BANKS ETHIOPIA  |  ANALYSIS

Three Bets on the Birr: Can Ethiopia’s Forex Ambitions Hold?

The Ministry of Finance is forecasting currency stability, a narrowing parallel premium, and a functioning interbank market — all by the start of the new fiscal year. The case is coherent on paper. The stress points are significant.

When Finance Minister Ahmed Shide presented Ethiopia’s proposed 2026/27 federal budget to Parliament last week, the macroeconomic picture he painted was, on balance, optimistic. Growth is projected at 9.8 percent, driven by double-digit expansion in industry. The birr, he indicated, is expected to stabilize. The gap between the official and parallel foreign exchange markets — long a symbol of structural dysfunction — is narrowing. And a sweeping set of reforms to the country’s foreign exchange architecture is already underway.

The government’s confidence is not unfounded. Significant legislative and institutional work has been done in a short window. But three of its central claims — birr stabilization, premium convergence, and reform operationalization — each rest on assumptions that deserve scrutiny. And crucially, these bets are interdependent: if one fails to materialize, it creates headwinds for the others.

The Case the Government Is Making

The reform architecture assembled over the past twelve months is substantive. Directive FXD/04/2026 represents one of the most far-reaching overhauls of Ethiopia’s foreign exchange regime in decades. It eliminates longstanding exchange restrictions, authorizes banks to issue internationally recognized foreign currency payment cards, removes the minimum balance requirement for foreign currency savings accounts, and extends full retention rights to service exporters and firms operating in Special Economic Zones. The more recent FXD/05/2026 takes a further step by transferring authority to approve deferred import transactions — Letters of Credit and Cash Against Documents — from the National Bank of Ethiopia (NBE) directly to commercial banks.

The logic behind these moves is clear: decentralize foreign exchange decision-making, bring informal transactions into formal channels, reduce bureaucratic friction, and let market signals do more of the work. Officials argue these measures are already compressing the parallel premium, with the NBE placing the gap at below eleven percent. An interbank foreign exchange market, launched formally in January on infrastructure provided by the Ethiopian Securities Exchange, is meant to reinforce this trend by enabling real-time, transparent pricing among major financial institutions.

Stress Test One: Birr Stabilization

The stabilization forecast is where the tension between official narrative and observable data is sharpest. Independent market tracking puts birr depreciation over the past year — from May 2025 to May 2026 — at between 17 and 20 percent depending on the benchmark: 17.3 percent at the Commercial Bank of Ethiopia, 18.6 percent on NBE auction weighted averages, and as high as 19.5 percent at private banks. The government’s own source document cites at least fifteen percent, but the actual trajectory runs steeper. Against this backdrop, projecting stabilization requires the government to be right about a constellation of variables simultaneously: global energy prices must not worsen further, Gulf tensions must ease, import demand must moderate, and the reform measures must begin generating meaningful inflows into formal foreign exchange channels.

The import bill makes this especially difficult. Ethiopia is projected to import USD 25.8 billion in goods in 2026/27, with fuel alone accounting for approximately USD 6 billion of that. During the first ten months of the current fiscal year, USD 18.4 billion was already allocated for imports — an eighteen percent year-on-year increase. The government attributes much of this to Middle Eastern conflict driving up energy costs, a factor it acknowledges has been considered in its forecasts. But the Persian Gulf is not a variable Ethiopia can model away: the parallel market has already seen renewed pressure, with rates reportedly strengthening by as much as three percent in recent weeks as regional tensions escalated. A birr that depreciated close to twenty percent under the current reform environment does not stabilize automatically just because more directives are in place.

Stress Test Two: The Parallel Premium

The premium gap is where the credibility of the official data is itself in question. NBE officials place the parallel market premium below eleven percent. Independent market data and analyst estimates put it at fifteen to twenty percent as of mid-2026, with the parallel rate quoted at around 178 birr to the dollar against an official bank average in the 160 range. That divergence is not a rounding error — it is a substantive disagreement about the state of the reform program’s most visible benchmark.

The IMF’s own track record on this point is instructive. Its Country Report No. 25/189 noted that following the July 2024 liberalization, the parallel premium initially collapsed from over one hundred percent to near zero — before widening again to around seventeen percent by May 2025. The IMF’s latest review acknowledges the measurement problem implicitly, noting that the NBE will develop new indicators and benchmarks to assess forex market progress, including the size and persistence of the parallel premium, interbank trading volumes, and banks’ net open positions. The fact that these metrics are still being developed — rather than already in use — suggests that current assessments of the premium gap are operating without the data infrastructure needed to be definitive. What is measured determines what is managed.

Stress Test Three: The Reform Architecture

The interbank foreign exchange market is the structural linchpin of Ethiopia’s forex reform program — and its performance to date is, by official admission, unclear. The NBE is currently developing a roadmap to deepen the market, and the electronic interdealer trading platform that would enable anonymous, real-time trading among major financial institutions is a key structural benchmark that has yet to be operationalized. The central bank aims to have it running in the first quarter of 2026/27. Settlement system upgrades that would allow domestic settlement of interbank forex transactions are also still underway.

This matters because the premium convergence thesis depends, to a meaningful degree, on the interbank market generating transparent, competitive pricing that informal market participants find credible enough to migrate toward. A market whose performance is unclear, trading on infrastructure that is still being configured, cannot yet play that role at scale. The reforms are directionally right — economists broadly agree that decentralizing forex decision-making to commercial banks and relaxing surrender requirements are appropriate steps — but the timeline is compressed, and the execution risk is real.

What Is at Stake If It Does Not Hold

The consequences of underperformance on any of these three bets compound quickly. Ethiopia is carrying a heavy debt service burden into the new fiscal year: 293 billion birr — approximately USD 1.8 billion — is earmarked for external debt obligations, representing 12.5 percent of the proposed budget. Domestic debt service adds a further 249 billion birr. The government is nearing the final stages of external debt restructuring negotiations, which provide some near-term relief, but the structural pressure on foreign exchange reserves remains acute.

There is also a material cost already on the books. The NBE has reported a USD 2.6 billion loss attributable to the forex reform program — a direct consequence of the balance sheet exposure created by moving to a market-determined exchange rate. In response, the central bank has imposed a new foreign exchange exposure limit of plus or minus eighteen percent of Tier 1 capital on banks. This is a significant constraint: it limits the flexibility of commercial banks to hold open forex positions, potentially dampening the depth of the interbank market the NBE is simultaneously trying to develop.

If the birr continues to depreciate at or near its current trajectory, the birr cost of external debt servicing rises automatically, squeezing fiscal space. If the parallel premium does not compress, the reforms lose a key credibility metric — both for domestic business confidence and for the IMF program, which has another twenty-four months to run and which underpins access to concessional financing. And if the interbank market fails to gain traction before the surrender requirement liberalization proceeds, the risk is that reducing exporter obligations accelerates outflows into informal channels rather than deepening the formal market. There is also a sectoral dimension: the projected USD 6 billion fuel import bill feeds directly into transport and logistics costs across the economy, with a clear transmission mechanism into already-elevated inflation if forex access tightens.

A Reform Program in a Race Against Its Own Timeline

None of this amounts to a verdict that the government’s projections are wrong. The reforms undertaken since July 2024 are substantive, and the direction of travel — toward a more market-oriented, decentralized, and transparent foreign exchange regime — is the right one. The alignment with IMF conditionalities provides both discipline and external validation. The balance of payments has recorded a surplus during the current fiscal year, driven by improvements in coffee and gold exports, private transfers, and net service trade — a genuine positive signal.

What the data does not yet support is confidence that the pace of institutional delivery will match the ambition of the targets. Stabilization is possible — but it requires a cooperative external environment that is not guaranteed. Premium convergence is achievable — but the measurement tools to confirm it are still being built, and the most recent independent data puts the gap considerably wider than official figures suggest. The interbank market can become the spine of a functioning forex system — but not before it has demonstrated actual performance, and not while the NBE’s own exposure limits are constraining banks’ ability to trade freely within it. The government is making three interdependent bets on a timeline it does not fully control. The new fiscal year will show how many of them pay off.

source: Capital Ethiopia