Ethiopia is set to remove its two-year-old lending cap by September 2025, a major shift aimed at stimulating credit growth and supporting economic expansion. The move, announced in the latest International Monetary Fund (IMF) review of Ethiopia’s economic reform program, is part of broader efforts to modernize the country’s financial sector and transition toward a more market-driven economy.

The National Bank of Ethiopia (NBE) first imposed the lending cap in August 2021 to combat high inflation caused by rapid credit expansion. Initially, the restriction limited commercial banks to increasing their annual lending by only 14% of their previous year’s loan volume. By the end of last year, this cap was slightly raised to 18%. However, businesses and financial institutions have long argued that the restriction severely constrained liquidity, limiting investment opportunities, and slowing economic growth.

With the cap in place, access to financing has been a major challenge, particularly for small and medium-sized enterprises (SMEs), which rely heavily on bank loans for expansion. Many businesses faced delays in securing funds, while sectors such as manufacturing, construction, and agriculture struggled to access the capital needed for growth.

The decision to lift the cap marks a significant policy reversal and aligns with Ethiopia’s broader financial reforms. According to the IMF, the removal of credit growth caps is a key step in transitioning toward market-based financial policies, where lending decisions will be driven more by economic fundamentals rather than regulatory constraints. However, the IMF emphasized that this shift must be carefully managed to avoid financial instability.

To ensure a smooth transition, the central bank is expected to adopt a more flexible approach to monetary policy while continuing to monitor inflation and liquidity conditions closely. The NBE has also committed to gradually adjusting interest rates to maintain positive real rates by March 2025, ensuring that borrowing costs reflect economic conditions.

Lifting the lending cap is expected to provide a much-needed boost to Ethiopia’s economy. With banks able to extend more credit, businesses and investors will have greater access to financing, allowing for expansion, job creation, and improved productivity. The removal of restrictions could also reinvigorate the real estate and construction sectors, which have faced significant financing hurdles due to limited credit availability.

However, financial experts caution that while increasing credit availability is positive, it must be accompanied by effective inflation control measures. Ethiopia has faced rising inflationary pressures, exacerbated by the depreciation of the Ethiopian birr since the country moved to a floating exchange rate system six months ago. The currency has lost over 100% of its value against the U.S. dollar, leading to increased import costs and inflationary risks.

The IMF projects that inflation will peak at around 25% in mid-to-late 2025 before gradually declining to single digits by 2028. To manage these risks, the central bank will need to implement a data-driven approach to monetary policy, ensuring that increased lending does not fuel excessive inflation.

Despite the positive outlook, the transition will require careful planning. The IMF has stressed the importance of sequencing reforms properly and maintaining clear communication with financial institutions and businesses to manage expectations. The central bank must also balance credit expansion with measures to stabilize the exchange rate and avoid excessive liquidity in the market.

One of the key recommendations from the IMF is to avoid direct central bank financing of government spending, which could undermine efforts to control inflation. Instead, policymakers are encouraged to focus on strengthening financial sector oversight and ensuring that banks allocate credit efficiently.

As Ethiopia moves toward lifting lending restrictions, the success of the reform will depend on how well authorities manage inflation, maintain investor confidence, and support a smooth transition to a more open and market-oriented financial system. If executed effectively, the move could mark a turning point for Ethiopia’s banking sector and broader economic trajectory, unlocking new opportunities for businesses and investors alike.