REASSESSING ETHIOPIA'S CURRENT EXCHANGE RATE POLICY: A PATH TOWARDS ECONOMIC STABILITY

Abstract

This study reassesses Ethiopia’s exchange rate policy, characterized by a managed float regime, as a critical tool for economic management amid challenges in fostering sustainable growth and stability. Persistent foreign exchange shortages, inflationary pressures, and trade imbalances raise concerns about the effectiveness of the current policy in supporting Ethiopia’s rapidly evolving economy. Utilizing a mixed-methods approach, the research integrates stakeholder perspectives with Difference-in-Differences (DiD) econometric analysis to evaluate the policy's impact on macroeconomic stability, trade competitiveness, and foreign investment. Primary data were collected through semi-structured interviews with 40 stakeholders, including policymakers, economists, central bank officials, and private sector representatives. Additionally, 333 questionnaires were distributed to managers and employees of commercial banks, export-oriented businesses, and foreign investors to assess perceptions of exchange rate impacts on trade and investment. Secondary data were sourced from the IMF (2023), World Bank (2025), National Bank of Ethiopia (NBE), and Central Statistical Agency (CSA), allowing for a comprehensive contextualization of the policy framework.

Findings indicate that while the July 2024 shift towards a market-referenced exchange rate improved transparency and predictability, it also induced short-term inflationary pressures and exacerbated foreign currency shortages. The DiD model reveals a statistically significant increase in inflation by 2.7%, alongside moderate gains in foreign exchange reserves (12.5%) and export competitiveness (5.4%) post-reform. Approximately 60% of questionnaire respondents noted improvements in predictability for foreign exchange transactions; however, 70% of businesses reported ongoing difficulties in accessing foreign currency, hampering export competitiveness. For a country like Ethiopia, heavily reliant on agriculture, the managed float regime presents limitations. It necessitates substantial capital for new exporters, creates market distortions, inflates commodity prices, and reduces exporters’ profit margins, ultimately decreasing societal purchasing power. Interviews revealed that the overvaluation of the birr has led to a 15% reduction in import growth in key sectors like basic commodities. Inflation, exacerbated by exchange rate misalignment, emerged as a pressing concern for 65% of respondents, particularly affecting low-income households. The study also identified regulatory rigidity and limited market liberalization as barriers to effective policy implementation. Stakeholders frequently proposed a phased hybrid managed floating exchange rate mechanism, supported by targeted reforms to enhance economic stability. While Ethiopia’s current exchange rate policy offers some stability, it falls short in addressing trade imbalances and fostering economic resilience. The research recommends a gradual transition from managed floating to a more market-driven exchange rate system, coupled with institutional capacity-building and inflation-targeting frameworks. Investments in export diversification and enhancing access to foreign exchange are essential to align the policy with economic goals. These findings contribute to the discourse on exchange rate policies in developing economies, offering actionable insights for policymakers aiming to promote sustainable growth and stability.