SCHOOL OF LAW AND FEDERALISM

LL.M PROGRAM IN INTERNATIONAL

LAW

INTERNATIONAL AND AFRICAN

ECONOMIC LAW

Foreign Exchange Regulations and Balance of

Payment Problems under Ethiopian Law

By:

Kibru Debebe (LL. B)

Messeret Tadesse (LL. B)

June 2018
 Contents

Introduction ......................................................................................................................................................... - 1 -
Chapter One ....................................................................................................................................................... - 2 -
Foreign exchange and its regulation............................................................................................................ - 2 -
1.1. Meaning and usage of the concept of foreign exchange ................................................... - 2 -
1.2. Regulations of exchange rate....................................................................................................... - 3 -
1.3. Determinants of foreign exchange rate...................................................................................... - 4 -
1.4. Exchange Rate Regimes ................................................................................................................. - 7 -
1.4.1. Fixed exchange rate system ................................................................................................ - 7 -
1.4.2. Flexible Exchange rate System............................................................................................. - 8 -
1.5. Ethiopian Exchange Rate regimes................................................................................................ - 9 -
Chapter Two ..................................................................................................................................................... - 11 -
The Link between Balance of payment and foreign exchange .......................................................... - 11 -
2.1. Balance of payment and foreign exchange: the interplay ............................................ - 11 -
2.2. Components and factors affecting balance of payment ............................................... - 11 -
2.2.1. Components of balance of payments ............................................................................. - 11 -
2.2.2. Factors that affect balance of payments....................................................................... - 12 -
Chapter Three................................................................................................................................................... - 14 -
Balance of payment problem in Ethiopia: Causes, Measures and Outcomes ................................ - 14 -
3.1. Causes of balance of payment in Ethiopia ............................................................................ - 14 -
3.2. Measures and outcomes: Ranging from tight control on FOREX to Devaluation. ........ - 15 -
3.2.1. Tight FOREX regulations and its adverse impacts ........................................................ - 15 -
3.2.2. Devaluation: pros and cons ............................................................................................... - 17 -
Summary ............................................................................................................................................................ - 19 -
Bibliography....................................................................................................................................................... - 21 -
Introduction

The issue of foreign exchange and balance of payment has a great effect in the overall status of a
country’s economy, depending on how they are managed. Both subjects have the capacity to
measure whether a given country’s economy is performing well or not. For this reason different
countries applies different measures to make sure that such variables are well addressed so that
they contribute positively to the economy. Both subjects are able to determine whether the economy
of a country is healthy or not and have greater contribution for the international transaction of
goods and services. For this reason countries adopts policies and laws that regulate the
performance of such subjects.

The same way people in different country speak different languages, they also transact using
different currencies, which is why the issue of exchange rate happened. It is all about the
conversion rate of given country currency in to another for the purpose of doing business. In
addition to exchange rate, the issue of balance of payment is vital for determining a country’s
economic performance. Balance of payment is the sum accounting of nations transactions with the
rest of the world. Therefore, given the impact they have in the overall economy of a country, both
issue needs to be managed well by governments.

This writing therefore, deals with the issues of exchange rate regulations and the problems related
with the balance of payments under the Ethiopian regime. It identifies the policies and laws being
applied and the practical problems the economy is facing.

-1-
 Chapter One
Foreign exchange and its regulation

1.1. Meaning and usage of the concept of foreign exchange

The foreign exchange (FX or FOREX) market is the market where exchange rates are determined.
Exchange rates are the mechanisms by which world currencies are tied together in the global
marketplace, providing the price of one currency in terms of another. 1 An exchange rate is a price,
specifically the relative price of two currencies. The exchange rate is just a price, but it is an
important one which plays a very important role in the economy since it directly influences
imports, exports, & cross-border investments. 2

Regarding how it works, the field of foreign exchange has no centralized market. Instead, a foreign
exchange market exists wherever the trade of two foreign currencies is taking place.3 It is open 24
hours a day, five days a week. This foreign exchange market exists to ease investment and trade.
The primary trading centers in the world are London, Paris, New York, Tokyo, Zurich, Frankfurt,
Sydney, and Singapore. All levels of traders, from central banks to speculators, trade currencies
with one another.4

There are many actors taking part in the exchange, and the major market participants include
central banks, sovereign wealth funds, and global corporations, trading firms, investment
managers, and hedge funds and trading banks. 5 The reasons for engaging in foreign exchange
markets can vary in purpose and size, ranging from global trade and overseas investing to tourism
and speculation. For instance, companies that import or export goods and services are either
making or receiving payments in a currency different from their own and this requires them to

1
“Foreign exchange markets” https://www.bauer.uh.edu/rsusmel/7386/ln1.pdf, last accessed on June 28, 2018.
2
ibid
3
“Foreign Exchange (Forex)”, last accessed on June 28, 2010 http://www.investinganswers.com/financial-
dictionary/forex/foreign-exchange-forex-699,
4
ibid
5
What is foreign exchange? https://www.straitstimes.com/business/invest/what-is-foreign-exchange, last accessed on
June 29, 2018

-2-
exchange one currency for another. Some companies will also use FX to protect overseas assets
against changes in the exchange rate, a process known as hedging. 6

1.2. Regulations of exchange rate

Foreign exchange controls are various forms of management imposed by a government on the
purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by non-
residents. There are different forms of control which can be imposed by governments on exchange
rates to make sure that their economy is not influenced by external factors.

According to an article shared by Saqib Shaik, Foreign Exchange control is a system in which the
government of the country intervenes not only to maintain a rate of exchange which is quite
different from what would have prevailed without such control and to require the home buyers and
sellers of foreign currencies to dispose of their foreign funds in particular ways. 7According to
Haberler, “Foreign Exchange Control means the monopoly of the government in the purchase and
sale of foreign currencies in order to restore the balance of payments equilibrium and disregard
the market forces in the decision of monetary authority”. When tariffs and quotas do not help in
correcting the adverse balance of trade and balance of payments the system of Foreign Exchange
Control is restored to by Governments.8

One may wonder what will be the main objectives of the exchange rate control mechanisms which
will be imposed by the government, and the following are some of the real purposes which are
supposed to be met with that imposition.9

To Conserve Foreign Exchange:- The main objective of foreign exchange regulation is the
conservation of the foreign exchange resources of the country and the proper utilization thereof

6
ibid
7
Foreign Exchange Control: Definition, Objectives, Types and Conditions, available on
http://www.economicsdiscussion.net/foreign-exchange/foreign-exchange-control-definition-objectives-types-
and-conditions/13973, last accessed on June 29, 2010
8
ibid
9
“foreign exchange 2 exchange control” http://www.psnacet.edu.in/courses /MBA/economics%20notes/10
.pdf, accessed on June 29, 2018

-3-
in the interest of the national development. This is one of the important objectives of foreign
exchange regulations of many other countries too.

To Check Capital Flight: - Exchange control may be employed to prevent flight of capital from
the country and to regulate the normal day-to-day capital movements. if adequately implemented
and enforced, exchange control tends to be highly effective in curbing erratic outflows of capital.
When exchange control authorities refuse to sell foreign exchange far this purpose, they close the
only legal avenue through which capital may leave a country.

To Improve Balance of Payments:-Exchange control is one of the measures available to improve

the balance .of payments position. This can be achieved by restricting imparts by means of
exchange control.

To Curb Conspicuous Consumption:- In the developing countries especially, there is a craze far
the consumption of imparted articles, which are regarded as inessential 'luxury' goods. Exchange
control may be used to prevent their import and, thereby, their consumption.

To make Possible Essential Imports:-Due to the non-availability of or scarcity within the country,
the developing countries generally have to impart capital goods, know-how and certain essential
inputs and consumer goods. By giving priority to such imparts in the allocation of foreign
exchange, exchange control may ensure availability of foreign exchange far these imparts.

To Protect Domestic Industries:- Exchange control may also be employed as a measure to protect
domestic industries from foreign competition.

To Check Recession-induced Exports into the Country:- If foreign economies are undergoing
recession when 'the dames tic economy is free from it, the decline in prices .of foreign goods, due
to the recession, may encourage their exports into the country not yet affected by recession.
Exchange control may be employed to check such recession-induced exports into the country.

1.3. Determinants of foreign exchange rate

In the international trade or transaction, foreign Exchange rate (Forex rate) is one of the most
important means through which a country’s relative level of economic health is determined. A
country's foreign exchange rate provides a window to its economic stability, which is why it is
constantly watched and analyzed. However, this does not mean that, the exchange rate of a given

-4-
country currency could always be stable. There are many factors which determine the rate of an
exchange of a currency everywhere in the world. According to Jason Van Bergen 10, the following
are the main factors which determine the exchange rate of a currency at a given time:-

I. Differentials in Inflation

As a general rule, a country with a consistently lower inflation rate exhibits a rising currency
value, as its purchasing power increases relative to other currencies. During the last half of the
20th century, the countries with low inflation included Japan, Germany and Switzerland, while the
U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically
see depreciation in their currency in relation to the currencies of their trading partners. This is
also usually accompanied by higher interest rates.

II. Differentials in Interest Rates

Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest
rates, central banks exert influence over both inflation and exchange rates, and changing interest
rates impact inflation and currency values. Higher interest rates offer lenders in an economy a
higher return relative to other countries. Therefore, higher interest rates attract foreign capital
and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if
inflation in the country is much higher than in others, or if additional factors serve to drive the
currency down. The opposite relationship exists for decreasing interest rates – that is, lower
interest rates tend to decrease exchange rates.

III. Current-Account Deficits

The current account is the balance of trade between a country and its trading partners, reflecting
all payments between countries for goods, services, interest and dividends. A deficit in the current
account shows the country is spending more on foreign trade than it is earning, and that it is

10
Jason Van Bergen, “6 factors that influence exchange rates”,
https://www.investopedia.com/articles/basics/04/050704.asp, accessed on June 29, 2018.

-5-
borrowing capital from foreign sources to make up the deficit. In other words, the country requires
more foreign currency than it receives through sales of exports, and it supplies more of its own
currency than foreigners demand for its products. The excess demand for foreign currency lowers
the country's exchange rate until domestic goods and services are cheap enough for foreigners,
and foreign assets are too expensive to generate sales for domestic interests.

IV. Public Debt

Countries will engage in large-scale deficit financing to pay for public sector projects and
governmental funding. While such activity stimulates the domestic economy, nations with large
public deficits and debts are less attractive to foreign investors. The reason? A large debt
encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with
cheaper real dollars in the future.

V. Terms of Trade

A ratio comparing export prices to import prices, the terms of trade is related to current accounts
and the balance of payments. If the price of a country's exports rises by a greater rate than that of
its imports, its terms of trade have favorably improved. In a given country economy the Increasing
in terms of trade shows greater demand for the country's exports. This, in turn, results in rising
revenues from exports, which provides increased demand for the country's currency (and an
increase in the currency's value). If the price of exports rises by a smaller rate than that of its
imports, the currency's value will decrease in relation to its trading partners.

VI. Political Stability and Economic Performance

Foreign investors inevitably seek out stable countries with strong economic performance in which
to invest their capital. A country with such positive attributes will draw investment funds away
from other countries perceived to have more political and economic risk. Political turmoil, for
example, can cause a loss of confidence in a currency and a movement of capital to the currencies
of more stable countries.

-6-
1.4. Exchange Rate Regimes

Sometimes exchange rates are determined by demand and supply. But governments can influence
those exchange rates in various ways. The extent and nature of government involvement in
currency markets define alternative systems of exchange rates. For this reason there are different
types of exchange rate systems being used by countries. Exchange rate regimes can be represented
on a spectrum that constitutes hard pegs (currency union, dollarization, currency board),
conventional fixed peg, intermediate regimes (band, basket peg, and crawling peg), managed
floating, and independent floating according to the degree of fixity of exchange rates. Some
developing countries have experienced major changes in their exchange. 11

However, the following are the main exchange rate systems. I.e. fixed exchange rate and Flexible
exchange rate system.

1.4.1. Fixed exchange rate system

Fixed exchange rate system is a system where the rate of exchange between two or more countries
does not vary or varies only within narrow limits. Under the fixed or stable exchange rate system,
the government of a country adjusts its economic policies in such a manner that a stable exchange
rate is maintained; it is a system of changing lock to the key. 12 The main purpose of a fixed
exchange rate system is to keep a currency's value within a narrow band.13

There are some advantage of using this system, among other, it helps government to avoid
currency fluctuations, encourages investment by keeping the rate stable, keeps inflations at a low
level and prevents the worsening of current account by controlling rapid appreciation of currency
rate.14 For this reason developing economies often use a fixed-rate system to limit speculation and
provide a stable system. A stable system allows importers, exporters and investors to plan without

11
Hisayuki Mitsuo (ed.) (2007) “New Developments of the Exchange Rate Regimes in Developing Countries”, Palgrave
Macmillan publisher, p.1
12 Simranjot, “what are the Two Main Types of Exchange Rate Systems? “ Available on
http://www.preservearticles.com/2011092013732/what-are-the-two-main-types-of-exchange-rate-systems.html accessed on
June 27, 2018.
13
“Fixed Exchange Rate” available on https://www.investopedia.com/terms/f/fixedexchangerate.asp, accessed on June 28, 2018
14
For detail explanation on advantages and disadvantages of fixed exchange rate regime, see for example Imad A. Moosa (2005),
Exchange Rate Regimes: Fixed, flexible or something in-between?, Palgrave Macmillan, pp63-89

-7-
worrying about currency moves. 15 However, a fixed-rate system limits a central bank's ability to
adjust interest rates as needed for economic growth. A fixed-rate system also prevents market
adjustments when a currency becomes over or undervalued. Effective management of a fixed-
rate system also requires a large pool of reserves to support the currency when it is under
pressure.16

1.4.2. Flexible Exchange rate System

In this type of regime, governments and central banks do not participate in the market for foreign
exchange. The relationship between governments and central banks on the one hand and currency
markets on the other is much the same as the typical relationship between these institutions and
stock markets. Governments may regulate stock markets to prevent fraud, but stock values
themselves are left to float in the market. The U.S. government, for example, does not intervene in
the stock market to influence stock prices.17

It is a system where the value of one currency in terms of another is free to fluctuate and establish
its equilibrium level in the exchange market through the forces of demand and supply. Under the
flexible exchange rate system, the rate of exchange is allowed to vary to suit the economic policies
of the government; it is a system of changing key to the lock. The flexible exchange rates are
determined by the forces of demand and supply in the exchange market.18 There are no restrictions
on the buying and selling of the foreign currencies by the monetary authority and the exchange
rates are free to change according to the changes in the demand and supply of foreign exchange. 19

Generally, there are two major types of floating or flexible exchange rates. The first one is Free
Floating. Under this the exchange rate of a country is determined by the market and there is no
intervention either by the government or the central bank of the country. It is determined by the
interaction of the demand and supply for the currency. Under this system there is a risk of the

15
Simranjot, Supra note 12
16
ibid
17
Exchange Rate Systems, available on https://saylordotorg.github.io/text_principles-of-economics-v2.0/s33-03-
exchange-rate-systems.html, accessed on June 29, 2018.
18
Supra note 12
19
ibid

-8-
currency either appreciating or deprecating suddenly resulting in currency coming in to pressure
and becoming more volatile. It is also called clean float.20

The second one is the Managed Float; in here, In order to reduce the volatility in currency
countries follow managed float, under this system central banks of the country tend to intervene
from time to time in order to smoothen the fluctuations in the exchange rate in the currency
market.21

1.5. Ethiopian Exchange Rate regimes

Writers on Ethiopian monitory policy often dichotomize the exchange rate regimes of Ethiopia in
to pre 1991 and post 1991 exchange rate regimes. According to Borenna, the pre-1992 is a fixed
exchange rate regime where the Ethiopian Birr was pegged to the USD and the post -1992
managed -floating exchange rate regimes.22 The fixed exchange regime during the Imperial and
Derg Era (the so called pre reform or pre 1991) was left unaltered for two decades despite the
floating of the major world currencies including the US dollar. 23

In the post-reform or post 1991, an attempt was made to liberalize foreign exchange market and
the national Bank of Ethiopia has taken a number of initiatives. Accordingly, the fortnightly
auction market for foreign exchange was introduced on May 1, 1993. 24 The auction-system
initially worked alongside the official (fixed)exchange rate which applied to critical imports and
external debt-service, but the system was further liberalized over 1993-96. 25 In august 1996, the
fortnightly auction market was changed to weekly to accommodate the growing demand for foreign

20 Imad A. Moosa (2005), Supra Note 14, p.98-104 and also see Vinish Parikh (2010), Types of Floating Exchange Rate System
available at http://www.letslearnfinance.com/types-of-floating-exchange-rate-system.html, accessed on June 28,
2018

21
Ibid, Vinish Parikh (2010)
22
Borena Desalegn, “the effect of exchange rate movement on trade balance in Ethiopia”, unpublished thesis on international
political economy, University of Tokyo ,2013, p.17
23
Dr. P.Nandeeswara Rao and Tassew Dufera Tolcha (2016) “determinants of real exchange rate in Ethiopia”, International
journal of research granthaalyah, Vol.4 (Iss.6): Pp183-210
24
Ibid
25
Alemayehu Geda, Tony Addison and Getnet Alemu, The Current State of Ethiopian Financial Sector and Its Regulation: What
is New after a Decade and Half Strategy of Gradualism in Reform, 2001-2017, p.4

-9-
exchange and commercial banks were allowed to also established foreign exchange Bureaus. In
1998 the inter- bank foreign exchange market was introduced and worked alongside the auction
system until 2001.26 In the present day, the official exchange rate is determined in the daily inter-
bank foreign exchange market on a daily basis and the regime is characterized as “managed
floating exchange rate policy.”27

26
Borena Desalegn ,Supra Note 22 ,p 18
27
Alemayehu Geda et al, Supra Note 25, p.4; see also Abebe Deresa, “ exploring the link between exchange market pressure and
monitory policy in Ethiopia”, a paper presented for in house presenteation forum of the Economic research and monetary policy
directorate, national bank of Ethiopia, p.34

- 10 -
 Chapter Two
The Link between Balance of payment and foreign exchange

2.1. Balance of payment and foreign exchange: the interplay

There is a growing body of literature on the impact of exchange rate volatility on trade. These
literatures makes clear the empirical relationship between balance of payment and foreign
exchange. This relationship arises because the transactions involving trade and capital flows,
which are recorded on the balance of payments, give rise to demand for and supply of currencies. 28
Transactions in the market for goods and services, such as imports and exports, give rise to
demand for and supply of foreign exchange respectively. Equivalently, these transactions lead to
the supply of and demand for the domestic currency respectively.

Many empirical findings support the hypothesis that an increase in exchange rate volatility leads
to a decrease in trade flows because in most international transactions, goods are denominated in
terms of the currency of either the exporting or importing country. Exchange rate volatility is a
statistical measure of the tendency of the exchange rate to rise or fall sharply within a short period
and is important in understanding foreign exchange market behavior. Be it of the nominal or real
exchange rate, volatility creates uncertainty in macroeconomic policy formulation, investment
decisions and international trade flows.29

2.2. Components and factors affecting balance of payment

2.2.1. Components of balance of payments
The balance of payments is a statement of all transactions made between entities in one country
and the rest of the world over a defined period of time, such as a quarter or a year. It summarizes
all transactions that a country's individuals, companies and government bodies complete with
individuals, companies and government bodies outside the country. These transactions consist
of imports and exports of goods, services and capital, as well as transfer payments such as foreign

28
Imad A. Moosa (2005), Supra Note 14, p. 38
29
Anthony Musonda (2008), “Exchange Rate Volatility and Non-Traditional Exports Performance: Zambia,” 1965–1999 Research Paper 185
African Economic Research Consortium, Nairobi, Kenya. Available on https://econpapers.repec.org/RePEc:pra:mprapa:26952

- 11 -
aid and remittances.30 Balance of payment of a given country is mainly divided in to two major
categories. The current account and capital account. The current account on the balance of
payments measures the inflow and outflow of goods, services, investment incomes and transfer
payments.

According to an article by Tejvan Pettinger, the main components of the current account are,
Trade in goods (visible balance), Trade in services (invisible balance), e.g. insurance and services,
Investment incomes, e.g. dividends, interest and migrants remittances from abroad, and Net
transfers – e.g. International aid.31According to him, a deficit on the current account means that
the value of imports is greater than the value of exports. A surplus on the current account means
32
that the value of imports is less than the value of exports.
On the other hand, a capital account shows the net change in physical or financial asset ownership
for a nation and includes foreign direct investment (FDI), portfolio and other investments, plus
changes in the reserve account. A capital account may also refer to an account showing the net
worth of a business at a specific point in time.33

2.2.2. Factors that affect balance of payments

Since balance of payment is the composition of current account and capital account, the factors
which affect it also differ according to the type of account. Therefore, the main factors which affect
the balance of payments in turn affects the current account and capital account. Factor which
affect the current account are Inflation, National Income, Government Restructures and Exchange
Rates.34

30
“Balance of Payments (BOP),”https://www.investopedia.com/terms/b/bop.asp, accessed on June 28, 2010.
31
Tejvan Pettinger, “Current Account Balance of Payments”,
https://www.economicshelp.org/blog/glossary/current-account-bop/, accessed on June 29, 2018
32
ibid
33
Capital Account, https://www.investopedia.com/terms/c/capitalaccount.asp , accessed on June 29, 2010
34
Factors Affecting Balance of Payments, https://edugeneral.org/blog/business/factors-affecting-balance-of-
payments/, accessed on June 27, 2018

- 12 -
On the other hand factors which affect the capital account are government policy by imposing a
new tax, anticipated exchange rate movements by investors in securities, and interest rates are the
main ones. 35

35
ibid

- 13 -
 Chapter Three
Balance of payment problem in Ethiopia: Causes, Measures and Outcomes

3.1. Causes of balance of payment in Ethiopia

Countries in the system of international trade transact each other on goods they have more
opportunity cost than others36 by maintaining their balance of payment. A Balance of payment is
a state of equilibrium between imports and exports; incomes and expenses. However, sometimes
“disequilibrium in the external balance of a country develops due to disparities in export revenues
and import expenditures, on the one hand, and owing to the inequality in capital inflows and
outflows, on the other hand”. 37
Moreover, factor endowments (labor and capital)
and productivity, trade policy, exchange rates, foreign currency reserves, inflation and demand
are among the factors that affects balance of trade. 38 Since the economy of any country is a fully
integrated network of internal and external accounts, imbalance in one area is likely to influence
other areas through all the tubes and tunnels that define the flow structure.39

Ethiopia has continuously suffered from a recurred balance of payment problems since at least
1990’s.40 The causes of the problem are many and complex though the major determinants of
foreign exchange play a great role. First, the export industry which is the major source of foreign
currency is mainly dependent on limited number of agricultural products. Thus, absence of
diversified export sources summed up with “heavy and sudden fluctuations in quantity and price
of exports could create a serious problem in balance-of-payments, national income, investment as

36
Just like the Torrens-Ricardo Principle, however, Haberler’s Principle rests on the implicit assumption that, in autarkic
equilibrium, each country produces and consumes all commodities. See Murray C. Kemp (2008), “International trade
Theory: A critical review”, New York: Routledge, p.16
37
Dilip K. Ghosh and Gilles Duteil, “Full Employment, Balance of Payments and Adjustments in Unified (Fixed) Exchange Rate
Regimes”, p.3 in Augustine C. Arize, et al (eds.)(2001), Balance of Payments Adjustment: Macro Facets of International finance
Revisited, London: GREENWOOD PRESS.
38
Mary Hall, “Which factors can influence a country's balance of trade? “Available on
https://www.investopedia.com/ask/answers/041615/which-factors-can-influence-countrys-balance-
trade.asp#ixzz5JzkdzgGR Updated on June 22, 2018 — 2:10 PM EDT
39
Dilip K. Ghosh and Gilles Duteil (2001), Supra Note 37.
40
Naod Mekonnen Anega (2010), “The Balance of Payment-Constrained Economic Growth in Ethiopia”, EJBE Vol. 1,
No.2,p.100

- 14 -
well as the overall growth.”41 Second, the recent instability also takes the lions share in dwindling
foreign direct investment affecting capital transfer and economic growth. Third, strong and
relatively stable remittances play an important role in bolstering external stability in Ethiopia.
IMF data suggest that remittances and official transfers represent more than 4 percent of
Ethiopian gross domestic product. 42 However remittances have seriously underperformed in
recent years (as compared to the Government’s objective in its Development Plan). 43 Foreign
reserve decreased from around USD 4 billion or 2.5 months of imports at end 2015 to USD 3.2
billion or 2 months of imports in June 2017. 44 The tightening immigration law of the country and
the current USA position with regard to banning immigrants will have a possible decreasing effect
on remittances.

Policy makers and regulators of an economy therefore try to correct any imbalance as a result of
these factors with the least cost and loss of time.

3.2. Measures and outcomes: Ranging from tight control on FOREX to Devaluation.

3.2.1. Tight FOREX regulations and its adverse impacts

The lack of adequate foreign reserve as a result of a prevalence in negative exposure to the
determinants of balance of payment necessitates measures to control and administer the
circulation of hard currencies. The National Bank of Ethiopia (NBE) issued various directives
ranging from limiting the holding time and amount of foreign currencies by Nationals to
circulation in and out of foreign currencies by various institutions. 45

However, researchers and economists disagree on the excessive control on foreign exchange.
According to Tom Kiange, Ethiopia maintains a number of foreign exchange restrictions on
payments and transfers that are not consistent with international standards, as determined by the

41
See an article by Fitsum Zewdu Mulugeta, “The Contribution of Major Export Commodities of Ethiopia to the
Instability of the Country’s Export Earnings” Ethiopian Economics Association – Ethiopian Economic Policy Research Institute
(EEA/EEPRI)
42
International Monetary Fund, “The Federal Democratic Republic of Ethiopia”, IMF country report No 15/300.
43
Zerihun Getachew Kelbore and Nora Dihel, “Ethiopia: Impacts of the Birr Devaluation on Inflation”, November 08,2017
44
Ibid
45
See FOREX control regulation issued in 1977 and its various amendments including suffix [FX] post reform directives of NBE.

- 15 -
IMF.46 The following are criticisms forwarded by Kiange on excessive regulation and control of
foreign exchange.

First, the restriction or limits on foreign currency inflows and outflows and the amounts that local
and foreign individuals and corporations can hold, result in foreign exchange rate appreciation,
leading to a widening of the current account deficit. This deficit is further driven upward by the
significant imbalance between public capital inflows and export growth, which has been stifled by
the strength of the local currency and underdevelopment of private sector banking and
manufacturing. In turn, this reduces real income for many workers, with a resulting negative effect
on consumer spending. Furthermore, domestic production is suppressed as the strength of the birr
allows for the cheap import of substitute goods, reducing domestic production incentives.

Second, Foreign exchange controls may increase money laundering and terrorism financing risks
for Ethiopia when individuals, particularly immigrant workers, and businesses seeking to operate
internationally need to find alternative means of managing their foreign exchange needs. These
alternative means are difficult for the authorities to monitor and track. At a more individual level,
foreign exchange controls limit the ability of a population to travel overseas, an important
component of international trade and business development that is needed in order to boost a
country’s exports and secure the resulting foreign exchange, trade deficit reduction, and overall
economic benefits.

The third adverse impact of foreign exchange controls on the Ethiopian economy is the extent to
which immigrant workers entering Ethiopia from countries such as China and USA are believed
to bring foreign currency with them in excess of NBE regulations. Their expenditures drive up the
price of goods and services. A more open foreign exchange regime would likely translate into a
reduced need for foreign currency to be smuggled into the country. Regional inflation might also
be less severe, although high-spending immigrant workers will have an impact on prices in the
areas where they live.

46
Tom Kiang, “Growing an Economy: Impact of Foreign Exchange and Remittances on Ethiopian Development” , policy brief:
Global center on cooperative security, September 2014

- 16 -
3.2.2. Devaluation: pros and cons
Devaluation is an official downward adjustment to the value of the nation’s currency, relative to
another currency, group of currencies or standard. It is a means of letting the devaluating country
to lose some percentage of the value of its currency relative to dollar or any other currencies. 47

The effectiveness of devaluation as a tool of maintaining balance of payment is also contested by

various researchers. Some economists argue, devaluation as one of the best successful policies in
making exported goods cheaper and imported goods expensive so that the country‘s export will be
encouraged where as its import will be discouraged. 48 As a result, the nation may be able to solve
its balance of payment deficit through devaluation.

Though it is a known fact that theoretically devaluation can improve balance of trade through
making the domestically produced and exportable goods cheaper in the world market and
imported goods expensive in domestic market simultaneously, “numerous scholars of economics
argue that, its immediate result is aggravating the trade balance.”49 One counter argument basis
itself on Marshall-Lerner approach. In this approach “devaluation causes tells us that devaluation
will have a favorable effect on the current account if the sum of the absolute values of the
elasticities of demand for exports and imports is greater than unity.” 50 In this approach, the
dynamic response of the current account to devaluation (or depreciation) is different in the short
run (the period immediately following devaluation) than it would be in the long run (the period
further out in the future). This is because the elasticity of demand is lower in the short run than in
the long run. If the Marshall–Lerner condition is satisfied in the short run but not in the long run,
there is a possibility that the current account may deteriorate even further in the short run before
recovering in the long run. 51

The Case of Ethiopia is not different with the forecast approaches of economists. On October 10,
2017, the National Bank of Ethiopia (NBE) devalued the Birr by 15 percent as pressures on the

47
W.R Folks and S.R Stansell (1979) “Revaluation versus Devaluation: A Study of Exchange-Rate Changes”, the Chicago
Mercantile Exchange, p. 32
48
H.G Mannur (1995), “International Economics”, Pivas publishing house PVT LTD, p.66
49
Medina Mohammed Umer, devaluation and its impact on Ethiopian economy, unpublished LLM thesis, Hacettepe University
Graduate School of Social Sciences.
50
Imad A. Moosa (2005), Supra Note 4, p. 38
51 Ibid

- 17 -
foreign exchange intensified.52 According to the Government, the devaluation was undertaken to
encourage exports and overcome the foreign exchange shortage.53 Though, since devaluation is
‘inherently inflationary’ 54 nation’s domestic consumers are majorly affected by the continuous
devaluation of birr.

52
Zerihun and Nora (2017), Supra Note 43, Ethiopia’s exchange rate arrangement is classified as a crawl-like arrangement by the IMF. The
authorities describe it as a Managed float with no predetermined path for the exchange rate. In practice, the Birr is pegged to the US dollar.
53
National Bank of Ethiopia, 2017. Newsletter (Amharic Version), Vol. 5, No. 25, October 2017, Addis Ababa, Ethiopia;
and https://addisfortune.net/articles/ethiopia-devalues-currency-raises-interest-rates/
54
Befekadu Degefe and Kebre Moges (1994), Post Devaluation: From Stagflation to Stagflation. In Mekonnen Taddesse and Abdulhamid
Bedri Kello (ed.), The Ethiopian Economy: Problems of Adjustment, Proceedings of the Second Annual conference on the Ethiopian Economy.

- 18 -
Summary
It is understandable that the economy of any country is a result of fully integrated network of
internal and external accounts, and the imbalance in one area is likely to influence other areas
through all the tubes and tunnels that define the flow structure. The main factors which determine
this kind of integrated network of a given country are the healthy relationship which existed
between exchange rate and balance of payments of such country.

The concept of foreign exchange rate is vital for the smooth conduct of international trade between
countries, simply because both governments owned or private companies that import or export
goods and services are either making or receiving payments in a currency different from their own
and this requires them to exchange one currency for another. On the other hand balance of
payments is important in the sense that it has the capacity to determine whether a given country’s
economy is going the right direction or not. Balance of payments being divided at least to two
categories, namely the current account and the capital account of a given country’s economic
movements measures the status of an economy, whether it is in a trade deficit or trade surplus.
There are many factors which also determine how the exchange rate or balance of payments of an
economy could be well managed (regulated) or ill-managed. Therefore, it is mandatory to give
due consideration to the determinant factors timely and choose the best way available to regulate
such issues, so that the economy functions well.

Regarding the status of Ethiopian exchange rate regulations and its balance of payments during
different regimes, given the different forms of governments and economic ideologies which were
followed, the country’s economy had experienced many positive and negative results. When we
look in to the incumbent or recent performance of the economy, especially since the 1990’s, it has
suffered many balance of payments problems owing to different reasons, mainly the dependence
of its export on some agricultural products, recent political instability limited foreign direct
investment, underperformance of remittances are worthy of mentioning.

In order to regulate the poor balance of payments status by rectifying the above mentioned
problems, the governments has been taking some measures such as controlling the circulation of
hard currency through the national bank and devaluating the rate of the currency. However, even
these measures could not ultimately save the economy from being imbalanced. Some of the side

- 19 -
effects of imposing a tight currency circulation regulations are that, it resulted in foreign exchange
rate appreciation, increased the risk of money laundering and terrorist financing and affected
immigrant workers entering the country holding currencies in excess of what is allowed by the
national bank regulation. In relation to the devaluation measure, it has also brought the problem
of affecting domestic consumers, though it was thought to encourage export of goods and services.

To conclude, though Ethiopia as a country has been trying through the adoption of policies and
laws for the best regulations of exchange rate and balance of payments and also took some
practical measures, it is clear that the problem of imbalance still persists. Therefore, the
government is supposed to have a look again in to the practical outcomes of the measures and
might need to re-adjust its policies to meet current situation.

- 20 -
Bibliography

BOOKS and ARTICLES

Anega, Naod M., (2010), “The Balance of Payment-Constrained Economic Growth in Ethiopia”, EJBE Vol.
1, No.2

Arize, Augustine C., et al (eds.) (2001), Balance of Payments Adjustment: Macro Facets of International
finance Revisited, London: GREENWOOD PRESS

Deresa, Abebe: exploring the link between exchange market pressure and monitory policy in Ethiopia, a
paper presented for in house presentation forum of the Economic research and monetary policy directorate,
national bank of Ethiopia

Desalegn, Borena (2013) “the effect of exchange rate movement on trade balance in Ethiopia”, unpublished
thesis on international political economy, University of Tokyo

Dr. P.Nandeeswara Rao and Dufera, T. Tolcha (2016) determinants of real exchange rate in Ethiopia,
International journal of research granthaalyah, Vol.4 (Iss.6)

Geda, Alemayehu, Addison, T. and Alemu, G., The Current State of Ethiopian Financial Sector and Its
Regulation: What is New after a Decade and Half Strategy of Gradualism in Reform

Ghosh, Dilip K. and Duteil, Gilles, Full Employment, Balance of Payments and Adjustments in Unified
(Fixed) Exchange Rate Regimes

H.G Mannur (1995), International Economics, Pivas publishing house PVT LTD

Hall, Mary, Which factors can influence a country's balance of trade? “Available on
https://www.investopedia.com/ask/answers/041615/which-factors-can-influence-countrys-balance-
trade.asp#ixzz5JzkdzgGR Instability of the Country’s Export Earnings” Ethiopian Economics Association –
Ethiopian Economic Policy Research Institute (EEA/EEPRI)

International Monetary Fund, the Federal Democratic Republic of Ethiopia

Kelbore, Zerihun G. and Nora Dihel, Ethiopia: Impacts of the Birr Devaluation on Inflation

Kemp, Murray C. (2008), International trade Theory: A critical review, New York: Routledge

- 21 -
Kiang, Tom, Growing an Economy: Impact of Foreign Exchange and Remittances on Ethiopian
Development, policy brief: Global center on cooperative security

Mitsuo, Hisayuki (ed.) (2007) New Developments of the Exchange Rate Regimes in Developing Countries,
Palgrave: Macmillan publisher

Moosa, Imad A. (2005), Exchange Rate Regimes: Fixed, flexible or something in-between?, Palgrave
Macmillan

Mulugeta, Fitsum Z. The Contribution of Major Export Commodities of Ethiopia to the

Musonda, Anthony: (2008), Exchange Rate Volatility and Non-Traditional Exports Performance: Zambia,
1965–1999 Research Paper 185 African Economic Research Consortium, and Nairobi, Kenya

Taddesse, M. and Abdulhamid Bedri Kello (ed.), The Ethiopian Economy: Problems of Adjustment,
Proceedings of the Second Annual conference on the Ethiopian Economy.

Umer, Medina M., devaluation and its impact on Ethiopian economy, unpublished LLM thesis, Hacettepe
University Graduate School of Social Sciences.

W.R Folks and S.R Stansell (1979), Revaluation versus Devaluation: A Study of Exchange-Rate Changes,
the Chicago Mercantile Exchange

WEBSITES

https://www.investopedia.com/terms/b/bop.asp,
https://www.economicshelp.org/blog/glossary/current-account-bop/,

https://www.investopedia.com/terms/c/capitalaccount.asp
https://edugeneral.org/blog/business/factors-affecting-balance-of-payments
https://www.bauer.uh.edu/rsusmel/7386/ln1.pdf

http://www.investinganswers.com/financial-dictionary/forex/foreign-exchange-forex-699,

https://www.straitstimes.com/business/invest/what-is-foreign-exchange

http://www.economicsdiscussion.net/foreign-exchange/foreign-exchange-control-definition-objectives-
types-and-conditions/13973

http://www.psnacet.edu.in/courses /MBA/economics%20notes/10 .pdf

https://www.investopedia.com/articles/basics/04/050704.asp

http://www.preservearticles.com/2011092013732/what-are-the-two-main-types-of-exchange-rate-systems.html
https://www.investopedia.com/terms/f/fixedexchangerate.asp
https://saylordotorg.github.io/text_principles-of-economics-v2.0/s33-03-exchange-rate-systems.html,
http://www.letslearnfinance.com/types-of-floating-exchange-rate-system.html
LAWS

National Bank of Ethiopia Consolidated FOREX Directives

- 22 -
- 23 -