Introduction

Developing countries, including least developed countries (LDCs) and small island developing states (SIDS), are increasingly exposed to trade-related climate measures (TrCMs) despite their minimal contribution to global greenhouse gas (GHG) emissions. This briefing paper focuses on the European Union Deforestation Regulation (EUDR), a novel TrCM set to take effect by the end of 2026. The analysis evaluates the economic and financial risks arising from the application of the EUDR to Ethiopia’s coffee sector, a vital component of the national economy that supports approximately 15 million people.

Conceptual framework and methodology

The research adopts a framework developed by the Network for Greening the Financial System (NGFS) to assess exposure to economic and financial risks. It identifies transition drivers and transmission channels that operate at both macro and micro levels. The study utilised primary data collection through 28 key informant interviews (KIIs) conducted across a range of stakeholders, including financial institutions, cooperative unions, exporters, processors, and government bodies such as the Ethiopian Coffee and Tea Authority (ECTA).

Ethiopia’s coffee sector, risks and potential incentives

Coffee is central to Ethiopia’s economy, with the European Union (EU) accounting for approximately 30% of the country’s coffee exports in 2024. While coffee production is not a significant driver of deforestation—with no more than 20 coffee plots linked to post-2020 deforestation—the sector faces substantial administrative compliance risks. Ethiopia’s historical contribution to climate change is minimal, accounting for an estimated 0.36% of global emissions in 2023. However, climate change is already affecting production through increased pests, diseases, and the need to relocate cultivation to higher altitudes.

Ethiopia’s coffee production systems and market

The sector is dominated by around 4 million smallholder farmers who account for approximately 95% of total output. Production for the 2025/26 season is projected at 11.6 million 60-kilogram bags, reflecting a sustained expansion in output. Ethiopia achieved record revenue of $2.65 billion in the 2024/25 fiscal year. Production systems are heterogeneous, with garden coffee accounting for 50% of national production, followed by semi-forest (35%), forest (10%), and plantation systems (5%). These systems are often forest-friendly but present challenges for the plot-level traceability required by the EUDR.

Key findings: EUDR economic and financial risks

Ethiopia’s coffee export system is categorised into five supply chain tiers with varying levels of traceability. Preparedness efforts led by ECTA include a three-year National Action Plan and the development of the Ethiopian Coffee Traceability Management System (ECTMS). As of July 2024, ECTA had compiled geolocation data covering approximately 200,000 hectares, or 23% of the total coffee area. Despite this progress, significant challenges remain regarding the high costs of data collection, which are estimated at $4–7 per plot for collection and $5–12 per plot for verification.

The potential for market exclusion is high, with estimates suggesting that geolocation constraints could affect 10–20% of smallholders, while traceability issues could impact up to 57% of exports. These risks translate into potential coffee revenue losses ranging from $160 million in a conservative scenario to $453 million in a severe scenario. Benchmarked against a nominal Gross Domestic Product (GDP) of $126.36 billion in 2025, these losses could reach 0.5% of GDP. Macroeconomic consequences include potential foreign exchange losses of 2.2% to 6.3%, and up to 8.5% in a worst-case scenario, further straining foreign currency reserves which stood at $4.4 billion at the end of the 2025 fiscal year.

Complementary incentive mechanisms for avoiding deforestation

The report explores incentive mechanisms to complement due diligence approaches. These include price management and sustainability premiums, such as those provided by the Rainforest Alliance and Fairtrade International. Environmental pricing mechanisms, including carbon credits, results-based payments (REDD+), and payments for ecosystem services, are identified as potential additional revenue streams. For instance, the Oromia Forested Landscape Program provides a model for results-based payments in forest landscapes that overlap with coffee production areas.

Findings and recommendations

The study recommends reducing the risks of EUDR exclusion by working with informal collectors to understand exclusion risks and supporting smallholders to transition to more organised sales within cooperatives. It suggests that policymakers engage with EU authorities to clarify acceptable legality evidence and seek country-specific flexibility. Furthermore, the report advises developing complementary environmental pricing mechanisms that address productivity and sustainability jointly, while improving the functioning of cooperatives through increased liquidity and transparent benefit-sharing mechanisms.