A NATION RECOVERING FROM CURRENCY CRISIS: CURRENCY SUBSTITUTION

Dr. Forster Kum-Ankama Sarpong

According to Dr. Forster Kum-Ankama Sarpong, a lecturer in Finance and Quantitative Models,
we all spend every living moment either approaching crises, in a crisis or recovering from
crisis. Nobody or country is immune. His question rather is how do we live to handle these
crises? He said that the Ghana cedi has over the years gone through crises and perhaps now
recovering.
Dr. Sarpong said that the cedi has suffered some heavy falls in recent times. We went as low as
exchanging our cedi at GHC4 and GHC4.5 per dollar, Dr. Forster Kum-Ankama Sarpong, said.
The currency of West Africas second-biggest economy has depreciated enormously this year,
the most among 24 African currencies. In the first half of the year 2015, the slide in the cedi
kept spurring. The price of everything from baby food to coffin and from toiletries to fuel in the
country kept urging.

Dr. Sarpong further explained that the currency substitution we are experiencing now and the
high demand for dollars for importation has caused the main pressure on the cedi. The
governments own demand for dollars for projects and to settle debt also went high. The
central bank stepped in to raise interest rates to contain inflation at a 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.
Foreign-currency account holders lost confidence in the Ghanaian banking system after the
central bank announced tight foreign-exchange measures in the year preceding 2015. The
decision caused most non-resident customers to transfer their dollars abroad. This caused a lot
of foreign currency difficulties.
Finally the government had to borrow from the International Monetary Fund to bolster its
falling foreign-exchange reserves. Perhaps this is one of the source of the breathier we are
experiencing today.
Dr. Forster Kum-Ankama Sarpong in chat with the Prof. Samuel Larteys Carayol College
Business Students Network members charged the odd selection of corporate executives,
public officers, aspiring leaders, 2015 group of new graduates from the Juniorr High Schools
and the Ghanaian political leadership and entire populace to help the finance and economic
leadership to redeem and protect the value of our dear cedi.
Explaining the history of the current currency difficulties, Dr. Sarpong traced the history of the
Ghana cedi. He said it is the fourth regime of legal tenders in the Republic of Ghana. After
Ghana gained independence it separated itself from the British West African pound, which was
the currency of the British colonies in the region. The new republic's first independent currency
was the Ghanaian pound (1958-1965). After Ghana's change to a single-party state a new
currency with an African name Cedi (1965-1967) was introduced. After a military coup the new
leaders wanted to remove the face of the old president, Kwame Nkrumah, from the
banknotes. The New Cedi (1967-2007) was was introduced. After decades of high inflation had
devalued the New cedi, it was gradually phased out in 2007 in favor of the Ghana cedi at an

exchange rate of 1:10,000. in 2007 the largest of the New cedi banknotes, the 20,000 note, had
a value of about two US dollar. By removing four digits the Ghana cedi became the highestdenominated currency unit issued in Africa. It has since lost about 75% of its value.
Dr. Sarpong said countries are substituting the use of their local currency with foreign ones.
This practice needs to be realligned. Dr. Sarpong cited many cases of nations that have suffered
from such crisis. He described them as nations in currency crises. He said that when this happens it
leads to currency substitutions.
Dr. Sarpong explained a currency crisis to mean a situation in which there are serious doubts as to
whether a country's central bank has enough foreign exchange reserves to maintain the country's fixed
exchange rate. The crisis is often accompanied by a speculative attack in the foreign exchange market.
A currency crisis results from chronic balance of payments deficits, and thus is also called a balance of
payments crisis. Often such a crisis culminates in a devaluation of the currency.

According to Dr. Sarpong, Governments often take on the role of fending off such attacks by
satisfying the excess demand for a given currency using the country's own currency reserves or
its foreign reserves. Currency crises have large, measurable costs on an economy, but the
ability to predict the timing and magnitude of crises is limited by theoretical understanding of
the complex interactions between macroeconomic fundamentals, investor expectations, and
government policy. He said in general, a currency crisis can be explained as a situation when
the participants in an exchange market come to recognize that a pegged exchange rate is
about to fail, causing speculation against the peg that hastens the failure and forces a
devaluation.
Dr. Sarpong advised that the our national economic actors need to adopt a strong foreign
currency regime as that legal tender usually reduces the transaction costs of trade among
countries using the same currency. He said there are at least two ways to infer this impact
from data. The first one is a significantly negative effect of exchange rate volatility on trade in
most cases, and the second is an association between transaction costs and the need to
operate with multiple currencies. He continued to say that effective currency management

leads to economic integration with the rest of the world and it becomes easier as a result of
lowered transaction costs and stabler prices.
Dr. Sarpong explained that adopting a strong foreign currency as legal tender helps to
eliminate the inflation-bias problem of discretionary monetary policy. 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, the loss of monetary policy autonomy, and the loss of the exchange rate
instruments. He explained seigniorage revenues as the profits generated when monetary
authorities issue currency. 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.
According to Dr. Sarpong, the cost of losing an independent monetary policy exists when
domestic monetary authorities can commit an effective counter-cyclical monetary policy,
stabilizing the business cycle. This cost depends adversely on the correlation between the
business cycle of the client country (the economy with currency substitution) and the business
cycle of the anchor country. In addition, monetary authorities in economies with currency
substitution diminish the liquidity assurance to their banking system.
Dr. Sarpong added that financial currency substitution occurs when the participants and the
economic actors in a financial transaction use a foreign currency in parallel to or instead of the
domestic currency. Currency substitution can be full or partial. Partial currency substitution
occurs when residents of a country choose to hold a significant share of their financial assets
denominated in foreign currency. Full currency substitution has taken place in some countries,
mostly in Latin America, the Caribbean and the Pacific that are heavily dependent on the

United States. He explained why these distinctions must be well identified and employed
appropriately.
Dr. Sarpong emphasized 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. This
phenomenon he called the "flight from domestic money". It 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.
Dr. Sarpong said, the flight from domestic money depends on a country's institutional
factors. He explained that the first factor is the level of development of the domestic financial
market. 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.
Dr. Sarpong concluded by creating a contrast. He said in contrary, by facilitating the domestic
holding of foreign currency, a country might mitigate the shift of assets abroad and strengthen
its external reserves in exchange for a currency substitution process. However, the effect of
this regulation on the pattern of currency substitution depends on the public's expectations of
macroeconomic stability and the sustainability of the foreign exchange regime. As a nation, we
need to define our alignment and communicate it clearly through our national vision and
financial and economic agenda.