To ensure adequate liquidity for loan allocations in response to the Central Bank’s new decision, financial industry experts are urging the regulatory body to release a portion of the funds from Treasury bonds that banks have acquired for each new loan disbursement.
Experts recommend increasing productivity as a means to curb inflation rather than implementing drastic measures on the banking industry.
The Monetary Policy Committee’s (MPC) proposals for maintaining price stability and promoting growth have been accepted by the board of directors of the National Bank of Ethiopia (NBE).
According to an NBE statement issued on Tuesday evening, the MPC, which was established under the recently ratified NBE Establishment Proclamation, held its first meeting on Tuesday, December 31st.
During this meeting, the MPC reviewed Ethiopia’s recent inflation developments, trends in the fiscal, external, and financial sectors, overall economic activity indices, and international conditions that significantly impact local circumstances.
“Based on a thorough assessment of these developments and the near-term outlook, the Committee recommends the appropriate monetary policy stance and a specific package of monetary policy actions to be implemented in the upcoming period,” the statement indicated.
Chaired by NBE Governor Mamo Esmelealem Mihretu and Vice Governor for Monetary Stability Clusters and Chief Economist Fikadu Digafe, who also serves as deputy chairperson of the MPC, the committee made several decisions, including raising the credit cap by four percentage points to 18 percent.
Opinions on the Credit Cap
The NBE statement noted that, although recent inflation trends have been positive and suggest a generally disinflationary direction, it remains crucial to maintain a prudent monetary stance.
The Committee highlighted that the inflation rate is still high, significantly exceeding the medium-term goal of achieving single-digit inflation.
According to the Committee, two aspects of the macroeconomic outlook necessitate a cautious monetary stance: the anticipated easing of fiscal conditions over the coming months (due to the normal budgetary execution cycle and increases in salaries, social spending, and safety nets) and the moderately expansionary impulse likely stemming from increased net foreign exchange inflows.
Additionally, the Committee acknowledged the sharp real decline in monetary aggregates compared to nominal GDP, the unusually tight liquidity and credit conditions within the banking system, and the recent disinflationary trend, with monthly inflation data showing a decline of 0.8 percent for November 2024.
“In balancing these considerations, the Committee determined that the current prudent stance of monetary policy should be maintained, albeit with modest modifications,” the statement added, noting that the NBE board of directors authorized easing the credit cap that was implemented in August 2023.
The NBE board has approved the MPC’s recommendation to continue using a credit growth target, with moderate adjustments to the targeted credit growth rate, increasing it from 14 percent to 18 percent.
However, most of the previous measures, including the National Bank Policy Rate of 15 percent adopted earlier this budget year, will remain unchanged until March 25.
Various analysts have noted that the current modification to the rate for disbursement by commercial banks is expected to have significant implications. However, they also stated that, apart from a few financial firms, its overall impact may be minimal.
They claimed that the primary obstacle they face is a liquidity crisis, which the NBE statement acknowledged as unusual.
Newly established banks, with limited lending experience due to their early stages of operation, strongly protested the agreement when the loan cap was implemented on August 11, 2023.
According to a monetary policy decision announced around a year and a half ago, credit growth is to be restricted to 14 percent. “All commercial banks will be directed to restrict the expansion of their loan books in order to comply with this aggregate credit ceiling,” the decision stated.
Despite the regulatory body lowering the lending ceiling by 4% to increase it to 18%, new banks are currently facing even more challenges.
The president of one recently established bank informed Capital that the liquidity shortage is preventing banks from reaching the previous maximum limit.
“I am confident that the majority of banks are not meeting the 14 percent cap, with very few exceptions,” he stated.
Another president of a newly established private bank added, “The issue is not just for my peer banks; the liquidity challenge is industry-wide.”
For the current cap change to have a meaningful impact, industry experts suggest at least two essential remedies.
Their primary argument is that the NBE needs to enhance liquidity to facilitate the repayment of the Treasury bonds it has collected from banks over the past two years.
According to the November 2022 NBE directive No. MFDA/TRBO/001/2022, which mandates all commercial banks to purchase a five-year treasury bond equivalent to 20% of their new loan disbursements, the total stock had reached 109.6 billion birr by the end of September.
One president of a well-established bank told Capital, “Those who provide limited new loans should be exempt from purchasing the bond going forward.”
Experts who supported the bankers’ comments indicated that even if central banks adjust the lending limits, there would still be very little credit available.
Financial industry expert Eshetu Fantaye, who now serves as a consultant for various domestic and international organizations, agreed with the bank president’s statement and offered additional policy recommendations to mitigate inflation.
While he acknowledged that increased financing would contribute to inflation, he noted that it is a minor factor within the Ethiopian context.
Regarding the banking sector, Eshetu, a former senior leader and influential figure in several banks, emphasized the need for a liquidity solution, stating, “At the current level, banks are not in a position to conduct business.”
“Most financial institutions, including the largest and most established banks whose annual reports I reviewed, have loan-to-deposit ratios, including bonds, of 95 percent,” he recalled, noting that he had examined half of the reports from banks currently in operation.
“They would not have enough cash on hand to issue new loans because most of their funds have already been allocated. Thus, the recent NBE move will not lead to an increase in the disbursement of new loans,” the expert stated.
Eshetu highlighted that banks’ concerns are valid, citing the MPC statement, which indicated that the reserve would maintain its current rate.
He further suggested that the NBE’s policy aimed at reducing inflation needs to be re-evaluated. “I do not agree with this rationale,” he clarified, referring to the regulatory body’s belief that aggregate demand is the primary driver of inflation when implementing this new monetary policy.
Another expert with a different perspective expressed concerns about the oversupply of borrowers.
According to an anonymous expert, similar to bank presidents, “it is doubtful that there are potential borrowers who will effectively engage with the fund in this chaotic situation.”
He added that another reason borrowers are hesitant to take out bank loans is due to the high interest rates banks charge. “The inability of banks to meet the 14 percent credit ceiling can also be attributed to a lack of liquidity.”
Fresh Perspectives
Experts argue that the government should explore additional policy measures to achieve the desired outcomes, as the banking sector alone requires more monetary policy options.
“I believe that one of the main causes of inflation is production costs,” Eshetu stated. He noted that the unification of exchange rates affects the prices of gasoline, fertilizer, and other inputs essential for local productivity.
Supporting Eshetu’s claim, experts pointed out that essential consumer goods and services, primarily food and transportation, are significant drivers of inflation in Ethiopia.
“The production costs of domestically manufactured goods have a greater impact on inflation than the sheer volume of money in circulation,” analysts added.
They emphasized that, in addition to maintaining peace in conflict-affected areas, the government should prioritize increasing production.
Experts highlighted that agriculture is the backbone of Ethiopia’s economy, asserting that “stopping the war is also a crucial step toward combating inflation, as instability undermines areas with potential for agricultural productivity.”
They further emphasized the importance of export revenue, bank deposits—such as the USD 700 million allocated to the Commercial Bank of Ethiopia (CBE)—and direct advances from the National Bank of Ethiopia (NBE) as key sources of monetarization.
In line with a new proclamation establishing the NBE, the government has restricted itself from obtaining loans from the NBE to 15% of its revenue from the previous year.
Analysts noted that this restriction means the government will inject only a limited amount of money into the market that will reach banks.
“The funds flowing to the CBE are critical to Ethiopia at this stage as part of the monetarization scheme aimed at stimulating the market,” they explained.
Eshetu remarked that “Ethiopian inflation is not driven by bank loans,” indicating that there isn’t a significant flow of money throughout the economy.
He suggested that economies with robust market liquidity would benefit from the recent actions of the NBE.
According to analysts, most farming operations in Ethiopia lack better methodologies, and the unification of exchange rates has raised input costs for farmers.
“Monetary policy decisions providing some benefits will not play a crucial role in managing price increases,” they continued, adding that the impact of currency unification also affects the manufacturing sector.
Eshetu proposed that to reduce inflation, there must be a structural adjustment in agricultural production, focusing on directing funds into agricultural productivity and the fundamental agro-processing industry.
“They (NBE) regard credit restrictions as a key tool for curbing inflation,” Eshetu said, adding, “It might help, but not significantly, because the underlying issues remain.”
He also suggested that NBE should reinstate the 20 percent bond to enhance banks’ liquidity, but noted, “When it is reinstated, it must impose restrictive policies in areas that will boost productivity.”
“Addressing the production and productivity of basic commodities to alleviate inflation is a key issue,” he states. “Currently, most economic activities, such as corridor development and construction projects in both urban and rural areas, are injecting money into the public without contributing to food supply in the market.”
MPC’s View
The NBE statement noted that year-on-year inflation has continued to decline, reaching a five-year low of 16.9 percent as of November 2024, aided by the tightened monetary policy initiated in August 2023.
“Although food inflation remains high at 18.5 percent, it has been on a broadly moderating trend for over a year,” the statement indicated.
Additionally, non-food inflation saw a slight increase to 14.4 percent in November 2024, partly due to recent exchange rate fluctuations and rises in certain administered prices.
The NBE’s statement highlighted that the most recent monthly inflation report for November 2024 showed a significant month-on-month decline of -0.8 percent, consistent with seasonal trends and indicative of limited exchange rate pass-through effects to date.
Following a real GDP growth of 8.1 percent in 2023/24, activity indicators suggest continued strong growth momentum for the current fiscal year. A favorable rainy season across much of the country and various supply-side initiatives in agriculture indicate a likely record harvest for this crop season.
Quarterly production data for electricity, iron, and steel point to robust year-on-year output growth in the industrial sector, while service activity appears bolstered by increases in air transport and tourism arrivals. Overall, most activity indicators suggest continued strong growth for the 2024/25 fiscal year.
The NBE statement also mentioned that the MPC acknowledged a sharp slowdown in the growth rates of key monetary aggregates in 2023/24, which helped reduce inflationary pressures and expectations last year.
“Since the start of the current fiscal year, somewhat higher growth rates have been observed for all key monetary aggregates: broad money and base money grew by 20 percent and 17 percent, respectively, as of November 2024, while domestic credit also showed strong year-on-year growth at 19 percent,” the evaluation on monetary development stated.
However, despite the recent uptick in monetary growth rates, the Committee noted a significant decline in key monetary aggregates relative to the economy’s size—growth rates for broad money, base money, and domestic credit were all substantially below the growth of nominal GDP—and that a gradual reversal of this real decline would be beneficial to support medium-term growth.
In its review of the financial industry, the NBE statement observed significant liquidity strains in certain segments of the banking system, as reflected in high loan-to-deposit ratios and a low ratio of excess reserves to deposits in the private banking sector.
“These liquidity challenges are being somewhat alleviated by the recent establishment of both an inter-bank money market and a Standing Lending Facility at the NBE,” it stated.
Concerning the fiscal position, the NBE statement noted that budgetary developments have been largely favorable due to ongoing fiscal consolidation. “This has enabled zero monetary financing of the deficit thus far in the fiscal year, which has been highly supportive of the central bank’s monetary policy stance.”
The statement concluded by saying that the reforms initiated in July have led to significant improvements in international trade and money transfers.
“The external position is showing significant improvement, characterized by strong growth in exports and remittances, modest compression of imports, and substantial capital inflows from both private and official sources,” the report states. “These developments have resulted in a current account surplus in the first quarter of the fiscal year and have also increased foreign exchange reserves to record highs at both commercial banks and the National Bank of Ethiopia (NBE).”
In terms of the global environment, commodity price trends—the primary means by which the global economy influences domestic conditions—have been generally favorable.
The report noted that changes in global conditions have positively impacted the domestic economic situation.
“Global oil prices have declined by 15 percent since the start of the fiscal year, while prices for Ethiopia’s largest exports, coffee and gold, have reached record highs, contributing to a significant improvement in the balance of payments.” It also mentioned that despite some parts of the global economy, including Ethiopia’s major trading partners, experiencing a growth slowdown, this has not yet had a significant impact on exports or foreign direct investment (FDI).
