Central bankers in Accra, Ghana’s tropical capital city, will have felt the heat rise over the past month as they risk taking an ignominious place in financial history next to their peers in Argentina.
In January 2018, the Central Bank of Argentina decided to cut interest rates by 75 basis points, to 27.25 per cent, even though inflation was running at about 25 per cent.
The move, widely seen as premature, alarmed investors and kick-started a spiral that led the peso to lose more than half its value against the US dollar, inflation to spiral to 48.9 per cent and interest rates to be jacked up to 60 per cent in an attempt to stop the currency falling further still.
Matters are nowhere near as bad, at least not yet, in west Africa’s second-largest economy. However Ghana’s currency, the cedi, has fallen 9.8 per cent to an all-time nominal low against the dollar since the central bank surprised markets by cutting rates by 100bp to 16 per cent on January 28, making the cedi the worst performing currency this year of the 140 tracked by Bloomberg.
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“Despite pressure on the cedi, the Bank of Ghana acted to ease domestic financing conditions.
The monetary policy committee’s policy choice revealed a preference for supporting domestic activity over guarding against external vulnerabilities — for now,” said Dylan Smith, analyst at Goldman Sachs.
To be fair to the BoG, its decision to cut rates may have appeared sound. Inflation had fallen from 19 per cent to a six-year low of 9 per cent, within the bank’s target range of 8 per cent, plus or minus 2 percentage points, and was forecast to remain under control.
And even with the rate cut, real rates were still a chunky 7 per cent, among the highest in frontier markets.
The MPC said that “immediate risks to the disinflation path are well contained” and inflation expectations “well anchored”, and that it thus saw “scope to translate some of the gains in macro stability to the economy” by easing short-term rates.
“We are sympathetic to BoG efforts to find the acceptable level of interest rates relative to inflation,” said Charles Robertson, chief economist at Renaissance Capital, an emerging markets-focused investment bank.
“This was a move that did not look rash, but was unexpected . . . Investors might be worried about anti-inflation commitment, similar to Argentina.”
The bank’s decision reflected “a difficult trade-off between easing tight domestic financial conditions and preserving the attractiveness of local assets for foreign investors,” said Mr Smith.
Unfortunately for Ghana, it is more vulnerable than most to sentiment in the world’s financial capitals. Foreign investors currently hold 30.6 per cent of Ghana’s local currency bonds, one of the highest rates of foreign ownership among emerging and frontier nations, as the second chart shows.
A lot of money could be withdrawn if they lose confidence in the BoG’s commitment to tackling inflation.
Foreign investors “may fear the central bank cut interest rates to cut borrowing costs and is taking risks with inflation,” said Mr Robertson, who noted that government debt was equal to nearly 60 per cent of gross domestic product last year.
Not everyone believed the BoG was to blame for the cedi sell-off, however. Victor Yaw Asante, head of commercial, corporate and investment banking at First National Bank Ghana, instead pointed to a temporary supply and demand imbalance in the forex market.
The imminent expiration of an IMF funding programme, which Ghana entered into in 2015 following a series of budget overruns, led some foreign investors to sell down their holdings of cedi-denominated bonds, Mr Asante said.
This coincided with seasonal demand for dollars from Ghanaian importers, which are now receiving invoices for goods imported in the run-up to Christmas.
Although this happens every year, importers have accelerated their buying. “When they see the dollar getting ahead of itself and the cedi getting weaker, people bring forward their [dollar] purchases,” said Mr Asante, who was critical of the central bank for not anticipating the dollar shortage.
Mr Robertson also believed the imminent departure of the IMF may have unnerved some investors. He said Ghana had a “terrible” fiscal record in the election years of 2008, 2012 and 2016 and, with the next election looming in 2020, a recent decision not to hike electricity prices “despite all the power utilities calling for price hikes” might be interpreted by some as a sign that the four-year pattern could repeat itself.
One obvious risk is that the currency’s slide reignites inflation. Data for February showed a modest uptick, to 9.2 per cent, hinting at a degree of early pass-through from the currency.
Mr Asante said inflation could tick up to 10-11 per cent in the near term. At this stage, though, most observers see little prospect of an Argentina-style catastrophe.
Mr Asante was confident that the BoG was belatedly getting into a position to supply the market with sufficient dollar liquidity. A $500m-$750m bridge financing arrangement with a consortium of banks should be concluded by the end of this month, he said, while the Ghana Cocoa Board, the state marketing organisation, should be able to draw down $300m against this year’s crop.
The banks behind the bridge finance are also marketing a proposed $3bn eurobond, with a Ghanaian delegation believed to be doing the rounds of Boston, New York and London to gauge appetite this week.
Mr Asante was also hopeful of a rise in production of oil, a key export alongside cocoa and gold, with the UK’s Tullow Oil having said it plans to increase output this year, helping support the current account.
“The [cedi’s] bleeding should stop in the next couple of weeks and then, after it stabilises, there should be some recovery,” he said. An equally relaxed Mr Robertson argued that a crucial difference between the travails of Ghana and Argentina was that the peso was “horribly overvalued” when its central bank caught markets off-guard.
In contrast, the cedi is the second cheapest currency in Africa, just behind the Tunisian dinar, based on RenCap’s real effective exchange rate model, at just 70 per cent of its long-term value.
Mr Smith said Goldman’s models also suggested the cedi was undervalued and, with Ghana on course to boost its reserves, which in December stood at just $7bn, equivalent to 3.6 months of import cover, investor interest “may resume as Ghana’s high local yields look more attractive to investors at lower exchange rates”.
Assuming the BoG now pauses its easing cycle until the middle of the year, before pulling the trigger on two more 100bp cuts later in 2019, and current global market conditions persist, he believed the cedi was likely to stabilise.
In order to help avoid the risk of Argentina-style accidents in the future, however, Mr Robertson called on the central bank to start providing some forward guidance on interest rates and for the government to consider negotiating a standby arrangement with the IMF.
“Even if there is no funding, IMF monitoring would be valuable,” he said.
