Navigating The Complexities Of The Birr’s Floating

Exactly one year ago, Ethiopia took a significant step in its economic reform journey by allowing the Ethiopian Birr to float freely against foreign currencies. This policy shift marked a departure from strict exchange rate controls that had been in force for decades to a more market-determined regime. While the decision aimed to address fundamental macroeconomic imbalances and attract foreign investment, it also ushered in a new set of challenges that require careful management and strategic responses. Even as the regulatory National Bank of Ethiopia (NBE) claims on the anniversary of this pivotal policy change that it has delivered impressive results, it is crucial to understand its impacts and chart a course to mitigate the ensuing risks.

Ethiopia’s economy has long struggled with a heavily undervalued exchange rate, limited foreign currency reserves, and distorted market signals under a controlled system. The government’s move to float the Birr, part of its comprehensive macroeconomic policy reform, was driven by the need to transform the national economy  by improving macroeconomic stability, attracting greater foreign direct investment (FDI), and ensuring a more realistic valuation of the currency consistent with market forces. It was also aligned with broader economic reforms intended to liberalize sectors, improve resource allocation, and foster integration into global financial markets. The introduction of the radical shift came at a time the need to fundamentally reshape Ethiopia’s economy was acute. The country faces severe pressures from multiple crises – including soaring inflation, unsustainable debt, critically low reserves, persistent unemployment, and regional conflicts the Russia-Ukraine war. These combined threats risked crippling the economy, making sweeping reforms essential to avert collapse.

In its initial months, the floating exchange rate raised concerns about Ethiopia’s macroeconomic management. Nevertheless, the market-determined rate soon began to contribute to a more realistic exchange value, encouraging exports by making Ethiopian goods more competitive internationally. It also reduced the distortionary effects of artificial controls, allowing a natural price discovery that benefits sectors involved in foreign trade. Furthermore, the flexibility of the exchange rate improved Ethiopia’s ability to respond to external shocks, such as fluctuations in global commodity prices. It gradually boosted foreign exchange inflows as well, as investors and traders perceived a move towards market-orientation, promising a relatively more transparent and predictable environment for business.

However, the Birr’s floating has also given rise to several significant challenges that Ethiopia must confront. One immediate consequence has been a sharp depreciation of the Birr, which, while aligning with market fundamentals, has led to inflationary pressures. Imported goods—ranging from fuel and machinery to food items—became more expensive, directly impacting consumers and increasing production costs for businesses. The inflationary surge has burdened low-income households and eroded purchasing power, exacerbating social discontent, especially among vulnerable populations. The ensuing economic hardship has sparked a sense of disenfranchisement, threatening political stability and undermining citizens’ confidence in economic policies. Moreover, despite initial inflows, Ethiopia’s foreign exchange reserves remain constrained, and the floating rate has exerted pressure on reserves as the market adjusts. The persistent demand for foreign currency, especially for imports and debt servicing, continues to strain liquidity and raises concerns about the country’s external stability.

Moving forward the government must implement a comprehensive strategy addressing both immediate pressures and long-term structural issues to navigate these turbulent waters. By the NBE’s own admission the foremost task awaiting it and other relevant government agencies is to tighten both monetary and fiscal policies with a view to rein in the debilitating hike in the cost of living and ensure fiscal discipline to avoid the unnecessary government spending  that fuels depreciation. Maintaining macroeconomic stability requires careful coordination between monetary and fiscal authorities. Another equally vital measure is to address supply-side constraints, such as improving agricultural productivity and promoting export diversification and import substitution given they are crucial for long-term sustainability and price stability. Aside from these steps it is incumbent on the government to undertake targeted social safety nets and price stabilization programs to mitigate the negative impact of the Birr float on vulnerable populations.  Most importantly, though, if the benefits of the reform touted by the government are to be realized there is no option but to endeavor to  put the fundamental preconditions in place—stability, good governance, unity of purpose, robust institutions, and enabling conditions that facilitate the effective utilization of the factors of production.