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Analysts: Ghana Fuel-subsidy Cut Is Merely Quick Fix

People walk past a vendor selling newspapers with its front page reporting about an Argentine naval vessel involved in a debt dispute, in Accra, Ghana, December 2012.
Ghana's removal of fuel subsidies last week was designed to reassure investors ahead of a $1 billion Eurobond in July, but it carries risks. Analysts say more action will be needed to tackle a large budget deficit.

Ghana - one of Africa's fastest-growing economies - began producing oil in 2010, ranks as the world's number two cocoa producer, and is Africa's second biggest gold miner. Though popular with investors, the government has seen its fiscal management criticized amid big wage demands from restive civil servants.

Ghana's credit-worthiness was hit by a 2012 budget deficit of 12.1 percent, more than double the official target, analysts say. The announcement last month of a plan to issue a Eurobond in July to finance debt and capital projects has added to the pressure to curb the deficit.

A 3-year bond auction last week, though oversubscribed, sounded a warning when yields climbed to 19.2 percent, up from 16.9 percent in March.

It signaled that investors fear the government is failing in its attempt to pare the deficit to 9 percent this year. Analysts say scrapping fuel subsidies is a response.

Friday's announcement has so far not sparked the strong opposition that has often greeted decisions to remove subsidies elsewhere in Africa. There was no immediate reaction from the opposition National Patriotic Party or from unions, and there were no signs of street protests.

“There is definitely a positive on the fiscal front. The government will now be able to get some savings by not subsiding fuel,” said Edward Al-Hussainy, a sovereign risk analyst with Moodys ratings agency in New York.

“The flip side is that it tells us that the government is having a tough time meeting its fiscal target,” he said.

No opposition reaction

Looking ahead, the risk of higher inflation from the removal of subsidies could leave the government vulnerable to renewed militancy by public sector unions over wages. Inflation stood at 10.6 percent in April.

Ghana saw a weeks-long strike by doctors and other civil servants in March and April in a dispute over how to implement a salary structure the government inherited from its predecessors.

That structure saw some civil servants' salaries jump by 240 percent, and the overall public sector wage bill rise by 47 percent in 2012.

The impact on prices will be further exacerbated as the decision in February to partially remove fuel subsidies filters through to the economy, according to Razia Khan, regional head of research at Standard Chartered.

“There is no fiscal room [to] maneuver especially with the public sector pay bill and some of those subsidies should have gone some time back,” said Khan.

“It would have been better if there were gradual adjustment to prices. But having left it too late and having seen overruns in other areas, the authorities have little choice but to implement more dramatic action now,” she said.

The International Monetary Fund said in April the ballooning wage bill threatens the economy's health, though public servants argue they have historically been underpaid and point to wasteful spending by politicians as a cause of their militancy.

Questions for investors

The nation of 25 million presents a paradox to investors. By some measures, it has the fourth biggest economy in sub-Saharan Africa and GDP growth in 2012 stood at 8 percent, making it one of the hottest economies on the continent.

Oil production allows Ghana to join an elite group: an African state with petroleum, peace, stable democracy and a reputation for good governance.

The deficit plus a current account balance clouds the picture. It is further darkened by international reserves which stand at just three months of imports as of the end of April.

One key question facing Ghana is how far the deficit will weigh on investor confidence.

“I do hope that Ghanaians will understand that we really cannot afford the large deficit,” said Joe Abbey, executive director of the Center for Policy Analysis think-tank in Accra.

Shortly after Ghana announced that its budget deficit last year overshot its 6.7 percent target, Fitch ratings agency reduced the country's outlook to negative from stable.

Carmen Altenkirch, a director at Fitch, said on Monday the removal of subsidies was the kind of action the government should be taking to combat high borrowing costs.

“This is encouraging, but you are seeing high bond yields so significantly you would hope for more,” she said.

The government should attempt to slow a rise in the public sector wage bill to below the rate of inflation and improve financial management in part by installing better IT systems, she said.

It was also important to improve the tax net, according to Altenkirch and other analysts.