A lecturer in Finance and Quantitative Models lecturer, Dr. Forster Kum-Ankama Sarpong, has called for the development of the domestic financial market to support the local currency, the cedi, so that the over-reliance on foreign currency as an inflation hedge will reduce.

“An economy with a well-developed financial market can offer a set of alternative financial instruments dominated in domestic currency, reducing the role of foreign currency as an inflation hedge,” he told the B&FT in an interview.

Dr. Sarpong, therefore, called on corporate executives, public officers, political leadership, economists and financial experts to help the finance and economic leadership to redeem and protect the value of the cedi.

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The local currency has since June 30 recorded over 25 percent gain on the dollar, and the surge of the cedi further threatens to reverse entirely the losses it incurred against its major trading partner in 2015.Several analysts and officials from the Central Bank stated that the recent recovery of the cedi is partly due to increase of dollar sales on the interbank market to US$20million a day -- up from US$14million a week.

The cedi was trading at 4.33 to the US dollar as at June 30 (year-to-date depreciation of 26.2 percent). However, as at July 17 it was trading at GH¢3.21 to the US dollar (year-to-date depreciation of 3.4 percent).

“The government’s own demand for dollars for projects and to settle debt went high. The central bank stepped in to raise interest rates to contain inflation at four-year high and made cedi assets more attractive. The Bank of Ghana applied many other monetary policies to salvage the cedi, but that was not enough to ward off the cedi weakness.”

He stated that due to the failed measures foreign-currency account holders lost confidence in the Ghanaian banking system and most non-resident customers transferred their dollars abroad. “This caused a lot of foreign currency difficulties.”

Dr. Sarpong added that in most economies, it is the high and unanticipated inflation rates that decreases the demand for domestic money and raise the demand for alternative assets, including foreign currency and assets dominated by foreign currency.

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This phenomenon he called the ‘flight from domestic money’, results in a rapid and sizable process of currency substitution.

“In countries with high inflation rates, the domestic currency tends to be gradually displaced by a stable currency. At the beginning of this process, the store-of-value function of the domestic currency is replaced by the foreign currency. Then, the unit-of-account function of the domestic currency is displaced when many prices are quoted in a foreign currency. A prolonged period of high inflation will induce the domestic currency to lose its function as medium of exchange when the public carries out many transactions in foreign currency.”

The financial expert therefore, suggested that the economic actors need to adopt a strong foreign currency regime because this reduces the transaction costs of trade among countries using the same currency.

Dr. Sarpong explained that adopting a strong foreign currency as legal tender helps to eliminate the inflation-bias problem of discretionary monetary policy. He added that the expected benefit of currency substitution is the elimination of the risk of exchange rate fluctuations and a possible reduction in the country's international exposure.

He however cautioned that currency substitution cannot eliminate the risk of an external crisis but provides steadier markets as a result of eliminating fluctuations in exchange rates. This therefore calls for a prudent currency management systems.

Dr. Sarpong added that currency substitution when not well managed leads to the loss of seigniorage revenue – profits generated when monetary authorities issue currency– the loss of monetary policy autonomy, and the loss of the exchange rate instruments.

“When adopting a foreign currency as legal tender, a monetary authority needs to withdraw the domestic currency and give up future seigniorage revenue. The country however loses the rights to its autonomous monetary and exchange rate policies.”

Due to the loss of monetary policy autonomy, exchange rate instruments and seigniorage revenue, Dr. Sarpong strongly urged for the protection of the local currency as the legal tender in the country.

Source: thebftonline.com