The ailing cedi since redenomination

The currencies of developing countries continue to suffer from adverse depreciation, and the cedi is no exception. This write-up will focus on dissecting the real causes of cedi depreciation since Ghana redenominated its currency in July 2007, and propose workable, realistic recommendations to policymakers for implementation.

Economically, a fall in value of a country’s currency is not bad in itself as it can boost balance of trade, since imports become more expensive and exports become cheaper. On the other hand, a continuous fall in value of a country’s currency is indicative of serious structural problems in the economy. In Ghana’s case, there is a weak export sector coupled with an import-dependent economy; which means a depreciation of the cedi will negatively affect other macroeconomic indicators. The chart below presents how the cedi has performed against the world’s most traded currency – the dollar – since 2007.

 

Statement of the Problem

A chronic depreciation of the Ghanaian cedi since redenomination.

Causes of the Depreciation

It is worth noting that there are external and domestic factors which causes the cedi to depreciate against major trading currencies. A key external cause for depreciation of currencies in developing and emerging markets, including the cedi, is the hike in USA interest rates. There is often not much to be done about such external headwinds, but policymakers should formulate domestic policies to strengthen their currencies.

Current Account Deficit: A current account deficit means that a country imports more goods and services than it exports. To finance this deficit, a surplus on the financial/capital account will be needed. Since Ghana runs a large/persistent current account deficit, it negatively impacts the balance of payment account and hence weakens the currency.

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Collapse of Confidence: The collapse of confidence in the financial sector, especially banking, has negatively affected stability of the local currency. This has made the banking system very unattractive, and both investors and the general public are withdrawing their funds – causing an outflow of currency because of the risk in losing their currency. Instead, people are holding their cash in dollars off the banks…causing a shortfall in supply of dollars.

Price of Commodities: Ghana is a price-taker of its major exports – i.e. gold, cocoa and oil. This means a fall in the price of these commodities on the international market affects our net international reserves – and hence triggers depreciation of the cedi.

Speculation and ‘Black Market’ Trading: Policymakers sometimes don’t pay much attention to speculation. Ghana operates a floating exchange rate regime; hence, the currency’s price is determined by the forces of demand and supply. Despite this regime, the BoG can periodically intervene to avert continuous depreciation of the local currency. While this regime has proved to be effective, there is a need for the central bank to timeously communicate developments which might trigger currency fluctuation to prevent speculation that could cause depreciation.

In the value chain of currency trading, we have the Bank of Ghana, Interbank market and Forex Bureau market; but there is a huge ‘black market’ that is neglected. So, the big question is: how can the central bank learn the amount of foreign currency in circulation in this economy? The huge amount of unaccounted and undocumented foreign currency has periodically been used to ‘artificially’ trigger depreciation of the cedi.

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Recommendations

  1. The surest way to have a stable currency is to produce more. Government and other stakeholders should aggressively pursue import substitution and export-led growth industrialisation. Increased exports will boost our net international reserves and hence strengthen our currency.
  2. There is currently a policy that inhibits the pricing of goods and services in foreign currencies. Effective implementation of this policy will help stabilise the currency.
  3. The temporary/knee-jerk solution of floating external bonds and pumping additional foreign currency is not sustainable. After disbursement and utilisation, depreciation kicks in. Ghana issued its first Eurobond in 2007, and Cocobod annually raises a syndicated loan to purchase cocoa beans. These external funds temporarily support the cedi; but after utilisation there is a return to the currency’s downward trajectory.
  4. Government should reconsider the policy of floating local dollar-denominated bonds. In October 2016, government floated its first dollar-denominated bond. Hence, the interplay of demand and supply for the foreign currency could affect the local currency’s price. Linked to that is the participation of foreign investors in domestic bonds. Despite government’s quest to attract external funding through bonds, amortisation of those bonds could adversely affect the local currency.
  5. The central bank can also interrogate the possibility of having special arrangements for specific industries which demand huge amounts of foreign currency for their trade. A classic example is the Bulk Oil Distribution Companies (BDCs).
  6. It might be difficult to disband the ‘black market’, but that is the way to go. The aforementioned recommendations can help strengthen the ‘ailing cedi’.

 

jelilius@gmail.com                                                    e.amoah-darkwah@gmail.com

 

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