A severe cash shortage squeezes the economy, and the deposit-to-loan ratio has slumped below 80pc, hitting its lowest point in decades. The scarcity of credit, often termed a credit crunch, has a strangling effect on the economy. Few businesses secure the funds they need, and enterprises struggle to meet working capital requirements. One need only talk to borrowers to sense the desperation of an ever-increasing number of banks, which may greet them with new branches, yet few can provide the liquidity required to finance businesses.
A new monetary policy by the National Bank of Ethiopia (NBE), under Governor Mamo Mihiretu, is part of the cause.
In his zeal to quell inflation, stubbornly around 19.9pc year on year (YoY) last year, the Governor has imposed a cap on credit growth for over a year, restricting how fast banks can expand their lending portfolios. Initially fixed at 14pc, this ceiling was only slightly loosened recently, allowing credit to grow by four more percentage points. But it hardly offers solace to those who had hoped the authorities would release the pressure on the economy more substantially.
Governor Mamo’s reluctance appears to have come from the desire not to flood the economy with cash, thus ceding a vital tool in the fight against inflation. At heart, he may have preferred a blunt ceiling on credit to not letting inflation run rampant, even if it stalls what he and his aides have often championed as price stability.
A second factor feeding the squeeze is dwindling deposit mobilisation. As the number of private banks has proliferated — 30 of them now jockeying alongside two state-owned behemoths — competition for deposits has grown fiercer. The past year has seen a remarkable expansion of bank branches, adding 266 new outlets in the last quarter alone to bring the total to 12,426. Yet, depositors are keeping their purse strings tight, and the impetus to save has wilted in the face of negative real interest rates.
Inflation so far outstrips deposit rates that saving becomes less attractive, eroding the fundamental base on which credit depends. Despite these headwinds, banks continue to lend, albeit under constricted circumstances.
In the final quarter of last year, loans amounting to 122.4 billion Br were disbursed, a modest but noteworthy 7.8pc increase from a year earlier. Private banks, for the first time edging past their public counterparts, accounted for 54.5pc of this volume. Such a milestone would normally cause applause, for it suggests these younger and smaller financial institutions are finally finding traction in an industry long dominated by state-owned banks.
The beneficiaries of these loans are spread across sectors, manifesting the slow but steady evolution of the economy. Domestic trade received the second largest share of the loans at 20.5pc, preceded by agriculture, which remains a mainstay, especially for smallholder farmers. It drew the largest share at 27.3pc, while the rising importance of manufacturing (15.7pc) points to a gradual push toward industrialisation.
Nonetheless, the overall credit picture is somewhat more complex.
Total outstanding credit has reached 2.1 trillion Br, a 10.1pc expansion YoY, but virtually all — 99.6pc — is tied up in private enterprises and cooperatives. The ratio mirrors the government’s encouragement of private-sector-led growth, a central plank in official rhetoric for years now. But, the balance between private and public lending, in practice, has not delivered the egalitarian spread of credit that policymakers sometimes pledge to achieve.
Recent data on reserve money uncovers the conundrum of the Governor and his team’s deliberate tightening in their bid to subdue inflation.
The banks’ reserve money shrank by 1.1pc in the past year to 473.2 billion Br. Ironically, the reserve requirement for commercial banks climbed by 15.4pc to 173.4 billion Br, an additional shackle on lenders who can ill afford further constraints. Yet, the reserve money multiplier jumped from 4.5 to 5.2, an indication that commercial banks have become more adept at generating credit out of deposits. While this might appear to hint at greater financial dynamism, it also points to mounting systemic risks.
The tension between curbing inflation and stimulating growth has rarely been sharper. Policymakers find themselves under siege, confronted with a double bind. Inflation might pick up anew if they loosen policy too much; if they remain hawkish, businesses would be strangled, and growth would decelerate. With national savings on a downward trend and foreign exchange in short supply, the Central Bank has chosen to emphasise inflation control.
Inaction, however, could not be an option. A downturn caused by illiquidity could develop into a deeper slump if left unaddressed. Lowering the reserve requirement ratio, thereby letting commercial banks deploy more of their funds as loans instead of holding them as sterile reserves, can be considered.
In a cash-starved environment, unlocking liquidity swiftly stimulates spending by businesses and households alike. Companies looking to expand, invest in new businesses, or cover wage bills could do so with greater ease, generating a ripple effect through employment and consumer demand.
Understandably, the Governor’s policy advisors remain sceptical of lower reserve ratios and caution against overreach. The memory of past bursts of lending that stoked inflation lingers. Flooding the market with cheap credit can, indeed, fuel price surges if the economy’s capacity to absorb increased spending lags behind. It may also spawn asset bubbles, especially in real estate ,where speculation runsahead of fundamentals.
Nonetheless, the immediate need for growth should weigh against these concerns. If inflation has shown signs of moderation — or at least is no longer galloping — then channelling extra cash into the credit system might tip the balance in favour of expansion. This, in theory, can boost investments, create jobs, and tighten the output gap so that the economy does not contract further.
Those who champion a cut to reserve requirements also note its precision compared to broader measures like across-the-board credit caps. Reducing the reserves, banks hold can be adjusted up or down more fluidly, providing the Governor with a fine-tuned instrument to nudge liquidity levels. On the contrary, credit caps risk stunting growth indiscriminately by treating all banks as uniform. The banks’ themselves, which vary in size, risk appetite, and portfolio composition, are then forced into a one-size-fits-all approach. Doing so has left promising enterprises starved of funds, a particular worry where finance is already scarce.
After all, an economy can ill afford stalling growth when it still relies on borrowed capital, and perhaps, as some would say, borrowed time.
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