Policy Rules and Bidding Behaviour in the Ethiopian Foreign Exchange Auction

Abstract

Ethiopia adopted a repeated Dutch auction for foreign exchange in May, 1993, for dedicated imports by the private and the state sectors. Various African countries with rudimentary financial systems and thin foreign exchange markets have successfully employed auctions in transition from centralised, controlled systems to decentralised interbank markets. This paper characterises the rules, regime shifts and auction outcomes in Ethiopia. It is emphasised that institutional micro-design and operation of an auction can have important macroeconomic consequences during liberalisation. Models for the Central Bank's supply rules for pre-announced supply of dollars in fortnightly and later weekly auctions, confirm the objective was to stabilise the exchange rate (the marginal auction price) in a thin market around depreciating trends. Bidders were able to learn the supply rules, clustering their bids around predicted target rates. Using a method novel in auction empirical literature, bidders' learning in repeated auctions is examined via the adjustment to equilibrium in error correction equations for the bid spread. Robust models for a similar learning process were found across both frequency regimes; but learning was faster where the exchange rate target was more transparent and uncertainty lower. Thus, a fairly stable depreciation was achieved over four years, despite considerable regime shifts from trade liberalisation, the progressive lifting of auction entry barriers, increased frequency of auctions, fiscal and other seasonality in demand, and temporary price shocks in coffee export earnings.