The Ghana Cedi: To devalue or not to devalue?

It is often said that the exchange rate is the most important price in an economy. It affects all other prices. This is particularly so in developing economies that are mostly import dependent.

The Ghana cedi has been relatively stable in recent times. The level of depreciation against major currencies since 2017 has been very moderate compared to what we’ve been used to. In fact, the cedi even strengthened against the US dollar for some time during this year. Ironically, it came under pressure a few weeks ago even as the news of Ghana receiving US$2bn in sovereign bond sale hit the markets. All things being equal this news should have helped strengthen the cedi.

This piece is a contribution to the unending debate as to whether the central bank and for that matter government should desist from intervening to prop up the cedi whenever it comes under pressure. Why should the central bank use its finite reserves to protect the currency or do so at the expense of high-interest rates? Is it beneficial to allow the local currency to depreciate? If so, at what stage in our developmental process is it ideal to do so? These are difficult questions that have no definite answers just as many economic questions.

Over the course of currency history, especially in the days of the gold standard, countries mostly wanted a strong currency or at least a stable one. Governments made great efforts to maintain exchange rate pegs, some were even willing to use such interest rates to prop up their currencies even if those rates prompted economic downturns. Only in circumstances such as the great depression of the 1930s and the 1970s, were those attempts deemed too high a price to pay and the pegs abandoned.

Following the 2008 global financial crisis, however, it seems stronger currencies are no longer fashionable. “The weak shall inherit the earth” became the new mantra. Many countries now seem to prefer their currencies to depreciate so their exports could be cheaper and gain market share. Many countries now get apprehensive from a strengthening currency as opposed to enjoying the glory that it is a sign of market confidence in their economic policies.

The Japanese yen has been weak for decades. In the 2016 US presidential election, then-candidate Trump promised to label China a currency manipulator, partly blaming it for the US’s huge trade deficit with China ($375bn as at 2017). In recent weeks the Trump administration and the Chinese regime have been at each other’s throat on issues of trade tariffs. This is largely about the same currency politics.

The situation, however, is different in developing economies especially primary commodity-exporting countries such as Ghana, desirous of restructuring into value-added export-based economies.

Calls have emerged from several analysts, including persons from bodies such as the IMF and the World Bank, arguing at one time or another that currencies of some developing economies including Ghana have been overvalued and that central banks should allow the markets to freely determine their values.

So why do policymakers seem to be content when our currency appreciates?

The exchange rate has a very profound impact on economic activity in a country such as Ghana. It determines how international prices get translated into local prices and vice versa.

Exchange rate policy is one of the most important policy decisions governments have had to make. It involves hard and complicated trade-offs.

A strong cedi, for instance, means its value is high in relation to other currencies like the US dollar. This is good for Ghanaian consumers as it increases their purchasing power by making imported goods and services more affordable to them. However, that could be bad news for Ghanaian manufacturers and farmers who export their goods.

As the exchange rate makes it more expensive, foreign buyers would abandon Ghanaian exports for cheaper options. On the other hand, a depreciating cedi should be welcome news for our local producers since their goods would be relatively less expensive. It gives them the competitive advantage over foreign producers both on the domestic and foreign markets.

From the above, the choice facing policymakers is that of a weak currency that makes Ghanaian producers more competitive and the consumers poorer by eroding their purchasing power, or a stronger cedi that hurts producers and helps the consuming public. Either option has both short and long-term implications.

Some have argued that all things being equal, keeping our currency relatively weak is a good idea. In today’s environment, most poor countries need to encourage domestic production of goods that can be sold abroad. Countries such as Taiwan, South Korea, and lately China achieved great successes using this strategy.

In all these cases, the push to produce for export was facilitated by government policies that kept the national currency weak. The proponents argue further that a buoyant manufacturing sector that can export competitively would ultimately generate employment locally for our youths and provide foreign exchange.

Opponents of a weaker currency may argue that this will certainly make the consuming public worse off as that can erode their purchasing power. Besides, with globalization allowing giant foreign companies to dominate our economy, coupled with technology and the consequent machine automation of jobs, any expected positive impact on job creation will not be commensurate. It would only create super profits for foreign companies to repatriate and ultimately put further pressure on our exchange rate.

Another argument is that allowing the local currency to weaken in the name of encouraging export-led growth will be pre-mature since most African countries still face severe production and infrastructural bottlenecks, coupled with their inability to meet the high-product quality requirements imposed by major trading partners. This situation stifles the ability to take advantage of any competitive edge afforded by a weak local currency.

Until these challenges of infrastructure, product quality and other production bottlenecks are appropriately addressed, the stronger the local currency the better for our citizens.

Debt from external investors can be an important potential source of funding for development if the money is well used. Governments and companies of developing countries including Ghana have a substantial amount of our debts in foreign currency. These debts are important to finance the investment needs that we cannot finance with the country’s tax and other sources.

Devaluation/depreciation of the local currency would increase the real burden of the foreign debt. For example, according to the May 2018 Bank of Ghana MPC report, Ghana’s total external debt at the end of February 2018 stood at GHC76.8bn. If the exchange rate to the US dollar was GHC4.4, this would be USD17.5bn.

Suppose the cedi depreciates against the US dollar to say GHC4.6, the debt burden increases from GHC76.8bn to GHC80.5bn. The impact of currency depreciation/devaluation on a country’s debt position is said to be one of the major causes of debt crises in the history of many developing countries. A stable currency can help the country avoid getting into serious troubles with our foreign debts.

Another significant impact of a stable exchange rate is that it helps promote domestic monetary stability. i.e. low inflation. High inflation has been one of the major challenges of developing countries, where prices rise uncontrollably as witnessed in Ghana in the late 70’s to mid-80’s.

Over this period there were four major devaluations of the currency to the US dollar (i.e., 1967, 1971, 1978 and 1983). The devaluation led to a sharp rise in inflation in each case. Again, Zimbabwe is one of the most recent cases in Africa of hyperinflation where prices increased by thousands of per cent a year.

High inflation can disrupt normal economic activity and retard economic growth by creating uncertainty about the future. A strong/stable cedi in relation to other currencies effectively keeps inflation low. The stability of the cedi since 2017 is a clear example in this regard. The CPI has trended down to 9.6% as at April 2018, the lowest in more than four years.

Several countries around the world have used this strategy of strong/stable exchange rate to successfully reduce disabling rates of inflation. However, this strategy to tackling inflation comes at a cost as the central bank will be constrained in its ability to stimulate the economy with monetary stimulus should there comes the need.

It is often said that exchange rate policy is inherently political. In a democracy such as ours, policy makers would always be guided by the competing interest of various constituents in considering the exchange rate policy to implement at any time. If the exchange rate is excessively weak this helps producers/exporters at the expense of consumers. This could have very positive impact on the economy in the long run. However, government risks upsetting the consuming public which could lead to undesirable repercussions.

The jury is still out there as to when, in our economic restructuring process, should we consider pursuing a weak currency strategy to boost the export sector. Perhaps, to ensure the1D1F and similar future import substitution policies succeeds, policy makers may consider the currency strategy at some point, to discourage imports such as rice etc and promote patronage of locally produced substitutes.