Ethiopia’s Currency Dilemma: Balancing IMF Agreement on a Precarious Edge
(Bloomberg) — International Monetary Fund officials are heading to Ethiopia, where the authorities face a tough decision needed to win a bailout that’s key to restructuring the nation’s debt: whether or not to allow its currency to weaken and risk triggering higher inflation and social instability.
An IMF mission to Addis Ababa is expected to take place “in the coming weeks,” the Washington-based lender said in an emailed response to questions. The visit follows meetings in October, when the IMF made “good progress” on how to support the nation’s economic program, it said.
The latest trip is on investors’ radars after a group of Ethiopia’s official creditors in November set a four-month deadline for the government to reach a preliminary deal with the fund, failing which they’ve threatened to nullify a debt-servicing suspension deal. That set the clock ticking on talks with the IMF and the currency reforms on which its funding is contingent.
The government has managed the birr’s value against the dollar for decades, and letting it slide would push up prices of fuel, fertilizer and other imports. The Ethiopian authorities are in talks with the IMF to borrow about $3.5 billion and a similar amount from the World Bank, Reuters reported last month.
Ethiopians are already contending with a surge in living costs, with consumer prices rising 29.2% in October. The currency officially trades at about 56 per dollar, almost double its value on the parallel market, where a dollar buys 113 birr.
The government needs to consider a staged approach to devaluing the currency to avoid sharp inflationary shocks, said Irmgard Erasmus, economist at Oxford Economics Africa.
“It’s really a knife’s-edge situation,” she said by phone, adding that foreign-exchange reforms will form a key part of negotiations between the IMF and Prime Minister Abiy Ahmed’s administration. “There will need to be concessions on both sides. This is a very politically sensitive challenge.”
Allowing a 12% to 13% depreciation in the birr this quarter would show the IMF the government is acting in good faith, and a slightly greater weakening may be permitted in the following three months, Erasmus said. While Erasmus sees it more likely than not that Ethiopia will reach a staff-level deal with the fund this quarter, Fitch Ratings said Dec. 27 this may prove “optimistic.”
Ethiopia’s dollar bonds, which fall due in December, have rallied since the government said last month it proposed a restructuring that would avoid capital losses for bondholders in return for a lower coupon and extended maturities. The price of the 2024 bond has risen to the highest since Aug. 7 at 68.83 cents on the dollar.
Net-present value reductions using the IMF’s 5% discount rate would be in the single digits under that plan. That compares to an about 40% cut Zambia agreed to with its bondholders under a preliminary deal that ultimately fell through.
“If the IMF deal happens within a reasonable time frame we obviously then need to see exactly what stance official creditors take and then to see the extent to which the guidelines the government has already suggested on the Eurobond will be improved or maintained,” said Nick Eisinger, co-head of emerging markets active fixed income at Vanguard. “The country at this stage does not have a solvency challenge as such and instead one of liquidity – bonds might be worth in the region of high 60s to some where in the 70s. The longer this drags on the lower these recovery rates can be.”
Ethiopia needs an IMF program to proceed with a sovereign-debt restructuring under the Group of 20’s so-called Common Framework. The government, which defaulted on Dec. 25 on an interest payment for its $1 billion eurobond, hasn’t said how much of its liabilities it wants to rework.
The nation’s public sector external debt totaled $27.8 billion at the end of September, according to Finance Ministry data. The government has contracted an estimated $14.1 billion in debt from Chinese lenders, according to Boston University Global Development Policy Center.
Ethiopia isn’t the only African nation grappling with the fallout of currency depreciation. Malawi devalued it’s kwacha by 44% in November to win an IMF bailout, while Nigeria has let the naira trade more freely, which triggered a slump in its value.
In Egypt, Ethiopia’s northern neighbor, the IMF has called on the government to introduce a flexible exchange-rate system as further disbursements of a $3 billion package agreed to in 2022 are delayed. The inflation rate in Egypt has reached about 33.7% after previous rounds of currency devaluation, and there are expectations that the authorities will allow further weakening this quarter.