The International Monetary Fund (IMF) has revised its inflation forecast for the 2024/25 year, commending the government’s efforts to control rising prices in light of recent macroeconomic reforms.
Despite the successful implementation of a flexible exchange rate, the response of foreign exchange supply has been slower than anticipated in the initial months following the reform’s launch.
According to the latest IMF report, the government is working to expedite the treasury bills market to secure additional funding.
The IMF Executive Board recently completed its first assessment of the four-year Extended Credit Facility (ECF) for Ethiopia, following a visit by an IMF staff team led by Alvaro Piris from September 17 to 26.
The updated forecast from the IMF reflects changes made since July 29, the day Ethiopia initiated a bold macroeconomic reform program that introduced a flexible currency rate.
The IMF’s most recent review indicated that inflation rates in July and August of 2024 were lower than expected. The report stated, “There have been no indications of significant inflationary pressures, and the transition to a market-determined exchange rate is proceeding smoothly.”
While there were anecdotal reports of notable price increases for some imported goods in Addis Ababa, such as cooking oil, the IMF noted that there have been no signs of widespread price pressures.
To address concerns about perceived unjustified price hikes and hoarding, local authorities in Addis Ababa took actions including temporary shop closures. Simultaneously, the central government imported 50 million liters of edible oil and $20 million worth of sugar to increase supply and alleviate price pressures, aligning with measures to reduce the social impact of the reforms outlined in the Fund-supported program.
Headline inflation decreased to 17.2 percent, driven by reduced food price inflation, particularly for staple goods, and the effects of credit growth restrictions.
Experts anticipate that inflation will be one of the expected short-term challenges of such significant reforms; however, Ethiopia has managed to keep inflation contained in its most recent experience.
In its latest report released on Monday, November 5, the IMF revised its inflation forecast for the current budget year from 30.1 percent in July to 25 percent.
Looking ahead, the IMF projects that inflation will drop to a single digit by the fiscal year 2028/29. If this projection holds true, it would mark nearly two decades since the nation grappled with hyperinflation following the 2005 national election.
By August 16, 2024, foreign exchange reserves increased from USD 1.4 billion at the end of June 2024 to USD 3.6 billion. This growth was driven by the recent reform, supported by financial assistance from the IMF and the World Bank, and was bolstered by higher-than-expected gold export revenues.
The rise in reserves was also aided by lower-than-anticipated foreign exchange sales by the National Bank of Ethiopia (NBE) and stronger gold exports in July and August 2024, which contributed to surpassing the net international reserves target set for August 16.
The report indicated that the monetary policy stance remains restrictive, which is essential for maintaining inflation and exchange rate expectations, with the goal of ensuring medium-term price stability.
In line with the authorities’ adoption of an interest rate-based monetary policy framework, there is a commitment to increase the monetary policy rate to ensure positive real rates by the first quarter of 2025, while moving away from quantitative constraints on bank lending.
The first review of the Extended Credit Facility (ECF) noted that interest rate increases may be necessary later in the year to achieve positive real interest rates and to lift quantitative restrictions, unless inflation expectations continue to decline significantly.
It emphasized the importance of closely monitoring inflation and exchange rate developments, as well as the need for clear communication from the NBE regarding policy objectives and actions to anchor expectations. The authorities should also be prepared to accelerate the pace of monetary policy rate increases as necessary.
The report highlighted that avoiding monetary financing of the fiscal deficit through direct advances is crucial for maintaining low inflation and ensuring the success of the new monetary policy framework.
The IMF recommended that increased participation by banks in treasury bill auctions with attractive rates will be key to stabilizing the economy.
“Further measures are required to enhance market functioning, facilitate price discovery, and address the ongoing issue of undersubscription in Treasury bill auctions,” stated the IMF document.
According to the IMF, two pension funds—the Public Social Security Service Agency and the Private Organization Employees’ Social Security Administration—along with the state-owned Commercial Bank of Ethiopia (CBE), accounted for over 80 percent of Treasury bill purchases from July to September 2024, although a few smaller banks have started to increase their holdings.
“While Treasury bill rates are theoretically allowed to adjust freely to market-clearing interest rates, ongoing demand from pension funds at deeply negative real interest rates, the practice of allowing CBE to include Treasury bills in their reserve requirement calculations, and the historical trend of NBE rejecting auction bids above 10 percent have all contributed to limited participation from the banking sector,” it added.
The authorities acknowledge the necessity of increased participation from the banking sector and are committed to ensuring that market participants understand the new regulations governing the Treasury bill market.
To enhance transparency and predictability, it is recommended that Treasury bill auction results be published promptly, along with a fixed issuance calendar. These steps are essential for developing the local currency bond market.
In line with this, the authorities will abolish the requirement for commercial banks to purchase 5-year Treasury bonds by the end of this fiscal year (new structural benchmark: June 25) and will rely exclusively on market-based financing going forward.
The authorities are also open to exploring additional measures to boost banking sector participation. These measures may include expediting the removal of requirements for banks to purchase government securities and DBE bonds, as well as completely eliminating the inclusion of Treasury bills in the reserve requirement calculation for the CBE.
In the Memorandum of Economic and Financial Policies addressed to Kristalina Georgieva, Managing Director of the IMF, on October 7, the officials stated, “We will take further steps to improve the T-bill market’s functioning and price discovery to enhance domestic resource mobilization and strengthen monetary policy transmission.”
The letter of intent, signed by Ahmed Shdie, Minister of Finance, and Mamo E. Mihretu, Governor of the NBE, noted that although T-bill rates are now allowed to adjust freely to the market-clearing rate and new internal auction procedures were implemented in July 2024 to facilitate better market performance, auctions have remained undersubscribed, with interest rates significantly below the monetary policy rate.
“Acknowledging the need for significantly increased banking sector participation in the T-bill market, we will enhance communication with market participants to ensure that the rules governing the T-bill market are clearly understood, including the absence of restrictions on bids,” they stated. “We are prepared to consider additional measures, such as advancing the commitment to remove the eligibility of T-bills for meeting the CBE’s reserve requirement (currently at least 50 percent by December 2024, with complete elimination by the end of 2025), should T-bill rates continue to fall substantially below the monetary policy rate.”
The IMF reported that the transition to a more flexible exchange rate, supported by its technical assistance, has been progressing well, although the FX supply response has been slower than expected. The exchange rate has aligned closely with the pre-reform parallel market rate, with tight monetary conditions contributing to its stability. Remittance platforms are also offering similar exchange rates.
