OPTIMAL EXPENDITURE PATH FOR FISCAL SUSTAINABILITY IN THE GHANAIAN ECONOMY

Abstract

Fiscal non-sustainability which has remained a major challenge in Ghana in the last three decades was precipitated by the uncontrolled procurement of external loans and aid as well as the consequent debt overhang problem. The country’s emergence as an oil-producing nation offers an opportunity to proactively evolve a prudent fiscal framework for attaining an enduring fiscal sustainability. This study was carried out to determine an optimal expenditure path for achieving fiscal sustainability in Ghana. Annual data series from the Bank of Ghana and Ghana Statistical Services was employed for the study. The study period covered 1980 to 2009 with projections up to 2015. An econometric analysis anchored on learner’s functional finance theory was used to determine Ghana’s optimal expenditure path. The inter-temporal and dynamic optimizing models based on the Pontryagin Maximum Principle were subsequently developed. The impact of oil on national revenue was modeled using nominal exchange rate movements, along with the interacting impacts of relevant variables, such as the growth rate of the Gross Domestic Product (GDP), interest rate, and changes in debt and aid levels. The estimation techniques included the Ordinary Least Squares as well as forecasting, simulation and sensitivity analyses. Ghana’s fiscal profile was continuously unsustainable between 1980 and 2009. This was mainly due to the perpetually rising domestic and external debt to finance chronic inefficient public capital investment. A significant increase in government recurrent expenditure, mainly on rising staff emoluments and huge election-time expenses, accounted for this unsustainability. The derived socially optimal level of government expenditure as a percentage of GDP in 2009 was 32.9% with aid and 26.7% without aid. Increase in the levels of debt financing reduced the utility maximizing level of expenditure. The derived optimal expenditure path based on oil revenue injection for 2011 rose to 39.3% of GDP, but declined to 39.2% of GDP in 2012. The outcome for 2013 was 40.2% of GDP and this increased further to 42.2% and 44.8% of GPD in 2014 and 2015, respectively. Similarly, the optimal deficit ratio (fiscal debit as a proportion of GDP) required to finance these optimal expenditure levels declined from 8.0% of GDP in 2011 to 2.0% of GDP in 2015. A GDP growth rate below 4.0% and an interest rate of above 11.0% will undermine the attainment of fiscal sustainability in the Ghanaian economy. Also, an exchange rate appreciation of beyond 43.0% rendered the fiscal stance unsustainable. Government’s expenditure financing sources posed a challenge to the attainment of fiscal sustainability. Reduction in both domestic and external debt and a prudent management of oil revenue are therefore required for sustainability. For the optimal expenditure path to be kept, the government should ensure a low interest rate, a high non-inflationary GDP growth rate and non-persistent exchange rate and exchange rate appreciation of the Cedi. Keywords: Fiscal profile, Optimal expenditure, Oil revenue, Ghana, Pontryagin Maximum Principle. Word count: 461.