Pressure mounts on Ghana’s government to address imbalances

Pressure mounts on Ghana’s government to address imbalances

Deteriorating twin deficits have put pressure on the government to adopt austerity measures. But risks of social unrest and reduced FDI may force authorities to moderate their rebalancing efforts.

Although the Ghanaian economy is projected to grow at an annual average rate of 7.4% in 2014, redressing its aggravating macroeconomic imbalances poses significant risks. The government has come under pressure to implement a strict fiscal consolidation plan to reassure investors of its ability to honour its debt obligations. But the authorities’ strategy to redress its balance sheets is likely to trigger labour protests and prompt foreign companies to retract their planned investments.

With the 2016 election already looming, political considerations may temper the severity of the government’s austerity plans, increasing the likelihood of a fiscal slippage in 2014 if the authorities concede to sustained expenditure pressures.

What hides beneath GDP growth

Two years of excessive pre-electoral spending have deteriorated public finances, while weak commodity prices and sluggish demand from major trading partners have subdued export revenue at a time when capital imports are on the rise to support the nascent oil and gas industry.

The central bank’s efforts in mopping up excess liquidity to tame double-digit inflation have not been effective, and the currency has continued to depreciate, prompting the monetary authorities to hike interest rates and impose stringent FX controls. Foreign exchange reserves have dangerously dipped to around three months of import cover.

As the current account deficit continues to widen, the dependency on volatile portfolio inflows places Ghana in the basket of countries most vulnerable to tightening global financing conditions. With almost a third of its debt in the hands of increasingly risk averse foreign investors, the economy’s faltering capacity to shield itself from a deceleration in capital inflows has become a daunting concern as its financing thirst cannot be quenched domestically.

Downgrade alert

During the government’s presentation of the 2014 budget last November, Finance Minister Terkper confirmed Fitch’s October call that justified its decision to downgrade Ghana’s sovereign credit rating from B+ to B (5 notches below investment grade). The rating agency had projected that the authorities would fail to meet their 9% fiscal deficit target for 2013, highlighting the government’s continued overrun on public sector wages, interest costs and arrears.

The fiscal deficit ballooned above 10% of GDP (up from 4% in 2011), while debt levels surpassed 50% of GDP last September (up from 38.3% in 2011). With the dip in prices of Ghana’s major export commodities (gold and cocoa) and a costly import bill, Fitch projected Ghana’s current account deficit to widen to 13.1% of GDP in 2013, warning against the economy’s accentuated exposure to exogenous shocks.

As expected, the approved 2014 budget revised its 2013 deficit target upwards to 10.2%, delaying its objective deficit target of 6% to 2016 and reinforcing Fitch’s view that the government’s ability to implement its fiscal consolidation plan remained limited. With its policy credibility undermined, both Moody’s and Standard & Poor’s subsequently proceeded to downgrade their rating outlook last December from stable to negative, sounding the alarms on Ghana’s creditworthiness and prompting the government to take further action.

Pressure to balance the imbalances

In spite of restored investor confidence after the lawful resolution of the disputed electoral results last August, Ghana’s weak revenue profile does not bode well for the government’s plans to continue tapping international markets to plug its deficits and raise funds for much-needed infrastructural development projects.

Although the launch of the $750 million Eurobond last July provided some financing respite, the government effectively paid a premium to compensate investors for the risks associated with its macroeconomic imbalances. With the yield on the 10-year instrument hovering above its issuance level, investor appetite for Ghana’s fixed income securities appears to be wavering. With the prospect of rising rates in developed markets, reduced global liquidity will engender greater discrimination against frontier markets with poor macroeconomic fundamentals and Ghana is visibly on the radar.

Consequently, the authorities have been urged to tighten the belt to minimize the risk premia associated with issuing sovereign debt. A strategy of public expenditure rationalization and revenue mobilization will however come at the expense of consumers and companies already burdened by higher costs, with the specter of protests and reduced investments potentially forcing the government to concede to social and corporate demands as political considerations enter the government’s calculations.

The opportunity cost of consolidating

In 2014 the government will be confronted with policy conundrums on both the monetary and fiscal side as the urge to curb inflationary pressures and restrain spending conflicts directly with the need to stimulate domestic consumption and boost capital expenditure.

The central bank’s ability to ease monetary policy will be heavily dependent on progress made on the fiscal side and its capacity to stem the currency’s depreciation. Rampant government expenditure and high levels of capital imports brought inflation to 13.5% last December (4.5 percentage points above target). The Cedi has been one of the worst performing African currencies in 2013, having depreciated by more than 23% (year-on-year) against the dollar.

The Bank of Ghana (BoG) recently raised the policy rate by 200 basis points (from 16% to 18%) and is expected to keep a tight monetary stance throughout 2014, particularly as the low level of foreign currency reserves limits the BoG’s ability to temper exchange rate pass-through effects. With the prospect that the government will continue to borrow aggressively, lending rates will remain prohibitively high, effectively crowding out the private sector and dampening domestic investment.

Following a 17% decline in government revenue last year, the authorities will be forced to cut recurrent expenditure and either implement further tax increases or streamline its revenue collection capacity. While some measures have already been implemented to ratchet up government revenue (cut in fuel subsidies, utility tariff hike, a 2.5% increase in the Value Added Tax), additional steps will be required to ration the deficit.

The most obvious strategy for the government will be to reduce the public sector wage bill, which makes up 72% of tax revenue (up from 35% in 2008). But at a time when consumers’ purchasing power has taken a hit from higher fuel and electricity prices, wage cutbacks in the public sector are likely to spark protests.

Last October, the Trade Union Congress (TUC) emitted strike warnings after the hike in utility tariffs and more recently it has warned the government that any freeze or reduction in public sector wages is “not workable”, particularly as the government is yet to pay workers for 2013 arrears.

Following the reintroduction of a temporary fiscal stabilization tax of 5% on the profits of corporations across the financial, extractive and communication sectors last July, firms are expecting further levies but have demonstrated their disgruntlement towards a government incapable of meeting its own financial obligations.

The authorities’ plan to introduce a 10% windfall profit tax in the mining sector has been met with hostility from foreign companies threatening to lay off national workers, while construction work on the Atuabo gas plant was stalled after the government’s failure to pay contractors on time, with over $400 million owed to foreign firms that are now reconsidering their long-term capital investments in Ghana.

The government may give in to political pressures and grant expenditure concessions to ease rising popular and corporate discontent. Indeed, the government’s partial reinstatement of subsidies and the delayed implementation of the windfall profit tax are indicative of this. As a result, fiscal retrenchment will be limited, with a high likelihood of a fiscal overshoot in 2014.

This will inevitably be met with skepticism from frontier market investors, who will be demanding higher rates in the event that the government effectively moderates its rebalancing efforts further, at the cost exacerbating its debt burden at a time when it can ill afford to do so.

In a nutshell, President Mahama’s economic team is confronted with a sturdy trade-off, but while consolidating may be politically costly, the necessity to restore macroeconomic stability through measures that will create fiscal space, re-anchor inflation expectations and reduce the country’s vulnerability to external shocks should trump any short-term political considerations.

About Author

Jose Luengo-Cabrera

Jose currently works at the EU Institute for Security Studies. He has previously worked for the European External Action Service, International Crisis Group and the United Nations Department of Peacekeeping Operations. His research focuses on developments across Sub-Saharan Africa, principally on the drivers of political (in)stability and economic growth in West Africa. The views expressed on this site are Mr. Luengo-Cabrera’s and do not reflect those of the EUISS or any previous institutional affiliations.