforms. Short-term desperate policy tools alone –be they franco-valuta, foreign exchange controls or credit rationing—cannot address them. Otherwise, it may substantially increase imports over exports, further widening trade deficit of the country.
In addition, in the absence of flexible or floating exchange rate policies and effective policy coordination and supervision capabilities of existing financial institutions, Franco-valuta may exacerbate import mis-invoicing and tax evasion. Franco-valuta may also increase black-market activity for hard currency, widen the gap between official and unofficial (black-market) prices for foreign currency, encourage illicit trade and financial outflows as traders with liquid domestic currency compete for hard currency to meet their franco-valuta import needs.
Alternative policy tools available for Ethiopia
Ethiopia needs to put sound political, microeconomic, and macroeconomic policies and strategies in place to relieve key binding constraints to it development and address chronic and systemic socioeconomic challenges. The country should identify its comparative advantages, exploit regional and global opportunities and mobilise all available resources through unified political agenda to accelaerate production transformation and achieve inclusive and sustainable economic growth.
First and foremost, Ethiopia needs to revisit its political narratives to relieve simmering inter-ethnic tension and conflicts. It will be difficult for the country to address its developmental challenges and meet the demand for essential consumer items for its growing population without resolving such recurrent political difficulties. Nor will it be able to curb galloping inflation and improve its foreign currency position.
The country cannot invest in modernising agriculture, agro-processing, and other manufacturing activities and fostering linkages between these and other critical economic sectors under political instability and policy uncertainty. Without sustained peace, stability and security, the country cannot mobilise domestic private sector (investment) and attract foreign direct investment (FDI) to enhance production, promote its exports, create employment opportunities and kick-start structural economic transformation.
Side by side with political reforms, diversification of export items, expanding destinations (markets) and substituting imported consumer items with local produce should be pursued as key strategies to narrowing the country’s trade deficit.
Secondly, the country should address its financial and monetary policy limitations, focusing on narrowing government expenditures and rationalising its credit policies. The Government of Ethiopia should particularly consider counter-cyclical economic and monetary policies. Such policies should limit or restrict Government borrowing, especially when the country is under inflationary pressure.
Thirdly, linked to the above counter-cyclical policies, Ethiopia needs to adopt robust and effective policies and strategies to curb money supply within the economy. This should include effectively controlling treasury bills (currency) and checks in circulation both in volume and velocity. Lending by private banks also needs to be rationalised and linked to production financing instead of enhancing consumption.
There should also be incentives, including manipulating interest rates to enhance propensities to save and invest by undercutting the tendency to consume. Reducing credit to consumption and services-oriented private sectors can positively impact inflation as it limits the accumulation of inventories. Companies tend to sell inventories when prices are under control, further reducing speculation and inflationary pressures.
Fourthly, Ethiopia must close the gap between legal (official) and black (unofficial) price variations for foreign currency. Efforts to enhance transparency in foreign currency management, use, distribution (allocation) and accessibility, including stemming corruption and gradually legalising operations of forex bureaus are critically important. Moreover, there need to be incentives and interventions to redirect remittances from abroad (notably diaspora remittances) away from supplementing consumption towards enhancing savings and investment in production transformation.
Lastly, but more importantly, the Government of Ethiopia needs to enhance its capacity to complete mega projects in time as a crucial step to reducing the bludgeoning budget deficit due to inflation and high cost of implementation. However, this should be pursued as a long-term objective as it can pose a formidable challenge to achieve in a short period in any developing country, let alone Ethiopia.
Following such a strategy means that borrowing by the Government, particularly from domestic sources and through quantitative easing, needs to be conducted with utmost care. Banks’ liquidity (liquid cash held in proportion to assets) needs to be converted into government securities, gold reserves, and government guarantee securities such as bonds.
Any increase in banks’ deposits must be invested in the production process, depriving the banks of holding large reserves. Commercial banks should also cease borrowing from the National Bank of Ethiopia to slow down credit expansion and exert downward pressures on price rise, particularly on consumer items.
References:
1) Conceptually franco-valuta is a license that allows importers and manufacturing firms to import locally scarce goods or inputs (to manufacturing exports) by using their own foreign currency deposits but with no foreign currency payable through traditional banking and financial systems. Importers and exporters can exchange goods without traditional financial or banking instruments such as Letters of Credit (LC) or Letter of Understanding (LoU).
2 For further information on Ethiopia’s rate of inflation please see Bloomberg news article of 24 January 2022, the joint report of United States Department of Agriculture, USDA, Foreign Agriculture Service and Global Agriculture Information Network (GAIN) of 10 March 2022 and the press conference of the Ethiopian Statstictics Authority (Amharic) of 20 April 2022.
Bloomberg, Ethiopian Inflation Tops 35% in December as Food Costs Surge, Annual consumer prices up from 33%; food index increased 41.6%. 24 January 2022. Available on: https://www.bloomberg.com/news/articles/2022-01-24/ethiopian-inflation-tops-35-in-december-as-food-costs-surge.
Ethiopian Monitor, Ministry of Finance Lifts Restrictions on Franco-Valuta Privileges, 10 April 2022. Available on: https://ethiopianmonitor.com/2022/04/10/ministry-of-finance-lifts-restrictions-on-franco-valuta-privileges/
Ethiopian Statistics Agency (press release) 20 April 2022. Availablke on: https://www.statsethiopia.gov.et/consumer-prices/.
Federal Democratic Republic of Ethiopia, Council of Ministers Regulation No. 8/1996). Available on: https://chilot.me/wp-content/uploads/2011/11/reg-no-8-1996-importation-of-machinery-and-goods-on-franco.pdf.
National Bank of Ethiopia (2000). Directives and Foreign Exchange Regulations of Ethiopia. 1 June 2000. Addis Ababa, Ethiopia.Avilable on: https://nbebank.com/wp-content/uploads/pdf/useful-links/consolidated-forex.pdf.
Statista (2022). Ethiopia: National debt from 2016 to 2026, US$ billions. Available on https://www.statista.com/statistics/531575/national-debt-of-ethiopia/.
UNCTADstat(2022). Country Profile (Ethiopia). Available on https://unctadstat.unctad.org/CountryProfile/GeneralProfile/en-GB/231/index.html.
United States Department of Agriculture, USDA, Foreign Agriculture Service and Global Agriculture Information Network (GAIN). Food Inflation Stands High in Ethiopia despite Policy Measures to Stabilise Prices. 10 March 2022, Report No.ET2022-0011. Available on: https://apps.fas.usda.gov/newgainapi/api/Report/DownloadReportByFileName?fileName=Food%20Inflation%20Stands%20High%20in%20Ethiopia%20despite%20Policy%20Measures%20to%20Stabilize%20Prices_Addis%20Ababa_Ethiopia_ET2022-0011.pdf.
*Mussie Delelegn Arega (PhD) is Officer-in-Charge, Productive Capacities and Sustainable Development Branch, Division for Africal LDCs and Special Programs, at the United Nations Conference on Trade and Development (UNCTAD). The opinions expressed in this article are the author’s own and do not represent the views of UNCTAD or the United Nations. The author can be reached at (mussie.delelegn@unctad.org).
