Ethiopia is set to issue licences to let foreign investment banks operate in the country, a key step ahead of its planned launch later this year of a securities exchange, the regulator's director told Reuters.

The liberalisation initiative has attracted foreign investors like Kenyan telecoms operator Safaricom but faced recent setbacks due to what some analysts say is an unpredictable regulatory environment, security concerns and macroeconomic instability.

The justice ministry authorised the capital markets regulator this week to go ahead with issuing the licences, said Brook Taye, Director General of the Ethiopian Capital Market Authority.

The move is part of a drive by Prime Minister Abiy Ahmed since 2018 to open up the country of 120 million to greater private investment.

Ethiopia's economy is still heavily controlled by the state, a legacy of being a command economy for decades, but the shift by Abiy towards more private sector involvement was notable for being more ambitious than previous attempts at opening up.

There are currently no investment banks in Ethiopia, and commercial banks are only able to offer limited funding to businesses due to prudential requirements.

Brook said demand for capital-raising services is "huge" because businesses are currently paying 25% interest on commercial bank funding and have to provide collateral worth 70% of the value of the loan.

"This is the biggest bottleneck in the Ethiopian economy. There is no optimal way to raise capital," he said.

The regulator is offering licences to global and regional investment banks, securities brokers and dealers and credit rating services providers who can help businesses list shares on the securities exchange and issue corporate debt, he said.

Brook said the exchange would launch sometime this year and would enable the government to plug its budget deficit by offering debt securities to retail investors.

Zemen, an Ethiopian commercial bank, will be among the owners of the exchange, after it committed to buying 5% of the shares last week, Brook said.

The Horn of Africa nation is facing acute foreign exchange shortages and high inflation. It defaulted on its $1 billion international bond last month after failing to make a $33 million coupon payment. (Reporting by Duncan Miriri; Editing by Aaron Ross and Hugh Lawson)