NBE itself, the introduction of a wider range of monetary instruments should “engender competition, efficiency and transparency and broaden financial intermediation in the banking system.” It also ought to “promote liquidity management of commercial banks and gradually leads to the development of well‐ functioning money and financial markets, which could serve as catalysts for economic growth and development.”<sup>101</sup> The NBE should therefore envisage to use a mix of diversified monetary policy instruments to more effectively carry out its monetary management function. In coordination with the government issuance of tradable securities (see above), the NBE should use open market operations to sale or purchase government securities and its own certificates as the main indirect instruments of controlling liquidity. To prepare the ground for enhanced open market operations, the yield on government securities should be at least close to the minimum saving deposit interest rate—currently 7 percent on annual basis—or targeted inflation rate. As a next step, a secondary market for government securities needs to be established, together with the development of direct borrowing/lending in the inter‐bank money market and introduction of a re‐purchase agreement (repo/reverse repo operations).

Phasing out administered interest rates. The interest rates on government securities, NBE‐bills and associated ones, and SOEs’ borrowing rate from CBE have been set administratively. This policy, which has resulted in a growing mis‐allocation of resources, has contributed to the scarcity of resources in the economy and hindered sustainable economic development. Thus, the NBE should consider letting those rates be determined by market forces in the not too distant future.

Phasing out mandatory financing of priority sectors and directed credit. As noted above, the banking system has been financing the priority sectors mandatorily and credit has been directed largely to the public sector. This has been done in two ways in line with the ownership structure of the banks. On the one hand, public banks (CBE and DBE) have been required to allocate resources as per their annual cashflow prepared by NBE and approved by the Macro Committee. Financing needs of SOEs have been the main factors considered in the approval process, in addition to financing capacity of the banks. These allocations have been made based on an administered interest rate structure. On the other hand, private banks are required by a directive to allocate part of their resources to sectors identified by NBE through a below‐market interest rate, that is, through the 27‐percent rule. The NBE should gradually relinquish its discretionary power on credit allocation and let the market participants make their own choices.

# 4.6. Improving fiscal and monetary policy coordination and transparency

Improving the coordination between monetary and fiscal policy. The move to more indirect monetary controls would require greater coordination between the NBE and the MOF. The NBE and MOF already decide the amount and tenor of the securities to be issued, considering both the government’s cash requirements and what is required for monetary policy purposes. Moving forward, the two institutions would need to clarify whether NBE transactions in government securities are for meeting the government’s borrowing needs or for monetary policy purposes. The MOF would also need to significantly improve the quality of the forecast of the current and future domestic debt transactions and central government cash flows.<sup>102</sup>

> 101 NBE (2009). NBE’s Monetary Policy Framework, Economic Research and Monetary Policy Process. Addis Ababa.

> 102 World Bank (2013). Debt management Performance Assessment (DeMPA). World Bank Group. Washington D.C.

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