The Economy of Ghana II · 2015. 10. 11. · The Economy of Ghana II . The Financial Sector and...

The Economy of Ghana II

The Financial Sector and Inflation Part 2.

The Financial Sector and Inflation (Pt. 2)

The Financial Sector in Historical Context

The Current State of Affairs

Inflation – Trends and Analysis

The Financial Sector and Inflation (Pt. 2) The Financial Sector in Historical Context

The history of the financial system in Ghana mirrors in many ways the development strategy adopted from the beginning of independence.

Given the limited financial services available to the majority of Ghanaians, it became imperative for the creation of specialised banks by the Government to serve the demands of distinct economic groups.


In 1953 the Ghana Commercial Bank was established to address what was regarded as the inadequate lending policies of the two established foreign banks – Standard Chartered and Barclays – which favoured well-established foreign firms in the granting of loans and advances.

Subsequent to this, throughout the 1960s and 1970s, various development banks were established to meet the financing needs of specific sectors of the economy.


These were: ◦ Agricultural Development Bank ◦ Bank for Housing and Construction ◦ The Cooperative Bank ◦ The National Savings and Credit Bank – formerly the Post Office Savings

Bank ◦ The Social Security Bank ◦ Merchant Bank ◦ National Investment Bank


Thus, by 1990 the formal financial system was made up of the central bank, four commercial banks, three development banks (DFIs), two merchant banks and the two smaller banks which grew out of the Post Office Savings Bank and the co-operative movement. In addition, there were 124 unit rural banks.

However, not much attention was paid to the development of non-bank financial institutions in this early phase of financial development.


Despite this state of affairs, when policy makers felt the need to deepen the financial services sector, especially following increasing dissatisfaction with the pace of the sector's development (in terms of service coverage), this was manifested in growth in the branch networks.

Thus, throughout the 1970s, state-owned banks were encouraged to expand their coverage by increasing branch network.


Moreover, it is worth noting that over 90% of the rural banks were established between 1976 and 1984, reflecting the policy decision to expand banking coverage to as many people as possible.


As may have become obvious in our discussion so far, the history of the development of the financial sector during the early years of independence was closely linked to extensive government intervention.

Hence, in an attempt to achieve rapid industrialisation, the government intervened in every sphere of the economy. Consequently, financial policies were set within an overall import-substituting industrialisation strategy.


Consequently, the financial sector had some important characteristics, a few of which is discussed here:

Interest Rate Policy: The BOG determined the structure of bank interest rates, including minimum interest rates for deposits and maximum lending rates.

Moreover, priority sectors, such as agriculture, received preferential lending rates, and in some cases these were lower than the minimum savings deposit rates.


Credit Controls: This involved the use of sectoral credit guidelines based on an annual credit plan drawn up by the BOG.

These were imposed on the banks to channel credit towards the priority sectors of agriculture, manufacturing and exports, and would usually take the form of maximum permitted percentage increases in the stock of loans to each sector, with priority sectors accorded larger increases than non priority sectors.


These conditions imposed by the state meant that by the 1970s, interest rate controls and credit ceilings ensured that cheap credit was available to government-imposed priority sectors such as manufacturing.

Besides, heavy taxation of the banking sector had become a major source of revenue for the government.

In addition, high reserve requirements were placed on the banks. These restrictive policies created major distortions in the financial sector. In the presence of high inflation, real interest rates became negative. .

The Financial Sector and Inflation (Pt. 2) The Financial Sector Reforms

The financial sector reform programme, referred to as the Financial Sector Adjustment Programme (FINSAP) was initiated in the last quarter of 1987.

The reforms were pursued with very little national debate. Most of the discussions which took place were between sector participants, the government and the "World Bank.


The financial reforms had the following objectives:

a) to establish a sound prudential and regulatory framework for banking

operations;

b) to ensure uniform accounting and auditing standards for all banks;

c) to put in place a more effective Banking Supervision Department (BSD) endowed with the requisite personnel and skills to enforce the prudential rules and regulations and a code of conduct for the banking sector;


The financial reforms had the following objectives: d) to create a framework for restructuring distressed banks with the

intention of transferring their non-performing assets, which had choked their balance sheets and stunted initiative in credit operations, to a new government agency, the Non-Performing Assets Recovery Trust (NPART);

e) to engage efficient top management for distressed banks;

f) to develop fully liberalised money and capital markets in Ghana


These reform objectives can be summarised below:

to address the institutional deficiencies of the financial system, in particular by restructuring distressed banks, reforming prudential legislation and the supervisory system, permitting new entry into financial markets by public and private sector financial institutions, and developing money and capital markets.


Further liberalisation of financial markets took place in 1992 with the adoption of indirect instruments of monetary control which entailed the introduction of market determined Treasury Bill rates.

From 1994 a second phase of the FINSAP began with the major objectives being the privatisation of public sector banks and development of non-bank financial institutions (NBFIs) to fill the gaps in the financial markets not served by the banks.

The Financial Sector and Inflation (Pt. 2) The Current State of Affairs

Ghana's financial system has undergone a process of restructuring and transformation in recent years.

Consequently, one observes that the regulatory and supervisory framework is strong, backed by a modern financial infrastructure.


More generally, Ghana’s financial system is not deeply integrated with the international financial markets; consequently there is greater reliance on domestic funding. Nonetheless, the credit markets have remained buoyant and financial institutions generally continue to be stable.

Despite these positives there are some strains within the system. Credit conditions for enterprises and households are generally tight, which are the result of inflationary pressures and high interest rates on bank credit.


We have already noted that the financial sector is largely dominated by banks. This is the result of the long-term structural improvements in the macroeconomic environment following a series of financial sector reforms.

Thus, with the introduction of a new banking law in 2003, many financial institutions have emerged resulting in greater competition among financial institutions.


The number of licensed commercial banks have increased to 28, with a branch network of over 790 across the country.

Many other financial institutions have also been established offering differing range of financial services to sections of the population that were previously unserved or under-served by the commercial banks.

Many other financial institutions have also been established offering differing range of financial services to sections of the population that were previously unserved or under-served by the commercial banks.

The Financial Sector and Inflation (Pt. 2) The Current State of Affairs Another means by which many sections of the population have become incorporated into the financial system is through Mobile banking.

This phenomenon is due to the high rate of mobile phone subscription (approximately over 70 percent of the adult population) and the growth in mobile service providers over the last two decades.

Consequently, Mobile banking has become well developed and continues to experience tremendous growth in Ghana. There are a variety of products are available to consumers, from payment systems for university students to balance inquiries on savings accounts.


Other aspects of the financial sector, such as the capital/equity markets have developed rapidly in recent decades. As of early 2015, the Ghana Stock Exchange (GSE) had 37 listed companies, with a market capitalization of listed securities at the end of December 2013 of Ȼ61,158.29 million.

It is also worth noting that the Ghana Stock Exchange has been fully automated since 2008. Current regulations allow foreigners to invest in securities listed on the stock exchange without exchange-control restrictions.


Additionally, the fixed income market (such as government bonds and other securities) is fairly active, though debt markets have recently experienced a narrowing of options for new sovereign issues.

In the fixed income market, the central bank regularly issue a wide range of government securities with varying maturities on the primary market.


Approximately 34 licensed primary dealers, including banks, discount houses and brokerage firms, operate in the country's security markets and all bids, on both competitive and non-competitive basis, must be submitted via primary dealers.

Secondary market trading of government securities has tended to be largely conducted on an over-the-counter basis via networks of primary dealers.

The insurance market is relatively developed, with more than 30 companies competing on the market, including branches of international companies.

The Financial Sector and Inflation (Pt. 2) Inflation in Ghana – Trends and Analysis

In our earlier discussion we noted that one of the main functions of the Bank of Ghana is to formulate and implement monetary policy aimed at achieving the objectives of the Bank, as well as promote by monetary measure the stabilisation of the value of the currency within and outside Ghana.

The key point to note is that the Bank of Ghana has now been granted the legal powers to fight inflation through measures and interventions that it deems necessary and appropriate.

The Financial Sector and Inflation (Pt. 2) Inflation – Trends and Analysis

Who/What at all is this animal called Inflation?

Inflation or more appropriately, the rate of inflation, is a measure of the rate at which average prices change in an economy over a period time.

More specifically, the rate of inflation measures the rate at which the average price level increases over time. Consequently, inflation may be simply defined as a sustained and persistent increase in the price level.



Note that the opposite of inflation is deflation, where we observe a sustained decrease in the price level over time.

Here a note of caution is important!

As stated above, the opposite of inflation is deflation. Nonetheless, when the term inflation is used, note that we are referring to price level increases.



What the inflation rate does indicate or report is the rate at which this increase occurs over a period of time.

So, a decrease in the inflation rate from 10% to 5% does not mean the average prices have declined. It only means the rate at which the average prices are rising have reduced from 10% to 5%.

Also, inflation does not imply high prices. It only means prices are rising at some rate.



What the inflation rate does indicate or report is the rate at which this increase occurs over a period of time.

So, a decrease in the inflation rate from 10% to 5% does not mean the average prices have declined. It only means the rate at which the average prices are rising have reduced from 10% to 5%.

Also, inflation does not imply high prices. It only means prices are rising at some rate.



Another point worth noting is that the inflation rate is computed using the notion of the average price level. This average is based on a basket of goods and services consumed by representative households in the economy.

Hence, not all goods and services are included in this basket. Consequently, the effects of changes in prices will affect different households, differently.


Measuring the Rate of Inflation:

The common measure of the rate of inflation is the rate of change in the consumer price index.

The Consumer Price Index (CPI) measures the change over time in the general price level of goods and services that households acquire for the purpose of consumption.



In Ghana, the computation of the rate of inflation is undertaken by the Ghana Statistical Service, which publishes the inflation rate on a regular basis – usually monthly.

The major components for the computation have been divided into Food (and Non-Alcoholic Beverages) and Non-Food items. This distinction allows for a better understanding of the inflationary pressures within the economy.



Food and Non-Alcoholic Beverages include: Vegetables including potatoes and other tuber vegetables; Bread and cereals; Fish; Fruit; Meat; Milk, cheese and eggs; Oils and fats; Food products n.e.c.; Sugar, jam, honey, syrups, chocolate and confectionery; Mineral waters, soft drinks and juices; Coffee, tea and cocoa



Non-Food include: Hotels, cafés and restaurants; Clothing and footwear; Furnishings, household equip. etc; Health; Transport; Housing, water, electricity, others; Recreation and culture; Alcoholic beverages etc; Miscellaneous; Education; Communications

The Financial Sector and Inflation (Pt. 2) Inflation Trends, 1965 - 2014

The Financial Sector and Inflation (Pt. 2) Inflation Trends, 1965 – 2014

In the immediate years after independence the country encountered very little inflationary pressures.

But from 1964 when the country began to encounter balance of payments problems, inflationary pressures began to build up in Ghana.

But since 1970 inflation has continued to present itself as a major economic problem in Ghana.

The Financial Sector and Inflation (Pt. 2) Inflation Trends, 1965 – 2014

In the immediate years after independence the country encountered very little inflationary pressures.

But from 1964 when the country began to encounter balance of payments problems, inflationary pressures began to build up in Ghana.

But since 1970 inflation has continued to present itself as a major economic problem in Ghana.

The Financial Sector and Inflation (Pt. 2) Inflation Analysis – why inflation?

In recent years however, the country has not experienced the episodes of high inflation experienced throughout the mid-1970s to the end of the 1990s.

Improved policy measures, such as the setting up of the Monetary Policy Committee (MPC) of the Bank of Ghana and the pursuance of a single-digit inflation targeting regime appear to have helped in this regard.


In general inflation may result from Demand pressures (Demand-Pull) or supply (Cost-Push) pressures.

Demand pressures result when there is an increase in Aggregate Demand for any existing Aggregate Supply conditions.

Supply/Cost pressures arise from factors that result in an increase in the cost of production for firms.


Despite these pressures discussed earlier, the main arguments put forward to explain inflation can be distinguished into the Monetarists and Structuralists camps.

Monetarists contend that inflation is a monetary phenomenon; a rise in the money in circulation causes prices to rise resulting in inflation.

Structuralists contend that inflation is the result of structural rigidities (bottlenecks) that characterise many developing-country economies. These rigidities largely constrain supply within these economies thus pushing up prices

The Financial Sector and Inflation (Pt. 2) Inflation Analysis – Drivers of Inflation in Ghana

Money supply

Domestic food (cereal) production

Exchange rate

Imported inflation and oil prices

Inflation inertia

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The Economy of Ghana II · 2015. 10. 11. · The Economy of Ghana II . The Financial Sector and...

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