Liberalization of Ethiopia’s Foreign Exchange Market 

On 29 July 2024, the National Bank of Ethiopia (NBE) unveiled the Foreign Exchange Directive No. FXD/01/2024 (“New FX Directive”), marking a historic shift in Ethiopia's foreign exchange regulatory landscape. This directive repeals all previous foreign exchange directives and circulars issued by the NBE, introducing a new, consolidated legal framework to regulate the country's foreign exchange system. 

Most notably, the New FX Directive liberalizes Ethiopia’s foreign exchange regime by introducing a competitive, market-based exchange system. Banks and foreign exchange dealers can now freely buy and sell foreign currencies at negotiated market rates. The directive also addresses a wide range of foreign exchange-related activities, including exchange rate determination, foreign exchange retention, exports, imports, services, remittances, payment instruments, foreign currency accounts, capital account transactions, repatriation of profits and dividends, and other miscellaneous items.

In this edition of our insights piece, we highlight key aspects of the New FX Directive and the subsequent guidelines and circulars issued by the NBE.

Key Highlights 

Introduction of a Market-Based Exchange Regime 

Ethiopia’s foreign exchange regime has been tightly controlled and regulated by the NBE for decades. Foreign currencies were bought and sold at rates determined by the NBE. In the past, the NBE fixed the daily buying price of currencies for all commercial banks, while banks determined the daily selling price, which had to be higher or equivalent to the daily buying price set by the NBE.

The New FX Directive shifts the former system to an open and competitive foreign exchange market. Banks and authorized foreign exchange dealers are now permitted to buy and sell foreign currencies from/to their clients and among themselves at freely negotiated rates. For the first time, the directive also allows non-bank entities to operate in the foreign exchange market with prior authorization from the NBE.

The directive has established two levels of spot foreign exchange markets, where settlement from both parties is made within two working days (T+2) after the conclusion of the transaction:

1. Wholesale/Inter-bank forex market – a forex market where foreign currency transactions between authorized banks are conducted. Banks will operate in this market by submitting quotes for other banks. Banks are not permitted to charge any fees or commissions on foreign exchange market transactions. Instead, all costs associated with these transactions will be reflected in the spread between the buying and selling prices.
2. Retail forex market – a forex market where foreign currency transactions between authorized banks/foreign exchange dealers and their customers are conducted. Banks are allowed to conduct their buying and selling transactions based on freely negotiated rates with their customers.

To facilitate the free buying and selling of forex in the market, the directive outlines the roles and responsibilities of various market participants, including banks and independent foreign exchange bureaus.  

The New FX Directive further provides that the determination of foreign exchange rates by banks and authorized foreign exchange dealers should be guided by the following principles:  

• The free negotiation of rates between the parties to the forex transaction.
• The reporting of the exchange rates used by the banks to the NBE daily.
• The publication of daily indicative exchange rates by the NBE based on the daily reports obtained from the banks and foreign exchange dealers.
• The use of the indicative exchange rates published by the NBE as a reference price (and not mandatory transaction price) for banks and foreign exchange dealers in their foreign exchange transactions.

These principles represent a significant change in Ethiopia's foreign exchange regulation. The NBE's regulatory role has shifted from strictly dictating foreign exchange policies to embracing a more hands-off approach where commercial banks and their customers have a bigger say in the conduct of the forex transaction. 

Additionally, the directive introduced the entry of non-bank entities, referred to as independent foreign exchange bureaus, to participate in the foreign exchange market. These bureaus are required to be licensed by the NBE and may only undertake the buying and selling of foreign exchange cash notes. They are prohibited from engaging in any banking activities. The directive provides detailed eligibility, licensing and compliance requirements that must be met for independent foreign exchange bureaus to be licensed by the NBE. 

Elimination of Priority Listing in Forex Allocation 

The market-based exchange system introduced by the New FX Directive has eliminated the previously practised foreign exchange rationing system. Under the former system, NBE directives mandated foreign currency allocation based on a priority list (priority 1, 2, and 3). Banks were required to allocate at least 50% of their total foreign currency reserves for the import of goods and services according to this list. Payments for the importation of goods such as pharmaceuticals, LPG, fertilizer, and dividend payments were included in the priority list. For other types of payments, such as external debt repayments, banks had to use a first-come, first-served approach.

The New FX Directive abolishes the priority listing system. Foreign investors can now access foreign currency on demand to undertake imports, repatriate payments for profits and dividends, proceeds from liquidation and share transfers, profits from portfolio investments in equity or debt securities, or return of investment if unable to start operations.

Elimination of Forex Surrender Requirements, New Forex Conversion and Retention Rules

Under previous NBE directives, commercial banks were required to surrender a portion of the forex generated from exports and inward remittances to the NBE. The New FX Directive has removed this obligation. However, a mandatory conversion is now instituted. Exporters of goods and services (“Exporters”) are now required to convert, immediately and at freely negotiated rates, 50% of the forex generated to the commercial banks processing their forex transactions (“Conversion Requirement”).

Exporters may retain the remaining 50% of the forex in their forex retention accounts, a 10% increase from the previously allowed retention amount of 40%. However, while Exporters were previously allowed to retain forex in their accounts indefinitely, the New FX Directive stipulates that foreign currency in retention accounts must be sold to the transacting bank at a freely negotiated rate after no more than 30 calendar days (“Sale Requirement”). In other words, the 50% forex retained in the retention account must be used, sold, or converted within a 30-day window.  

The directive indicates that the Sale Requirement is a temporary measure intended to support the development of the interbank foreign exchange market. It is not yet clear how long this measure will be in place, nor whether the Sale Requirement applies to foreign currency already existing in retention accounts. The directive mandates the NBE to modify the Conversion and Sale Requirements periodically. Depending on how the market evolves, we anticipate that the NBE will use this mandate to make the necessary and timely revisions.

Exemption from Conversion Requirements 

Previously, recipients of inward remittances and NGO transfers were permitted to open retention accounts and maintain a portion of the forex received. Similar to exporters of goods and services, inward remittances and NGO transfers were subject to a surrender requirement to the NBE, albeit at a higher rate of 70%.

The New FX Directive has removed inward remittances and NGO transfers from the category of eligible retention account holders. Instead, NGOs are now eligible to open Foreign Currency Accounts and retain 100% of the forex received from external sources. This is a significant change for remittance recipients, increasing their retention amounts from 20% to 100%.

Additionally, the New FX Directive expressly exempts the following categories of incoming forex from the new Conversion Requirements.

1. Foreign Direct Investment inflows
2. Foreign Grants
3. All FCY accounts
4. External Loans and
5. Portfolio inflows
6. Export earnings by investors in Special Economic Zones.

The exemption of foreign grants from the Conversion Requirement is a major adjustment that addresses a longstanding challenge faced by local companies eligible for foreign grants from various international financial and non-profit institutions. Previously, foreign grants were considered inward remittances and subject to retention rules, allowing companies to retain only 20% of the foreign exchange. 

Repatriation of Funds for Foreign Investments 

Under the Investment Proclamation No. 1180/2020 (Investment Proclamation), the rights of investors to repatriate, among others, profits and dividends earned from the investment made into the country is expressly recognized. The New FX Directive recognizes the rights of foreign investors to repatriate the following payments in convertible currency: 

• Profit and Dividends accruing from investment;
• Proceeds from the sale of liquidation of an enterprise and
• Proceeds from the transfer of shares or ownership of an enterprise
• Return back of investment if unable to start operation
• Profits from portfolio investment in equity securities or debt securities

The list provided in the directive offers broader recognition for the repatriation of funds than what is provided under the Investment Proclamation. Investments that have failed to commence operations may now repatriate their initial funds. Furthermore, the directive includes new investment schemes (debt and equity securities) introduced by the Capital Market Proclamation 1248/2021, allowing them to benefit from repatriation rights.

Documentary requirements must be fulfilled when applying for the repatriation of funds for each category of payments listed above. The directive explicitly states that the NBE shall not deny any request for repatriation of profits and dividends, provided the requirements are met.

The New FX Directive offers special provisions to address a backlog of outstanding requests for repatriation of profits and dividends. Dividend repatriation requests that have not yet been effected will be handled through a special repayment schedule. This schedule will only apply to profits and dividends that were approved by the NBE before the enactment of the New FX Directive.

Foreign Currency Accounts (FCY)

The New FX Directive has made amendments and simplified the type of foreign currency accounts that can be opened and operated in Ethiopia.  

1. FCY Account for Foreign Entities – FDI companies, International Organizations, Embassies, and Foreign NGOs and their foreign individual employees are allowed to open FCY Accounts. FCY accounts may be opened at more than one bank and credited with a) Foreign currency coming from abroad b) Payments by Ethiopian residents under NBE authorization and c) Payments from other non-resident foreign currency accounts. Holders of this account may use the foreign currency for all foreign payments without any restriction.
2. FCY Accounts for Resident and Non-Resident Ethiopians and Ethiopian Diaspora – Ethiopians, NGOs receiving foreign grants, non-resident Ethiopian individuals, and persons of Ethiopian origin (Ethiopian Diaspora) may open an FCY account. Although an explicit mention of Ethiopian companies is missing, the requirements and conditions to open FCY accounts for resident Ethiopians indicate that businesses may open this account by submitting their Memorandum/Articles of Association or formal registration. However, it remains to be seen whether Ethiopian companies that receive foreign currency through means other than export will be allowed to open FCY accounts. Among other things, holders of this account are allowed to make foreign service payments upon presentation of underlying invoices.
3. Retention Accounts – Exporters of goods and services are eligible to open retention accounts, allowing a portion of their export proceeds to be retained in foreign currency. The account holder may utilize the foreign currency exclusively for their own use and can make payments for all current account transactions of the same legal entity, including payments for imports of goods, services, dividends, and external debt service repayments. Investors in the special economic zones (SEZs) or industrial parks may use forex from their retention account to buy or sale inputs or raw materials from investors within the same or other industrial parks and SEZs.
4. Offshore Accounts: The New FX Directive maintains all the provisions of Directive No. FXD/86/2023 that regulated the opening and operation of offshore forex accounts for specific strategic investors in the PPP, Mining and infrastructure sectors. Except for those strategic investors permitted by NBE, Ethiopian nationals (natural or juridical) residing in Ethiopia are not permitted to own, possess or operate foreign currency accounts abroad without the explicit authorization of the NBE.

One of the new developments under the New FX Directive is the permission to transfer FX from one local FX account to another. Investors within industrial parks are allowed to trade raw materials or inputs or manufactured products in foreign currency amongst themselves, via debt or credit from their local FX retention account or FX account. Additionally, these investors are allowed to pay their foreign employees in foreign currency directly from their FX retention account or FX account.  

New Rules on External Loans and Supplier's Credit Schemes 

The New FX Directive provides new rules on eligibility and procedures for obtaining external loans and suppliers’ credits. While many of the previous documentary and approval procedures are maintained, the directive introduces the following: 

1. Expanded list of Eligible borrowers: Previously, only exporters, foreign investors, domestic manufacturers, and importers of agricultural machines or inputs were eligible to obtain foreign loans or supplier credits. The New FX Directive has now expanded this list to include companies in the construction sector to benefit from the supplier's credit scheme. Construction machinery such as graders, loaders, excavators, and road-construction-related machinery, as well as bitumen used for construction projects, may now be imported through suppliers’ credit.
2. Elimination of the cap on interest rates for foreign loans –   in the past, external loans and supplier credit schemes were subject to a maximum all-in-cost ceiling (rate of interest, other fees, and expenses). For instance, prior directives of the NBE capped a USD-denominated loan with an average maturity period of more than five years at a maximum all-in-cost ceiling of six months SOF plus 5%. The New FX Directive has eliminated this cap, allowing interest rates to be freely negotiated between the parties. However, the NBE retains the power to review the draft loan agreement, which must include the interest rate and other charges, before granting approval or disapproval of the loan agreement.

Participation of foreign investors in Ethiopia's equity and bond market 

The New FX Directive includes provisions regulating the entry and participation of foreign investors in Ethiopia's equity and bond markets. With the recent introduction of capital markets in Ethiopia, there was a lack of clarity on how foreign investors (excluding FDI) could participate in the equity or bond market with the upcoming launch of the Ethiopian Securities Exchange. The uncertainty stemmed from the strict requirements under the Investment Proclamation and Investment Regulation regarding sector regulation, minimum capital requirements, registration, and profit repatriation.

The New FX Directive clarifies that foreign investors will be allowed to participate in the Ethiopian capital market. However, participation in the equity or bond market may only be conducted through the Ethiopian Securities Exchange or another licensed exchange. Detailed rules regarding maximum ownership in a given security, limitations based on the type of institutions, source of funding, track record of the investor, and adherence to the minimum-security holding period will be established by the NBE and the Ethiopian Capital Market Authority at a future date. 

Conclusion  

Considering the highly controlled foreign exchange monitoring and regulation system that has been in place for over five decades, the New FX Directive represents a radical policy shift for Ethiopia. From the full liberalization of the forex regime to the removal of stringent regulatory requirements on the inflow and outflow of forex, Ethiopia is entering uncharted territory. The new rules will impact various aspects of doing business in Ethiopia.  As the directive takes effect, new markets and practices will evolve. We anticipate the emergence of new regulations from the NBE and other sectors, such as tax, to accommodate the changes.  

For more information: contact Mekdes Mezgebu mekdes@mekdesmezgebu.com and Maya Misikir maya@mekdesmezgebu.com