You'll need to do a bit of digging and wirenut a pigtail on that ground, but yes, that is a ground and should be used to ground your switch, as well as the box if it isn't already hooked up to said box. All metal things associated with a circuit hook up to the circuit's ground wire, by the way, so you can still hook onto it if it's grounding something "down the line" -- as long as all the cables coming in are connected to it, all the downstream boxes and devices will still be grounded.
The ground wire is ONLY for emergencies. The 'return' from an appliance or light MUST be a separate neutral wire. Re: "Any help on explaining why this is set up this way" is very simple: THEY WIRED IT UNSAFELY IN VIOLATION OF THE ELECTRICAL CODE!
Yes, you need to run more wire. People do all sorts of crazy things. The NEC exists to prevent fires and electrocution.
You can look up the current electrical code at NFPA.org (free registration required) but there's no search function. Read about grounding and bonding in Section 250.
I'm not quite clear what wires go where, but the outside light needs a switched hot, and a neutral to return from that.
In previous versions of the NEC, you could have the hot and neutral come to the box holding the light, and lead the hot from the light box to the switch then back to the light. IIUC, this is no longer allowed.
The only way to do it now is to have hot go to the switch, then to the light, and run a neutral from the same branch circuit to the light. Typically this runs with the switched hot wire.
So-white (neutral), black (hot) and bare ground to the switch box, black to switch, neutrals connected together, grounds connected together (but not to neutral) then white (neutral), black (switched hot) and bare ground to the light. If you don't have enough conductors for this, you need to run more wire.
Best Answer
That won't work. The problem with this and any other powered switch, dimmer, motion sensor, etc. is that the switch itself is a load.
As such the powered switch needs always-hot and neutral all by itself, and of course it also needs a switched-hot wire so it can operate the light. That is three wires, and the ground doesn't count.
I see where you have only one /2 Romex with two wires in it. That means it is a "switch loop" (that's a google word) and will not have a neutral. (Or perhaps it is wired backwards, and it has a neutral and no hot).
Since you have the wall off, consider replacing that /2 run with a /3. That will provide what you require. Use the red for the switched-hot.
This is now required for new construction.
Another option is to use a "smart switch" to control the light, which talks wirelessly to a control module in the light fixture. In this case the control is wireless and the switch loop wires are redesignated as always-hot and neutral.