Ethiopia’s Birr Devaluation: How Employers Can Address the Crisis

Birches Group delivers expertise on emerging labor markets from around the world, including insights into current trends and events that affect these markets. 

Ethiopia’s central bank allowed the Birr, its local currency, to float or trade freely based on market forces on July 29, 2024. This decision triggered an immediate plunge of about 30% in the Birr’s value against the United States (US) Dollar. According to the Commercial Bank of Ethiopia, the country’s largest lender, the exchange rate had been 57.48 Birr per dollar on July 26, 2024. By August 16, 2024, it devalued further to 103.96 Birr per dollar, a drop of over 80%. 

Understanding the devaluation 

Ethiopia’s adoption of a new exchange rate policy, as reported by the Associated Press and Africanews, marks a historic shift. For half a century, the government maintained control over foreign currency prices.  

The National Bank of Ethiopia introduced this policy change, alongside other reforms, with several key goals in mind:  

  • Curbing the rise of an unregulated parallel market for foreign exchange 
  • Enhancing the country’s appeal to foreign investors 
  • Securing up to US$10.7 billion in financial aid from the International Monetary Fund (IMF), the World Bank, and other creditors. 

Ethiopia, Africa’s second-most populous country, faces severe economic hurdles. It grapples with high inflation rates of approximately 20% and a critical shortage of foreign currency reserves. The Associated Press highlights that the Birr has been one of the weakest currencies in the region in recent months. Moreover, the country defaulted on its debts in December 2023, worsening its economic difficulties. 

Analysts are concerned that Ethiopia’s currency crisis could further stoke inflation and potentially trigger social unrest. Bloomberg notes that Nigeria and Egypt, which partially relaxed controls on their local currencies in 2023 and March 2024 to secure IMF funding, have since grappled with rising prices and growing civil unrest. 

Ethiopia’s move toward a more flexible exchange rate marks a significant but risky step. The government aims to stabilize the economy and attract foreign investment, but the potential for increased inflation and social instability underscores the complexities of this transition. 

What the Birches Group’s Market Monitor reveals 

Based on our review of our Market Monitor reports over the past 12 months, labor market conditions in Ethiopia have significantly changed since August 2024. 

In our Market Monitor, dated August 1, 2024, Ethiopia entered our Six Levels of Volatility at Level Two. Such a volatility level shows dynamic market conditions, with an exchange rate movement exceeding 20% within the last six months. Our tracking shows a 32.8% exchange rate movement in Ethiopia over the past six months. This shift suggests increasing volatility and potentially emerging economic pressures that have begun to affect the labor market. 

In our most recent Market Monitor, dated August 15, 2024, the situation escalated dramatically, with Ethiopia’s volatility level rising to Level Four. This corresponds to a “sudden or unexpected socio-economic event,” which includes a currency devaluation of 50% or more in six months or less, as well as a disjointed and unclear comparator response in our salary surveys. Our tracking now shows a 79.8% exchange rate movement in Ethiopia over the past six months. 

Next steps for employers 

The devaluation of the Ethiopian Birr presents a challenging landscape for employers in Ethiopia. However, decisive and informed action can mitigate the impact on both your workforce and your organization. 

Take immediate action 

The recent devaluation of the Birr has created an immediate need for employers in Ethiopia to adjust their compensation strategies.

For employers that denominate salaries in Birr:

An immediate adjustment is highly recommended. To mitigate the impact of the devaluation on employees’ purchasing power, an increase of 10 to 20% should be applied now. While this does not fully match the prevailing rate of inflation or completely close the gap, it is a significant measure. A 10-20% increase is a substantial adjustment, and staff would appreciate it if they received it tomorrow.

Organizations that have not dollarized now face pressure to raise salaries to stay competitive. This gap of 80–90% compared to dollarized employers will be hard to ignore and will require adjustments. You should make moderate adjustments to start closing the gap without overcompensating, as market conditions are likely to shift over the next 12–24 months. Historically, it takes about 2.5 years for a market to stabilize after a major exchange rate change. Managing these expectations will be crucial. Some organizations may feel compelled to dollarize simply to keep up with others, but if you choose to remain Birr-pegged, you’ll need a strong rationale for both your senior management and staff.

For employers that denominate salaries in US Dollar:

A major risk factor is that employers have effectively lost control of the market position of their pay, which is now determined by the exchange rate of the Birr, not by the supply and demand for talent nor by other compensation market fundamentals. 

Such a drastic adjustment in a short period, especially when it’s beyond your control, poses significant challenges. While staff may enjoy the immediate increase in purchasing power (about 80% more in Birr than a few weeks ago), the real challenge will be managing expectations over the next year or two. The increase of 80–90% far exceeds adjustments made for inflation, which was 26% over the same period. It also surpasses market movement adjustments, which averaged about 20% based on our surveys from July 2023 and July 2024. Our surveys cover a wide range of roles, from general laborers to senior experts, and the general adjustment over the past year was about 20%, roughly aligning with inflation.

Experience shows that those who dollarized are now 80% ahead of the market position from three weeks ago and 90% ahead from a year ago. Such a gap is difficult to justify and maintain. You will face pressure to avoid further significant adjustments while managing expectations in a high-inflation environment, where inflation remains in double digits.

For organizations denominated in hard currency, it’s advisable to cut your losses and transition to Birr as soon as possible. Plan for a long adjustment period of 2 to 2.5 years with relatively low salary increases to avoid being significantly ahead of the market. Manage staff expectations during this period.

Monitor the market regularly 

The economic situation in Ethiopia remains fluid. Employers should stay abreast of labor market changes and adjust their strategies accordingly. Regularly reviewing salary data and the overall economic climate will help ensure compensation packages remain competitive and equitable. Given that Ethiopia is in Level Four, employers should review and update their salary scale three times a year to prevent compensation from lagging or leading the market. 

Avoid dollarization 

In times of currency volatility, the idea of dollarizing salaries can be appealing. But Birches Group advises against dollarization, except in extremely limited cases. Denominating salaries in US Dollars or other hard currencies creates a divide between the international development community and the broader local market. 

Dollarization may seem like a quick fix for your organization’s current challenges, but it can lead to significant overpayment of staff in the long run. As we highlighted to our clients in our August 15, 2024, webinar on the Ethiopia crisis: 

“Dollarized employers will be delivering approximately 80% more in pay today than they were two weeks ago, and over 90% more than one year ago, despite no significant underlying changes in the labor market fundamentals.” 

Once inflation slows down and the labor market catches up, likely within the next two years, organizations that have dollarized salaries will find themselves significantly out of sync with local pay scales. 

While dollarization might offer a temporary sense of stability, it’s a risky strategy that can create more problems than it solves. 

The critical need for a Special Measures Policy 

Employers need a clear plan for navigating the compensation challenges during economic crises. A Special Measures Policy defines how your organization will adapt its compensation approach in a crisis. But, more importantly, having such a policy allows you to act quickly as soon as unexpected volatile events like currency devaluation occur. 

Birches Group partners with organizations to craft Special Measures policies. Contact our team today to learn more.  

More resources 

Birches Group conducted a webinar about Ethiopia on August 15, 2024, attended by over 200 participants. We are happy to make the recording available to clients upon request, and are also publishing an FAQ that summarizes the most common questions and answers discussed during the webinar.

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