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Cablegate: Ethiopia: Exchange Rate Depreciation

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.

----------------------------------------
BIRR HOLDS MOSTLY STEADY FOR FIVE YEARS,
WITH OFFICIAL HELP
----------------------------------------

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.

--------------------------------------------- ---
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.

----------------------------------------
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

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