The central bank is embracing a price-based monetary policy, a departure from its traditional approach, as part of a comprehensive three-year strategy outlined by the National Bank of Ethiopia (NBE). The shift, spearheaded by Governor Mamo Mihretu, and his advisors, is seen as an essential step towards addressing the country’s long-standing macroeconomic constraints.

The strategy, unveiled last week, aspires to achieve robust macroeconomic stability through a series of quantitative goals, including beefing up the foreign currency reserves to cover two and a half months of imports by 2026. The plan also targets a significant reduction in inflation, bringing it down to eight percent. It seeks to expand the role and value of digital payments and financial services, with an ambitious goal to increase them more than fourfold to 17 trillion Br.

Central to this strategy is the establishment of a market-based monetary system. The central bank is set to reactivate a monetary policy committee that will spearhead this transition. The committee is expected to guide the economy towards a system where monetary policy decisions are influenced by market dynamics, rather than ideologically driven and government-directed path. Price stability is presumed to be the top priority. Eventually, reconsidering current policies on capital accounts and current accounts based on studies is also part of the strategy.

Fikadu Digafe, the central bank's vice governor, described the shift as a move towards a "more modern system." He believes the price-based monetary system is in line with global central banking trends, where using interest rates as a nominal anchor to steer the economy is the rule. According to Fikadu, this approach allows for enhanced liquidity management, which is crucial for a growing economy like Ethiopia.

"It's an essential instrument in liquidity management," he told Fortune.

A critical instrument in the new strategy is open market operations, a tool for managing liquidity in the economy by allowing the movement of finance based on demand and supply. The central bank's recent agreement with the US-based technology firm, Motran, is instrumental. Motran will supply a Central Securities Depository (CSD), a system essential for implementing open market operations. Supported by a 2.5 million dollar fund from the World Bank, the company's earlier involvement includes supplying the CORE banking system twelve years ago.

One of the central bank’s key initiatives is to transform the size, shape, and scope of the financial sector. This transformation includes expanding access to financial services, digitisation, and encouraging foreign investors and capital markets participation. The strategy emphasises the need for a 'clean and adequate' currency supply, ensuring financial institutions access sufficient high-quality bills. The approach is expected to streamline currency management across the banking sector.

The shift in policy is also expected to have implications for the nascent capital markets. Interest rates are anticipated to play a more significant role in market dynamics, with the central bank retaining a mandate over inter-banking operations. Brook Taye (PhD), the director general of the Capital Market Authority, noted that market-based principles in security markets facilitate a transparent price discovery process, which is indispensable for a thriving capital market.

"The price discovery process can help," Brook told Fortune.

Zemen Bank recently became an inaugural investor in the Ethiopian Security Exchange (ESX) with a five percent stake. Its President, Dereje Zenebe, welcomes the central bank's move, noting that the lack of modern financial instruments has previously impacted liquidity.