Inflation causes panic

The current inflationary trend, which has been a source of worry to economists globally, remains a threat to the Ghanaian economy, a research has indicated.

According to the new research carried out by Databank Financial Services Limited on the outlook and analysis on the economy, the sensitivity of the economy to global commodity price developments and fiscal concerns are likely to worsen inflation expectations in the coming months.

Due to these factors, inflation is likely to close the second quarter above 16.5 percent in spite of the recent increase in the prime rate.

However, the research explains that unless government intervenes through fiscal policy the situation will not change.

At the same time, monetary tightening through the prime rate will be ineffectual in the short term.

Databank earlier reported an inflation of 18.4 percent for June, thus analysts and the populace are waiting patiently to see whether the projection will materialize as the Ghana Statistical Service releases the June inflation on Friday, July 11.

“In an inflation targeting regime, the increase in the prime rate was expected; but clearly, our disinflation process between 2004 and mid-2007 was anchored on fiscal discipline and exchange rate stability and we do not expect this trend to change within the medium term.

“We believe that the increase in the prime rate will hurt private sector capital borrowing and slow output growth within the short term”.

The study explained that increasing the prime rate will not significantly reduce money supply, but will instead give room for the banks to increase their spread and make relatively higher interest income.

However, the increase is likely to make fixed income market instruments more attractive as investors, based on expectations, may be inclined towards investing in medium term securities to lock in the prevailing high interest rates.

On the external sector outlook, the study reiterated that the economy remains fragile and thus moving forward, it expects these risk exposures to remain within the short to medium term.

Also, Gross International Reserves was anticipated to a further decline, from the current 2.2 months of import cover to about 1.8 months of import cover by July this year according to the research.

With regard to the Exchange Rate Outlook, the deterioration in the economy’s current account deficit and the continuing realignment of major international currencies will continue to weigh down on the cedi.

From the beginning of the year to date, the local currency recorded a depreciation rate of 3.3 percent, which is relatively sharp compared to 0.55 percent in the corresponding period in 2007.

Overall, the report noted that it expects the cedi to further depreciate on the back of the increasing crude oil prices and an expected fiscal stimulus package by government to cushion consumers and business against existing cost pressures.

On policy outlook and financial market implications, it stated that the prime rate will remain steady within the band of 16 percent and 17 percent for the rest of the year, unless inflation deteriorates above 20 percent by September 2008.

As the Bank of Ghana is overly focused on maintaining low inflationary expectations, interest rates are likely to further increase above 20 percent if inflation deteriorates above 20 percent as well, the study emphasized.

Though the increase in the prime rate is likely to hurt private sector growth within the short-term, it is needed to make monetary policy more effective.