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As the Bank of Ghana steps up its intervention to support the weak cedi, the local currency could throw up perhaps the biggest challenge to monetary policy this year, judging from indications picked up by the Business & Financial Times. Further cedi weakening, which is not a far-fetched scenario in the course of this year, would batter importers and trigger inflation -- and if bad expectations run amok in the midst of all this, a vicious cycle of imbalances could ensue. Though some forecasters see the cedi, which has fallen by about 3 percent in the past three weeks, returning to stability in the short-term, none have written off potential risk factors that may emerge in 2012. Investment bank Renaissance Capital said last week that the recent weakness in the cedi is due to a brief surge in foreign exchange demand, which is likely to subside and give room for a partial reversal of the losses. �We believe cedi-weakness in recent weeks is largely due to an increase in year-end foreign exchange demand. Anecdotal reports suggest this is partially due to corporates: we think it is related to working-capital financing as corporates stock-up for the festive season and the new year,� the investment bank said. It observed that while oil production and exports may be positive for Ghana�s trade account, it implies an increase in payments to foreign service-providers, and in repatriated income both of which put pressure on reserves. �Given that we attribute the significant weakness... (in the cedi) to temporary heightened foreign exchange demand from corporates, we expect the cedi to retrace in the short-term and stabilise in the GHS1.70/$1 region in 2012,� Renaissance said. This supports the view that there is a seasonality about the cedi�s recent slide as similar conditions prevailed in January 2011 when an attempt by importers and corporates to replenish depleted stocks boosted dollar-demand and dragged down the currency. Despite the assurance in Renaissance�s forecast, global conditions and election-related uncertainties still put the economy and importers at the risk of a weaker cedi a situation that will require sound fiscal policy and an active central bank. If the global economy and financial markets continue to falter, a wave of short-term capital outflows from equities and debt could be likely -- as happened in the second half of 2011 with negative consequences for the cedi. The World Bank has already said the risk of a much broader freezing-up of capital markets and a global crisis similar in magnitude to the Lehman crisis remains. In that event, the world could be thrown into a recession as large as, or even larger than, that of 2008-09, the bank said. Again, most analysts reckon the elections that are due in less than a year could heighten the domestic political fever and give investors a bout of the jitters, triggering sell-offs or a hold-up of fund inflows. Says Renaissance Capital: �We expect uncertainty to increase as the elections approach, owing to concerns about policy continuity and the possible build-up of tensions during the campaign period. We think this will be negative for the cedi, as some short-term investors close their positions and others adopt a wait-and-see approach.� A forecast by Yaw Adu-Koranteng of Gold Coast Securities said the cedi could incur losses of between 8-9 percent this year, with the risk of a steeper fall if fiscal profligacy is encouraged ahead of the December polls. All told, importers would take a beating and price stability would be threatened. Early on this month, as the cedi weakened, the Ghana Union of Traders Association -- a huddle of importers and distributors -- said they were having to squeeze their margins to prevent an increase in prices. A weak cedi may also signal an invitation to inflation, which can trigger an aggressive response by the central bank with policy-tightening. According to Renaissance, if cedi depreciation persists, the Bank of Ghana could start hiking its policy rate in the first half of this year. Not all is gloom Analysts at Renaissance Capital point to at least two factors that could support the cedi this year: upward potential for oil exports and revenues, and a positive commodity-price outlook. �We expect oil export earnings to increase by about 20 percent year-on-year in 2012, which would be positive for the cedi,� they said. Though still below peak, oil output will improve to an average of between 70,000-90,000 barrels a day this year, Tullow Oil said in a trading statement last week. The commodity-price outlook is fair, Renaissance added. It forecast that the price of gold, Ghana�s biggest export, will increase significantly in 2012 to an average of US$1,738/oz from US$1,573/oz. �The strong correlation between the gold price and the country�s foreign exchange reserves suggests reserves will continue to improve in 2012, which is positive for the cedi,� it said. Planned bond auctions in 2012 will also be a source of strength for the local unit as foreign investors sell dollars in an attempt to take their positions. But caution, pro-activeness warranted When the cedi began its recent slide, the Bank of Ghana was passive for a while. Many currency dealers reckoned an early anticipation and a more robust defence of the cedi could have eased the fall. But as trading ended last week, they reported that the central bank had been active in the market and provided some defence for the cedi. Many indicated they expect this to continue. The external and domestic deficits must be watched. Central bank figures show that the trade gap widened in the first eleven months of 2011 to US$2.6billion; and though lagging behind exports, imports are pacing quite rapidly. For the government�s part, sticking to the budget deficit target while consolidating fiscal reforms will help the outlook and firm-up confidence in the economy.