The interconnectedness of economic elements can often create a domino effect, where a ripple in one sector can trigger a tidal wave in another. This is notably observed in the relationship between inflation and poverty. Recent events in Ghana provide a stark illustration of this phenomenon. The country, celebrated for reducing its poverty rate by over half from 52.6% in 1991 to 21.4% in 2012, has faced economic challenges. The World Bank’s 7th Ghana Economic Update revealed that an unexpected price surge in 2022 plunged close to 850,000 Ghanaians back into poverty, effectively undoing years of economic progress.
Inflation refers to the rate at which the general level of prices for goods and services is rising. It decreases purchasing power – each currency unit buys fewer goods and services. Inflation is quantified as an annual percentage increase, and as the inflation rate rises, the currency’s purchasing power falls. The most common measures of inflation are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).
Inflation has a direct impact on the economy. Moderate inflation is expected in a growing economy. However, high inflation can be harmful, causing uncertainty and discouraging investment and savings. Inflation can severely disrupt economic and social order at very high levels, as witnessed in hyperinflation scenarios like Zimbabwe in the late 2000s.
The Situation in Ghana
Ghana’s recent economic woes can be attributed to a variety of factors. The World Bank report pinpoints an increase in prices throughout 2022, resulting in a loss of average purchasing power by 15.7%. This situation was felt across all income levels, with the poorest 20% of the population losing 16.1% of their purchasing power and the wealthiest 20% losing 15.5%. Everyone felt it across the board. Notably, these losses intensified towards the end of the year as inflation surged.
A substantial contribution to this inflationary situation stemmed from Ghana’s energy sector. Challenges such as electricity underpricing, the poor performance of distribution companies, and excess power generation and gas supply contracts have led to a buildup of sectoral arrears totalling about $2.3 billion by the end of 2022. Without corrective action, these arrears could exceed $8 billion by 2025. Even with the government’s attempt to increase electricity tariffs, exchange rate depreciation eroded the gains as most generation costs are incurred in US dollars. We need to understand that combating Ghana’s inflation is an uphill battle.
Link Between Inflation and Poverty
The effect of inflation on poverty is multifaceted. First, inflation can cause wage stagnation. In Ghana, the minimum wage increased by only 10% in 2022, even as the general price levels rose by over 53%, meaning workers’ real incomes dropped by over 43%. This disparity implies that income can’t keep up with the rising cost of living, pushing people towards or further into poverty.
Secondly, inflation leads to higher costs of goods and services. Any price increase can be significant for low-income households already stretching every cedi. The rise in costs can force families to forgo necessary expenses, like healthcare or education, perpetuating a cycle of poverty.
Lastly, inflation can wipe out savings. Many people, especially those living in poverty, don’t have the luxury of investing in inflation-protected assets. If they have them, their savings are often in cash or cash-equivalent assets whose value is eroded by inflation. This problem was highlighted in Ghana, where rising inflation caused households to deplete their savings or sell assets to meet their needs.
In the case of Ghana, inflation also led to a regressive effect on power tariffs. The necessity of fiscal sustainability led to a significant increase in electricity tariffs, with the most considerable impact felt by those consuming between 30 and 200 kWh per month. This burden was particularly heavy for the poorest households, who consume nearly 70 kWh per month. This situation was exacerbated by the depreciation of the cedi, which drove up prices of imported goods and services and increased pressure on domestic substitutes’ prices.
Impact of Inflation on Ghana’s Economy
The repercussions of inflation are not restricted to individual households but extend to the macroeconomic level, disrupting the economic equilibrium. For Ghana, the surge in inflation in 2022 delivered a blow to the country’s economic growth and amplified existing fiscal vulnerabilities. The Ghanaian cedi faced significant depreciation, which amplified the rate of inflation.
Let me explain – when a country’s currency depreciates against others, the prices of imported goods increase. The World Bank report acknowledges this, stating that the depreciation of the cedi has contributed to inflation by driving up the prices of imported goods and services and putting pressure on domestic substitutes’ prices.
It’s crucial to remember that Ghana, like many developing economies, heavily relies on imports for consumer and capital goods. As a result, currency depreciation led to a dramatic increase in the prices of these imports. But that’s not all. The depreciation also impacted the domestic production sector, making imported inputs more expensive. In a knock-on effect, the prices of locally produced goods rose, adding to the inflationary pressure.
Moreover, the report noted that many energy sector costs are incurred in US dollars. This means that as the cedi depreciated, the cost of maintaining the energy sector, crucial for any functioning economy, escalated, causing an additional fiscal burden. The government, striving to compensate for this, was forced to increase electricity tariffs, which led to higher living costs for households and, consequently, increased poverty levels.
Strategies to Mitigate Inflation
Mitigating inflation, particularly in a complex scenario like Ghana’s, requires careful economic planning. Central to any plan should be strategies that address the root causes of inflation while ensuring that these measures do not disproportionately impact the most vulnerable groups in society. Here, both government and financial institutions have significant roles to play.
The government could start by strengthening the energy sector. By eliminating inefficiencies and focusing on sustainability, they can reduce the budgetary support required for this sector. The World Bank report mentions that the Energy Sector Recovery Program (ESRP), initiated by the Ghana government in 2019, enhanced the sector’s governance and restored financial viability. Accelerating the implementation of such programs could significantly improve the sector’s performance.
Next, structural reforms aimed at improving fiscal discipline, increasing domestic revenue mobilization, and reducing debt could be beneficial. They might also consider diversifying the economy to reduce import dependency, cushioning future currency depreciation’s impact.
Financial institutions should keep a close eye on inflation trends and ensure that their policies support stable and sustainable economic growth. Regularly revising interest rates and employing monetary tools can help curb inflation.
Additionally, providing financial education to citizens, particularly those in lower-income brackets, about saving and sound entrepreneurial strategies could effectively combat the adverse effects of inflation.
Inflation, thus, has a domino effect, beginning with increased prices, leading to wage stagnation, higher costs of goods and services, and the depletion of savings. As evidenced in Ghana, it’s a brutal cycle where the poor bear the brunt of the impact. Inflation can have dire consequences on an economy and can be particularly detrimental to the poorer segments of society, as the Ghanaian experience shows. It is a multifaceted issue with deep-seated roots that require comprehensive, well-thought-out strategies to tackle effectively.
While inflation has undoubtedly driven many Ghanaians into poverty, there’s also a significant opportunity here. An effective response could pave the way for structural reforms that rein in inflation, drive economic growth, and reduce poverty.
As we move forward, it will be crucial for Ghana to learn from this experience. The World Bank’s report provides a roadmap for understanding how inflation impacts poverty and presents a framework for crafting effective policy responses. With strategic interventions and careful planning, there’s hope that Ghana can rise to this challenge, curb inflation, and chart a path to a more economically stable future.
Wishing you a highly productive and successful week ahead!