Determinants of foreign exchange reserve and exchange market pressure in Ethiopia

Purpose During the period from 1995 to 2024, Ethiopia experienced a declining trend in foreign exchange reserve adequacy and increase in exchange market pressure. Foreign reserve remained below three months of import coverage on average and the county’s currency gradually lost its value. This study aims at analyzing the determinants of foreign reserve and exchange market pressure in Ethiopia, emphasizing the effect of foreign price, domestic policy and international capital inflows in the form of remittance and foreign direct investment (FDI), which are not considered in the earlier works in case of Ethiopia. Design/methodology/approach Theories on motives for foreign exchange reserve holding and monetary approach to balance of payment are used as a theoretical basis. Seemingly unrelated regression model, justified by cross equation residual correlation, is applied to annual data from 1995 to 2024. Findings The result from seemingly unrelated regression shows that foreign reserve is affected by GDP, remittance, domestic credit and foreign price. Foreign reserve increases with a rise in GDP and remittance but declines with increase in domestic credit and foreign price. Exchange market pressure is affected by GDP, net export and domestic credit. Increase in GDP and net export reduces exchange market pressure while increase in domestic credit increases it. The results remain robust across alternative control variables and proxies for foreign price. Practical implications This study implies that policy measures related to reserve and exchange rate should take into account economic conditions in the rest of the world. Promoting remittance, managing domestic credit, supporting import substitution and economic growth is crucial. Originality/value This study is different from earlier works in Ethiopia because, firstly, it is comprehensive, including external factors and domestic policy variables. Secondly, it uses seemingly unrelated regression model and benefits from cross equation residuals information.