How the BoG has stabilised the cedi

With just days for the 2016 general election, it is now clear that for the first time in the history of Ghana’s Fourth Republic, that the cedi will remain stable against the major international trading currencies of the world all through the political season. This realisation is beginning to take over as the biggest – and most welcome – economic news of the season.

But much more important, although not yet as widely realised is the fact that barring a complete collapse of world market prices for Ghana’s major export commodities, the cedi’s stability is a medium or possibly even a long-term phenomenon. This means that while the domestic currency will inevitably continue to suffer short-term ups and downs, just like every other floating currency around the world, the sort of sharp, sustained depreciation which it has suffered in the past is a rapidly receding prospect.

The cedi has depreciated by a mere 4.3 per cent against the US dollar so far this year, a complete reversal of the sharp falls the currency suffered in both 2014 and 2015, which averaged some 30 per cent a year in each of those years. Even more instructively, 3.0 per cent of this year’s depreciation occurred between May and early September, when the delay in the endorsement by the Executive Board of the

International Monetary Fund of the third review of Ghana’s performance under the ongoing Extended Credit Facility Programme generated some nervousness in the local foreign exchange market. Since the endorsement was belatedly given in mid-September, the cedi has barely depreciated at all.

This has resumed the longest- running cedi stability since the currency was removed from the hitherto fixed exchange rate regime in the mid-1980’s; over the 16 months since July 2015, the cedi has barely fallen against the US dollar.

Indeed, if not for the inevitable downward pressures created by the forthcoming election, this year’s version of the annual major forex inflows season – brought about by the annual international syndicated loan for local cocoa purchases and the latest Eurobond issue which between them have generated over US$2.5 billion – would have actually led to significant appreciation of the cedi.

The conventional wisdom, dictated by traditional doctrine with regard to economic liberalism, is that the cedi’s new found stability is the result of improvements in Ghana’s external finances. This doctrine dictates that sustained local currency depreciation will eventually discourage imports and encourage exports, until there is a balance between the two, resulting in local currency stability.
But this is not what has happened.

What has happened rather has been the Bank of Ghana’s tight monetary policy which is stifling unnecessary demand for foreign exchange and the central bank’s ongoing reforms of the local forex market which is boosting confidence among forex dealers and end-users alike.

Ironically, the central bank has been much maligned for its tight monetary policy which has inevitably contributed to rising interest rates. However, it is this same tight monetary policy that has halted the cedi’s depreciation by stifling demand for forex by making liquidity scarce.

Ghana’s trade deficit has not narrowed since the beginning of the year and indeed the current account deficit, although narrowing, remains wide enough to generate significant further cedi depreciation, if there are enough cedis in circulation to support effective demand for foreign exchange.

During the first half of 2016, the trade deficit actually widened on account of lower oil prices and lower volumes of cocoa exports. Thus export receipts declined, year on year by about 10 per cent while imports grew marginally. While the current account deficit improved from the 1.9 per cent of Gross Domestic Product recorded in the first quarter of 2015, it was still a significant 1.3 per cent of GDP in the first quarter of this year.

But by restricting liquidity through its tight monetary stance, the BoG has restricted demand for forex strictly to necessary transactions, while at the same time ensuring the adequate supply of forex on the local market to meet that demand, through a combination of direct interventions by funding the market whenever required and local forex market reforms which have increased the supply of forex from private sources.

To be sure, this has come at a cost. The tight monetary policy has made credit less accessible and more expensive where it can be obtained. However, despite the publicly trumpeted complaints of the private sector over this, it is instructive that all the surveys of business confidence recently conducted by both the Association of Ghana Industries and the BoG itself have revealed that business confidence is rising, mainly because of the cedi’s stability and the numerous knock-on effects such as improved industry performance and more positive consumer sentiments. This indicates that cedi stability is actually higher on the wish list of the private sector than access to affordable credit, and thus justifies the tight monetary stance of the BoG.

The other initiative by the central bank which has reigned in the cedi’s depreciation is the ongoing forex market deregulation.This is effectively passing over a large chunk of Ghana’s forex inflows from the BoG itself to the commercial banks for direct use on the local forex market. In turn, this has greatly enhanced confidence among both forex traders and forex end-users as to its availability whenever it is needed. Thus, there is no longer the temptation to stock up forex that is not actually needed immediately, out of fear of future scarcity.

The reforms started on July 1, this year, when export proceeds were subject to compulsory surrender to the BoG requirements. This has freed up forex generated from mineral and cocoa exports for sale on the local forex markets although the latter excludes proceeds from the annual cocoa syndicated loan. But even those proceeds are now being auctioned to the commercial banks for sale on the forex market.

The next step, now being taken, involves the introduction of a rule-based and market-determined system for the sale of whatever forex the BoG continues to receive.

The final phase of the reforms will start allowing all lump sum prepaid export proceeds from cocoa to be surrendered to commercial banks rather than the BoG.
All these have engendered greater confidence in the market, and the resultant cedi stability is simply putting currency speculators, who have hitherto been taking positions against the cedi for profit, out of business.

Which explains why the cedi has become stable, even in the face of continued merchandise trade and external current account deficits, and why the cedi’s resilience will continue to defy all the forces working against that stability, from the activities of speculators, to export earnings shortfalls, to the worries generated by the impending general election.