May 23, 2007

Ghana: Economist Intelligence Unit report

Economist Intelligence Unit report on Ghana


Policy trends

Although Government has announced that it will not renew its poverty reduction and growth facility following its expiry in October 2006, we do not expect economic policy to change significantly over the forecast period.

As underlined in the last IMF review of the PRGF in June 2006, Ghana has had a relatively good record of policy implementation in recent years and will seek to remain in favour with donors by continuing to push ahead with economic reform, led by improvements in good governance and the business environ-ment.

Government also confirmed, when presenting the 2007 budget, that it would opt for the IMF's policy support instrument, in which no financial support is given but policy implementation is closely monitored as a signal to donors that the country remains on track.

This is likely to ensure a continuation of the current goals of strengthening public expenditure management, increasing revenue to improve government capacity, improving the business environment through lowering taxes, and extending credit and support for the private sector.

However, although Government will seek to maintain macroeconomic stability under the PSI, there is expected to be a change of emphasis, with an increasing focus on investment in infrastructure and poverty-reduction schemes in an attempt to increase the longer-term growth potential of the economy and less priority given to economic stability.

This strategy was laid out in the Ghana Poverty Reduction Strategy II and outlined in the Scale-up Investment Plan produced by the government in 2006. The government hopes that this will allow it to achieve 8% annual growth in the medium term, although it would like to achieve a more realistic 6.5%, at least in the immediate future.

Fiscal policy

In recent years Government has used the net domestic debt/GDP ratio as its fiscal policy anchor rather than any particular spending targets or budgetary deficit. A low fiscal deficit has been important, largely in the battle against inflation, and this has allowed the Bank of Ghana (BoG, the central bank) to reduce interest rates.

Moreover, Gvernment has steadily reduced the budget deficit, from 9.7% of GDP in 2000 to 2.1% of GDP in 2005. Although greater control of expenditure (despite some slippages) has been a key element in reducing the deficit, revenue growth—from domestic sources and from high levels of donor support—has probably been more important.

However, there has been a change in the emphasis of government policy. This was apparent from the 2006 Ghana Poverty Reduction Strategy II, agreed by the IMF, which shifted the focus away from macroeconomic stability and towards a strategy that is likely to see a rise in government spending in order to drive growth.

This change in policy has implications for the fiscal balance as demonstrated by the latest BoG fiscal figures produced in March 2007, which already reveal an increase in the deficit to around 6.5% of GDP for 2006. We expect such slippages to continue across the forecast period as both the government revenue and expenditure targets come under pressure.

On the expenditure side, in addition to the planned increases in capital expenditure, with elections approaching in 2008—and following strikes by doctors and teachers in 2006—the government will face substantial pressure to boost public-sector wages.

Government has already undertaken, in the 2007 budget, to carry out a comprehensive review of the public-sector pay structure to end distortions in it, and an overall increase in the wage burden is likely as a result. On the revenue side, we believe that the government will be unable to meet its optimistic revenue forecasts. The latest BoG figures show that revenue for 2006 was 6.9% under the level programmed.

However, despite this under-performance, in the 2007 budget Government has forecast an increase of 48% in domestic revenue on the 2006 figure. Although we agree that domestic tax revenue will rise, it will not reach this level, particularly as both the 2006 and 2007 budgets included substantial tax cuts for individuals and businesses

Overall, we therefore estimate that the fiscal deficit will rise in nominal terms over the forecast period, though falling as a percentage of GDP to 6% in 2007 and 5.4% in 2008. In addition to financing the deficit on the domestic markets, Government is actively seeking to borrow externally from the commercial debt markets through a bond issue in the first half of 2007. This will be the first external debt issuance by an African sovereign since the 1980s.

Monetary policy

The BoG has had two competing and partly contradictory monetary policy aims in recent years. The first, which has been the main focus of monetary policy, has been to restrain liquidity growth with the aim of reducing the average annual inflation rate to single digits.

This has been carried out by increased sales of foreign exchange—although this has led to real appreciation of the cedi—and also by tighter financing of the fiscal deficit. The reduced deficit has been funded primarily through the issuance of Treasury bills rather than more expansionary forms of credit to the public sector.

As shown by the decline in inflation in 2006, this policy has largely been a success, even though Government narrowly missed its single-digit inflation target for the year.

Nonetheless, perhaps owing to increasing pressure from Government, which has one eye on boosting economic growth ahead of the 2008 elections, the BoG has been lowering interest rates to ensure increased lending to the private sector.

In contrast to the monetary policy aim of reducing inflation, this has had an expansionary effect on the money supply. The political pressures on the BoG have been apparent, as it cut interest rates at various times in 2006 on the grounds that inflation was on a downward trend, even though the declines have been modest and the inflation rate has remained in excess of the BoG"s stated target.

Although we believe that the timings of the steady cuts in interest rates since mid-2005 have been premature, the BoG may even consider further reductions in 2007 as long as inflation continues on its broad downward trend.

Although the global economy is growing rapidly, tighter policies in the developed economies are likely to cause world GDP growth (on a purchasing power parity basis) to slow from 5.3% in 2006 to 4.7% in 2007 and 4.6% in 2008.

Continued uncertainty on global markets and the weakness of the US dollar will keep the price of gold high, at a forecast average of US$653/troy oz in 2007 and US$643/troy oz in 2008. Cocoa prices are forecast to rise fractionally, from 72.1 US cents/lb in 2006 to 73 US cents/lb in 2007.

Continued high global demand and a lack of spare production will mean that international oil prices will remain reasonably high by historical standards, at an average of US$61/barrel, in 2007. Increased production and reduced demand should ensure that oil prices fall in 2008, although they will remain high, at an average of US$58/b.

Economic growth

Despite ongoing power shortages throughout 2006 that have affected mining output and are likely to have increased production costs for the industrial sector, Ghana’s real GDP growth is estimated to have been both broad based and robust, at 6% for the year as a whole. We expect this trend to continue over the forecast period.

Following a record year for cocoa production in 2005/06 (October-September), we expect continued strength in the cocoa sector, and in the agricultural sector in general. However, the outlook for industry is mixed. Manufacturers will continue to struggle, owing to the strong exchange rate, high inflation and growth in imports.

High gold prices and new investment in the mining sector are expected to lead to a substantial rise in gold output. The services sector is likely to record strong growth, particularly in telecommuni-cations, transport, tourism and government services.

Construction should also post robust growth, driven by donor- and government-funded infrastructure projects for the 50th anniversary of independence celebrations in 2007 and the Africa Nations Cup football tournament in 2008, as well as housing development. Overall, we expect the current rate of real GDP growth to be maintained during the forecast period, with the economy set to grow by just over 6% in both 2007 and 2008.


Having trended down in recent years to average 10.9% in 2006, the inflation rate rose modestly in December 2006 and January 2007, before falling again, to 10.4%, in February. The BoG expects the downward trend to continue and has set a target of an average rate for the year of 8.8%.

However, although inflation may fall further, we do not expect the fall to be as significant as that forecast by the BoG, owing to a number of factors. Foremost among these are expected tariff increases for utilities, notably within the power sector, as low water levels have led to reduced hydroelectric production at the Akosombo dam; the expected loosening of fiscal policy that is likely to include public-sector pay increases; and the BoG’s pursuit of lower interest rates that resulted in a drop of 2 percentage points in the prime rate at the end of 2006.

However, on a positive note, offsetting these pressures to an extent will be the effects of slightly lower international oil prices and a stable currency. Overall, the inflation rate will fall fractionally, to average 10% for the year. By 2008 we anticipate that the expected loosening of fiscal policy, combined with lower interest rates, will have had a noticeable inflationary effect, with the inflation rate forecast to climb to an average of 10.5% for the year.

Exchange rates

Since 2000 the BoG seems to have used the exchange rate as an anti-inflationary tool, particularly in 2005. However, the stability of the cedi in nominal terms has eroded the competitiveness of non-traditional exports and increased the volume of imported goods, leading to a large current-account deficit in 2005.

Although currency stability broadly continued, the cedi declined in real terms against the US dollar, possibly heralding a softening of the BoG’s policy, in a bid to relieve pressure on the export sector and to boost growth. Nevertheless, given rising remittances and high global prices for gold and cocoa, we expect inflows of foreign exchange to be strong.

We forecast that the cedi will fall back only modestly against a weak US dollar, to average C9,320:US$1 in 2007. An expected strengthening of the US dollar is likely to lead to a faster depreciation in the value of the cedi in 2008, which we forecast will average C9,647:US$1 for the year.

However, given Ghana’s limited foreign-exchange reserves, its high dependence on commodity exports and the fact that demand for foreign exchange is structurally higher than supply (owing to the economy’s import dependence and small manufacturing base), the cedi will remain vulnerable to external shocks, which could lead to a sharp collapse in its value, as occurred in 2000 and 2002.

External sector

The confusion behind Ghana’s current-account data was underlined when new data from the BoG, released in March, revealed a deficit of US$810m in 2006. This contrasts with its previous data, which showed a current-account surplus in the first half of 2006, and the 2007 budget, released in November 2006, which projected a current-account deficit for 2006 of only US$555m.

Despite problematic data, some trends are clear. Exports appear to have performed extremely well over the year, largely due to higher revenue from cocoa production, which—in line with BoG figures—tends to be concentrated in the first half of the year, and from gold exports.

However, it is also clear that imports rose dramatically, owing mainly to power shortages caused by low water levels at hydroelectric dams, which increased reliance on expensive imported oil, a strong currency that made imported goods a cheap way of satisfying domestic demand and imports of capital goods by gold mining companies.

Assuming a return to normal weather conditions, we expect a lower current-account deficit in 2007. A modest rise is forecast in overall exports; in which the mining sector is again expected to be crucial, with a large increase in the value of gold exports as production from the Ahafo mine attains its optimum level and prices reach a forecast US$653/troy oz.

Imports are also set to rise modestly, again owing to mining developments and robust domestic demand, but this will be nowhere near the increases seen in 2006. To some extent, the high level of imports will continue to reflect goods in transit to neighbouring countries as uncertainty over the political situation in Côte d’Ivoire leads shippers to use Ghana’s ports.

In addition, 2007 will be the first full year in which Ghana benefits from the reduced interest payments resulting from the multilateral debt relief initiative, which will offset increased profit remittances from mining companies on the income account. As a result, we forecast that the current-account deficit will fall to 5.6% of GDP. In 2008 a probable slight rise in gold production should help to support the current account and, with strong real GDP growth forecast, the deficit should equal 5.1% of GDP.

backdrop for policy

The Ghanaian economy’s high level of dependence on a limited range of commodities—notably cocoa and gold—and the fact that the rate of poverty remains very high is the subject of an intense national debate as the country moves towards the 50th anniversary of its independence, which will officially be celebrated in March.

With such a high level of public interest and debate on the issue, in recent months it has become clear that the New Patriotic Party government is slowly shifting the focus of its economic policy away from the theme of its first term in office, achieving macroeconomic stability, towards trying to put the economy on a higher growth path that will enable the country to meet the Millennium Development Goals and to achieve its stated aim of ensuring that Ghana becomes a middle-income country by 2015.

However, in its efforts to achieve this,Government is keen that it does not undermine the strong economic fundamentals of recent years.

It was against the background of this change in emphasis of economic policy that Government released details in November of its "Golden Jubilee" budget for 2007. In line with the more growth-oriented policy, the finance minister, Kwadwo Baah-Wiredu, presented a budget based on a real GDP growth target of 6.5-8% in 2007, significantly higher than the 5.4% growth that the country has averaged over the last five years.

To achieve this goal, Government outlined two basic tenets of policy in the coming year and beyond. Firstly, Government is keen to improve the environment for private-sector business, through a combination of less government interference, improved regulation and infrastructure development. Secondly, however, Government is to increase spending in targeted areas, with the aim of reducing poverty.

Tax reductions are a key part of the budget

One of the first steps towards achieving the first goal—and a central element of the 2007 budget—was a series of tax reductions, or abolitions, designed to help the private sector. In particular:

* withholding taxes on dividends and rent were reduced from 10% to 8%;

* capital gains tax was reduced from 10% to 5%;

* the National Reconstruction Levy was abolished; and

* tax relief was awarded to venture-capital funds, while pharmaceutical companies were given value-added tax (VAT) relief.

The overall thrust of these changes is to build on reductions in corporate income tax that have reduced the benchmark tax rate by 7.5 percentage points over the last five years. However, this time, rather than a blanket reduction, the cuts are aimed at priority sectors in order to boost private-sector growth. The lower taxes are also designed to increase investment into Ghana, by bringing its tax rates more closely into line with those of other Sub-Saharan governments.

Domestic revenue growth has been strong in recent years

One potential problem for the government is that, by reducing tax rates, it is relying on a sharp pick-up in the overall growth rate to offset the revenue losses caused by the tax cuts.

This would appear achievable, given the strong growth in domestic revenue in recent years, but there are some concerns highlighted in the recent budget data. Total government revenue (domestic revenue plus grants) grew by 30% in 2004 and 14.8% in 2005, with the main source of revenue growth being domestic revenue, which increased by 38% and 22% for the respective years. However, this trend changed in 2006.

Although the budget estimates strong total revenue growth of 15.5%, this was driven by proceeds from the multilateral debt relief initiative (MDRI), which represented 7.7 percentage points of the growth in revenue and contributed to an overall-growth in grants of 26.7%.

Furthermore, the planned pick-up in domestic revenue sources did not occur, and revenue from domestic sources came in 7.1% lower than the government had budgeted for the first three quarters of 2006. The government will thus have to hope that, with the economy continuing to grow strongly, domestic revenue growth will pick up again in 2007

Given Government’s spending commitments and tax reductions for 2007, it is likely that it will have to secure other forms of financing. Government is already exploring a number of options; notably, it is at an advanced stage in terms of planning to raise money on the private international debt markets (November 2006, Economic policy).

Government, advised by Citigroup, is expected to issue a sovereign bond worth up to US$500m, either towards the end of the first quarter or during the second quarter of 2007. This would be a hugely important step for Sub-Saharan Africa, making Ghana the only Sub-Saharan country, other than South Africa, to enter the international capital markets since the largely unsuccessful forays by Nigeria and Côte d’Ivoire in the late 1970s and early 1980s.

This debt was eventually defaulted on and then restructured as Brady bonds. In the case of Côte d’Ivoire, these are still outstanding, although the Nigerian government has made significant advances towards a debt buyback deal with its private creditors.

Government is also likely to seek to borrow at concessional rates from bilateral and multilateral donors, led by China, which has already announced that it will finance and build a US$600m hydroelectric dam at Bui.

Negotiations with China are continuing over extending the loan facility, which is likely to be up to 70% on conditional terms. Ghana is likely to increase its borrowing from other bilateral lenders, such as India and Japan, and traditional multilateral lenders, such as the World Bank and the African Development Bank.

MCA funding is under threat

Government has had a setback recently in securing additional external funding, as the Millennium Challenge Account initiative of the US president, George W Bush, seems under major political threat.

Under the MCA, the US had awarded Ghana US$547m in aid, to be spent largely on agricultural development and transport infrastructure (November 2006, Economic policy). However, following the US mid-term elections in November 2006, in which Mr Bush lost control of the US Senate and House of Representatives, it looks unlikely that Ghana will receive the full amount.

In announcing the MCA, Mr Bush had said that he would ask Congress for US$5bn per year to fund the scheme but, owing to spending restraints, he requested just US$3bn for it for 2007. Furthermore, an article in January in a US newspaper, The Wall Street Journal, suggested that the actual amount allotted to the MCA could be as little as US$1.2bn. This would significantly reduce the funds delivered to Ghana.

Targeting spending is more problematic

The main problem for Government, however, may not be its ability to raise revenue, either domestically or internationally, but how it spends the money, and whether it can achieve a reduction in poverty. In particular, in recent years two problems have become apparent.

Firstly, Government has proved unable to spend its capital budget. Government has blamed a delay in planned privatisations, the revenue from which it had earmarked for capital spending.

However, even before 2006, increases in capital spending had slowed from the rapid rises of 98% in 2003 and 67% in 2004 and, as a proportion of total government spending, capital spending rose only fractionally from 37% in 2004 to 39% in 2005.

Furthermore, in the latest figures for 2006, revealed in the 2007 budget, Government admitted that investment outlays for the first three quarters of the year came in 19.6% under the level programmed in the 2006 budget.

Government’s claims regarding delayed privatisations have some credence but, in general, large increases in capital investment by many Sub-Saharan African governments have failed to occur in recent years. This reflects their limited capacity to oversee and implement large projects.

Secondly, and crucially, much of the increase in spending in recent years has been in recurrent expenditure, notably wages (most people employed by the government in Ghana are far from poor).

In the 2007 budget Mr Baah-Wiredu revealed that spending on wages reached C8.4trn (US$915m) in the first three quarters of 2006, 11% above the budgetary target for the period. In addition, with elections scheduled for 2008, and following several strikes in the second half of 2006, the government is under increasing pressure to spend even more on public-sector wages instead of capital projects. Ghana’s public-sector wage bill is already equivalent to 9.5% of GDP.

Pressure to raise wages in 2006 was particularly intense in the health sector, where many key workers can easily find employment in rich Western economies. Government responded by granting doctors large pay rises (in excess of 100% in some cases), which were estimated to add an additional C1trn to the budget. As a result, Government admitted that as a proportion of discretionary spending, the public-sector wage bill would increase from 30% in 2006 to 66% in 2007.

New public-sector pay structure agreed

The disparities created by the increases in health workers’ wages have come back to haunt Government, as the rises broke the guidelines laid down by the Ghana Universal Salary Structure and caused resentment in other areas of the public sector, resulting in widespread strike action.

In its 2007 budget, Government therefore announced the abolition of the GUSS, and introduced what has been termed the "single spine" for public-sector salaries. This is expected to be in place in three to five years, following investigation by a Fair Wages Commission, which is being set up to look at wage levels across the public sector.

The most likely outcome of this process is an across-the-board increase in public-sector wages. However, the Economist Intelligence Unit doubts that Government has implemented the necessary reform of the public sector to justify the pay increases.

The 2007 budget did contain references to "linking the public-sector pay structure with productivity" and "a programme of right sizing". However, we expect that it is likely to be more difficult for Government to implement public-sector reform after the pay review than to do both at the same time. As a result, we expect recurrent expenditure to add to the overall fiscal deficit from 2007 onwards.

Government confirms that it will not sign up to new PRGF

We have few doubts that Government will continue to attract high levels of donor support in coming years, but, in order to ensure that donors do remain committed, Mr Baah-Wiredu used the budget speech to point out that although Government would not renew Ghana’s poverty reduction and growth facility with the IMF, which expired in October 2006, it would sign up to an IMF Policy Support Initiative.

The PSI was introduced by the IMF in October 2005 to provide support to low-income countries that do not want or require the Fund’s financial assistance. Instead, the aim of the PSI is to facilitate the design of effective economic programmes that provide the necessary signals to development partners (donors, multilateral development banks and markets) that the IMF has endorsed the country’s economic policies as sound and reflective of market-led policies.

Mr Baah-Wiredu also highlighted the areas on which he believed a PSI would focus, which seem broadly in line with those outlined by the IMF (November 2006, Economic policy). They include:

· enhancing growth-promoting policies, while sustaining macroeconomic stability;

· further strengthening of debt management;

· deepening of the domestic capital markets; and

· creating the environment to access international capital markets in the appropriate circumstances.

Government announces commitment to WAMZ

In the 2007 budget Government also announced its commitment to meet the convergence criteria for the West African Monetary Zone, in order to join its single currency by 2009. There are four primary convergence criteria, of which Ghana presently meets just two, in relation to central bank financing of the government deficit and the level of reserves.

However, the country came close to meeting the inflation criterion, and we forecast that Ghana will meet the single-digit inflation target by the end of 2007. The real question, therefore, will be over the fiscal deficit, and we consider it unlikely that Ghana will meet the required budgetary deficit over the outlook period.

In addition to the primary criteria, in 2005 the WAMZ Convergence Council adopted a new action plan designed to facilitate a single currency for the WAMZ members: Ghana, Nigeria, Sierra Leone, Liberia, The Gambia and Guinea. The updated WAMZ programme includes structural measures such as the liberalisation of financial markets as well as the full liberalisation of capital accounts within the WAMZ.

Under these plans, it is expected that the WAMZ will implement full capital-account liberalisation by December 2007 to facilitate the realisation of a customs union by December 2008, although the governor of the Central Bank of Nigeria, Charles Soludo, has already indicated that Nigeria is unlikely to meet these requirements this year. In addition, the Economic Community of West African States (ECOWAS) Common External Tariff, which is scheduled to be agreed by the end of 2007, is a further step towards the WAMZ, and one which the Ghanaian government reiterated its support for in the 2007 budget.

However, although the rigours of aiming to meet the convergence criteria may be a useful exercise for Ghana, we doubt whether the single currency will be adopted within the timeframe, given the divergent nature of the countries and the economic dominance of Nigeria.@VE

Cedi to be redenominated

In January the Bank of Ghana (the central bank) announced a redenomination of the country’s currency, the cedi. This has become a common trend in Africa as countries have brought down traditionally high inflation rates, with Mozambique the most recent African state to undergo such an exercise. To be contd.

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