Depreciation of the Cedi: Is Dollarization or a Currency Board the fix?

Feature Article Depreciation of the Cedi: Is Dollarization or a Currency Board the fix?

The Bank of Ghana and the various governments, including the current government, seem to find it extremely difficult to invent an economic policy to resolve the persistent depreciation of the Cedi. The strategies of the Central Bank and the various governments (whether past or present) do not have the practical policy efficacy to fix the depreciation of the Cedi.

The current level of depreciation of the legal tender of Ghana has provoked the call for the dollarization of the economy or the institution of a Currency Board. The demand currently for the Ghanaian authorities is to evaluate the policy potentials of dollarization or the use of a Currency Board. The depreciation of the Ghana Cedi can be identified as a difficulty in addressing the supply-side of the dollar; the depreciation of the Cedi can be explained using a demand and supply model.

The adequate supply of foreign currencies such as the dollar, pound sterling, euro, yen, and others stabilizes exchange rates. The supply of foreign currencies depends on generating enough foreign income through exports or other activities that supply foreign income – remittances, grants, and donations from the rest of the world, loans from multilateral and bilateral institutions, foreign direct investments (FDIs) etc. This side of the foreign exchange equation tends to be a great hurdle for Ghana and most developing countries to deal with.

The Director of Research at the Institute of Economic Affairs (IEA) suggested Ghana adopt the dollar as a temporary legal tender to stabilize the economy. That is, the economy should be dollarized; the country should put measures in place to recognise the United States legal tender, the dollar, as a medium of exchange. The handicaps associated with the “dollarization” of an economy do not make it (dollarization) an appropriate fix. The inability of the Ghanaian authorities to supply dollars to meet the demands of corporations, individuals, and households will worsen the plight of businesses and individuals in the country. This is obviously predictable, as the Central Bank of Ghana or government does not control the supply of the dollar; it does not issue the U.S. dollar. Aspects of the Ghanaian economy have been dollarized, and this is contributing severely to the depreciation of the Cedi. Therefore, the proposed idea of adopting the U.S. dollar as the legal tender for Ghana is technically fragile, as there are no practically effective measures to execute such an idea.

The Director of Research at the Institute of Economic Affairs (IEA) equally proposed that the Central Bank of Ghana be converted into a Currency Board. The inconvenience associated with the use of Currency Boards makes this proposal too risky and irrelevant in dealing with the depreciation of the Cedi. A Currency Board eliminates the traditional function of a central bank as the lender of last resort, in the case of pure Currency Board Arrangements. A Currency Board places restrictions on the capacity of the monetary authority of a country to assist banks in distress. Currency Boards are systems based on rules rather than discretion. There can be legislations that limit the board in undertaking certain activities including lending to banks with liquidity issues.

One of the essential conditions applying to the use of a Currency Board is that lending to the government by the Currency Board is prohibited. The government of Ghana with excessive appetite for over-spending, relies on the Central Bank of Ghana to finance its deficits. The use of a Currency Board will reduce government expenditure – the fiscal policy of a government will be distracted in the end, which may result in lower economic performance and lower output. Domestic borrowing by a government is usually limited or even zero. Currency Board frameworks prevent authorities from running a budget deficit, unless it is financed by foreign loans or grants, posing fiscal policy constraints eventually.

There is no doubting the benefits of a Currency Board regarding better inflation performance, better currency depreciation performance, and fiscal deficits. They are always significantly lower under Currency Board Arrangements than under floating or fixed exchange rate regimes. However, the literature indicates that most modern Currency Board Arrangements only came into existence after crisis. The better performance growth in countries where Currency Board Arrangements were instituted may be a direct reflection of an economic rebound effect and not necessarily the effectiveness of a Currency Board.

Thus, in the appropriate context of Ghana, the solution to resolving the depreciation of the Cedi cannot be found in neither dollarization nor the use of a Currency Board. These two proposed ideas will not produce effective solutions to the demands of this economic challenge. Pre-existing conditions such as policy credibility and fiscal discipline are obviously lacking. The country is currently with the IMF to gain some policy credibility. Without fiscal discipline, a Currency Board will immediately fail to attain the purpose of establishing it. Yet, a Currency Board cannot guarantee fiscal discipline, even though it promotes it.

The consequences of a failed Currency Board are substantial. Therefore, the country needs to thoroughly examine areas such as regulating capital flight, registering the sellers and buyers of foreign currencies to track their demand and supply, dealing with imports, and other practical measures the authorities consider appropriate to deal with the depreciation of the Cedi. A Currency Board is neither a quick fix nor the ultimate panacea to solving the depreciation of the Cedi.

Emmanuel Kwabena Wucharey
Economics Tutor, Advocate and Religion Enthusiast.