In January 1994, the French government caved in to pressure and slashed the value of the CFA currency, used by its former colonies in Africa, by half.

Overnight, prices skyrocketed, purchasing power dropped, and widespread violence erupted in many cities. In response, the IMF was invited in, France slashed debts owed by the CFA countries and desperate price controls were imposed by many of the governments of the affected countries.

The event sparked a deep dive into the many aspects of exchange rate setting and movements in developing countries. Economists in the hallowed halls of development finance, at the World Bank, the IMF, in academia, took stock of the massive specialist literature on what drives exchange rates, updated a few concepts and reignited many old debates.

All the flurry of reflection however turns around a simple question: how to tell if an exchange rate is overvalued or undervalued?

In the Ghanaian context that seemingly simple question has some profound implications for assessing the government’s attempts to stop the free fall of the national currency, the Cedi. The Cedi has depreciated by a whopping 40% since the beginning of the year. Is this depreciation merely a rational adjustment to balance the country’s true position in the global economic system? That is to say, does the Cedi’s depreciation reflect a true picture of economic fundamentals and therefore is its depreciation merely a movement to an accurate level?

This is a very complicated matter to address. It requires empirical estimation of something called the “long-run equilibrium real (effective) exchange rate” that attempts to compare how the prices of similar and dissimilar goods behave in Ghana versus its trading partners to ascertain if the exchange rate is merely trying to maintain balance. One may even have to make provision for so called “behavioral factors” to balance the current (or “spot”) demand and prices with near-future or “forward” demand and prices etc.

Pernicious Supply – Demand Imbalance

A far simpler question may be to ask whether the usual demand for dollars in the economy is being met by the usual supply. Or, whether, as the government now insists, “speculative bubbles” are inflating demand and thereby triggering artificial scarcity. If one reduces the problem to one created largely by speculation, the policy response may favour a lot of “signaling” rather than actions to address real and structural issues.

A government fighting speculators is essentially engaged in a game of bluff. It huffs and puffs that it has enough forex (usually dollars) to meet all legitimate dollar needs in the medium-term so the exchange rate is bound to return to its natural rate at some point, leaving speculators carrying massive losses. If speculators blink first, it wins. In a country with such a fine tradition of political propaganda, such huffing and puffing flows quite naturally. Government spinning goes into overdrive in a style very similar to the one recently witnessed of the Minister of Information threatening speculators to immediately release their hoards back into the market or face annihilation.

If you look carefully though, you will see the old menacing question of how to determine the accurate exchange rate disguised in the implied claim that there is a natural rate that speculators are disrupting. Should it be the case that speculators are merely profiting from a gap between what should be the true, more devalued, Cedi rate and a current, artificially propped up, rate, then it is easy to see how the government’s actions merely increases the eventual profit of bound-to-win speculators.

Africa has seen many instances of such misguided government machoism. One famous instance in Malawi also occurred in 1994, the same year as the titanic CFA devaluation. The country was in that year forced to abandon its commitment to auction adequate volumes of forex to meet legitimate demand. Malawi buckled because the pledge proved unsustainable as it became clear that structural demand rather than speculation was driving the imbalance.

An intuitive survey of recent data and trends in Ghana inclines one to the view that the equilibrium exchange rate in Ghana is influenced more by inflation and changes in rational expectations by investors and other actors in the economy than by interest rates and real incomes. Even a cursory survey of the asset management market will bring up many serious complaints by industry players of a serious outflow of funds from Cedi-denominated assets and uncover widespread perceptions that the central bank’s rate-signaling actions are having zero effect so far. Misguided “government control” interventions in the forex market without due attention to such a reality could strain the balance sheet of the central bank and spillover into the broader financial sector.

Gauging the True Forex Market Balance from Trading Data

To discern a structural demand-supply imbalance of the dollar stock in Ghana, one does not necessarily have to build complex empirical models to ascertain the equilibrium rate. It is possible to glean enough insights to arrive at fairly sound conclusions about the current forex crisis in Ghana by looking at recent trends in actual forex flows in the country supplemented with a brief analysis of the central bank’s forex operations.

The first critical point to note is the sheer expansion of the country’s forex trade in less than a decade. Between 2012 and 2020, commercial banks were able to expand their dollar stocks, earned domestically, from $7 billion to $24.82 billion. Absa Bank alone, in 2020, was responsible for $5.68 billion of this amount, many times higher than the forex repatriated by the entire mining sector. Ecobank accounted for $2.648 billion, and Stanbic $2.508 billion. Note that all these three banks earned more forex from a range of sources such as customers involved in exports and remittances than the country earned from the pre-export financing package for Cocobod that the Ministry of Finance is currently touting as the miracle cure for the depreciation.

In fact, the total amount of forex mobilised in the private sector by the commercial banks – i.e. $24.82 billion – in 2020 was double the $12.18 billion that went through the official Bank of Ghana corridor that year, or the $12.65 billion earned in 2019.

More fascinatingly, the 2020 amount of forex mobilised by the commercial banks was also nearly double the $12.7 billion the same banks earned in 2019, underlying the potential for massive volatile swings in this segment of the forex market that is highly sensitive to investor sentiment. Reinforcing the volatility point is the corresponding 2018 figure of $25.95 billion for commercial bank forex earnings. In summary, aggregate commercial bank forex trades have swung from ~$26 billion to $12 billion and back to $25 billion in a single 3-year cycle.

The Central Bank’s Reserves Muscle

Judging from these numbers, both in respect of scale and volatility, one wonders if the Bank of Ghana has the financial muscle to manage a floating regime when it goes awry as a result of shifting private investor sentiments, especially in the context of a liberalised capital account.

Below we provide snapshots of the forex reserve composition of the Bank of Ghana across the 3-year cycle and a lagging picture from 2015. (PS: Note the rigidity implied by the amount of reserves held as fixed deposits.)

The 2015 comparative is very interesting for two reasons. Firstly, the total forex flows through the official Bank of Ghana corridor amounted to more than $10 billion. Secondly, the reserve composition of $6 billion is highly consistent with the scaled level of forex receipts and payments through the official Bank of Ghana corridor.

Contrast this relatively stable picture with the dynamics in the commercial dealer banks’ corridor, where total flows amounted to $4.27 billion, a far cry from the ~$25 billion range being observed at the peaks of recent cycles. The massive mismatch between Bank of Ghana cyclical forex swings and the cycles observed at the commercial bank level renders any attempt to use the central bank’s meagre reserves to stabilise supply-demand imbalances created by shifts in sentiment among private sector market participants no longer viable in Ghana.

Bridging and Swapping Galore

A further factor worthy of note is the role played by bridge and swap facilities in smoothing liquidity bumps in periods when the country has access to the Eurobond window. These secretive arrangements involve significant flows of forex that have a real effect on local supply. In 2015, these short-end mechanisms yielded over $2 billion spread helpfully across the year.

By 2020, these sources were generating nearly $5 billion in forex value. The Bank for International Settlements, for instance, supplied $3.2 billion in bridge facilities in 2017, $1.5 billion in 2015, $1.6 billion in 2018 and $800 million in 2019. In 2020, the amount picked up again to $1.3 billion. The unscrutinised nature of such bridge and swap facilities (often bundled with the omnibus “international capital market program” and negotiated quietly, away from the prying eyes of parliament) mean that their volatilities are not all that well understood by the broader market.

It is intriguing that in the most recent year that Ghana witnessed a sustained depreciation episode, in 2019 that is, a number of negative shocks can be seen to be operating in tandem in the data. First, we witnessed a halving of forex flows through the commercial banking window. Next, a significant decline in bridge and swap deals. Before a raft of countervailing measures, such as a large Eurobond issuance, took hold, Bloomberg reported the Cedi as the worst performing among 146 tracked currencies worldwide that year.

A stronger tide of similar negative shocks are currently rippling through the commercial banking forex corridors but this time around the country is unable to depend on the Eurobond market for relief. Of course, a vicious cycle then ensues as the liquidity pills of swap and bridging facilities have also, in keeping with their strong correlation with large debt issuances such as those available in the Eurobond market, run short.

In these circumstances, where monetary policy has become accommodating of considerable fiscal recklessness leading to runaway inflation, and private market participants are thus exiting Cedi assets into the refuge of the dollar, the extent of imbalances, given the size of the commercial bank segment of the forex market as described above, and the dwindling capital receipts in the Bank of Ghana corridor, can no longer be addressed by small inflows that merely serve a signaling effect. Unless expectations improve on account of an improved inflation and investor confidence picture.

Afreximbank & Cocobod Facilities

Which discussion brings us to the issue of the Afreximbank and Cocobod facilities that the government has, with customary spinning skill, hoisted as its victory banner over speculators.

Afreximbank is one of the government’s recent partners in its swap and bridge programs. In 2018, Afreximbank offered Ghana a $300 million facility. In 2019, because of the headwinds in the economy, it followed other counterparties in lowering its provision to $150 million. In 2020, it didn’t bite at all. It is curious therefore that in seeking for a facility to signal capacity to intervene in the market, the government had to resort to a project-financing facility from Afreximbank of the sort that it took to Parliament.

Regular readers of this blog will recall that we have in previous commentary questioned the suitability of milestone-tied financing for the kind of signaling interventions the Bank of Ghana is engaged in. As it turned out, the highly provisional term sheet presented to the relevant committee of Parliament was merely cover for what looks like a separate and undisclosed contractual arrangement not available for scrutiny. The government now insists that it has received the project financing in full. Uncharacteristically, Afreximbank itself has remained silent about the facility and its disbursement. The Ghanaian case is more similar to a series of transactions in Zimbabwe that are now the subject of a lawsuit. And less like other project deals that Afreximbank tends to widely publicise. Afreximbank has been known to drive a tough bargain where it is clear that its resources may be put at risk, as evident in recent strained dealings in Swaziland.

To the extent that the Afreximbank – Ghana deal is shrouded in considerable murkiness and opacity, there is little more that can be said except, as repeatedly explained, its total insufficiency in making a dent in the serious forex shortfall situation in Ghana today unless and until confidence is restored to the bulkier commercial bank end of the market.

Regarding the Cocobod pre-export financing facility, the issues are more straightforward. The historical disbursement rate has been in the $600 million for the first tranche, and not the $910 million the government insists will arrive in October.

Given major shocks to output in the Ghanaian cocoa sector, and Cocobod’s heavily deteriorated finances, it is not clear why the government believes that the banks would consent to such frontloading. But, here again, as with the Afreximbank facility, there may well be undisclosed factors that make determinative analysis impossible. It is also important to mention that in recent years there appears to be parallel flows of forex linked to cocoa separately from the pre-export financing facility itself amounting to roughly 30% of the total receipts. The fact remains however that out of a total $1.3 billion facility secured in 2020, only $860 million was eventually disbursed. In the course of 2021, disbursements again fell short despite a much celebrated $1.5 billion raise.

The meat of the matter

In the final analysis, all things considered, neither the opaque and assumed $750 million Afreximbank injection nor the $600 million to $910 million likely to flow from the Cocobod facility in October can defend against the tides should trading in the private markets continue to be driven by negative sentiments about inflation, loose monetisation of the still outsized fiscal deficits, and the willingness of the government to credibly rein in expenditure. Together, they amount to $2 billion if disbursed fully. Ghana’s forex market has in recent years easily absorbed $40 billion. The Cocobod-Afreximbank injection is thus a mere 5% of total throughput. In extreme dislocation scenarios, $12 billion swings have been observed. A $2 billion blip on the radar, with noisy speculation also bubbling in the background, will thus barely make a beep.

So long as the government’s announced fiscal consolidation plans do not show any clear evidence of a selective default on wasteful obligations, of a sincere and serious spending review, nor of adjustments to spending beyond the perfunctory cuts to discretionary funding that per this author’s analysis do not even amount to 2% of discretionary spending, the government’s signaling will fail. The Cedi will continue to suffer acute bouts of depreciation, with periodic relief proving short-lived, until government’s actions start to match the rhetoric. Recall that the government’s public pledge is to cut 30% of discretionary spending. It should start by at least redeeming it.

Unfortunately for Ghana, investors and other private market participants are by their nature less swayed by spin than by action.