A couple of weeks ago, an argument developed over a message a doctor friend of mine posted on an e-mail forum. The message advised that we shouldn’t be too excited about some modest gain we had made on a fund set up for a project.
It was interesting and very insightful monitoring the diverse views on the subject. The crux of the debate was that inflation and depreciation had eaten up all the income and capital gains we had made on our fund. Regular reports on the fund had been sent to the forum earlier, and no such debates took place. My doctor friend was becoming paranoid, and rightly so, because he had seen the cedi slip rapidly in value since the beginning of 2011. At the end of 2010, GH¢ 1.48523 could buy a dollar. It meant that if AunteEsi needed to send US$500.00 to her trading partner in China for a box of toothpicks, she would need GH¢ 742.615 from the bank or forex bureau. By February 3, 2011, the cedi had depreciated by approximately 7%. In a matter of 34 days, at the same price of US$500.00, AunteEsi would have to import the same box of toothpicks for GH¢ 795.21. She had to add about GH¢53 extra for the same amount of US Dollars. The figure below traces the exchange rate between the cedi and the US Dollar from September 1, 2010 to February 23, 2011.
If the 7% for the 34 days is annualized and the situation is assumed to continue till the end of the year, she would require almost double (GH¢ 1,373.84) the same amount of cedis to import the same box of toothpicks by February 3, 2012. It may look absurd, but it has happened before in our economic history. Ghana’s exchange rate history has gone through what I describe as four major phases in the last twenty years. These are:
PHASE I (The Pre-2000 era): The era of high exchange rate fluctuation, during which the cedi lost more than half of its value against its major trading partners.
PHASE II (The pre-redenomination era): The cedi remained resolute against the US Dollar and other international currencies.
PHASE III (The post election 2008 era): Here, the global financial crisis, among other factors, pushed the cedi marginally down.
PHASE IV (The post-2010 Christmas era): After several months of stability and intermittent exchange rate appreciation, the cedi has begun to show signs of fragility, eliciting fears of significant loss in value akin to what was experienced many years ago.
In each of these periods, significant attention was focused on the cedi’s value and extensive public discourse centered on the subject. Are the latest fears founded? Have we lost the grip on the cedi’s stability?
Every economy practices one of three management policies, i.e. Fixed, Flexible and Managed. Under the flexible exchange rate policy, the local currency’s value against its trading partners is fully determined by the market forces of demand and supply. Fixed exchange rate policy regimes rely solely on government or monetary authorities’ intervention to set the exchange rate of the local currency against other foreign currencies. Managed exchange rate policies are a hybrid of the fixed and flexible policies, with direct intervention by monetary authorities in the market to ensure that market imperfections do not unsettle the economy. This is the most common type of exchange rate policy, and even the most capitalist of economies, such as the US, practice it sometimes.
So, if exchange rate fluctuations are market phenomena, who is behind this phenomena in Ghana? Who is responsible for the 7% drop between January 1, 2011 and February 3, 2011? Who are the buyers and sellers of Dollars, Pound Sterling, EURO, Yenetc? Everybody in Ghana is a buyer and the sellers are forex bureaus and banks. Everybody in Ghana is a buyer because we all consume some foreign products, which are imported not with the cedi, but with foreign currency (US Dollars, Pounds Sterling, EURO etc). It is from here that the demand for foreign currency emanates. On the supply side, all exporters supply foreign currency. Government also generates and supplies dollars when some foreign aid, foreign direct or donor support is attracted into the country. Foreign Direct Investments (FDIs) also bring foreign currency into Ghana.
So what causes the exchange rate instability? When we demand more dollars than we generate from both public and private sources, we put significant pressure on the cedi. It is therefore not surprising that, having spent significant amount of dollars importing Christmas goods, while exporting less of the locally produced goods, the cedi has come under severe pressure during the first quarter of 2011.
Loser and gainers
Movements in the value of the cedi against its major trading currencies leave in their trail gainers and losers, in what may be described as a quasi zero-sum game. The ultimate loser, however, is the state. The major gainers are essentially currency traders or investors. In periods of exchange rate depreciation, some investors reorganize their portfolios by moving money into hard currency. The gain is the difference in value of the cedi against the US Dollar. For our example, if an investor had bought US Dollars at the beginning of the year, he/she would have gained 7% return on that investment. Losers are the buyers of foreign currency who need it to purchase the same amount of foreign goods and services. The state is a loser because policy-makers worry about sharp and significant deterioration in the value of the cedi considering its effects on macroeconomic stability. All three economic prices are related. Some exchange rate instability will filter through and generate some amount of inflation, with lenders absorbing the shock with a mark-up in interest rates. It is important to note, however, that policy-makers sometimes devalue the local currency for strategic economic reasons. It therefore means that the loss in the value of the cedi is not entirely a bad phenomenon. For prudent external trade management purposes, some devaluation or depreciation, for that matter, is necessary. The loss in the value of the cedi makes locally produced goods cheaper for the international market and could trigger major foreign exchange in-flow if the demand for Ghanaian goods is favorable on the international market.
In the very short-to-medium term, the cedi will continue to be unstable. The import-oriented structure of our economy has not changed, and may not change for another 5-10 years. This is both a social and economic phenomenon. The Ghanaian consumer’s appetite for foreign goods cannot change overnight. The national reorientation efforts aimed at promoting made-in-Ghana goods is yet to produce results. There are, of course, certain capital goods that no major industries in Ghana can produce to cater for local consumption. There are, however, other import-substitutes that can be help save us some dollars and ease the pressure on the cedi. Perhaps, if we can enhance our commitment to these simple facts, some progress, no matter how small, may be made in our fight against unbridled depreciation and the panic it continues to engender.
On the supply side, we may see some gains. Oil export proceeds are expected to shore up our foreign reserves, which, for many years, has remained below 5 months of import cover. As we build up more reserves from oil revenue in-flow, the cedi’s resilience will improve and we may have enough dollars to cushion any major shocks.
On the balance of probabilities, the undercurrents generated by recent unrests in the gulf region may put some pressure on the cedi as crude oil prices trend towards the US$120 per barrel mark. In the short term, our local currency should remain marginally stable as a few interventionist policies and in-flows from exports, donor support and some foreign direct investments (FDIs) would generate some buffer.