Currency devaluation is not the way forward for Ghana

The economic history of Ghana shows the various legal instruments used by the Bank of Ghana (BoG) to regulate the foreign exchange market.

During the colonial era Ghana’s currency was called the Ghana Pound, which was tied to the British Pound.  The historical analyses of the various exchange rate regimes show that Ghana operated a fixed exchange rate system from 1958 to 1985 prior to the introduction of the Foreign Exchange Auction market (window 1 & 2) in 1986.

In 1988, the BoG implemented the licensing of Forex Bureaux leading to a Fully Floating Interbank Market Rate in 1990, which has been in force to date with some regulatory oversight.

During the fixed exchange regimes in Ghana currency devaluations were undertaken in specific years including 1971; 44 per cent, 1972; 20.4 per cent, 1978; 58.2 per cent and 1983, 92 per cent.

Under the current dispensation of floating exchange rate, once could only talk about currency depreciation and not devaluation.  For example, the cedi depreciated by 99 per cent in 1999 but only two per cent in 2004 and five per cent 2011.
 
Devaluation and depreciation of the currency

It is important to emphasise that devaluation occurs in a fixed exchange rate and depreciation occurs in a floating exchange rate system but both devaluation and depreciation mean a fall in the value of the currency.

To this end, contributors to the debt of devaluation in Ghana cannot be talking about devaluation under the current floating exchange rate system unless they are calling for a return to the fixed exchange rate regime.

Therefore contributors to the discourse of devaluation should not confuse devaluation with depreciation because devaluation is only possible under a fixed exchange rate system.

Our history as a country shows that we have made significant gains since the implementation of the floating exchange rate and the BoG must be encouraged to perfect the existing floating exchange rate regime.

Why devaluation

When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currency’s fixed exchange rate untenable.

In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate.

When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.  This is very expensive to operate as it requires significant amount of dollar reserves.

A key effect of devaluation is that it makes the domestic currency cheaper relative to other currencies.

A devaluation of the exchange rate would make exports more competitive and appear cheaper to foreigners while imports would become more expensive.  The expectation is that there would be an increase demand for exports while the demand for imports reduces.  The higher exports and lower imports should increase aggregate demand and income and thereby improve economic growth in the medium to long term.

Should Ghana pursue devaluation

Some financial experts including Dr Obeng-Okon, Lecturer in Public Accounting at GIMPA told the Ghana News Agency that Ghana should not pursue devaluation because the conditions for the successful working of devaluation of the Cedi are not conducive.

The conditions he mentioned include the structure of Ghana’s exports and imports, high inflation, poor state of the global economy, competition within the international community.

Structure of Ghana’s Exports and Imports

Dr Obeng-Okon noted that the structure of Ghana’s exports is largely primary products.

The top exports of Ghana are Gold ($4.39 billion), Crude Petroleum ($3.73 billion), Cocoa Beans ($1.62 billion), and Cocoa Paste ($764 million), Timber and Timber products ($182 million)using the 2014 figures.

On the other hand, Ghana’s imports are of manufactured goods including significant refined petroleum products, industrial raw materials, cars and delivery trucks, intermediate goods, and other consumer on goods.

Given the structure of the Ghanaian economy, it would continue to have unfavourable terms of trade, so it would lose more under devaluation.  The success of devaluation for Ghana therefore depends on the elasticities of exports and imports of Ghana.

Domestic Price Stability

Maintenance of internal purchasing power of a devaluing country is very essential to realise the fruitful effects of devaluation.  Success of devaluation requires that when the external value of a currency is deliberately reduced, the internal value of the currency should not change otherwise the whole purpose would be defeated.

In other words, the cost-price structure of the devaluing country should not alter. In other words, inflation should be almost non-existent.

Ghana’s end of period inflation was 13.5 per cent in 2013 increasing to 17.0 per cent in 2014 and 17.7 per cent in 2015.

Clearly, there is a potential upward risk to inflation forecasting due to: additional taxes introduced on fuel in January 2016; increase in withholding taxes from five per cent to 7.5 per cent for services in January 2016; increase in withholding tax on payments to subcontractors of petroleum operators from five per cent to 15 per cent in January 2016; increase in water and electricity rates in December 2015 by more than 69 per cent and 59 per cent.

These increments were in line with the IMF package, which the government signed in April last year to restore a fiscal balance.

These inflationary expectations do not justify devaluation of the cedi.

Devaluation May Aggravate Inflation in Ghana

Devaluation may worsen our inflation through the following: (a) When imports of certain goods in Ghana are curbed as a result of devaluation but their domestic output is not increased, scarcity of such goods would be felt, which may cause a rise in prices of such goods.

(b) If Ghana’s exports increase without an adequate expansion of export industries, the supply of domestic market would decrease to impact negatively on the prices of such goods.

(c) If Ghana becomes capital-deficient as a result of devaluation, our import of necessary intermediate goods may rise and as a result a price of Ghana’s industrial output may rise.

Unless we are able to put import substitution industries to replace those intermediate goods.

(d) Devaluation induced inflation may lead to further agitations of demand for higher wages by labor and cost-push inflation may gather further momentum.

International co-operation

Dr Obeng-Okon explained that devaluation would serve its purpose only if other countries do not retaliate by resorting to other economic policies that would not be in our interest.

The rest of the world must be prepared to co-operate fully with Ghana if it devalues currency by not raising import duties or giving export bounties or devaluating its currency, which also may tend to nullify the beneficial effects of devaluation to be enjoyed.

Other countries exporting gold include Switzerland, Hong Kong, the United States, Australia and South Africa.   In the area of cocoa bean exports, Ghana faces competition from Cote d’Ivoire, Nigeria, Ecuador, and Indonesia.      Competition may lead to retaliatory positions by these countries and the impact of devaluation on our exports may not yield the desired impact, he noted.

Currently, the low crude oil prices have forced exporting countries to supply even more just to maintain their market shares.

In 2014, Global inflation generally declined with a sharp fall in oil prices being the underlying factor in both advanced and emerging markets.

With the continuous fall in the crude oil prices currently to less USD27.00 per barrel, 2015 global output and economic performance would continue to post sluggish growth.

In this time of global recession, devaluation should be the last resort because there would be insufficient global demand to boost Ghana’s exports.

From the analysis above, a significant danger of devaluation is that it could aggravate inflation.

If this happens, the government may have to raise interest rates to control inflation, but at the cost of slower economic growth.

Another risk of devaluation is psychological. To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the nation may be jeopardised.

Thus, devaluation may dampen investor confidence in Ghana’s economy and hurt the country’s ability to secure foreign investment.

Devaluation may shrink the size of Ghana’s GDP in USD terms and comparatively lower our competitive global position.

It would swell our external debt position in the local currency and worsen the already high debt to GDP ratio.

This would impact negatively on our capacity to service our external debt.  Additionally, it would lead to hardships on the part of mortgagees as they grapple to service their mortgages.

By Francis Ameyibor

Source: GNA