The Ethiopian birr dances a frenetic, unpredictable tango on Bank and forex bureau screens today, a stark departure from the rigidly choreographed performance of previous eras. Since the pivotal decision to loosen the grip of strict government control and embrace a more market-determined foreign exchange regime, the national currency has embarked on a volatile journey. The rate has surged to over twice its pre-reform value, a numerical testament to a profound economic transition.
This shift, while fundamentally aligned with sound economic principles, has laid bare the complex realities of an economy in undergoing a structural change. The core economic truth is inescapable: in a nation wrestling with limited export diversification and a formidable appetite for imports, the innate market pressure, all else being equal, points towards depreciation. The policy challenge, therefore, transcends the simple adoption of a floating regime. It evolves into an issue of managing the transition, where the core principles must be judiciously woven with a deeply responsible and inclusive orientation to governance. The recent dynamics surrounding the National Bank of Ethiopia’s (NBE) forex auctions offer a compelling, if concerning, case study in this delicate balance.
From a purely theoretical standpoint, the move towards a market-responsive exchange rate is a cornerstone of modern financial economics. It allows the price of foreign currency to act as a critical signal, reflecting the true relative scarcity of foreign exchange, encouraging export competitiveness, and rationing imports. It is a necessary long-term medicine for an economy seeking integration and efficiency. However, financial economics is not a doctrine applied in a vacuum; it is a discipline acutely aware of frictions, imperfections, and transitional pathologies.
The current Ethiopian context is characterized by such frictions: an inelastic demand for essential imports—from pharmaceuticals to industrial inputs—and a supply of forex that is constrained by modest export earnings and remittance flows still navigating new formal channels. In this setting, the textbook model predicts overshooting and heightened volatility. The exchange rate doesn’t glide to a new equilibrium; it can lurch, driven by pent-up demand and speculative anxieties.
It is precisely to temper this volatility, to smooth the transition, that the NBE has rightly assumed its role as a stabilizing actor through the forex auctions. This is textbook central banking: providing liquidity to an illiquid market to prevent disruptive gaps. Yet, the mechanism’s outcomes are revealing a critical friction not in the macroeconomic structure, but in the intermediary behavior of the commercial banks.
What we are observing is a poignant example of a short-term profit motive trumping long-term market stability and collective welfare. In their urgent quest to cover their own forex liabilities and meet client demands, banks are bidding at auctions at rates that exceed the prevailing interbank or open-market rates. This is not a mere competitive scramble; it is an action with profound signaling power. By validating these elevated levels in the formal auction setting, they effectively rubber-stamp a new, higher benchmark. The subsequent effect is a ratchet: today’s auction price becomes tomorrow’s market reference, creating a self-fulfilling prophecy of ascent.
This aggressive bidding reveals a further layer of institutional myopia. Ironically, many of these same banks are now paying a steep price for the very opposite behavior in the pre-reform era.
For years, operating within a controlled system, a culture of over-trading in foreign exchange positions became prevalent—taking on significant forex liabilities without the genuine hedging discipline a true market demands. Now, as the birr depreciates sharply, these accumulated imbalances are crystallizing into substantial valuation losses on their own books. They are, in effect, caught in a pincer movement: suffering losses from the legacy of a distorted past while their present actions actively worsen the conditions causing those losses. Their frantic bidding is thus not merely profit-seeking; it is also a defensive scramble to cover exposed positions, a reactive maneuver that tragically amplifies the very systemic risk they seek to mitigate for themselves.
The economics of this behavior are clear for the individual bank: secure the currency at any attainable price, maintain the sacred buy-sell margin, and pass the full cost—plus commission— onto the importer client. The bank’s ledger remains protected; its profitability on the transaction may even be enhanced. But this is where responsible governance must vehemently interrupt the narrow financial calculus. This micro-rationality sums into a macro-irrationality, a collective action problem where the pursuit of individual stability undermines systemic stability. The consequence is a transmission of relentless inflationary pressure. Every birr devaluation captured in these auction spikes translates directly into higher costs for essential imports. These costs cascade through the economy, inflating the price of medicines, fertilizer, machinery, and ultimately, the cost of living for every Ethiopian citizen.
To ask, “Do the banks care about the public consequence?” is to ask a question about the very soul of financial intermediation. An institution that is truly customer-centric, that views its role as a fiduciary partner in national development, must look beyond the immediate quarterly statement.
This is not a plea for a return to heavy-handed control, nor a suggestion that the NBE should force banks to participate at artificially low rates—such a move would simply kill the auction and drive activity into the shadows. Rather, it is an argument for a recalibrated understanding of enlightened self-interest and regulatory stewardship.
The NBE, in its commendable mission to stabilize, operates within its direct tools: injecting supply and setting auction parameters. However, the ceiling of sustainable rate increase—the point beyond which social and economic stability is jeopardized—can only be reached if all actors in the ecosystem share the burden of responsibility. The commercial banks must recognize that their role is not that of passive spectators in a market they decry as unstable, but active co-pilots. Exercising restraint in auction bidding, developing more sophisticated forex risk management for their clients, and innovating to foster export sectors are not charitable acts; they are strategic imperatives for operating in a fragile, transitioning economy. Their long-term viability is inextricably linked to the nation’s macroeconomic health.
Ultimately, the path forward demands a synthesis. Financial economics provides the map: a market-determined rate is the destination, but the journey requires buffers, signals, and managed expectations. Responsible and inclusive governance provides the compass: every policy and commercial decision must be gauged against its impact on the broader public, on the small business owner needing imported spare parts, on the family budgeting for household necessities.
The NBE’s auction is more than a liquidity window; it is a theater where this synthesis is tested daily. For the reforms to succeed, for stability to emerge from the current volatility, the actors on this stage must play their parts with a dual consciousness: of the rational profit motive and of the profound social contract inherent in managing a nation’s currency.
The quest is not for a perfectly stable, artificially pegged rate, but for a credible and responsibly guided journey towards a market rate that reflects economic fundamentals without being hijacked by short-term opportunism. In this endeavor, looking beyond the immediate bid is the very essence of both sound economics and patriotic duty.
(William Brooks is a freelance consultant with interests in business and politics in East Africa. He can be reached at [email protected])
Contributed by William Brooks
