17/05/2022

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Ghana’s Cedi is under stress: some long, medium, and short term solutions

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An economy with strong fundamentals is one that is resilient, has a well-developed exports base, is industrialised, and creates jobs. That kind of economy can mobilise resources domestically, without much reliance on external support, and can even borrow at a lower cost. The citizens of this kind of economy have good roads, good transportation, good health, and good educational systems. They are well-resourced and free from civil unrest.

For decades, African countries have chalked up successes but these have not been significant enough to transform their economies. Most countries on the continent are still far from achieving these indicators of an economy with strong fundamentals. They often export primary commodities and import finished products.

The Ghanaian economy is no exception. It is still very much the Guggisberg economy. Sir Gordon Guggisberg was a British empire colonial administrator in what was then Gold Coast (1919-1927). He designed an economy to focus on the export of raw materials and importation of finished goods. Hence the moniker.

A century later, cocoa and gold are still Ghana’s major exports. Ghana is Africa’s top gold exporter at 138.7 tonnes. It has since added oil and gas, and some non-traditional commodities.

Ghana’s reliance on exporting raw materials and importing finished products contributed to the country’s persistent demand for, and less supply of, foreign currencies. This is why, for a long time, Ghana’s cedi has been depreciating against the other major trading currencies.

Why is the cedi depreciating so fast?

Ghana is an import-dependent economy. Because of this, the country continues to buy foreign currency to meet its import demands, with less supply of foreign exchange from its exports. Sometimes, the country records a net gain with exports earnings exceeding import costs, but these are paper gains. The actual money is repatriated by the foreign companies that operate in the country. The retention law is not effective to restrain them from repatriating all their profits.

The depreciation of the cedi has always been seasonal. It’s at its worst between February to March. This is the period during which Ghana-based multinationals repatriate profits. Also, local businesses that had imported goods on credit ahead of the Christmas season settle their debts. These are the major causes of the cedi depreciation.

And the fundamentals have not improved significantly over the years.

The exchange rate was quite stable, especially during the peak of the COVID-19 period (2020-2021), because imports slowed due to border closures by most countries. But as of 28th February 2022, the Ghanaian cedi was the worst performing currency among 15 top currencies in Africa, depreciating by 7.6% within the first two months of 2022.

So what has sped up the decline?

The first reason for the recent depreciation is the increased demand for foreign currencies since most businesses in Ghana are now recovering from the COVID-19 shock. This is not limited to Ghana. Most businesses globally are recovering and getting into serious production.

The second reason is the country’s inability to borrow from the international capital market. Because Ghana isn’t able to generate enough foreign exchange through exports, successive governments have tried to manage the depreciation of the cedi through borrowing from the international capital market, issuing dollar-denominated domestic bonds, and depleting the country’s foreign exchange reserves.

Whenever Ghana’s sovereign bond is no longer profitable and there are not enough reserves to shore up the Cedi, the currency depreciates. The events of March 2019 provide a perfect picture. That month the US Federal Reserve increased its interest rate making it more profitable to attract investors. Investors responded by selling sovereign bonds of developing countries like Ghana.

The world economy is bouncing back after the pandemic, pushing global inflation up. Inflation has moved from 3.1% in 2020 to 3.8% in 2022. The US inflation has risen from 1.35% in December 2021 to 7.46% in February 2022. The US Federal Reserve has responded by increasing the interest rate, making US sovereign bonds very attractive. Many investors are now selling their bonds in developing countries like Ghana to purchase those of advanced-economies like the US.

Effects of the depreciation

Depreciation of any currency makes its imports more expensive and exports cheaper. Some countries intentionally devalue their currencies to make their exports cheaper. However, because Ghana‘s export sector is not significantly developed, the country is not able to take advantage of the Cedi’s depreciation by exporting more and earning more foreign exchange. The effect of currency depreciation has been an increase in the cost of imported goods. Most of the imported goods are intermediate goods that are used for local production. This has led to rising inflation.

For example, the ex-pump prices of fuel depend a lot on the exchange rate since a greater part of the refined fuel is imported. Currently, there is increased global demand for crude oil as most industries are now recovering from the effects of COVID. At the same time, the supply of crude oil has slowed down after the Russian invasion of Ukraine. The international crude oil price is expected to continue increasing for some time.

The combined effect of cedi depreciation and increases in international crude oil prices means that the ex-pump price of fuel in Ghana is expected to keep rising, at least until the end of the year 2022.

In response to high inflation, the Bank of Ghana will increase its policy rate in an attempt to control the growth of credit. This will lead to an increase in the cost of borrowing. Higher borrowing costs will eventually lead to increased costs of production, which will further increase inflation.

Solutions

The long-term solution is for the country to industrialise, add value to its exports, increase local production and cut down on imports so that there will be enough foreign exchange in the country. The government’s policy of modernising agriculture, and the one-district-one-factory should be improved to speed up the process of industrialisation.

The medium-term solution is for the government to be able to raise more domestic revenue to be able to service its debts, and finance its development without a heavy reliance on borrowing.

The short-term solution is for the government to borrow externally and bring foreign currency into the country. This can only happen after the government demonstrates to the investment community its ability to mobilise domestic revenue to service debt.

As a matter of urgency, the government must revise the design of the electronic levy (e-levy) and pass it within the shortest possible time to access Eurobonds. According to the international credit rating agencies, the passage of the e-levy and the reversal of the 50% benchmark values at the ports will signal to international investors that government of Ghana is on the fiscal consolidation path and that it can raise domestic revenue to service its debt.

In the short term, government can also demonstrate its ability to mobilise domestic revenue by paying attention to other sources of revenue such as property tax, tax exemptions, and natural resources.