Release

NPP

March 26, 2014

Pointers from Dr. Bawumia Lectures

• The latest lecture comes in the wake of past lectures given by Dr. Bawumia in which he made certain analysis of the state of the Ghanaian economy and made certain predictions of what lies ahead if the government continues managing the economy in the way they are managing it

• For example in his first lecture at the Ferdinand Ayim Memorial Lectures in May 2012, Dr. Bawumia tackled the issue of the so called single digit inflation and exposed to all of us, how those numbers were inconsistent with the other economic indicators and suggested that the Statistical service do a review of the inflation basket so as to get accurate inflation figures based on his proper policies could be fashioned out. His suggestion was met with a lot of scorn as usual but barely weeks later, the IMF Mission to Ghana virtually endorsed his position and the Statistical Service indeed reviewed the inflation basket.

• As far back as early 2012, he warned the government to be careful about its unchecked borrowing since the increase in the public debts would cause problems for the economy in the future; again this advise was ignored and today, the effects are clear with us spending so much of our revenues on servicing our debts and thus preventing us from having money for statutory and other payments as Dr. Bawumia showed yesterday.

• In his last lecture before this one at the Aliu Mahama Memorial Lectures, he also predicted that the cedi would see a rapid fall due to how the economy was being managed; again, he was hounded and insulted but today we’ve all seen where the cedi is and how his prophesy has come to pass.

• Dr. Bawumia from the outset of the lecture stated that the issues are purely economic and not politics and that it is therefore important that we stick to the empirical evidence and data he presents in reaching conclusion so some light would be thrown on the issue for a dispassionate and non-partisan discussion by all stakeholders that would inure to the benefit of Ghana. And clearly, he presented the facts dispassionately and as they are

• Dr. Bawumia as the scholar he is, clearly laid the foundations for where we are today by establishing the history of the Ghana cedi and the foreign exchange rates over the years and under various regimes.

• The topic he treated was one which is so dear because the rapid depreciation of the cedi inevitably means a rise in the cost of living, utilities and a fall in incomes while it also makes the country globally uncompetitive.

• The rate of depreciation of the cedi against the US dollar in 2014 has been at an unusually fast pace. The cumulative depreciation in 2013 was 14.5%. In the first quarter of this year it has already depreciated by 16% so far! For a small open economy like Ghana, this trend is worrying because these massive depreciations in the currency end up increasing the cost of living and the cost of doing business.

• It should be recognized that other currencies like the Dollar, Pound, Hong Kong Dollar and even the CFA Franc have over the decades remained fairly stable unlike the cedi meaning that with prudent measures especially fiscal and monetary discipline, the cedi can also attain some fair level of stability. The cedi since its introduction in 1965 has lost 99.9999% of its value and has since the dollar and pound appreciate against it by over 2,000,000%.

• But the biggest part of the lecture dealt with the causes of the rapid depreciation of the cedi we are experiencing now. Dr. Bawumia broke the causes down with empirical facts and dispelled a lot of the wrong diagnosis of the issue also with empirical facts.

Weak Economic Fundamentals

• Dr. Bawumia proved in his lecture that the most credible reason why the cedi is depreciating now is the weak economic fundamentals caused by mismanagement under the current NDC government. The facts Dr. Bawumia laid bare include:

• Real GDP growth in Ghana, notwithstanding the onset of oil production, has declined significantly since 2011. From a real GDP growth of 8.4 percent (without oil) in 2008, real GDP growth reached 15.0 percent in the year 2011 as a result of oil production. Since 2011 however, real GDP growth has slowed down to 7.9 percent in 2012 and further down to a projected growth of around 5.0 percent for 2013.

• The data for non-oil growth shows that real GDP growth has declined from 9.4 percent in 2011 to 3.9 percent in 2013. This means that Ghana’s economy (excluding oil) is growing at the same growth rate as the year 2000 and half the rate of economic growth in 2008.

• The decline in the rate of real GDP growth is most noticeable in the agriculture and industry sectors. The quarterly real GDP numbers show that real GDP growth for the third quarter of 2013 (the latest data available) slowed down to 0.3 percent, with agriculture growth declining by 3.8 percent and industrial growth declining by 11.8 percent. This is the lowest quarterly growth recorded in recent history and indicates that all is not well with the economy.

• Fiscal developments also indicate deterioration in the state of public finances, with government unable to meet statutory payments such as the GETFUND, DACF, NHIS, etc. Payments to contractors are also in arrears and there are problems with salary payments to government workers.

• This situation with regards to Ghana’s public finances has arisen because of a major increase in government expenditures relative to revenues in the 2012 and 2013. While government tax revenue stayed constant at some 17.7% of GDP between 2011 and 2013, government expenditures increased by a whopping 6.6% of GDP from 20.1% of GDP in 2011 to 26.7% of GDP at the end of 2013. This has resulted in double digit fiscal deficits (12.0% of GDP in 2012 and 10.9% of GDP in 2013) over the last two years. This is the first time in the history of Ghana that we have we have had double digit fiscal deficits two years in a row and it looks like that this year will be no different.


• There has been a dramatic increase in central bank financing of government recently (i.e. equivalent to the printing of money), in addition to borrowing to finance the fiscal deficit. Central bank financing (net claims on government) has increased from GH¢1,448 million in 2008 to GH¢11,327 million by 2013, a 700% increase

• An expansionary fiscal policy accommodated by increased central bank financing of government is a sure recipe for increased inflation and exchange rate depreciation. The question that we should ask ourselves is what is this level of printing of money by the central bank actually financing? Have we reached the stage where we are resorting to the printing of money to pay government salaries and interest on government debt?


• The developments relating to the growth of the public debt stock is even more worrying. We should keep in mind that Ghana was declared a HIPC country in 2001, being unable to service our debts on a sustainable basis. By the end of 2008, Ghana’s total public debt stood at GH¢9.5 billion (33% of GDP). In the last five years however, the stock of public debt has seen a dramatic increase to GH¢49.9 billion (57.7% of GDP) at the end of 2013. This is an increase in the stock of debt by GH¢40.4 billion or the equivalent of $20 billion using the average exchange rate for 2009-2013. This also represents an increase in the stock of debt by 426% over a five year period (i.e. an average increase in the stock of debt by 85% a year).

• Sometime this year, Ghana’s debt stock would cross the 60% of GDP level that developing countries with limited access to capital flows should worry about in terms of debt sustainability. In fact, at this rate of debt accumulation, Ghana is headed back towards the debt unsustainability that led to HIPC. However, HIPC debt relief will not be available again

• It is not clear exactly what developmental projects all this $20 billion borrowed has been used for. The increase in government debt over the last five years is an amount that can build at least 15,000 km of tarred roads. It is an amount that could have built 6,000 senior secondary schools even at the high cost of GH¢6.0 million each. It is an amount that could have built hundreds of first class hospitals. It is an amount that could have solved Ghana’s energy and water problems.

• The increase in Ghana’s debt has placed a major burden on public finances with regard to interest payments on the debt. Interest payments on domestic and external debt declined from 7.5% of GDP in 2000 to 2.3 percent by the end of 2008. Since then, interest payment has increased to 5.1% of GDP in 2013 and would reach 6.5% of GDP by the end of 2014

• To show how serious the situation is, in the 2014 budget, the entire allocations to the Ministry of Roads and Highways (GH¢779 million), Trade and Industry (GH¢256.5 million) Ministry of Fisheries (GH¢279 million), Ministry of Food and Agriculture (GH¢128 million), Ministry of Water Resources and Housing (GH¢531 million) and Ministry of Transport (GH¢89 million) amounted to a total of (GH¢2062 million). Interest payments in 2014 would amount to some GH¢6604 million, three times what was allocated to these six key ministries combined!

• As a result of the major increase in debt over the last five years, interest payments in 2013 ((GH¢4,397million) was more than twice the Ghana’s revenue from oil ((GH¢1,633 million). In 2014 interest payments (GH¢6604 million) will be four times Ghana’s revenue from oil (GH¢1,670 million). Mr. Chairman, the benefit of Ghana’s oil discovery has been compromised by the increase in Ghana’s borrowing.

• Debt service alone absorbed 36.3 percent of total government revenue in 2013. With declining economic growth, the increase in interest payments has taken up the fiscal space or cushion that previously existed. We are in a very tight corner.


• Ghana’s external payments position has also deteriorated since 2011, with increasing current account deficits and a fragile foreign exchange reserves position. The current account of the balance of payments has seen a steady deterioration over the last four years, increasing from a deficit of $2,769 million (8.3 percent of GDP) in 2010 to $4,924 million (12.2 percent of GDP) in 2012 and $5,839 million (13.2 percent of GDP) in 2013. As with the fiscal deficit, the current account has also recorded two successive years of double digit deficits.

• Ghana’s gross international reserves increased from $2.03 billion in 2008 (equivalent to 2.1 months of import cover) to some $5.6 billion (equivalent 3.3 months of import cover including the stabilization and heritage funds which are encumbered) at the end of December 2013. By February 2014, the Ghana’s gross international reserves have declined to $4.8 billion. This is equivalent to some 2.5 months of import cover.

• Foreign exchange reserves are held to provide a buffer against adverse shocks to the balance of payments (BOP) and to enhance confidence in the country’s economic management and ability to meet its international payment obligations, such as debt servicing, without disruption. Consequently, the level of foreign reserves is an important indicator used in the assessment of a country’s sovereign credit rating, along with the size of central government budget deficit/surplus. The foreign reserves also provide a buffer against delays in disbursements of donor programme aid. The foreign exchange reserves thus provide shock absorbers for the economy.

• An examination of the more important net international reserves (NIR) position tells a more worrying story. The NIR is gross foreign reserves less outstanding short-term liabilities of the central bank and any credit advanced by the International Monetary Fund. It is a measure of what a country’s central bank effectively has available to make external payments. This is the measure that is of most concern to international investors.

• Ghana’s net international reserves have declined from a peak of $4.4 billion in 2011 (equivalent to 3.1 months of import cover to some $1.5 billion in February 2014 (equivalent to some 0.6 months of import cover or some two weeks of import cover).

• In terms of months of import cover, this is the lowest import cover for the NIR since 2000 and the lowest for any middle income or oil producing country in the world. Mr. Chairman, with this low level of NIR, it is clear that we are not only travelling in a boneshaker, but it also has no shock absorbers!

• The low level of net international reserves means that the central bank’s capacity to effectively intervene in the foreign exchange market has been severely compromised. It also indicates that the ability of the government to meet its obligations is limited. At this rate of decline of Ghana’s net international reserves, the country will be on its knees before the end of the year if significant foreign exchange inflows are not forthcoming.

• When one examines the state of our public finances and net international reserves position, it is difficult not to conclude that that the ongoing dumsor dumsor problem (electricity blackouts) may be more financial than technical. This situation of low foreign exchange reserves has contributed significantly to the loss of confidence in the economy by both local and international investors, and has resulted in an increase in demand for foreign currencies and contributed to the cedi depreciation that we have seen recently.

The assessment of the fundamentals of the Ghanaian economy point to an economy with weak and deteriorating fundamentals, including:

• Declining Real GDP Growth
• Increasing Inflation
• Double digit fiscal deficits for two years in a row, and likely three years in a row
• Large and increasing central bank financing of government
• Double digit current account deficits for two years in a row, and likely three years in a row
• Massive increase in the public debt stock,
• Net international reserves at a precarious level
• Government unable to meet is statutory obligations
• Declining consumer and investor confidence

• The question is how can any country expect its currency to be stable after this economic outcome? The depreciation of the cedi that we are observing is the result of the weakening fundamentals of the economy. There is no mystery here. At the heart of the problem is the lack of fiscal and monetary discipline.

Dr. Bawumia, also took his time to dispel some of the popular misconceptions about the fall of the cedi.

• It is also important that the explanations for the current episode of cedi depreciation are not adhoc. This is because the cedi has also seen some stability during past periods. Cedi exchange rate depreciation vis-à-vis the US dollar was 4.5 percent over the year 2003, and 2.2 percent for the year 2004, 0.9 percent in 2005, 1.1 percent in 2006 and 4.8 percent in 2007. Between 2004 and 2007, the cedi depreciated by an average of 2.25 percent against the U.S. dollar. Similarly in 2010 and 2011 the cedi depreciated by 3.1% and 4.9% respectively against the US dollar. Therefore, any adequate explanation of the current cedi depreciation must also be able to explain why in the periods where cedi exchange rate stability pertained, these factors disappeared.

Dollarization

• Dollarization has been offered as probably the biggest cause of the cedi depreciation and this has even led to the government imposing measures in attempt to stop dollarization and hope that that can also stop the depreciation of the cedi.

• But Dr. Bawumia proved with empirical facts and arguments that if anything dollarization is the effect of constant depreciation of the cedi and not the cause as has been wrongly diagnosed and therefore the measures taken is at best, an exercise in futility. This explains for example why the cedi has continued depreciating even after the measures. The cedi has depreciated by over 6% since the measures were announced.

• One of the key functions of money is to act as a store of value. Throughout history, when money ceases to perform this function, people have found refuge in other commodities as a replacement store of value. “Dollarization” happens in countries with a history of high inflation and exchange rate instability. The resort to dollars for savings is essentially a risk mitigation measure. Ghanaians have over the years learnt the hard way that they cannot trust governments to keep the cedi stable. Cedi depreciation has become a fact of life and therefore Ghanaians have come up with coping strategies to deal with exchange rate depreciation, including the holding of foreign currency. For example, if you had GHC 100,000 in 2008, you had roughly the equivalent of US$100,000, but today that same GHC100,000 is only equal to US$38,500 meaning that through no fault of yours and just by deciding to hold on to your assets in cedis, you would have lost over US$60,000 or 60% of your assets in just 5 years and therefore people would want to hold their assets in much stable currencies.

• On the issue of pricing goods in foreign currency in Ghana, it is the law that firms should be required to quote their prices in cedis, the legal tender. It is a good law and should be enforced. While that is so, as long as the economic fundamentals are weak, there is no law that can stop any firm or individual from wanting to hold dollars as a store of value or thinking in dollar terms even though they price in cedis. If a trader thinks in dollars and prices in cedis, how would you know? Once they receive the cedi equivalent of the black market dollar price, they would immediately buy dollars to save either from forex bureau or black market. People will buy dollars if they want dollars. There is not much a government can do about this once people lose confidence in the cedi. Even in the revolutionary days of military enforcement of foreign exchange laws, the black market thrived. We have come to learn that price controls, exchange controls, interest rate controls, and import controls don’t generally work. Government should rather focus on pursuing policies that would stabilize the cedi and make the dollar irrelevant in domestic transactions.

• We should ask ourselves why dollarization disappeared in the five year period between 2002-2007 when the exchange rate of the cedi was very stable? And if the argument is that it didn’t disappear, then why did dollarization not cause a similar rapid depreciation of the cedi? Why is dollarization suddenly rearing its head again at an unprecedented rate? The fact is that dollarization only rears its head when the economic fundamentals are weak and people lose confidence in the ability of the cedi to maintain its value. Dollarization is and has been a consequence of weak economic fundamentals and not the cause of poor economic performance. The lesson here is that, trying to solve the problem of cedi depreciation by focusing on de-dollarization is attacking the effects of a problem and not its causes.

Colonial Structure of the Economy

• Dr. Bawumia also tackled the issue of the much touted colonial structure of the economy which has also been offered as an explanation for the fall in the cedi. At the end of the day, it was clear that that could not be the cause of our current depreciation because we had the same structure of the economy in the years we had a stable cedi; for example between 2003 and 2007 when the cedi depreciated on an average by 2.75% annually and even in 2010 and 2011 under the NDC and for which they took so much credit for.

• Ghana indeed experienced the best period of exchange rate stability during the colonial era under the WACB arrangements. The value of the currency was virtually unchanged between 1912 and 1957. What maintained the value of the currency was the fiscal and monetary discipline imposed to keep the exchange rate fixed. Also, the CFA franc zone countries like Cote D’Ivoire, Burkina Faso, and Senegal, have similar production structures like Ghana but are operating under a fixed exchange rate arrangement which requires fiscal and monetary discipline to work.

• The Asian Financial crisis of 1998 which saw major depreciation in the currencies of countries like South Korea, Thailand, Indonesia etc. also demonstrated that simply being a producer and exporter of manufactured goods would not make you immune to exchange rate depreciation if the fundamentals of your economy are perceived to be wrong.


• There is also the view that our imports are too high and we need to impose import controls in order to protect the currency from depreciating. It is in fact the case that Ghana’s imports make up 56% of GDP whereas exports are 46% of GDP. How does this compare internationally?

• Countries like Hong Kong and Singapore which have very stable currencies also have the highest import/GDP ratios in the world. They have however matched their high import/GDP ratios with even higher export to GDP ratios. Argentina and Brazil on the other hand have relatively low import and export to GDP ratios. That notwithstanding, Argentina has had higher exchange rate depreciation than Brazil because the latter has had stronger economic fundamentals recently.

• The evidence therefore is that having high import/GDP ratios does not mean that your currency would automatically depreciate. It depends on the extent to which those imports are leveraged to produce exports. The question we should be asking as a country is why we are not transforming the 77% of imports of intermediate and capital goods sufficiently in to production for exports? What are the factors inhibiting the productivity and global competitiveness of the private sector? What incentives are we giving to local industries to assist them become globally competitive? Why is the Tema Oil Refinery not processing most of our crude oil production?

Single Spine Salary Structure
• Dr. Bawumia then dealt with the hoax that the Single Spine has caused the depreciation of the cedi and the difficulties the economy is facing and rendered the attempt to blame workers for the government’s own failings redundant with facts.

• At the end of 2008, the Government wage bill amounted to GHC1.98 billion, representing 41.3 percent of total domestic revenue of GHC 4.8 billion. By the end of 2012, after 99% implementation of the single spine salary system, the government wage bill jumped by some GHC4.6 billion to GHC6.6 billion. While the government wage bill increased by some GHC4.6 billion between 2008 and 2012, total government revenue also increased from GHC4.8 billion to GHC15.5 billion over the same period. The increase in domestic revenue by GHC10.7 billion was more than twice the increase in the government wage bill. Indeed, by the end of 2012, the government wage bill following the implementation of the single spine salary system was 42.9% of total domestic revenues. This is not significantly different from the 41.3% in 2008.

• In 2013, the wage bill was 53% of total domestic revenues but this was not due to an increase in the wage bill because as has already been stated, by 2012, the government itself claimed to have implemented 99% of the single spine, the jump to 53% was due to low taxes and revenues which the government in its 2014 budget attributed to among others the dumsor-dumsor which affected production and business.
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• It appears as though government does not appear to have done a holistic analysis of the impact of its policy choices on the budget and fiscal outlook. If it had done so, it should have been clear that the policy of accelerated borrowing which increased the debt stock by 426% in five years for example would take away some of the cushion or fiscal space that was available to the economy in terms of increased interest costs. The same conclusion would also have been reached with regard to the accelerated payment of judgment debts, GYEEDA, etc.

• The problem is therefore not with the SSSS which was planned for, even if poorly implemented. The problem is with the fiscal space that has been eliminated by the high levels of borrowing, dubious payments under GYEEDA, SADA, SUBAH, and questionable judgment debt payments all of which were not planned for at the time the single spine salary system was designed. The SSSS is therefore not the cause of the depreciation of the exchange rate or the current economic woes and therefore should be left alone.

• The sad fact is that Ghana’s economy is in a crisis. The problem we have is that there appears to be an unwillingness to face the truth and admit that we are in a crisis. In fact, we appear to be in a state of denial. At this rate, one should expect much more depreciation of the cedi this year.

Bank of Ghana Measures

• The measures so far taken by the Bank of Ghana through the imposition of foreign exchange controls, despite all the good intentions, have rather added an element of uncertainty to Ghana’s exchange rate regime and this discourages the very investment needed to grow the economy

• The directives are problematic. In putting together the Foreign Exchange Act of 2006 (Act 723) and its accompanying regulations, the Bank of Ghana sought to encourage individuals and firms to have the confidence to bring their dollar and other foreign currency holdings into the banking system. Since 1988, successive efforts have been undertaken to make the banking system the conduit for foreign exchange transactions and not the black market. Forcing exporters to now surrender their earnings within 5 days means that they would likely have to buy foreign exchange at higher price to import raw materials at a later date. It is a tax on exporters that will have the effect of discouraging the repatriation of export earnings.


• The Bank of Ghana also encouraged people to bring their foreign exchange into the banking system. To give people the confidence to bring their foreign currency holdings into the banking system, the rules allowed them to withdraw their deposits in foreign currency. After all it is their money. If they want to withdraw it and put it on their center table to look at it all night, that is their prerogative. Forcible conversion into cedis and restrictions on dollar withdrawals amount to a breach of contract which would undermine confidence in the banking system. It would discourage people from bringing in their foreign exchange holdings into the banking system and drive foreign exchange transactions into the black market. If these two new directives are meant to stop the depreciation of the cedi, then they are bound measures are meant to tackle dollarization, they are destined to fail because dollarization is not the cause of depreciation but rather a vote of no confidence in the local currency. Unfortunately these directives are retrogressive steps that have destroyed so much of the hard work on the foreign exchange market going back 30 years.

Recommendations for Government to save situation

Dr. Bawumia made recommendations on how the crisis can be resolved

• The government has to admit that the economy is in crisis. The denial must stop. The problem will not go away by refusing to acknowledge it.

• Government should restore fiscal discipline by ensuring that we cut our coat according to our size. Revenue enhancing and expenditure reducing measures such as:

o ensuring value for money in the award of government contracts through a transparent and competitive procurement process that minimizes sole sourcing
o Dealing effectively with corruption in the management of public finances

• We need a legal framework to anchor fiscal discipline. When the suggestion was made a few months ago that we needed a Fiscal Responsibility Act, the refrain was that there were existing laws such as the Financial Administration Act, but these are obviously not effective because they were unable to prevent the fiscal excesses of 2008 and 2012. The immediate passage and enforcement of a Fiscal Responsibility Act that has bite will be important in this regard if it is supported by political will. A Fiscal Responsibility law will require governments to declare and commit to a fiscal policy that can be monitored. It will include fiscal rules (including rules governing election year spending), provisions for transparency and sanctions (including sanctions on the Executive).

• To enhance the confidence of the markets in monetary policy while at the same time strongly preserving the independence of the Bank of Ghana, the Bank of Ghana Act should be amended to introduce an accountability mechanism or process for breaches of the Act by providing for regular reporting (say twice a year) by the Governor to Parliament on the fulfillment of its responsibilities under the Bank of Ghana Act. The Governor could appear before the Parliamentary sub-committee on finance for example, in the same way as the Chairman of the Federal Reserve in the United States regularly appears before Congress. This will enhance transparency

• In response to the economic difficulties, government has resorted to increasing taxes on virtually every good or service. These higher taxes have served to increase the cost of doing business in Ghana compared with neighboring countries and would reduce economic growth. The fact is import duties in Ghana are too high and discourage production and investment. In the globally competitive world that we find ourselves today, most countries that manufacture goods for export also import a significant proportion of its raw materials.

• These countries have come to understand that high import tariffs can increase their cost of production and make them uncompetitive globally and therefore to support higher production and exports, import tariffs are kept relatively low. Singapore and Hong Kong for example have zero average import duties. The philosophy of taxing everything to raise revenue must be re-examined. Sometimes you can actually make more revenue by reducing taxes to stimulate production.


• Government should as a matter of policy and urgency, significantly cut down on borrowing for now. The announced intention to borrow an additional $1billion from the capital market this year should be shelved because it would only be achieved at very high cost which would worsen the fiscal and current account situation and make Ghana’s debt unsustainable. With low net international reserves, a double digit fiscal deficit, double digit current account deficit, and double digit inflation, Ghana would have had to pay a double digit interest rate for any sovereign bond issue this year.

• To restore confidence in the banking system and a degree of certainty in the foreign exchange regime, the Bank of Ghana should immediately reverse the new directives relating to the forced conversion into cedis of repatriated export earnings and forced conversion into cedis of withdrawals from FCA and FEA accounts. There is no problem with repatriation of export proceeds but there must not be forced conversion of those proceeds into cedis. During the years 2002-2007 and 2010-2011 the cedi was relatively stable even though exporters were allowed to retain their repatriated earnings in dollars and foreign account holders were allowed to withdraw their savings in dollars. This was therefore not responsible for the depreciation of the cedi.