FOREIGN EXCHANGE SHORTAGE HURTS U.S. BUSINESSES

UNCLAS SECTION 01 OF 04 ADDIS ABABA 002569 SIPDIS SENSITIVE DEPARTMENT FOR EEB/IFD/OMA - JWINKLER AND EEB/CBA - DWINSTEAD DEPARTMENT PASS TO USTR FOR BILL JACKSON, CECILIA KLEIN, AND BARBARA GRYNIEWWICZ DEPT OF COMMERCE WASHDC FOR ITA BECKY ERKUL DEPT OF TREASURY WASHDC FOR REBECCA KLEIN, BILL PELTON, ANTHONY MARCUS, MATTHEW MOHLENKAM, AND CELINE SENSENEY E.O. 12958: N/A TAGS: BEXP ECON EFIN ETRD EINV ET SUBJECT: FOREIGN EXCHANGE SHORTAGE HURTS U.S. BUSINESSES REF: A) ADDIS ABABA 753 B) ADDIS ABABA 2325 ADDIS ABAB 00002569 001.2 OF 004 SENSITIVE BUT UNCLASSIFIED; NOT FOR INTERNET DISTRIBUTION SUMMARY -------------- ¶1. (SBU) The limited supply of foreign exchange (forex) in Ethiopia's banks has begun to take a toll on U.S. commercial interests as private and public entities have increasingly become unable to import essential consumer inputs and industrial capital goods from abroad or get hard currency to repatriate profits abroad. As a result, some prominent U.S. business interests in Ethiopia such as Coca Cola, Proctor and Gamble and Caterpillar are considering suspending business operation in Ethiopia. The Government of Ethiopia's (GoE) recent tightening of the banking regulations to manage its limited forex reserves has dampened real supply for certain desired consumer and industrial imports and has precipitated a foreign exchange crunch. The GoE's opaque allocation process of its dwindling forex reserves may signal an unofficial hierarchy among economic sectors and priority programs, with the state-driven growth in construction, transport and communication as well as domestic food and agricultural subsidization programs taking the lion's share of reserves. Moreover, the GoE's forex allocation process has caused grumbling in the private sector about the inequality in accessing Ethiopia's banking resources. End Summary. BACKGROUND -------------- ¶2. (U) With a trade deficit equivalent to 23 percent of GDP and hard currency reserves able to cover only six weeks of imports, Ethiopia is facing an acute shortage of hard foreign currency reserves. The National Bank of Ethiopia's (NBE, Ethiopia's Central Bank) recent unofficial policy response of reducing the flow of forex to the market has squeezed the bottom line for both commercial and public sector entities and has in many cases inhibited the ability of businesses to operate. The GoE has even gone as far as to eliminate the previously open and thriving black market for forex, which has exacerbated the supply of hard foreign currency (Ref A). Since March 2008, the NBE has been reluctant to sell foreign exchange to the inter-bank market and has effectively cut supply and authority of commercial banks to sell forex to private companies without prior approval from either international banking divisions at banks' head offices, the NBE Governor and lastly the Prime Minister's office. ¶3. (U) The GoE's forex crunch can be attributed to recent exogenous and endogenous shocks that have rapidly depleted its coffers: soaring external oil prices and soaring internal inflation, as well as rising demand for imported consumer and industrial goods. The exogenous shock resulting from the surge in global oil prices has forced the GoE to draw down rapidly on its forex reserves simply to meet its soaring domestic fuel bill. An economist at the NBE informed EconOff that the GoE is paying as much as USD 50 million every month for a fuel subsidy in order to cushion the local market from the record rise in fuel costs. Additionally, the GoE has significantly drawn downs its forex coffers due to endogenous pressures such as the government's move to import wheat at a cost of USD 165 million in order to offset record high food inflation (Ref B); and the growing demand for import of capital goods and intermediate inputs for the state-driven growth in construction, transport and communication, as well as in light manufacturing and agriculture sectors. WHERE NOT EVEN COCA COLA CAN OPERATE -------------- ¶4. (SBU) Coca Cola's primary bottling facility in Addis Ababa, Coca Cola Sabco, is facing an impending production halt in Ethiopia as a result of the forex limitation. As a result of the severe inventory shortfall, Coca Cola Sabco estimates that it only has roughly two weeks of stock ingredients to produce its key consumer goods such as Coke and Sprite soft drinks for the Ethiopian market. Coca Cola's senior public relations manager said that Coca Cola will be forced ADDIS ABAB 00002569 002.2 OF 004 to cease production in Ethiopia after two weeks if the forex situation has not ameliorated to allow it to replenish key imported ingredients due to its inability to pay its overseas suppliers in hard currency. ¶5. (SBU) Coca Cola Sabco has been in business in Ethiopia for close to fifty-seven years and has made significant investments to build up the existing soft drink market and infrastructure in Ethiopia. According to Coca Cola's in-country representative, Coca Cola boasts over fifty-six percent of the soft drink market share in Ethiopia and has experienced double digit growth in the last six years, with twenty-plus percent growth in business in 2007. As a result of the booming demand, Coca Cola Sabco had convinced its headquarters and several large investors to commit USD 100 million to open two mega production facilities in Debre Zeyit and Dire Dawa in order to meet the soaring demand for Coca Cola products in Ethiopia and the East Africa region. Ethiopia was slated to be one of twelve countries in Africa and Asia to host a mega bottling facility. The current forex crunch and broader market indicators have forced the company to suspend plans to pursue the USD 100 million expansion. ¶6. (SBU) Coca Cola Sabco has tried to offset its forex crisis by sourcing inventory from local sugar, bottle and crate manufacturers, but has faced serious quality control issues and a margin crunch (local sugar is more expensive than imported). Coca Cola Sabco has also reached out to the GoE backed banks to secure alternative credit arrangements, such as extending a letter of credit at the NBE using Coca Cola's name to continue imports. The company has also attempted to initiate a franco valuta agreement with the government, which would allow direct soft loans of hard currency from Coca Cola's international headquarters to Coca Cola Sabco. A franco valuta agreement would bypass Ethiopia's banking sector and allow foreign corporations or investors to fund directly the local Coca Cola bottler's production and capacity needs. Since the franco valuta scheme had been effectively outlawed in the mid-1990s only domestic cement importers have been able to utilize this mechanism to meet the demands of the government-backed construction sector. In spite of Coca Cola's repeated pleas to the NBE and GoE officials, all requests for alternative solutions to its forex crisis have fallen on deaf ears. PROCTOR AND GAMBLE: NO FOREX TO IMPORT CONSUMER GOODS -------------- -------------- ¶7. (SBU) Proctor and Gamble (PG) has also been severely impacted by the foreign exchange crunch in Ethiopia. PG's External Relations Manager for the East Africa region reported to EconOff that business has been stalled in many of his company's leading consumer products due to the foreign exchange shortage. Despite sustained and growing demand, PG's primary distributor in Ethiopia (Petram) has not been able to access forex to meet its import bills for future orders of PG consumer products slated for the Ethiopian market. To date, PG has been one of the top market leaders in the sale of consumer products (i.e. fabric care, feminine care and household goods) in the Ethiopian market, clocking double digit growth over the last five years. In spite of enjoying a hefty market share and rapid growth in Ethiopia, PG's External Relations Manager for the East Africa region said that "PG is being forced to reconsider Ethiopia as a viable market, pending a change in the foreign exchange market." According to Petram and PG officials, Dashen Bank, the primary bank that allocates reserves to Petram cannot accept new applications for foreign exchange until it clears a significant backlog. Currently, Petram has been out of stock on Ariel washing detergent (PG's leading consumer product by sales in Ethiopia) for the past three weeks. ¶8. (SBU) PG and Petram have recently decided to move from a monthly order schedule to a quarterly order schedule in order to offset the foreign exchange shortages. PG and Petram are currently stocking up products slated for Ethiopia in Djibouti (where Petram is incurring additional demurrage costs) and will import them into Ethiopia in small quantities as reserves become available. The PG representative said that as long as the forex reserve market worsens, PG will have no choice other than to stop all new orders of its products to Ethiopia and, as a last resort, completely pull out ADDIS ABAB 00002569 003.2 OF 004 of the Ethiopian market. CATERPILLAR: GETTING FOREX LIKE MOVING MOUNTAINS -------------- --- ¶9. (SBU) Similarly, Ries Engineering, one of Ethiopia's largest industrial equipment importers (50 percent market share) and exclusive distributor for Caterpillar, Massey Ferguson and Perkins, has seen its new orders for Caterpillar component parts and new heavy-duty machinery take a serious dip as a result of the foreign exchange crunch. According to Ries's sales and marketing manager, the company is anticipating a halving of its USD 80 million annual Caterpillar business as a result of the foreign exchange situation. Ries's sales manager told EconOff that the company has had real difficulty in being able to stock new component and service parts for its existing Caterpillar clients due to the unavailability of forex. The component parts make up the "bread and butter" of Ries's sales, as existing clients need regular maintenance of equipment. Moreover, Caterpillar has signaled to Ries that it cannot honor any of its future orders of new heavy duty machines. At this time, Ries has adequate levels of inventory to service its clients' needs in the near term. However, the company projects significant business decline, i.e. up to 50 percent of its current revenue, if they are not able to replenish their inventory. FOREX HAMPERS GOE TRAVEL -------------- ¶10. (SBU) Traveling GoE officials are not immune to the forex shortage in Ethiopia. Recently, several GoE officials traveling overseas for meetings found themselves unable to access forex from the National Bank of Ethiopia (NBE),the primary forex provider for traveling GoE officials. Post has learned through an NBE source that the NBE suggested to the traveling GoE officials to make an official plea to the NBE Governor or Prime Minister's office in order to obtain clearance to access hard currency in order to facilitate their travel outside of Ethiopia. The NBE official disclosed that prior to the NBE's tightening on forex to the interbank market, the NBE as well as other local bank branch offices did not have to consult the NBE governor or get prior approval from the Prime Minister's office to allocate foreign currency requests to clients. Local banks could entertain requests for amounts up to USD one hundred thousand per transaction at any given time. However, in light of the NBE's recent unofficial mandate to limit the flow of forex, only the international banking divisions at banks' head offices or the Prime Minister's office are authorized to evaluate and approve every single foreign currency request. ETHIOPIAN STUDENTS CANNOT PAY U.S. SCHOOL FEES -------------- - ¶11. (SBU) Ethiopian students studying abroad have been directly affected by the GoE's placement of foreign exchange limits (USD one thousand USD cash and USD two thousand in traveler's checks) for travelers going out of the country. According to a recent e-mail sent to U.S. Embassy Addis Ababa consular section, by Michael J. Murphy, an International Student Counselor in the Office of International Affairs at Texas Tech University, a growing number of Ethiopian students at his University are being pinched by the forex limitations in Ethiopia. Murphy noted that over the past two years most of the Ethiopian students matriculating at Texas Tech University cannot meet their financial obligation as a result of their families' inability to access foreign exchange in Ethiopia. At this time, the NBE does not have provisions which allow parents to send money by wire transfer to children who are studying in the U.S. for their living expenses. COMMENT -------------- ¶12. (SBU) An acute shortage in Ethiopia's foreign exchange market has stalled business in both the private and public sectors and is hurting U.S. business interests in Ethiopia. In addition, local consumers may soon feel the pinch in their now strained budgets as already high inflation may be compounded due to a supply shortfall ADDIS ABAB 00002569 004.2 OF 004 in the much desired consumer goods. The real effects of limited reserves and a growing perception among private businesses of inequality in the allocation of foreign exchange may be leading to a dramatic drop in private business confidence of the Ethiopian market. This trend could lead to rent-seeking behavior at the local banks, as private companies clamor to have their forex requests quickly fulfilled in spite of long waiting lists at most banks. There appears to be a real risk of a domino effect of United States and other foreign businesses stopping business in Ethiopia as banking regulations tighten and market confidence dwindles. While a liberalization of Ethiopia's foreign exchange regime would allow for the depreciation of Birr (which is currently estimated to be more than 30 percent overvalued),GoE officials have rejected such an option as it would further exacerbate the already unprecedented inflation. Ambassador and PolEcon Chief will raise concerns over the viability of the existing regime and its impacts on U.S. trade and investment with the Economic Advisor to the Prime Minister in coming weeks. The Embassy will continue to urge the GoE to open the financial sector and otherwise liberalize the economy in order to address forex concerns and other structural imbalances. END COMMENT YAMAMOTO