BoG ponders over interest rate hike
Dr Ernest Addison — Governor, BoG

BoG ponders over interest rate hike

The Bank of Ghana is set to hike its key benchmark interest rate by over 150 basis from 27 to almost 28.5 per cent in a bid to tame soaring inflation and sanitise the exchange rate market, analysis of data and trend has revealed.

This is expected to raise the cost of borrowing and reduce pressure on the exchange rate market as the Monetary Policy Committee of the central bank begins its 110th meeting to gauge the health of the economy to determine where to plot its policy rate.

There will not be any surprises when that announcement is made on January 30. Graphic Business projects that MPR will be increased yet again from its current level of 27 per cent, which is already an all-time high.

The only question to be answered is the degree of the impending key interest rate hike.

Throughout 2022, the BoG played by the book, tightening monetary policy each time it met (once every two months) in response to similarly continuously rising consumer price inflation, which itself was driven up sharply by severe cedi depreciation as the closure of international capital markets to Ghana, coupled with net outflows of foreign investment capital in cedi denominated domestic debt securities completely overcame the country’s trade surpluses.

At the start of the year in January 2022, consumer price inflation was 13.9 per cent; by the end of the year, for December, it had risen to 54.2 per cent, the highest level in about four decades.

Underlying this was a parallel increase in the BoG’s measure of core inflation – which excludes energy prices and public utility tariffs – which rose from 13.3 per cent in January to 39.7 per cent by October, more or less matching consumer price inflation for that month.

Consequently, the BoG, in line with its primary objective of curbing inflation, kept tightening monetary policy through MPR hikes all through the year, raising it from 14.5 in January to 27 per cent in November, when the MPC met for the last time in 2022.

Exchange rate

Since then, consumer price inflation has risen from 40.4 per cent (for October which was the latest figure available at the time of the meeting) to 54.2 per cent and this alone would be enough reason for a further hike in the MPR.

But there is another reason too – the need to dampen demand for foreign exchange, the shortfalls in its supply having caused the steep cedi depreciation that has been the biggest driver of inflation in the first place.

In 2022, the cedi depreciated against the dollar by anywhere between 44 and 100 per cent - depending on whether interbank, forex bureau or black market rates are used for the computations – before a late rally following the announcement of a staff level agreement between the Government of Ghana and the International Monetary Fund in December, with the crucial prospect of US$3 billion in balance of payments support over a three-year period.

That rally enabled the cedi to gain ground against the dollar in December. At the start of November last year, one dollar was exchanging for GHc13.1046 on the interbank market with the spectre of the rate rising to GHc15 being a real one.

However following the announcement of a staff level agreement with the IMF, enterprises and households alike that had invested in holding dollars were falling over themselves to sell of their holdings before the cedi rallied and this became self-fulfilling; by the end of December, the exchange rate had fallen to GHc8.860.

The Cedi has begun picking up the pace again as there are worrying signs that the IMF bailout is delaying.

Forex demand

Tightening liquidity to curb demand for forex is crucial; last year’s sharp depreciation was largely the result of enterprises and households stocking up forex as a hedge against possible debilitating shortages, as well as sheer speculative currency trading positions taken against the cedi for profit by speculators.

Higher borrowing costs will discourage businesses from getting their bankers to demand forex on their behalf financed through credit facilities.

This is made all the more imperative by the fading euphoria of the IMF agreement announcement – by January this year, the cedi was sliding again, reaching GHc11.462 by January 17.

But even as the central bank’s MPC prepares to hike the MPR yet again, its members are acutely aware of critics who point out that such hikes actually add to inflation; since Ghana is largely a credit-driven economy, interest rate hikes, by increasing the cost of debt financing, generate cost push inflation.

However the BoG is confident that monetary tightening does much more to dampen demand pull inflation by squeezing liquidity than it does to ignite cost push inflation.

Indeed Dr Addison insists that the interest rate hikes it implemented through 2022 prevented inflation from rising higher and faster according to the data that has been generated.

Besides, with Ghana now needing the consent of the IMF’s Executive Board for direly needed forex support to begin, the BoG knows it is not the time to try and think outside the box of accepted neo-classical monetary economics in its policy decisions.

Rising inflation

Indeed, the biggest argument for the suspension of monetary tightening despite still rising inflation is that it stems economic growth.

But the IMF which is now positioned to call the shots, coming to restore economic stability, not accelerate economic growth, and the BoG’s stance is that growth is not sustainable without macroeconomic stability anyway.

Actually, the data suggests that economic growth is not yet a worry; despite the severe challenges facing Ghana’s economy, it grew by 3.3 per cent during the first quarter of 2022, by 4.8 per cent for the second quarter and over 5 per cent for the third quarter, well above the IMF’s global growth projections of under three per cent for 2023.

While another MPR hike is therefore a certainty, the question of how steep that hike will be is very uncertain. Industry chieftains are hoping it will be smaller than the 250 basis points increase implemented at the last MPC meeting in November last year.

They point to the BoG’s own forecast that inflation will peak in the first quarter of 2023 and subsequently decline to around 25 per cent by year’s end.

Furthermore, the central bank will be under pressure to curb government’s debt servicing costs, since the achievement of debt sustainability is the last major hurdle Ghana has to cross before getting IMF support.

The bigger the impending MPR hike, the harder it will be for government to achieve debt sustainability.

Capping interest

Here, the proposed debt exchange programme will work in government’s favour; by capping interest rates on medium and long-term bonds under the proposed new bonds, there will no longer be the need to incentivise foreign investors in cedi denominated bonds by offering relatively high coupon rates (to compensate them for the associated foreign exchange risk) .

All things considered, the smart betting money is on a hike in the MPR of between 150 and 200 basis points – which amounts to further monetary tightening but in a smaller dose than the one delivered at the last meeting in 2022.

This may appear to be a compromise of sorts, aimed at preventing the IMF, government and borrowers from sulking. But the economics behind it is as good as it gets.

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