Is our monetary policy to curtail inflation effective?
In West Africa, Ghana’s interest rate is the highest compared to those of its neigbours. The average interest rate in sub-Saharan Africa is between eight per cent and 12 per cent, whereas Ghana’s policy rate is extremely higher.
Relatively high interest rate signals a high cost of doing business in a country. It depicts soaring cost of financing (specifically, debt) in an economy. Businesses in such economies borrow at high rate of interest, accordingly making such businesses not to thrive well.
In addition, stock exchanges in such economies are not expected to perform well since investors would divert their investment to the government for a reasonably higher rates of returns.
On the other hand, studies suggest that it serves as a strong antidote curtailing exchange rate volatility. Foreign investors are expected to purchase T-bills and sovereign bonds of the nations with comparatively towering rate, consequently piloting exchange rate volatility and variability to a safe destination of stability. Similarly, managers of the economy raising policy rate also serves as a defence wall to control the flooding of inflation.
The central bank is the only institution mandated by law to control inflation by steering interest in the appropriate direction. The governing body of the bank is the Board of Directors as stipulated in the Bank of Ghana Act, 2002 (Act 612).
The Board consists of the Governor, who is also the Chairman, two Deputy Governors and nine Non-Executive Directors. The board is responsible for formulating policies necessary for the achievement of the Bank’s objectives which are:To maintain stability in the general level of prices; To ensure effective and efficient operations of the banking and credit systems; and to support general economic growth.
In Ghana, the Monetary Policy Committee (MPC) is responsible for setting the policy rate. The policy rate is synchronised by the committee to restrain inflation. However, the MPC is not expected to sacrifice economic growth at the expense of managing inflation although the rivalry between the two is as strong as Ashanti Kotoko and Hearts of Oak. The task for the MPC is undoubtedly a herculean task as refereeing the boxing fight between your two lovely children.
The MPC is expected to meet on March 18, 2016 and brief the press on March 21, 2016. The major question for both household and firms is, “would the policy rate be increased again”? It is against this background that this script seeks to provide a trend analysis of the current macroeconomic conditions in the economy and provide suggestions to that effect.
Inflation
The Consumer Price Index (CPI) measures the change over time in the general price level of goods and services that households acquire for the purpose of consumption, with reference to the price level in 2012, the base year, which has an index of 100 – Ghana Statistical Service. The diagram below shows prices in Ghana since January 2015, using the consumer price index. It shows the price level, measured by an index relative to the base year of 2012.
It also shows annual price change (Inflation) for the same periods).
The latest inflation numbers show that five months of consecutive months of increases in headline inflation, which pushed inflation to 19.0 per cent in January 2016, inflation fell marginally to 18.5 per cent in February 2016.
The inflation rate eased for the first time in six months as the stability of the cedi during the month avoided further rises in cost of imported items. Inflation rate in Ghana averaged 17.14 per cent from 1998 until 2016, reaching an all time high of 63 per cent in March of 2001 and a record low of 0.40 per cent in May of 1999.
There appears to be an upside risks to inflation as government continues to embark on Fiscal consolidation through the removal of subsidies on petroleum and utility prices. Worsening of external financing conditions as well as the gradual rise in crude oil prices also poses warning to inflation.
Interest Rate
No discussion of inflation would be complete without some mention of interest rate. Interest is the cedi amount paid by borrowers to lenders. The interest rate is the amount paid per year as a percentage of the amount borrowed. In this write up, interest rate and policy rate is used interchangeably. The higher the interest rate, the higher the cost of borrowing in the economy, other things being constant.
Ghana’s interest rate of 26 per cent is the highest in the world after Malawi, 27 per cent not only is the current Policy Rate the uppermost in the world but the highest in the country since the last 13 years. The average policy rate since 2002 is 17.22 per cent with the utmost of 27.5 per cent occurring in March and May 2003. The lowest rate was fixed at 12.5 per cent from December 2006 to August 2007.
Last year the Monetary Policy Committee increased the Policy rate four times. In May 2015, it was increased from 21 per cent in February to 22 per cent. It went up by 200 basis points in July. The MPC increased it marginally to 25 per cent in September. The year was ended with a policy rate of 26 per cent in November.
The 68th meeting of the MPC is scheduled to come off on the 18th of this month with press briefing three days later.
As spectators of this crucial match, what would be the score line of this bout? As a service to our nation, we can’t afford to sit aloof but to draw the attention of the committee to certain area of concern.
Policy rate and inflation
Interestingly, as the policy rate was augmented with the aim of curtailing inflation, the changes in the CPI continued to rise, recording 17.7 per cent in December, 2015. These happenings made analysts question the effectiveness of the traditional Fisher’s Models of retraining inflation. Is raising interest rate still the best way to control inflation? Couldn’t it be that the raising of policy rate was causing inflation? Well, the logic is that (though to some extent contrary to theory) raising policy rate could lead to high cost of borrowing for firms. Higher bank base rate could also lead to sky-scraping cost of doing business.
Firms in turn pass on these costs to consumers through high prices. The effect of inflation in this scenario becomes inevitable.
The MPC maintained the policy rate at 26 per cent percent and in February 2016, inflation slumped to 18.5 per cent from 19 per cent in January. Could it be that, three lagged periods of maintaining interest rate is negatively related to inflation? Perhaps the traditional economic model in controlling the changes in CPI is not working for Ghana currently. Managers of the economy could recheck their models again since there appears to be a strong positive correlation between the two variables, Ceteris Parabus, without losing sight of issues relating to moment sequence econometrics replicas.
GDP Growth Rate
The Ghana Statistical Services define Gross Domestic Product (GDP) as the estimate of the total value of final goods and services produced in the country during a given period.
Real GDP growth rate recorded the highest growth of 14 per cent in 2011, this is largely due to massive growth in industry from 6.90 per cent in 2010 to 41.60 per cent in 2011 (The highest ever).
The lowest GDP growth occurred in 2014, recording 4.0 per cent growth. The decreased was caused by industry recording the lowest growth ever, 0.8 per cent from 6.6 per cent in 2013.
From the analysis, it is obvious that Industry has the brawniest connection with the GDP though services and agriculture exhibited stronger brunt.
Using simple average, industry recorded not only the highest of 11.3 per cent, but above the average growth rate of GDP, 7.2 per cent. This was largely due to the unusual growth of 41.6 per cent in 2011 which resulted from mining and quarrying subsector, specifically, oil production.
Though Services prove strong positive force on Industry, Agriculture exhibits strapping unenthusiastic impact on Industry. This could be explained by large export of our agriculture produce, which could serve as raw materials to industry. Also government inability to bridge the gap between industry and agriculture could account for these situations.
Save the manufacturing sub-sector
Ghana's Industry sector could be classified into four subsectors: Mining and quarrying, manufacturing, electricity, and water and sewage construction.
Industry Sector recorded a marginal increase from 0.8 per cent in 2014 to 9.10 per cent in 2015 amidst the "Dumsor" situation. This was accounted for by Construction increasing from 0.00 per cent in 2014 to 30.60 per cent in 2015. The unprecedented second highest growth since 2008 could be as a result of the upcoming election ofl its promise on infrastructure. The launch of the green book attests to this fact.
Electricity and water and sewage also performed well. Electricity inched up to 3.2 per cent from 0.30 per cent in 2014. This could be attributed to high utility tariffs and government efforts to solve the "dumsor" problem in the country. Water rallied from -1.10 per cent to 15.6 per cent in 2015 resulting from Government effort to solve the water and hygiene issues in the country.
On the other hand, the performance in Utility and Construction seems to have had an unconstructive blow on the manufacturing subsector, since there appears to be a downbeat parallel between these other subsectors.
Manufacturing has been on a steady decline since 2011 after recording the highest ever of 17 per cent, to -2 per cent in 2015. This could be attributed to high cost of borrowing in the country. Ghana currently has the second highest policy rate of 26 per cent after Malawi. Increasing inflation, cedi depreciation coupled with power rationing all seems to be affecting the Manufacturing subsector.
Manufacturing subsector records not only below average, but the lowest average growth rate of 2.72 per cent in the Industry Sector. This could be as a result of increasing inflation, high interest rate, increases in taxes, and currency volatility resulting from high government expenditure. The AGI business barometer has also been on a downward trend.
The Ghana Stock Exchange
The effect of the rising policy rate could also be sighted in the performance of the Ghana Stock Exchange. High interest rate is viewed as an effective tool to discourage investment in the economy. Firms not ready to borrow at a high cost might not embark on debt financing for expansion, affecting investment growth in the economy. Rational investors might disinvest in the exchange for relatively higher rates of returns from sovereign bonds, Treasury bills, and Bills of the central banks. These developments affect the performance of the stock exchange negatively, consequently slowing economic growth in the country.
The Ghana Stock Exchange Composite Index has been on a downward trend after an impressive performance in 2013, recording 78.81 per cent. In 2014, the witnessed a decline in performance to 5.40 per cent. Last year’s percentage in GSE-CI was -11.77 per cent, reflecting rising interest rates in the country. This year the sliding trend of the bourse persists unabated with a week -on -week performance of -4.6 per cent and a year to date returns of -2.13 per cent.
Exchange rate performance
The performance of the cedi against the dollar rate has been relatively stable this year against last year. The cumulative depreciation against the US dollar has been on slower pace relative to last year. This year’s depreciation has seen about 1.69 per cent cumulative depreciation against the US dollar compared to some 9.10 per cent same period last year. The variability has also seen some sort of relative stability, recording some 0.36 per cent against last year’s 0.86 per cent for same periods.
Conclusion
From the exploration it seems not oblivious that increasing the policy rate again with the aim of curtailing inflation might do more harm than good in our current situation. At the outset, there appears to be an affirmative correspondence between interest rate and inflation. Thus managers of the economy are entreated to revisit their models again.
The Fiscal consolidation exercise of the economic managers is commendable; however, it appears that removal of subsidies could be one of the factors pushing inflation.
In any case, subsidies constitute a relatively small percentage of Government expenditure, compared with workers’ compensation, interest payment, and infrastructure.
Additionally, not only is Ghana’s policy rate one of the highest in the world, it gives the impression to be having a depressing impact on economic growth through high cost of financing for firms.
This is evident in the performance of the manufacturing subsector. The Ghana Stock Exchange Composite Index also attests to the slow growth of the economy. The AGI business barometer is no exemption in this regard. We suggest the economic mangers take a jiffy gaze at curtailing inflation, yet not sacrificing growth from a connubial view point of monetary and fiscal policies.
The authors are the C.E.O and Head of Economic Research and Policy Analysis, at the Institute of Certified Economists of Ghana (ICEG)