Recent monetary policy moves: Stimulating lending or mopping up excess liquidity?


In response to recent inflationary pressures and exchange rate volatility, the Monetary Policy Committee (MPC) of the Bank of Ghana took decisive action. Similar to measures by central banks worldwide, the MPC significantly increased the policy rate (MPR) from 14.50% in January 2022 to 30% by the end of 2023.

Although this move successfully lowered inflation from historic highs of above 50% to the current 25.80%, it potentially came at a significant cost.

Many observers note that the high monetary policy rate is effectively competing with treasury bill rates for banks liquidity, thereby impeding the pace of decline in short-term treasury bill rates.

Despite the evident success in reducing inflation, it could be argued that monetary policy tools were not the most effective means of addressing the circumstances, as some attribute the inflation primarily to supply-side factors such as high energy costs and supply chain disruptions resulting from the COVID-19 pandemic and subsequent global geo-political events including the Russian/Ukraine conflict. However, some may argue that policy measures deployed by the central bank and government during the pandemic, particularly aimed at stimulating the sluggish economy, contributed to increased aggregate demand, since these introduced substantial liquidity into the system, thus fuelling further inflationary pressures.

Given that monetary policy tools are the primary instruments available to the central bank, the MPC had limited options but to utilize them to address inflationary pressures. However, some suggest that fiscal authorities could have played a more significant role in complementing these efforts.

Having achieved a significant reduction in inflation and stability of the Ghanaian cedi, the MPC signalled a shift towards monetary policy easing during its first meeting of the year, dropping the rate by 100 basis points, to the expectation of many market observers. Yet, in a surprising move to many, the MPC deciding to increase the cash reserving ratio (CRR) for banks during its second meeting in March 2024, linking it to banks’ Loans to Deposit ratio. This suggested a desire to stimulate private sector lending and growth.

Nevertheless, the Bank of Ghana’s conduct of open market operations (OMO) at the current policy rate of 29% appears to still target current inflation rate which is still far above the target of 8%± 2%.
The two steps appear to send rather conflicting signals. While one step suggests an intent to stimulate lending and growth, the other implies a desire to reduce lending and stifle aggregate demand.

Granted the intent was to mop up excess liquidity, some argue that the MPC could achieve that by simply increasing the CRR without reference to banks’ loans to deposit ratio, and possibly reduce the policy rate.

On the other hand, if the intent was to stimulate lending to the private sector, the loan-to-deposit ratio approach may be more suitable. Nonetheless, given the Ghanaian economy’s heavy reliance on imports, this could translate into additional import demand, thereby adding further pressure on the local currency, which is not what was intended.
To address above conundrum, a more targeted approach to the cash reserving ratio could be adopted, to encourage banks to lend to specific sectors and in return, benefit from lower cash reserving ratios. This could help direct resources to key sectors that stimulate the domestic economy, contributing to job creation and foreign exchange generation/conservation. Collaborating with fiscal authorities, this approach could complement fiscal policies such as tax incentives, aimed at directing resources to preferred sectors of the economy.

By Alhassan Musah, Treasurer, Stanbic Bank

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