The Calamitous Falling Value Of The Cedi

Thu, 19 Jul 2012 Source: Baafi, Alex Bossman

By Alex Bossman Baafi

The Calamitous free falling value of our national currency, (the cedi) vis-à-vis the hard currencies including the US dollar in the country has become the major concern of many well meaning Ghanaians. This economic problem that has gripped our economy today is due to a multiplicity of factors including low agricultural output, excess liquidity, low domestic savings and trade liberalization.

Low Agricultural Output Low agricultural output is due to our inability to invest in mechanized and irrigation farming. We depend much on rain-fed agriculture; there is low incentive to farmers and high cost of agriculture inputs, all of which contributing to low production in the country.

Excess Liquidity The excess liquidity comes from both the government and the banking public. The nation is spending more than it is producing (GNP). It is living beyond its Gross National Product (GNP). This implies that the demand for goods and services, which is not satisfied out of the nation’s own production, is satisfied through imports of goods and services. This increases the supply of the cedi and the demand for the hard currencies. In simple economic analysis, the value of the cedi falls, the price of say the dollar goes up and general price levels increase. There is excess liquidity because most of government spending is capital in nature in the face of low exports. This normally happens in election year when the government embarks upon many development projects in order to win elections through the ballot box. Our excess liquidity could also be attributed in part to massive corruption in the system. Suppliers’ contract in roads, health, education and other infrastructure are overpriced. Mention must be made of gargantuan judgment debts paid for no work done. These lead to too much money in the system without a corresponding increase in output culminating in the depreciation of the national currency.

Low Domestic Savings As part of the developing community we are poor because of our poverty. We have very little capital investment because the incentives which must exist for the savings and investment functions are woefully lacking. What is more, there is very little savings because the level of real income of our people is low. The low level of real income is the result of low productivity which in turn results from lack of capital for investments, hence poverty. We are always under the mercy of Foreign Direct Investment which also faces global competition making us vulnerable for adequate investment to create descent jobs and improve incomes domestically.

Our business community has begun experiencing uncertainty and lack of investment due to the depreciation of Cedi. It is difficult for the businesses to predict their costs and revenues and that discourages them from investing and therefore a fall in economic growth. If care is not taken, policies to reduce the rate of depreciation may themselves reduce the rate of economic growth especially in the short-run. For example the Bank of Ghana recently increased the prime rate from 13.5% to 14%, a policy step which many economists find it difficult to understand.

The point is that, there is high interest rate and the value of the cedi (exchange rate) is falling. I must say that higher interest rates tend to slow the growth of the economy because it could reduce the level of aggregate demand for domestic goods and services. I have a difficulty to talk about inflation because the single digit that we have is unrealistic and very much confusing when matched against the current interest rate and depreciation. Exchange rate could strongly influence the demand for the country’s export as higher inflation rates affect consumer’s income and for that matter the purchasing power. Perhaps what make these problems more serious is that interest rates, exchange rates and inflation could also have an impact on each other and that make the overall assessment of their impact on the economy more complex.

In the opinion of the writer, the rate of inflation which is already in single digit is relatively low and needs to be checked by the government because it is giving a misleading picture. Firms are constantly raising prices to cover their rocketing cost. That will in turn drive workers to demand huge pay increases in an attempt to stay ahead the cost of living. A situation where prices and wages chase each other will not auger well for our economy to the extend that companies and certain rich individuals may not want to save in the local currency, instead they may want to change it quickly into hard currencies like say US dollars to the detriment of the national economy.

Trade Liberalization The trade liberalization policy has crippled our manufacturing sector. Our indigenous producers could not compete with their foreign counterparts whose goods continue to flood our markets. Most of our local producers could not make sales to break even and consequently shut down. Our economy is dependent on foreign countries. We import more than we export hence the fall in the value of our currency and its concomitant inflation. How can a nation importing virtually everything, including Tooth Pick could maintain the value of her currency?

Suggestions To halt the falling value of the cedi the government and the Bank of Ghana should carefully apply monetary and fiscal deflationary policies or instruments.

Government The government on her part must reduce her spending. A decline in domestic spending will induce some fall in prices which may assist the process of balance of payments and adjustment. Exports products will become more attractive to foreigners because of lower prices. Domestic substitutes for import products become more attractive also to residents because of their low prices. One may argue that the success of this action to induce favorable movement of the nation’s current account depends upon the elasticity of demand. That is, if foreign demand for the nation’s export is inelastic, the decline in the price will lead to a smaller total foreign expenditure on the exports and that the physical volume of exports will not rise large enough to offset the unfavorable effects on the volume of exports resulting from the fall in their prices. Conversely, an elastic demand means a more than proportionate increase in the physical volume of purchases as prices fall so that foreigners’ total expenditure for the export rises. I must say that even if the foreign demand for export is inelastic, the balance of payment position will improve if the value of imports falls even more than the fall in the value of exports. Again the government should give incentives to our farmers and put in place an attractive package to entice investors both home and abroad to invest more in our agricultural sector. In the area of trade liberalization, the government may limit the value of import through some selective controls such as those which specify that only a certain amount of goods may be imported over a given period, here the income that is no longer spent on imports may be diverted to the purchase of home produced goods. The fact is that even the developed nations like UK, USA and Japan; protect some sectors in their economies for example agriculture. Concerning the freely floating exchange rates system, it has not worked to perfection in any economy in the world. Even in the developed world, the system used is called “managed” or “dirty” float where the monetary authorities sometimes intervene in foreign exchange market to either buy or sell a currency depending upon the nature of the market and its impact on their national economies.

Bank of Ghana The Bank of Ghana recently increased the prime rate from 17 to 18.5 percent in this period of Global Economic Downturn per. Perhaps the objective behind this critical step is that, by raising the rate of interest, it will reduce the supply of loan able funds. The government would cut down investment spending and her consumption expenditure, which will lead to a reduction in domestic expenditure. The fall in domestic expenditure reduces the demand for import. It also releases home produced goods and services form domestic use and makes them available for export, or it releases resources from the production of goods for the home market to the production of different goods for the foreign market. These measures will reduce imports and consequently inflation. A major question concerning this monetary policy is whether or not higher interest rates are an effective restraint on spending. Some argue that the interest rate is a small part of the cost of doing business and that, higher interest rates have little effect on investment and therefore little effect on spending and borrowing. Personally, I think this is true in our economy where loans are given to the buying and selling public in the short term to the detriment of medium and long term investment. Others minimize the effectiveness of higher interest rates on the grounds that borrowers’ expectation of continually rising prices will offset higher interest charges as far as profit expectations are concerned, thus there is little incentive to reduce borrowing. I think that monetary policy to combat inflation does not work solely through the effect of higher rate of interest on spending. It also involves credit rationing, the supply of loanable funds is reduced, and loans to some credit worthy borrowers are denied. Have we taken the pain to analyse the policy’s far reaching implications on the private sector businesses and investments? I believe that the measure has the potential to crowd out the private businesses more especially the small and medium scale enterprises. Let us carefully analyze that. Other standard methods of reducing money supply spending are for the central bank to: 1. Raise reserve requirement so that each cedi of reserves support fewer cedis of demand deposits, thereby forcing a contraction of banks' loans and demand deposits. 2. Raise the cost of borrowing reserves from monetary authorities, which induces banks to raise interest charges to their borrowers and warn the banking community that monetary authorities desire credit restraint and; 3. Sell securities from its own portfolio to the commercial banks, which pay for them by reducing their deposits (reserves) at the central bank and/or to the public, which pays for them by reducing its demand deposits at commercial banks, sales to the public lead to a fall in bank reserves as the public’s funds are transferred from the commercial banks to the central bank. 4. The Bank of Ghana can also fall on its reserves by selling say US Dollars in the open market just to shore up the value of the Cedi. This will prove very expensive and also will depend on the availability of more than enough reserves.

Fiscal Policy The government may also apply Excise taxes as well as Export taxes and subsidies.

Export Tax and Subsidies Export duties and subsidies provide a means for protecting an economy from internal I instability that would be caused by variation in exports and they can have an important effect on international reserves. For example, when foreign demand for a nation’s export is rising the imposition of export tax will divert to the government some of the extra income which would otherwise go into private hands. Conversely, when foreign demand declines, the reduction of export taxes lessens the fall in private income and this tend to sustain internal income and economic activity. This is what some of the underdeveloped raw material-producing countries rely on to manage their economies from time to time. Export subsidies may be used both to increase domestic economic activity by expanding export income and to increase foreign currency earnings for balance of payment reasons and reducing the price charged foreigners, thereby inducing an expansion of export production. This is very important.

Conclusion Some economists argue that sometimes currency depreciation is associated with rapid economic growth and structural changes in the economy as in the case of China. However, I believe that a non-industrialized developing economy that cannot respond to an increase in demand for its exports and experiencing constant depreciation of the currency could be heading towards economic, social and political chaos.

Email: abkbossman@yahoo.co.uk

Columnist: Baafi, Alex Bossman