IMANI Alert: Could the Recent Monetary Policy Decision Change Ghana’s 2016 Economic Outlook?

On Monday, 25th January 2016, the Monetary Policy Committee (MPC) of the Bank of Ghana announced its decision to maintain the policy rate at 26 per cent consistent with the advice of the previous IMANI Alert

The policy stance was commendable considering the fact that the IMF advised further increase in the 11-year-high policy rate which would have increased the cost of borrowing.  Taking the advice would have been detrimental to the survival and/or performance of businesses should one take into account recent increases in utility tariffs, petroleum levies and various taxes, not forgetting that some business are now recovering from the adverse impact of the energy crises last year.

Primary reasons for the decision of the MPC include its observation of moderate price movements in the past few months as well as moderate inflationary expectation going forward. Other notable reasons relate to the hope that the energy situation will improve and on-going fiscal consolidation will persist.

Despite the positive outlook of the inflation rate, the MPC recounted possible challenges such as exchange rate developments, aggravating external financial conditions and the second round effects of petroleum price adjustments.

The MPC was also optimistic about economic growth recovery prospects within the medium term but enumerated risk factors including weak consumer confidence, falling commodity prices, slack in global growth (in countries such as China) and the intrinsic detrimental impact of tight fiscal and monetary policy.

The Committee concluded that it perceives, “the risks to inflation and (economic) growth as balanced, and therefore decided to maintain the monetary policy rate at 26 per cent.”
Analysis

Although the Committee’s decision not to further increase the policy rate deserves applause, some of its reasons are not strong and some of its assumptions are too strong. For instance, the Committee mentioned that, “…risks (to further inflationary pressure) would however be moderated by lower crude oil prices, and improvements in the energy situation”.

The committee appears to also overlook the ‘damning effect’ of the fiscal policy authority’s decisions ‘sitting’ between the global prices of crude oil and the possible ex-pump prices which feeds into the current supply side inflationary pressures.  It [MPC] again appears to have an unrealistically optimistic perception of the future especially with regards to the magnitude of the upside risk factors of inflation since the increase in utility tariffs and petroleum levies would further heighten inflation through higher self-fulfilling inflationary expectations. With the FED further increasing interest rates the risks on inflationary pressure via the exchange rate could be higher than the MPC has estimated.

Moreover, even if slow increase in core inflation happens to “steer inflation down towards the medium target band of 8±2 per cent” as suggested by the Committee, it is important to note that core inflation excludes energy and utility prices and is intended to measure not just underlying inflation but underlying inflation in the long run. With the economic policy statement targeting single-digit inflation by the end of the 2016 financial year coupled with increases in utility costs and petroleum levies, the long-run measure underestimates the impetus of inflationary pressure within the year ahead.

The downside risks to growth cannot be balanced with the upside inflationary risks. Indeed this is too simplistic an assumption, with further pressures evinced in the desire and strong incentive of government to increase expenditure and growth going into the elections (possibly to fulfil manifesto promises). This could be a mitigating factor to the downward risk of economic growth. Although the FUND in its January review indicates a commitment to the consolidation program to tame expenditure and restore stability, there is no reason to denounce the existence of the appetite of government for spending in electioneering years with an attending negative effects on the financial markets via domestic borrowing.

It is agreed that, subject to the Lucas critique, past macroeconomic relationships may not necessarily persist in the future so that fiscal consolidation could persevere this year. But with the risk variable inherently being a probability variable, it is important to mention that the likelihood of the rate of inflation rising to that of economic growth falling further do not necessarily concur considering the fact that 2016 is an election year.

In essence, the rate of inflation is likely to increase and more than the maintained policy rate is required to curb inflationary pressure in such a manner which will not be significantly detrimental to economic growth. It is worthwhile reiterating the following recommendations and conclusion going forward.
Recommendations and Conclusion

The estimates by the committee are expected to reign in positive results over the next quarter until their sitting in late March (2016). With the currency expected to decline in value and a possible second round effect of utility and petroleum tax hikes, there is evidence to suggest that chasing inflation with the monetary policy rate will not deliver the results. The authorities could have ‘shifted’ focus to pursue growth recovery, particularly at the time when the transmission mechanism from the policy rate to inflation appears non-existent at best.

The commitment of government to its announced economic policy for the 2016 financial year is crucial since the private sector typically forms inflationary expectations based on the announcement. Thus reneging on its expenditure commitment is likely to lead to an increase in inflation making the economy worse off.

It must be clearer to the government by now that a more shrewd reduction in the usually bloated expenditure in an election year should be vigorously pursued in order to reduce the size of our odious debts. But it must act cautiously and not dramatically increase taxes lest it creates further distortion in the market-place for innovation and basic livelihoods.

Lastly, a more pragmatic monetary policy that truly asserts the independence and effectiveness of the Central Bank may be borrowed from a note IMANI’s President, Franklin Cudjoe shared after an insightful meeting at the Bank of England with it Director for International Development for the Bank last November: “Three roles for the central bank, ensuring micro prudential, macro prudential and monetary Policy. The Bank is independent in ensuing the fiscal targets set by any UK government is met. However, if the government deviates from what the bank proposes to be done, then it loses credibility and will be punished by the voting public. Curiously, the Monetary Policy Committee’s decisions are published but will in the interest of transparency and market confidence, publish minutes of its meetings including what each of the nine -member committee said in its meetings. So, prudent monetary policy management must resonate with prudent fiscal foresight. Our finance minister in Ghana should not have a fiscal target whilst the central bank can have a mind of its own, and the electorate can simply applaud.”

Reference

Author: Hubert Nii-Aponsah is Member of the Center for Economic Governance and Political Affairs at IMANI Africa.