The major purpose of this paper is to examine the extent to which the problem of vertical imbalance arises in Ethiopia's newly emerging system of fiscal decentralization and to critically assess existing arrangements for resolving it. It concludes that the degree of vertical imbalance n regional budgets is rather pronounced and that there are a number of limitations in the mechanisms used in resolving the problem. The revenue sources assigned to the regions are inadequate to help them discharge the weighty responsibilities assigned to them. Attention should be given to measures that will boost the capacity of the regions to enhance their efforts at resource mobilization since grants will be the major means of covering the revenue shortfall of regions, it is important to establish criteria and mechanisms for the provision of grants that are transparent and easy to administer. There should also be an attempt to depart from the practice of having only one type of grant (le, the matching type). It is further necessary to develop detailed criteria to govern borrowing by the regions from the central government. The existing legislative provisions are inadequate and full of ambiguities. Ultimately, however, the issue is a political one and centers on the relationship between the center and regional governments. The task is one of ensuring that this relationship is based on mutual understanding rather than distrust. In general, however, there is nothing to be gained by undue haste in implementing the new system of fiscal decentralization.