Will backing cedi with gold induce stability?

Ghana, a country known for its rich natural resources such as oil, gold, and cocoa, has been facing challenges with the stability of its currency, the cedi. In an effort to address this issue, the government recently announced a plan to back the cedi with gold. However, analysts and economists have expressed concerns about the effectiveness of this strategy. Wilson Zilevu, a Fixed Income and Economic Analyst at Databank, shared his insights on the situation in a recent interview with CNBC Africa. Zilevu pointed out that Ghana is an import-dependent country, and backing the cedi with gold only addresses short-term measures rather than addressing the fundamental reasons behind the cedi's volatility in the foreign exchange market. He highlighted that Ghana operates a floating exchange rate system, and increasing exports of gold to boost foreign reserves may not be sufficient to stabilize the currency in the long term. Moreover, Zilevu raised questions about the government's partnership with the Royal Gold Refinery, where the government holds only a 20% stake, while the Indian partners hold 80%. He emphasized that this arrangement might not generate enough foreign capital to support the cedi adequately. In his view, the government's plan to back the cedi with gold may only offer temporary relief without addressing the root causes of the currency's performance. In addition to the gold backing, there have been calls for the Ghanaian government to diversify the economy further to reduce reliance on traditional exports like oil, gold, and cocoa. Zilevu acknowledged these calls but expressed skepticism about the refinery's ability to single-handedly stabilize the cedi, given the country's heavy dependence on imports and foreign currency. Looking at the fixed income market, Zilevu discussed the recent trend of Ghana missing its treasury bill targets for the sixth consecutive time. Despite this, he identified a positive development stemming from the country's inflation rate, which dropped to 20.9% in July, the lowest since April 2023. This decrease in inflation has led to more stable food and non-food prices, indicating a positive trend for consumers. Zilevu explained that the high monetary policy rate in Ghana, around 31%, has been a factor in the high treasury market yields in the past. However, with the declining inflation rate, he expects investors to adjust their required rates of return to align with the diminishing inflation expectations. This positive correlation between inflation and yield expectations could lead to lower yields on treasury bills in the future. Looking ahead, Zilevu forecasted a downward trend in inflation rates, with expectations of lower yields on treasury bills as investors respond to the inflation dynamics. Despite challenges such as the Bank of Ghana's contracting open market operations and the government's reliance on domestic financing, Zilevu remained optimistic about the potential for decreasing yields in the short term. In conclusion, while the government's initiative to back the cedi with gold may offer some short-term stability, analysts like Zilevu emphasize the need for comprehensive measures to address the underlying issues affecting the currency's performance. With inflation trends and investor behavior shaping the fixed income market, Ghana faces both challenges and opportunities in its quest for economic stability and currency sustainability.