At the beginning of next week the Bank of Ghana will certainly raise its benchmark Monetary Policy Rate significantly. TOMA IMIRHE explains why this is absolutely necessary and examines the factors that will determine how big the impending hike will be as well as the impact it will have on both government and the private sector.
Corporate Ghana, Finance Ministry officials, both resident and foreign bond investors, local treasury bill investors, commercial lenders, fund managers, public policy analysts, the financial media and even financially included households are all awaiting the scheduled announcement this coming Monday, May 23, by the Bank of Ghana Governor, Dr. Ernest Addison as to what the benchmark Monetary Policy Rate will be for at least the next two months.
The announcement, at a press conference to b e held on the central bank’s 5th floor from 11am will be the culmination of three days of (currently ongoing) deliberations done by the Bank of Ghana’s Monetary Policy Committee (MPC) from Wednesday, May 18 to Friday May 20.
No previous MPC meeting has attracted this much attention and anticipation. This is because of the peculiar circumstances surrounding the awaited announcement.
During many of the previous MPC meetings – which are held every two months, making for six times a year – the direction and size of the change in the Monetary Policy Rate MPR), if any change is to be made at all, can only be speculated on, and often, monetary policy analysts and commentators get it wrong, the eventual actual decision taking most of them by surprise.
This time around however the unusual -and severely dire- situation makes a sharp hike in the MPR an absolute certainty. All that is left to be speculated on is the size of the increase with bets ranging from 100 basis points (1%) to 400 basis points (4%). This range of possible MPR hikes – at a time that severe macroeconomic instability has returned to Ghana -makes for intense uncertainty that economic actors and other stakeholders want resolved especially because of the sheer impacts that the impending interest hikes will have on them.
At the last MPC meeting held in late March, the MPR was increased by 250 bps. The hike had been expected but not the severity of it. The fact that a similar hike is on the cards coming at the very next MPC meeting illustrates just how trouble Ghana’s economy is in.
Simply put, inflation is on the rampage and as an inflation targeting central bank, so, necessarily, is the BoG. As at the time of the last meeting of the MPC in March, inflation for February was 15.7% and rising, this necessitating an increase in the MPR from 14.50% to 17.00%. But inflation has since risen even further to over 23%, its highest level since 2004, and every indication points towards a further rise over the coming month, with the latest increase in commercial transport fares (of more than the 20% announced by the public transporters union) about to set off another bout of price increases.
Indeed this is in part why economists are so concerned about the impending interest rate hike. Monetary tightening, is the generally accepted main tool for combating inflation since it is eminently useful in curbing demand pull inflation; the less the liquidity in an economy and the higher the cost of money (which is what interest rates express) the less the demand for goods and services and consequently the lower the rate at which their prices increase.
However, since Ghana is highly credit driven, higher interest rates conversely fuel inflation by increasing production costs through higher costs of financing production. The debate over whether interest rate hikes lower inflation through their effect on demand pull inflation or whether they raise it by fueling cost push inflation still rages although the majority of economists in Ghana agree with the BoG that the net effect is certainly positive with regards to curbing inflation and cedi depreciation as well.
Nevertheless, for enterprises that rely heavily on short term debt (such as overdrafts, as well as trade financing and working capital loans) or are already locked in to medium to long term debt (perhaps taken to equip or retool, or taken in the form of a mortgage) the impending interest rate hike will have major implications for their financial sturdiness.
Even a 200 basis points hike in the MPR next Monday would take the Ghana Reference Rate – which serves as the base lending rate for all the commercial banks, and is currently at 18.04% – to over 20%. In turn this would push the average lending rate – currently at 21.02% – to over 23%.
The GRR’s rise in recent times clearly illustrates the worries of borrowers. The universally applied base lending rate is computed by the BoG in conjunction with the Ghana Association of Bankers, based on the MPR and treasury bill rates. Less than a year ago – as at June 2021 – it was just 13.80%. Indeed it was stable at that level until the end of the year standing at 13.39% by December. Then, following Ghana’s sovereign risk rating downgrade it began to rise in February, crossing the 14% level. A 200 basis point rise in the MPR this coming Monday would take the GRR to about one and a half times the level it was at just three months ago.
The average lending rate has been stickier as it moves upwards more slowly than the GRR, proving to move more in line with the MPR itself. However because the ALR is a weighted average and the biggest borrowers are the big corporations with the biggest cash flows (most of their debts are short term working capital debt such as overdrafts) they are also the safest borrowers and so can borrow relatively cheaply. This lowers the ALR computations and masks the fact that most borrowers (measured by their number) are smaller in size, have smaller cash flows and thus are regarded as bigger credit risks meaning their loans are considerably more expensive than the ALR.
Worse still, higher interest rates automatically make their loans even riskier in the perception of the lender and so banks would tend to increase the risk premium they put on the base rate they all use and this would make effective lending rates rise even faster than the rate at which the MPR is rising this year.
Curiously though, it is public sector borrowing that has influenced commercial lending rates the most.
The rise in inflation above the coupon interest rates offered by government on its treasury instruments has created immediate, severe problems for the government. Since a fortnight ago, even before the Ghana Statistical Service announced that the March inflation rate of 19.7% had crossed the 23% mark in April, government has been failing to get investors to subscribe to much of its cedi denominated domestic debt securities, short term and medium term alike, even though it has increased its coupon rates significantly over the past month or so.
Indeed, by mid May, the coupon rate offered for 91 day treasury bills had risen to 18.23%; 182 day treasury bills were offering 19.26%; and 364 day treasury notes were offering 21,13%. These rates are roughly 500 basis points (five percent) more than what they were a year ago.
But now even government’s medium term domestic debt securities are offering coupon rates that fall behind the current inflation rate. By mid May, two year treasury notes were offering 21.5% and five year treasury bonds were offering 22.3%.
This is discouraging local institutional investors such as banks, insurance companies, pension funds and fund management firms as well as high networth individual investors, who between them were expected to take up the slack created by the mass exit of foreign bond investors who themselves have been sent scurrying for the gates by sharp cedi depreciation which itself was ignited by the downgrade of Ghana’s sovereign bond ratings (both domestic cedi denominated and foreign dollar denominated)
Foreign investors themselves may not be attracted even by higher coupon rates generated by the impending increase n the MPR unless it is inordinately large since the cedi’s fragility is a major concern. Furthermore with inflation rising in their own dominions (inflation in the United Kingdom has just reached a 40 year high of ….seven percent!) monetary tightening is leading to rising interest rates at home which are a more attractive proposition for them than rising interest rates in Ghana.
This means the MPC should have to set the MPR at a level that pushes treasury bill rates above inflation. The problem here is that with the current spread of a little over 120 basis points for 91 day treasury bill rates over the MPR, the BoG’s benchmark interest rate would have to rise to at least 22% for this to happen. This would require a politically challenging 500 basis points rise – or more – to be decided on by this Friday and announced on Monday next week.
To be sure, Ghana has lived with a higher MPR than this before; it rose to 26% during the final year in office of the Mahama administration in 2016 – with a different executive management in place at the central bank – before beginning to fall. Most of that fall however has occurred during the tenure of President Nana Akufo Addo as President and Dr. Addison as BoG Governor and both gentleman and their fellow chieftains having demanded credit for the sharp decline in interest rates since then, would be loath to see the MPR close in on the peak levels they inherited, while still in office.
They have good reason. While interest rates in general and investment securities pricing are being driven by government’s own debt refinancing and fiscal deficit financing needs , the MPR is just as impactful on the cost of private sector debt and thus economic growth rates too.
Expect loud protests from elements of the private sector when the impending increase in the MPR is announced shortly. Indeed the Ghana Union of Traders Associations has already begun advocating for it to be left where it is despite macroeconomic fundamentals making an increase absolutely imperative.
But the increase is inevitable; and with inflation likely to rise even further over the coming months, the impending hike in the MPR may not be the only one before the end of 2022.