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Opinions of Friday, 15 May 2009

Columnist: Baafi, Alex Bossman

The Falling Value Of The Cedi And Inflation

(By Alex Bossman Baafi)

THE RAPID FALLING value of our national currency, (the cedi) vis-à-vis the hard currencies including the US dollar and the current rate of inflation in the country have become the major concern of many well meaning Ghanaians. These economic problems that have gripped our economy today are due to a multiplicity of factors including low agricultural output, excess liquidity, low domestic savings, trade liberalization and exchange rate policies being pursued currently.

In this article, the writer focuses attention on the depreciation of the Cedi and inflation which are amongst the economic problems facing us as a nation.

INFLATION

The rate of inflation measures the annual percentage increase in prices. The most used measure is retail prices. It may be extended to cover other commodities including food prices, house prices, and import prices and so on. Therefore the respective rate of inflation is simply their annual percentage increase in a certain period of time.

COSTS OF INFLATION

In a developing country like ours, inflation almost invariably leads to lack of economic growth because of the structure of the economy which is a major problem because people want higher living standards. Absence of economic growth leads to unemployment which adversely affects the unemployed who tend to loose confidence in themselves and also the economy which suffers a loss in output. Inflation redistributes income away from those on fixed incomes, those in a weak bargaining position, to those who can use their economic power to gain large pay, rent or profit increases. Those with assets in the form of property enjoy during periods of rapid inflation while those with savings that pay rates of interest below the rate of inflation suffer as the value of their savings would erode by the inflation. Pensioners will be badly hit by the rate of inflation in the country if nothing is done to halt it now.

Our economy has begun experiencing uncertainty and lack of investment due to the soaring of inflation. It is difficult for the business community 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 inflation 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 17 to 18.5%, a policy step which many economists find it difficult to understand. Why should an economy which had experienced average growth of around 6.2% over the last few years ago was predicted to grow by 5.9%? If because of the current global economic circumstances we cannot have the confidence, the experience and the political will to improve upon it, I believe it makes economic sense to maintain it in order not to move the nation backward.

The problem is that, there is high interest rate, the value of the cedi (exchange rate) is falling, and there is also high rate of inflation. 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. 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 makes the overall assessment of their impact on the economy more complex.

Mention must be made of Balance of Payment. The current rate of inflation is likely to worsen the country’s balance of payment position as our exports will become less competitive in the world market. Imports become relatively cheaper than home produced goods. It means export will fall and import will rise. It stands to reason that our balance of payment is going to deteriorate and the exchange rate for the cedi will continue to fall.

In the opinion of the writer, the rate of inflation which is already in two digits is relatively high and needs to be checked by the government to avoid a situation where firms constantly raise prices to cover their rocketing costs. 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 a hard currency like say US dollars to the detriment of the national economy.

SUGGESTIONS

To halt the falling value of the cedi and reduce inflation, the government and the Bank of Ghana should carefully apply monetary and fiscal deflationary policies and instruments some of which have been discussed below.

GOVERMENT

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. The government therefore must encourage exports for example in the area of non traditional products.

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. This is very critical and holds the key to impact positively on both the inflation and the price of the cedi (exchange rate).

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. Perhaps the objective behind this critical step is to reduce the supply of loan able funds and control excess liquidity (more money in circulation) in the system.

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. 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.

Whatever be the case, have we taken the pain to analyse this 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.

We live in a developing world where the government cannot boast of a lot of income because of the structural – cum administrative problems in revenue mobilization. The role of private sector investments cannot be overemphasized. We therefore must encourage the private sector to champion investment to create more jobs for our jobless people as our own home grown stimulus package to get out of the poverty trap in which we find our selves. We can achieve this by lowering the cost of borrowing while at the same time public unproductive spending is checked by the government.

FISCAL POLICY

The government may also apply Exercise taxes, Export taxes and subsidies.

EXPORT TAXES AND SUBSIDIES

Export duties and subsidies provide a means for protecting an economy from internal 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 incomes and this tend to sustain internal incomes and economic activity. Export subsidies may be used both to increase domestic economic activity by expanding export incomes and to increase foreign currency earnings for balance of payment reasons. Some economists argue that sometimes higher inflation is associated with rapid economic growth and structural changes in the economy. This is true; however, I believe that, in a developing economy, when constant higher-inflation is being experienced, then the country could be heading towards economic, social and political chaos. In the light of this the policy makers must leave no stone unturned to get on top of the situation now before it is too late. Time indeed is running out. Email contact: abkbossman@yahoo.co.uk