Ghana
Background Information on Output and Investment Performance
Author: International Monetary Fund
Publication Date:
17 Aug 1995
eISBN:
9781451814804
Language:
English
Keywords:
ISCR; CR; capital expenditure; fiscal policy; public enterprise; banking system; consumer price index
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This paper examines some factors that may have accounted for the investment and growth performance of Ghana during the past two decades, with special emphasis on the economic recovery program (ERP) period. The paper highlights that Ghana’s growth performance responded well to the liberalization of the exchange and trade regime and the elimination of price controls. Sustained implementation of stabilization policies without reversals was also strongly supportive of growth. However, inflation remained relatively high—at about 25–30 percent—and unpredictable, dampening the incentives for the private sector to save and invest.

Abstract

This paper examines some factors that may have accounted for the investment and growth performance of Ghana during the past two decades, with special emphasis on the economic recovery program (ERP) period. The paper highlights that Ghana’s growth performance responded well to the liberalization of the exchange and trade regime and the elimination of price controls. Sustained implementation of stabilization policies without reversals was also strongly supportive of growth. However, inflation remained relatively high—at about 25–30 percent—and unpredictable, dampening the incentives for the private sector to save and invest.

Ghana: Output and Investment Performance

I. Introduction and Summary

In 1983 Ghana launched an economic recovery program (ERP), after years of mismanagement. The country’s response to the policies adopted during 1983-91 was impressive: severe fiscal imbalances were brought under control, a highly distorted exchange and trade system was liberalized, and inflation was lowered significantly. This was achieved without a contraction in domestic demand. A strong recovery in real growth allowed tangible increases in real per capita incomes, reversing a long decline. However, private sector activity was still limited, and saving and investment performance was uneven. The purpose of this background paper is to examine why output response was strong during the ERP, but private saving and investment lagged. In reviewing Ghana’s adjustment record, it should be noted that a real growth rate of 5 percent, which translates into 2 percent on a per capita basis, while impressive by sub-Saharan African standards, would not be sufficient to propel Ghana onto an accelerated growth path. At this rate of growth, it would take 30-40 years for Ghana to eradicate poverty (i.e., for the absolute poor to cross the “poverty line”). 1/

This paper examines some factors that may have accounted for the investment and growth performance during the past two decades, with special emphasis on the ERP period. Ghana’s growth performance responded well to the liberalization of the exchange and trade regime and the elimination of price controls. Sustained implementation of stabilization policies without reversals was also strongly supportive of growth. However, inflation remained relatively high--at around 25-30 percent--and unpredictable, dampening the incentives for the private sector to save and invest. The public sector continued to dominate the economy, and critical structural adjustment reforms in the financial, parastatal, and agricultural sectors were implemented at a slow pace. Policies directed at the private sector such as privatization and tax reforms, were started late in the adjustment period. Thus, despite a significant liberalization of the price system and the trade regime, a continued excessive public sector involvement in the economy sent mixed signals to the private sector which impeded its response. By contrast, a dynamic private sector was critical to the success of the fast growing Asian economies.

In retrospect, Ghana’s economy could have benefitted significantly more if it could have been possible to initiate and implement a wider range of structural policy measures in the earlier annual programs of the ERP to go hand in hand with macroeconomic stabilization policies. It should nonetheless be noted that given the severity of the crisis confronting Ghana, regaining control over the macroeconomic situation become a higher priority. Ghana’s experience illustrates the need to maintain macroeconomic stability and make an early start with structural reforms in order to elicit the necessary private sector response. Recognizing the lessons from the high performing economies, and from its experience during the ERP, Ghana’s current strategy aims at actively removing the impediments to private sector saving and investment and reducing public sector involvement in the economy in order to achieve a private sector-led accelerated growth.

The paper is organized as follows: Section II provides a review of Ghana’s long-term economic performance, contrasting the periods prior to, and during, the ERP. Section III discusses factors that may have influenced the path of saving, investment, and growth, particularly during the period of economic adjustment. Section IV reviews progress in structural reforms and provides an assessment of the remaining structural obstacles to faster investment and output growth. Section V draws some conclusions and policy implications from the analysis. Empirical analyses of growth factors, investment, and external shocks are provided in the appendices. The study has been undertaken against the background of data deficiencies in certain areas, particularly in private saving and investment and in the labor market. 1/

II. Long-Term Economic Performance

1. Origin of the crisis

At independence in 1957 Ghana was the world’s largest cocoa producer, per capita income was the highest in sub-Saharan Africa, and its external reserves were equivalent to three years of imports. However, by 1982-83 Ghana’s economy had virtually collapsed. Per capita income had dropped by one third from its peak in 1977, and the country had depleted its foreign exchange reserves, and incurred large external payments arrears. Inflation was running at 123 percent, and the parallel market exchange rate was over 20 times the official rate, and cocoa production declined to less than one third of earlier levels. 2/

Long-term trends in economic performance in Ghana have been well documented in a number of studies. 3/ In general, these studies have demonstrated that Ghana’s economy responded well to episodes of liberalization even when they were brief, and declined precipitously when interventionist policies were intensified (Table 1). During the 1960s two main periods of civilian rule emphasized a greater role for public sector intervention in the economy, and during the 1970s a succession of military governments progressively intensified controls. Over the course of the 1960s and 1970s continued mismanagement of the economy entailed policies which relied on direct public sector planning and intervention through the parastatal sector, foreign exchange, price, and credit controls, and quantitative restrictions on imports. Government deficits increased, the balance of payments deteriorated, and inflationary pressures surged. These policies weakened the economy significantly. Gross fixed investment declined steadily from 19 percent of GDP in 1961 to 4 percent by 1983, and real GDP growth, which averaged 3-4 percent per annum in the 1960s, came to a halt during 1972-77, and turned negative during 1978-82.

Table 1.

Ghana: Selected Indicators of Long-Term Economic Performance, 1961-94

(Period averages in percent, unless otherwise specified)

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Sources: Data provided by the Ghanian authorities; and staff estimates.

PPP estimates of GDP are from the International Comparisons Project (ICP) data set on output and capital inputs measured at internationally comparable prices or prices that have been adjusted for differences in purchasing power parity- 1993 figure is estimated by the actual real GDP growth rate.

Data for 1983 onwards include statistical discrepancy.

Broad coverage from 1983 onward, which includes capital expenditure financial through external project grants and loans. Prior to 1983 no distinction was made between broad and narrow coverage.

End period data related to last year of the sub-period.

Commercial banks’ average savings deposit rate, except for 1961-66, which is the interest rate on 12 month time deposits.

Commercial banks’ unsecured lending rate.

Defined as [(1+i)/(1+p)-1] 100 where i is the nominal interest rate, and p is the CFI inflation rate.

Defined as the market rate/official rate, in percent; end period data.

Last period averaged over 1992-93 only.

Prior to 1983, in percent of merchandise exports.

The period just prior to the ERP (1978-82) was one of persistent and severe economic decline and a succession of political crises with frequent changes in government. Overvalued exchange rates and price controls severely distorted the incentive system against agriculture in general, and cocoa exports in particular. Export earnings fell to a low point of 7 percent of GDP, and external financing dried up as creditors’ and investors’ confidence in the economy declined. Price controls led to a widespread proliferation of parallel markets, and the emergence of acute shortages of goods and services, foreign exchange, and imports. Even the parastatals in the industrial sector were affected by the shortages of inputs and spare parts, which contributed to the collapse in investment and output. High fiscal deficits reflected a shrinking revenue base, and contributed to high inflation.

To compound these difficulties Ghana experienced a severe drought in 1983, world cocoa prices had already started their decline, and more than 1 million Ghanaians who had been working in Nigeria during the oil boom were sent back home. On the eve of the ERP Ghana’s financial and structural problems posed a formidable policy challenge.

2. Record of adjustment during the ERP, 1983-91

With the launching of the ERP in April 1983, the Government set out to shift the direction of economic policy away from economic controls and centralized regulation and in favor of a more liberal, market-oriented approach. 1/ The ERP was supported by financial assistance from the Fund, the World Bank, and other multilateral and bilateral sources. 2/ The key elements of the reform strategy were (a) a realignment of relative prices to encourage more productive activity, promote exports, and strengthen economic incentives; (b) a progressive shift away from direct controls and intervention and toward greater reliance on market mechanisms; (c) the early restoration of fiscal discipline, an increase in public saving, and reduced recourse to bank financing of the Government; (d) the rehabilitation of economic and social infrastructure; and (e) the implementation of structural and institutional reforms to enhance efficiency in the economy and encourage private saving and investment. 1/

The initial phase of the ERP, 1983-86, was essentially a period of economic stabilization. It featured exchange and price decontrol, a restoration of fiscal discipline, and discrete devaluations of the cedi rate, followed by the introduction of an auction-based exchange rate system. The economy responded well to the change in policy strategy, and experienced a sustained recovery in growth; a sharp reduction in inflation, from 123 percent in 1983 to 33 percent in 1986; and an improvement in the overall balance of payments (Table 2, Chart 1). However, exports remained unduly concentrated in cocoa and the economy was therefore vulnerable to swings in world cocoa prices. Structural and institutional rigidities persisted in the agricultural, financial, and parastatal sectors.

Table 2.

Ghana: Selected Economic and Financial Indicators, 1983-94

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Sources: Data provided by the Ghanaian authorities; and staff estimates and projections.

Excluding project-related grants.

Excluding capital outlays financed through external project aid.

Including net lending and from 1987 onward, the special efficiency program.

In percent of broad money at the beginning of the period.

Excluding the takeover by the Government in 1990 of the accumulated valuation losses of the Bank of Ghana.

Including financing of the Cocoa Board’s operations, but excluding other items (net).

Including capital expenditure financed through external project aid.

Including official grants.

End period data; including debt to the IMF.

CHART 1
CHART 1

GHANA: Main Economic Indicators, 1976-93

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities, staff estimates; and Information Notice System.1/ Broad coverage includes (narrow coverage excludes) capital expenditures financed by external project old.2/ Calculated using The official exchange rate for the cedi. 1980=100.3/ Calculated as the ratio of the market ced1/US$ exchange rate to the official exchange rate. Right-hand scale.

During the next phase of adjustment, 1987-91, the thrust of policies was broadened to encompass structural and institutional reforms. Most of the structural reforms were implemented gradually, building on the successful implementation of preceding reforms. The systematic dismantling of the institutional barriers to reform was difficult, given the legacy of the pre-ERP period and strong political opposition in key segments of the economy such as the parastatal sector. Nonetheless, the structural reforms spanned a wide range of areas. Foreign exchange bureaux were introduced in 1988, and the exchange system was further liberalized. A flexible producer pricing policy for cocoa was introduced and reforms in the financial management of public enterprises were implemented. A major restructuring of the financial sector was initiated in 1990 with the removal of non-performing assets from the portfolio of distressed banks. Toward the end of the ERP period, a number of initiatives for promoting the private sector were undertaken, including corporate income tax reforms in 1991. During this phase, economic performance continued to improve, GDP growth was sustained in the range of 5 percent a year, and exports continued to record strong growth, despite a cumulative decline of 35 percent in the terms of trade. The overall balance of payments and the fiscal balance recorded surpluses throughout this period, and foreign reserves reached the equivalent of 4.1 months of imports in 1991. External arrears were eliminated as Ghana normalized its relations with creditors. The inflation rate, which remained in excess of 30 percent during 1986-90, was reduced significantly in 1991.

From the perspective of saving-investment balances, the turnaround during the ERP period was quite dramatic (Table 3). Between 1970 and 1983, savings and investment declined sharply, while during the ERP, there was a strong reversal of these downward trends.

Table 3.

Ghana: Savings and Investment, 1970-94

(In percent of GDP)

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Sources: Statistical Service, Accra; and staff estimates.

Defined as gross national disposable income minus total consumption.

Gross national savings minus external official transfers.

Central Government current budget deficit; the latter is estimated as total revenue and grants (broad coverage) minus current expenditure and special efficiency.

Discrepancy between the national accounts estimates of external balance on goods and nonfactor services, net factor payments, and transfers, and the balance of payments estimate of the current account balance.

Ghana: Saving-Investment Flows, 1970-91

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The improvement in saving, however, stemmed almost entirely from the improvement in fiscal performance. Despite consistent GDP growth during the ERP period, the level of nongovernment saving at the end of the adjustment period was well below historical levels. Investment rates improved in both the government and nongovernment sectors, and was partly financed by a widening in the external current account deficit. For the nongovernment sector, there has been a shift in access to investable funds, away from the pattern of parastatal investment in heavy industries during the pre-ERP period, to investment during the ERP in sectors where market forces played a more active role in ensuring higher returns, such as in trading and services. 1/

3. Recent developments, 1992-94

During the post-ERP period, 1992-94, there was a marked downturn in economic performance. The year 1992 was a watershed in the political and constitutional history of Ghana: a new constitution was adopted in April, and presidential and parliamentary elections were held in November and December. In the run-up to multiparty elections, large increases in wages and in wage-related benefits were granted to public sector employees. Accordingly, the fiscal balance turned from a surplus of 1.5 percent of GDP to a deficit of 4.8 percent, and was mainly financed by the banking system. Inflationary and balance of payments pressures intensified. The Government implemented policies in 1993-94 with the object of regaining control over the budget deficit, but had only limited success. Large divestiture receipts were used to finance the fiscal deficit in 1994. The growth in money supply accelerated in 1994, however, mainly because of an increase in domestic debts by the national petroleum corporation from the Bank of Ghana. This led to an intensification of inflationary pressures. Both private saving and investment declined. Government savings also fell because of the poor fiscal performance (excluding divestiture receipts). However, government investment remained strong and foreign investment increased, mainly in response to privatization of the mining industry and buoyant gold prices.

4. Sources of long-term growth: evidence from empirical studies

This section attempts to identify the determinants of Ghana’s long-term growth using three approaches based on endogenous growth models (see Appendix I). 1/ The first approach, based on cross-country analysis (Barro (1989)), relates the growth of real per capita income to rates of physical and human capital accumulation, and to the initial level of per capita income. 2/ While the results do not directly capture the impact of policies, they do suggest that based on Ghana’s factor accumulation over the sample period (1960-92), and its initial relative income gap, Ghana could have been expected to grow substantially faster than it actually did. In Ghana’s case, two thirds of the sample period (i.e., 1960-82) was characterized by severe structural distortions, and the resulting uncertainty of economic conditions and policies probably had a critical influence in lowering Ghana’s growth.

The second approach, based on Fischer (1993), was used to examine the influence of economic policies and external conditions on Ghana’s long-term growth. This approach, based on an analysis of cross-country and time series panel data, explores the effect of macroeconomic and structural policies on output growth, and the channels--total factor productivity growth, and capital accumulation--through which these effects are transmitted. 1/ Based on the results from the entire sample (1970-92) on how particular policies were correlated with growth, Ghana’s poor long-term growth performance was not surprising since it had a number of poor macro-economic factors that were negatively correlated with growth through both the investment and productivity channels: macroeconomic instability as measured by high inflation, policy rigidities and uncertainty as captured by high levels of parallel market exchange rate premia, large budget deficits, and a significant deterioration in the terms of trade. 2/ 3/ The analysis also suggests that Ghana’s low growth during this period was associated with a low initial level of investment in human capital. Moreover, Ghana’s low rate of capital accumulation was linked to its high level of trade taxation and underdeveloped financial system. The long-term rate of growth and capital accumulation in Ghana during 1970-92 were lower than the averages in sub-Saharan Africa and all developing countries as a group. The results indicate that this relatively poor performance reflected economic policies in Ghana that for most of the period were not supportive of growth, capital accumulation, and productivity gains, compared with these two groupings.

The third approach, based on Bruno and Easterly (1994) was used to differentiate Ghana’s stronger growth record during the ERP from its long term growth record. 4/ This analysis indicates that Ghana’s growth performance during 1970-82 (the pre-adjustment period) was significantly worse than the world average, after controlling for the long-term determinants of growth. However, during the ERP, growth shifted to rates markedly above the world average, and by somewhat more in the second phase (1986-91) of the adjustment program. 1/ While Ghana’s growth performance after 1991 did not improve compared to the 1986-91 period, it continued to be stronger than before the ERP. This may reflect the ongoing impact of the adjustment policies pursued under the ERP. The strengthening of growth since 1983 was significant even after controlling for the investment variable. This result indicates that other determinants including productivity gains had contributed significantly to the shift in Ghana’s economic performance. In particular policy-related factors--especially the reduction in the parallel market exchange rate premium--were found to partly account for the growth differential between Ghana and the world average.

Indeed, estimates of total factor productivity growth for Ghana confirm that there was a significant rebound in productivity growth during the ERP period. After experiencing, on average, a decline at the rate of 1.6 percent during 1970-82, total factor productivity turned around dramatically and grew at a rate of about 3.2 percent during the ERP. 2/ Moreover, these productivity gains were steady and sustained in both phases of the adjustment program. These productivity developments in Ghana compare quite favorably with sub-Saharan Africa, as well as several comparator countries in the region.

III. Factors Affecting the Path of Savings, Investment, and Output During Adjustment

In marked contrast to many developing countries, Ghana achieved a strong, and almost immediate, sustained recovery in output growth following the launching of adjustment policies under the ERP (Table 1, Chart 1). While the initial impressive economic recovery no doubt partly reflected a rebound from a prolonged period of extreme economic depression, the fact that higher growth rates persisted throughout the 1980s suggest that more fundamental factors were at work. The period of adjustment was also marked by a substantial recovery in public investment supported by concessional external inflows. At the same time, the revival of private investment and savings was slow and modest.

This section examines the determinants of savings, investment, and growth during the adjustment period. Specifically, the role of financial policies, macroeconomic stability and policy credibility, external shocks, and external financing is considered. First, the determinants of saving and investment behavior are explored. Econometric and other evidence point to a large role for macroeconomic instability and/or policy credibility in explaining the modest and uneven recovery of saving and private investment. Next, the extent to which financial policies supported growth and their influence on the path of saving and investment is considered. The analysis shows that financial policies supported a strong recovery in output and demand, especially in the early stages of the ERP, but did not sufficiently bring inflation firmly under control. Finally, the sustainability of fiscal policy and the factors underlying the stubbornly high rate of inflation are examined. Here, the conclusion is that fiscal policy was, for the most part, on a sustainable path consistent with low inflation, but that monetary policy accommodated inflationary pressures. In sum, evidence suggests that while financial policies supported the recovery in output, they were not as conducive to a strong revival in private investment and saving, largely because of the accommodation of relatively high rates of inflation. The analysis that follows is based largely on partial indicators of the links between macroeconomic policies, external shocks, and outcomes; data limitations preclude a more rigorous econometric approach.

1. Factors affecting savings performance

After falling to very low levels in the early 1980s, national savings rose significantly--from under 4 percent of GDP to 18 percent between 1983 and 1988 (Chart 3). 1/ The recovery in savings during the first five years of the ERP mainly reflected a sharp turnaround in central government saving, from dissavings of over 4 percent of GDP per annum on average in the pre-adjustment period to positive savings of more than 5 percent of GDP. 2/ The private sector (including public enterprises) savings response to the adjustment program was slower and more modest. After 1988, savings fell sharply to below 5 percent in 1993, reflecting declines in both private (from 1988 on) and public savings (during 1992-93).

CHART 2
CHART 2

GHANA: Annual Growth Rate of Real GDP, 1976-93

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Source: International Financial Statistics Yearbook.
CHART 3
CHART 3

GHANA: Composition of National Savings, 1980-93

(In percent of GDP; in current prices)

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities; and staff estimates.1/ Includes private, public enterprises, and statistical discrepancy.

Firm evidence on the determinants of private saving in Ghana is scant and attempts to directly estimate a private savings equation for Ghana were not successful, in part reflecting data difficulties. 1/ Nonetheless, econometric estimates of a savings function based on panel data for African countries suggests that the main determinants of the recovery in private saving between 1983 and 1988 were the sharp drop in the rate of inflation and the improvement in the terms of trade. 2/ Although inflation was reduced sharply, it remained high and variable throughout the ERP and probably dampened savings by creating uncertainty about future returns on savings or the future course of policies. The decline in saving after 1988 is largely explained by the deterioration in the terms of trade. The steady rise in government savings under the ERP probably also had a negative impact on private savings throughout this period; however, available empirical evidence suggests that the increase in public savings was likely to be only partly offset by the drop in private savings. 3/

There is some evidence to suggest a role for other factors such as interest rates influencing saving behavior, primarily through their impact on financial saving; however it is difficult to gauge the magnitude of their influence. Moreover, because of likely measurement errors, it is probable that changes in financial savings may have led to a larger impact on measured than on true savings. 4/ The increase in real interest rates during the ERP from sharply negative to mildly negative levels may have encouraged financial savings. On the other hand, several factors may have discouraged financial savings, including low returns as a result of high transactions costs, and a lack of confidence in the banking system, reflecting the weak financial health of banks. High rates of inflation are also likely to have a considerable impact on the structure of saving. With only a limited range of financial instruments available to investors until recently, and none yielding positive real returns before 1991, there is evidence that savings took the form of hoarding in consumer durables or in foreign currency as a hedge against inflation and/or exchange rate depreciations.

2. Factors influencing investment behavior 1/

During the latter half of the 1970s, both private and public gross fixed investment fell to minimal levels--reaching 2 percent and 1 percent of GDP by 1982, respectively, which was insufficient to offset capital depreciation (Chart 4). Following the start of the ERP, the rate of public investment recovered strongly with the help of substantial foreign financing, and by the mid-1980s it had surpassed the levels achieved in the 1960s and 1970s. This investment was aimed at rehabilitating infrastructure, that had suffered years of neglect. In contrast, the recovery in private investment was more modest and uneven, and only during the second phase of the ERP (1987-91) were substantially higher rates of investment consistently attained. In 1992 and 1993, private investment slumped in the wake of slippages in the implementation of financial policies. The level of foreign direct investment (except in the gold sector) also remained very low throughout the entire period.

CHART 4
CHART 4

GHANA: Gross Fixed Investment, 1980-93

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities; and staff estimates.

Econometric estimates of private investment (see Appendix II) indicate that policy-related factors had a considerable influence on the path of investment during the ERP (Chart 5). The most important impact of policies on private investment behavior was through their effect on macroeconomic instability and uncertainty. In particular, the estimated equations show that the parallel market exchange rate premium, which probably captures the influence of macroeconomic instability as well as the impact of foreign exchange controls, had a major adverse effect on private investment during 1976-83. This confirms the results of empirical analyses on the determinants of long-term growth discussed in Section II. Moreover, the elimination of the exchange rate premium between 1983 and 1991 appears to have been by far the most important positive influence on the recovery of private investment over the course of the ERP.

CHART 5
CHART 5

GHANA: Actual and Estimated Path of Private Investment 1/

(In percent of GDP; in current prices)

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

1/ See Appendix II. The estimated data are derived from equation 2.

In contrast, the econometric results do not provide any evidence that the rise in public investment following the adoption of the ERP directly boosted private investment. On the contrary, it appears that public investment--whether at the Central Government level or including public enterprise investment--had a significant, albeit small, direct crowding-out effect on private investment. 1/ Any beneficial impact of public capital spending on private investment, appears to have operated indirectly through its effects on aggregate demand, which (measured by lagged GDP growth) did provide a significant stimulus to investment--especially later in the adjustment process when economic activity recovered sharply.

As discussed in the next section, the revival of real GDP growth in part reflected the stance of financial policies. However, the available evidence on the effects of monetary conditions on private investment provides a mixed picture. Even though interest rates were controlled for most of the period (i.e., until 1991), which would suggest that credit rationing effects were important, the availability of credit was not found to have a statistically significant influence on private investment. 2/ In contrast, real interest rates were statistically significant, which would suggest that the shift from highly negative to less negative real interest rates during the ERP would have had some dampening effect on private investors. 3/ It appears that the surge in private credit during 1984-86 (see next section) reflected, to a considerable extent, re-intermediation of flows that had previously shifted to informal credit markets as a result of severe financial repression, rather than an effective increase in available credit. To some extent, the expansion of recorded credit during this period was also the result of a major broadening of the coverage of the monetary accounts.

External factors do not appear to have had a major impact on the private investment. Income effects stemming from export price fluctuations influenced the path of investment only to a small degree--possibly through effects on profitability, and/or by tightening or easing foreign exchange constraints on import of capital goods.

Other evidence suggests that a number of factors may have dampened private investment, but which could not be adequately captured in the estimated investment equation. Although there was a considerable improvement in the macroeconomic environment under the ERP, a significant degree of uncertainty and financial instability still remained, and probably held back the recovery in private investment. Private investors may have taken a wait-and-see attitude in the face of the shift to a starkly different policy regime under the ERP, repeated policy and regulatory adjustments during the early years of the ERP, and fear of a return to earlier arbitrary policy actions, such as the confiscation of bank deposits in 1982 (see Aryeetey (1993)). The persistence of high inflation, by creating uncertainties about future policies and financial returns, as well as obscuring relative price movements, may also have dampened private investment behavior throughout the ERP (this is supported by the empirical results discussed in Appendix II). Structural distortions, and delays in addressing the problems of the financial and public enterprise sectors, also appear to have been important influences delaying the recovery in private investment (see Section IV).

3. The mix of stabilization policies

Stabilization policies can influence savings, investment, and growth through several channels. First, by affecting the level of domestic demand they affect capacity utilization and hence investment and output growth. Second, they can change the composition of domestic demand in favor of investment--through strengthening savings and enhancing policy credibility. Third, they change incentives in favor of the production of traded goods. This section examines the impact of stabilization policies on economic activity in Ghana during the ERP. Two important conclusions emerge from the analysis. First, financial policies did not squeeze domestic demand in the early part of the ERP; rather, they supported the strong recovery in output and domestic demand. In the later years of the ERP, financial policies were more restrained, but even then they did not exert a significant contractionary impact on economic activity. Second, expenditure-switching policies, which included a massive exchange rate correction, trade reform, and major domestic price realignments from the onset of the ERP, were successful in providing a strong stimulus to domestic output. Of course, one would not attribute the recovery in economic activity solely to macroeconomic policies--a renewal of external financing (largely in support of domestic policies) and positive exogenous shocks also contributed to the strength of the recovery in the first phase of the ERP. 1/

The process of stabilization and adjustment often involves some contraction in aggregate demand--which may delay or dampen a recovery in output and investment--until the positive impact of expenditure-switching policies on supply takes hold. Ghana, however, does not appear to fit this mold. While a measure of the output gap (the deviation between actual and an estimated potential or trend output) shows output below trend during 1983-86, this was a carry-over from the earlier crisis years (Chart 6). 1/ The recovery began immediately in 1983 and the output gap disappeared quickly through strong output growth. Moreover, real domestic absorption rose during the early years of adjustment. Import volumes also grew rapidly during this period, suggesting that imports were neither being unduly compressed by a contractionary squeeze on domestic demand nor were they acting as a constraint on the recovery of economic activity (Appendix III, and Chart 6); rather, the additional external financing that accompanied the adoption of the ERP appears to have helped ease a severe squeeze on imported inputs.

CHART 6
CHART 6

GHANA: Growth of Expenditures and Output, 1976-93

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities; and staff estimates.1/ Consumption plus gross investment.2/ Measured as the deviation between actual and estimated trend output.

Fiscal policy supported the recovery of output and investment during the first phase of adjustment, through its effect on aggregate demand. A simple measure of the impact of fiscal policy on aggregate demand is given by the fiscal impulse (Table 5, and Chart 7). 2/ For an economy such as Ghana’s this measure must be interpreted cautiously: “cyclical” influences on revenues and expenditures are likely to differ from those in industrial countries because revenue developments are likely to strongly reflect drought-related supply-side shocks in agriculture and terms of trade shocks. The fiscal impulse measure will therefore reflect, among other things, the extent to which supply-induced revenue windfalls (or shortfalls) are sterilized (or accommodated). Nevertheless, the calculations do suggest that, on average, the fiscal impulse was small during the period 1983-91. 1/ During the first phase of adjustment, when output was below trend, the fiscal impulse was mildly positive, and in the second adjustment phase it turned slightly contractionary when the output gap was positive. By contrast, in 1992-93, fiscal policy provided a strong expansionary stimulus which fueled inflationary pressures.

Table 4.

Ghana: Factors Influencing Private Investment, 1970-93

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Source: Ghanaian authorities; and staff estimates.

Ratio of market exchange rate to official exchange rate.

Central government capital expenditure, including capital expenditure financed by foreign project aid.

See Appendix III for the derivation of this measure; a negative number reflects an adverse shock.

Table 5.

Ghana: Measures of Fiscal Adjustment, 1983-93 1/

(In percent)

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Source: Ghanaian authorities and staff estimates.

Refers to central government.

Deviation of actual from potential output (calculated using the Hodrick-Prescott filter).

Calculation described in Section III.3.

Includes capital expenditure financed through external project grants and loans.

CHART 7
CHART 7

GHANA: Fiscal Impulse and Output Gap

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities; and staff estimates.

In broad terms, monetary policy appears to have accommodated the strong expansion in output after 1983, but at the cost of inflation that remained stubbornly high. Three indicators of monetary conditions are examined in order to assess the influence of monetary policy on the expansion of domestic demand, but interpreting all of them is complicated by the transition from a period of severe financial repression. One indicator is the level of real money balances, which provides a measure of the availability of liquidity for the private sector. Although a reliable measure of the demand for money is not available, there is evidence that excess liquidity in the economy persisted at least until the late 1980s. 2/ Subsequently, excess liquidity probably re-emerged in 1992-93, when fiscal expansion fueled a sharp increase in the growth of broad money. A second indicator is the level of real interest rates. During the period 1983-93, real interest rates increased considerably, but only reached positive levels in 1991 (following the liberalization of interest rates in 1989-90--Chart 8). A third indicator of the “tightness” of monetary conditions is the rate of growth of bank credit to the private sector measured in real terms. 3/ During 1983-86, the rate of real credit expansion was high--on average, 29 percent a year, but this probably reflected in part a reintermediation of financial flows into the banking system. Real credit growth slowed considerably to an average annual rate of 6 percent in 1987-91, but subsequently accelerated sharply as financial policies were relaxed in 1992-93.

CHART 8
CHART 8

GHANA: Interest Rates and Credit Growth, 1980-93

(In percent)

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities; and staff estimates.1/ Nominal deposit and lending interest rates, respectively, deflated by the consumer price index.2/ Credit from the banking system to the private sector excluding crop financing, deflated by the consumer price index.

Exchange rate policy was a key component of the ERP, involving the correction of the massive initial overvaluation in the official exchange rate. This correction, together with a front-loaded trade reform program, significant price liberalization, and substantial adjustments in administered prices, succeeded in tilting price incentives in favor of the production of tradable goods. Following the correction of the initial imbalance, an auction market was established to allow market forces to determine the exchange rate, and by 1990 the foreign exchange market was unified. 1/ In the event, this led to further nominal depreciation and a roughly constant real exchange rate. During this period the foreign exchange market was aided by substantial external inflows.

Because of the existence of a sizable parallel market in foreign exchange, movements in the official exchange rate or relative price measures, such as the real effective exchange rate (REER), may not be accurate indicators of changes in competitiveness. In fact, before 1988, when almost all imports became eligible for funding at the foreign exchange auctions, it is likely that a considerable share of imports, particularly consumer goods, were financed through the parallel market. For this reason the relative price of tradables and nontradables in the consumer price index basket of goods may be a more accurate measure of the real exchange rate than the REER--at least for consumer goods. With respect to exports, an important measure of production incentives, particularly for cocoa, is the ratio of producer to world prices and the ratio of export prices to domestic consumer prices; cocoa producer prices continued to be administered during the ERP. All of these measures of the real exchange rate show a sharp increase in incentives for the domestic production of tradable goods during the first adjustment phase, which was largely sustained during the second phase of adjustment (Charts 9 and 10). 2/

CHART 9
CHART 9

GHANA: Relative Price of Traded and Nontraded Goods 1/

(1983 = 100)

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Source: Staff estimates.1/ Based on components of the consumer price index.
CHART 10
CHART 10

GHANA: Cocoa Producer and Export Prices and Production, 1976/77-1994/95 1/

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghana Cocoa Board; and staff estimates.1/ Crop year ending September 30th.2/ Calculated as the ratio of producer price to export revenue (Cedis per metric ten).3/ Calculated using CPI, re-centered to correspond to crop years.4/ Main crop plus mid crop.

Imports and exports responded quickly to the expenditure-switching policies (exchange rate, trade reform, and domestic price adjustments). Ghana succeeded in making gains in its share of export markets and in reducing the intensity of imports compared with past trends (see Appendix III); the volume of imports nevertheless rose sharply, reflecting the strong recovery of output and the increased availability of financing. The impact of these policies also appears to have strengthened, on average, during the second phase of the ERP. In particular, the volume of merchandise exports increased substantially throughout the period 1983-93 (Chart 11).

CHART 11
CHART 11

GHANA: Export and Import Volume Indices

(1985 = 100)

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Source: World Economic Outlook database.

4. Policy credibility and sustainability

One possible explanation for the sluggish response of private investment and saving to the ERP was that policies were initially perceived to be unsustainable or lacking in credibility. Such perceptions could have arisen from, among other things, an inconsistency of policy measures, the poor track record because of the failures of past policies, or political uncertainty. One clear signal of such a potential problem was the failure of inflation to fall below a level of about 30 percent for a sustained period. 1/ This section considers two questions related to the credibility of financial policies. First, was the magnitude of the fiscal deficit reduction consistent with the objective of reducing inflation and a shift to positive real interest rates on public domestic debt? Second, why was inflation persistently high?

Private sector assessments of the sustainability of fiscal policy can have an important influence on the response of private investment and savings. An important aspect of this assessment is the effect of fiscal policy on the public debt burden. Chart 12 presents the results of some debt dynamics calculations for Ghana, based on the intertemporal budget constraint for the public sector. The actual primary fiscal balance at different stages of the adjustment process is compared with two notions of a “sustainable” balance: (1) the primary balance that would keep the public debt-to-GDP ratio constant at its current level, assuming that the current rate of inflation (and hence seigniorage) and the current interest rate on domestic debt (and hence the extent of financial repression) are maintained in the future (indicated as the base scenario); and (2) the primary balance that would keep the public debt-to-GDP ratio constant at its current level in a context of low inflation and no financial repression (indicated as the alternative scenario). 2/ This latter measure is a more comprehensive indicator of fiscal sustainability, since it provides a measure of the deficit reduction that is needed to make fiscal policy consistent with other important goals of an adjustment strategy, namely low inflation and efficient financial intermediation. The convergence of the two measures of sustainability beginning in the late 1980s reflects the progress made in diminishing the degree of financial repression and in reducing inflation to some degree.

CHART 12
CHART 12

GHANA: Actual and Sustainable Fiscal Primary Balances, 1983-93

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities; and staff esimates.1/ Primary balance needed to maintain the public debt-to-GDP ratio constant on the assumption of 5 percent inflation and no financial repression.2/ Primary balance needed to maintain the public debt-to-GDP ratio constant on the assumption that inflation rates and the degree of financial repression are maintained at their actual levels.

The results indicate that fiscal policy was on a sustainable path, in the sense defined above, between 1984 and 1991, even when it is assumed that the negative real yields on domestic debt and high levels of seignorage revenue would not be available as sources of financing in the future. 1/ During 1992-93, the expansionary stance of fiscal policy shifted the primary balance to an unsustainable position--in the sense that it implied continued increases in the debt/GDP ratio. As to the composition of the fiscal adjustment, increased outlays on health, education and infrastructure rehabilitation were also positive aspects (see Section IV.3).

The fundamental factor underlying inflation inertia, after the initial sharp fall in inflation in 1984-85, was the absence of an effective nominal anchor. 2/ Uncertainties about the appropriate equilibrium level of the exchange rate and the low level of reserves prevailed against the use of a nominal exchange rate anchor at the time the ERP was adopted. Moreover, credit and incomes policies, which had been expected to bring down inflation further, proved to be insufficient. In the event, monetary policy accommodated inflationary pressures, at times from cost-push factors, and may have contributed to keeping inflationary expectations high.

The limited effectiveness of incomes policies in reducing the cost-push factors on inflation is reflected in the substantial rise of nominal wages under the ERP. During 1983-88, significant increases in nominal wages were granted in the public sector in order to reverse the severe compression in real wage levels prior to the ERP and to improve the quality of the civil service. From the perspective of efficient public administration, this reversal was necessary, but, the large increases (on average 64 percent per annum, or 28 percent in real terms) put upward pressure on the price level directly through their impact on demand, and indirectly through their demonstration effect on private (formal) sector wages (Chart 13) and on inflationary expectations. In 1989-91, nominal wages in the public sector increased more closely in line with inflation, but in 1992, the civil service was granted a wage rise of 80 percent.

CHART 13
CHART 13

GHANA: Nominal and Real Wages, 1975-91

Citation: IMF Staff Country Reports 1995, 078; 10.5089/9781451814804.002.A001

Sources: Ghanaian authorities; and staff estimates.1/ Index of average monthly earnings (1983=100).2/ Index of average monthly earnings deflated by the CPI (1983=100).

The rapid growth of broad money, which was consistently higher than the rate of inflation by a large margin during 1983-89, was due primarily to the large expansion of credit to the public sector during 1983-86, and the rapid increase in the net foreign assets of the banking system during 1987-88 (in part reflecting high levels of external concessional assistance, which was only partially sterilized). 1/ During 1989-91, broad money growth declined, as the Government made net repayments to the banking system. Sterilization operations started to become more effective in the post-ERP period following the introduction of open market operations at market-determined yields. However, in 1992-93, the large increase in the fiscal deficit fueled a resurgence in monetary expansion.

5. External financing

Ghana’s substantial and sustained reform effort attracted significant inflows of capital, including large amounts of concessional assistance, and the path of output and investment during the ERP was not unduly constrained by an inadequate level of external financing. During the first phase of adjustment (1983-86), net external financing flows (net capital inflows plus official transfers) provided scope for strong growth in import volumes--averaging 13H percent a year--which reversed the import starvation that occurred in 1982-83 (see Appendix III). 2/ At the same time, sizable repayments of arrears were made and relations with creditors were normalized. In the second adjustment phase (1987-91) net external financing increased sharply, more than doubling from US$176 million a year during 1983-86 to US$472 million in 1987-91; for the most part this reflected a rise in net official inflows, especially transfers (Table 7). In the face of a large and persistent decline in the terms of trade, these inflows allowed Ghana to avoid a sharp contraction in domestic absorption, which could have dampened the recovery in output and investment. However, the significant increase in external inflows, which was larger than expected, also complicated efforts to restrict the growth of broad money.

Table 6.

Ghana: Fiscal Sustainability Calculations, 1983-93 1/

(In percent of GDP)

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Sources: Ghanaian authorities; and staff estimates.

Broad budget balance.

Table 7.

Ghana: Balance of Payments, 1983-91

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Sources: Data provided by the Ghanaian authorities; and IMF staff estimates.