After rebasing the economy in August 2019, y-on-y inflation rate from August to December 2019 averaged 7.8 percent with August 2019 recording a rate of 7.7 percent, below the central path of 8%. This trajectory was maintained into Q1 of 2020, also averaging 7.8 percent.

However, inflation rate has since, trended upward beyond the target to as high as 11.4 percent, being a change of about 360 basis points (3.6 percentage change) in July, 2020, owing to the economic fallout of the COVID-19 pandemic— decline in economic activity as a result of imposition of restrictions, the partial lockdown and shortage of goods as a result of the closure of borders.

Meanwhile, during this period, the Central Bank trimmed down the policy rate from 16.5 percent to 14.5 percent in order to cushion the impact on businesses and households.

From August 2020 to November 2020, y-on-y inflation rate trended downward very sharply from 10.5 percent in August to 9.8 percent in November— a rate within the inflation band (inflation rate for December 2020, yet to be released). For obvious reasons, inflation has been falling due to the bounce back to a new normal economic climate.

Suppose this fall in inflation continues into 2021, in the context of the commencement of the AfCFTA, would inflation levels fall below the central target of 8 percent again— the déjà vu effect, in the first quarter of 2021? (The ‘déjà vu effect’ exists when the fall in inflation below the 8 percent central target is repeated.)

Level of Inflation in a Free Trade Area

Based on theory, it is suggested that a free trade area has an inverse relationship with the rate of inflation. This means that inflation rates tend to be low when an economy is more trade-open, a situation which is helpful for the economy.

On the one hand, the effect of trade expansion and the increase in the availability of cheaper imported goods due to the removal of trade barriers and increased competitiveness tends to directly drive down prices or force domestic producers to lower prices, thereby reducing inflation.

Furthermore, a free trade area may indirectly reduce inflation by enhancing efficiency and fostering productivity growth through channels such as the transfer of technical knowhow, innovations, economies of scale and specialization.

Ghanaian Businesses may lose out on AfCFTA benefits

Will Inflation fall below the 8% target in Q1 of 2021?

In an AfCFTA era, the interplay of these mechanisms aforementioned are likely to work to keep inflation low. Albeit, the current slow pace in the readiness of businesses, especially in the manufacturing sector and the deficit in infrastructure to harness the full benefits of the AfCFTA may delay the trend in the fall in inflation for Q1 2020. For example, the importation of foods such as maize and other grains may drive food inflation upwards.

This is likely to be the case due to the country’s very large composition of the services sector as compared to the industrial sector. In such a circumstance where imports are favored the more as compared to exports of manufacturing goods, this would translate into further depreciating the domestic currency and may rather hurt the economy by increasing inflation and reducing competitiveness.

In the near-term, however, the benefits of the AfCFTA on the economy regards further driving inflation down would not be immediate. Thus, benefits from the transfer of technical knowledge, and a switch towards the production of goods with comparative advantage would not materialize in the short term.

Nevertheless, it is possible that the country may begin to see the effect of a decline in inflation below the central target in the medium-to-long term.

Central Bank’s Action to keep Inflation low

This therefore sets the tone for the Central Bank to review the medium-term target of inflation downwards.

With trading partners like Kenya who have medium targets of 5+/-2 percent and South Africa with 3-6 percent, and who also double as countries with relatively large industrial sector as compared to that of Ghana, we may lose out on competition with them.

Ghanaian businesses need to be provided with an enabling environment that can ensure they can better compete and reel in the benefits of this trade pact in the medium-to-long term.