Evolution of the Exchange Rate System
Following independence. Ghana’s currency, the cedi, was pegged to the pound sterling until 1971.36 During that period the cedi was devalued only once, in mid-1967. The collapse of cocoa prices during the late 1960s, however, forced the government to devalue again in December 1971, to moderate the domestic effects of a deterioration in the terms of trade. The government was toppled soon after the devaluation, and the cedi was revalued in steps and then pegged at ¢1.15 to the dollar in March 1973. During the remainder of the decade the authorities were generally unwilling to devalue the cedi: when faced with balance of payments problems, they tended instead to resort to ad hoc restrictions on trade and foreign exchange transactions. The 1973 parity was maintained until June 1978, when the cedi was devalued to ¢2.75 to the dollar. It was then kept unchanged until April 1983. when it was again devalued in the context of the Economic Recovery Program.
During the 1970s and most of the 1980s, administrative controls played an important role in the allocation of foreign exchange, giving rise to a very active parallel foreign exchange market. In an effort to curb this market, the Ghanaian authorities allowed foreign exchange bureaus to operate beginning in February 1988. This initiative led to the absorption of the parallel market into the redefined legal structure. The result, however, was an exchange system with two spot foreign exchange markets and two exchange rates: a bureau rate and an auction rate. (See Box 9.1 for a description of Ghana’s exchange rate arrangements.) In March 1992 an interbank market in foreign exchange was set up.
With foreign exchange now being allocated by market mechanisms, the need for exchange restrictions has gradually declined. Beginning in October 1986, reforms of the exchange rate system were accompanied by the removal of import licensing, rationalization of import tariffs, and the removal of all restrictions on payments and transfers for current international transactions. By February 1994 Ghana was able to accept the obligations of Article VIII. Sections 2, 3, and 4, of the IMF Articles of Agreement.
These significant reforms notwithstanding, the foreign exchange market was shallow in the 1990s, with most transactions taking place on a bilateral basis between the Bank of Ghana and commercial banks rather than among the commercial banks. The Bank of Ghana quoted an exchange rate based on an average of indicative rates quoted by the commercial banks, which did not reflect actual rates for market transactions. A deeper problem was the suspicion that the Bank of Ghana was using administrative pressure and moral suasion to maintain the currency at an overvalued level to support payment of external obligations and for imports, while controlling inflation. In 1999 Ghana suffered a major terms-of-trade shock with the fall in cocoa and gold prices and the rise in crude oil prices (see section III). International reserves declined to precariously low levels, and the cedi depreciated by 50 percent by the end of the year on an end-of-period basis.
Traditional Competitiveness Indicators
A useful measure of a country’s international competitiveness is the real exchange rate, whose movements are associated with changes in the country’s balance of trade in goods and nonfactor services. The real exchange rate is usually constructed by deflating the nominal exchange rate using standard price indices in the country and its trading partners–such as the consumer price index (CPI), the GDP deflator, the export deflator, or the import deflator– or using cost indices, such as unit labor costs.
No single indicator provides an unambiguous assessment of competitiveness; each has its pros and cons. Among the real exchange rate measures based on price indices, that based on CPI differentials is readily available in most countries and covers a wide range of products that are fairly comparable across countries (Turner and Van’t dack, 1993). In addition, because wages are often influenced by CPI developments, CPI-based real exchange rates can serve as a good proxy for developments in a country’s cost competitiveness. However, CPI-based real exchange rates also reflect taxes and other institutional distortions; they include the prices of services, many of which are nontradable; and they do not take directly into account the prices of many tradable goods, such as intermediate goods, which are not purchased by consumers. Real exchange rates based on GDP deflators incorporate the ratio of the relative prices of nontradable to tradable goods at home and abroad, and accordingly, movements in important determinants of trade flows; however, these data are less frequently available and less accurately constructed than CPI data.
Exchange Rate Arrangements, 1983–97
Initial conditions
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Official exchange rate pegged; dollar used as intervention currency.
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An active parallel market with rates that differed significantly from the official rate.
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Widespread restrictions on trade and payments.
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Direct allocation of foreign exchange through licenses and import programs.
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Import deposit requirements.
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Bilateral payments arrangements with various countries.
Measures after 1983
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Adoption of a real exchange rate rule in which exchange rate movements were linked to the inflation differential between Ghana and its major trading partners; introduction of a system of bonuses on foreign exchange receipts and surcharges on payments (April 1983).
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System of bonuses and surcharges abolished (October 1983).
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Authorized foreign exchange dealers permitted to open foreign accounts for residents and nonresidents (June 1985).
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Dual exchange rate system introduced, with two windows (one an auction); foreign exchange sold to end-users only (September 1986).
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Foreign exchange bureaus established, resulting in two spot foreign exchange markets (February 1988).
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Wholesale foreign exchange auction system introduced and the retail auction discontinued (April 1990).
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Weekly wholesale foreign exchange auction, coordinated by Bank of Ghana, replaced by an interbank market (March 1992).
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Ghana accepts the obligations of Article VIII, Sections 2, 3, and 4, of the IMF’s Articles of Agreement (February 1994).
Real exchange rates based on export and import deflators provide useful information on a country’s export and import performance, respectively, and consequently on its trade balance. However, because neither indicator contains all the information relevant for assessing both import and export performance, these indicators may not incorporate all the information on competitiveness needed to explain movements in the trade balance (Marsh and Tokarick, 1994), Furthermore, the range of products covered by these indicators varies greatly from country to country, making these indicators difficult to compare across countries.
Indicators based on unit labor costs provide information about underlying costs of production and are defined similarly across countries. However, they are essentially focused on the manufacturing sector, and they cannot detect changes in the costs of other components of production, such as capital and intermediate inputs. Unit labor cost-based indicators are also less widely available than price-based indicators and, where available, are subject to large measurement errors (Lipschitz and McDonald, 1991).
Competitiveness indicators for Ghana
This section assesses Ghana’s international competitiveness using indicators based on prices and unit labor costs. Real effective exchange rates (REERs) are calculated based on the CPI; on GDP export, and import deflators; and on unit labor costs. Again, the choice of competitiveness indicators is limited by the availability and accuracy of data. The results are analyzed taking into consideration these limitations as well as the inherent advantages and disadvantages of each indicator.
Price-Based Indicators
Ghana’s CPI-based REER with respect to its major trading partners was calculated for the period 1990–99 (upper left panel of Figure 9.1).37 The figure shows a steady, but modest, gain in competitiveness through 1994. (The index is constructed such that a fall in the index represents a fall in Ghana’s relative prices at the current exchange rate, and thus a rise in competitiveness.) The 1995–97 period, however, is characterized by a deterioration in competitiveness, as shown by the CPI-based REER, which by 1997 had already risen 35 percent from its 1994 level. It continued to rise into the second half of 1999. The cedi depreciated by 15 percent in nominal terms in the 12-month period ended in September 1999, about three times faster than in the previous year. However, this was not sufficient to prevent a further real effective appreciation of the cedi, owing mainly to intervention by the Bank of Ghana.
Real Effective Exchange Rates
(Based on alternative price indices, 1990=100)
Sources: IMF Information Notice System and World Economic Outlook, various issues.The fall in the CPI-based REER in the early 1990s reflected the reforms of trade and the exchange system that continued through 1994. The cedi depreciated in nominal terms during this period, reaching a value of ¢1,052 to the dollar at the end of 1994. The subsequent rise in this measure of the REER reflected the slow rate of depreciation of the cedi compared with the inflation differential between Ghana and its partner countries. This trend continued into 1999, although at a slower pace.
The REER based on the GDP deflator presents a picture very similar to that depicted by the CPI-based REER (upper right panel of Figure 9.1). Competitiveness improved in the early 1990s, albeit at a slower pace than in the 1980s. The GDP deflator-based REER then rose gradually over the period 1995–98.
The REER based on the export deflator (bottom left panel of Figure 9.1) shows a pattern very similar to that displayed by the previous real exchange rate measures, thus further substantiating the evidence that there had been a substantial appreciation of the cedi in the second half of the 1990s. The terms-of-trade shock that hit Ghana in 1999, owing to the drop in world cocoa prices and the increase in oil prices, has been a major determinant in the reversal of this trend in the real exchange rate. As of June 2000, the cedi had depreciated in nominal terms by 82 percent since the beginning of the year, and the CPI-based REER was 10 percent below its lowest level in the 1990s, recorded in July 1994.
Unlike the previous indicators, the REER based on the import deflator (bottom right panel of Figure 9.1) shows that competitiveness did not deteriorate over the 1994–99 period. This could reflect slower growth of import prices than that of the prices of local products in the CPI product basket. In 1997 such a difference could be attributed to the sharp reduction in petroleum prices. However, the import deflator measures price differentials in production inputs and thus is not a direct measure of external competitiveness.
Unit Labor Cost-Based Indicators
Ghana’s REER based on unit labor cost indices was also calculated for the period 1990–99 (Figure 9.2).38 This index, after falling almost steadily since 1982, reached its lowest point in 1991. It then rose in 1992 by 57.7 percent, largely because of the 80 percent wage increase granted to public employees that year. In the following two years the index returned to approximately the level reached in 1991, as the government made efforts to contain wage increases. In 1996–97 this measure of the REER showed a slight strengthening.
Real Effective Exchange Rates Based on Unit Labor Cost Indices
(index, 1990=100)
Sources: IMF Information Notice System and World Economic Outlook, various issueDespite wage containment during 1995–98, this indicator suggests a slight tendency for Ghana’s competitiveness to weaken. As with the indicators based on the CPI and the GDP deflator, the real appreciation of the cedi over this period was reversed in 1999 owing to the substantial nominal depreciation at the end of the year following the terms-of-trade shock.
A Comparison with Some Neighboring Countries
Ghana’s competitiveness during the 1990s can be compared with that of four neighboring countries: Burkina Faso, Côte d’Ivoire, Nigeria, and Togo. The period examined here is from the third quarter of 1990 to the second quarter of 1999. The comparison is built on the CPI-based REER. calculated considering three different groups of trading partners. The first group comprises all major trading partners of the country; the second consists of the single most important trading partner:39 and the third includes all major trading partners except the most important one.
After the conclusion of the exchange system reform in 1990, Ghana continued to gain in competitiveness with respect to all of the other countries considered except Nigeria until the first quarter of 1994, when the CFA franc was devalued (top panel of Figure 9.3). Thereafter the trend in Ghana’s competitiveness followed a pattern close to that of the CFA countries considered (Burkina Faso, Côte d’Ivoire, and Togo), whereas Nigeria’s competitiveness deteriorated markedly. Overall, from the third quarter of 1990 to the second quarter of 1998, Ghana’s REER followed closely that of the CFA countries, although after the devaluation of the CFA franc it rose slightly faster.
External Competitiveness of Ghana and Four Neighboring Countries
(index, 1990Q3=100)
Source: IMF Information Notice System.Ghana’s competitiveness with respect to its major trading partner remained broadly unchanged from the third quarter of 1990 to the second quarter of 1998. A slight improvement through the first quarter of 1994 was followed by a slight deterioration that continued until the first half of 1998 (middle panel of Figure 9.3). In the third quarter of 1992 Ghana’s competitiveness by this calculation experienced a slump, as the pound sterling was devalued and the United Kingdom exited the European Monetary System. Over the period under consideration, Ghana’s bilateral REER with the United Kingdom roughly followed those of the CFA countries with France.
From the third quarter of 1990 to the second quarter of 1998, Ghana’s competitiveness against its other major trading partners–mostly the countries of the European Union, the United States, and Japan–followed smoothly that of the CFA countries under consideration (bottom panel of Figure 9.3). Overall, from 1990 to the first half of 1994. Ghana’s competitiveness showed a tendency to improve; however, from the second half of 1994 to the first half of 1998 there seems to have been a slight but continuous deterioration.
The substantial nominal depreciation of the cedi after the terms-of-trade shock in 1999 caused Ghana’s CPI-based REER to weaken relative to its neighboring countries. This result emerges no matter which of the three groups of trading partners is used to calculate the index.
An interesting competitiveness comparison is that with Côte d’Ivoire, which, like Ghana, derives a significant portion of its export receipts from cocoa. Except for 1994, when the CFA franc was devalued, the REER shows significantly greater stability in Côte d’Ivoire than in Ghana, as inflation in Côte d’Ivoire has been much more stable (and lower). This factor alone raises the competitiveness of Côte d’Ivoire compared with Ghana. Moreover, if one assumes that in 1995, one year after the CFA franc devaluation, exchange rates in Ghana and Côte d’Ivoire were in equilibrium, one could conclude that from 1992 to 1995 Ghana had a competitive advantage over its neighbor, but that that advantage deteriorated between 1996 and mid-1999.
Conclusions
On the basis of a set of price and unit labor cost indicators, Ghana’s competitiveness improved in the early 1990s through 1994. The evidence for 1995–98 is quite strong. With the exception of the import price-based REER. REER measures indicate declining competitiveness. Compared with its neighboring countries. Ghana’s competitiveness shows a pattern similar to, but smoother than, that of the CFA franc countries Burkina Faso, Côte d’Ivoire, and Togo from the third quarter of 1990 to the second quarter of 1998. However, after the devaluation of the CFA franc, the cedi’s tendency to appreciate was slightly steeper. Overall, Ghana’s competitiveness remained quite stable from 1990 through 1998, with its level in the second quarter of 1998 very close to its 1990 level.
The severe terms-of-trade shock in 1999 precipitated a 50 percent nominal depreciation of the cedi by the end of that year. All the REER-based measures of external competitiveness employed in the analysis presented here show gains in competitiveness after November 1999.
The Bank of Ghana is suspected to have used administrative means and moral suasion to influence the exchange rate, resisting the cedi’s depreciation. However, with a terms-of-trade shock as severe as that of 1999, and with the Bank of Ghana running dangerously low on international reserves, a rapid depreciation of the cedi to levels more in line with relative prices was inevitable. The terms-of-trade shock forced the Bank of Ghana to focus more clearly on maintaining adequate foreign reserves. The depreciation may then have helped make the foreign exchange market more active and the nominal exchange rate more representative of market conditions.
