IV Ghana

Tomás Baliño, Charles Enoch, and William Alexander
Published Date:
July 1995
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Ghana introduced indirect monetary instruments after major reform efforts to reduce the macroeconomic imbalances and an initial period of institution building. Its experience illustrates that certain key measures that affect the structure of the financial system need to be in place in order to ensure momentum in the transition to a market-based monetary control system. Furthermore, even when these conditions are met, the ultimate success of the program in achieving macroeconomic stability depends critically on fiscal responsibility and disciplined control of money and credit.

Motivation for Reform

In Ghana, the period prior to 1983 was characterized by large fiscal deficits, high rates of growth of domestic credit and broad money, an inflation rate exceeding 70 percent, and external imbalances fostered by wide differences between the official and parallel market exchange rates. Credit ceilings, which were derived in proportion to each bank’s credit market share, were imposed on all banks. Such a scheme perpetuated market shares independent of a bank’s competitiveness and efficiency. In addition, highly negative real interest rates and measures to control fraud—freezing bank deposits pending investigation for tax liability—weakened confidence in the banking system and led to a significant switch of bank deposits into currency outside banks, particularly to rapid growth of the informal financial sector.

In 1983, the government of Ghana started a comprehensive program of financial and structural reforms, named the Economic Recovery Program. In the first phase, 1983-86, the program focused on price liberalization, reduction of the imbalances in government finances, and containment of rapid credit expansion. During the second phase, 1987–89, the main focus of policy actions shifted to structural issues, such as liberalization of the exchange and trade system, privatization of the major state enterprises, tax reform, downsizing of the civil sector, and institutional and financial reforms to strengthen the domestic banking system.

Economic performance during the 1983-89 period was impressive: real GDP growth averaged more than 5 percent a year; inflation declined from 120 percent to 25 percent by end-1989; the balance of payments switched from a large deficit to sizable surpluses; external arrears were eliminated; and the debt-service ratio fell to less than 30 percent of exports.

However, underdeveloped financial markets and the associated high transaction costs limited the ability of economic agents to dispose quickly of built-up money balances. This resulted in a substantial increase in currency outside banks and boosted the demand for foreign exchange in the parallel foreign exchange market. In view of these developments and the resurgence of inflation, the Ghanaian authorities launched a monetary policy and financial sector reform in 1989 supported by the IMF and the World Bank. During the period 1990–91, the program aimed at improving the regulatory framework for financial sector activities and banking supervision, restructuring the banking system, and implementing a market-oriented system of monetary control based on indirect instruments.

Process of Reform

The transition to an indirect system of monetary control was gradual. As a first step, the government focused on improving the structure of the banking system and enacted the Revised Banking Act of 1989. The new law provided for tighter risk exposure limits, higher minimum capital adequacy ratios, stronger accounting standards, and more stringent reporting requirements for banks.

The financial restructuring plan for the banking sector addressed the problem of banks’ nonperforming loans and other claims on both state-owned enterprises and the private sector. These nonperforming assets were either replaced by Bank of Ghana (BOG) bonds or offset against debts owed to the BOG and the government (“bad bank approach”). As a result, banks were able to meet the new capital adequacy requirements.

The BOG proceeded to unify the minimum cash and liquid reserve requirements for banks and introduced open market type operations. In addition, a stock exchange was set up. In the context of liberalizing interest rates and credit controls, the BOG removed limits on maximum bank lending rates and minimum bank term deposit rates and controls on sectoral allocation of bank credit. In addition, the government made sizable net repayments to the banking system during this period, which led to a substantial deceleration of net domestic credit and, to the extent that the repayments were made to the BOG, contributed to a sterilization of liquidity and a reduction in excess bank cash reserves in relation to bank deposits. A large volume of liquidity was also sterilized through the sale of nonrediscountable BOG instruments. The BOG introduced reserve requirements, securities auctions, and refinance instruments.

A cash reserve requirement and a separate secondary liquidity requirement were imposed on commercial banks. Beginning in December 1990, bank deposits at the BOG to meet the cash requirement were remunerated at 3 percent, a rate later raised to 5 percent. After the cash reserve requirement was reduced from 27 percent to 5 percent over the three years that ended in December 1993, remuneration on deposits to meet the cash requirement was eliminated in January 1994. The cash requirement is uniform for both time and demand deposits, while there are no requirements on foreign-currency-denominated deposits. Both government and private deposits are subject to cash reserve requirements.

Eligible liquid assets to fulfill the secondary reserve requirement are defined as government medium- and long-term securities and treasury bills, BOG bills, and commodity bills; call deposits with the discount houses are no longer considered eligible liquid assets.

Money market financial instruments or securities (including BOG issued bills and bonds, treasury bills and notes, and commodity bills) are traded through weekly auctions at the BOG. The auctions are open to banks and nonbanks alike. However, existing limits on bank financing of the government have encouraged banks to bid for BOG securities. Thus, banks’ holdings of government securities have been almost nil. On the other hand, nonbanks have not faced this constraint. The auction uses a multipleprice format, and participants can submit multiple bids of both prices and quantities; there are no noncompetitive bids. As long as the banks meet the criteria for banking supervision, they have access to the auction.

The postauction cutoff rate is determined by the volume of sales. However, a bid may be rejected by the BOG if it is “out of line” with the majority of the bids and is not of “significant” volume. During the week, the same securities are also offered on tap at the weighted-average rate determined in the previous auction.

The interbank secondary market for government and BOG securities is very thin, but discount houses account for some secondary-market transactions. The fairly liquid position of most banks and the automatic access to the tap during the week have hindered the development of a secondary market. The BOG does not engage in repurchase operations.

By law, discount houses stand ready to provide liquidity to commercial banks. They have automatic access to the BOG discount window, although within weekly limits. The banks also have direct access to the discount window, but the BOG is not obliged to rediscount securities held by the banks.

Ghana has put in place many of the building blocks necessary for an active and efficient money market. Instruments include treasury bills and bonds, BOG bills and bonds, bank acceptances, and certificates of deposit. Adequate settlement procedures also exist. Nevertheless, the money markets are still rudimentary when such tests as turnover, liquidity, and responsiveness are applied.

Interest rates on auctioned government and BOG instruments have remained constant over long periods. Thus, the yields on government and BOG instruments do not convey useful information about the short-run pressures and activities in Ghanaian money markets.

In addition, commercial bank rates on loans and deposits tend to lag in adjusting to changes in the rate on government and BOG securities. Three years after the introduction of indirect instruments of monetary policy, bank deposit and lending rates were still negative in real terms. Interest rates were unresponsive to the tightening in domestic liquidity for three main reasons: (1) the large share of public ownership in banks and the oligopolistic structure of the banking system; (2) concerns of BOG about the impact of high interest rates on its own profitability; and (3) concerns regarding the balance sheet position of banks when they were replacing nonperforming assets.

In the absence of active secondary markets, control of the money base by BOG is accomplished by adjusting the net amount of BOG bills issued each week.


Ghana has had a relatively successful transition from a system of direct monetary control to a policy framework that relies on indirect instruments. Several key factors were critical in affecting the timing of the reforms. First, the reforms in the financial sector ensured the soundness of the banking system and increased public confidence. Second, the increase in profitability and independence of the BOG was important in ensuring an efficient conduct of monetary policy. The BOG suffered heavy losses on its foreign liabilities because it assumed the foreign exchange risk of loans undertaken by a number of state enterprises and government-owned banks;3 this considerably inhibited the efficient use of monetary policy instruments initially. The revaluation losses accumulated by 1990 were converted into interest-bearing long-term government bonds, which allowed the BOG again to conduct a more independent monetary policy without being impeded by concerns about its own profitability. Finally, the fiscal containment was crucial in determining the successful transition and efficiency of indirect instruments.

Ghana’s experience suggests that even though the indirect instruments of monetary policy may be in place, their efficiency in achieving macroeconomic stability is determined also by fiscal responsibility and by the control of money and credit by the authorities.

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