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