Feature Article of Wednesday, 11 April 2007
Columnist: Adjimah, Harrison
The die is cast and nothing can delay the Bank of Ghana come July 1. The real challenge would be the behaviour of cost and price setters thereafter and more particularly from 2008, when prices are no longer quoted in the old unit. Cost and price setting behaviours would be key to the success of the GH¢, the new Ghanaian money. It is therefore crucial that the BoG includes cost and price setting behaviour management programs and focuses more on these in its public education exercise.
Many Ghanaians recognised the cash handling and accounting problems associated with the old cedi. The major concern over the redenomination however, is the increase risk of higher inflation and exchange volatility usually associated with such exercises. To be fair, the BoG has made it clear that the cedi is not being revalued and it would not be fixed to the dollar. The Bank also maintains that the redenomination would not lead to higher inflation due to the relative stability of the economy. Nonetheless from all indications people believe the exercise is highly likely to increase internal and external instability and this expectation would certainly affect their financial decisions. Setting ¢10,000 to GH¢ 1 would itself have significant influence on cost and prices setting behaviours.
The assumption that the Ghanaian economy is currently relatively stable, to begin with, is a weak one. The BoG should open up and give a clear quantitative definition and its policy reference point of price stability. Although the inflation rate has dropped from near-hyper levels to about 10%, no serious economist and indeed credible central bank would accept a double digit rate as stability. Given the imbalances in the economy; the risk of potential shocks from the current energy crisis; and the high absolute unit of accounts of the cedi as ratios are low when figures are high, the current level of inflation in Ghana is nothing to take for granted. Clearly economic agents have genuine expectation of higher inflation.
Indeed, it is quite obvious that the redenomination would directly increase the smallest unit of market exchange rate volatility to ¢100 (1Gp). This means that the smallest unit of change in the cedi against the dollar ($) on the market would be over 100 basis points, given the current exchange rate of about ¢9,800 (98Gp). The figure would be 80 and 60 basis points for the euro (€) and the pound (?) respectively. Unless exchange rate developments are sterilized, with the increasing access to real time data, daily and even an hourly movement in the exchange rates would be normal. The worry is this increase in the margin of rate volatility could have devastating impacts on prices of imported goods particularly items currently selling for about $1 (GH¢1) (¢10,000) and below. Although the dollar, the euro and the pound move by similar margin against each other, the plain truth is the new Ghana cedi would still be a weaker currency. Secondly, as a direct result of the redenomination the least possible increment in prices of items currently selling for about ¢1,000 (10Gp) for instance would be 10%. And it possible such changes can occur twice or thrice a year, due to cost push factors. In practice too, movements in prices would not be by the smallest margin. In predominantly cash and informal economies, prices of basic items have a high tendency of moving fast to the next round denominations if inflationary pressure is strong and persistent. Another technical source of inflation is the increase in ratios, as the absolute monetary unit is reduced. Businesses in general and particularly in the informal sector would make price increment by adding up absolute cedi and pesewa units. But this would result in higher percentage increments as ratios would increase after the redenomination by 10,000. Having been used to large figures, Ghanaian economic agents would also face a syndrome of disregarding small monetary units and costly rounding ups when considering and setting cost and prices. The cumulative effect of all these would reflect in higher changes in the general price level. The inflationary problem is not as simple as rounding up to ¢100 (1Gp) when converting from the ¢ to the GH¢. The core problem is that arbitrarily fixing one monetary unit to another would undoubtedly create some distortions in the market conditions which would require time to readjust. This readjustment process itself could be a substantial source of instability and could lead to further propagation of inflationary pressure in the economy if cost and price setting behaviours are not managed.
Instead of playing politics and downplaying on the inflationary concerns, it would be more credible if the BoG is open, admits there is a potential risk of instability and elaborate on it strategies to avert or minimise it. The successful implementation of such monetary programs certainly requires good politics, but even more important and indeed in ensuring price stability, the overriding monetary policy objective, is the credibility of the Central Bank.
Paying special attention to the behaviour of cost and prices setters (households, businesses and the government) in the initial public education would be useful. There should also be strategies to manage cost, price and wage setting behaviours during the adjustment period. Effective management of cost and price setting behaviours would require some kind of public intervention in commercial contracts, restraints on non productivity related wage rises and limiting upward adjustment of utility prices. We must also be prepared to sterilize exchange rate developments for sometime.
Some of the above measures seem quite robust but are necessarily to prevent things from getting out of control given the constraints to monetary policy in Ghana. Reactionary monetary policy in general has an uncertain time lag and outcome. It is particularly less effective in Ghana in regulating inflationary pressure because of low credit to the private sector and robust public sector borrowing which is rather very insensitive to interest rates. There are also large amount of cash outside the banking system and many households have access to interest free trade credit which are out of the control of the Central Bank. The strong political desire to see the already very high market interest rates down to realistic levels could also limit the ability of the BoG to raise rates (the prime and the Open Market Operation rates) to match very high inflationary pressure.
If the appropriate steps are taken, the initial distortions may only lead to a transient and short lived increase in inflation, which could quickly reverse. On the other hand, if the cost and price setting behaviours are not managed, the initial surge in inflation would further propagate in the economy and inflationary pressure would remain strong and for a long time.