Every election year in the Fourth Republic, especially the hotly
contested ones, has been associated with excesses (in spending and behaviour),
rapid depreciation of the cedi, and accelerating inflation. The most recent to
such years is election year 2000, when the excesses led to an exchange rate
depreciation (number of cedis per US dollar) 0f 100 percent from 3,500 old
cedis at the beginning of the year to 7,000 at the end of the year.
The next after that was election year 2008 when election year excesses
led to a fall in the value of the cedi from 1.0152 cedis per dollar in June
2008 to 1.4524 cedis per dollar in June 2009, a year-on-year depreciation of
about 43 percent, which was halted only by the stabilisation programme agreed
with the IMF.
The current situation has seen the cedi depreciate by about 17.3 percent
in the first half of the year and by about 20.5 percent year-on-year, from June
2011 to June 2012. The pass through from depreciation to inflation is obvious.
A stable cedi (in the sense of predictability of value in
domestic foreign exchange and goods markets) must be anchored on the
fiscal policy stance. This has proved elusive in post-Independence Ghana.
In the market-oriented Fourth Republic, the cedi has been particularly
vulnerable to speculative attacks in every election year, resulting in sharp
depreciation in foreign exchange markets, large losses in gross international
reserves and upsurge in inflation.
Accelerated growth with productive jobs for poverty reduction, and
macroeconomic stability requires fiscal and debt sustainability. Operationally,
fiscal policy should target medium to long term economic growth, leaving
monetary policy to deal with the short-run trade-off between economic growth
and job creation, on the one hand, and macroeconomic stability low inflation
and stable exchange rate on the other hand.
The mild depreciation pressure of the fourth quarter of last year was
initially mistakenly attributed to seasonal factors rather than financial
markets concerns about the excesses of election year spending - the so-called
political business cycle (PBC) observable in nascent democracies in developing
countries.
Thus in response to the sharp depreciation of the cedi in January, the
BOG intervened with a large injection of foreign exchange estimated at about
US$800 million. As the record shows, this was neither sufficient nor
sustainable.
By the end of the month, it became obvious to the monetary authority
that something credible and sustainable needed to be done to improve the
attractiveness of the cedi and cedi based financial assets relative to holding
foreign exchange. Investor fears about the value of the cedi resulting from
excessive election year domestic spending had shifted the balance against
holding the cedi. The MPC Press Release of February 2012, observed and reported
the flight from the cedi as investors exercised their right and liquidated
their holdings of domestic bonds in exchange for foreign exchange in
expectation of a rise in yields in subsequent new bond issues.
The decisive shift in preferences against the cedi has been the cause of
the fast-depreciation of the cedi and the surge in inflation.
Thus far, the BOG has done the right thing. Beyond the direct
interventions in the foreign exchange market, the BOG also instituted a number
of off-market measures which seek to enforce existing regulations and in the
process support the monetary policy tightening objective.
Among these was the measure to ensure that foreign investors stay firmly
off the short-term end of the money and domestic bond market.
Another important measure was the directive to banks to keep the
mandatory cash reserve requirement of 9 percent of total deposits i.e. both cedi-based
and foreign currency based in cedis only.
At a time like the present when banks are awash with excess reserves
i.e. reserves beyond the mandatory requirement and face a fast depreciating
cedi, this single act holds out important potential positive outcomes:
§ It locks up the
(cedi) equivalent of 9 percent of foreign currency deposits, thus reducing the
excess reserves by as much,
§ It frees the foreign
exchange held as reserves, thus increasing the supply of foreign exchange onto
the market,
§ It discourages
domestic residents who purchase foreign exchange from the forex bureaux to
deposit in their foreign exchange accounts, thus reducing the demand for
foreign currency and hence the pressure on the cedi.
For the same foreign exchange deposit, the cedi value rises with
depreciation. Therefore, the bank would have to hold 9% of this larger value in
cedis. This raises the cost of the foreign exchange account to the bank. And,
moreover, as market interest rates rise, the cost of holding the foreign
currency deposits would rise even further.
The information that banks would pass on the increased cost of holding
foreign currency deposits to their clients created a lot of anxiety on the part
of would be investors, as this was interpreted by the public to mean that the
BOG intended to close foreign exchange accounts.
In response, the BOG issued a statement of denial and emphasized its
objective has been that of shifting the balance of preference in favour of the
cedi and cedi based assets.
In its statement, the BOG stated that:
“The Bank of Ghana’s attention has been drawn to media reports being
attributed to the Bank that it is planning on closing all foreign deposit
accounts and has instructed that a 2% per annum charge be levied on all foreign
deposit accounts in the banks.
The general public and all stakeholders are assured that the Bank of
Ghana has not taken any such decision.
The recent policy measures taken by the Bank are intended to make the
cedi assets more attractive to hold.”
A government spokesman also pointed out that the BOG is only taking
steps to stop certain uses of foreign exchange accounts that are in breach of
the foreign exchange laws and the dollarisation of the economy.
He explained that opening a foreign exchange account in the domestic
banking system is legal with the backing of a law passed by Parliament. The BOG
cannot close foreign exchange accounts without a repeal of the relevant law.
The spokesman indicated that there is, however, a difference between
using the foreign exchange accounts for one’s business and offloading it to
another business or a foreign exchange bureau.
This latter activity implies trading in the currency, which is outside
the law. The BOG is drawing attention to the fact that such uses of foreign
exchange accounts may be in breach of the law.
The idea behind the increased cost of holding large speculative foreign
currency balance is therefore to cause people to see some advantage in selling
some of their foreign exchange holdings to increase the supply of foreign
exchange in the market and thus help bring about the needed exchange rate
stabilisation. With the robust tightening of monetary policy, these
interventions by the BOG can be expected to be increasingly effective over the
course of the year.
There is considerable concern over how much further monetary tightening
can go. The MPR has reached 14.5 percent. Money market rates have also risen
quite sharply. The recent 5-year bond issued by the GOG to pay maturing issues is
the third government bond issued thus far this year and was described as
oversubscribed, although the fixed yield rose to 26% per annum - an increase of
1000 basis points.
The most powerful indication and proximate cause of the present
macroeconomic instability is the private sector financial balance - the
difference between spending and income of households and private business.
Normally, but particularly, in election years, this turns into a
significant deficit i.e. debt financed. This puts strong responsibility on the
government to contain domestic spending pressure by running a surplus primary
balance if at all possible i.e. ensuring that some portion of the debt service
requirement is from own resources and not from borrowing.
As the saying goes, the sovereign is the actor upon whom investors
depend for rescue during systemic crises. When this appears, unlikely doubt and
fright turn to flight to safe havens. The current rapid depreciation of the
cedi is one such instance of a flight from the cedi into foreign assets.
In a panic, fear has its own power speculative attacks become
self-fulfilling. To assuage fear and panic, one needs a lender of last resort
willing and able to act on an unlimited scale. Perceptions matter and, as such,
it is in our national interest to have the IMF and the Development Partners by
our side; providing support to deal with the speculative attack on the
cedi.
The economy is in a fragile state, facing a trade-off between
macroeconomic stability and jobs. Public interest in the policy decisions being
taken has also led to anxiety and intense debate over what needs to be done to
address the recent challenges facing the country.
An effective management of the situation, therefore, requires first,
that the central bank improve its communication of policy measures being taken
to reduce the anxiety and misunderstanding on the part of the public.
It also requires that there is better complementarity between fiscal and
monetary policy, as well as an improvement in the forecasting of cash flows
that would enable the central bank to stay ahead of events.
Accelerated growth with jobs requires fiscal and debt sustainability,
with monetary policy playing a complementary role to smoothen any short-term
deviations from the trend growth path.
There must, therefore, be a strong national all
political parties and relevant stakeholders commitment to fiscal responsibility
and expenditure accountability.
The agreement between the MoFEP and the IMF to extend the programme with
the IMF is a move in the right direction towards showing Government’s
commitment to fiscal responsibility during this election year.
In CEPA’s view, however, there is a need for an agreed IMF
staff-monitored programme that would run into the first quarter of 2013.
This would assure:
§ The commitment of the
IMF to provide support in the face of speculative attacks; and
§ A national commitment
to fiscal responsibility, which would be independent of the outcome of the 2012
elections.
Source: Centre for Economic and Policy Analysis
(CEPA) http://www.cepa.org.gh/pressreleases2/Election%20Year%20Excesses%20Cedi%20Depreciation%20and%20Inflation55.pdf
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