Allowing for more exchange rate flexibility can help reduce FX borrowing needs, as well as lower the FX risk premium in domestic interest rates, the International Monetary Fund (IMF) has recommended.
“Greater exchange rate flexibility, with interventions limited to smoothing sharp fluctuations, can help reduce FX borrowing needs as well as lower the FX risk premium in domestic interest rates,” the IMF said in its 2021 Article IV Consultation report.
But Courage Kingsley Martey, Senior Economist with Databank the asset management company, said in an interview with B&FT that the Fund is signalling the central bank to allow for more currency depreciation.
“Its recommendations sound like they believe the central bank interventions are too much, and should therefore be reduced to allow further depreciation of the Ghana cedi,” Mr. Martey said.
He added: “Essentially, they feel that our FX borrowing needs are high because we need the inflows to support central bank interventions and keep the cedi from falling fast. In effect, the IMF believes that if we allow more flexibility in the exchange rate we will be less inclined to intervene with FX supply, and this will reduce our urge to borrow FX to prop up the reserves.”
Currently, the Bank of Ghana’s measures on capital flow management only allow a limit of US$10,000 withdrawal and per annual transfer without documentation. Thus, the Fund in its 2021 Article IV Consultation report said the removal would be consistent with its institutional view on Capital Flows Management Measure (CFMs).
CFMs are measures that are designed to limit capital flows and reduce systemic financial risks stemming from such flows.
The BoG’s main source of FX inflows is gold and cocoa exports. There are tentative plans to purchase monetary gold domestically. However, its FX outflows are larger and, mostly, driven by government debt service, energy payments, and FX sales to domestic banks.
“The result is a sizeable FX cash flow deficit, which so far has been covered through borrowing. While pressures appear contained for the moment, these large FX gross borrowing needs can quickly deplete reserves and lead to a sudden depreciation if market access is curtailed,” the Fund said in the report.
The Capital and Financial Account recorded an inflow of US$3.33billion in Q2-2021 compared with US$1.61billion in Q2-2020, driven by higher portfolio and foreign direct investments inflows. The lower current account deficit and higher inflows into the capital and financial accounts resulted in an overall balance of payments surplus of US$2.37billion, compared to a surplus of US$1.01billion in the corresponding period of 2020.
“In the short-term, foreign currency inflows tend to offer a false sense of exchange rate security. But over time, debt service obligation erodes the FX cover; and in a tight global financial market condition it becomes difficult to replenish the stock of FX reverses without paying significant premiums,” Mr. Martey explained.
He said this sizable government spending and borrowing, which leads to high borrowing in foreign currency, ends up creating a ‘waiting-depreciation’.
“This ‘waiting-depreciation’ crystalises when the external debt service obligations start to fall due and the reserves are used up to pay for debt service – exposing the Ghana cedi to depreciation pressure as other market participants may not have enough forex to meet their demand.”
The Fund is of the view that although currently the gross international reserves are at an all-time high, with the recent inflow of US$1billion IMF Special Drawing Right (SDR), the economy is still dependent on external borrowing – which requires the BoG to remain alert to the erosion of external buffers.
As at the end of June 2021, the country’s Gross International Reserves (GIR) stood at US$11.03billion from a stock position of US$8.62billion at the end of December 2020. This was sufficient to provide a cover of 5.0 months for imports of goods and services compared with 4.3 and 4.0 months of import cover recorded at end-June and end-December 2020 respectively.
“A gradual reduction in FX borrowing needs, supported by greater exchange rate flexibility and smaller financing needs, can help mitigate FX rollover risks,” the Fund emphasised.