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BoG‘s policy hike was imperative

BY: Suleiman Mustapha
Dr Ernest Addison
Dr Ernest Addison

After more than five years of falling interest rates, which has seen the benchmark Monetary Policy Rate (MPR) falling from well over 20 per cent to a long-term low of 13.5 per cent over the past year, the Bank of Ghana (BoG) has been forced into a sharp reversal with the highest single increase in the benchmark rate since it was first introduced.

Indeed, ahead of the last Monetary Policy Committee (MPC) meeting in March, an increase in the MPR was generally seen as inevitable; as consumer price inflation had been rising since mid-2021, and is at 19.4 per cent for March, the highest level since early 2017.

Inflation rates in much of the western hemisphere, particularly the United States (US) and the United Kingdom (UK), are at their highest levels in nearly half a century.

But it was the sheer magnitude of the central bank’s interest rate hike that has generated discussions. The 250 basis points hike has taken the MPR to 17 per cent, its highest rate in more than half a decade.

This, therefore, appears to negate the expansionary effects of the two per cent cut in the MPR, executed in late March 2020 that was meant to persuade commercial banks in the country to keep on lending to the private sector despite the economic slowdown occasioned by the arrival of the COVID-19 pandemic and the public policy responses introduced to curb its spread.

However, while credit-reliant business people and other potential borrowers are ruing the situation, economists generally agree that the BoG took the most prudent choice — some even say the only choice — under complex, difficult circumstances.

Tightening monetary policy, as the best means of curbing rising inflation, has become the most prudent stance for several interrelated reasons. At the core, is the issue of exchange rates.

In a country that is inordinately reliant on imports, this sharp currency depreciation inevitably is contributing heavily to inflation, particularly through its effect on energy costs.

Exchange rate stability

This makes the restoration of exchange rate stability a most urgent imperative; and to achieve it, two things are required.

One is to reduce demand for foreign exchange, which itself has risen sharply over the past year as the country’s economy rebounds from the recession by COVID-19 during the second and third quarters of 2020 and the requisite socio-economic restrictions that formed public policy in 2020 and much of 2021.

The higher cost of cedi financing created by monetary tightening can be expected to slow demand for forex significantly.

The other is to reduce the pace of monetary growth, which was allowed to rise to record highs in 2020 (a year in which broad money supply growth climbed by nearly 30 per cent) by a combination of both fiscal and monetary stimulus in order to dampen the slump in economic activity brought about by COVID-19.

Actually, this, alongside the inevitable global supply chain disruptions brought by the pandemic, is the primary reason why inflation has reached long-term record highs worldwide.

While making money more easily available to investors, corporations and small businesses encouraged them to remain economically active during the COVID-19 imposed slump, it has left too much money in circulation and with the global economy now rebounding, this has resulted in “demand pull’ inflation as money-laden businesses outbid one another to acquire production inputs and business support services to step up their output.

The higher interest rate regime put in place by the BoG is expected to curb these circumstances somewhat.

Headwinds

However, even as monetary policy stance makes the BoG biggest, best hope towards a return to macroeconomic stability, the economy still faces headwinds that the central bank itself can do little about.

Firstly, the current surge in inflation is being inordinately propelled by rising food inflation. Food and beverages account for roughly half of the basket of items used to compute consumer price inflation in Ghana, and here the problem is largely the result of supply chain disruptions, particularly the closure of the country’s land borders through which much of the foodstuff consumed in the country arrives.

This is outside the central bank’s purview although the recent decision to reopen those land borders shows government’s recognition of the source of the problem and presents a prudent solution. But government has not been that clever in the handling of its own debt securities issuances and unfortunately some analysts have incorrectly included the BoG as a culprit in a situation where it has actually been a safety net of sorts.

The cedi’s stability in recent years has been largely the result of sales of cedi denominated domestic debt securities with tenors of between two and 15 years to offshore investors who bring in forex, change it to cedis to make their investments but are guaranteed the ability to convert back to forex when exiting those investments.

This has guaranteed a steady net inflow of forex – alongside yearly Eurobond issuances of some $3 billion annually – that have assured readily available forex to importers.

Sovereign downgrade

The problem now is that the recent downgrade of Ghana’s sovereign risk ratings by two international credit ratings agencies has not only prevented it from issuing new Eurobonds at an affordable interest rate – it has also convinced foreign investors in cedi denominated government debt instruments to exit, demanding their investments back in US dollars.

Indeed, the BoG’s introduction of forward auctions of forex on a fortnightly basis over the past three years – which has pulled the rug from under the feet of currency speculators who have been taking positions against the cedi for short-term profit – plus its astute buildup of

Ghana’s gross foreign reserves to record highs of between $8 and 10 billion have been pivotal in maintaining exchange rate stability by facilitating efficient price discovery for forex and in building confidence among local forex market participants.

Now, however, in order to keep those foreign investors from flocking away, the BoG has had to tighten monetary policy with a 250 basis points increase in the MPR and for many, this has made it a culprit rather than the savior.

Ultimately, though, the fact is that the BoG, more than any other institution of the state, is one that continues to prevent the Ghanaian economy from tottering over the edge.

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