The deal will enable the two states to exchange principal in different currencies
Ethiopia and Sudan will sign a currency swap deal enabling them to use their currency in the territory of the other without currency convergence. For the three-year deal, the two sides will swap currencies worth 16 million dollars. The agreement will be the first in its kind while Sudan already has a similar deal with Egypt.
The swap, which will enable the two states to transact off-balance sheet exchanging principal and interest in different currencies, is expected to be signed soon, as the two countries have already reached an agreement after months-long negotiations.
The move is part of the government’s efforts to ease the severe shortage of foreign currency in the country, according to the National Bank of Ethiopia (NBE).
Upon the conclusion of the deal, Ethiopia can buy goods from Sudan in Birr and vice versa.
While swapping their currencies, the two countries exchange their principal but not in hands, and the exchange of the principal will have an interest rate. On the trade date, the counterparties exchange initial amounts in the two currencies.
During the term of the transaction, each country will pay interest periodically, in the same currency. On the maturity date, both sides will swap the initial principal amounts, reversing the first exchange at the same spot exchange rate.
The deal will enable the countries to escape exposure to foreign exchange rate fluctuation risk and reduce the cost of borrowing foreign currency. And also it can serve as a safety net when countries are hit by a currency crisis, according to financial experts.
Considering the persistent shortages of foreign currency due to ever-increasing current account deficit, signing the deal can serve as a protection, despite not being activated frequently when the need arises, according to Abdulmenan Mohammed, a financial expert.
Ethiopia is jumping to the deal in a time when foreign currency crunch reached its peak. In 2015/16 fiscal year, the international reserves of the country financed 2.6 months of the country’s import. Furthermore, during the first nine months of the recently ended fiscal year, the nation’s foreign currency reserve covered only the 2.3 months of the import bill.
For this deal, the central banks of the two countries have been negotiating four areas of cooperation: currency swap, cross-border trading, opening a branch of Commercial Bank of Ethiopia (CBE) in Sudan and investment cooperation, since last year.
Before that, the two countries signed a Memorandum of Understanding (MoU) in February 2016, and consequently, they formed a joint banking committee that will work on studying the applicability of the agreements and preparing the legal framework for the deals.
Before reaching an agreement, the respective executives visited both countries and had a discussion based on the MoU they have signed. In addition to currency swap, the two nations agreed to share experiences in areas of Islamic banking, Islamic microfinance and liquidity management.
To commence operations in Khartoum, Sudan, CBE is waiting for the license from the Central Bank of Sudan. Opening a branch of Sudanese bank will not work in Ethiopia’s context as the country’s financial law has closed its doors for foreign banks to operate in Ethiopia.
In 2009, CBE opened a branch in Juba, South Sudan, CBE-Southern Sudan Ltd with a paid up capital of 15 million dollars. CBE also has a branch in Djibouti.
During the negotiation, Ethiopian experts travelled to different countries such as China and India to share experiences, according to a source from the NBE.
Once the deal is signed, both sides will exchange their money via the central banks of the two countries at global exchange rates.
The country’s trade deficit has also been increasing year to year. The state spent 16.9 billion dollars on imports last year while generating only 2.9 billion dollars from exports, widening the trade gap to 14 billion dollars.
Sudan also advances on Ethiopia with a favourable trade balance. Sudan’s goods trade surplus with Ethiopia was one billion in the previous fiscal year, a decrease from 1.5 billion Br in 2015/16.
In the past fiscal year, Ethiopia exported 2.1 billion Br worth of goods to Sudan, which is 12.5pc lower than the preceding fiscal year. The same year, the country imported 3.9 billion Br of goods from Sudan.
From Ethiopia, Sudan largely imports pulses, coffee, spices, electricity and live animals. In return, Ethiopia imports Petroleum and packaged foods from Sudan.
Accounting for 3.2pc of Ethiopia’s export proceeds, Sudan is the third highest importer of Ethiopia’s goods next to Somalia and Djibouti. The share of Sudan from the total import bill of the country stood at 1.2pc.
“From the economic vantage point, it is dubious that Sudan is the right choice as persistent forex shortage has hit the country due to a current account deficit for some years,” said Abdulmenan.
International Monetary Fund (IMF) projects that the deficit will last beyond 2020.
“I believe that the currency swap deal is made to strengthen political ties between the two countries as the level of economic integration between Ethiopia and Sudan is minimal,” said Abdulmenan.
The deal may also have a risk at the time the maturity is reached; the floating interest rate would represent a bigger value than the whole purpose of the swap.