written By: Samson Tsedeke
On 29 July 2024, Ethiopia experienced a pivotal transformation in its foreign exchange policy landscape as the National Bank of Ethiopia (NBE) issued the Foreign Exchange Directive No. FXD/01/2024 (“New FX Directive”). This directive supersedes all prior foreign exchange directives and circulars, establishing a unified regulatory framework governing the nation’s foreign exchange operations.
A key feature of the New FX Directive is the liberalization of Ethiopia’s foreign exchange system, transitioning to a competitive market-driven exchange mechanism. Under this new system, banks and foreign exchange dealers are empowered to trade foreign currencies at market-driven rates through negotiations. The directive comprehensively covers various aspects of foreign exchange operations, including rate setting, currency retention, and transactions related to exports, imports, services, remittances, payment instruments, foreign currency accounts, capital account dealings, and the repatriation of profits and dividends.
This insights piece delves into the essential elements of the New FX Directive along with the latest guidelines and circulars from the NBE.
Market-Based Exchange Regime Introduction
For many years, Ethiopia’s foreign exchange was under stringent regulation by the NBE, with currency buying and selling rates being centrally determined. Previously, the NBE set the daily purchase rates for currencies, while commercial banks established the daily selling rates, which could not be lower than the NBE’s buying rate.
The introduction of the New FX Directive marks a significant shift to a liberalized foreign exchange market where banks and certified foreign exchange dealers can set their buying and selling rates through free negotiation. Notably, the directive allows, for the first time, the participation of non-bank entities in the foreign exchange market, subject to prior approval from the NBE.
The directive delineates two main tiers of spot foreign exchange markets with a two-working-day settlement period (T+2) post-transaction:
- Wholesale/Inter-bank Forex Market: This is a marketplace for foreign currency transactions among authorized banks, where banks provide quotes to each other. In this market, banks are prohibited from imposing fees or commissions. All transaction costs are incorporated into the spread between the buying and selling prices.
- Retail Forex Market: This market facilitates transactions between authorized banks/foreign exchange dealers and their clients, with rates negotiated freely.
The directive outlines the responsibilities of market participants, including banks and independent foreign exchange bureaus, to ensure a smooth operation of buying and selling forex.
Principles for Exchange Rate Determination
The directive stipulates that the determination of exchange rates by banks and authorized dealers should adhere to several principles:
- Freely negotiated rates between transaction parties.
- Daily reporting of transaction rates by banks to the NBE.
- Daily publication of indicative exchange rates by the NBE, which are derived from bank reports.
- Use of NBE’s indicative rates as reference prices in forex transactions, although not as mandatory transaction prices.
These changes mark a significant departure from previous regulatory practices, with the NBE moving from a directive role to a more facilitative approach in forex transactions, giving more autonomy to banks and their customers.
Moreover, the directive allows the entry of independent foreign exchange bureaus into the market. These bureaus must obtain a license from the NBE and can engage only in the buying and selling of forex cash notes, barred from conducting banking operations. The directive specifies the criteria for eligibility, licensing, and compliance for these bureaus to operate legally.
This comprehensive reform aims to enhance the efficiency and flexibility of Ethiopia’s foreign exchange market, fostering a more dynamic economic environment.
Elimination of Priority Listing in Forex Allocation
The introduction of the market-based exchange system by the New FX Directive has led to the abolition of the former foreign exchange rationing system, which was regulated by the National Bank of Ethiopia (NBE). Previously, banks were mandated to allocate at least 50% of their total foreign currency reserves based on a priority list for the import of crucial goods and services, including pharmaceuticals, LPG, and fertilizers. Payments for such imports and for dividend remittances were categorized within this priority structure, while other payments, like external debt repayments, were handled on a first-come, first-served basis.
With the implementation of the New FX Directive, the priority listing system is discontinued. Foreign investors now have the flexibility to access foreign currency on demand for various purposes including imports, repatriation of profits and dividends, and proceeds from share transfers or liquidation, enhancing the operational fluidity for foreign investments and financial transactions.
Elimination of Forex Surrender Requirements, New Forex Conversion and Retention Rules
Under previous directives, commercial banks were compelled to surrender a portion of the forex obtained from exports and inward remittances to the NBE. The New FX Directive eliminates this requirement, introducing a mandatory conversion rule instead. Exporters must now convert 50% of their forex earnings at market-driven rates immediately upon receipt through their transacting banks, known as the Conversion Requirement.
Exporters can retain the remaining 50% in their forex accounts, an increase from the previous 40% retention limit. However, the New FX Directive imposes a new stipulation that retained forex must be sold or converted within a 30-day period, termed the Sale Requirement. This measure aims to bolster the development of the interbank forex market, though its duration and applicability to existing forex in retention accounts remain unspecified. The NBE retains the authority to adjust these requirements based on market conditions.
Exemption from Conversion Requirements
The New FX Directive removes inward remittances and NGO transfers from the category of eligible retention account holders, allowing NGOs to open Foreign Currency Accounts (FCY) and retain 100% of received forex. This marks a significant enhancement for recipients, increasing their retention capacity from previously allowed percentages. Additionally, categories such as Foreign Direct Investments, foreign grants, external loans, and portfolio inflows are explicitly exempted from the new conversion mandates. This exemption, especially for foreign grants, resolves challenges faced by local entities eligible for such funds, enhancing their financial management capabilities.
Repatriation of Funds for Foreign Investments
The directive recognizes and broadens the rights for repatriation of various financial returns for foreign investors under the Investment Proclamation No. 1180/2020. It covers profits, dividends, proceeds from enterprise liquidation or share transfers, and returns on investments that haven’t commenced operations. New investment mechanisms like debt and equity securities introduced by the Capital Market Proclamation 1248/2021 are also included, facilitating broader investment opportunities and financial repatriation under more streamlined and clear regulatory provisions.
Foreign Currency Accounts (FCY)
Significant revisions have been made to the FCY account structures under the New FX Directive. These accounts are now accessible to a wider range of entities including FDI companies, international organizations, and the Ethiopian diaspora, with fewer restrictions on the sources and uses of the foreign currency. Moreover, special provisions have been established for exporters and investors in Special Economic Zones, allowing them greater flexibility in managing forex for various operational needs.
Offshore Accounts and New Developments
The New FX Directive maintains the existing framework set by Directive No. FXD/86/2023 for the operation of offshore forex accounts by specific strategic investors in sectors such as Public-Private Partnerships (PPPs), Mining, and Infrastructure. However, other Ethiopian nationals residing within the country are restricted from holding foreign currency accounts abroad without explicit authorization from the NBE. This measure ensures control over foreign exchange but provides strategic flexibilities for significant sectors that are critical to national development.
One innovative aspect of the New FX Directive is the facilitation of foreign currency transactions within local markets. Investors operating within industrial parks are now permitted to trade raw materials, inputs, or manufactured products among themselves using foreign currency. This is made possible through transfers from their local FX retention accounts or FX accounts. Additionally, these investors can directly pay their foreign employees in foreign currency from their FX accounts, enhancing operational efficiency and financial fluidity within these zones.
New Rules on External Loans and Supplier’s Credit Schemes
The directive revises the eligibility and procedures for acquiring external loans and suppliers’ credits. While it retains many of the previous documentation and approval requirements, it significantly broadens the list of eligible borrowers to include the construction sector. This expansion allows companies engaged in importing crucial construction machinery and materials like graders, loaders, and bitumen to benefit from suppliers’ credit schemes, facilitating growth and development in infrastructure projects.
Furthermore, the directive removes the previous cap on interest rates for foreign loans, allowing rates to be negotiated freely between parties. The NBE will continue to review loan agreements, focusing on the stipulated interest rates and other charges, ensuring that these terms meet regulatory standards and fairness.
Participation of Foreign Investors in Ethiopia’s Equity and Bond Market
The New FX Directive also addresses the participation of foreign investors in Ethiopia’s burgeoning equity and bond markets. With the upcoming launch of the Ethiopian Securities Exchange, the directive clarifies that foreign investment in these markets is permitted, though it must be conducted through licensed exchanges. The NBE and the Ethiopian Capital Market Authority are expected to issue detailed regulations concerning ownership limits, investment types, funding sources, investor track records, and security holding periods, providing clarity and governance to ensure a stable and transparent market environment.
Conclusion
The New FX Directive signifies a transformative shift in Ethiopia’s approach to foreign exchange management. By liberalizing forex transactions and broadening the spectrum of financial operations and investment opportunities, it aims to enhance economic dynamism and attract more foreign investment. The changes introduced are likely to prompt further regulatory adjustments in other sectors, including taxation and corporate governance, to align with the new forex regime. As these developments unfold, the business landscape in Ethiopia is set to evolve, offering new opportunities and challenges for domestic and international stakeholders. (samsonTsedeke, samson@multilinkconsult.com)