The deal will also help introduce high-speed 4G broadband network in the capital Addis Ababa and 3G service throughout the country.
Huawei, the world's second largest telecom equipment maker, has been involved in developing phone and internet services in the Horn of Africa country for several years.
Africa's rapidly expanding telecoms industry has come to symbolize its economic growth, with subscribers across the continent totalling almost 650 million last year, up from just 25 million in 2001, according to the World Bank.
Andualem Admassie, acting chief executive officer of state-run Ethio Telecom, and Jony Duon, his counterpart at the Chinese firm, signed the agreement that will double subscribers to 56 million.
"Although our target is 40 million, now including 3G it will 56 million by 2015. That would be the capacity," said Debretsion Gebremichael, Ethiopia's deputy prime minister and minister of communications and technology.
The agreement is half of a $1.6 billion project split between Huawei and ZTE, China's second-largest telecoms equipment maker. Both firms will finance the amount. Ethiopia will sign the other half of the agreement next week, Debretsion said.
Ethio Telecom is the only mobile operator in the country of more than 80 million people, one of the last remaining countries on the continent to maintain a state monopoly in telecoms.
Although lacking much of a telecoms industry, the government last year gave approval for private companies to provide value-added services - all services other than standard voice calls.
Ethiopia's ministry of communications and information technology says it has received applications from 218 firms to provide such services. South Africa's MTN Group, Africa's largest mobile phone company, has already been granted a licence.
The government has ruled out liberalising its telecom sector saying the six billion birr ($321 million) it generates each year is being spent on railway projects. Ethiopia plans to build 5,000 km of railway lines by 2020.