1 CREDIT Research Paper No. 07/07 Capial Flows and Curren Accoun Susainabiliy: The Ghanaian Experience by Absrac Maxwell Opoku-Afari Boh heoreical and operaional definiions of curren accoun susainabiliy show a persisen and fragile curren accoun balance (defici) for Ghana. This has creaed a financing gap in he Ghanaian economy, ypically filled by capial inflows, in paricular aid. Even as Ghana depends o a large exen on aid inflows i has ended o be procyclical. I is eviden from he analysis ha curren accoun susainabiliy in Ghana is very sensiive o donor flow dynamics raher han rade flows. To make Ghanaian curren accoun deficis susainable a more sable and predominan rade conribuion is required. Remiances from abroad are of increasing imporance since 2000 and are relaively sable and couner-cyclical, and if managed can conribue o curren accoun susainabiliy. Cenre for Research in Economic Developmen and Inernaional Trade, Universiy of Noingham
2 CREDIT Research Paper No. 07/07 Capial Flows and Curren Accoun Susainabiliy: The Ghanaian Experience by JEL Classificaion: F32, F35, F41 Maxwell Opoku-Afari Keywords: Curren Accoun, Susainabiliy, Capial Inflows Ouline 1. Inroducion 2. Concep of Susainabiliy 3. Curren Accoun Susainabiliy Crieria 4. Is he Ghanaian Curren Accoun Susainable? 5. Conclusion The Auhor Maxwell Opoku-Afari was he Head of he Special Sudies Uni in he Research Deparmen of he Bank of Ghana a he ime of wriing his paper. Views expressed here are enirely hose of he auhor and do no necessarily represen he official view of he Bank of Ghana. Auhor s conac: Acknowledgemens The auhor acknowledges useful commens from Dr. E. K.Y Addison (Direcor of Research, Bank of Ghana) and research assisance from Messrs Emmanuel Kinful and Ibrahim Abdulai. However, all errors are enirely his own. An earlier version was presened a a Workshop on Capial Flows and Curren Accoun Susainabiliy in African Economies, organized by UNECA in Accra, Ghana on Sepember 2005 Research Papers a
3 1 1. INTRODUCTION As he Ghanaian economy posiions iself on he pah o move he economy from sabiliy o growh, policy makers and inernaional communiy as a whole have been concerned wih idenifying he drivers of growh and wheher hese sources of growh would lead o a susainable growh needed o plunge he economy o ha much awaied susainable growh pah owards middle income saus by Righ from he days of Srucural Adjusmen Programme (SAP) ill now, Ghana has benefied immensely from significan capial inflows, mosly in he form of donor assisance. More recenly, Ghana has also idenified anoher form of inflow, remiances, as a significan componen of he curren accouns 1. While hese developmens have been seen as crucial o he curren rend of sabiliy, people have quesioned he susainabiliy of his rend and how imporan his is in erms of promoing growh. Over he pas wo decades, curren accoun balance in Ghana has consisenly been in he defici reaching a peak of 12.5 percen in However, in recen years while posiive economic growh has reurned in Ghana, large and increasing curren accoun deficis have become common making he quesion of susainabiliy imperaive. On he one hand, a curren accoun defici is a reflecion of he srengh of a developing economy, insofar as i measures underlying financing of invesmen demand in excess of naional savings. On he oher hand, a curren accoun defici can reflec a dangerous and unsusainable imbalance beween naional savings and invesmen and he accumulaion of deb. I would be exremely imporan and ineresing o know which of hese wo scenarios represen he siuaion in Ghana. Given he firs scenario, if curren accoun deficis in Ghana represen he underlying driver of growh, hen i would reflec in major srucural changes ha have led o an inflow of capial causing invesmen and economic growh. These in mos cases have been viewed in he case of a developing counry as 1 In addiion o significan increases over recen years in remiances, improvemen in recordings a he recipien banks following new guidelines released by he Bank of Ghana accouns for he sudden surge. Implying some of he increase are no new remiances flows. I is also believed ha abou wo-hirds of remiances are in he informal secor (see Addison, 2004).
4 2 represening he ransiion process from sabiliy o growh. We could also have he siuaion where he defici resuls in he accumulaion of unsusainable deb. Looking a i differenly, he defici could be seen as a performance crierion of he Ghanaian economy. Tha is, given ha he curren accoun defici is closely relaed o fiscal balance (public savings) and privae savings, i has imporan implicaions for overall growh. Similarly, i would have implicaions for he exchange rae and compeiiveness, which could prove couner-cyclical o growh effors being pursued. Hence, our exploring he dynamics of he curren accoun and is underlying drivers would illuminae our undersanding on he overall performance and prospecs of he Ghanaian economy. This is a huge ask especially in developing economies, which are perceived o have a very prolonged ransiion rajecory. This if no properly undersood and managed could make he economy more suscepible o large and unpredicable shocks, he consequences of which canno be overemphasized. This paper aemps o idenify he underlying srucure of curren accoun deficis in Ghana, and specifically assess he susainabiliy of he Ghanaian curren accoun using a muli faceed suie of models and indicaors. We have paricularly been moivaed o invesigae he curren accoun susainabiliy in Ghana due o he following: he size of he defici relaive o GDP in recen years (rising as high as 12.5% in 1999) he relaively poor income and savings rae indicaing ha deficis are he resul of high consumpion and low savings unsusainabiliy of exernal deb plunging he counry ino he HIPC saus real appreciaion of he exchange rae posing hreas o our exernal compeiiveness relaively unchanged srucure of he Ghanaian economy over he pas wo decades quesioning he sources of growh.
5 3 The paper begins wih a review of background and rends in curren accoun balance in Ghana. Secion wo discusses he concep of curren accoun susainabiliy. Secion hree looks a crieria for susainabiliy of curren accouns deficis. Secion four presens a deailed assessmen of curren accoun susainabiliy in Ghana, while secion five presens suggesions o improve susainabiliy. Secion six concludes he paper. 2. THE CONCEPT OF SUSTAINABILITY Simulaneous achievemen of domesic and exernal macroeconomic equilibrium is considered o be driving macroeconomic managemen in boh developed and developing economies. Domesic balance can be defined as he condiion where non-radables goods clear in he curren period and are expeced o be in equilibrium in he fuure. Exernal balance is mosly defined as he curren accoun balance ha is compaible wih long-run susainable capial inflows (Opoku-Afari e al, 2004). A simulaneous achievemen of inernal and exernal balances resul in a corresponden opimal real exchange rae and consumpion (or domesic demand) consisen wih boh exernal and inernal balances. The figure below represens differen scenarios of boh inernal and exernal (dis) equilibrium. Char 1 demonsraes he differen sages of macroeconomic (dis)equilibrium paricularly for developing economies which are always in ransiion. The righ side of he CA* line represen a siuaion of curren accoun defici. An economy showing chronic defici would persisenly be on he righ side of CA* line. Similarly, an economy showing depressed oupu would be on he lef side of inernal balance (ha is he Y* line). We can have four differen scenarios, a curren accoun defici wih inernal balance (labeled inflaionary pressured curren accoun defici), or a curren accoun surplus wih inernal balance (inflaionary pressured curren accoun surplus). We can also have siuaions where here is inernal disequilibrium (depressed oupu) wih a curren accoun surplus or depressed oupu wih a curren accoun defici.
6 4 Which of hese four scenarios is preferable and which of hem characerize he presen siuaion in Ghana? I is no hard o see ha he Ghanaian economy has suffered persisen curren accoun deficis and hus puing us on he righ side of he CA* line. In addiion, growh in Ghana has no been susainable (unil recenly) and his is coupled wih he fac ha unemploymen levels are exremely high (here are no formal esimaes), credi o he privae secor is depressed. Given hese characerisics, one can convincingly say ha oupu in Ghana has been significanly depressed, resuling in an inernal imbalance. This comforably pus Ghana above he poin E in char 1, an indicaion ha Ghana s macroeconomic condiion could be classified as a siuaion of depressed oupu wih curren accoun defici. One can also say ha judging from high inflaionary levels (unil recenly when he economy sared disinflaion), Ghana s economy is believed o be iling owards he righ side of poin E, an indicaion of he underlying inflaionary pressures. Char 1: Macroeconomic (Dis) Equilibrium RER CA* Y* Depressed Oupu CA Defici R* E Inflaionary Pressure CA Defici Depressed Oupu CA Surplus Inflaionary Pressure CA Surplus Real Domesic Demand
7 5 Following from he macroeconomic analysis above and concenraing our paper on he exernal balance, we decompose he curren accoun ino rade balance including ne of expors of goods and services (TB = X M ), ne facor income which includes ne invesmen income ( NIC ) and ne ransfers including remiances ( NT ). CA = X M + NIC + NT (1.1) Similarly, he curren accoun can be defined as he difference beween savings (S) and invesmen (I) for he whole economy, which reflecs he power of a developing economy albei wih some danger if he negaive difference is unsusainable and his he exernal economy. This is represened below as 2 : CA = ( S I ) + ( S I ) = S I (1.2) p p g g Equaion (1.2) shows he underlying srucure of he curren accoun. I is no hard o see ha a defici could eiher resul from dissaving eiher by he privae or public secor. Convenionally, i is expeced ha a curren accoun defici resuling from low domesic savings is likely o be unsusainable han one resuling from high invesmen. Obviously, high invesmen has he poenial of increasing producion capaciy and hus fuure oupu and rade surpluses 3, an indicaion ha in dynamic analysis high invesmen is preferable even hough in saic analysis boh may have he same impac. 3. CURRENT ACCOUNT (UN)SUSTAINABILITY CRITERIA Recen financial crisis in Asia and Lain America have made i clear ha here is no a simple mehod of assessing he susainabiliy or oherwise of curren accoun deficis. This is due mainly o he fac ha foreign exchange crisis ha occurred proved o be couner-inuiive in cerain counries given he rends in he curren accoun deficis. Having said his, here are however, commonly held views ha have been used hroughou he lieraure o assess he healh of he curren accouns balances. We noe ha hese crieria have raher ended o be necessary bu no sufficien condiions for assessing he healh of curren accouns. In his secion we will discuss various measures 2 Subscrips p and g denoes privae and governmen respecively. 3 We are mindful of he fac ha he composiion of invesmen o a large exen deermines he exen of ranslaion ino rade surpluses.
8 6 available o policy makers o make a judgmen on he healh of he exernal secor and o use as early warning signals for imminen crisis. As noed by Roubini and Wachel (1998), a counry is solven as long as he discouned value of he counry s foreign deb is non-zero in he infinie limi. This implicily means ha he counry is no in he posiion of increasing is foreign deb faser han he real ineres rae on his deb. They herefore concluded ha any pah of curren accoun ha reurns he infinie sum of all curren accouns o be equal o he iniial foreign deb is consisen wih solvency. They concluded by saying ha a counry could hen run a large curren accoun defici for a long period of ime and remain solven as long as here are surpluses a some poin in he fuure. This also has an obvious implicaion of running a large foreign deb as long as he rae of increase is lower han he real ineres rae. The above obviously has very loose implicaions of solvency and wih he benefi of hindsigh i is no longer a surprise ha some counries in Asia and Lain America experienced financial crisis under he wach of solvency. The looseness of he above has promped analyss o look a a more pracical aspec of susainabiliy. According o Summers (1996), curren accoun defici in excess of 5 percen of GDP should be seen as uncomforable. He mainained ha i is even more criical if his defici is paricularly financed in a way ha leads o rapid reversals or hrough a ponzi-ype of game. This even became more prominen when empirical sudies afer he Asian crisis concluded ha counries ha were hi hard were hose wih large defici/gdp raios hroughou he 1990s (Corsei, Peseni and Roubini, 1998; Radele and Sachs, 2000). Similarly, Milesi-Ferrei and Razin (1996) have mainained ha susainabiliy depended on he counry s willingness o pay and crediors willingness o borrow, making i even more difficul o use sandard measures o predic susainabiliy. In his ligh hey suggesed cerain key issues o observe in susainabiliy assessmens such as large
9 7 imbalances relaive o GDP, reducion in domesic savings raher han increasing in naional savings rae and exremely low naional savings rae. Furher o hese measures, ohers have also developed empirical models o assess he vulnerabiliy of developing and emerging economies o exernal shocks in addiion o assessing he susainabiliy of he curren accouns deficis 4. Wha became obvious from hese empirical models is he fac ha here was no unique susainable rajecory of he curren accoun deficis (exisence of muliple opimal pahs). 3.1 Fundamenal Deerminans of (Un)Susainabiliy Graned ha curren accoun is equal o he difference beween naional savings and invesmen, we could comforably define a curren accoun defici as resuling mainly from eiher a fall in savings or increase in invesmen. In his case, he (un) susainabiliy of a given defici will depend o a large exen on he source as explained above. This involves real secor dynamics o reveal he underlying sources of he curren accoun defici. This brings ino quesion he conceps of privae consumpion, governmen expendiures, invesmen and ne expors in addiion o naional income (or commonly referred o as growh or ne cashflow). How hese variables inerac would deermine wheher he economy would be running a curren accoun defici or surplus and wheher his defici is susainable or no. I is well esablished ha a curren accoun defici ha is caused by a fall in naional savings could eiher be due o a fall in privae savings or in public savings (higher budge deficis) as esablished in equaion (1.2). I is poenially worrying if lower public savings is driving he defici. I is also riskier han privae savings as privae savings reducion could be seen as a ransiory phenomenon in he dynamic sense while srucural public secor deficis have he endency of becoming endemic 5 (Roubini and Wachel, 1998). 4 See GS-SCAD model in 1997 developed by Goldman and Sachs and he Deusch Bank model developed in Poenial of unsusainable build-up of deb
10 8 To be able o rack he underlying real secor sources of he curren accoun defici in Ghana, we employed he framework iniially developed by Obsfeld and Rogoff (1995), called he Iner-Temporal Model of Opimal Benchmark. This model is used o forecas he opimal ime pah of curren accoun balances and ha is compared wih he acual balances o assess wheher here are huge deviaions and wheher hese deviaions are sysemic. This approach has been used widely by Ghosh and Osry (1994) for a hos of developing counries, Adedeji (2001) for Nigeria, Hudson and Senne (2003) for Jaimaica, Cashin and McDermo (1996) and Makrydakis (1999). For he purposes of his paper, we ouline below a very brief resaemen of he framework (see appendix for deail analysis and empirical esimaions of he model for Ghana). The main hrus of he framework using he ineremporal uiliy funcion of a represenaive individual (exhibiing raional expecaions) in a small open economy wihou liquidiy consrains (abiliy o borrow and lend o smoohen ou consumpion), is ha a consumpion smoohing componen of he curren accoun is given as: * ca (1 ) j = E + r z+ j (1.3) j= 0 This shows he exen of movemen in he curren accouns as a decreasing funcion of he persisence of emporary shocks in ne cashflow (or oupu), as permanen shocks wih no implicaions on ne oupu would have no impac on he curren accoun. This implies ha an economy would regiser a curren accoun surplus if i expecs is ne cashflow o be falling emporarily in he fuure (he converse holds). This follows from he inuiion ha households end o save when hey expec heir fuure labour income o fall in he fuure. Obviously savings would reflec in curren accouns and labour income would reflec in ne cashflow. Equaion (1.3) is very informaive and one could draw a number of useful policy implicaions from i. For insance curren accoun deficis on is own may no necessarily signal imminen crisis or srucural problems. I could be ha here is a emporary
11 9 increase in governmen expendiure, in invesmen or a decline in produciviy, which would obviously lead o a defici. This should no necessiae drasic exchange rae policy measures aimed a devaluaion o correc he problem. Also if he observed curren accoun defici represens consumpion smoohening of privae agens hen such deficis may no necessarily resul in exernal deb build up. Finally, observed defici may be a wake up call on he economy o accelerae growh in he fuure o repay borrowed savings used o smoohen ou consumpion. These are imporan policy implicaions making he sudy of underlying causes of curren accouns deficis imperaive. To arrive a he consumpion smoohening componen of he curren accouns one needs o esimae Equaion (1.3), however, his would prove o be quie challenging. However, Campbell and Schiller (1987) 6 inroduced an innovaive way of doing his, which is resaed below 7 as: z ϕ11 ϕ12 z 1 ε1 CA = + ϕ ϕ CA ε (1.4) where in his case balance and CA is he derended consumpion smoohening curren accoun z is he changes in ne cahsflow or oupu. Given he above, we could perform a number of ess. In paricular, i should be possible o evaluae and es he fac ha should equaion (1.3) be rue, he behaviour of economic agens mus be such ha changes in he curren accoun should predic fuure changes in he ne privae cashflow (ha is expeced emporary shocks in cashflow should reflec in movemens in he curren accoun). Also as noed in Hudson and Senne (2003), we could es formally for (un)susainabiliy base on wheher or no he prediced value equals he acual curren accoun balance. This implies ha ϕ11 = ϕ21 and 6 The basic insigh of Campbell-Schiller s mehodology is ha as long as he informaion se used does no conain all he informaion available o privae agens, hen pas values of curren accoun conain informaion useful in consrucing esimaes of agens expecaions of fuure values of z. 7 See appendix for deailed derivaion of Campbell and Schiller (1987) s innovaion.
12 10 ϕ22 ϕ12 = (1 + r). Finally we could es wheher he curren accoun Granger-causes subsequen movemens in ne cashflow which implies ha ϕ 12 < 0 and significan. Daa and resuls Using annual daa from 1960 o 2002, we aemp an empirical analysis of he dynamics of he Ghanaian curren accouns by esimaing he presen value model. Similar o Adedeji (2001) and in line wih Hudson and Senne (2003) we use privae consumpion, governmen consumpion, naional invesmen, gross domesic produc (GDP) and gross naional income (GNI). These variables are in nominal erms so we divided by GDP deflaor for Ghana (1995 as base) and oal populaion o ransform he variables ino real per capia erms. Insead of using he curren accoun as per he balance of paymens accouns, we raher derived he curren accouns from he naional accouns by subracing privae and governmen consumpion as well as invesmen from GNI. These ransformaions gave us real per capia privae consumpion expendiures ( c ) and ne cashflow (which is esimaed as GDP less invesmen and governmen consumpion expendiures and adjused for ne facor paymens). This is denoed as z. The consumpion smoohing curren accoun balance (adjused for consumpion iling) is derived by using DECOMP 8 o decompose oal curren accoun balance ino rend and residual and he residual in his insance used o represen consumpion smoohing curren accoun balance while he rend represens he consumpion iling componen. All our daa were aken from World Developmen Indicaors of he World Bank. In line wih sandard pracice and more specifically for he purposes of he heoreical underpinnings of his paper, we deermined he (non)saionariy properies of hese variables used in esing he ineremporal model. As noed by Campbell and Schiller 8 See Opoku-Afari e al (2004) for deail analysis of DECOMP and oher univariae decomposiion mehodologies.
13 11 (1987), he consumpion smoohing componen of he curren accoun balance ( ca sm ) and he changes in ne privae cashflow ( ) mus be saionary (ha is I(0)). We also needed z o esablish, in order o suppor he underlying heory ha here exiss a long run relaionship beween z and c (implying hey should be inegraed of order one). We esed for boh uni roos and coinegraion using boh he Augmened Dickey Fuller (ADF) and he Philip-Perron (PP) procedures 9 for he uni roo analysis and he Johansen procedure for he coinegraion es esablishing he long run properies (see Table 1 in appendix for resuls). Using he Johansen mehodology, we are able o esablish a long run coinegraion relaion beween ne cashflow and privae consumpion 10. In addiion he error correcion model following he esablishmen of he coinegraion relaion showed a significan error correcion erm albei wih very small adjusmen coefficien. This goes o confirm ha he Ghanaian exernal posiion saisfies he ineremporal solvency condiion. Unlike he case for Nigeria (which is in he same sub-region as Ghana and shares common characerisics wih Ghana), he long-run coefficien beween ne cashflow ( z ) and privae consumpion ( c ) is 1.92 (wih a -saisic of 2.4). I is obviously larger han 0.87 and 0.95 for Nigeria (Adedeji, 2001) and larger compared o Ghosh and Osry (1995) for mos developing counries and 1.05 for Jamaica (see Hudson and Senne (2003). The obvious implicaion of he 1.92 long run coefficien is ha Ghanaians end o pospone curren consumpion for he fuure. This resul is quie couner-inuiive o wha he general low savings rae in Ghana predics. In effec, i implies Ghanaians end o smoohen heir consumpion more han adjusing (iling) heir consumpion o reflec long-erm rends. 9 We included a consan and a rend erm in boh procedures. 10 Using a model wih a consan in he coinegraion equaion bu no deerminisic rend and wih an opimal lag lengh of 3, we are able o esablish a coinegraing vecor.
14 12 We esimaed he opimal curren accoun model for Ghana using he framework discussed above (see Table 2 in appendix for esimaion resuls) 11. Char 2 plos he opimal and acual curren accoun balances for Ghana as implied by he model 12. I is obvious ha he opimal curren accoun forecased from he model is able o rack significanly he acual curren accoun (correlaion of 0.5). However, i is no hard o see why Ghana has consisenly had a negaive curren accoun balance as he opimal in mos years have been below he acual reflecing in persisen negaive deviaions wih sharp spikes in 1974 and , reflecing he oil price shock and he adverse erms of rade shock in Ghana respecively. For mos of he period up o 2000 he acual curren accoun was in excess of he opimal curren accoun and his resuled in a persisen defici in he curren accouns. However, one can easily see a reversal of rends for a greaer par of he period afer The acual curren accoun ends o lag behind he opimal curren accoun, an indicaion of conained exernal balances. This rend could easily be explained. In addiion o effecive policies pu in place during his period, Ghana benefied from HIPC deb relief and also considerable increase in ne ransfers of which remiances forms a greaer par. This has obviously ranslaed he susainabiliy dynamics of he curren accoun balance in Ghana in recen years 14. One quesion o ask is wheher he underlying fundamenals of he dynamics in curren accoun balances in recen years are susainable. This quesion goes beyond his model. One needs o specifically access he susainabiliy of donor inflows ino Ghana a his juncure and also he dynamics of remiances ino Ghana o assess wheher hey could susain he curren accoun balances. 11 Resuls are presened in he appendix. 12 To ease he picorial analysis and also o reflec he ransformaions done in our daa by convering everyhing o real values using GDP deflaor (1995 as base), we rebased boh he opimal curren accoun series and he acual curren accoun series o See char 3 ploing he deviaions 14 We noe ha no all increases in ne ransfers and hence remiances are new money. Some proporion of i represens improved recordings by banks following revision of reporing procedures by Bank of Ghana.
15 13 Char 2: Ghana-Acual and Opimal Curren Accoun Balance (1995=100) Index Period Opimal Acual Char 3: Ghana-Deviaion Beween Opimal and Acual Curren Accouns Index Period 3.2 The Role of Exernal Deb in Curren Accoun (Un) Susainabiliy The curren accoun defici could be seen as a mismach beween naional savings and invesmen derived from curren resources generaed wihin he economy and his deviaion could be financed eiher by deb creaing capial inflows. An exising large burden of deb compromises he counry s credi worhiness as i affecs heir abiliy o service his deb, affecing he counry s abiliy o mee is curren accoun imbalance. The above is derived from he undersanding ha a large deb burden will pu excessive
16 14 pressure on expor revenues, which compees wih impors of invesmen goods ha are needed for growh. In mos cases (and ypical of Ghana), his creaed a deb rap, which culminaed in he rescheduling of deb servicing and ulimaely some developing counries oping for he HIPC iniiaive (including Ghana). Following from he above, i would be ineresing o assess Ghana s curren accoun (un) susainabiliy aking ino consideraion he role of exernal deb. To achieve he above, we adoped he accouning approach o curren accoun susainabiliy, which focuses on deb raio analysis 15. As discussed in Hudson and Senne (2003), his framework defines a susainable curren accoun as he one ha does no generae increases in he deb o GDP raio. This is drawn from he general undersanding ha exernal indebedness evolves from he rade balance as well as ineres paymens. In his ligh, he framework defines he exernal financing consrain as: B ( X M) = (1 + i ) (1.5) B 1 B 1 where B denoes he deb sock, i represen he ineres rae payable on he deb and X M represen he rade balance. Equaion (1.5) can be re-wrien as: B = (1 + i ) B ( X M) (1.6) 1 Given he ime pahs for i and ( X M ), equaion (1.6) describes he ime pah of he ne exernal liabiliies. One could infer from he above ha if rade is exacly balanced (i.e X M = 0 ), he counry s ne exernal indebedness would grow exacly as he rae of ineres ( i ). I follows from his same logic ha should he economy run a rade defici, he deb sock would grow a a rae ha exceeds he ineres rae. Having se he above line of logic, we derive he (un) susainabiliy condiion by seing equaion (1.6) in growh erms by dividing hrough by Y on he assumpion ha Y = (1 + g ), where g Y is he growh rae of GDP. This would reurn equaion (1.6) as: 1 15 Typically deb o GDP raio.
17 15 B B ( X M) (1 + i ) B ( X M) = (1 + i ) = 1 1 Y Y Y (1 + g) Y 1 Y (1.7) For simpliciy we denoe he raios as lower case leers and recas equaion (1.7) as: 1+ i b = b 1 ( ) 1 x m g + subracing b from boh sides i 1+ g b = b b ( x m) g 1+ g i g = b 1 ( x m ) 1+ g (1.8) herefore he condiion for susainabiliy would be given by he relaion below: i g b 1 ( x m ) = 0 1+ g (1.9) In effec wha equaion (1.9) implies is ha should he rade be exacly balanced, he change in he deb o GDP raio would depend on he deviaion beween he ineres rae on he economy s ne exernal liabiliies and he growh of GDP 16. Tha is if g < i, hen he deb o GDP raio would increase. Obviously, a preferable siuaion is where g indicaion ha growh is enough o couner increases in deb build-up. > i, an Wih a general agreemen ha curren accoun is susainable if i does no generae deb build-up (ha is o mainain a paricular deb o GDP raio), i implies ha rade mus generae surpluses sufficien o offse he growh in he deb sock as a resul of pure ineres rae/gdp growh differenial. Negaive values of equaion (1.9) imply he rade 16 The obvious lieral implicaion of equaion (1.9) is ha he susainable rade balance and for ha maer curren accoun balance is he one ha does no resul in a change in he sock of deb.
18 16 defici and for ha maer curren accoun defici has he poenial of increasing he deb sock, implying an early signal of he poenial unsusainabiliy of he curren accoun deficis Char 4: Curren Accoun Defici Susainabiliy Crieria (Using Accouning Approach) raio Period Source: Auhor s own Derivaion from he Accoun Approach Model Char 4 above clearly shows an ineresing picure of rends in curren accoun balance in Ghana. I is obvious ha his corroboraes oher findings and he exising daa in Ghana. I is clear ha he posiion in Ghana over he pas decade suppors he unsusainabiliy crieria discussed in he model (ha is i has consisenly been in he negaive). This is an indicaion ha rade defici had poenially increased exernal deb in Ghana and has compromised he susainabiliy of curren accoun deficis. However, one noices an ineresing paern. From 1994 ill 2000 here was a seady increase in he negaive rend 18. This rend however reversed afer 2000 showing a seady reducion in he negaive rend. This is an indicaion of a reversal of he worsening curren accoun defici The main shorcoming of his approach is he fac ha i does no ake ino accoun he role of lenders and invesors in deermining evoluion of deb. 18 Ghana experienced he wors curren accoun shock beween 1999 and I is possible for one o aribue he reversal in 2000 o Ghana s adopion of HIPC, and hus a reducion in he deb sock, bu a look a he deb sock figures show ha i only sared reducing from Given ha his dismisses ha line of argumen, one could confidenly aribue his reversal o improved privae and public secor savings (see char 8).
19 Oher Insiuional Measures of (Un) Susainabiliy In addiion o he wo models presened above (ha is he ineremporal model and he accoun approach), here are oher ses of crieria, which are used simulaneously o deermine he healh saus of exernal balances. I mus be noed ha no paricular crieria is sufficien in deermining he (un) susainabiliy of curren accoun deficis. As noed by Roubini and Wachel (1998), here is no simple way of finding ou wheher he curren accoun defici in a paricular economy is susainable or no, even hough heoreically an economy s susainabiliy of inernaional financial obligaions (solvency) can be considered as a proxy indicaor of susainabiliy of he curren accoun defici 20. Due o he inconclusiveness associaed wih sandard models and indicaors of susainabiliy, a number of pracical crieria ha obviously suppor he heoreical underpinnings discussed earlier have been used and we discuss a few of hem for he purposes of assessing he susainabiliy of Ghana s curren accoun defici. Increasing exernal deb o GDP raio is an indicaion of unsusainabiliy. As discussed in he accouning approach model, a curren accoun balance ha leads o increasing exernal liabiliies is an indicaion of unsusainabiliy of he defici. As noed by Summers (1996), a curren accoun defici o GDP raio higher han 5 percen sends a srong signal for an evaluaion of (un)susainabiliy of he curren accoun defici. However, i is noed ha one needs o uncover he source of he higher defici as a defici driven by invesmen growh is more likely o be more susainable in a dynamic concep 21 han a defici driven mainly by falling naional savings (higher budge deficis). I is obvious following from he above ha a fall in naional savings is problemaic for curren accoun defici susainabiliy. Inasmuch as we associae 20 As we have noed earlier his indicaor is problemaic due o a cerain level of indefinieness associae wih he ineremporal budge limiaion and real ineres raes. 21 Higher curren accoun deficis are more likely o be susainable under condiions of higher economic growh.
20 18 fall in he public componen of naional savings wih higher budge deficis, rends in fiscal deficis hen become an auomaic indicaor of (un)susainabiliy of curren accoun deficis. Composiion of he curren accoun is very imporan in deermining wheher i is susainable or no. Given ha i could be broadly broken down ino rade defici and ne facor income, hese wo sub-componens become a source of defici (un) susainabiliy. A curren accoun defici may be less susainable if i is derived from a large rade defici han from a large negaive ne facor income (Roubini and Wachel (1998). Large and persisen rade deficis indicae a srucural compeiiveness problems while large and negaive facor incomes may be a fall ou of higher exernal deb profile. In his conex he level of expors o GDP raio could be a good indicaor of srucural compeiiveness. In addiion, we could use he real exchange rae as a measure of srucural compeiiveness and rends in he real exchange rae could be a good indicaor of compeiiveness and hus (un)susainabiliy of deficis. Gross inernaional reserves have been used widely o measure he susainabiliy of curren accoun deficis. I is believed ha higher gross inernaional reserves o deb sock indicae susainabiliy of curren accouns (in some insances he number of monhs of impors hese reserves could suppor is also used). The susainabiliy of curren accoun deficis is believed o be coningen upon a sound and sable domesic financial sysem wih srong supervisory and regulaory role. Since he financing gap creaed by curren accoun deficis are filled by foreign capial inflows, hen he sae of poliical sabiliy of he economy and predicabiliy of economic policies which hinges on coninuiy of he sysem of governmen is an imporan indicaor of aracing foreign inflows and hence imporan for curren accoun susainabiliy. Las bu no leas, and in fac very imporan is he role of capial inflows. Since he financing gap generaed by curren accoun deficis are normally filled hrough foreign capial inflows, is composiion and size is very crucial. As he general
21 19 noion sill holds, shor-erm inflows are more dangerous in financing he curren accoun deficis han long erm inflows. Even hough long erm inflows in he long erm may enhance he curren accoun, in he long run i is expeced o have real effecs as he real exchange rae would end o appreciae and compromise he compeiiveness of he economy and consequenly re-inroduce srucural rade deficis, which would worsen he iniial curren accoun deficis, making i unsusainable. 4. IS THE GHANAIAN CURRENT ACCOUNT DEFICIT SUSTAINABLE? The curren accoun in Ghana has persisenly been in a defici since early , bu wih significan variaion over he period. The average defici for he period 1975 o 2004 is abou 3.4 percen of GDP. I can be said ha he rend has worsened over ime unil recenly where one can posiively idenify a reversal of he rend (see Char 5). For he period , he curren accoun regisered an average defici of 0.32 percen of GDP. This modes average worsened significanly in he 1980s where a defici of 1.87 percen was posed. The 1990s saw he wors period of high deficis wih an average of 6.1 percen of GDP and a peak of 12.5 percen in However, his rend has reversed wih a modes average of 1.87 percen of GDP regisered beween 2000 and According o Char 6, i is no hard o see ha Ghana s curren accoun pah has mainly been driven by developmens in he goods and services componen. This has dicaed he slope and urning poins of he curren accouns defici rajecory in Ghana unil 2001 where one can see a significan deparure from rends in goods and services as agains curren accoun balances 22 Wih he excepion of 2003 where a surplus of 2.89% of GDP was recorded.
22 20 Char 5: Ghana-Trade and Curren Accoun Balances 10 5 Percen of GDP TB/GDP CA/GDP Period Char 6: Ghana-Curren Accoun and Fiscal Balances Percen of GDP FB CAB Period Char 7: Ghana-Curren Accoun and Principal Componens Percen of GDP CAB G&S Ne Trans Ne Inv. Inc -25 Period
23 21 Given he narrowness of he expor base in Ghana, one is no misaken o say ha he goods and services componen has been driven mainly by impors which available daa indicaes ha no unil recenly, a greaer percenage (abou 30%) of he goods componen is dominaed by consumpion goods. This obviously is a conservaive esimaed given ha ohers in ha sub-componen is mainly made up of consumpion goods bu due o improper classificaions has been lef ou of his esimaion. In addiion abou 50 percen of he goods and service componen is made up of capial goods, which underscores he counry s effor o increase invesmen o drive growh. Nowihsanding, 30 percen of goods and services driving curren accoun deficis is quie a subsanial amoun raising concerning as o wheher Ghana s curren accouns are susainable. This is coming from he fac ha if curren accoun deficis indicae dominance of consumpion hen i underscores lack of domesic savings, which is an imporan recipe for unsusainabiliy and financial crisis. I is obvious from char 6 ha curren accoun deficis have shared a sochasic rend wih he level of public secor savings (measured as fiscal deficis). Deerioraing public savings, which is also refleced in naional savings (see char 8 below), have in mos cases dicaed he rend of curren accoun deficis in Ghana, wih urning poins in curren accoun deficis dicaed by public savings. This is an ineresing developmen, as worsening public savings end o lead worsening curren accoun deficis. As explained earlier, if curren accoun deficis emanae from fall in public savings and for ha maer naional savings, hen ha is roubling as i sands he chance of becoming endemic and making he curren accoun defici unsusainable. I is obvious from char 8 ha naional savings have persisenly lagged behind invesmen since 1983 and while invesmen is increasing on average, savings is falling, a clear sign ha he consequen curren accoun defici is also driven by falling savings 23, bringing o he fore he unsusainabiliy of he Ghanaian curren accoun deficis over he period Rising invesmen is dominaed by foreign capial inflows. 24 Once again i is imporan o noe ha over he pas hree years or so ha gap has sared closing up, also due o increases in savings rae on he one hand and fall in invesmen rae on he oher. The laer is no good hough for he economy bu he former is a welcome developmen.
24 22 Char 8: Ghana-Savings and Invesmen Raes Rae (% of GDP) Invesmen Rae Savings Rae Period I is also obvious from he ineremporal model which assesses he exen of he defici from he real secor of he economy. As noed in char 2, he acual curren accoun in Ghana has in mos cases been above he opimal curren accoun forecased from he model. Given ha he model racks movemens in he Ghanaian curren accouns balances, we are convinced ha he deviaions measured give a clear indicaion of persisen deficis in Ghana wih brief episodes of acual being below opimal. I is however, concluded ha over he period covered in his sudy, he defici has been persisen and raises quesions of unsusainabiliy. Looking a i from exernal liabiliies dynamics, we also developed he accouning model which looked a he foreign deb consequences of curren accoun deficis. I is obvious from char 4 ha he persisen curren accoun defici in Ghana has resuled in increasing foreign deb 25. This allies very well wih he available balance of paymens (BOP) daa for Ghana as he wors scenario was in 1999/2000 where we had he larges negaive number and in pracice had he larges defici o GDP raio (12.5%) 26. This obviously necessiaed he adopion of he IMF/World Bank HIPC iniiaive which was unavoidable, an indicaion of insolvency due o problems wih meeing deb repaymen schedules. The obvious conclusion is ha deb-creaing financing of he defici is no 25 As he model dicaes ha a negaive sign implies he rade balance would lead o increases in foreign deb and hus a sign of unsusainabiliy. 26 This developmen necessiaed he adopion of HIPC which was obviously unavoidable
25 23 compensaed for by increasing growh, and hus a sign of unsusainabiliy. I is clear ha he siuaion has sared improving saring from Given ha foreign capial inflows is very crucial in deermining he susainabiliy of curren accoun deficis, i is imporan o look a how capial inflows in general impac on Ghanaian curren accoun deficis. From char 7 above, i is obvious ha ne ransfers of which remiances forms a greaer percenage serves as a huge moderaing facor in supporing he curren accoun deficis in Ghana. While he pro-cyclical naure of aid inflows and i being highly volaile engender he susainabiliy of he defici, remiances are seen o be relaively sable and using ha as a pivo of curren accoun dynamics in Ghana has he poenial of improving upon is degree of susainabiliy. As demonsraed in char 9 below, aid shock (volailiy) has influenced he exen of curren accoun defici in Ghana (see Addison and Opoku-Afari, 2005 for deails). One easily observes wo periods represening an inernal shock (afermah of democraizaion and he wai and see aiude of donors) and severe erms of rade shock in The firs shock is a resul of high cos of democraizaion which came along wih significan falls in donor inflows (aid shock) due o he wai and see aiude of developmen parners as ha was he firs democraic elecions afer a long period of miliary rule and observers were no sure wha he oucome was going o be given he insabiliy of he sub-region. This obviously slowed down he economy and resuled in high fiscal deficis as a way of closing he gap. The second shock represens a erms of rade shock, as Ghana s major expors cocoa and gold suffered a sharp fall in world prices in addiion o rising crude oil prices on he inernaional marke. This erms of rade shock was furher aggravaed by an aid shock 27 forcing he governmen o once again rely on domesic borrowing o accommodae he gap (indicaed by high domesic borrowing o GDP raio over ha period). 27 This is measured by he difference beween projeced and acual aid ino Ghana.
26 24 Char 9: Aid Shorfall (Shock) and Curren Accoun Balance US$ Million Evidence of changes in curren accoun balance leading changes in aid shorfall in Ghana. This ends o sugges aid has more ofen han no been pro-cyclical Shorfall Period Curr Acc Bal These wo episodes underscores how unsusainable a curren accoun defici pivoed on aid inflows and fragile rade balances could be. I is clear from he above ha a more srucural change in favour of rade balanced based on diversified expors o aler he curren composiion of GDP is more favourable o he curren dependence on primary commodiies which makes he rade gains raher suscepible o inernaional marke developmens of which Ghana has very lile (if no) conrol. I is generally expeced ha large capial inflows have he poenial of causing real exchange rae appreciaion. Tha is he downside risk of over depending on capial inflows o fill he curren accoun defici gap. The appreciaion in real exchange rae could cause a loss of compeiiveness 28 and furher srucural worsening of he rade balance, which in mos developing economies ends o drive he curren accoun defici. Once he source of he rade defici is srucural, i is likely he ensuing curren accoun defici would be unsusainable. Roubini and Wachel (1998) noed ha alhough he cause of he curren accoun defici is due mainly o invesmen and savings gap, if i is accompanied by a real appreciaion of he exchange rae, he defici could become less susainable 29. The obvious quesion is how has real exchange rae appreciaion affeced he curren accoun balance dynamics in Ghana. As indicaed in he plos in chars 10 and 28 See Opoku-Afari e a l (2004) for deailed analysis of he role of capial inflows on real exchange rae appreciaion and consequenly loss of compeiiveness. 29 We noe ha no all real exchange rae appreciaion could lead o curren accoun defici worsening as some real exchange rae appreciaion would be in response o changing fundamenals and no necessarily misalignmen.
27 25 11 below, movemens in real exchange rae in Ghana have racked and boh rade balance and curren accoun balance movemens consisenly. In boh cases appreciaing real exchange rae 30 have consisenly driven rade deficis and curren accoun deficis. This period of appreciaing real exchange rae coincide wih periods of massive capial inflows ino Ghana 31 (period afer he Srucural Adjusmen Programme in 1983) 32. This has consequenly driven rade deficis, which in urn has driven curren accoun deficis in Ghana Char 10: Real Exchange Rae (REER) and Trade Balance in Ghana REER Index REER Trade Bal Trade Balance (US$ Million) Period Noe: REER is defined in such a way ha an upward movemen denoes depreciaion and a downward movemen denoes appreciaion Char 11: Real Exchange Rae (REER) and Curren Accoun Balance in Ghana REER Index REER Curr Acc Bal Curr. Acc Bal Period Real exchange rae has been defined in such a way ha downward movemen represen appreciaion and upward movemens represen depreciaion. See Opoku-Afari (2004) for derivaion of Real Effecive Exchange Rae for Ghana. 31 For deailed analysis of impac of Capial Inflows on real Exchange Rae in Ghana, see Opoku-Afari e al (2004) 32 A perfec example of he impac of large capial inflows on real exchange rae appreciaion.
28 26 Finally we look a he level of inernaional reserves as anoher indicaor of Ghana s curren accoun defici susainabiliy. An increase level of inernaional reserves ensures higher susainabiliy of he economy s liabiliies han a decreasing level of inernaional reserves. I is no hard o see he deerioraing naure of inernaional reserves as he Ghanaian economy recorded as low as less han a monh s impors by 1999/2000. However, he siuaion has improved significanly moving o abou 4.0 monhs of impors which is considered close o he opimal level of 4.5 monhs of impors. Obviously, he improvemen in he inernaional reserves is no due mainly o rade gains as during his period of improvemen he rade balance has raher worsened. I is no hard o see ha he recen improvemen in inernaional reserves is mainly due o implici savings from deb relief as well as increases in remiances. The laer is a welcome developmen and relaively sable bu he former (implici savings from deb relief) is unsusainable, raising doubs abou he susainabiliy of curren accoun deficis looked a from inernaional reserves perspecive. Char 12: Ghana-Inernaional Reserves (in Monhs of Impors) Monh Period 5. SUGGESTIONS FOR IMPROVING CURRENT ACCOUNT DEFICIT SUSTAINABILITY IN GHANA A number of imporan issues came up during he analysis above. I was obvious ha he curren accoun defici in Ghana has been driven by a few fundamenal srucural problems. Imporan among hem is he fac ha he srucure of he economy has virually remained he same for he pas wo decades and over (see char 13 below).
29 27 Char 13: Secoral Conribuion o GDP Growh in Ghana Secor Conribuions o GDP 100% 90% 80% % % of oal 60% 50% 40% % 20% % 0% P Agriculure Indusry Services Source: Daa obained from Bank of Ghana and various issues of budge saemens This confirms ha Ghana has been relying on he same sources of expor revenues, as has been he case since independence. I is no surprising ha rade deficis have driven curren accoun deficis over he period making i eviden he criical imporance of rade in ensuring curren accoun defici susainabiliy. Thus we could confidenly sae ha Ghanaian curren accoun defici susainabiliy in he long run is coningen upon rade defici susainabiliy. This calls for a complee srucural change in he Ghanaian economy, since he shorer roue of reducing impors o make he rade defici appear susainable is no plausible. Inasmuch as capial goods and inermediae goods make up abou 75 percen of oal impors of goods and services, hen one can say ha he source of rade defici unsusainabiliy is from he expor sub-componen. We are however no underplaying he poenial of he economy s abiliy o subsiue impor goods wih similar qualiy of locally produced goods. As his has go o do wih ase and generally ase changes slowly, we are proposing ha a conscious effor is made o drive up expors o ensure susainabiliy of rade balance. This calls for measures o improve our compeiiveness in he inernaional marke. Here, i is no only he policy measure of depreciaing real exchange rae ha would increase our compeiiveness, bu here are issues wih access o inernaional markes which is lacking in Ghana. This is a
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