Ethiopia: The Newly-Introduced Banknotes and the Possible Ramifications

Earlier this week, the Ethiopian government has disclosed the newly printed denominations of its paper money. The 10, 50 and 100 Birr banknotes are changed and a newer denomination of Birr 200 has been introduced.

A few months ago, the Ethiopian Bankers Association (EBA) has reported that over 113 Billion birr is out of the formal banking system. EBA has also recommended demonetizing the currency notes so that it would make such a significant amount of money back to circulation. The stashed 113 Billion birr will now have no room outside banks. In the eyes of pure economics, this measure would have paramount importance particularly in availing investment capitals and for healthy functioning of the financial sector.

Shortage of liquidity for the past few years has costed commercial banks of huge profit that they would have earned had they availed capitals for investment. This demonetization measure coupled with the newly adopted directives of the National Bank (such as withdrawal limits) would noticeably impact the availability of capital in the hands of commercial banks. This of course is a big favour the government did for the banks. Besides, the majority of the unbanked society would definitely be banked through the process of changing the old currency with the new one. And I hope commercial banks would seize this opportunity and make the most of it in banking the unbanked Ethiopians.

In a nutshell, the money supply in the formal economy would be updated and be controlled by the central bank. Investopedia defines 'Money supply' as all the currency and other liquid instruments (such as bank checks) in a country's economy on the date measured. The money supply roughly includes the cash and the deposits that can be used almost as easily as cash. Money supply (MS) is directly linked to the rate of interest, investment, employment and inflation. When money supply increases the availability of cash in the hands of commercial banks would increase. This in turn reduces the rate of interest which then attracts investment. Investment on the other hand creates more job opportunities and employment. However, over 113 Billion birr out of the banking circulation has adversely been interrupting economic activities. The re-injection of this huge amount into the banking system will definitely stabilize the finance industry and enable businesses to be conducted in a healthy manner.

In addition to the positive impact on the finance industry in returning the stashed 113 billion into the banking system, the introduction of these new denominations would curb illegal trade activities and illicit financial flows that our economy has been suffering from. When transactions and payments are made through the formal banking system, it gives the National Bank an opportunity not only to control the money supply and circulation but also the types of business activities to which the payments are attached to. For instance, trade activities such as the illegal arms deal, drugs trafficking, contraband, the financing of terrorism can never be conducted through the formal banking system. Various institutions, individuals and interest groups engaging in such illicit and illegal activities would now have to give it a rest at least for years till they devise another means of running their businesses.

Some experts, however, fear that this demonetarization measures would escalate the rate of inflation. Well, I argue against this notion. It is of course expected that the groups or individuals that have been engaging in illegal trade activities would tend to exchange their stashed amount of cash with real estates, gold, vehicles and other fixed assets. They won't be buying other consumable and perishable products which would have increased the existing rate of inflation. The purchase of fixed assets (if there be) would last only for a month since the window of changing money more than 100,000 is only within thirty days. Besides, in such times of uncertainty and strong government control measures, it is unlikely that people will sell their products with highly inflated prices. Even if they do sell with whatever level of price, the money has to come to banks. And this would ultimately fulfil the very purpose of the demonetization.

These experts also say that the illegal groups and individuals will exchange their stashed old banknotes with foreign exchange (hard currencies). The government on the other hand is taking actions on the major black market operators. Therefore dollarizing the old currencies cannot be a way out for the licit traders and corrupt individuals. Moreover, the patrolling of the government with the integrated effort of the military, the police, border keepers, National Intelligence and Security Service (NISS) and other agencies would definitely close every window through which the illegal traders would escape. However, one way that the government may fail in hunting the illegals is if the illegal traders and corrupt individuals succeed in exchanging their old currency with the foreign exchange in the hands of the diaspora. The diaspora, instead of sending remittances through formal money transfer means, prefers to sell the foreign exchange to the partners of the illegals living abroad; and the illegals in Ethiopia transfer the money to receiver here. This would increase the price of dollar in terms of the Ethiopian birr. And the diaspora might find it attractive to exchange the money through this window. And still, this can only happen for a month which makes the overall impact insignificant.

Though the Prime Minister hasn't explicitly disclosed that this measure is directed towards weakening the financial capabilities of the Tigrean People Liberation Front (TPLF), many people believe that the Federal government is ambushing TPLF's oligarchs. Given the current situation between the Federal government and the TPLF, people think that the demonetization measure would significantly downsize the financial means of the old oligarchs if of course, they have stashed billions of the old banknotes. On the whole, whoever has kept the money out of the banking system would certainly be forced to pay a visit to banks.

To sum up, the demonetization of the banknotes brings a substantial impact on the performance of the financial sector to the better. The three months window of changing currencies can be a bit difficult for the majority of the unbanked populace living in rural areas that don't have access to the banking system. It should also be noted that changing currencies can't bring a long-term solution. Digitalization of the economy must be given due attention by the government and the financial sector. Unless the digital economy and transaction systems are introduced, a sole demonetization measure is like a postponement of the existing financial sector problems for the next generation to deal with it. Change the banknotes now, digitize the economy soon!

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