SOEs at a far lower interest rate than the market ones. For instance, on average the NBE financed about half of the domestic financing during the last three years at a rate of 3 percent per annum. That is in addition to its financing through the DBE. The minimum deposit interest rate is currently 7 percent and the annual headline stood at 10.9 percent in January 2019. Social security agencies are required to invest their pension receipts on government T‐bills at 1.2 percent per annum. Fiscal costs therefore dwarf any other considerations (e.g., macroeconomic stability, resource allocation efficiency) in the authorities’ interest rates decision.

# 3.2. Inflationary pressures

The NBE has become less effective in controlling monetary aggregates and prices. As noted above, a main purpose of the NBE is to maintain stable rate of price.<sup>65</sup> To achieve this objective in the absence of indirect monetary instruments, the NBE sets the monetary base as a nominal anchor to ensure that its growth remains in line with the projected nominal GDP growth rate.<sup>66</sup> Given that the NBE does not directly control broad money, the growth rate of base money/reserve money is used as the NBE’s operational instrument.<sup>67</sup> In conducting such a direct monetary control, the robustness of the causal relationship between the instrument (base money) and the final objective (inflation) depends on two key variables: the stability of money demand and the quality of real GDP forecast. First, with the ongoing rapid financial deepening (total deposits of the banking system increased by 28.4 percent in 2017/18), the money multiplier (ratio of broad money to reserve money) has significantly increased over time. It has doubled over the last 7 fiscal years. In September 2018, the money multiplier was 8.6 percent higher than a year earlier. This makes the forecasting of the demand for money in any NBE financial programming exercise quite uncertain, and so the new injection of reserve money consistent with the inflation objective. Second, the forecasting of real GDP growth introduces another major uncertainty in the exercise; especially when the forecasting error tends to be systematically positive. Using data on intensity of light emitted at night as measured by satellites from outer space, it has been estimated that GDP in Ethiopia may have been over‐estimated by around 17 percent since 2008.<sup>68</sup> The combination of these uncertainties and biases has loosened the control of the NBE on broad money growth and ultimately inflation.

Annual inflation increased to 16.8 percent in 2017/18 against a target of 8 percent. Annual inflation accelerated in the aftermath of the October 2017 devaluation and peaked at 16.8 percent in June 2018. It has since decelerated to 10.9 percent in January 2019 as monetary policy was tightened. This was facilitated by some inflation repression. Several goods and services are subject to direct or indirect price controls in the forms of subsidies (e.g., wheat, edible oil, petroleum products), export bans on selected food items (e.g., teff), and public utilities. The Trade Competition and Consumers’ Protection Authority is reportedly exercising at times moral suasion when private sector operators decide to increase their sale prices.<sup>69</sup>

> 65 Proclamation No. 591/2008.

> 66 NBE (2009). NBE’s Monetary Policy Framework, Economic Research and Monetary Policy Process.

> 67 Reserve money or base money is defined as the sum of currency in circulation and deposits of commercial banks at the NBE.

> 68 McGregor, Thomas (2018). Shining a Light on Ethiopia’s GDP. IMF mimeo.

> 69 See the Trade Practice and Consumer’s Protection Proclamation No. 685/2010.

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