BoG entering risky territory

...but confident of defences

The Bank of Ghana (BoG) said last week it is in talks with the Ministry of Finance to lift restrictions on foreign investors’ participation in the government debt market; but the plan, which is purposed to boost market competition, will put the economy at increased risk of capital flow shocks the B&FT has been told.

The proposal is to allow foreigners be able to purchase one- and two-year government debt, hitherto restricted to domestic investors, in a bid by government and the central bank to intensify competition and reduce yields. This will eventually mitigate the surge in interest costs of government as it battles to control spending and reduce the budget deficit.

“Opening up the two- and one-year instruments to portfolio investors -- who for some time now have been making a case for this -- will be good news to the market. It brings a lot of certainty in advising foreign investors who are increasingly interested in our market, and I think it has the potential to get interest rates lower at that end of the market,” said Sampson Akligoh, an economist who heads Databank’s research unit.

But there are pitfalls, he warned: “We do not see any problem except from the policy side -- that is, if we juxtapose a potential increase in portfolio inflows with our reserves position and persistent current account deficit.”

The yields at auction on Ghana’s three-, five- and seven-year bonds -- the only instruments that foreigners can buy at present -- were 19.2 percent, 19 percent and 18 percent respectively in October. But borrowing at the short end has been more expensive, with the 91-day, 182-day, one- and two-year notes yielding 19.9 percent, 19.9 percent, 19 percent and 19.3 percent respectively in the same period.

“You would realise the yields on the three-, five-, and seven-year bonds are lower than the short-term yields. This is just because we have foreigners participating in that market. We are therefore thinking of allowing them to buy the one- and two-year notes to introduce competition at the short end and correct the yield curve,” said Adams Nyinaku, the BoG’s Head of Treasury. “It will also improve the flow of foreign exchange,” he added.

But the central bank’s reserves, which stood at US$5.6billion in November or 2.9 months of import cover, are not a sufficient bulwark against a crisis situation in which foreign investors pull out of their investments unexpectedly and rapidly, Mr. Akligoh said, adding a sudden reversal of flows could cause volatility in the local currency.

This vulnerability to shocks is not far-fetched as a bout of capital flight in the first half of 2012 saw the cedi weaken by 18 percent against the dollar.

“This may be the first attempt at totally liberalising the market, but we must do it with a lot of caution and preparedness,” Mr. Akligoh warned.

Foreign investors have increased their holdings of domestic public debt in Ghana since 2010 as more bonds have been sold by government at some of the world’s most attractive yields. The hankering for the lucrative yields by the investors has also been fuelled by ultra-loose monetary policies in advanced economies.

From a share of almost zero in 2005, foreigners now hold around one-third of domestic public debt. This development has exacerbated Ghana’s vulnerability to capital flow reversals, the International Monetary Fund (IMF) warned last month in its twice-yearly review of sub-Saharan African economies.

The BoG is mindful of the risk of further liberalisation, Mr. Nyinaku told the B&FT, and added that rapid capital outflows are often triggered by a crisis or shortage of foreign exchange, which the central bank has always tried to avoid.

“We don’t want to give the impression that we’re not able to honour redemptions, so we give portfolio investors first priority. We always make sure we meet their demands,” he said.

He added that Ghana will not suffer a shock from tighter monetary policy in the United States -- a prospect that many emerging markets have been fretting about -- because the country’s yields remain attractive and there is a large share of foreigners who hold their instruments to maturity.