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28.10.2008 Business & Finance

Credit Crunch— Investment Inflows And Remittances Could Be Hard Hit

Credit Crunch— Investment Inflows And Remittances Could Be Hard Hit

It is now official that the world economy is close to recession. Economic data, including unemployment figures from advanced economies, are not interesting reading; the US in particular has record levels of unemployment.

The problems, caused by the sub-prime crises in the US, have led to a widespread downturn in the global economy.

Ghana may have been spared the direct impact of the global stock market scare but it could still experience a significant economic downturn in 2009 because of the crises. Bernard Otabil explains how the problems could derail the country's economic gains.

Analysts and leading economists are of the view that the global credit turmoil, economic slowdown in industrialised countries and rising inflation will curb the rapid growth in developing economies this year and beyond.

Significantly, the credit crunch will have a far greater impact on developing countries such as Ghana, according to a survey by the Graphic Business research team.

The credit crunch problems are wide-ranging, with a multiplier effect that goes beyond the non-availability of credit. The issue is that credit drives an economy and it has been a useful tool in economic growth and expansion.

Banks and other financial services institutions involved in the business of giving credit facilities want to ensure that they have the cash to increase their credit portfolio in order to increase their profit margins; that is, with the right credit control procedures in place.

Also, consumers would want to have the much needed cash, either for business expansion or consumption, available at all times.

The net effect is that consumption would spur on economic growth and create the cycle of economic activities that ensure that an economy is well oiled.

This is the cycle that shapes economic activities in every society and that is the reason the current global credit squeeze has quenched the life out of industrial economies, with developing economies yet to experience its full impact.

Therefore, in any period of economic squeeze, especially with regard to credit, the likely effect is that the economy could run into recession; low consumption could lead to low street sales and low business profits, which could lead to redundancy and unemployment.

With unemployment comes reduced household incomes which, in effect, affect household spending. The most vulnerable in society are unable to cope, and it is not surprising that in a period of economic downturn the low income population suffer the most.

A survey by the Graphic Business research team found that Ghana would be largely spared the direct effect of the global economic downturn because of the nature of the Ghanaian economy and the level of its integration into the global economy. But it would be affected heavily — indirectly — if the economic malaise should continue.

Available data show that the problems of the global economy were caused mostly by the impact of the sub-prime loans on the balance sheet of banks, a credit function that should have rather spurred economic growth.

But the truth is that those were “bad” loans but which had been packaged as good financial instruments, through exotic financial engineering by the quantitative experts, and gained the approval of the financial community because the international rating agencies had also favoured their appeal.

In effect, the instruments had no credible book value and could not be easily turned into the much-needed cash that the banks desperately needed to operate.

Therefore, when the underlying securities were exposed as “worthless” most of the institutions that had confidently valued the securities as part of their credible portfolio of assets were caught napping.

The multiplier effect is that banks have become cautious in their lending, both to themselves and also to individuals. The lack of credit has far-reaching consequences on every economy, and with a whole country like Iceland close to bankruptcy because of the credit crisis, the impact of the sub-prime crisis cannot be taken lightly.

Credit crunch and Ghana's economy

There is no doubt that the credit crunch will have a significant impact on the Ghanaian economy. At the macro level, however the economic managers are confident that with the strong economic fundamentals, the country should be able to withstand most of the external shocks.

The argument put forth by most observers is that with the price of gold, cocoa, bauxite and other commodities relatively strong, compared to other periods of economic downturn — like that of the late 1990s — and oil prices easing in recent weeks, Ghana should be able to absorb most of the external distortions that could arise from the global crisis.

Therefore, the market correction should not be painful, or it may not even be felt, they argue.

But with the spongy nature of the Ghanaian economy, highly dependent on external financial support, the reverberating problems of unemployment and high levels of bankruptcies in the advanced countries owing to the current crisis could hit the low income population hard.

One area that will suffer the direct consequences of the high levels of unemployment, mortgage foreclosure and banking crisis is inward remittances into the country.

Remittances play a big part in the economies of most developing countries, including Ghana.

The World Bank estimates that total recorded flows of remittances reached US$167 billion in 2005. This is a staggering sum that dwarfs other financial sources, such as official development assistance, bank lending and private investment into developing countries.

Annual flows of remittances even exceed foreign direct investment (FDI) for the majority of developing countries. And Ghana is no exception.

Family members in Ghana use remittances primarily to finance consumption, including food, shelter, health care and basic necessities.

In the early 1980s during the period of economic downturn in the country, remittances helped the Ghanaian economy greatly, influencing economic policies positively and straightening the economic fundamentals in the economic structural adjustment programme.

And since remittances are “unrequited” (they do not result in claims on assets, debt service obligations or other contractual obligations), they have a more direct benefit on economic development.

In a research paper submitted to the African Economic Research Consortium (AERC) in February 2006, Dr. Peter Quartey, Research Fellow of the Institute of Statistics, Social and Economic Research of the University of Ghana, argued, “Urban households will experience a rise in food prices [in periods of economic downturn] and since food accounts for a greater proportion of household budgets in Ghana, household welfare will decline unless incomes are augmented with migrant remittances.”

According to Dr Paul Acquah, Governor of the Bank of Ghana, remittances have helped the Ghanaian economy greatly. Assessments of the Ghanaian economy by the central bank have always highlighted significant contributions to national development by remittances from Ghanaians abroad.

Year-on-year figures show a steady rise, with conservative figures showing a more than 25 per cent increase in remittance flows since the later parts of 2006.

Even though available data are sketchy because of the high levels of informal sector participation, many analysts and observers agree that the sector has improved greatly and is much more relevant today than foreign direct investments.

“Private transfers are much bigger and more stable than Official Development Assistance (ODA) and Foreign Direct Investment (FDI) over the period 1990 – 2003.

“Also, remittances have been increasing more than proportionately compared to GDP and export earnings”, Dr E Addison, Head of Research at the central bank, noted in a research paper he presented at a migration seminar in 2004.

Since then, the industry has experienced tremendous growth, but the credit crunch problems which will affect the disposable incomes of Ghanaians abroad could affect the amount of cash available for friends and family back in the country.

Also, the massive level of global unemployment will have an impact on remittances to developing countries, including Ghana.

Apart from that, the credit crunch would affect foreign direct investment in the country. The Ghana Investment Promotion Centre (GIPC) has already warned that this fourth quarter could be tough for the country's investment climate.

The third quarter investments figures showed impressive gains, despite the global economic turmoil, but this, the GIPC says, will not be the case in the last quarter.

Clearly, the global economy is in dire straits. “The stark reality is that developing countries must prepare for a drop in trade, capital flows, remittances, domestic investment, as well as a slowdown in growth,” says Robert Zoellick, World Bank Group president.