Monetary policy shift: A welcome development

By Prof. Samuel Lartey

Introduction

ON Friday, the Monetary Policy Committee (MPC) of the Bank of Ghana (BoG) announced a key decision to reduce the policy rate from 29% to 27%, marking a significant shift in the country’s economic management strategy.

The Governor of the BoG, Dr. Ernest Addison, explained that this decision was influenced by a favourable economic outlook, particularly a consistent decline in inflation over the past five months.

Headline inflation decreased by 5.4 percentage points, while core inflation dropped by 6.9 percentage points over the same period, signaling that the disinflation process is on track.

This policy shift is an important development for Ghana’s economic landscape, and its impact on the socioeconomic well-being of the citizenry deserves thorough exploration.

By examining the broader implications of this decision, we can better understand how it fits into the context of Ghana’s economic recovery, financial stability, and the livelihood of its people.

The Economic Context: Inflation and Financial Tightening

Since the beginning of 2023, inflationary pressures have dominated the economic narrative in Ghana. At the end of 2022, inflation peaked at 54.1%, driven largely by external shocks such as global supply chain disruptions, rising fuel prices, and local factors including currency depreciation and fiscal imbalances.

In response, the BoG took aggressive measures to stabilise prices, tightening monetary policy by hiking the policy rate to 29%, the highest in decades. This move, while necessary to curb inflation, also contributed to higher borrowing costs, putting a strain on businesses and consumers alike.

The policy rate determines the interest rates at which commercial banks borrow from the central bank, directly influencing lending rates to businesses and consumers. Higher interest rates make borrowing more expensive, discouraging investments, business expansion, and consumer spending, which are critical components of economic growth. As such, while the rate hikes helped stabilise inflation, they also slowed economic activity.

As inflation began to ease in 2023, with headline inflation falling by 5.4 percentage points and core inflation decreasing sharply, the BoG’s decision to cut the policy rate to 27% reflects optimism that the worst of the inflationary period is behind us. However, what does this mean for the everyday Ghanaian?

Impact on Businesses and Employment

Ghana’s business landscape, particularly its Small and Medium Enterprises (SMEs), is the backbone of the economy, contributing about 70% of GDP and employing roughly 80% of the workforce.

During periods of high inflation and elevated interest rates, SMEs struggle with limited access to affordable credit. The high cost of borrowing stifles expansion reduces productivity, and often leads to layoffs or wage cuts. The policy rate cut, therefore, offers a lifeline to these businesses by reducing the cost of borrowing, which could reignite business investments and job creation.

According to data from the BoG, commercial bank lending rates in Ghana averaged 35.8% in the first half of 2023, a prohibitively high level for many businesses. The reduction in the policy rate could see lending rates ease by the end of 2024, improving credit availability and affordability. This could also lead to more capital being available for expansion, innovation, and job creation, which are essential for sustainable economic growth.

For the broader population, increased employment opportunities and wage growth are vital components of socioeconomic development. A healthy business sector not only creates jobs but also spurs higher consumer spending, which feeds back into economic growth.

Consumer Behaviour and Livelihoods

High inflation erodes the purchasing power of consumers, leading to a decline in real incomes and living standards. In 2022, when inflation soared, the cost of food, fuel, and essential services rose sharply, disproportionately affecting low-and-middle-income households. The Ghana Statistical Service (GSS) reported that food inflation reached a staggering 59.7% in December 2022, putting enormous pressure on household budgets.

The gradual decline in inflation in 2023, coupled with the reduction in the policy rate, could alleviate some of this pressure. Lower inflation stabilizes the cost of goods and services, while reduced interest rates may encourage consumer spending by making credit more affordable.

 According to the BoG’s 2023 Financial Stability Review, household debt as a percentage of disposable income stood at around 37%, driven by high borrowing costs and inflation.

A reduction in borrowing costs could relieve this burden, improving the financial stability of households and allowing for increased spending on essential services such as education, healthcare, and housing.

Moreover, lower inflation has a direct impact on the prices of essential goods and services. As inflation trends downwards, the prices of food, fuel, and transportation services should stabilise, improving the real purchasing power of Ghanaian households.

In turn, this will enhance their overall well-being, allowing them to save, invest, or spend on critical needs such as education, healthcare, and housing.

Investment and Financial Markets

The reduction in the policy rate also has implications for Ghana’s financial markets. Lower interest rates often encourage investment in higher-risk, higher-reward assets like stocks and real estate.

This could stimulate activity in the Ghana Stock Exchange (GSE), which has been underperforming in recent years due to high interest rates that made government bonds and treasury bills more attractive. In 2022, the GSE Composite Index recorded a 12.38% decline, driven largely by investor flight to safer assets like government bonds.

A lower policy rate could shift investor appetite towards equities and real estate, stimulating growth in these sectors. For Ghanaian savers and investors, this presents opportunities to diversify their portfolios and potentially earn higher returns on investments.

Challenges and Risks

While the policy rate cut signals a positive outlook, it also comes with potential risks. A rapid reduction in interest rates could lead to renewed inflationary pressures if economic activity accelerates too quickly.

Additionally, Ghana’s public debt levels remain high, with the country’s debt-to-GDP ratio standing at 76.6% as of mid-2023. Servicing this debt requires prudent fiscal management, and any misalignment between monetary policy and fiscal discipline could undermine the progress made in controlling inflation.

The International Monetary Fund (IMF) has warned that while monetary easing is essential for growth, it must be coupled with robust fiscal measures to prevent excessive borrowing and ensure macroeconomic stability. The government’s commitment to fiscal reforms, including the ongoing debt restructuring efforts, will be crucial in ensuring that the benefits of lower interest rates are not offset by fiscal imbalances.

Conclusion

The Bank of Ghana’s decision to reduce the policy rate from 29% to 27% is a welcome development, offering a glimmer of hope for businesses, consumers, and investors alike. For businesses, particularly SMEs, it provides an opportunity to access cheaper credit, expand operations, and create jobs.

For consumers, lower inflation and borrowing costs could enhance purchasing power and improve living standards. For investors, it signals the potential for higher returns in equities and other investment avenues.

However, this optimism must be tempered with caution. The path to socioeconomic recovery requires a careful balancing act between monetary policy and fiscal discipline. The government must continue to pursue fiscal reforms and debt restructuring to ensure that the benefits of lower interest rates are not eroded by unsustainable debt levels.

As Ghana navigates these economic challenges, the BoG’s rate cut offers a vital stepping stone toward economic stabilisation and recovery. The disinflation process is on track, but ensuring long-term socioeconomic development will require sustained efforts on multiple fronts, from prudent fiscal management to continued support for businesses and households. This policy shift presents an opportunity for Ghana to reset its economic trajectory, with the potential to improve the quality of life for millions of citizens in the years to come.