Ethiopia Developments in Reserve Money and Monetary Ratio 2022/2023 QII

In the second quarter of 2022/2023, Ethiopia experienced notable developments in its reserve money and monetary ratios, reflecting the dynamics within the country's monetary system. The Reserve requirement of commercial banks has reached 121.6 million birr and Reserve money reached Birr 420.4 million birr at the end of second quarter 2022/23; indicating a 26.5 percent annual and 12.3 percent quarterly growth. This significant annual increase in reserve money was reflected by 27.3 percent rise in banks’ deposits at NBE and 25.8 percent growth in currency in circulation. Due to a downward revision of reserve requirement from 10 percent to 7 percent and the boost in saving deposit in the banking system, excess reserve of commercial banks showed dramatic 533.9 percent annual growth

Reserve requirements for commercial banks refer to the regulations set by the central bank or banking authorities that mandate the minimum amount of reserves that banks must hold against their deposits. These reserves are typically held in the form of cash or deposits with the central bank. The purpose of reserve requirements is to ensure that banks maintain a certain level of liquidity and have sufficient funds available to meet the demands of depositors. Reserve requirements serve as a safeguard to protect depositors' interests, maintain stability in the banking system, and facilitate the effective implementation of monetary policy.

The provided data presents information on reserve requirements, actual reserves, and excess reserves for commercial banks (CB) for the periods 2021/22 QII, 2022/23 QI, and 2022/23 QII. The reserve requirement for commercial banks decreased from 135,408.1 million birr to 108,871.2 million birr and then increased to 121,694.2 million birr over the given periods. This represents the minimum amount of reserves that commercial banks are required to hold against their eligible liabilities.

The actual reserves held by commercial banks increased from 145,557.2 million birr to 169,741.7 million birr and further to 186,027.9 million birr. This indicates the total amount of reserves held by commercial banks, including both required reserves and any excess reserves voluntarily held by the banks.

The excess reserves for commercial banks increased from 10,149.1 million birr to 60,870.5 million birr and further to 64,333.7 million birr. Excess reserves represent the amount by which actual reserves exceed the required reserves. These excess reserves provide banks with additional liquidity beyond the minimum requirement.

Overall, the data shows that commercial banks have maintained reserves above the required minimum. The increasing trend in excess reserves indicates that commercial banks have voluntarily held higher levels of reserves, potentially reflecting a more cautious approach or a preference for maintaining higher levels of liquidity.

Reserve money, also known as high-powered money or monetary base, refers to the total amount of currency in circulation and the reserves held by commercial banks in a country's central bank. It represents the most fundamental form of money supply in an economy and serves as the basis for the creation of other types of money in the financial system.

Reserve money consists of two main components

• Currency in circulation: This refers to the physical notes and coins in the hands of the public, including individuals, businesses, and financial institutions. It represents the portion of money supply that is held outside of the banking system.

• Reserves held by commercial banks: Commercial banks are required to hold a certain percentage of their deposits as reserves, which are typically held in accounts with the central bank. These reserves serve as a safeguard to ensure that banks have sufficient liquidity to meet customer demands and regulatory requirements. They can include both required reserves, which are mandated by central bank regulations, and excess reserves, which banks hold voluntarily.

The central bank has the authority to control and influence the level of reserve money in the economy through various monetary policy tools. By adjusting the reserve requirements or conducting open market operations, such as buying or selling government securities, the central bank can increase or decrease the supply of reserve money.

The provided data represents reserve money, currency in circulation, and banks' deposits at the National Bank of Ethiopia (NBE) in millions of birr over a period of time. The reserve money increased from 332,391.5 million birr in QII of 2021/22 to 374,445.4 million birr in QI of 2022/23 and further to 420,369.6 million birr in QII of 2022/23. This indicates an expansion in the monetary base, which is driven by factors such as the central bank's open market operations, changes in reserve requirements, or injections of liquidity into the banking system.

Currency in circulation, representing the physical notes and coins held by the public, increased from 187,463.1 million birr in QII of 2021/22 to 207,614.8 million birr in QI of 2022/23 and further to 235,833.6 million birr in QII of 2022/23. This indicates a rise in the demand for cash in the economy, potentially reflecting increased economic activity or changes in people's preferences for using physical currency.

Banks' deposits at the NBE, which include both required reserves and excess reserves held by commercial banks, increased from 144,928.4 million birr in QII of 2021/22. to 166,830.6 million birr in QI of 2022/23. and further to 184,536.0 million birr in QII of 2022/23. This indicates that banks held more reserves with the central bank, potentially due to factors such as increased deposit inflows, changes in reserve requirements, or adjustments in the central bank's monetary policy operations.

Overall, the increasing trend in reserve money, currency in circulation, and banks' deposits at the NBE suggests an expansionary monetary policy stance during the given period.

The money multiplier refers to the ratio that represents the relationship between the money supply and the monetary base (reserve money) in an economy. Specifically, the data provided presents the money multiplier ratios in terms of narrow money to reserve money and broad money to reserve money. The provided data represents the money multiplier ratios for the periods 2021/22 QII, 2022/23 QI, and 2022/23 QII, expressed as the ratios of narrow money to reserve money and broad money to reserve money.

Narrow money refers to a specific measure of the money supply that includes the most liquid forms of money, typically consisting of currency in circulation and demand deposits held at banks or other financial institutions. It represents the portion of the money supply that is readily available for transactions and immediate spending.

The narrow money to reserve money ratio increased from 1.5 to 1.6 and then decreased back to 1.5 over the given periods. This indicates that, on average, each unit increase in the reserve money resulted in a corresponding increase in narrow money by a factor of 1.5 or 1.6, reflecting the expansion of the money supply through bank lending and deposit creation.

Broad money refers to a measure of the money supply that includes not only narrow money but also additional components that are less liquid but still considered part of the overall money stock. It encompasses a wider range of financial assets that serve as stores of value and mediums of exchange. The components of broad money typically include: Narrow money , Savings deposits, Time deposits, and Money market funds. Broad money provides a more comprehensive view of the money supply within an economy. It captures a broader range of financial assets that serve as a store of value and can be readily converted into purchasing power.

The broad money to reserve money ratio increased from 4.4 to 4.8 and then slightly decreased to 4.6 over the same periods. This signifies that, on average, each unit increase in the reserve money led to a broader expansion of the money supply, encompassing various types of deposits and liquid assets, by a factor of 4.4, 4.8, or 4.6.

The trends in the money multiplier ratios indicate the extent to which the banking system has been able to create money through its lending activities. A higher ratio suggests a greater ability to generate credit and expand the money supply, while a lower ratio indicates a relatively lower level of credit creation.

The provided data presents monetary ratios expressed as percentages for the periods 2021/22 QII, 2022/23 QI, and 2022/23 QII. These ratios provide insights into the composition and relationships between different components of the money supply. In the provided context, the term 'currency' refers to physical notes and coins that are issued by the central bank and held by the public. It represents the tangible form of money that individuals and businesses can use for transactions. In addition, quasi money refers to a component of the money supply that includes financial assets that are highly liquid and can be easily converted into cash or used as a medium of exchange, but are not considered physical currency.

The currency to narrow money ratio decreased from 38.6% to 34.8% and then increased to 36.5% over the given periods. This indicates that, on average, a smaller portion of the narrow money supply was held in the form of physical currency, while a larger proportion was held in demand deposits or other more liquid forms.

The currency to broad money ratio decreased from 12.8% to 11.5% and then increased to 12.1% over the same periods. This suggests that, on average, a smaller portion of the broad money supply was held in the form of physical currency, while a larger proportion was held in savings deposits, time deposits, or other less liquid components.

The narrow money to broad money ratio remained relatively stable, with slight variations around 33.3% to 33.2% over the given periods. This indicates that, on average, narrow money represents approximately one-third of the broader money supply, encompassing both narrow money components (currency and demand deposits) and broader components (savings deposits, time deposits, etc.).

The quasi money to broad money ratio remained relatively constant around 66.7% to 66.8% over the same periods. Quasi money refers to the portion of the money supply that is relatively less liquid, including savings deposits, time deposits, and other near-money instruments. The stability of this ratio suggests that quasi money consistently represents approximately two-thirds of the broader money supply.

Overall, the data indicates certain trends in the composition of the money supply. There is a decreasing reliance on physical currency as a proportion of both narrow money and broad money, indicating a greater preference for digital and non-cash transactions. The ratios also highlight the relatively stable relationships between different components of the money supply, reflecting the overall structure of the monetary system.

Source: Staff Computation, NBE