How Ethiopia’s Central Bank Plans to Keep Prices in Check Without a Credit Cap

The National Bank of Ethiopia (NBE) is preparing to lift its long-standing credit cap, a major move that would unlock 1.3 trillion Birr in bank lending.

According to officials, the reform reflects both rising investor appetite and improving economic conditions. The decision also follows years of complaints from businesses that borrowing limits choked large-scale projects. 

Some of the commentary around the planned removal of the 18 percent credit growth ceiling has framed it as a loosening that will inevitably reignite inflation. However, I take a different view.

The change should be understood as a transition from a blunt, quota-based control to a modern, market-based framework in which interest rates, liquidity operations, prudential tools, and fiscal coordination do the heavy lifting to curb price pressures. The stance can remain tight even as the instrument changes. The real question is not whether the cap vanishes, but how effectively the new toolkit is deployed to land inflation in single digits.

Media reports indicate that the regulator coupled the shift away from quantitative controls with a deliberately tight stance, maintaining the policy interest rate at 15 percent and moving government financing toward market auctions, ensuring that prices rather than quotas anchor conditions as the cap is phased out.

It is important to acknowledge the concerns voiced by commentators and experts who hold opposing views. NBE introduced a 14 percent annual credit growth cap in August 2023 to curb inflation driven by rapid loan expansion. At the very end of last year, the ceiling was raised to 18 percent amid easing inflation, tighter monetary conditions, and stronger supply-side factors. Before the cap, credit growth averaged more than 25 percent annually across the banking sector, with some major banks exceeding 30 percent.

The real estate market, which had seen years of continuous price increases, slowed after the cap was imposed. While not the sole factor, many observers credit the measure with cooling price hikes in the sector.

Critics of removing the cap warn that new credit could flow into the real estate sector or non-productive areas, such as the car market, and drive up prices. That risk is real in any transition. Yet looking at the shift only through the lens of ‘freeing more loans’ misses what the IMF actually argued when it said the existing credit cap is a weak or ineffective instrument for disinflation. The more useful question is how the authorities intend to push inflation from today’s level down to single digits as the cap is phased out.

The answer lies in the implementation of price-based tools that influence saving, borrowing, expectations, the exchange rate, and the overall monetary environment, rather than merely suppressing the quantity of loans.

Why Credit Caps Are Being Phased Out

As the IMF (2025) argues in Building Monetary Transmission in Ethiopia, quantity-based credit ceilings are blunt and distortionary. They throttle loan growth irrespective of sector or borrower quality, weaken monetary transmission by sidelining interest rates, and do little to shape broader drivers of inflation such as expectations, the reward for saving, or exchange-rate pass-through. The shift now underway replaces a single credit ceiling with a set of price-based levers that can be tightened or eased as conditions evolve.

But Will Removing the Cap Push Inflation Up?

With the right instruments applied in parallel, the likelihood of inflation rising materially because of cap removal alone is low. What matters is not the symbolism of lifting a ceiling but the strength and consistency of the stance. A credible policy rate that keeps real returns positive anchors savings and discourages marginal borrowing. Transparent Treasury bill and bond auctions absorb excess liquidity when needed. Open‑market operations and standing facilities stabilize short‑term funding conditions so policy signals pass through to lending and deposit rates. If credit demand were to accelerate beyond what the disinflation path can tolerate, the central bank can drain liquidity, raise the policy rate, or adjust reserve requirements. These measures act faster and more precisely than an annual quota. As further evidence of transmission, Treasury‑bill yields have averaged around the mid‑teens in 2025, with interbank benchmarks positive, signs that savers are being rewarded and marginal borrowers are deterred.

The central bank plans to replace blunt quantitative controls with a market-driven, inflation-adjusted interest rate regime. It will do this by establishing a benchmark rate tied to inflation and creating an interbank corridor with standing lending and deposit facilities, allowing banks to reprice deposit and lending rates from that anchor.

The draft policy, which is set to be tabled to the Board, outlines a three-year transition away from the current structure in which minimum savings rates are fixed at 7 percent while lending rates float. The change is driven by the fact that negative real rates (for example, ~8 percent average deposit, ~14.3 percent lending, versus ~14 percent inflation) erode savers’ money and distort credit pricing.

Under the new setup, the central bank would absorb excess liquidity when rates drift too low and inject liquidity when they spike, stabilizing short-term funding so policy signals transmit.

Some experts welcome the move but caution that without deeper market infrastructure, such as secondary and capital markets, and broader reforms, the benchmark may sit close to inflation. This could raise borrowing costs and temper loan demand, even as it strengthens monetary credibility.

Are Banks Ready? 

Ethiopian banks are being readied. The National Bank’s Recovery Plan of Banks Directive (effective May 13, 2025) requires each bank to file a comprehensive recovery plan that covers governance, early-warning indicators, triggers and thresholds, scenario analysis, and a menu of credible recovery options. The goal is to ensure that stress can be contained without halting productive lending.

Banks must map the signals that trouble is building, for example, deposit outflows, rising arrears, or spikes in funding costs. They must also test their plans under severe but plausible scenarios and pre-agree on actions such as tightening consumer underwriting, repricing deposits, selling liquid assets like T-bills, conserving capital and liquidity, diversifying funding, or restructuring liabilities. They are also required to safeguard critical functions such as payments, deposit-taking, and essential lending, while setting clear internal escalation and communication protocols.

Practically, this functions as a system-wide safety drill. The first plan is due within eight months of the directive’s effective date. The National Bank must review it within six months of submission. Annual updates are required, and penalties apply for non-compliance.

How the Regulator May Use the Toolkit

The move away from a credit growth ceiling only makes sense if price-based tools are used actively and in parallel. Think of it as a ladder the authorities can climb, with each rung tighter than the last, until inflation is clearly on a path to single digits.

The figures below are illustrative to show the mechanics, not policy promises. Start with the policy rate. If monthly and quarterly readings show inflation pressure building, for example, drifting from 14 percent toward 16 percent, the NBE can lift the policy rate from 15 percent to 17 percent. Interbank funding costs will reprice within days. Commercial banks will pass this through to their own prices: a typical lending rate that reached 22 to 23 percent could move to 24 to 26 percent. That immediate jump changes borrower behavior. Marginal projects are shelved, working-capital lines are trimmed, and consumer loans cool.

At the same time, deposit rates adjust upward. If headline inflation is 16 percent, banks that were offering 14 percent on term deposits could move toward 18 percent on the most competitive tenors. This allows savers to earn a small positive real return. This is the core of the IMF’s guidance in plain language: depositors should not lose purchasing power by saving. Positive real returns keep money in the banking system and reduce the chase for foreign currency or real assets.

While the policy rate provides the signal, Treasury bill auctions do the heavy lifting on liquidity. Suppose the 91- and 182-day T-bill yields have been around 14 percent. The Ministry of Finance can coordinate with the NBE to accept higher clearing yields, for example 16.5 to 17 percent, on larger auction volumes for several weeks. Banks and funds willingly park cash in risk-free bills at those yields. This “crowds out” some private lending and soaks up the same liquidity that fresh bank loans would otherwise inject into the economy. In practical terms, the extra Birr that might have chased inventories or real estate is instead tied up in T-bills.

If inflation pressures persist after these price moves, the next rung is the reserve requirement. Raising required reserves from, for example, 7 percent to 9 or 10 percent forces banks to hold more idle balances at the central bank. That directly shrinks loanable funds even if banks still want to lend. This measure bites system-wide, so it is used sparingly and usually after rate and bill-market tools have been given time to transmit. 

Open-market operations and the standing facilities run in the background every day to keep the stance tight. When the market is awash with liquidity, for example, after seasonal payments, the NBE sells government paper from its portfolio or offers attractive term deposits to banks to drain the excess. When overnight rates diverge from the policy stance, the lending and deposit standing facilities pull them back inside the corridor. The goal is to keep the short end of the curve aligned with the policy signal so banks cannot cheaply fund a lending surge that would undermine disinflation.

Once the credit ceiling is removed, the actual destination of credit, whether it fuels productive growth or inflationary consumption, depends heavily on two things:

(1) how banks price loans, and
(2) how the NBE supervises them.

With interest rates and funding costs already high, commercial banks naturally face stronger incentives to lend cautiously. Riskier and short-term loans are less attractive when money is expensive. But pricing alone is not enough, which is where supervisory guidance comes in. The NBE should make its expectations explicit: credit should be steered toward sectors that expand Ethiopia’s supply side and export base, such as agriculture, manufacturing, and tradables, rather than toward loans that simply fuel consumption, such as luxury imports or non-essential personal spending.

Even under higher rates, banks may still be tempted to chase fast-growing consumer lending for short-term profits. If regulators detect such patterns, they do not need to revert to an outdated one-size-fits-all credit ceiling. Instead, they can rely on a modern, targeted policy toolkit, which includes:

·         Stricter underwriting standards: Ensuring banks carefully assess a borrower’s ability to repay before approving credit.

·         Higher risk weights: Forcing banks to hold more capital against certain types of consumer loans, making them more expensive to issue.

·         Time-bound limits: Placing temporary caps on the growth rate of unsecured or consumption-driven credit if it's rising too fast.

These tools allow the NBE to surgically cool overheated segments of the credit market without choking off capital to farmers, exporters, or industrial firms. This approach preserves lending freedom for productive sectors while keeping inflation in check.

Why Coordination Is Key to Fighting Inflation

All of the mentioned tools only work if fiscal policy moves in the same direction. Market-based deficit financing at the new, higher T-bill and bond yields keeps monetary transmission clean. Stronger tax administration and reduced leakage ensure the budget does not rely on the NBE’s money creation. If a supply shock hits, such as a spike in fuel, wheat, or fertilizer prices, the response should be surgical: time-limited tariff relief or targeted transfers to vulnerable households, rather than broad subsidies that reignite demand and unanchor expectations.

It's important to note that this commentary sets aside, for clarity, the inflation that may arise from supply-side interruptions in a fragile and rapidly changing global environment and from the bureaucratic red tape that still hinders domestic production. Those pressures are real and must be managed with separate tools. Judged on its own terms, however, the removal of the credit cap per se is unlikely to push inflation higher, provided policy remains tight and instruments are applied with discipline.

Thus, the public discussion should move beyond the shorthand of ‘cap removal equals more inflation’ to the mechanics of a modern framework.

If the above elements hold, inflation should continue to drift downward toward single digits. If they falter, policymakers have clear levers to tighten further. The lifting of the cap is not the opening of floodgates; it is the retuning of the gate, ensuring that prices rather than quotas govern how much water flows.