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Available online at www.sciencedirect.com ScienceDirect Review of Development Finance 4 (2014) 115–125 Financial and monetary policies in Ghana: A review of recent trends Peter Quartey a,∗ , Gloria Afful-Mensah b a Department of Economics, University of Ghana, Legon, Ghana b University of Professional Studies, Accra, Ghana Abstract This study has reviewed recent monetary and financial policies pursued in Ghana. The paper concludes that generally, while there have been remarkable improvements in the key monetary indicators which suggest relatively effective monetary policies during the period under review, the fiscal imbalance in the country has limited these outcomes. There is clearly the need for greater fiscal discipline given that monetary policies cannot achieve their intended purposes in the presence of fiscal imbalances. Moreover, although the policy rates have signalled a downward trend in lending rates, this has not reflected in the lending rates charged by deposit money banks (DMBs). This suggests that there are other factors driving interest rates in the country and therefore the need for policy intervention to make the cost of doing business favourable to the private sector. © 2014 Africagrowth Institute. Production and hosting by Elsevier B.V. Open access under CC BY-NC-ND license. JEL classification: F31; G21; G28 Keywords: Financial policy; Monetary policy; Ghana 1. Introduction Monetary policies all over the world have been pursued together with fiscal policies to ensure that economic progress is achieved while fiscal and other macroeconomic challenges are addressed. These policies and strategies have been dynamic and in line with global trends in order to be relevant. Monetary policy involves the use of different measures with the aim of regulating the value, supply and cost of money in consonance with the expected level of economic activity. The common objectives of any monetary policy may include price stability, maintenance of balance of payments equilibrium, creation of employment, output growth, and sustainable development. In order to be effective and globally acceptable, monetary policies have to be dynamic. Thus, monetary policies have undergone dynamic changes globally but in African countries this begun in the 1980s and 1990s where there was a conscious ∗ Corresponding author. E-mail addresses: [email protected] (P. Quartey), [email protected] (G. Afful-Mensah). Peer review under responsibility of Africagrowth Institute. 1879-9337 © 2014 Africagrowth Institute. Production and hosting by Elsevier B.V. Open access under CC BY-NC-ND license. http://dx.doi.org/10.1016/j.rdf.2014.07.001 move away from the direct control measures to indirect monetary policy. However, due to the absence and illiquidity of financial markets such as secondary bill markets, many countries were hardly employing indirect monetary control instruments such as open market operations (Ncube, 2007). In the specific case of Ghana, monetary policies have evolved from the use of direct instruments1 to the market-based approach where the main target of policy is the money supply (see Alexander et al., 1995; Roe and Sowa, 1997). For instance, before the start of financial sector reforms in 1992, the Bank of Ghana (BoG) operated a system of managing the amount of money in the economy by using direct controls and a fixed exchange rate system. While this approach was relatively easy to implement and also appealed to the government (which was mainly interested in channelling resources to certain “priority sectors” of the economy), there were several inefficiencies associated with its ability to give the right signals for allocating resources efficiently. As the reforms began, this system was abolished in favour of a relatively more marketbased form of distributing and managing resources. Under the market-based system, the aim was to use indirect instruments to regulate money supply in order to achieve price stability and other economic objectives. This approach was based on the strong conviction that inflation in Ghana was solely or predominantly a monetary phenomenon, following the monetarist school 1 This was made up of interest controls, credit and sectoral credit controls and reserve requirements. Such policies contributed massively to financial repression in Ghana before the financial reforms in 1992. 116 P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 of thought. Within this monetary policy framework, reserve money served as an operating target, money supply (M2+) as the intermediate target, with the final target being inflation. Globally, as economies developed, with corresponding developments in the financial sector, several substitutes for money emerged, which rendered monetary targeting not very effective, particularly in the short run. Eventually, Ghana, along with other countries, abandoned the monetary targeting framework and adopted inflation targeting as a strategy for conducting monetary policy. In Ghana, the Bank of Ghana Act 2002 specifically considers the BoG as an inflation-targeting central bank by indicating in the BOG Act 617, Section 33(2) that: “The Bank, in counteracting unusual movements in the money and prices in the country, shall use any of the instruments of control conferred upon it under this Act or under any other enactment to maintain and promote a balanced growth of the national economy” The Bank of Ghana has since 2002 mimicked the policy of price stability,2 particularly; low inflation and a fairly stable exchange rate (Sowa and Abradu-Otoo, 2007). Quartey (2010) notes that although the central bank has been pursuing low inflation policies as of 2002 albeit it does not follow an explicit inflation targeting framework. However, the low inflation policy framework mimics an inflation targeting regime in which a specific level of inflation is set and targeted jointly by the central bank and the Ministry of Finance, but the target does not involve the usual modelling and minimizing of the loss functions as is typically done under inflation targeting regimes (Sowa and Abradu-Otoo, 2007). However, one thing that is very evident is that although this “inflation targeting” framework has been operational since 2002; its outcome has not received much interrogation. This paper therefore reviews recent trends in financial and monetary policies before and after the inflation targeting framework was instituted. Specifically, the paper analyze the current trends in monetary policies and movements in some of the key indicators. The rest of the sections are as follows: The next section discusses the monetary policy options pursued under the various mediumterm development strategies. The subsequent section reviews the monetary policy outcomes after the financial sector reforms. The final section provides the concluding remarks. 2. Developments in the monetary and financial sector 2.1. Banking laws and regulations Ghana’s banking sector appears vibrant compared to those in other countries of the sub-region. Despite the relatively welldeveloped and structured banking system, the sector was widely used by previous governments in their massive, state intervention programmes, particularly between the 1960s and 1970s. 2 The Bank of Ghana’s mission statement declares that, “Our mission is to pursue sound monetary and financial policies aimed at price stability and create an enabling environment for sustainable economic growth”. See www.bog.gov.gh/. This led to significant losses for the banks in terms of the ratio of bad loans to their total portfolio. As part of measures to restructure the banking sector, reforms were instituted (including a market for securities) to ensure effective monetary policy. As a result, a weekly auction in Treasury bills was introduced in 1986. Gradual attempts were subsequently made by the central bank to move away from the direct control regime3 to the indirect system of policy measures which was more market-oriented. Given the negative consequences from the repressive measures, the Financial Sector Adjustment Programmes (FINSAP 1) was introduced between 1988 and 1990 to, inter alia, restructure distressed banks, increase the mobilization of savings and efficiency in credit allocation, and develop money and capital/securities markets (Gockel et al., 1997). Subsequently, the government amended the existing banking law in August 1989 in order to strengthen the banking system. Under this new law, banks were required to keep 6 percent of their net assets as their minimum capital base even though the Bank of Ghana had the discretion to increase the ratio for any specific bank or even for the entire banking sector. Among the measures of the central bank to improve its supervisory and regulatory framework, the new banking law also introduced limits to single borrowers. The period 1990/91 then witnessed the modified version of FINSAP 1 in FINSAP 2.4 This was followed by the enactment of the Non-Bank Financial Institutions Law of 1993.5 As part of the liberalization process in the sector, a number of new laws6 aimed at facilitating financial transactions, strengthening and deepening the financial system in general and the Bank of Ghana in particular, were laid before Parliament in 2000/2001. The implementation of the Financial Sector Strategic Plan which began in 2003 led to the passage of the Banking Bill and the Payments System Bill in 2003. While the Banking Bill was aimed at providing an effective supervision framework by the Bank of Ghana for the banking industry, the Payment System Bill was aimed at modernizing and improving the efficiency of the country’s payment system. The following paragraphs discuss some of the new developments in the financial sector since the year 2000. 3 The period witnessed the use of unorthodox monetary policy measures especially in the 1970s and early 1980s. Examples of such policies included low interest rates (minimum deposit rates and maximum lending rates) set by the central bank to serve as incentives in order to increase investment in the country. There were also bank-specific credit ceilings and sectoral credit controls (between 1960 and 1990) purposively to promote a specific investment pattern by channelling funds into certain “priority sectors”. The low interest rate policy used was based on the underlying assumption that the cost of capital and not the availability of loanable funds were the major determinant of investment (Khan and Hasan, 1998) and hindrance of access to funds by potential investors. Another major policy instrument was the imposition of a required reserve ratio by the Bank of Ghana averaging about 50 percent (by 1983) and 32 percent (between 1987 and 1989). 4 FINSAP 2 was meant, inter alia, to finish any unfinished project in FINSAP 1, divest state-owned banks and promote and strengthen the non-bank financial institutions. 5 See Gockel et al. (1997). 6 The new laws included the Banking Law, the Bank of Ghana Law, the Bills and Cheques Bill and the Payment Systems Bill. P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 2.2. Developments in the financial sector since 2000 2.2.1. Universal banking The Bank of Ghana in 2003 introduced the concept of universal banking into the country. Universal banking made it possible for banks to undertake commercial, development, investment and/or merchant banking without necessarily having separate licenses. Thus, universal banking was to make the banks versatile in providing services to their customers. However, such banks do so at their own risk since it is dependent on the respective bank’s own capital resources given that such expansion requires relatively huge resources. 2.2.2. Payment System Bill 2.2.2.1. Real Time Gross Settlement System (RTGS). Before the introduction of the Real Time Gross Settlement System (RTGS) in 2006, Ghana’s economy was predominantly cashbased. Given the high transaction costs (in terms of carrying loads of money for various transaction purposes) and the opportunity costs (with respect to serving as potential source of funds for investment purposes if such funds were deposited in the financial institutions), it was crucial for policy intervention in order to transform the economy into an eventual cashless one by providing relatively more efficient payment methods – such as cheques and electronic cards – that would lead to less cash holdings. The introduction of the RTGS for high-value interbank payment minimized payments and settlement risks, given that orders for payments were executed almost immediately, thereby creating “an enabling environment for safe, sound, secure and timely payments” (Bank of Ghana Consultation Paper, October, 2007). In addition, the Bank of Ghana also introduced a paperbased credit clearing system in 2007 to facilitate the settlement of low-value payments. 2.2.2.2. National Switch (E-ZWICH) Programme. In line with making the economy cashless, a National Switch known as the EZWICH was introduced in 2008. The purpose of the E-ZWICH was to establish a common platform for all payment transactions in the country and also allow banks which did not have platform switches to join that common platform at very low cost. “The E-ZWICH was also to allow the interoperability of all automated teller machines (ATMs) and the settlement of payments transactions by customers to different banks at Point of Sale” (Bank of Ghana, 2007). With this national switch, subscribers in places with telecommunication network coverage are able to do transactions online through Universal Electronic Payments technology. In addition, the E-ZWICH card, a biometric smartcard, was introduced in 2009 to help solve the problem that only a small percentage of the population uses debit cards. The unique features of this smartcard made it possible for cash deposits and withdrawals, transfer of e-money, point-of-sale purchases, bank debit cards, loading and withdrawal of wages and salaries. Hence the smart card was seen to be efficient given that it had low transaction costs, limited infrastructure needs, and was convenient, safe and simple. By the end of 2010, the number of card holders had increased by about 48.9 percent (Bank of Ghana, 2010). 117 2.2.2.3. The Cheque Codeline Clearing System. In order to speed up the cheque clearing system, the Bank of Ghana in 2009 introduced the Cheque Codeline Clearing (CCC) in Accra with the cheque truncation system and this was later extended to other parts of the country. This made the cheque clearing process less cumbersome by reducing the clearing cycle to 2 days from the initial 3–8 days nationwide (Bank of Ghana, 2010). 2.2.3. The currency redenomination The currency regime came with high transaction costs and very high risks due to the need to carrying huge amounts of currency around for daily transactions. Other burdens were in the form of maintaining bookkeeping and statistical records and the pressure on the payment system, especially the ATMs. Such difficulties necessitated interventions by the central bank. The major one was the redenomination of the cedi by the BoG in July 2007. Currency redenomination is the process of changing the currency value on a financial security or simply “striking out some zeros” from a currency. In Ghana’s case, four zeros were cancelled. It is important to note that currency redenomination does not mean loss of value of the currency in question. Empirically, there is evidence that many countries embark on redenomination at the end of a stabilization period to signal to their citizens and investors that the country is no longer going to have high rates of inflation. Therefore, it was not surprising that Ghana took this step in order to make the economy more attractive to both local and foreign investors and also because Ghana was doing its best to achieve the convergence criteria set by the West African Monetary Zone (WAMZ). Between July 2007 and December 2007, the Bank of Ghana carried out the redenomination, exchanging the old ¢10,000 for the new GH¢1.00. During this period, both the old and new currencies were in circulation until January 1, 2008 when the old currency was no longer accepted as legal tender and could only be changed at the central bank or the commercial banks. While the new currency was called the “Ghana cedi” (GH¢), its sub-unit was called the “Ghana pesewa” (Gp). 2.2.4. The Foreign Exchange Act (Act 723) Among the measures to deepen the financial system in the country, the Exchange Control Act, 1961 was replaced by the Foreign Exchange Act (Act 723) in December 2006. During the exchange control regime, foreign transactions in the country were generally limited, with restrictions placed on the issuance and transfer of securities in addition to external loans contracted between residents and non-residents (such loans required approval by the Bank of Ghana). Therefore, the introduction of the Foreign Exchange Act was to ensure a shift from these restrictions to a more liberalized foreign exchange regime. Under this new Act, the inflow of foreign exchange was liberalized in order to encourage foreign direct investment. In addition, loans contracted by residents no longer required Bank of Ghana approval, given that banks were required to submit reports on all foreign exchange transactions to the Bank of Ghana. Other features of the new Act included the removal of restriction on foreign holdings of equities listed on the Ghana Stock Exchange, and the granting of permission to non-residents to invest in 118 P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 2.3. Developments in banking and non-banking financial institutions market7 benefited the most. Liberalization of the financial sector increased competition, especially in the banking industry. It also introduced best practices in the business environment, technology, product and risk management systems. The banking industry in the early 1990s was made up of the central bank, three commercial banks (Ghana Commercial, Barclays and Standard Chartered), three merchant banks (Merchant, Ecobank Ghana and Continental Acceptances) and seven secondary banks. In addition, two discount houses (Consolidated Discount House and Securities Discount House) were established in 1987 and 1991 respectively. In the same period, there were almost 100 rural and community banks (RCBs) at the bottom of the hierarchy, which accounted for only about 5 percent of the banking system’s total assets. As part of the financial adjustment programme specified in the ERP in 1983, the government in 1991 established the first Finance Company in order to help companies that were distressed but potentially viable to regain their position in the system. Hence, the financial sector in the early 1990s was relatively active. Even though between 1997 and 2001 the number of banks in the country remained at 17, there were interesting developments in the banking sector. For instance, in 1997 the sector witnessed the introduction of new products or services by the two oldest foreign banks in the country, Barclays and Standard Chartered. Specifically, Barclays Bank introduced the Akuafo Bond (which was geared towards improving the saving habit of farmers) and the Business Master (a system that enabled large companies to access their bank accounts by logging into the bank’s system). Standard Chartered Bank launched a new service whereby payment of customers’ utility bills could be effected through their ATMs. Also, with effect from August 1998, the Bank of Ghana placed an embargo on the licensing of new entrants into the financial sector in view of the fact that the bank was dealing with many applications which required proper examination in order to ensure that only those who met the criteria would be allowed in the sector. At the end of 2010, the number of deposit money banks (DMBs) had risen to 26, made up of 25 Class 1 banking licenses and one with a general banking license. Out of the total DMBs, ownership was evenly distributed – 13 of them were Ghanaian owned and the remaining 13 foreign owned (Bank of Ghana Annual Report, 2010). By January 2013, there were 29 banks in the country with both Ghanaian and foreign ownership including the emergence of some Nigerian Banks. With regard to rural banking, an assessment of the trend reveals a gradual increase in the number, although there was both exit and entry of RCBs. For example in 1997, there were 132 RCBs in the country but by December 2012, the number was 133. In this case, a quick conclusion of only one entry into rural and community banking in the country within the period may be misleading given that some years recorded new entry or exit or even in some cases, both. Another finding worth noting is the fact that between 1998 and 1999, the sector witnessed 22 exits from the rural and The restructuring of the financial sector in Ghana led to the creation of the financial market, made up of the bond, equity, foreign exchange and derivative markets. However, the money 7 The money market in Ghana is made up of the central bank, brokers or discount houses, corporate and other financial institutions. money market instruments of a tenor of at least three years (Bank of Ghana, 2007). 2.2.5. Minimum paid-up capital of banks and non-bank financial institutions (NBFIs) The liberalization agenda of the various policy reforms also had negative consequences on the economy. For instance, even though the Foreign Exchange Act objective of better integrating Ghana’s financial system with the rest of the world benefited Ghana by opening up new opportunities by encouraging foreign direct investment, it was not without risks or costs. Hence there was the need for banks to hedge. For example, the introduction of the RTGS and the Cheque Codeline Clearing System required financial institutions to keep up with internationally accepted standards. Meanwhile, the banking sector was made up of so many banks in the lower tier without enough capital base and depth to support significant levels of lending, which could make them vulnerable to unfavourable macroeconomic conditions and external shocks. For this and other reasons, there had to be some adjustments in entry conditions into the banking industry in order to strengthen their capital base to support the new opportunities emerging from globalization. Hence, the minimum capital requirements for both banks and non-bank financial institutions (NBFIs) were revised. Specifically, the minimum capital requirement for banks was increased from GH¢7 million to between GH¢ 50 million and GH¢60 million. The capital requirements for depositing-taking NBFIs and finance houses increased from GH¢1.0 million and GH¢1.5 million, to between GH¢ 5 million and GH¢8 million. Even though the new minimum capital requirement was announced in 2007, banks and deposit-taking NBFIs were expected to submit capitalization plans to the BoG by the end of June 2008 in order to guarantee them continued access to the settlement and primary dealership system. By December 2008, institutions that failed to meet the new minimum capital requirement were denied the opportunity of participating in the settlement system and the remaining banks which were unable to meet the new capital requirement were placed on the lower tier. Meanwhile, banks and NBFIs granted licenses six months earlier and those operating with a provisional license were given a grace period of two years from the date of operation to meet this new requirement. In recent years, the financial system has become relatively diversified with regard to the range of services and the increasingly innovative products and services that are introduced. The banking sector continues to be very important for businesses, suggesting that the subsequent thrust of financial market policy should be aimed at developing a vibrant capital market to serve as a vehicle for raising funds to support large amounts of equity finance and investment. P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 Table 1 Composition of non-bank financial institutions as of 1997. Table 3 Inflation rates in Ghana, 1997–2012 (%). Type of institution Number Year Rate 1. Finance house 2. Savings and loan 3. Leasing companies 4. Discount houses 5. Building societies 6. Venture capital 7. Mortgage financing Total 13 7 6 3 2 1 1 33 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20.8 15.7 13.8 40.5 21.3 15.2 31.3 16.4 14.8 10.5 12.8 18.1 16.0 8.6 8.6 8.8 Type of institution Number 1. Finance house 2. Credit reference bureau 3. Savings and loans 4. Leasing 5. Finance and leasing 6. Mortgage financing Total 25 3 19 2 3 1 53 Source: Bank of Ghana. community banking. The other periods, however, were mostly characterized by either one or two entries or exits. However, banking in Ghana has become an urban phenomenon, with most urban areas flooded with banks (including rural banks). Meanwhile, there has also been a remarkable increase in nonbank financial institutions (NBFIs) since 1997 with their number close to doubling by 2012. Tables 1 and 2 present the structure of NBFIs between 1997 and 2012 respectively. It is important to emphasize that this growth plays a significant role in financial deepening, given that such institutions also help in the financial intermediation process between the surplus and deficit spending units in the economy. 3. Trends in monetary indicators (post-1997) 3.1. Inflation The Central Bank’s choice of inflation targeting, which is centred on the fiscal framework of the government, involves a public announcement of a specific rate of inflation which is jointly set by the Ministry of Finance and Economic Planning and the Bank of Ghana. This targeted rate of inflation is clearly spelt out in the annual budget. In this new framework, transparency is very important since it promotes credibility of the process and of the Central Bank. Again, transparency is regarded as democratic accountability to the public, in exchange for independence. Given this targeted inflation rate for the year, the monetary policy committee (MPC) of the Bank of Ghana uses the prime or policy rate as a major tool in driving the inflation rate to the targeted rate. Source: Ghana Statistical Service. A point worth noting in this new framework is that the central bank also invariably targets the monetary aggregate in the process. Table 3 shows the rates of inflation during the period under review while Fig. 1 shows the effectiveness of the inflation targeting framework used by the MPC of the Bank of Ghana so far by comparing target rates to the actual rates achieved for the respective year. Generally, while the inflation targeting framework was not very effective in its early days of implementation – there was a substantial difference between the target and actual rates (particularly between 2003 and 2005 and from 2007 to 2009) – it can be considered as very effective since 2010. It is worth noting that between 2010 and 2011, the actual inflation rates (8.6 percent in both years) were below the target rates (9.2 and 9.0 percentages respectively). On the whole, it looks like the economy is better off with this new framework. Following the 5.3 percentage point increase in the inflation rate (from 12.8 percent in 2007 to 18.1 percent in 2008), the Ghana Shared Growth and Development Agenda (GSGDA) aimed to tighten both monetary and fiscal policies in order to sustain single-digit inflation (8.6 percent) rate achieved in 2010. In the process, the framework sought to improve the food component of the consumer price index (CPI). To this point, the GSGDA’s target with regard to the food and non-alcoholic beverage component of the CPI has been attained and sustained, 60.00 50.00 40.00 30.00 Growth Rate 20.00 10.00 0.00 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Table 2 Composition of non-bank financial institutions as of 2012. Percentage Source: Compiled from various issues of the State of the Ghanaian Economy Report. 119 Source: Compiled from various issues of ISSER, State of the Ghanaian Economy Report Fig. 1. Growth in M2+, 1997–2012. 120 P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 Table 4 Headline inflation rates, 2010–2012 (%). Month Inflation over 12 months Yearly inflation (average) Combined Food and beverages Non-food Combined Food and beverages Non-food 2010 Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec 14.78 14.23 13.32 11.66 10.68 9.52 9.46 9.44 9.38 9.38 9.08 8.58 9.08 8.17 7.35 5.81 4.69 6.13 5.84 5.33 5.67 5.62 5.32 4.50 18.79 18.54 17.55 15.82 14.98 11.89 11.96 12.25 11.84 11.82 11.50 11.22 19.64 18.78 17.66 17.46 16.82 15.76 16.05 14.64 13.47 12.46 11.29 10.71 15.16 14.16 12.98 12.25 11.47 10.61 9.84 8.63 7.82 7.05 6.73 6.13 22.88 22.10 21.02 21.19 20.63 19.41 20.42 18.85 17.40 16.21 14.65 14.01 2011 Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec 9.08 9.16 9.13 9.02 8.90 8.59 8.39 8.41 8.40 8.56 8.55 8.58 4.84 4.59 4.70 4.18 3.93 2.78 3.25 3.79 3.74 4.03 4.41 4.27 11.82 12.12 12.00 12.16 12.15 12.44 11.76 11.38 11.30 11.32 11.08 11.21 10.26 9.56 9.53 9.32 9.17 9.09 9.57 9.29 8.83 9.17 8.93 8.73 5.77 5.47 5.25 5.12 5.05 4.78 4.56 4.43 4.27 4.14 4.06 4.04 13.43 12.90 12.44 12.13 11.89 11.94 11.92 11.85 11.81 11.76 11.73 11.73 2012 Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec 8.70 8.60 8.80 9.10 9.30 9.40 9.50 9.50 9.40 9.20 9.30 8.80 4.50 4.30 4.40 4.80 5.00 5.40 5.50 4.40 4.40 4.10 3.90 3.90 11.30 11.20 11.40 11.70 11.90 11.90 12.00 12.50 12.40 12.20 12.40 11.60 8.73 8.69 8.66 8.66 8.68 8.72 8.79 8.88 8.95 9.01 9.07 9.09 4.08 4.40 4.20 4.03 4.90 4.21 4.41 4.50 4.55 4.58 4.57 4.53 11.70 11.65 11.59 11.57 11.55 11.53 11.50 11.55 11.63 11.70 11.78 11.82 Source: Ghana Statistical Service. according to the available data since 2010. That is, the component recorded less than 10 percent yearly inflation rates. Table 4 reviews the headline inflation rates from 2010 to 2012. Progress in the food and non-alcoholic beverage component of the CPI was remarkable during 2011, with rates generally below 5 percent and the worst performance (of about 4.84 percent) in terms of rate of increase recorded in January 2011. This significant progress led to the single-digit inflation rate target achieved in the preceding year being sustained. There was a further reduction in the inflation rate from about 9.08 percent in January 2011 to about 8.58 percent in December the same year. However, the lowest yearly rate (2.78 percent) in the food and non-alcoholic beverage component was recorded in June 2011. One critical issue worth raising here is what rate of inflation is optimal or growth maximizing for Ghana. Quartey (2010) found that the growth maximizing rate of inflation for Ghana is not a single digit and therefore suggest that the government policy of achieving single digit inflation should be considered carefully taking into consideration inflation thresholds and growth outcomes. 3.2. Exchange rate The US dollar, pound sterling and the euro continued to be the preferred foreign currencies, with some Ghanaians storing their wealth in them in order to maintain income values, given that the cedi was believed to perform poorly as a store of value. Even more worrying is the fact that most economic activities (especially the hospitality industry, real estate companies, educational institutions and trading firms) quote their prices in foreign currencies. It appears that over the years, the cedi has been relatively more stable in relation to the US dollar. On the other hand, the P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 Table 5 Cumulative percentage change in the cedi and selected major currencies (using interbank exchange rates). Year ¢/$ ¢/£ ¢/D 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 14.05 4.78 2.21 0.87 1.14 5.40 7.70 16.64 3.15 5.10 7.21 21.86 14.02 12.51 −10.67 14.14 7.00 3.40 25.25 6.57 9.63 20.74 25.60 23.93 10.86 −13.33 11.37 18.80 12.4 18.10 −4.35 8.73 16.43 Source: Compiled from various issues of Bank of Ghana Statistical Bulletin. cumulative depreciation of the cedi against the major foreign currencies shows that the cedi’s performance has generally been weak against the pound sterling. Between 2002 and 2012, the cedi recorded its best performance in 2005 with a cumulative depreciation of less than 1 percent against the dollar while at the same time appreciated against the pound and the euro (by 10.67 percent and 13.33 percent respectively). It is worth noting that over the period 2003 and 2005, the cedi remained relatively stable against all the major foreign currencies (Table 5). This may probably be as a result of the continuous decline in the rate of inflation and nominal interest rates within the same period, which helped to increase confidence in the cedi. The subsequent effect is an increase in demand for investments in the local currency. There was further appreciation of the cedi particularly during the last quarter of 2009 into 2010. Nevertheless, the depreciation in early 2009 was significant and can be attributed to the high budget deficit recorded during the 2008 elections and its repercussions on the economy thereafter. Recently, the Cedi has been quite unstable and this has partly been attributed to the slowdown in the global economy (foreign exchange market pressures) and also weakness in the internal 121 structures in Ghana, especially the huge budget deficit recorded since the 2012 elections and the associated decline in investor confidence. As at 2013, the exchange rate to the dollar was GHs1.9085 and GHs 3.096 to the pound. As at 30th December, the exchange rate was GHs2.37 and GHs3.88 to a dollar and the Pound respectively. As at 28th February 2014, the dollar and the pound exchanged for GHs2.57 and GHs4.26. The Cedi declined by 23 percent in 2013, thereby making it Africa’s worst performer after the South African Rand. To reiterate, the main cause has been the excess spending in the election year, the dollarization in the Ghanaian markets causing high demand for the dollar amongst others like low confidence in the cedi, high trade deficits, foreign loan payments and the excessive use of cash for foreign transactions. The bank of Ghana in order to control the further decline in the currency has released a total of $60 million onto the market for use by banks whose customers want them for foreign transactions in addition to enforcing stricter exchange control regulations (see Bank of Ghana Notice No. BG/GOV/SEC/2014/01). Laudable as these policies were in addressing the instability on the exchange market, there has been little education on the policy and this rather led to ‘panic buying’ of foreign currency thereby making the black market premium higher. 3.2.1. Interest rates Nominal interest rates have generally followed the trend of inflation rates. It appears that the central bank’s policy rate has been a very effective instrument for bringing down the inflation rates. Given that the Bank of Ghana did not necessarily interfere in the financial market to fix the lending and savings rates (as may have happened in the past), real savings rates within this period were consistently negative; meanwhile, real lending rates were consistently positive. While the non-interference may seem good, its repercussions in terms of discouraging savings, which are needed to serve as loanable funds to enhance investment activities, may raise a Table 6 Interest rate structure, 1997–2012 (%). Year Nominal saving rate Nominal lending rate Prime/policy rate Inflation rate Real savings rate Real lending rate 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 27.68 16.50 10.50 18.00 14.50 11.13 9.75 9.50 6.38 4.75 4.75 5.18 10.00 5.88 4.05 5.25 44.22 38.50 36.50 47.00 43.75 36.36 32.75 28.75 26.00 24.25 24.17 27.25 32.75 27.63 25.93 25.72 45.00 37.00 27.00 27.00 27.00 24.50 21.50 18.50 15.50 12.50 13.50 17.00 18.00 13.50 12.50 15.00 20.80 15.70 13.80 40.50 21.30 15.20 31.30 16.40 14.80 10.50 12.80 18.10 16.00 8.60 8.60 8.80 6.88 0.80 −3.30 −22.50 −6.80 −4.07 −21.55 −6.90 −8.42 −5.75 −8.05 −12.92 −6.00 −2.72 −4.55 −3.55 23.42 22.80 22.70 6.50 22.45 21.16 1.45 12.35 11.20 13.75 11.37 9.15 16.75 19.03 17.33 16.92 Source: Compiled from various Bank of Ghana Statistical Bulletins. 122 P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 Table 7 Interest margin spread, 1997–2012 (%). Table 8 Selected allocation of DMB credit, 1997–2001 (%). Year Nominal savings rate Nominal lending rate Interest margin/ spread 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 27.68 16.50 10.50 18.00 14.50 11.13 9.75 9.50 6.38 4.75 4.75 5.18 1.00 5.88 4.05 5.25 44.22 38.50 36.50 47.00 43.75 36.36 32.75 28.75 26.00 24.25 24.17 27.25 32.75 27.63 25.93 25.72 16.54 22.00 26.00 29.00 29.25 25.23 23.00 19.25 19.62 19.50 19.42 22.07 31.75 21.75 21.88 20.47 Source: Compiled from various Bank of Ghana Statistical Bulletins. policy concern. For instance, on average, the nominal lending rate has been almost four times the nominal savings rate thereby widening the spread between these two rates (Table 7). How then does the negative real savings rate motivate surplus spending units to make their funds available for the deficit spending units through the financial intermediaries? Thus, negative real savings rate may be seen as a disincentive to financial intermediation. While Table 6 shows the trend in interest rates during the review period, Table 7 further looks at the interest rate margin or spread. Given the generally direct relationship between inflation and interest rates, it was quite puzzling to note that in some periods, this direct association did not exist. Thus, between 2002 and 2003, despite the increase in the rate of inflation, both nominal saving and lending rates declined. In another instance, even though the rate of inflation increased, the nominal lending rate declined by about 0.08 percentage point (from 24.25 percent in 2006 to 24.17 percent in 2007). Meanwhile in the same period, the nominal interest rate on savings remained unchanged. However, in recent times, although inflation rates have generally improved, particularly since 2004, these improvements have only resulted in marginal changes in interest rates (especially the savings rate). Thus, the successive declines in inflation rates between 2004 and 2007 translated into consistent declines in nominal interest rates. Then during the period between 2008 and 2009, despite the decline in the inflation rate, the savings rate almost doubled; at the same time, the lending rate also increased (Table 7). However, interest rates recorded marginal declines even though the spread between lending and deposit rates remained higher in 2011 than in 2010. It appears that the spread between the lending and saving rates averaged at least 20 percent for the period under review (Table 7). Such a huge margin obviously does not encourage savings and so it is not surprising that most Ghanaians do not have the habit of saving. Many Ghanaians, especially those engaged in informal sector Sector 1997 1998 1999 2000 2001 Agriculture Manufacturing Mining Construction Others Total 12.00 22.80 5.10 10.10 50.00 100.00 12.20 24.60 5.00 11.20 47.00 100.00 11.80 24.90 5.80 8.90 48.60 100.00 9.60 28.10 5.50 6.80 50.00 100.00 9.60 19.30 4.00 6.80 60.30 100.00 Source: Compiled from various issues of ISSER, State of the Ghanaian Economy Report. activities, are more comfortable keeping their money outside the banking sector. 3.3. Credit to the private sector On the whole, the period under review witnessed consistent improvements in terms of total DMB credit to the private sector. This is in line with the macroeconomic policy objective of enhancing private sector competitiveness. Despite the consistent increase in credit to the private sector, the rate of growth was very gradual between 1997 and 2004 compared to the growth rates in the last eight years. Comparing private sector credit to gross domestic product (GDP), there has been significant improvement. In 1997, private sector credit was only about 8 percent of GDP but since 2007, such credit has been more than a fifth of the GDP (Table 8). This also suggests a relatively good investment climate and increased opportunities being created in the economy. At the end of the third quarter in 2012, private sector credit was about 40 percent of GDP. 3.4. Sectoral credit allocations by the DMBs The structure of credit allocation by the deposit money banks has not changed very much. Tables 8 and 9 show that the areas that have enjoyed greater proportions of DMB credit in Ghana are: manufacturing, domestic trade and the services sectors. In contrast, the agricultural sector, which is considered to be the mainstay8 of the Ghanaian economy – has not received much attention from the DMBs. It is worrying that within the 15-year period of this study, the trend remains almost the same. The manufacturing sector received the highest share of DMB credit between 1997 and 2004, receiving on average 20 percent of total DMB credit. Between 2005 and 2010, domestic trade received more credit from the DMBs (Table 8). Table 9 shows that the average percentage of DMB credit to domestic trade between 2005 and 2010 was about 23.78. Also, the new weight of the services sector is evident within this period–it was the second highest recipient of DMB credit. An assessment of DMB credit allocation since 2011 also confirms this assertion since the services sector received on average about one quarter of total credit from the deposit money banks. 8 The sector is very important in terms of its contribution to GDP, employment and foreign revenue. P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 123 Table 9 Sectoral Allocation of Credit by DMBs, 2002–2012 (%).a Sector 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Agriculture Mining Manufacturing Construction Electricity, gas and water Import trade Export trade Domestic trade Transport, storage and communications Services Others Cocoa marketing Total 9.40 3.80 21.10 7.80 4.90 6.40 2.80 12.80 4.00 11.30 13.30 2.30 99.90 9.40 2.30 20.70 4.70 2.90 7.30 5.00 20.40 4.40 8.80 11.30 2.90 100.10 7.70 2.20 21.50 6.00 2.80 8.10 6.40 15.60 2.10 11.30 11.40 5.00 100.10 6.70 3.70 19.10 5.70 1.80 8.10 1.70 22.40 4.00 14.70 11.00 1.00 99.90 5.40 3.80 18.50 7.90 3.60 6.90 1.30 22.60 3.10 18.40 7.60 0.80 99.90 4.90 4.10 15.50 7.60 3.80 5.30 1.40 24.10 3.10 21.30 8.00 0.80 99.90 4.30 2.90 11.90 6.80 4.00 5.20 1.40 26.20 2.90 23.90 9.60 1.00 100.10 4.74 2.75 11.63 7.84 6.31 5.32 1.70 24.10 3.99 20.97 9.99 0.68 100.02 6.13 2.71 13.26 7.53 6.52 5.78 1.94 23.25 4.02 20.64 7.74 0.49 100.01 5.74 4.26 8.95 8.04 6.68 9.21 1.20 16.27 4.19 26.82 8.10 0.54 100.00 5.11 1.29 10.47 4.31 2.40 8.95 7.80 16.75 9.50 24.94 8.17 0.31 100.00 Source: Compiled from various issues of ISSER, State of the Ghanaian Economy Report. a The presentation of the sectoral allocation of credit by the DMBs is based on the BoG’s modifications for the groupings. 3.5. Financial deepening Financial deepening, which is also known as financial expansion, has usually been defined in terms of the development of the financial sector (particularly the banking sector) and this refers to the increase in provision of financial services to an economy. In other words, financial deepening measures the extent to which financial institutions are able to satisfy the needs of a society through financial intermediation. This plays a very critical role in the growth and development process of any economy, given that the more liquid money is, the more opportunities there are for sustained growth. Common indicators used to measure financial expansion include the ratio of money supply to GDP (M2/GDP or M2+/GDP), the currency–money supply ratio (Cu/M2+) and credit to the private sector as a share of GDP. Despite the disagreement over whether financial deepening produces economic growth or economic growth rather leads to financial development, most modern economists believe that financial development has a significant impact on economic growth. The proponents of the “demand-leading” theory believe that as the economy grows and there is technological expansion, productive processes require extra financial resources and this will induce financial development (Ireland, 1994). Meanwhile, McKinnon (1973) and Shaw (1973) believe, with the “supply-leading” theory, that financial deepening brings about economic development. While it is generally accepted that financial deepening leads to economic growth, it is important to emphasize that financial deepening does not affect growth positively when the economy is experiencing high inflation rates. Thus, Rousseau and Wachtel (2009) show that during crisis periods, the benefits of financial deepening may not be significant but if the crisis is prevented, then financial deepening will have a significant impact on economic growth. This means that as the financial system of an economy expands, there should be effective financial sector policies and reforms in Table 10 Financial deepening, 1997–2012. Year Nominal M2+ (GH¢ mm) Nominal M1 (GH¢ mm) Currency Cu (GH¢ mm) Private sector Credit (GH¢ mm) Nominal GDP (GH¢ mm) M2+/GDP M1/GDP Cu/GDP Cu/M2+ PSC/GDP 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 250.60 39.30 489.65 724.81 1024.80 1536.81 2117.39 2666.72 3041.75 4230.25 5750.70 8061.20 10,233.08 13,775.46 18,195.19 22,620.05 176.57 207.00 219.25 351.65 512.65 821.80 1137.28 1458.40 1558.12 2094.83 2931.20 3801.60 4159.63 6439.28 8714.40 11,156.73 98.18 108.36 127.24 263.60 308.99 467.16 633.78 730.33 803.23 1019.60 1302.20 1663.80 2084.44 2925.85 3763.27 4918.73 107.00 163.90 246.60 382.60 447.20 586.40 805.20 1041.72 1445.58 2064.03 3295.60 4884.30 5653.96 6776.62 8752.36 11,477.37 1386.30 1715.70 2058.00 2715.30 3801.40 4776.40 6526.20 7865.00 9631.90 11,490.32 13,976.70 17,211.70 21,630.00 25,934.00 26,328.00 30,089.90 0.18 0.02 0.24 0.27 0.27 0.32 0.32 0.34 0.32 0.37 0.41 0.47 0.47 0.53 0.66 0.75 0.13 0.12 0.11 0.13 0.14 0.17 0.17 0.19 0.16 0.18 0.21 0.22 0.19 0.25 0.31 0.37 0.07 0.06 0.06 0.10 0.08 0.10 0.10 0.10 0.08 0.10 0.09 0.09 0.10 0.11 0.14 0.16 0.39 2.76 0.26 0.36 0.30 0.30 0.30 0.27 0.26 0.24 0.23 0.19 0.20 0.21 0.21 0.22 0.08 0.10 0.12 0.14 0.12 0.12 0.12 0.13 0.15 0.18 0.24 0.28 0.26 0.26 0.32 0.38 Source: Calculated from various issues of the Bank of Ghana Statistical Bulletin. 124 P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 order to prevent financial crisis. Table 10 presents the indicators of financial deepening for the review period. During the period under review, even though the ratio of M2+ to GDP generally recorded an upward trend, the increases were only marginal, suggesting that the country’s financial expansion has been very gradual. However, comparing the M2+/GDP ratio in 1997 to that of 2012, there has been a remarkable increase (from 0.18 in 1997 to 0.75 in 2012). On the whole, the Cu/GDP, Cu/M2+ and PSC/GDP have been very low. 4. Conclusion This study has outlined the monetary and financial policies pursued over the past decade as well as the trends in key monetary indicators to ascertain possible inter-relationships. Monetary policies have been pursued in Ghana to reorient the economy towards the path of growth. Consequently, the conduct of monetary policy in Ghana has moved away from the use of direct control measures to indirect, market-oriented tools and recently to inflation targeting. It appears that the main objective of monetary policy in Ghana has been to stabilize prices and subsequently create an enabling environment for both foreign and domestic investors. In this regard, there has been a number of medium-term development plans (MTDPs) aimed at turning the long-term development objective (attaining middle-income status by 2020) into a reality. The study therefore looked at the various monetary policy strategies and trends in key indicators and made interesting findings. First, given that any effective monetary policy should be accompanied by fiscal discipline, fiscal policies in the period were also designed to ease those monetary difficulties associated with huge budget deficits that compel governments to resort to large-scale borrowing at high interest rates, which crowds out the private sector. Within the period 1996–2000, M2+ grew at about 31 percent on average and inflation averaged about 22.7 percent. Thereafter, Ghana recorded its highest growth in M2+ (about 50 percent) immediately after joining HIPC in 2002. The growth in M2+ in recent years has slowed down with 2012 recording a growth rate of about 24.32 percent. Inflation, on the other hand, has seen a remarkable improvement averaging around 14.65 percent within the same period. The economy is currently operating with the GSGDA which is expected to be completed by the end of 2013. Several strategies have been implemented under the GSGDA and key among them are the passage of the National Pension Act 2008 (Act 766) and the Anti-Money Laundering Act 2008 (Act 749). Since 2000, there have been a number of initiatives in the financial sector of the country. This study discussed some of them (universal banking, Payment System Bill, redenomination of the currency, the Foreign Exchange Act (Act 723) and the new minimum paid-up capital of banks and NBFIs). These initiatives have contributed to growth in the banking and non-banking financial subsectors of the economy in terms of their numbers and innovative products and services. In 1997, the financial sector of the country was made up of 17 banks and 33 NBFIs; by the end of 2012, this had increased to 29 banks and 53 NBFIs. These developments have also contributed to financial deepening, which is evident in the over 300 percent increase in the M2+/GDP ratio between 1997 and 2012. There has been steady improvement in the inflation rates, especially in the last three years, enabling Ghana to achieve one of the West African Monetary Zone (WAMZ) convergence criteria of attaining single-digit inflation, albeit, briefly. However, given the direct relationship between inflation and interest rates, it is puzzling to note that interest rates are still high, particularly lending rates and that real saving rates were negative from 1999 until only recently. Generally, while there have been remarkable improvements in monetary indicators (although some of them are very gradual) which suggest relatively effective monetary policies during the period under review, there is clearly the need for greater fiscal discipline given that monetary policies cannot achieve their intended purposes in the presence of fiscal imbalances. Thus, the government should continue to maintain a stable macroeconomic environment that ensures the monetary aggregates are within growth-optimizing limits. Secondly, despite the decline in policy rates and inflation rates during the period under review, lending rates remain high and this is stifling private business. It is suggested that the new Bank of Ghana formula for computing the base rate of banks is strictly adhered to in order to ensure efficient and realistic charges on loans. In addition, proper address systems and the use of credit reference bureaux should be highly encouraged to reduce the high loan default rate. Finally, government domestic borrowing from the banking system is severely affecting the cost of credit and crowding out the private sector and this should be curtailed. References Alexander, W.E., Balino, T.J.T., Enoch, C., Tomïs, J.T., Baliïo, Charles Enoch, 1995. The Adoption of Indirect Instruments of Monetary Policy, IMF Occasional Paper, Washington. International Monetary Fund 126. Bank of Ghana, 2007. Building a Financial Sector for an Emerging Market Economy: Implications for the Capitalization of Banks and Non-Bank Financial Institutions, Consultation Paper. Bank of Ghana, Accra. Bank of Ghana, 2010. Annual Report. Bank of Ghana, Accra. Gockel, A.F., Kwakye, J.K., Baffour, O., 1997. Financial and monetary developments: policies and options. In: Nyanteng, V.K. (Ed.), Policies and Options for Ghanaian Economic Development. , 2nd ed. Institute of Statistical, Social and Economic Research (ISSER), University of Ghana, Legon. Ireland, P.N., 1994. Money and growth: an alternative approach. Am. Econ. Rev. 84 (1), 47–65. McKinnon, R.I., 1973. Money and Capital in Economic Development. Brookings Institution, Washington, DC. Khan, A.H., Hasan, L., 1998. Financial liberalization, savings, and economic development in Pakistan. Econ. Dev. Cult. Change 46 (April (3)), 581–597. Ncube, M., 2007. Financial Systems and Monetary Policy in Africa, Economic Research Southern Africa Working Paper No. 20, Cape Town, South Africa. Quartey, P., 2010. Price stability and the growth maximizing rate of inflation for Ghana. Mod. Econ. 1 (3), 180–194. Roe, A.R., Sowa, N.K., 1997. From direct to indirect monetary control in SubSaharan Africa. J. Afr. Econ. 6 (March (1)), 212–264. Rousseau, P.L., Wachtel, P., 2009. What Is Happening to the Impact of Financial Deepening on Economic Growth? Vanderbilt University, Department of Economics Working Paper No. 09-W15. Sowa, N.K., Abradu-Otoo, P., 2007. Inflation management in Ghana – the output factor. Paper presented at the Bank of England/Cornell University Workshop P. Quartey, G. Afful-Mensah / Review of Development Finance 4 (2014) 115–125 on New Developments in Monetary Policy in Emerging Economies, London, 17–18 July. Shaw, E., 1973. Financial Deepening in Economic Development. Oxford University Press, New York. Further reading Cohen, D., 2000. The HIPC Initiative: True and False Promises. OECD Development Centre, Working Paper No. 166 (formerly Technical Paper No. 166). OECD, Paris. Government of Ghana, 1995. Ghana – Vision 2020: The First Step (1996–2000). Presidential Report on Co-ordinated Programme of Economic and Social Development Policies (Policies for the Preparation of the 1996–2000 Development Plan), Available at www.ndpc.gov.gh. 125 IMF, 2006. Poverty Reduction Strategy Paper, Available at: www.imf.org/external/np/prsp/prsp.asp (accessed 27.09.13). NDPC, 2003. Ghana Poverty Reduction Strategy (2003–2005). National Development Planning Commission, Accra. NDPC, 2006. Growth and Poverty Reduction Strategy (2006–2009). National Development Planning Commission, Accra. NDPC, 2010. Medium Term National Development Agenda – The Ghana Shared Growth and Development Agenda (2010–2013), vol. 1. National Development Planning Commission, Accra. NDPC, 2011. Annual Progress Report – Implementation of the Ghana Shared Growth and Development Agenda (GSGDA), 2010–2013. National Development Planning Commission, Accra.