Ethiopia is gearing up to relaunch its economic reform agenda after floating its currency and securing a $3.4bn IMF package in July.

The IMF deal was sealed after months of wrangling, with Ethiopia’s finance ministry reluctant to float the Ethiopian birr, a key demand of creditors. With inflation at 27%, officials feared that allowing the market to set the rate would hit domestic manufacturers that rely on imported machinery and lead to further price hikes for consumers.

However, pressure from creditors mounted after Ethiopia defaulted on its only international government bond in December, with the country already negotiating with China and Western lenders to restructure its bilateral debt. On 29 July, the central bank announced the end of foreign currency controls. The IMF deal was signed the same day, while the World Bank also released funds.

In total, Ethiopia hopes to receive $10.7bn from the IMF, the World Bank and other creditors. Prime Minister Abiy Ahmed has likened the reform to “the pain of surgery, endured for healing.” Mamo Mihretu, the central bank governor, says it represents “a new, transformative moment in Ethiopia’s economic journey”.

Birr loses half of its value

Three weeks after it was floated, the Ethiopian birr has lost nearly half of its value, to trade at 115 against the US dollar, alarming consumers.

By mid-2024, forex reserves barely covered two weeks of imports. To access foreign currency, traders often resorted to underhand methods such as under-invoicing, while the diaspora channelled remittances to relatives through the black market, depriving the government of sorely needed tax revenue.

Meanwhile, businessmen exported coffee, Ethiopia’s biggest agricultural product, at a loss to get their hands on precious dollars used to import other goods. The 2020-2022 war in Tigray exacerbated these distortions by destroying $27bn worth of infrastructure, crippling trade, and diverting spending towards defence – while also drawing Western sanctions over human rights abuses.

“Floating the currency is a necessary step for the economy that will allow Ethiopia to gradually move away from aid and towards global markets as a source of foreign exchange and investment,” says Nebil Kellow, founder of First Consult, which advises foreign investors.

However, currency reform will not solve Ethiopia’s economic woes, Kellow says: “The next question is, can we follow through with the rest of the reforms that are crucial to increase productivity, investment and exports?”

Abiy’s ambitious reform agenda

The pace of reform in Abiy’s Ethiopia is regaining momentum. Before floating the currency, the government passed legislation allowing foreigners to own property and buy coffee directly from producers, while the central bank is now using interest rates to set monetary policy, abandoning the old system of restricting private credit.

A new stock exchange will start trading this financial year, while plans are being revived to sell a second private telecoms licence and a stake in Ethiotelecom, the state provider.

“Business people are overjoyed,” says Henok Assefa of Precise Consult International, another advisory firm in Addis Ababa. “The old system was terrible, it generated huge uncertainty and put a cap on how big they could grow.”

Rising inflation remains a worry, however. After dropping from 33.9% in 2021/22 to 26.9% in 2023/24, the IMF predicts inflation to rise to 30.1% this year. The price of basic food, such as onions, has already risen, while some traders have hoarded products such as edible oil, a product that temporarily disappeared from shop shelves in Addis Ababa.

However, after an initial unsettled period, the IMF expects inflation to drop steadily towards 9.6% in 2028/29. To shield the public, the IMF and World Bank programmes include money for temporary fuel and fertiliser subsidies, as well as funding for social security programmes.

In early July, parliament passed a record budget for the Ethiopian 2024/25 fiscal year that included wage increases for civil servants to help them endure the initial “shock period” of the reform. Since the currency float, officials have closed down thousands of businesses hoarding food and other household items.

The path ahead is unclear

But the path ahead remains unclear. In theory, businesses can now freely buy forex from banks, but Ethiopia’s import-heavy economy still suffers from a chronic shortage of dollars, with businesses unable to withdraw the balance of their foreign currency accounts because bank branches simply have no greenbacks to give them. Some economic analysts fear the gap between the official and black market could open up again if traders cannot freely access dollars from banks.

If Ethiopians living overseas start channelling remittances through official channels, this could help plug the gap. Mining is another sector that could be formalised as a key source of hard currency. Gold traders, for example, sold gold through the black market to the Gulf, where it fetched a much higher price than Ethiopia’s official market. Alongside telecoms, several key industries, such as government sugar factories, are ripe for privatisation.

Assefa describes these as “low-hanging fruits”. He says: “If you can bring them into the formal economy, billions are going to come. The key is to build trust.”

Analysts say in the long-term, Ethiopia will need to build up agribusiness and its manufacturing base by encouraging investors put off by erratic policy-making, high risk and restrictive rules that required them to surrender their foreign currency earnings and made repatriating profits difficult. Ethiopia will also need to restructure its debt: last year more was spent on debt servicing than health.

Debt negotiations could be protracted. This month bondholders rejected a proposed 20% haircut of their holdings as “incompatible with a good-faith approach to debt restructuring.” However, with bilateral debt repayments suspended until 2025, the government has some breathing space.

Patrick Heinisch, an emerging markets economist with Helaba, says the IMF deal can make a “big difference”, but warns the reform process could strain Ethiopian society, which is already riven with ethnic tensions. He points to recent protests in Kenya over proposed tax increases and subsidy cuts as a signal that “they cannot push forward too hard because it will hurt people.”