The Institute of Economic Affairs (IEA), a Public Policy Institute, has urged the Monetary Policy Committee (MPC) of the Bank of Ghana (BoG) to maintain the policy rate at 22% when it meets to assess recent developments in the global and domestic economies later this week.
The IEA noted in a statement that if one was following the Inflation Targeting (IT) principle religiously, then based on the balance of risks facing the Ghanaian economy, a case could be made for increasing the Policy Rate (PR) by about 200 basis points.
However, the Institute emphasized that it is also clear that the PR alone cannot be relied on to address the current inflation crisis, especially in view of the peculiarity of the causes. It warned that “If we push the PR to the limit, the consequences on the real economy could be disastrous”.
“Indeed, many countries around the globe have come to this realization, and are taking unprecedented measures, beyond their orthodox inflation management frameworks, to deal with what is, obviously, an unprecedented inflation crisis. In view of this, our expectation is that the MPC will keep the PR on hold at 22%”.IEA
Inflation in Ghana hit a 21-year record of 33.9% in August, culminating to 15 consecutive monthly increases. High food and fuel prices attendant to Covid-19 and the Russia-Ukraine war have accentuated inflation across the globe—with Ghana having its share.
Ahead of the MPC’s next meeting scheduled for September 21-23, the IEA has warned in a statement that “There Is heightened urgency for Bank of Ghana and Government to act”.
Previous MPC decisions
Over the past 15 months, the MPC, acting in response to rising inflation, has tightened policy aggressively by raising its Policy Rate (PR) by 850 basis points from 13.50% to 22.00%. Over the same period, inflation has risen consistently from 7.5% in May 2021 to 33.9% in August 2022.
The IT framework used by the MPC to control inflation aims primarily to stem demand pressures while also mitigating any second-round effects that supply or cost factors may cause.
“We have constantly pointed out that the transmission of the PR is constrained in developing economies due to financial shallowness in those economies. The PR, which is essentially a demand-management tool, is even less effective in countering the effects of supply or cost factors. At 22.00% currently, the PR is substantially less than the inflation rate of 33.9%, quite a turn-around from the situation in May 2021, when the PR was 13.5% and inflation was 7.5%.”IEA
The IEA noted that while it is not unusual for monetary policy rates generally to fall behind the rate of inflation, the very wide gap in the Ghanaian situation may be interpreted to mean that monetary policy is not tight enough.
The Institute however, finds it “rather unusual” that the PR is also well below the (91 -Day) Treasury Bill Rate (TBR) of 27.5% and the Ghana Reference Rate (GRR), the base rate for banks’ lending, of 26.5%.
The IEA explained that the situation gives room for ’round-tripping’, to the extent that banks can potentially borrow from the central bank at the cheaper PR and on-lend to Government at the higher TBR or even to other borrowers in the market and profit from the transactions.
Avoiding this undesirable behavior, according to the IEA, requires a realignment of interest rates to eliminate the PR-TBR and PR-GRR gaps.
The Public Policy Institute further underscored that it was evident in the Mid-year Budget Review that Bank of Ghana had financed the budget to the tune of GHc22 billion in the first half of 2022. This was far in excess of the GHc3.5 billion ceiling, being 5% of the 2021 revenue of GHc70 billion, imposed by the Bank’s Act, it noted.
“The loan, which constitutes a huge liquidity injection into the economy, has the potential to accentuate the already heightened inflation. The loan, therefore, increases the pressure on the Bank of Ghana to sell treasury bills to mop up the liquidity it has created, an action that could be effective only by hiking treasury bill rates.”IEA
Targeting the underlying causes of inflation
The IEA indicated that it expects the Bank of Ghana to work with Government to adopt additional targeted measures to fight the inflation crisis. As such, it recommended measures that will help address food, fuel, transport and exchange rate challenges which it described as the underlining causes of the country’s long history of inflation.
Among other measures, the IEA called for reinforcement of measures to ensure that food stocks are easily transported from farm gates to markets. It calls for subsidies on basic staples like maize, rice, cooking oil and bread.
Regarding fuel, the Institute is advocating a reduction of some of the fuel taxes/levies and the use of part of Government’s windfall gains from higher oil prices to cushion pump-prices.
Regarding transport, it calls for expansion of public transport and subsidization of fares to cushion the masses.
Above all, to stabilize the exchange rate, IEA urged the Bank of Ghana to enforce the foreign exchange laws, including relating to forex carry-on limits for travelers, forex trading, pricing of goods and services in forex and forex transfers through banks.
Additionally, it called on the Central Bank to negotiate with foreign companies to stagger repatriation of their dividends and profits to reduce pressure on the exchange rate.