VZCZCXRO8193
RR RUEHROV
DE RUEHDS #0714/01 0661050
ZNR UUUUU ZZH
R 071050Z MAR 07
FM AMEMBASSY ADDIS ABABA
TO RUEHC/SECSTATE WASHDC 4968
INFO RUEHNR/AMEMBASSY NAIROBI 2874
RUEHGV/USMISSION GENEVA 3956
RUCPDOC/DEPT OF COMMERCE WASHDC
RUCNIAD/IGAD COLLECTIVE

UNCLAS SECTION 01 OF 02 ADDIS ABABA 000714 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD EINV ET
SUBJECT: ETHIOPIA: EXCHANGE RATE DEPRECIATION 
 
 
¶1. (SBU) Summary: The Ethiopian birr depreciated 1.6 percent against 
the US dollar from the beginning of December 2006 through February 
2007 - nearly as much as the birr had slipped in the previous five 
years.  The National Bank of Ethiopia (NBE, the country's central 
bank) follows a managed float exchange rate regime, intervening as 
it deems necessary to smooth excess volatility in the market.  The 
recent acceleration in the birr's depreciation appears to be a new 
GOE effort to reduce import demand and so mitigate pressure on the 
country's scarce hard currency reserves, but this approach will 
likely stoke inflation.  Falling assistance inflows last year 
compounded Ethiopia's chronic trade deficit; sizable hard currency 
outlays to finance Ethiopia's military presence in Somalia is also 
adding to the problem.  Additional liberalization of the economy, 
and resulting foreign investment, would appear to offer a better 
strategy for easing pressure on foreign exchange markets.  Overall 
aid flows are also likely to remain unpredictable as Ethiopia 
continues its bumpy democratization process.  Compounding the 
economic picture is a 27 percent inflation rate in the past six 
months.  End Summary. 
 
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BIRR HOLDS MOSTLY STEADY FOR FIVE YEARS, 
WITH OFFICIAL HELP 
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¶2. (SBU) The birr, Ethiopia's currency is pegged to the US dollar. 
The GOE claims to follow a managed float (aka "dirty float") 
exchange rate regime.  Prior to October 2001, the exchange rate was 
determined by the Dutch-type weekly foreign exchange auction market. 
 The marginal rate derived from the auction used to serve as an 
official rate used for transactions for the week following the 
auction.  Since October 2001, however, the exchange rate of the birr 
has been determined by the daily inter-bank foreign exchange market 
in which the National Bank of Ethiopia intervenes to regulate the 
movement of the exchange rate. Over the past five years, the 
exchange rate of the Birr against the US dollar has been steadily 
and slowly depreciating by Birr 0.0001 on a daily basis.  In October 
2001, the rate was 8.56 birr per dollar; five years later, in 
October 2006, the rate had fallen to 8.71 birr per dollar, 
indicating a cumulative depreciation of 1.7 percent.  The IMF has 
argued that this regime in practice amounts to a fixed exchange 
rate. 
 
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LOWER AID FLOWS; SURGING IMPOSTS STRAIN RESERVES 
--------------------------------------------- --- 
 
¶3. (SBU) Over the last 18 months, however, the pressure on the 
exchange rate appears to be on the rise owing to the ever-increasing 
trade deficit as well as falling external inflows in the form of 
direct budget support and other assistances from foreign 
governments.  The country's export receipts in 2005/06 totaled $1.0 
billion, while the total import bill was $4.3 billion for the same 
period.  The trade deficit with the U.S. aloe was over $400 million 
in 2006.  The gap was financed - as it has been for many years, by 
external inflows in the form of remittances, loans and assistance, 
debt forgiveness, and by running down NBE's reserves.  The 
suspension of direct budget support by the World Bank and several 
donor governments in the wake of political unrest in November 2005 
reduced assistance flows, however.  Many of those flows have since 
resumed, but at a lower rate than expected.  While Private 
remittances slightly climbed from $96 million in 2005 to $105 
million in 2006, net public transfers shrunk from $836 million to 
$483 million in the same period)  According to PM Meles, the GOE is 
also struggling with unexpectedly high dollar outlays to pay for the 
expenses of the Ethiopian military offensive in Somalia. 
 
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FASTER DEPRECIATION MAY WORSEN INFLATION 
---------------------------------------- 
 
¶4. (SBU) The rate of depreciation of the Birr has increased rather 
markedly since December 2006.  The exchange rate depreciated from 
8.7067 birr/1 dollar at beginning of December 2006 to 8.8415 
birr/dollar at the end February 2007 - a 1.6 percent drop.  In 
addition to an accelerated daily 0.0001 rate of depreciation, the 
authorities allowed further depreciation by a significant amount on 
four occasions in December 2006 and January 2007, with the Birr 
dropping on average by 0.03 birr in each time.  According to some 
economists at the NBE, the authorities are considering a shift in 
their longstanding strategy; depending on the pressure on Ethiopia's 
reserves, the bank may allow more depreciation of the Birr.  Some 
Senior economists at NBE (protect) are concerned that more rapid 
depreciation of the local currency will reinforce the existing 
upward trend in inflation.  Exchange rate depreciation will further 
erode the purchasing power of Ethiopians already reeling from 
significantly higher food prices. 
 
--------------------------------------------- 
COMMENT: ATTRACTING MORE FDI IS BEST STRATEGY 
 
ADDIS ABAB 00000714  002 OF 002 
 
 
--------------------------------------------- 
 
¶5.  (SBU) Though understandable, the NBE's apparent efforts to 
discourage imports through accelerated depreciation of the birr may 
come at a high cost in terms of inflation.  It will be difficult for 
the GOE to expand exports more quickly than it has so far and demand 
for imports is almost certain to remain high.  Foreign aid flows are 
likely to remain volatile and determined in some measure by the 
unpredictable evolution of Ethiopia's democratization.  Further 
liberalizing the economy would appear to be the best strategy to 
cope with this uncertain situation.  Additional privatizations and 
reduction in the role of state and party companies in the economy 
would attract foreign resource inflows in the form of FDI, long-term 
concession loans, grants and commercial loans.  End Comment. 
 
YAMAMOTO