Will procyclicality override Ghana’s new fiscal responsibility law?

Ghana has suffered from large fiscal volatility around election cycles for the past two decades. This volatility has been identified as one of the key challenges for Ghana’s future development path in the 2018 World Bank Systematic Country Diagnostic. Fiscal deficits increased sharply and above 5% of gross domestic production (GDP) in all but the 2004 election year since 2000. At 11.5% of GDP, 2012 had the largest ever recorded fiscal deficit in Ghana. And the level of overshooting in fiscal election cycles has increased over the past decade with the discovery of offshore oil fields in 2017. Between 2005 and 2012, public expenditure rose rapidly – related to increased spending on wages due to the introduction of the single spine salary structure, which standardized the public sector pay scale across Government entities and grade levels – from 20 to 30% of GDP.

Fiscal policy in Ghana is notably procyclical. The cyclicality of public expenditure can be measured as the correlation between real government expenditure and real GDP (the business cycle). Ghana was among the most procyclical countries over the period 1980 to 1999, with a correlation of 0.7 (figure 1a). And there is a clear bias towards overspending during good times, which explains why procyclicality is higher in boom than in bust periods (figure 1b). Strikingly, Ghana has become even more procyclical in the recent period 2000-17, while many countries were able to leave fiscal procyclicality behind.
 
The procyclicality is related to both the commodity and electoral cycles. The dynamics of the cyclicality over the business cycle can be assessed through estimating a time-varying measure of the fiscal pro-cyclicality using the Local Gaussian Weighted OLS method (figure 1c). There is a clear relation of procyclicality and the commodity and electoral cycles; between 1990 and 2016, four phases of procyclicality can be observed: First, a substantial reduction of procyclicality in the 1990s following the fiscal reforms of the 1980s. Second, procyclicality increased sharply in the run-up to the 2000 election. Third, procyclicality trends remained stable over most of the 2000s, when fiscal policy was conducted under a “quasi-fiscal rule” during the beginning of John Kufuor’s government. Fourth, the discovery of oil in 2007 and the approaching 2008 elections set the procyclicality on a rising trend all the way to 2017.
 
In an attempt to overcome the fiscal election cycles, Ghana introduced a fiscal responsibility law and a Fiscal Council in December 2018. The law establishes a de facto 5% cap on fiscal deficits in any given year. While this is a relatively high annual ceiling (the West Africa Monetary Zone primary convergence criteria for fiscal deficit is 4% of GDP), it is a suitable target to contain excessive fiscal over-expenditure in election years, where deficits tend to overshoot. While the exact implementation of the Fiscal Council, which ideally would be an independent body with sanctioning authority, is still the subject of public discourse in Ghana, the establishment of the law and the council are critical first steps to lock in a sustainable long-term fiscal path.
 
The next election cycle (2020) will likely fall into a boom phase. In a stark contrast to the mere 3.4% real GDP growth in the last cycle (2016), growth is expected to be above 6% over the period 2019 to 2021, and potentially higher if oil output can be increased in the short-term. The macro-fiscal economy is largely back on track after years of adjustment, supported by the World Bank and the International Monetary Fund. This means that Ghana will go into the next fiscal election cycle in 2020 from a much stronger position than in 2016. There are downsides as well, of course, as witnessed by the recent banking sector resolutions, which cost the equivalent of 3.4% of GDP in 2018. But the medium-term fiscal outlook is still positive. With the fiscal responsibility law and the fiscal council now in place, the 2020 election provides a unique opportunity to break the ever-increasing fiscal election cycles as strong economic growth in the medium-term does not require additional fiscal stimulus in 2020.

_{Source: Authors’ own calculations, using data from IMF (WEO). Definition of four quadrants follows the logic of the country classification of Frankel et al. (2013) in their 1960-2009 analysis.}