Election Year Excesses, Cedi Depreciation, and Inflation

- The Current Experience

Every

election year in the Fourth Republic, especially the hotly contested

ones, has

been associated with excesses (in spending and behavior), 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 / dollar in June 2008

to 1.4524

cedis / dollar in June 2009  a year-on-year depreciation of about 43

percent

which was halted only by the stabilization program 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 Ghanas 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 dollarization 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 ones 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

stabilization.

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 issue by the GOG to pay maturing issues  the

third

government bond issue thus far this year  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 in 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 program with the IMF is a move in the right

direction

towards showing Governments commitment to fiscal responsibility during

this

election year. In CEPAs view, however, there is a need for an agreed

IMF

staff-monitored program 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