Dr Bawumia: Dollarization not the cause of cedi depreciation

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Parent Category: Our Country

Category: Business & Finance

Created on Wednesday, 26 March 2014 00:00

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Dr Bawumia: Dollarization not the cause of cedi depreciation

Mahamudu Bawumia, Visiting Professor of Economic Governance at the Central University College and former Deputy Governor of the Bank of Ghana has said that dollarization is not the cause of depreciation but rather the effect of weak economic fundamentals and the loss of confidence in the cedi. He, therefore, says any attempt to solve the rapid depreciation of the cedi by focusing on de-dollarization will ultimately be an exercise in futility.

Dr Bawumia made these observations while delivering a lecture on the topic “Restoring the Value of the Cedi” at the Miotso Campus of the Central University College yesterday.

Speaking on some of the alternative views on the causes of the cedi which were largely faulty, Dr. Bawumia stated “One of the key functions of money is to act as a store of value. Throughout history, when money ceases to perform this function, people have found refuge in other commodities as a replacement store of value. “Dollarization” is the replacement of a country’s legal tender with another currency e.g. the US dollar.

This happens in countries with a history of high inflation and exchange rate instability. The resort to dollars for savings is essentially a risk mitigation measure. There is a vast empirical literature that supports the view that dollarization is a reaction by rational economic players to expected depreciation of a currency. It is not the cause of depreciation. Ghanaians have over the years learnt the hard way that they cannot trust governments to keep the cedi stable. Cedi depreciation has become a fact of life and therefore Ghanaians have come up with coping strategies to deal with exchange rate depreciation, including the holding of foreign currency.”

Dr. Bawumia, who was speaking as part of the Distinguished Speaker Series, noted that the cedi can depreciate against the dollar without the dollar even being present in the country since exchange rates basically reflect the purchasing power of one currency to another.

“Exchange rates fundamentally reflect the purchasing power of one currency relative to another for a given basket of goods. So if for whatever reason the value of the cedi declines (e.g. because of high inflation), we can expect, other things being equal, that its value relative to other currencies would fall. There is no requirement that these other currencies be even present in the country for such an exchange rate depreciation to take place.

This is why the cedi has been depreciating recently against the Hong Kong dollar, East Caribbean Dollar, Korean Won and the Chinese Yuan recently even though there is very little trading of these currencies on the Ghanaian market. In fact, I am sure very few people in this hall tonight have seen the Chinese Yuan or Hong Kong dollar even though the cedi has been depreciating at similar rates against these currencies as it has been against the US dollar.”

Dr. Bawumia noted that while the law mandating firms to quote prices in cedis is a good law, the key to the problem of dollarization is for government to pursue policies that will stabilize the cedi and thus make the dollar irrelevant in domestic transactions.

“On the issue of pricing goods in foreign currency in Ghana, it is the law that firms should be required to quote their prices in cedis, the legal tender. It is a good law and should be enforced. While that is so, as long as the economic fundamentals are weak, there is no law that can stop any firm or individual from wanting to hold dollars as a store of value or thinking in dollar terms even though they price in cedis. Shakepeare said in Macbeth that ‘There is no art to find the mind’s construction on the face’. So if a trader thinks in dollars and prices in cedis, how would you know?

Once they receive the cedi equivalent of the dollar price they would immediately buy dollars to save either from forex bureau or black market. People will buy dollars if they want dollars. There is not much a government can do about this once people lose confidence in the cedi. Even in the revolutionary days of military enforcement of foreign exchange laws, the black market thrived. Governments should rather focus on pursuing policies that would stabilize the cedi and make the dollar irrelevant in domestic transactions,” he stated.

Dr Bawumia added: “We should ask ourselves why dollarization disappeared in the five year period between 2002-2007 when the exchange rate of the cedi was very stable? And if the argument is that it didn’t disappear, then why did dollarization not cause a similar rapid depreciation of the cedi? Why is dollarization suddenly rearing its head again at an unprecedented rate? The fact is that dollarization only rears its head when the economic fundamentals are weak and people lose confidence in the ability of the cedi to maintain its value.

Dollarization is and has been a consequence of weak economic fundamentals and not the cause of poor economic performance. Persistent depreciation of a currency would result in dollarization. The lesson here is that, trying to solve the problem of cedi depreciation by focusing on de-dollarization is attacking the effects of a problem and not its causes; it is ultimately an exercise in futility.”

Touching on the measures introduced by the Bank of Ghana, he noted that despite the good intentions of the Bank, the imposition of foreign exchange controls had rather added an element of uncertainty to Ghana’s exchange rate regime and this discourages the very investment needed to grow the economy.

He stated that the Foreign Exchange Act (2006) was designed to give individuals and businesses, the confidence to bring their dollar and other foreign exchange holdings into the banking system and that since 1988, successive efforts had been made to make the banking system the channel for foreign exchange transactions and not the black market.

“The Bank of Ghana also encouraged people to bring their foreign exchange into the banking system as Foreign Exchange Accounts (deposited in Ghana with restrictions on transfer) and Foreign Currency Accounts (deposited from abroad and without restrictions on transfer). To give people the confidence to bring their foreign currency holdings into the banking system, the rules allowed them to withdraw their deposits in foreign currency.

After all it is their money. If they want to withdraw it and put it on their center table to look at it all night, that is their prerogative. Forcible conversion into cedis and restrictions on dollar withdrawals amount to a breach of contract which would undermine confidence in the banking system.

It would discourage people from bringing in their foreign exchange holdings into the banking system and drive foreign exchange transactions into the black market. If these two new directives are meant to stop the depreciation of the cedi, then they are bound to fail because dollarization, as I stated earlier, is not the cause of depreciation but rather a vote of no confidence in the local currency.”, he stated.

Source: thestatesmanonline.com

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