Key View

• At Fitch Solutions, we expect that the National Bank of Ethiopia (NBE) will continue to struggle to control inflation over the coming quarters.
• We forecast that inflation will accelerate further over Q421 and remain elevated at an average of 25.0% in 2022, as conflict in the northern Tigray and Amhara regions continues to weigh on food supplies.
• That said, we expect the NBE to leave its policy rate unchanged at 7.0% in the coming quarters, since this remains an ineffective policy tool.

At Fitch Solutions, we expect that monetary policy in Ethiopia will continue to have a limited impact on inflation over the coming quarters. In August 2021, the National Bank of Ethiopia (NBE) doubled the statutory reserve requirement for commercial banks to 10.0% and raised the share of banks’ foreign-exchange holdings they must remit to the NBE from 30.0% to 50.0%. The objective was to tighten monetary policy by reducing money supply, in order to tackle a sharp rise in domestic inflation. However, the monetary transmission mechanism in Ethiopia is very weak, and we believe that these measures will be largely futile, not least because of the supply-side nature of recent inflationary pressures.

Inflationary Pressures To Persist In The Near Term

Ethiopia - Inflation, % y-o-y

 

Note: Fitch Solutions forecast. Source: Bloomberg, Fitch Solutions

Supply-side constraints will keep inflation elevated in Q421 and 2022. Ongoing conflict between the federal government and the Tigray People’s Liberation Front (TPLF) in northern Ethiopia has displaced more than 2.0mn people since its start in November 2020. Given that Amhara and Tigray – the two most affected regions – host much of Ethiopia’s farmland, fighting has significantly disrupted food supplies across the country, compounding the impact of erratic precipitation over most cropping areas. This has led to soaring food prices, causing headline inflation to rise from 18.2% y-o-y in December 2020 to 34.8% in September 2021 – the highest rate since February 2012. We see inflation rising further over Q421 due to persistent food shortages, with the main October-December crop harvest likely to be well below average. Meanwhile, the continued depreciation of the Ethiopian birr, which has lost 15.9% of its value against the dollar in the year to date, will increase import costs, further fuelling inflationary pressures.

Against this backdrop, we have revised up our forecast for 2021 average inflation from 26.0% to 27.1%. In 2022, we expect that inflation will remain elevated, slowing very slightly to an average of 25.0%, up from our previous forecast of 20.8%. The anticipated slowdown reflects the base effects of soaring prices in 2021, and our assumption that fighting in the north will subside somewhat by H222, resulting in improved output in the Q422 harvest season and lower food price pressures.

Policy Rate To Remain Unchanged And Ineffective

Ethiopia - Central Bank Deposit Rate, %

 

f = Fitch Solutions forecast. Source: National Bank of Ethiopia, Fitch Solutions

That said, we do not expect the NBE to hike the current policy rate over the coming quarters, since this remains an ineffective policy tool. The NBE’s policy rate, which determines the minimum interest rate on banks’ deposits, has a limited impact on lending rates, which are set relatively freely by banks. The policy rate has been left at 7.0% since 2017 despite a steady increase in inflation since 2019, and we believe that policymakers are unlikely to change it over the coming quarters, until it is eventually replaced by a new policy tool.

Over the medium term, we expect that the NBE will tighten monetary policy with the introduction of a new monetary policy framework, including an interbank interest rate that will serve as the new policy rate. These changes are expected to be implemented over the next three years, establishing an inflation-targeting regime. The new policy rate is likely to be closer to prevailing lending rates, as well as near or above headline inflation, which will effectively lead to tighter monetary conditions.