Ethiopian central bank limits commercial lending to tackle inflation

The National Bank of Ethiopia (NBE) has announced measures to limit the amount of capital being lent by the country’s commercial banks in a bid to bring down inflation.

In a monetary policy statement released last week, the Ethiopian central bank introduced a new rule that restricts banks’ yearly credit expansion to 14%.

Part of the reason for this restriction is that commercial lending in Ethiopia has soared in recent years. In the twelve months ending February 2023, banks lent a total of 382bn birr ($6.9bn) – an 80% increase compared to the 209.6bn birr ($3.8bn) that was lent the year before.

Officials at the Ethiopian central bank believe that this stark increase in the amount of cash circulating in the national economy is partly responsible for the high levels of inflation the East African country is currently experiencing. Inflation has come down from its May 2022 peak of 37.7% but prices are still rising at just over 29%.

Despite the focus on commercial lending, there are several other factors that have contributed to inflation in Ethiopia. The weakening birr, at a time when the country is posting substantial trade deficits, has pushed up the cost of essential goods. The disruption to supply chains caused by the coronavirus pandemic and the war in Ukraine has also sent the price of goods higher, with the cost of Ethiopia’s food imports being particularly affected by President Putin’s decision to block Ukrainian grains reaching global markets. Ethiopia’s civil war in the Tigray region, which ended in November last year, has led to a reduction in agricultural production, creating further inflationary pressure.

The NBE hopes that the new credit limit on banks will help bring inflation below 20% by 2024 and under 10% by 2025 and have said the measure is “an important part of reducing inflation sustainably.”

Hailemelekot Berhan, a capital markets analyst based in Addis Ababa, tells African Business that “the central bank governor needs to take bold measures to bring down inflation,” but that the move “will have some negative consequences.”

“I think the limit will have a direct effect on individuals and businesses, especially small and medium sized enterprises (SMEs) who have tended to be the beneficiaries of commercial bank loans,” Berhan says. “The economy will probably slow down a little bit, but the central bank has also stressed that they are not totally limiting credit growth but capping it at 14%. And I think that will probably continue into the middle of next year.”

“You have to control inflation but at the same time you have to create jobs and stimulate the economy,” Berhan adds. “It’s a really fine line between controlling inflation but avoiding high unemployment.”

Implications for liberalisation

Ethiopia has taken several measures in recent months to liberalise its banking sector as Prime Minister Abiy Ahmed looks to instigate fundamental economic reform. In May, the central bank put forward plans to open up the country’s banking sector to foreign competition for the first time.

In the same month, the Kenyan company Safaricom secured a licence to launch its M-Pesa mobile money services in Ethiopia, in the first case of a foreign company being authorised to offer such services. Just this week, the fintech company Kacha received a licence from the NBE to launch full-scale commercial operations, becoming Ethiopia’s first private payments issuer.

Berhan believes that the NBE’s decision to limit credit expansion will not hinder the liberalisation or growth of Ethiopia’s banking sector and says that “the move sends a very good signal to private sector investors.”

“The government is now acting in a way which is more predictable – the central bank is making policy based on clear macroeconomic indicators,” he says.

“Inflation is high and the economy is a bit overheated so the government is trying to control it in a transparent way.”