Ethiopia’s choice to devalue the Birr has sparked significant debate. Within a matter of weeks, the Birr plummeted nearly 90% in value after the government adopted a market-driven exchange rate. This sudden shift has unsettled businesses, investors, and the general public.
This article will delve into the factors that contributed to the Birr’s devaluation answering what caused this sharp decline and if it was an unforeseen shock or a necessary correction. We will compare it to similar occurrences in other nations, and assess whether Ethiopia’s currency had been artificially inflated for too long. We will also reflect on how the situation could have been managed differently.
The Road to Devaluation
On July 29, 2024, Ethiopia's central bank, the National Bank of Ethiopia (NBE), took a significant step. It announced that the Birr would be allowed to float according to market forces rather than being tied to an official exchange rate. This change ended a long-standing strategy that had kept the Birr’s value artificially inflated for years, especially since around 2005. The government had maintained a fixed exchange rate to control inflation and stabilize the economy.
Once the NBE permitted the Birr to adjust, the effects were immediate and striking. The exchange rate surged from 57.48 ETB/USD to 74.73 ETB/USD almost overnight. By August 2024, the Birr had fallen to nearly 110 ETB/USD — an astonishing 90% decline in just a few weeks.
The Evolution of the Birr's Value
To understand the scale of this devaluation, let’s look at how the Birr’s value evolved over the past two decades:
- 2005: The official exchange rate was about 8.6 ETB/USD. At this time, Ethiopia’s economy was growing, but the currency was still fairly stable.
- 2010: The rate had risen to around 16.5 ETB/USD, reflecting the growing economy and rising demand for imports.
- 2015: By this year, the Birr had reached about 20.5 ETB/USD. The country’s infrastructure development was expanding, but so was its reliance on imports.
- 2020: At the beginning of 2020, the rate was pegged at 37.5 ETB/USD. While inflation was becoming a growing concern, the government continued to manage the rate to keep it under control.
- 2024: After the devaluation, the rate spiked to over 110 ETB/USD, marking a dramatic shift in Ethiopia’s economic outlook.
These numbers show a steady devaluation, but the biggest jump came when the government shifted its policy in 2024.
Why the Birr Devalued
1. Foreign Currency Shortages
For years, Ethiopia faced significant foreign currency shortages. By 2023, the country had a trade deficit of $4.4 billion. Essentially, Ethiopia was importing far more than it was exporting. As a result, businesses and importers were scrambling to secure foreign currency to buy essential goods like fuel and machinery. With limited access to foreign currency, the black market emerged, where the exchange rate was nearly double the official rate.
By 2024, the National Bank of Ethiopia’s reserves had dwindled to just $3.3 billion, enough to cover only about 2.4 months of imports. The growing shortage of foreign exchange created intense pressure on the Birr, ultimately leading to the devaluation.
2. Overvaluation of the Birr
The Birr had been overvalued for years. In 2023, the official exchange rate was 57.48 ETB/USD, but on the black market, the exchange rate was closer to 100 ETB/USD. This overvaluation made Ethiopian exports too expensive on the international market, putting local businesses at a disadvantage. While the goal was to keep inflation low and stabilize the economy, it had the opposite effect: it distorted the economy and caused long-term damage. The government continued to prop up the Birr, but the mismatch between the official rate and the real market rate became unsustainable.
3. Rising Debt and External Pressures
Another major factor behind the Birr’s devaluation was Ethiopia’s growing foreign debt. As of 2024, the country’s external debt stood at around $31 billion, roughly 47% of its GDP. The government had to seek financial support from international organizations, such as the International Monetary Fund (IMF). In July 2024, Ethiopia secured a $3.4 billion loan from the IMF under the Extended Credit Facility (ECF) program. One of the conditions for this loan was that the government would allow the exchange rate to float, which led to the decision to devalue the Birr.
The burden of military spending, coupled with the cost of ongoing conflicts, has also put significant pressure on the national budget. The money spent on defense and the associated economic costs have further strained Ethiopia’s financial situation, contributing to the devaluation.
Comparing Ethiopia’s Crisis to Other Countries
Ethiopia’s situation is not unique. Other countries have faced similar currency crises in recent years. Looking at their experiences can provide useful insights into how Ethiopia might recover and stabilize.
Egypt (2016)
In 2016, Egypt made the decision to float its currency, and the Egyptian pound lost about 50% of its value overnight, from 8.8 EGP/USD to 13 EGP/USD. Inflation surged, and the cost of living went up. But over time, Egypt’s foreign reserves grew by 50%, from $16.5 billion to $25 billion. Egypt’s economy eventually stabilized, showing that while devaluations can be painful, they can also lead to long-term recovery.
Nigeria (2023)
Nigeria faced a similar scenario in 2023 when it devalued the Naira. The official exchange rate was 410 NGN/USD, but the black market rate was above 750 NGN/USD. The Naira lost over 60% of its value, and inflation rose sharply. Still, after the adjustment, the currency stabilized, and foreign exchange shortages became less severe. Like Ethiopia, Nigeria had to deal with a mismatch between official rates and the black market.
Could Ethiopia Have Managed It Differently?
While the devaluation was necessary, there were other ways it could have been managed to soften the impact. For instance, the government could have adopted a gradual approach, allowing the Birr to depreciate more slowly through a "crawling peg system." This would have allowed businesses and consumers more time to adjust, avoiding such a sharp drop.
Additionally, Ethiopia could have focused on building stronger economic fundamentals earlier on—such as diversifying exports, improving fiscal discipline, and increasing foreign exchange reserves. A more robust economy would have made the currency transition less painful.
Conclusion
Ethiopia’s currency crisis was not an overnight shock but the result of years of economic pressures, including overvalued exchange rates, foreign currency shortages, and growing external debt. While the devaluation of the Birr has been challenging for many Ethiopians, it could have been an inevitable adjustment in the country’s economic development.
Looking at experiences from Egypt and Nigeria shows that although devaluations are tough, they can eventually lead to stability. Ethiopia must now focus on diversifying its economy, managing inflation, and improving its foreign exchange situation to ensure a more sustainable future for the Birr and the economy as a whole.
The real question for Ethiopia now is whether it can stabilize its economy quickly enough to avoid further economic challenges. Time will tell, but with the right strategies, the country can eventually recover from this crisis.