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Currency Exchange Rates and the Need for Forward Exchange Rate Market Financial Instruments: A Call for New Competencies in Local Banks

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It is essential to distinguish between an individual currency and an exchange rate. While one can possess a specific currency, an exchange rate indicates the value of one currency in relation to another (for instance, the exchange rate between the Birr and the USD). An individual currency can stand alone, but an exchange rate always involves two currencies: the price of one currency compared to another. The exchange rate represents the number of units of one currency (referred to as the price currency) that can be purchased with a single unit of another currency (known as the base currency). Alternatively, the exchange rate can be described as the cost of one unit of the base currency expressed in terms of the price currency.

From the study of economics, it becomes evident that the impact of a currency regime on a country’s ability to implement an independent monetary policy is a recurring theme in open-economy macroeconomics. Countries utilize monetary policy because achieving an ideal currency regime is challenging.

In theory, an ideal currency regime would possess three key characteristics:

Credibly Fixed Exchange Rates: The exchange rate between any two currencies would be reliably fixed, eliminating currency-related uncertainty regarding the prices of goods, services, and both real and financial assets.

Full Convertibility: All currencies would be fully convertible, meaning they could be freely exchanged for any purpose and in any amount, ensuring an unrestricted flow of capital.

Independent Monetary Policy: Each country would retain the ability to pursue an independent monetary policy to achieve domestic objectives, such as growth and inflation targets.

Unfortunately, these three conditions are not mutually compatible. If the first two conditions—credibly fixed exchange rates and full convertibility—were met, there would effectively be only one currency in the world. In this scenario, converting from one national currency to another would be as trivial as choosing between coins or paper currency in your wallet. Consequently, any efforts to influence interest rates, asset prices, or inflation through adjustments in the supply of one currency versus another would be ineffective.

Therefore, maintaining independent monetary policy is not feasible if exchange rates are credibly fixed and currencies are fully convertible. In practice, however, countries employ monetary policy alongside fiscal policy to manage their economies effectively. The major types of exchange rate regimes used by countries can be classified into three categories: Fixed RateManaged Floating Exchange Rates, and Free-Floating Exchange Rates. Each exchange rate mechanism has its own advantages and disadvantages as an effective tool for a country’s monetary policy.

Until October 1992, Ethiopia followed a fixed exchange rate regime pegged to the US Dollar. Since then, however, the exchange rate between the Ethiopian Birr and a major basket of currencies has been determined by the National Bank of Ethiopia. Over the last 32 years; before the adoption of the new policy last week, the Ethiopian Birr against USD has depreciated by about 3000 percent, but this decline has occurred gradually.

As of July 29, 2024, the Ethiopian government has adopted a Free-Floating Exchange Rate regime, which involves no day-to-day intervention by the National Bank of Ethiopia.

The pros and cons of adopting a specific exchange regime are contingent upon a government’s macroeconomic policy, which has been analyzed in various media outlets in recent weeks but will not be discussed in this article. Instead, this article focuses on the operation of exchange rates by banks and dealers under the newly adopted exchange rate regime moving forward.

In economics and finance, where exchange rates are determined by supply and demand, it is assumed that these rates follow a random walk, making daily fluctuations unpredictable. With the implementation of the new exchange rate regime, it is expected that local banks will no longer face restrictions on engaging in global foreign exchange dealings. This is significant, as the foreign exchange (FX) market—the marketplace where currencies are traded against one another—represents the largest market in the world, measured by daily turnover.

The FX market is a truly global marketplace that operates 24 hours a day on business days. It involves participants from every time zone, connected through electronic communications networks that link players ranging from multibillion-dollar investment funds to individual traders—all interacting in real time.

International trade relies heavily on currency exchange, facilitating cross-border capital flows that connect financial markets worldwide through the FX market. FX markets enable international trade in goods and services, allowing companies and individuals to conduct transactions in foreign currencies. This includes everything from companies and governments buying and selling products abroad to tourists engaging in cross-border travel.

While this aspect of FX markets is significant, an even larger portion of daily turnover is driven by capital market transactions, where investors convert currencies to move funds into or out of foreign assets. These transactions encompass a wide range of activities, from direct investments—such as companies purchasing fixed assets like factories in other countries—to portfolio investments, which involve buying stocks, bonds, and other financial assets denominated in foreign currencies.

Regardless of the underlying motivation for an FX transaction, it requires the exchange of one currency for another in the FX market. Before this necessary transaction occurs, market participants face the risk that the exchange rate may move against them. So far, local banks have limited their foreign exchange trading to spot exchange rates, where exposure related to foreign exchange forward transactions—such as those associated with Letters of Credit or other supplier credit arrangements—is directly transferred to companies or individuals, thereby eliminating currency exposure risks for the banks.

With the adoption of a free-floating system, forward exchange transactions that will settle within 30 to 90 days may expose customers to significant foreign exchange risks. Therefore, it is crucial for local banks to establish a forward exchange market, enabling customers to hedge against their foreign transaction exposures.

Moreover, all companies face some degree of foreign competition, and the pricing of domestic assets—such as equities, bonds, and real estate—also depends on demand from foreign investors. These various influences on investment performance are closely tied to developments in the foreign exchange market. Hence, understanding the foreign exchange market and related financial instruments has become a vital competency for our local banks following significant changes in foreign exchange policy. If they fail to adapt, local banks risk losing this lucrative market to emerging foreign banks that may be entering the country.

The views expressed in the article are my personal research findings. They do not reflect the views of HST, its partners, and directors.

Solomon Gizaw is the Chairman and Chief Executive Officer of HST. He can be contacted at: solomon.gizaw@hst-et.com.

Innovative branding and market disruption

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We explore Abiy Solomon’s, Chief Brand Officer of Komari Beverage, transformative journey from his innovative role at Orangeswitch to his groundbreaking work at Komari. His approach to brand development and marketing has redefined success in the Ethiopian beverage industry.

We dig into the story behind Komari’s flagship product, Arada—a hard seltzer that has quickly made waves in the market. Discover the challenges and triumphs of navigating this emerging category, and learn how Komari’s dedication to quality and innovation has led to significant achievements, including the prestigious Monde Selection Gold Award.

Abiy’s insights on balancing corporate success with artistic passions, overcoming industry challenges, and his vision for Komari’s future impact on Ethiopia’s economy and entrepreneurial landscape. This interview promises a revealing look into how Komari Beverage is shaping the future of the Ethiopian beverage industry. Excerpts;

Capital: Can you share how your past experience has influenced your approach to brand development and marketing at Komari?

Abiy Solomon: My experience in creating Orangeswitch, a creative agency, was foundational in shaping my approach to brand development and marketing. At Orangeswitch, I worked with a diverse range of clients across various sectors, which taught me the importance of versatility and adaptability in branding. This experience allowed me to understand the nuanced needs of different industries and how to create tailored brand strategies that resonate with target audiences. When it comes to Komari, I leverage this knowledge to push boundaries and create innovative brand experiences that are not only impactful but also enduring. My goal is to ensure that every brand we develop at Komari stands out and connects deeply with its audience.

Capital: How do you balance your corporate achievements with your pursuits in photography and multidisciplinary artist?

Abiy: Balancing my corporate role with my artistic pursuits is both challenging and rewarding. My work in photography and multidisciplinary art provides a creative outlet that fuels my professional work. The skills and insights I gain from my artistic endeavors often inspire fresh perspectives and innovative approaches in my role as Chief Brand Officer. Conversely, the strategic thinking and discipline required in my corporate role help structure my artistic projects. This synergy between my corporate and artistic work allows me to bring a unique blend of creativity and strategy to both realms, enriching my contributions to Komari and my personal art portfolio.

Capital: What are some of the most significant challenges you’ve faced in your career, and how have they shaped your approach to leading Komari’s brand and marketing strategy?

Abiy: One of the most significant challenges I’ve faced in my career was establishing Orangeswitch as a trailblazing creative agency in a competitive market. Building a reputation for excellence required perseverance, innovation, and a deep understanding of client and market need. Overcoming these challenges taught me the value of resilience and the importance of staying ahead of industry trends. At Komari, these lessons have shaped my approach to brand and marketing strategy. I am committed to continuous learning and pushing creative boundaries, ensuring that our brands not only meet but exceed market expectations. This proactive approach has been integral in maintaining Komari’s vision of redefining excellence in the creative industry.

Capital: Can you share the journey of Arada’s evolution from its inception to now?

Abiy: At Komari Beverage, we’re passionate about innovation and understanding our consumers. That’s what drove the creation of Arada, our flagship hard seltzer brand. We embarked on this journey by listening closely to the evolving preferences of our consumers. We saw a desire for a refreshing, flavorful, and convenient beverage option, and Arada was born.

Since its launch in 2021, Arada has been incredibly well-received. We’ve been constantly striving to improve and innovate, which is reflected in our recent achievement of the Monde Selection Gold Award, a globally recognized quality distinction. This award is a testament to our commitment to excellence and our dedication to exceeding our consumers’ expectations.

Capital: As a relatively new entrant in the beverage industry, what have been some of the key challenges you’ve faced, and how have you navigated them to achieve such rapid growth?

Abiy: As a new entrant in the Ethiopian beverage market, Komari  has certainly navigated its share of challenges. Launching during the initial stages of the COVID-19 pandemic forced us to adopt a remote work style practically overnight. This presented a hurdle, but our team’s dedication and agility ensured a smooth transition.

Shortly after, regional political conflicts arose, which hindered our expansion plans. We responded by focusing on solidifying our presence in key regions while remaining adaptable for future growth.

Inflationary pressures and evolving government regulations are realities we face in the beverage industry. To navigate these, we prioritize cost-efficiency and stay informed about regulatory changes. This allows us to remain competitive while adhering to the highest quality standards.

The founding management teams’ diverse backgrounds and team synergy has been instrumental in overcoming any and all challenges we have faced along the way. Overcoming these obstacles has not only strengthened Komari’s foundation but has also instilled a spirit of resilience that is core to our brand identity. Just like Arada, we strive for excellence while adapting to changing market conditions. This commitment to quality and perseverance is what truly defines Komari and Arada.

Capital: Komari Beverage competes in a market dominated by longstanding competitors, yet Arada has successfully integrated itself within the community in less than 3 years. What sets you apart?

Abiy: In a market traditionally dominated by beer and spirits, Arada has carved a niche for itself within a short period. We believe our success stems from a three-pronged approach:

Unique Product Offering: We understand the Ethiopian consumer’s desire for variety and refreshment. Arada stands out by offering a delicious, sugar-free hard seltzer option, a first-of-its-kind in Ethiopia. This caters to a growing segment of consumers seeking a lighter alcoholic beverage experience.

Collaborative Innovation: We actively involve our consumers in the product development process. This ensures Arada stays true to their preferences and values. This collaborative spirit has fostered a sense of community around the brand, building trust and loyalty among our consumers.

Disruptive Brand Identity: From our eye-catching logo and visuals to our engaging events and marketing initiatives, we strive to be disruptive, inspiring, and enjoyable. We want Arada to be more than just a beverage; it’s a brand that encourages self-expression and individuality. This resonates with our target audience, allowing them to connect with Arada on a deeper level.

The overwhelming positive response from our consumers is a testament to this approach. Arada’s impact has been truly remarkable, exceeding even our initial expectations. We’re proud to offer a unique and refreshing product that resonates with the consumer.

Capital: What makes Komari stand out in the beverage market?

Abiy: Komari stands out in the Ethiopian beverage market by introducing the hard seltzer category, distinct from the traditional beer/draught, wine, and spirits prevalent in the region. The Ethiopian alcoholic beverage industry is primarily limited to these traditional options. Before Arada, there was no alternative that offered zero calories, no carbs, and no sugar. Our hard seltzer combines carbonated water, flavors, sweeteners, and alcohol, providing a healthier choice with a refreshing taste that resonates with our customers. We prioritize rigorous quality control and continuous innovation to maintain a consistent and exceptional product standard.

Capital: Can you share your vision for Komari Beverage’s long-term impact on the Ethiopian economy and its role in fostering local entrepreneurship and job creation?

Abiy: The beauty of Komari lies in our young, energetic, and diverse team. Our vision for Komari Beverage extends beyond offering innovative products; we aim to make a significant impact on the Ethiopian economy by fostering local entrepreneurship and creating job opportunities. Starting with roughly 95 employees, we have now grown to over 200. Through our operations, we strive to empower local communities, support small businesses, and contribute to economic growth. By nurturing a culture of quality and innovation, we envision Komari not only as a leader in the beverage industry but also as a catalyst for sustainable development and prosperity in Ethiopia.

Capital: Building a brand involves a consistent image. Can you describe the visual identity of Arada and how it reflects the brand’s message?

Abiy: Arada’s visual identity is designed to be vibrant and modern, reflecting the youthful energy and innovative spirit that our brand embodies. We incorporated imagery that is both Ethiopian and pan African, fostering a sense of pride without compromising on a contemporary aesthetic. This creates a visually appealing brand that resonates deeply with a broad audience.  We believe this visual identity reflects Arada’s message perfectly. It’s fresh, exciting, and encourages self-expression, just like the experience of enjoying an Arada.

Capital: How did Arada win the Gold Quality Award? What significance does winning the Gold Quality Award hold for Komari Beverage and how to you plan to leverage this award?

Abiy: Arada’s recent achievement of the Monde Selection Gold Quality Award is a significant milestone for Komari Beverage. We actively sought participation in this prestigious international competition to showcase the exceptional quality of our product to a global audience.

The Monde Selection Award recognizes excellence across several key areas, including taste, ingredient quality, production processes, and presentation. Arada excelled in all these categories, particularly impressing the judges with its refreshing taste, unique flavor profile, and eye-catching packaging that stands out on the shelf.

Winning this award validates our team’s hard work and our commitment to quality and innovation at Komari. It signifies that Arada is not just a refreshing beverage enjoyed locally, but a product that meets the highest international standards. This is significant because it validates Komari’s vision to expand its brand reach in Africa and beyond.

Capital: What do you want consumers to know about Komari Beverage’s commitment to quality?

Abiy: At Komari Beverage, we believe quality is paramount. It’s the cornerstone of everything we do, and Arada perfectly embodies this commitment. Our state-of-the-art production facilities adhere to the highest standards. Rigorous quality control measures are in place at every stage of the process, from ingredient selection to bottling. This meticulous approach guarantees consistency and delivers the perfect balance of refreshment and taste .

We want our consumers to know that Arada is more than just a beverage; it’s a product crafted with care and dedication. It’s a testament to our unwavering commitment to exceeding expectations. When you choose Arada, you’re choosing quality you can trust, and a refreshing escape from the daily hustle.