The Cause of the Eritrean-Ethiopian Border Conflict


by Alemseged Tesfai


6. The Monetary Arrangement

Eritrea used the Birr until it introduced its own cur rency, the Nakfa, on November 8, 1998. The relevant provision for this agreement was signed in the Protocol Agreement on Harmonization of Economic Policies on September 1993. It provides as follows:-

Article 1

The Use of the Ethiopian Birr until Eritrea has its own currency.

In so far as a common currency is in use, the Contracting Parties agree:

  1. To harmonize exchange rate policies including consideration of pooling of reserves with the aim of establishing uniform exchange rates within the currency area.

  2. To harmonize interest rate structures in both countries.

  3. To work out a mechanism by which the increase in money stock is consistent with the growth and inflation objectives of the two countries.

  4. To work out a scheme to synchronize policies related to foreign exchange surrender requirements, allocation of foreign exchange to importers, capital flows and external debt management.

We have been hearing and we will yet hear allegations that this arrangement favoured Eritrea more than it did Ethiopia. How a country that uses someone else's currency can be deemed an exploiter is yet to be convincingly explained. It is like the US feeling raped because its dollar is spread all over the world.

In actual fact, throughout its use of the Birr, Eritrea was a victim of the Ethiopian monetary policy as it had no say in its formulation. Here, again, differences in economic policy between the two states created incongruities in the use of the Birr. On this topic we refer to an Eritrean economist's expert opinion, that of Dr. Woldai Fitur of the IFC, who says:-

" was clearly Ethiopia that benefited more from arrangements concluded between the two countries. For instance, the arrangements in the de facto currency union, which did not allow Eritrea a voice in Ethiopia's conduct of monetary policy, worked more in favour of Ethiopia. All seigniorage associated with issuing new Birr notes accrued to the National Bank of Ethiopia, while the costs associated with the overvalued exchange rate and unreasonably high interest rates imposed by the Ethiopian Government on the Birr area spilled over to the Eritrean economy, forcing Eritrea to adopt an independent exchange and interest rate structure.

It is important to appreciate that this interest and exchange rate structure was necessitated by the divergent economic (fiscal, monetary, trade, investment, etc.) policies that the two countries have chosen to pursue. Immediately after liberation, Eritrea adopted liberal trade, investment, and financial and foreign exchange regimes. These policies were quite different from those of Ethiopia. Under such circumstances, it behooved Eritrea to issue its own currency and pursue independent interest and exchange regimes for an effective management of its economy. Ethiopians should not have any reason to resent Eritrea's independent monetary, interest and exchange rate policies. The development of an active black foreign exchange market, which hadn92t existed for decades, was the natural consequence of the distortions by Ethiopia's foreign exchange policy. The Eritrean Government has in no way contributed to the development of this black market and should not be blamed for it. Moreover, Ethiopia paid in Birr for all Eritrean exports, including re-export of goods imported from third parties in hard currency. In view of this, it was Ethiopia and not Eritrea that benefited more form the de facto currency union. (Eritrea Profile, Vol. 5 No 1, August 15, 1998).

The Nakfa-Birr "controversy" is actually an Ethiopian creation. The accusation leveled on Eritrea by the Ethiopian government and media is that it sought to force upon Ethiopia a Nakfa convertible with the Birr on parity and that it insisted that both currencies circulate freely in both countries. Why the Ethiopians would think such a suggestion, though it was never made, a blasphemy cannot be rationalized. However, the records show that Eritrea never presented such a proposal or suggestion to the Ethiopian government. In March, 1997, the National Bank of Eritrea had entertained the following three points as payment options that "could be considered depending on the level of political commitment for closer cooperation and prospects for accelerated harmonization of economic policies of the two countries". These options were:

  1. a foreign exchange-based payment system, as is the case with the rest of the world;

  2. freely convertible Nakfa-Birr payment system in which trade between the two countries could be conducted with or without opening a letter of credit with a bank; and

  3. a partial convertibility of Nakfa-Birr system in which trade between the two countries could be conducted only by opening a letter of credit with a bank. (Bank of Eritrea, "Progress Towards the Introduction of Nakfa and the Disposition of the Birr, March 13, 1997, Asmara, Eritrea. P.14.)

The Bank of Eritrea did not make a secret of its preference for the second option which it saw as "the most appropriate for stimulating rapid expansion of trade and greater economic integration between Eritrea and Ethiopia." By the "free convertibility" of Nakfa-Birr in this option, it was not suggesting parity or the free circulation of both currencies. It was, rather, to put it in layman's terms, giving traders in either country the opportunity to agree on the use of the currency of their choice for settlement and to do so through the intermediary of banks in both countries. Any imbalances accruing from such a practice, according to this option, would be settled in foreign currency through the banking systems of Eritrea and Ethiopia. The assumption here, of course, was that the trade would be carried out without resorting to the opening of letters of credit.

In the joint committee meeting of 19 November, eleven days after the Nakfa had been introduced and the new Ethiopian Birr put into effect, the Ethiopian delegation presented the LC option as its final preference except in limited petty-trade. The US dollar was to be the official medium of exchange between the two countries. Later, the Ethiopians stipulated that the border petty-trade was not to exceed the value of 2000 Birr in each instance. The Eritreans felt that the Ethiopian preference was not in the interest of the people of both countries as it would encumber the traditional free flow of goods.

When the Nakfa came into operation, Ethiopian reaction was unexpectedly and astonishingly violent. Holders of that currency were harassed at all Ethiopian points of entry, the Nakfa was confiscated and sometimes torn or burned and the atmosphere of the complete break-down of trade created by Ethiopian authorities. In fact, trade from Eritrea to Ethiopia came to a virtual halt.

Nothing approaching that level of irrationality was seen prior to the Nakfa incident - not even at the time of Eritrean independence, especially by the TPLF cadres and their supporters. Suddenly, pictures of an economically weak Eritrea trying to get an easy ride on the back of Ethiopia started to be painted. Eritrea was now "the exploiter", a bully that "coerced" Ethiopian authorities into unbalanced and unfair agreements". The idea, apparently, was to teach Eritrea the lesson that (the old fallacy) its existence was irrevocably and forever tied to Ethiopia's abundant resources; that what amounted to a trade embargo, would bring it down to submission.

The mood in Eritrea was different.

The old traditional trade ties with Ethiopia, which were re-enforced by the mutual friendship apparent at independence had, in a way, clouded Eritrea's vision in many ways. So, the strain in trade relations following the Nakfa, though obviously lamentable, was a good thing, as it widened the nation's perspective and alternatives. That was how the incident was assessed and explained to the Eritrean public.

F. Concluding points

In the areas of trade and currency policies, the post-1991 agreements between Eritrea and Ethiopia did not work and, in fact, led to some confrontations. In other areas, including the issue of citizenship, no insurmountable problems were encountered and, one may say, they were generally successful.

We now hear a lot of "learned analysis" surmising that the root cause of the border crisis of May 1998 is Eritrea 's "failed" economy; that "the Badme Incident" was a tactic by the Eritrean Government to divert its people from its internal problems....etc. These are all Ethiopian allegations, so often repeated and so made wide-spread through the relentless use of every media, propaganda and diplomatic resource at their disposal that they, initially, confused quite a few people.

The facts are different. The latest economic indicators issued by the independent studies of the IMF and the World Bank attest to the following:-

The IMF Executive Board, which met on July 13, 1998, issued its official findings on July 16, 1998. Here it expressed its concern over the border conflict but, otherwise, fully endorsed the Eritrean government's policies and practices in every field of economic activity. Eritrea's "impressive progress made in economic reconstruction and social rehabilitation during the past six years" was welcomed by the Directors. They also welcomed the "further progress" made in 1997 "particularly in implementing structural reforms, reducing the fiscal deficit and successfully introducing the Nakfa." They also commended the "authorities92 strong commitment to strengthen macroeconomic performance and reform the institutional framework." Looking ahead, the Directors saw the present conflict as an impediment to the Eritrean authorities92 plans of "further reducing macroeconomic imbalances and accelerating growth." They also noted the adverse effects the conflict can play on the nation's fiscal policy, in spite of "the commendable reduction of the budget deficit in 1997." (IMF, No.98-277, July 16, 1998.)

The IMF further noted the boost that the private sector got through the privatization of 700 small-scale and 39 big and medium-scale manufacturing enterprises. It further stated, "Prices were decontrolled while differential interest rates between private and public sectors were eliminated." Consequently, the IMF pointed out, "the role of the private sector was boosted, resulting in buoyant growth in manufacturing and services exports."

With the benefit of these reforms, the report continued, "real output growth averaged 7 percent during 1993-96 and rose to 8 percent in 1997, translating into significant growth in per capita income".

The report also found the annual inflation rate for 1993-96 to have been at less than 4 percent. The reduction of government expenditure by about 10 percentage points and the increase in revenues by 6 percentage points was also noted as a result of both "the completion of some programs and the intention of the authorities to bring down the deficit to sustainable levels ", and the "broadening of the tax base and the ongoing strengthening of the collection effort respectively". As a result, "the deficit came down sharply from 16.4 percent in 1996 to 5.5 percent of GDP in 1997". Finally, the report notes, "the medium-term targets of real output growth of 6-7 percent per annum, annual rate of 3-5 percent and a built-up of reserves to 5.5 months of imports are quite ambitious and consistent with the authorities92 track record of perseverance with implementation of good economic policies."(IMF, BUFF/ED/98/105, July 10, 1998.)

The World Bank has more recently also given high marks to Eritrea's implementation of programs and projects. Last August, the Bank's representative for Eritrea, Ethiopia, Somalia and Sudan declared that Eritrea was one of the five countries in the world with whom the World Bank maintains exemplary relations. Its "impressive economic performance", the official also noted, "mainly emanates from its effective implementation of home-grown development strategies." (Eritrea Profile, Vol.5 No.24, August 22, 1998.) The virtual absence of corruption in the country and the safety and stability prevalent even in spite of the border conflict are invariably mentioned as great assets for Eritrea's future development.

There is, in short, no evidence whatsoever of the Ethiopian government's continuous claim that the Eritrean economy is in dire straits. At the time of writing this paper, mid-August, 1998, the Nakfa stands at 7.45-7.50 to the US dollar, still maintaining its pre-conflict levels. At this particular time (August, 1998), the Ethiopian Birr's position vis-à-vis the dollar is about the same. The price of fuel in Eritrea stays constant at 2.80 Nakfa per litre and bread is available at 0.20 cents Nakfa or about 0.03 cents US apiece, a price maintained since independence. Whereas it would be self-deceiving to claim that the conflict is not adversely affecting the Eritrean economy, the fact that it is still withstanding this adversity attests to its strong base.

Why, then, would a government that is doing so well on the economic, social and political fronts, want to start a border conflict and create problems for itself? Why would it want to dismantle all of its achievements of the past seven years?

The answer, definitely, lies somewhere else - on the border conflict that has its own background and history, not directly related to the cooperation agreements discussed above or to the performance of the Eritrean economy.

We now turn our attention to the events leading to the border conflict of May 6, 1998, where the real cause of the hostilities lie.