Can the Diaspora Resolve the Foreign Exchange Crunch in Ethiopia?

August 7, 2018

The new Prime Minister of Ethiopia called on his people in the diaspora to help him tackle the foreign exchange shortage. He announced the establishment of a Trust Fund to be financed by one dollar a day contributions from an estimated three million Ethiopians living outside of the country. This could be considered as innovative financing mechanism for development.

by Degol Hailu and Tsegaye Lemma

The new Prime Minister of Ethiopia called on his people in the diaspora to help him tackle the foreign exchange shortage. He announced the establishment of a Trust Fund to be financed by one dollar a day contributions from an estimated three million Ethiopians living outside of the country. This could be considered as innovative financing mechanism for development. Will he succeed?

The National Bank of Ethiopia (the Central Bank) and the IMF agree on one thing—the country’s foreign exchange reserves cannot finance imports for more than eight weeks. Added to this burden is the outstanding external public debt service payment of US$1.5 billion plus the significant obligations in the coming years.

The primary commodity exporting country is yet to generate adequate resources for financing the SDGs, pay its debt and complete the ambitious mega projects such as the Grand Ethiopian Renaissance Dam and the multitude of unfinished sugar and fertilizer factories, which themselves have drained the foreign exchange reserves. The Trust Fund is the Prime Minister’s appeal to those in the diaspora to help him finance the country’s development. He prioritized social investments that will support the elderly and the disabled.

But, what if those in the diaspora are members of the homo economicus genus? A patriotic appeal may not be sufficient to incentivize them to a significant amount. They may simply prefer to send remittances to their family members or invest directly in their pet projects back home. The National Bank estimates that the total remittance flows to Ethiopia was around US$4 billion in 2016. A recent report by the International Organization for Migration says as much as 78% of remittances may be flowing to Ethiopia through informal channels. Official remittances may also increase following the significant narrowing of the gap between the official and black-market exchange rates in recent weeks.

Would an investment fund be more attractive than a scheme that relies entirely on the patriotic will of the givers? We call it the Ethiopian Diaspora Investment Fund (EDIF) and it will work like this. The government will issue dollar denominated fixed-income securities (such as bonds) to the diaspora and it will pay interest on their investment in birr (the local currency).   The patriotic duty will be surrendering dollar denominated interest earnings.

The EDIF will address the incentive issue, which makes a sustainable flow of capital more attainable than the charity-based Trust Fund. It will give investors the option of donating the interest payments on their securities to family members or investing them in projects of their choice.

For instance, someone in the diaspora could invest US$12,000 in the EDIF that will mature in one year at 6% rate of interest. At the end of the year, she will earn US$720 or 20,000 birr in today’s exchange rate. This is equivalent to the country’s current GDP per capita income. By the end of the year, she will have the option to withdraw her US$12,000 or reinvest it back in the EDIF. She can also use the future expected income of 20,000 birr as collateral to obtain bank loans and finance family businesses in her hometown. She can also join others and together they can raise the principal investment of US$12,000. Pulled investments reduce transaction costs for both investors and fund managers.

In terms of the governance structure, just like credit unions or societies, the investors could own the EDIF. An independent Board with elected members could govern its operations. For instance, the Board could engage in third party investments by acquiring shares in local companies such as the flag carrier and the power utility (future sale of shares in these companies was announced recently). Such governance arrangements and diversification of the fund’s portfolio is not only a good risk management strategy but also set the EDIF apart from the other diaspora bonds the government of Ethiopia has issued in the past (namely the Millennium Corporate Bond and the Renaissance Dam Bond).

In terms of investor protection, international insurers such as the World Bank’s Multilateral Investment Guarantee Agency (MIGA) could provide insurance against political and expropriation risks. Local insurance companies, currently over ten of them, could also participate, but considering the challenges in protecting foreign currency denominated investments. The US Securities and Exchange Commission (SEC) would demand registration of the Fund, but it can exempt the EDIF from any fees on ground of development partnership between the two countries.

The EDIF is not a new idea. Israel, India and Nigeria have set up diaspora investment funds, with over US$40 billion raised through bonds.

The one dollar a day Trust Fund is only four weeks old and its success is yet to be seen. Prime Minister Abiy Ahmed may succeed in galvanizing the diaspora community to send money. However, ensuring innovative and sustainable flow of development finance may require an element of a quid pro quo investment strategy beyond the appeal to patriotic sentiments alone.