Ghana’s search for stable real exchange rate continues

M. Mbems, Accra, Ghana
September 29, 2024

Ghana earns foreign exchange from export, but must also pay for import in dollar, Euro, British Pound, Yen or Chinese Yuan. In 2022, Ghana earned over US$12 billion (GHC 144.1 billion) and imported goods worth US$12.4 billion (GHC 148.6 billion)¹. Also, in 2022, five international currencies (US dollar, Euro, British Pound, Yuan, and Yen) made up 95 percent of Ghana’s international debt. This means that movements in these currencies have implications for the economy and for the local currency.

According to the ministry of finance, the depreciation of the cedi alone accounted for US$6.2 billion (GH₵93 million) of the increase in the debt stock at end-December 2022². Ghana adopted a flexible exchange policy in 1983. This system gives the Bank of Ghana (BoG) more leeway to respond to macroeconomic indicators, such as inflation, the balance of payments, or rising unemployment.

Fluctuations

Ghana Cedi recorded a huge fall against the US dollar in 2022. The Cedi declined more than 55 percent between January and October 2022, recording the steepest declines of any currency in the world that year. The Cedi stabilized throughout 2023 and closed the year with a fall of 27 percent against the USD. A decrease in foreign direct investment inflows, fiscal, and trade deficits and public debt explain the continued depreciation of the Cedi.

The Bank of Ghana uses interest rate and other tools to curb the Cedi depreciation and achieve a stable exchange rate. In December 2021, the BOG’s policy rate was 14.50 percent. On June 2024, the monetary policy rate had doubled, reaching 29 percent. In Ghana, like other countries, a rise in domestic interest rates implicitly reflects an increase in expected inflation. Holding other parameters constant, high interest rates improve the value and attractiveness of, and demand for, a currency. Conversely, low interest rates decrease the attractiveness of a country to investors. Studies have shown that after a country loses access to financial markets, a subsequent depreciation of the real exchange rate follows. Therefore, the role of the BoG is also to manage and cushion the risks embedded in the dynamic relations between interest rates, exchange rates and debt distress³.

Productivity

When the Ghanaian economy achieves high productivity, it gives more units of Cedi to employees and to companies, or more value to each unit of Cedi. If productivity stagnates but the supply of Cedi decreases, then each unit of remaining Cedi must store greater value. But, in Ghana, productivity and inflation have interacted in tandem to weaken the Cedi. Since 2022, high inflation has reduced consumption and induced low productivity. During the same period, when productivity declined faster than the supply of money, the value of each unit of Cedi dropped.

The International Labor Organization (ILO) links low productivity growth to stalled structural transformation. It argues that three factors continue to constrain productivity in Ghana.

The first is that the export of unprocessed commodities does not boost manufacturing activities or generates added value activities. Second, the heavy reliance on the export of agricultural and mining commodities makes Ghana vulnerable to external shocks. Finally, the ubiquitous prevalence of the informal economy deprives entrepreneurs of access to finance, thus hampering their growth and their capacity to innovate.

The challenge for Ghana is identifying, developing and implementing the kind of structural policies that will boost productivity. Macroeconomic stability and a reversal of unfavorable trade patterns are important but insufficient. Improving spending in education to boost skills and minimize the skill mismatch in the labor market are also vital. The private sector also requests a reduction in the regulatory burden on firms and an improvement in access to finance for small and medium-sized enterprises.

Ghanaian authorities say that the consolidation and completion of ongoing infrastructural projects will enhance productivity. Empricial studies, markets and economic data support this approach. The government sees digitalization, industrialization, and innovation as areas that have high linkages with other areas of the economy and are conducive to higher productivity.

Ghana has received technical and financial help. The ILO, Swiss State Secretariat for Economic Affairs (SECO) and the Norwegian Agency for Development Cooperation (NORAD) are developing a “Productivity Ecosystems” in Ghana. Their joint program addresses productivity in an integrated way – across enterprise, sector and national-level rather than intervening at just a single level⁴ .

Monetary and fiscal policies

Growth prospects, inflation expectations, and global market conditions are major determinants of interest rates in Ghana. They are also fundamental aspects of currency valuation. The Bank of Ghana uses interest rates to achieve price stability and address external contagion. Monetary policies have to align with the government’s fiscal policy to produce optimal results. When other parameters are constant, expansionary monetary policy and expansionary fiscal policy have opposite effects on exchange rates. Interest cut means less inflow of capital investment, This, in turn, reduces demand for the Cedi and results in depreciation. An expansionary fiscal policy translates into an increase in deficit from lower taxes or high government spending.

The international economy has metamorphosed and increasingly, most governments accross the world have limited options when it comes to interest policy choices, especially during severe economic turbulence. During the financial crisis of 2008, many countries had to resort to "unconventional monetary policy", according to the Switzerland-based Bank for International Settlements (BIS). In a 2019 seminal research paper, the BIS found that during the 2008 crisis central banks in development natured quickly "exhausted the space of conventional monetary instruments". Example of these unconventional policies include: negative interest rates, lending operations with financial institutions, asset purchase programs, quantitative easing. Some of these unconventional policies have become acceptable practices today ⁵.

However, the Bank of Ghana however has focused primarily on keeping inflation close to a target level (8 percent annual rate) over the medium term, restoring fiscal stability and on employment objective. The BoG has pivoted towards a tight monetary policy while relying on the goverment to cut spending and increase taxes to boost state revenues. At the operational level, the BoG uses reserve capacity to steer the policy rate towards its target, while keeping risk low, with strong collaterals during open market operations. In the short term, the expectation is that these policies will restore fiscal balance and put the country on a recovery path. The IMF ECF program expects Ghana to pursue tight monetary and fiscal policies over the duration of the three-year economic reform program.

International Trade

Default has plunged Ghana into a low capital mobility situation. In this context, the country is relying on trade flows rather than capital flows to stimulate the transmission effects of monetary policies. A depreciation of the Cedi makes imports expensive (in Cedi terms) but generates earnings from export (for example, in USD).

Thus, under certain circumstances, a depreciation of the Cedi will reduce the trade deficit. Decision makers must increase national income and savings relative to expenditure, and also consider the elasticity of demand for import goods and export goods and services. When either import or export demand is elastic, currency depreciation can lead to an improvement in the trade deficit. However, such an outcome will depend on the composition of export goods and import goods.

At the moment, the goal of the government is to “strengthen the Ghana cedi”. The Bank of Ghana has short-term measures such as making special allocations to the oil marketing companies (OMCs), energy companies, as well as cement producing companies. Medium-term measures include an increase in the monetary policy rate to make domestic assets attractive and improve incentives for investing in cedi denominated assets. Long-term measures include other potential domestic gold purchasing programs to maintain or boost the level of gross reserves⁶.

Perception

Monetary and economic policies alone cannot stabilize the Cedi. The perception of the US dollar as a strong currency contributes to an informal and gradual dollarization of the Ghanaian economy. This perception can have a positive but also a negative influence on the domestic currency. The Cedi is the only legal tender in Ghana. A law prohibits the pricing, advertising, or payment for goods and services in foreign currency in without written authorization from the Bank of Ghana⁷. However, the enforcement of these regulations has had little impact.

Despite these laws, a perception of the US dollar as stable currencies leads to parallel use of this currency as a medium of exchange or as reserves. In major cities in Ghana, real estate developers show property prices in the US dollar on billboards. They claim to target the diaspora and thus want to show a transparent price to this market. But hotels and restaurants also show their preferences for US dollars.

Domestic banks, corporates, and individuals see these foreign currencies as safe hedge a depreciating Cedi. The US dollar has penetrated the economy, even reaching the informal economy. Shop owners at Accra major shopping malls told the New Economy Ghana, that landlords only accept payment for rental properties in US dollars. They accept the local currency equivalent but adjusted to extortionist US dollar rate. Businesses accept Cedi for payment, but accept the US dollars wherever possible. These formal and informal transactions in US dollars reinforce the perception of the Cedi a weak, volatile and risky asset⁸.

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