Ethiopia’s Precarious Economic Reforms

Addis Ababa’s main avenues are getting a facelift. The Ethiopian capital is adding maroon bike lanes, tree-lined verges, and new storefronts in regulation gray to its biggest streets. Prime Minister Abiy Ahmed has said that he wants the city to live up to the literal meaning of its name, “new flower,” to entice investors and tourists. He talks of parks and shopping malls, lighting and color schemes. Never mind the people pushed to the outskirts of town by redevelopment, their shops and homes deemed too unsightly to remain.

The changing cityscape is one sign of a broader economic reform package, Ethiopia’s most dramatic in a generation. On July 29, the Ethiopian central bank announced that it was floating its currency, the birr, which had previously tracked the dollar. The Ethiopian government is also opening up a swath of the economy to foreign competition and developing capital markets, and is loosening its grip on the financial sector.

These measures would be unremarkable in many countries. But in Ethiopia, they represent a departure from decades of state control. In an interview in August, Mamo Mihretu, a former World Bank official who now heads Ethiopia’s central bank, called the reform package a “transformative moment.” What he did not add is that it is also fraught with jeopardy.

Ethiopia’s recent history poses a question that troubles many African countries: How can you transform an agrarian economy into something more urban and productive against a backdrop of rapid population growth?

The Ethiopian People’s Revolutionary Democratic Front (EPRDF), a coalition of parties that fought its way to power in 1991, sought the answer in the form of state-led development and industrial policy. That approach showed some promise before it was eventually overwhelmed by social pressures from below. Economic transformation was fast enough to displace people as cities expanded and businesses grabbed farmland, but not fast enough to find jobs for them.

The result was a social crisis, refracted through the prism of ethnic politics, that threatened to devour the Ethiopian state itself. Years of roiling protests brought Abiy to power in 2018. He set about dismantling the position of a section of the elite, largely from the northern region of Tigray, who had dominated the state. A devastating war in Tigray followed. Although it ended in 2022, insurgencies continue in Amhara and in Abiy’s home region of Oromia, as Ethiopia’s centrifugal forces threaten to pull it apart.

The Tigray war and its fallout strained Ethiopia’s public finances, as did turbulence in the global economy. By 2022-23, the Ethiopian government was spending 37 percent of its budget on the military or on debt servicing. In December 2023, it defaulted on a bond payment to private creditors; the central bank’s international reserves covered just two weeks of imports. Ethiopia’s creditors insisted on a deal with the International Monetary Fund (IMF), which demanded market reforms. A $3.4 billion IMF package was announced on the same day the birr was floated in July.

Some close to Abiy also pushed reform from within. In economic policy, as in other areas, he repudiated the EPRDF regime from which he had emerged. He replaced the EPRDF with a new vehicle, the Prosperity Party, whose very name hinted at a new economic approach inspired by buoyant Pentecostalism and a self-help spirit. That meshed with the market reforms some of his advisors were advocating for.

“[Policymakers] were already thinking, ‘We need to do things differently’ back in 2018,” when Abiy took office, said Stefan Dercon, an economist at Oxford University whom Ethiopian officials used as a sounding board for ideas. “They looked up different ways to do it, but in the end they settled on the idea that [they] have to get the prices right.” In other words, the government would let more prices be determined by supply and demand.

Mamo, the central bank governor, underlined the same point. “This is our reform; we’ve spent years thinking about it,” he insisted.

Ethiopia’s totemic economic issue was the exchange rate. The birr had long tended toward overvaluation, a problem exacerbated by inflationary wartime spending. Before flotation, dollars were sold on the black market at twice the official price. Manufacturers of everything from cement to soft drinks were cutting output because they could not get the dollars to buy imported inputs.

The coffee sector was flooded with traders who exported at a loss so they could earn foreign currencies, according to people involved in Ethiopia’s coffee business. Foreign investors complained about rules that forced them to convert their dollars. “I have enough birr to sink a battleship,” said one exporter who spoke on the condition anonymity to protect his relationship with Ethiopian officials.

Observers long anticipated some kind of exchange rate adjustment. But they were still surprised when the government said it would let markets determine the exchange rate, rather than pursuing a managed devaluation.

“[At first] very few people understood what flotation means and how it would work,” said Ermias Eshetu, who sits on the board of Zemen Bank, a private bank in Ethiopia. Dollars remain in short supply as banks clear a backlog of requests.

The birr has lost more than half of its value against the dollar as the official and black-market rates converge. Initially, many Ethiopians worried that a tumbling currency, which makes imports more expensive, would cause domestic prices to rise. In preparation, the government tightened monetary policy, including restricting how much banks can lend. Mamo pointed out that most imports were already being priced at the black-market rate and that subsidies have been introduced for fuel and fertilizer, which were priced at the official rate.

In mid-August, Foreign Policy visited Merkato, the largest market in Addis Ababa. Uncertainty reigned. Many traders were still running down stock they had bought before the birr floated. They said they felt squeezed between wholesalers, who had hiked the price of imported goods, and government inspectors, who were arresting shopkeepers who put up their own prices.

“They are putting pressure on us, not the distributors,” said one woman who spoke on the condition of anonymity for fear that she, too, would run into problems with the authorities. By October, year-on-year inflation in Ethiopia stood at 16 percent, its lowest rate for several years.

Exporters hope a weaker birr will make their exports more competitive. “This is what we were crying for,” said Israel Degfa, the president of Kerchanshe Trading, one of Ethiopia’s largest coffee producers and exporters. He likened the old policy of overvaluation to “tying up our legs and telling us to run.” But many manufacturers rely on imported machinery and inputs, so they may not see much benefit overall.

Meanwhile the government is making a renewed push for other reforms, such as loosening “financial repression,” a nexus of regulations that squeezes savers and channels cheap credit to public projects. The central bank has promised to phase out a rule that requires banks to purchase government bonds at below-market rates. It will allow real interest rates to rise and is ceasing direct advances to the Treasury. In October, the national investment fund announced the sale of shares in 10 percent of Ethio Telecom, a state-run giant, as part of plans to establish Ethiopia’s first securities exchange.

The government is also letting foreigners do all sorts of things they could not do previously, such as own property, buy coffee directly from farmers, and take stakes in banks, and run supermarkets and telecoms companies.

But investment may be slow to materialize. “Foreign investors have been burnt in Ethiopia time and again,” said one with experience in the country who requested anonymity to speak candidly. Meanwhile, many Ethiopians worry, with good reason, about handing over profitable assets to foreigners when the country is still in an early stage of development.

The effects of insecurity in Ethiopia make the details of reform somewhat moot. There are kidnappings, massacres, and drone strikes as the army continues to fight rebels. The fledgling apparel sector has floundered since the United States withdrew duty-free access to its markets in 2022, citing “gross violations” of human rights by the Ethiopian government.

Flower farms in the troubled Amhara region have been looted and burned. Sesame, another important export, is grown in areas where regional militias vie for control. Disruptions to farming, transport, and seasonal labor migration are one reason 16 million Ethiopians need food assistance, according to United Nations estimates. More than 4 million people have been driven from their homes.

If inflation eventually accelerates, that would make matters worse, adding to the material pressures that help push young men into militias. Economic reform could also intensify the struggle between regional business elites, adding fuel to political fires.

Above all, Abiy must confront the same gnarly problem of economic transformation that preoccupied his predecessors. He is trying to steer the country’s focus away from state-led industrialization and toward sectors such as tourism, mining, and information technology. But it is unclear how doing so will provide work for people; opening the economy is not in itself an answer. The kinds of IMF-inspired reforms pursued over recent decades in other parts of Africa have not moved countries up the industrial ladder or created enough good jobs.

Abiy hopes he can impress investors with gleaming streets and plush resorts. That is an aesthetic vision, not an economic model. It says little to the thousands of Ethiopians who have been evicted on short notice to make way for bike lanes—or the millions of others worried about where their next meal is coming from.

Prices are up and work is down, said one market porter in Addis Ababa, slumped on an old tire after a morning spent lugging sacks of grain. “I’m just praying for God to save me.”