Overview
The first private bank in Ethiopia, Addis Ababa Bank, was established in the 1960s. Now over half a century later, the Ethiopian financial sector consists of 3 public banks including the Development Bank of Ethiopia (DBE), 28 private banks, around 20 private insurance companies, 1 public insurance company, 45 microfinance institutions with three having transitioned into banks in the past year and over 20,000 Saving and Credit Cooperatives (SACCOs) in both rural and urban areas.
For years, the sector has been affected by several issues ranging from discouraging regulations to a lack in capacity from the players in the sector. However recently the financial sector seems to have been targeted to spear head a new era for the country. From liberalizing laws, to allowing foreign investors to participate, effecting an enabling space for digital financing, and fostering communication within the sector, the Government is showing considerable effort in aiding the financial services sector to realize its full potential. These efforts were first reflected in the consecutive GTP (Growth and Transformation Plan) I and GTP II of the country in which the Government sought to realize economic development, using growth in GDP as its most important success marker in addition to the vision of Ethiopia becoming a lower middle-income country by 2025 as laid out in the GTP II. Despite the country's growth, it struggled to attain the desired level of structural transformation and increase exports due to challenges such as foreign exchange shortages, high inflation, and mounting foreign debt.
Building on these plans, the Government introduced the Home-Grown Economic Agenda in 2020, with the goal of addressing these issues by the end of the 2020s. The agenda revolves around three key pillars: macro-financial reforms, structural reforms to facilitate investment and economic growth, and sectoral reforms to enhance regulations and foster investment in specific areas. Its overarching aim is safeguarding macro-economic stability, rebalancing and sustaining growth and promoting private investment and structural transformation.
1. The Macro Financia l Reforms
The most significant reform in the financial sector was the transition to a market-based foreign exchange regime. Banks are now permitted to buy and sell foreign currencies freely among themselves and to their clients at negotiated rates.
The FX reform also reduced surrender requirements, allowing exporters to retain foreign exchange. This measure is anticipated to significantly increase the supply of foreign currency available to the private sector. Furthermore, restrictions on imports have been lifted for 38 product categories, facilitating broader access to foreign currency for goods and services while maintaining existing limits on capital account outflows. The previous waiting list system governing banks' allocation of foreign exchange has also been abolished, streamlining access for importers.
Other important changes in the FX regime include the removal of restrictions on franco valuta imports, simplification of rules for foreign currency accounts, and the ability for residents to open and operate such accounts based on various inflows. The reforms also lift interest rate ceilings on external borrowing for private sector companies from abroad. Special Economic Zones will also benefit from exclusive foreign exchange privileges under the FX reform, permitting companies to retain 100% of their earnings in foreign currency and trade in foreign currency among themselves.
The other significant macro financial reform is that foreigners will soon be allowed to invest in the banking sector of Ethiopia based on the policy that was passed in June 2024 and the proclamation is currently awaiting parliamentary ratification.
According to this legislation reputable, financially sound and well‑established foreign banks would be allowed to set up partially or fully owned subsidiaries; open a foreign bank branch or representative office; or purchase shares in an existing bank in addition to being able to employ foreign nationals as senior executives subject to certain restrictions.
The other major reform is the introduction of capital market in the country. Although there have been plans for an Ethiopian Stock Market for years, the plans have been solidified since the Government passed the proclamation 1248/2021 on the Ethiopian Capital Market. Consequently, the Government has announced in May of 2022 it plans to launch the Ethiopian Securities Exchange with plans to list around fifty companies initially. The launch of the ESX is expected to be in late 2024 or early 2025 with preparatory plans at their final stage. Currently the Ethiopian Capital Market Authority has finalized setting up a regulatory sandbox where in potential stock market sellers can develop their products with the Authority before going public. The Authority will be accepting applications for the Regulatory Sandbox until the end of September 2024. Ethiopia’s securities market will also be accessible to foreign and domestic investors.
2. Stabilizing Measures
The Government has also incorporated some plans to stabilize the market during the transition to a market-based FX exchange rate regime. The Government has opted to temporarily subsidize essential imports, such as fuel, fertilizers, medicine, and edible oil. This approach aims to mitigate the immediate impact of price fluctuations on these critical commodities, which are vital for millions of urban residents and farmers. By gradually passing through price changes while providing subsidies, the Government seeks to alleviate the financial burden on those most reliant on these imports. Recognizing the adverse effects of high inflation on real incomes, the Government is also enhancing financial support for affected individuals. To address both past and anticipated inflationary pressures, there are plans to supplement civil servant salaries in a sustainable manner. Additionally, funding for Ethiopia’s Productive Safety Net Program (PSNP), which supports low-income rural and urban families, will be substantially increased, aiming to assist nearly ten million households.
Furthermore, the Government is securing debt service relief to protect budget allocations for social services and capital projects. By arranging this relief in advance, the Government intends to alleviate the financial strain of external debt obligations, allowing for increased developmental expenditures in the current and future fiscal years. This strategic approach ensures that essential services and investments are not compromised by rising local currency costs associated with debt servicing. National Bank of Ethiopia (NBE) and the Ministry of Finance are also enhancing their collaboration to effectively manage the transition to a new exchange rate regime while ensuring sound monetary and fiscal policies in the immediate future.
Additionally, NBE has introduced an interest-rate-based regime, wherein the Bank has set a Policy Interest Rate or a National Bank Rate of 15% to help stabilize the economy and better handle inflationary pressure. Previously, the NBE had set a 14% lending cap on all commercial banks in the country. Now, with the shift towards an interest rate-based system, the lending cap is lifted but banks are required to set their borrowing interest rates within a standard rate close to the one set by the NBE. To ensure the effectiveness of this strategy, NBE may intervene if banks set rates significantly differing from its own.
Concurrently, the Ministry of Finance is implementing strategies to strengthen the revenue base, which will enable increased Government spending without resorting to inflationary financing methods, such as direct advances from the NBE.
A key aspect of this transition is the financial support package of $10.7 billion from Ethiopia's external partners, marking the largest coordinated commitment of international support for the country. This package includes exceptional financing from the International Monetary Fund (IMF), the World Bank, and various creditors, alongside an additional $2.8 billion in bilateral support through central bank deposits and swap lines. The IMF and World Bank have committed to providing front-loaded funding, reflecting their confidence in the Government's reform agenda.
In the immediate term, NBE will focus on ensuring a smooth transition to the new foreign exchange regime while maintaining its core mandate of price stability. To facilitate this process, NBE has revealed its plans to conduct regular press briefings and updates during the initial stages of reform.
3. Digitalization of Financial Services
The Government allowed the entry of foreign nationals of Ethiopian Origin into the digital financial services sector based on the Banking Business Amendment Proclamation issued in 2019. In 2022, foreign entities have also been allowed to invest in digital financial service provision in Ethiopia with the enactment of the National Payment System Amendment Proclamation No. 1282/2022.
This new law is part of the Government targeting legal framework as a pillar of digitalization of the country’s payment system. After launching the “digital Ethiopia’ initiative in 2020, the Government launched the National Digital Payment Strategy (NDPS) in 2021 to enable the digitalization of the country through efficient payment systems. The NDPS has four pillars and four enablers which respectively are:
- Developing a reliable, inclusive and interoperable infrastructure,
- Championing adoption of digital payments,
- Building a robust and consistent regulatory and oversight framework; and
- Creating an enabling environment for
- Committing to an efficient, reliable, and safe national payment system,
- Prioritizing and investing in capacity-building across the digital payment ecosystem,
- Guaranteeing active and ongoing coordination with national development reforms and policies; and
- Building a robust governance and implementation plan, and monitoring success using key performance indicators (KPIs).
Digital payment services in Ethiopia are experiencing significant growth. In 2021, Ethiotelecom launched Tele birr, its mobile money platform, which saw an impressive achievement of over 42 million users within two years of its service. The digital finance sector’s value, volume, number of subscribers, and transactions per subscriber are all increasing, with transactions reaching ETB1.6 trillion in 2022.
Currently there are over 11 non-bank payment service providers operating in the Ethiopian financial sector, including Ethiotelecom (Telebirr), Safaricom PLC (M-Pesa), Ethswitch (the national switch), Premier Switch Solution, Kacha Digital Financial Services, Arif Pay Financial Technologies, and Chapa Financial Technologies.
This surge in digital payment services marks a pivotal moment for indigenous fintech in Ethiopia. The digitalization of financial services has not only significantly reduced operational costs for businesses as well as financial institutions but has also increased return on equity for both digital service providers as well as the businesses that use them. Furthermore, digital technology has revolutionized customer communication, enabling the provision of innovative financial services while lowering barriers to entry in the financial market. This democratization of financial services is particularly crucial in a country where access to banking has historically been very limited. However, despite these commendable achievements, there are challenges such as frequent power outages and unreliable internet connectivity that pose significant risks to the stability and efficiency of digital payment systems. Concerns surrounding digital identification, cybersecurity, and customer protection also remain paramount.
Further, the country is seemingly on its way to opening itself to digital currency. In June 2024, the Council of Ministers approved a draft legislation that is expected to introduce a Central Bank Digital Currency (CBDC) to the country’s financial sector. This expectation is further supplemented by the fact that even though the country bans crypto currency considering Birr as only the legal tender, it still allows digital mining. This has been a long-standing hint at the country’s desire to study the sector and implement it as carefully as possible.
In conclusion, the digital financial service sector in Ethiopia offers a promising a promising and largely untapped investment opportunity.
4. The Potential Implications of these Reforms
According to the IMF's macroeconomic assessment, these reforms could sustain annual growth rates near 8%, reduce inflation to 10%, increase fiscal revenue to 11% of GDP, lower debt to 35% of GDP, boost goods and services exports to $20 billion, attract foreign direct investment (FDI) of $6 billion, and elevate foreign exchange reserves to $10 billion equivalent to 3.5 months of import cover.
The reform will significantly impact Ethiopia's foreign earnings potential. Current policies have inadvertently encouraged practices like smuggling, under- and over-invoicing, and capital flight, hindering the country’s ability to realize its full foreign exchange-generating potential. By addressing these issues, the reform will redirect valuable resources into the local economy, benefiting businesses that rely on foreign exchange.
The foreign exchange reform will also help rectify long-standing business practices that have fostered informality and illegality within the economy. The previous exchange rate regime in Ethiopia had significantly diminished the incentives for foreign exchange to flow into the country through formal banking channels. This has led to a situation where foreign exchange-earning companies and individuals are more inclined to keep their earnings outside the country. As a result, many businesses and remittance senders and beneficiaries have begun conducting transactions at these unofficial rates, undermining the formal financial system.
By recognizing the prevalence of informal practices, the reform seeks to create an environment that discourages reliance on parallel markets and aspires to restore confidence in formal financial mechanisms.
Another significant advantage of the foreign exchange reform is its potential to significantly aid Ethiopia's import-substituting industries. By allowing these industries to scale operations and gain market share, particularly within the consumer and industrial sectors, the reform aligns with initiatives like "Ethiopia Tamrit," which promotes local production.
The opening of previously restricted sectors to private and foreign investment such as telecoms, banking, and logistics along with improvements in the ease of doing business and the introduction of Special Economic Zones, have also created numerous opportunities. By improving the attractiveness of Ethiopia for foreign investors, the reform is expected to increase foreign direct investment (FDI) inflows. Currently, Ethiopia's regulated exchange rate system, characterized by controls and supply shortages, affected the country’s investment potential despite its advantages such as a large population, a cheap workforce, competitive input costs, and abundant natural resources. A more conducive exchange rate regime is anticipated to remove this barrier, thereby enhancing FDI interest and activity.
The reform will also directly impact investors engaged in foreign currency-generating activities. Key beneficiaries include farmers producing exportable crops such as coffee, sesame, and pulses; pastoralists and livestock owners exporting cattle and meat; miners involved in gold extraction; manufacturing employees in export sectors; and businesses in tourism and services catering to international visitors. Additionally, millions who receive remittances from abroad, along with NGOs and private institutions reliant on external financing, will also benefit. The ripple effect of these changes will extend to business partners, suppliers, and dependents associated with these sectors, broadening the scope of reform beneficiaries.
This reform will also affect large scale projects that rely on substantial foreign equity and debt financing for their successful implementation. Many projects were put on hold due to the foreign currency availability, convertibility, and transferability risks in the country as well as the strict rules that required the remittance of all FX earnings to the country. With the potential for increased foreign currency earnings and the introduction of more permissive regulations for conducting foreign exchange operations offshore, it is expected that numerous pending projects will now move forward to completion. This shift is likely to attract new investment interests in critical sectors such as power, infrastructure, mining, and telecom, all of which necessitate substantial foreign currency investments. The removal of ceilings on interest rates applicable to foreign borrowings is also expected to significantly improve access to foreign financing by private investors.