Ethiopia, Nigeria and How Currency Floating Impacts Economy

Now, Ethiopian citizens are bearing the brunt of a market adjusting to reflect the true value of the birr without official restrictions. While the government has tried to stop the dramatic climb of prices, including closing down businesses for hiking their prices and ransacking warehouses with hoarded goods, there is anxiety about what this new policy reform means for cost of living in the medium to long term.

“That’s not a smart idea,” says Chiejina Obi (who gave an interview on the condition of using an alias), a financial analyst and compliance executive at a Nigerian bank. He added that the Ethiopian government’s reasoning, that the confiscated goods were already imported and purchased before the currency float, is fundamentally flawed. “The price change makes sense for the business person because his revenue is what he will use to buy the next set of goods, and they still need to make profit on top of that. It’s a domino effect because no one wants to run at a loss and a macroeconomic shift like this immediately triggers increased prices.”

For Obi and many Nigerians on the other side of Ethiopia, what is happening in the East African country is all too familiar. Last year, after his inauguration into office, President Bola Tinubu changed Nigeria’s foreign exchange system from a fixed rate determined by the government to a float system determined by market forces. That, along with the removal of fuel subsidies and the increase in electricity tariffs, has become the major cause of an ongoing cost of living crisis, which recently triggered nationwide protests.

Earlier this year, Nigeria’s inflation rate reached a near three-decade high, a statistical indicator of how prices have shot up drastically in the last year-plus.

“It’s not just that the naira is at historic levels of weakness against the dollar that’s caused that, but there’s been multiple shocks caused by several times the exchange rate has kind of gotten out of hand,” Obi says.

The Nigerian government blamed a recent period of the dollar’s skyrocketing value against the naira on speculative forces, including the popular trading platform Binance.

Prior to the implementation of the float last year, the official rate of $1 was just under ₦500. At the same time, it was somewhere around ₦700 in the parallel market, where many businesses and individuals had to turn due to a shortage of dollars and other foreign currencies.

For several years, under former PresidentMuhammadu Buhari, Nigeria struggled to attract foreign investment but stubbornly held on to the fixed exchange rate, despite how expensive it was for the government to subsidize its official rate for those that could access foreign currency through those channels. The administration and former central bank governor Godwin Emefiele argued that the policy was staving off high inflation.

Even now, with the float, Nigeria continues to struggle to attract foreign investment and companies have exited the country citing FX shortages. “The problem is that fixed rates are expensive to manage when your economy isn’t optimized,” Obi explains, adding that floating doesn’t offer much reprieve because it just passes off the cost to consumers who are also navigating a less-than-ideal economy.

“If dollars aren’t readily available to banks, individuals and most people from the central bank, that demand puts pressure on the government’s capacity to help facilitate imports, because that’s what most of our economy runs on. The exchange rate and your currency’s value within the context of the global economy is largely dependent on the balance between your exports and imports, as well as investors injecting their foreign currency into your country’s economy.”

Like many financial analysts have opined, Obi believes floating the exchange rate is the best thing to do, but he says there has to be a commitment on the government’s side to ensure necessary economic, monetary and fiscal reforms. “They all go together,” he says. “For example, the CBN raised interest rates as a way to combat inflation, which makes sense on paper, but you’re doing it when the government is not addressing the obvious gap in local production and our insecurity problems, which means food and other things we can produce in Nigeria will just remain expensive, and some families and businesses will still need to borrow at those same interest rates just to survive.”

Obi, like many, has found the implementation of the currency floating to be horrible, in relation to the glaring needs of the Nigerian economy. It’s here he hopes that the Ethiopian government is much better and can learn from the mistakes of Nigeria. “The price shocks are normal but, if they have it properly planned out, Ethiopians will have the purchasing power to deal with the rising prices and that will lead to a new economic normal,” he says.

According to reports, Ethiopia floated its currency to secure funding from the International Monetary Fund (IMF) and World Bank, to the tune of about $20 billion. In addition to addressing the FX shortage and potentially boosting the economy, the funding is expected to help the country get back on track as it restructures its external debt of over $28 billion.

“From what I’ve seen online, the float was part of the conditions from the IMF for their new loan,” Obi says, adding that he understands cynics who don’t trust the organization. “There were reports that the IMF was behind the finance bill in Kenya that caused the protests, and they even played a role in the Structural Adjustment Program that seriously affected Nigeria’s economy under [former military dictator] Ibrahim Babangida. That said, I do believe that if — and that’s a very big if — the Ethiopian government is working for the people, the inflation situation would be temporary.”