For over three years, high inflation has been a persistent challenge for the National Bank of Ethiopia (NBE) and the overall Ethiopian economy. Retail and wholesale price increases above 30 percent eroded living standards and damaged confidence as the monetary authorities struggled to get inflation under control.
However, the latest data from the NBE provides tentative signs that the central bank may have finally found the right policy approach to tame prices. In a major development, latest figures show successes over recent months in reining in money supply growth and bringing down soaring inflation rates.
If sustained, this could mark an important turning point in the country's battle against rising costs of living. It would suggest the central bank's stricter monetary stance adopted last August is gaining traction and may help Governor Mamo Mihretu’s deliver his promise to guide inflation down to single digits by mid-2025.
The Policy Pivot
Faced with unrelenting inflationary pressures, the NBE announced in August 2023 that it was shifting to a tighter monetary policy. It placed limits on annual lending growth for commercial banks at 14 percent and increased the interest rate on banks' borrowing facilities with the central bank.
Direct advances to the government - which had ballooned in prior years - would also be slashed by two-thirds in the current fiscal year. The aim was to gradually deleverage public debt obligations from the central bank's balance sheet.
Observers saw these as decisive moves signaling the NBE's resolve to get tough on excess liquidity circulating in the system. Years of accommodative policy had worsened inflation, necessitating bolder action even at the cost of potentially slowing growth.
The new stance aimed to restore price stability as an overriding priority - a prerequisite for productive investment and sustainable development over the long run. Getting inflation under control was also critical for preserving the purchasing power of ordinary Ethiopians confronting high living costs.
Early Signals of Success
Now some six months on, initial figures released by the NBE point to the policy pivot having the desired effect of cooling key segments of the economy. The growth of broad money supply (M2), which captures total liquidity in the banking system, declined sharply.
M2 expanded by 49.5 percent in August but had slowed to 28.7 percent by the end of 2023, according to the central bank's monthly statement. This suggests commercial banks have obeyed the lending cap and tightened overall credit extension.
Meanwhile, the yearly increase in reserve money - the most liquid portion of the money stock comprising currency in circulation and bank reserves - eased from 33.4 percent to 18.7 percent over the same period. This points to moderating base money formation.
Other indicators also indicate slowing underlying cash growth. The annual rate of currency issuance came off 19.8 percent in August to just 6.7 percent by December. This is an indication of softer transactional demand for physical cash as overall economic activity loses momentum.
Most significantly of all, actual inflation outcomes have started to reflect the tighter financial conditions. The monthly headline inflation rate has fallen sharply, coming down from 3.4 percent in June to 0.7 percent by the close of 2023 according to NBE data.
Assuming this persists, the implied annualized inflation rate would moderate to 17.3 percent by end-2023 - still elevated but a notable slowdown from the prior months and an encouraging sign prices could continue easing over the coming quarters.
Signs of Disinflation, But Risks RemainÂ
While the recent decline in inflation indicators provides hope that Ethiopia's long battle with rising prices may finally be turning a corner, policymakers must remain cautious. It might be too soon to declare victory over inflation given several downside risks that could re-emerge.
One key risk is that the disinflationary trends so far only cover a short six-month period, which may not be long enough to confirm a sustained slowdown. Inflation data can be volatile, and longer trends will need to materialize before concluding that momentum toward lower inflation is durable.
Food prices additionally pose a threat, as they account for over half of the consumer basket and are influenced by unpredictable factors like weather and global commodity markets. High agricultural costs could arrest further declines in headline inflation.
Budget pressures also risk reversing the recent monetary tightening. Many government agencies are demanding higher budgets after reductions in the prior two fiscal years, potentially weakening fiscal discipline. Loose fiscal policy would clash with the central bank's inflation-fighting efforts.
External vulnerabilities compound these domestic risks. A weaker currency raises import prices and the disruption to Red Sea shipping has inflated costs for key exports like coffee. This drains foreign exchange needed to pay for imports and exerts more inflationary pressure. Ongoing foreign exchange shortages remain a vulnerability for consumer prices.
Only time will tell if these downside risks materialize or if monetary policy can consolidate gains against inflation. But economists agree the battle is not yet won given multiple factors that could still derail the tentative progress on prices. Continued vigilance is warranted.