Ethiopia: The Pros and Cons of the Currency Change

The birr is the unit of currency in Ethiopia.

The government announced (September 4, 2020) that the currency notes that are now in use will be shortly replaced by new currency notes and a new 200- Birr banknote will also be introduced. Printing and related costs amounted to 3.7 billion Birr (or about 105.7 million USD at the official exchange rate) and the total amount of the newly printed currency by value is 262 billion Birr and by number of notes (bills) 2.9 billion ("Reporter," Amharic, September 5, 2020).

The major and plausible reason given by the Governor of the National Bank of Ethiopia, Dr. Yinager Dessie, for the currency change is that there is currently too much currency (money) circulating outside banks. However, he did not give a specific amount for it. Prof. Befekadu Deguefe, a prominent Ethiopian economist cited a figure of 110 billion Birr for currency outside banks in a television interview in early September (with Gera Getachew on ESAT). As indicated above, the total amount of replacement currency newly printed is 262 billion Birr which is greater than the currency outside banks cited above by 152 billion Birr. Even allowing for currency within banks and in vault, the newly printed money is significantly greater than currency outside banks, i.e. 110 billion Birr.

Taking 262 billion Birr as a basis for estimating the total amount of money circulating outside banks that is perhaps closer to the true figure than the 110 billion Birr cited, the excess over the 110 billion Birr would be about 152 billion Birr. The simple calculation is as follows:

1.Amount newly printed -262 bln Birr

2.Official figure for currency outside banks -----110 bln Birr

3.20% estimate for currency within banks, and vault money 52 bln (20% of 262)

4.262-52 bln Birr = 210 bln Birr

5.210-110 bln Birr= 100bln Birr

So, the excess of the newly printed money over the official figure for currency outside banks after adjusting for currency within banks and vault money is 100 billion Birr. Where did this excess paper money come from? There are two prime suspects: one is, of course, the legal currency printing authority, the National Bank of Ethiopia (NBE); the other is counterfeit money. The international average for counterfeit money is about. 01 percent (e.g. USA). So, the total counterfeit money, which would eventually be detected and discarded, in the case of Ethiopia may be estimated at 11 million Birr, which in relative terms is minuscule. If counterfeit banknotes are not detectable with the available technology, then it should be assumed the notes were printed by foreign governments or well-organized crime syndicates.

On the other hand, the primary objective of printing new banknotes is to neutralize cash hoards in Ethiopia and outside held in the now old currency. Cash hoards crossing Ethiopia's borders to finance contraband trade (both imports and exports) should be curbed by the relevant border control authorities. On the other hand, cash hoards used internally for illegal trade and other activities including crime, should also be handled by the concerned legal enforcement bodies, including the police and the Ethics and Anti-Cooruption Commission, which (the latter) incidentally has done next to nothing in its nearly 19 years of existence.

Why then spend 3.7 billion Birr on issuing new banknotes when the commendable objective of safeguarding the national currency may be achieved at a much lower cost and on a more sustainable basis by:

a)Directly arresting suspected and identified criminals within the borders of Ethiopia and confiscating their cash hoards;

b)Strengthening border controls ;

c)Beefing up internal and external financial and monetary intelligence;

d)Availing state-of-the-art counterfeit currency detection technologies;

e)Allowing the Ethics and Anti-corruption Commission to operate in accordance with its establishment proclamation etc.

Above all, particularly the National Bank of Ethiopia and the Commercial Bank of Ethiopian should be significantly restructured. We all know the NBE overprinted currency and lent it to the government without any guarantee to enforce repayment. The CBE created money in its own way by disbursing loans in cash without ensuring their repayment. These two banks have been the main conduits for the currency outside banks (110 billion Birr) that is being manipulated by criminals of all sorts including contract killers. The irony is that some of the officials who are now leading the on-going currency change operation are those same people who helped mess up the financial and monetary system of the country.

However, now that the step has been taken, what are some of the positive outcomes that may accrue. First, this may be a good opportunity to enhance the security features on the banknotes; some success may be registered in neutralizing illegal cash hoards-inside and outside Ethiopia; In the process of the redemption of old banknotes, bank deposits could increase significantly and with cash withdrawal limits, cash savings in the banking system may rise on a more permanent basis; such increased bank deposits may help temper inflationary tendencies in the economy and improve bank loan-granting operations.

However, when everything is said and done, the fact remains that the Ethiopian banking system, particularly the state-owned one, has been plagued by a host of basic problems including insufficient oversight, incompetent management, counterproductive credit policies, corruption, inadequate technological improvement and innovation, poor credit analysis capacity, etc. Hence, a number of additional reforms need to be taken. The major ones are the following:

- Reorient the major objectives of the NBE back to inflation control, exchange rate stability and sound overall monetary policy to ensure the soundness of the country's banking and financial system;

- Revert the CBE to its primary functions as a commercial bank (from what it is supposed to do as a policy bank at present) to engage primarily in short-term loans for domestic trade, exports, imports, working capital and some medium-term and long-term financing for reliable business expansions and new start-ups from domestic savings mobilization of longer maturity (e.g. time deposits);

- Strengthen the Development Bank of Ethiopia and re-establish the now defunct Construction and Business Bank as a development bank and a mortgage bank, respectively, for the financing of long-term and medium-term enterprise development and housing and condominium and apartment financing;

- The NBE should impose transparent limits on:

- Government borrowing

- Lending to other banks for liquidity purpose

- Currency printing tailored to its core requirements

- Tolerable inflation rates

In addition, the NBE should fulfill its responsibilities as the nation's banking and financial watchdog by applying CAMEL (acronym stands for capital adequacy, asset quality, management, earnings and liquidity).

On the other hand, the CBE should substantially improve its customer service and branch expansion on current and future business expectations in order to mobilize domestic savings to the maximum possible extent. Similarly, on the lending side of the equation, loans and credits should be carefully scrutinized to ensure repayment with interest on the basis of internationally accepted credit analysis benchmark.

By way of conclusion, we should try to make the best of the currency change that has already become a done deal. Attempts should be made to fight counterfeiting, illegal cash hoards, money laundering and other illicit money transfers and domestic inflationary and exchange rate depreciation tendencies. Money is an instrument, and a powerful one at that, for rapid economic development if properly utilized. The main tool is bank credit which must be used to produce real goods and services by efficient entrepreneurs and operators.

To ensure that bank credit is paid with interest and on schedule, several safeguards are employed including the following:

- Collateral and hedging

- Careful credit risk analysis

- Thorough project analysis

- Trustworthiness of borrowers

- Careful background checks on borrowers, etc.

By contrast, what we have observed in Ethiopia in general is certain groups and circles using money (credit) as a means of creating inflation and using that inflation to plunder real resources. We have observed this phenomenon all too often, especially in the real estate sector, where a favoured borrower with a large bank loan comes to a construction materials market and mops up most of the materials at high prices, forcing other customers to go home empty-handed because of too high prices of construction materials. To add insult to injury, the bank loans so utilized may be written off by orders from above.

Anything is possible in a Mafia-like economic patronage system which existed in Ethiopia particularly before the reformist government put together by Prime Minister Abiy Ahmed. The currency change should be taken as a good opportunity to neutralize illegal cash hoards being used to perpetrate economic sabotage and commit heinous crimes and at the same time to make bank credit an instrument for rapid economic development and not a tool for economic exploitation by inflation.

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