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Published On  Feb 12,  2012
   
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An unofficial dollarisation of Ethiopia’s economy is underway, judging by how landlords across the capital value their assets, discovers Mahlet Mesfin, Fortune Staff Writer. Yet, there is no authority to pronounce the emerging practice legal or not.

 

Dollarisation of Ethiopia’s Economy Just Arrives

The cost of renting a house in Ethiopia especially for large size homes, with four or more bedrooms increased by 20pc on average for the last three years, according to Central Statistics Authority (CSA). This increment contributed for the rise of   inflation rate as rents together with construction materials, fuel, and power make up 15.4pc of the overall inflation index in Ethiopia.

A casual trek along Namibia Street, between Atlas Hotel and the Ring Road, reveals how much this neighbourhood has changed from an upscale residential area into a budding business district, within a mere decade. On both sides of the road, which Chinese construction firms managed to complete in 90 days, are businesses from hotels to kids’ stores, from liquor stores to night clubs, from restaurants to cinemas, and from shopping malls to banks.

Rental fees in this neighbourhood are known to be some of the highest in the city. One woman, a mother of three, has a one-storey modern villa up for rent. Lying on a 500sqm plot alongside the main road near the branch office of ethio telecom, a.k.a. Tele Bole, the villa incorporates four bedrooms, a large living room (with a dining room extension) as well as three bathrooms. It also takes pride in having a modest garden and service quarters behind the main house.

Previously rented out to foreigners paying the 64,000 Br monthly rent in euros, this typical house of the neighbourhood is again available for rent. But, the landlady, whose identity Fortune is keeping anonymous do to approaching her undercover, has a special request, should a prospective tenant agree to rent the house.

Not only ought the tenant pay the rental fees in advance for a year, which has become a common practice among the majority of upscale landlords across the city, the rental contract has a provision that explicitly states the rent amount in dollars, instead of in the country’s legal tender, Birr.

Hoping to rent it out for 4,000 dollars, the landlady plans to pay the us college fees of her two children. Neither was she willing to let this amount, incorporated in the rental agreement, be authenticated with the Documents Authentication & Registration Office (DARO), for fear of letting the tax authorities know about the true nature of the transactions.

Her interest in setting the rental fees in foreign currency is an emerging trend among homeowners and real estate companies, who prefer to quote prices in dollars and euros, hoping to fend off potential losses due to sudden changes in the foreign currency regime of the Birr. Even though many of them still use Birr as the currency of their transactions, they avoid using the actual value of the local currency. When contracts are drafted, prices are set mostly in dollars to be paid periodically in Birr, using the exchange rate on the day of payment.

Though this may not be seen in day-to-day transactions, such practices have become common place when drafting rental contracts in which tenants promise to pay their rent in an amount equivalent to the dollar amount that they agreed to with the landlord.

This is what economists describe as a “dollarisation of the economy.” Although in varied types and not like the full dollarisation of an economy described by Andrew Berg and Eduardo Borensztein, both senior staff members at the IMF, some succumb to it by holding deposits in foreign currency due to the uncertain record of the local currency, while others see it as an instrument to hedge against the inflation of the domestic currency policy.

A website dedicated to serve the needs of investors, investopedia.com, defines the concept of the dollarisation of an economy as a situation where “citizens of a country officially or unofficially use a foreign currency as legal tender for conducting transactions.”

That is because of the greater stability in the value of the foreign currency over the domestic, which has been what Birr has gone through since 2008.

Aiming at encouraging exports and improving the balance of payments of the country, Sufian Ahmed, minister of Finance & Economic Development (MoFED) once said that it would never stabilise in his lifetime. The administration of Prime Minister Meles Zenawi has made successive devaluations of the Birr against a basket of major foreign currencies beginning in October 2008.

If the devaluation of the Birr by 10pc was a bit of a shock to the market then, there were more in store for the subsequent years. The value of the Birr was further devalued by five per cent in January 2009, and followed by yet another 15pc within seven months.

Nonetheless, the hard pill that the economy was made to swallow came in September 2010, after the macroeconomic team, chaired by the prime minister, decided to devalue the Birr by a staggering 20pc.

Most brokers in the housing market recall that this informal dollarisation came to the scene, fully, after the largest and last jump.

“The trend started to become prevalent when the exchange rate of the dollar went above 16.5 Br, overnight,” a broker told Fortune.

One of such tenants who recently dealt with the many brokers was Yonas Abebe, a married father of one. He was taken by surprise when asked to pay his rent in dollars, after contemplating to move from his current house, as the landlords needed the house back where his family had lived for the past two years.

Yonas finally found a villa in Bole District with three bedrooms, two bathrooms, a kitchen, and a compound. However, in negotiating rental fees with the owner, he was asked to pay the equivalent of 1,500 dollars, whenever making payments.

“I have never experienced such a thing,” Yonas, who was changing his residence for the second time told Fortune in amazement. “It is not legal, I thought.”

Whether or not such a practice is legal, there appears to be no one to speak out on the issue with authority. It is as much ambiguous to officials at National Bank of Ethiopia (NBE), whose mandate includes monitoring monetary policies, as it is for legal experts in the country.

“The Bank does not have the legal grounds to limit individuals’ rights to determine the value of their contracts or the currency they quote, unless their contract explicitly provides for the actual transfer of the actual [foreign]bills,” Alemayehu Alemu Kebede, spokesperson of the central bank, told Fortune.

Legal documents do not state the illegality of the act, some of the legal experts who privately practise law boldly state. Recognising the effect of such a practice on the country’s economy, Birhanu Taye, a legal attorney who has a licence to appear before federal courts, argues that there is no legal provision that clearly criminalises the act.

“This is left to the contracting parties,” he told Fortune. “They can set the price in whichever currency they chose, as long as they are actually not transacting with the [foreign] bills themselves.”

Indeed, the nation’s Civil Code of the 1960s, which still governs contracts, supports this. Where a debtor is to pay a debt in a currency that is not legal tender at the place of payment, the amount can be paid in local currency at the rate of exchange on the day of payment, according to the provision of the law. 

When it comes to actual transactions in foreign exchange, however, the central bank has a clear mandate to control it. It is the only federal agency authorised to issue permits for individuals as well as institutions to transact in foreign currency, including Ethiopian Airlines, tour operators, and hotels.

Despite the differing opinions on the legality of the act, though, landlords who use dollar values for quotations are bold enough to state this clearly in their contracts with tenants. However, some of them are wary to present their contracts to the relevant government entity for the purpose of authenticating contracts. Most contracts are finalised with the contracting parties and witnesses of both sides without passing through federal or regional agencies.

“I have not encountered any legal problems when doing this,” the landlady, with the one-storey villa available for rent on Namibian Street, told Fortune.

Nonetheless, while legal experts and tenants make differing arguments over the legality, macroeconomic experts are worried about the long-term effect of the dollarisation of the economy.

Calling the recent practice an informal dollarisation, where citizens are using a foreign currency as a tender for conducting transactions, the experts argue that this is a bad sign for the economy.

“This is an indication that citizens have lost confidence in the local currency,” a macroeconomist told Fortune.

This growing tendency to transact in foreign currencies is attributed to the different physical policy measures that the administration has taken, bringing double-digit inflation to the economy, according to experts.

“Such informal dollarisation is a response to economic instability, high inflation, and the desire of residents to diversify and protect their assets from the risks of the devaluation of their currencies, wrote Berg and Borensztein in their paper, Full Dollarisation: Pros and Cons, posted on the IMF website in December 2000.

Inflation, largely fuelled by state-driven economic expansion, has been the scourge of Ethiopia since 2006. The consumer price index (CPI) registered a peak of 40.6pc in August 2011, earning the country a name, second only to Belarus in the world, for having the highest inflation rate. Although it subsided to 38pc in November 2011 and 32pc in January 2012, it has remained the Achilles heel of the administration of Prime Minister Meles in achieving a macroeconomic policy objective of taming inflation to single digits.

Not even his administration’s ill-advised policy of imposing price caps on basic food and non-food items back in October 2010 fared well. This resulted in a shortage of capped items, which again led to speculations.

“All of these factors reduced the purchasing power of the local currency in a relatively short amount of time,” the macroeconomist, who wanted to remain anonymous, said.

Indeed, landlords and other businesses resort to keeping their savings in hard currencies, using available means to get around the law.

This was raised as the main reason that a landlord, who is looking for a potential tenant renting his new two-storey villa, requires being paid in dollars and in advance for three months.

Located in Saris area by a roadside, the house was built on a 200sqm plot, after a shanty house there was demolished. It has four bedrooms, with three bathrooms, and a modern kitchen, with all rooms covered with wooden floors. With no compound incorporated, the house has a garage that can accommodate only one vehicle. A returnee from residence abroad for many years, the owner of this house demands 3,500 dollars in monthly rent.

“Since the cost of living is increasing everyday, I cannot make contracts in Birr for a loss,” he told Fortune. “Even if I peg it with the highest value of Birr for two years, it is obvious that the purchasing power of the local currency will decline.”

Sharing the concerns of this landlord, however, the macroeconomic expert fears that this practice has the potential to spread to other segments of the economy, eventually.

“A dollarising country relinquishes any possibility of having an autonomous monetary and exchange rate policy, including the use of central bank credit to provide liquidity support to its banking system in emergencies,” says Berg and Borensztein.

There are experts, however, who argue that such a phenomenon developing in Ethiopia cannot always be considered a bad sign but rather a symptom that shows that the country’s trade is integrated with other countries of the world.

“A country cannot avoid such a trend if its trade with other countries is increasing,” said the anonymous macroeconomist.

Neither do Berg and Borensztein dismiss the possibility of having some benefits in the dollarisation of an economy, although they see the possibility of nations resisting the idea on political grounds.

“A closer integration with both the global and US economies would follow from lower transaction costs and assured stability of prices in dollar terms,” they argue. “Rejecting the possibility of inflationary finance through dollarisation, countries might also strengthen their financial institutions and create positive sentiment toward investment, both local and international.”

Officials at the central bank, however, are not bold enough to comment on the practice’s effect on the economy, claiming that it needs further investigation.

“It is difficult to state the effect before conducting a detailed study,” Alemayehu said.  

While economists argue and try to make their points in economic terms, brokers who are accustomed with the unofficial dollarisation, on the other hand, argue that the practice will continue until the supply of houses brings the demand down. Homeowners know that there is a shortage in housing, according to a broker.

“They are confident in setting rental prices in whatever currency they want to,” the broker told Fortune.

Over the past decade, the population of the capital has shown a significant growth from 2.5 million inhabitants in 2001, to around 3.2 million people, today. The housing units in the city numbered only 628,986, according data from the Central Statistical Authority (CSA), released in 2009. This came to five persons for each house.

The number of housing units has only shown a 4.3pc increase since 2001, while the population size has shown a swift jump of 28pc. Additionally, the size of the population is too small to absorb the demand of the unofficial dollarisation if the administration remains inactive.

 

By Mahlet Mesfin,
Fortune Staff Writer

 
 
   
 
 
 

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