A couple of weeks ago, the National Bank of Ethiopia (NBE) released a monetary policy statement, unexpectedly lifting the lending cap imposed three years ago and announcing its focus on indirect monetary policy instruments, such as its policy interest rate. The lifting of the cap was accompanied by a 1 percentage point increase in the NBE policy rate to 16 percent (with a symmetric band of ±3 percent) to maintain the tight monetary policy stance maintained over recent years. In fact, the NBE had progressively relaxed the lending cap due to pressure from stakeholders.
While lifting the cap is a vital step—as direct credit ceilings are distortionary emergency measures—it is striking that this took place as inflation began roaring back due to conflict in the Middle East. The NBE justified its move by relying on the mechanism of the policy rate. Furthermore, the NBE has taken these steps while executing a massive gold purchase program at a premium from artisanal gold miners under its Gold Purchase and Reserve (GFR) scheme for foreign exchange reserves.
Although this program has enabled the central bank to build a substantial forex reserve to stabilize the foreign exchange rate through regular auctions, it has injected a significant volume of liquidity into the banking system, particularly at the state-owned Commercial Bank of Ethiopia. Neutralizing this excess liquidity required massive open market operations (OMOs), costing the central bank Br 3.33 billion in 2024/25—a figure projected to rise substantially in 2025/26. The implications of this liquidity accumulation, combined with the lingering effects of the former lending cap, are reflected in repeatedly oversubscribed foreign exchange auctions, OMOs, and Treasury bill auctions, as well as downward pressure on policy, Treasury bill, and money market interest rates.
With the lending cap removed, the NBE faces challenging tasks ahead. It must rely primarily on its policy rate to keep inflation at bay while simultaneously managing forex stabilization activities through the GFR scheme. The core trouble is the difficulty of simultaneously achieving monetary tightening and exchange rate stabilization when the GFR scheme continuously injects substantial liquidity into the banking system.
This accumulated and fresh liquidity enables commercial banks to lower lending rates and expand credit rapidly without restrictio…
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