Ghana’s monetary and fiscal policy choices in difficult times
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Ghana’s economic decline in the last 5 years echoes a sense of “loud silence” as the investor community was stunned by the adverse turn of events in an economy recently (and probably still) perceived as Africa’s rising star. While the economic downturn was triggered by domestic factors underpinned by the fiscal and monetary policy choices, the collapse in commodity prices due to weakened demand in China and the Eurozone added external pressure to the decline.
The start of hydrocarbon production in Dec-2010 coincided with a period of macroeconomic stability in Ghana (under an IMF-assisted fiscal adjustment program which expired in Jul-2012). The policy credibility attained under the IMF program culminated in a sustained decline in the average annual inflation rate from 19.3% in 2009 to 8.7% in 2011, supported by a relatively stable Ghana cedi over the period.
Investor confidence in Ghana’s economic prospects was firmly restored as the country commenced the commercial production of crude oil from its Jubilee oil field, fueling economic activity and FDI inflow.
Ghana’s real GDP growth consequently raced to a peak of 14% in 2011, representing the fastest pace of economic expansion in SubSaharan Africa. Evidently, the fiscal and monetary policy choices between 2009 and 2012 (under the IMF-assisted fiscal adjustment program) were complementary and supportive of a stable macroeconomic environment and investor confidence.
As observed in figure 1, periods of sustained macroeconomic stability (reflected by the declining inflation) are more likely to be associated with sustained economic growth (and vice versa).
THE ILLUSION OF CRUDE OIL REVENUE
The anticipated cash flow from crude oil liftings (including surface rentals, royalties & corporate taxes) underpinned the government’s bullish revenue expectations fueling the fiscal regime into overdrive.
The fiscal expansion embarked upon, resulting in expenditure overruns with fiscal commitments broadly exceeding budget limits as the 2012 elections pressure exerted greater demand on the national budget.
Total government expenditure at the end of 2012 (GH¢20.56 billion) surged by 54% year-on-year (exceeding the estimated limit by 8.2%) while capital expenditure (GH¢4.62 billion) turned out 22.7% less than projected.
The expenditure mix revealed an underlying problem in the structure of Ghana’s fiscal deficit: The bulk of Ghana’s crude oil revenue was earmarked and channeled into recurrent expenditure, undermining the country’s growth prospects while exerting fiscal pressure on the budget.
The public sector wage bill (GH¢6.67 billion) was expanded by 47% year-on-year in 2012 with an 18.2% overrun relative to the budget limit for the year. The surge in the wage bill was mainly influenced by the decision to migrate more than 500,000 public sector staff to a new pay structure (the Single Spine Salary Structure). The re-introduction of broad-based subsidies on utilities and petroleum products in the 2012 budget was in sharp contrast to the fiscal discipline achieved under the IMF program.
The total commitment for subsidies (GH¢808.98 million) also registered a 72.1% overrun beyond its threshold, creating a substantial buildup of arrears and contributing to the prevailing energy sector challenges in Ghana.` While the government embarked on a drive to boost recurrent expenditure (at the expense of growth-oriented capital expenditure), the revenue outturn from crude oil was grossly disappointing.
The total benchmark crude oil revenue for the 2012 fiscal year (GH¢557.61 million) was 36.5% short of expectations, amplifying the fiscal slippages on the expenditure side. The analysis of Ghana’s fiscal data by Databank Research revealed two key findings: the revenue perception from crude oil production is an illusion while the fiscal implication of this mirage has undermined the country’s growth prospects.
The start of commercial production of crude oil has created a sense of false hope underpinned by ambitious revenue expectations which motivated an expansionary fiscal policy, resulting in unsustainably high budget deficits with a risk of debt distress.
While fiscal deficit surged to 12.1% in 2012 (from 4.3% in 2011) and remained in double digits for three consecutive years, the resultant growth in the public debt has increased the debt service cost over time.
Ghana’s total debt service cost was GH¢9.08 billion at the close of 2015, representing a 463% surge compared to the level in 2011 as the wide fiscal gap fueled debt accumulation which hit ~ GH¢100 billion (71.6% of GDP). Essentially, the structure of Ghana’s public debt (in terms of the maturity profile of the various debt securities) is a reflection of the nature of the country’s fiscal deficit.
The fiscal policy choices following the start of oil production were geared towards expanded recurrent expenditure with little consideration for sensitivity and sustainability analysis. Sustaining the high recurrent expenditure in the face of lower revenue outturn resulted in the sizable issue of short term debts (and central bank financing of the deficit beyond the stipulated ceiling).
The government’s analysis of Ghana’s public debt portfolio as of Aug-2015 revealed an average maturity profile of 10 months, highlighting the vulnerability to rollover risks which contributed to the higher debt service cost.
FISCAL DOMINANCE IN MONETARY POLICY
Prior to the IMF-inspired amendments to the Bank of Ghana Act in Aug-2016, the initial regulation allowed central bank financing for the government budget by up to 10% of the previous year’s domestic revenue.
This financing window created the incentive for fiscal excesses as the government perceived the central bank as a ready and cheaper source of funding, an approach that undermined the independence and effectiveness of the monetary policy. As observed from the 2012 fiscal data, central bank net financing of the 2012 budget amounted to 18.8% of the previous year’s domestic revenue, significantly breaching the 10% limit.
Notwithstanding the government’s attempt to embark on the path of fiscal consolidation from 2013 (post-elections), the sustained fiscal slippages have undermined these efforts while monetary policy continued to accommodate the fiscal excesses (without an IMF support). Ghana’s Inflation Targeting (IT) framework was compromised by the dominant influence of fiscal authorities, reducing monetary policy decisions to a mere mop-up exercise aimed at sterilizing the monetization of fiscal excesses.
Against this backdrop, inflation assumed an upward trend since 2013 while exchange rate pressures consigned the Ghana cedi to sharp losses over the period to the 1HY2015.
RESTORING POLICY CREDIBILITY: IMF TO THE RESCUE
Difficult times must surely warrant tough measures and Ghana was in dire need of one as restoring policy credibility was necessary to re-engage with donor partners and trigger investor confidence.
A frontloaded (3-year) fiscal adjustment program ultimately commenced with technical support and an Extended Credit Facility from the IMF in Apr-2015, with marked improvements in the fiscal deficit (6.3%) by FY-2015. Beyond the fiscal measures, the IMF program (currently in its 2nd year) also aims to strengthen the Bank of Ghana’s independence and enhance the effectiveness of the IT framework.
An interest rate analysis by Databank Research revealed a misalignment of interest rates in the period before Nov2015 (figure 2). Despite the monetary-induced inflationary pressures in the 1HY-2015, the monetary policy rate continued to lag other market rates (particularly, the inter-bank interest rate).
We believe the situation undermined the credibility of Ghana’s monetary policy regime as the policy rate (below the interbank interest rate) lost its punitive features and signaling tendencies as an anchor rate.
With technical assistance from the IMF, the monetary authorities implemented a number of policy measures which included a merger of the policy rate and the reverse repo rate at 24% in Aug-2015 (from 22%).
The subsequent MPC meetings in September and November 2015 were concluded with hikes in the policy rate, closing 2015 at 26% and effectively correcting the perceived misalignment.
With the policy rate at 26% (a decision maintained in the four consecutive MPC meetings since Nov-2015), we reckon that demand pressures and interest rate expectations have been fairly anchored. The Bank of Ghana’s decision to maintain a rate-neutral stance so far in 2016 is in line with Databank Research’s expectations despite the heightened inflation expectations since the turn of the year.
The inflation dynamics in 2016 are indicative of the cost-push pressures arising from the utility tariffs and energy sector levies imposed. Under this circumstance, the policy options were constrained by the ultimate goal of fiscal sustainability while the uncertainty of potential second-round effect (of the cost pressures) necessitated a rate-neutral decision given an already tight monetary stance.
Despite the delay in kick-starting the much-anticipated disinflation process, there are indications of receding inflationary pressures as inflation appears to have already peaked at 19.2% in Mar-2016. While inflation should assume a downward path in the 2H-2016, the government of Ghana’s target of 10.1% by close of 2016 appears unlikely given the Jun-2016 rate of 18.4% (Databank Research Projection FY2016: 14% ± 100bps).
Overall, sustaining the emerging macroeconomic stability would be necessary for a rebound in economic growth in 2017 and this requires successful navigation of the election pressures ahead through fiscal discipline and tight monetary policy