High inflation, weak shilling: What’s happening?

Three economic fundamentals, including inflation, interest rates and a weak shilling are worryingly moving in the offside and at troubling speed.
The movements, experts warn, might have far reaching economic distortions, considering that Uganda has an expensive election year ahead and is already facing a number of challenges including low export volumes, reducing remittances and a cut back in tourism receipts.
Aly Khan Satchu, a Kenyan financial analyst, sums up the current situation: “Lending rates in Uganda have already been ratcheted higher but the issue is fiscal consolidation has been pushed over the horizon.”

“Therefore, in these circumstances, interest rates might have to even go higher,” he opines, considering that the central bank just last week sought to reduce money in the market by increasing its key lending rate (Central Bank Rate) from 12 per cent to 13 per cent.
This, according to Tumusiime Mutebile, the central bank governor, seeks to curb growth of inflation, which is expected to rise from the current 4.9 per cent to between 8 and 10 per cent by the end of the 2015/16 fiscal year.
“We will tighten our monetary policy further should there be deterioration in inflation outlook,” Mutebile said at a press briefing last week, which came on the back of an increasingly volatile shilling.
The unit closed Friday at a market average of Shs3,200 against the dollar but also for the first time in over a year it lost against other major currencies ncluding the euro and the pound with the currency market quoting the shilling at Shs3,255 and Shs5,022 respectively.

Inflationary dangers
As the central bank moves to reduce money in circulation, credit growth is expected to contract as loans are likely to become more expensive.
However, as Herbert Zake, the head of corporate affairs and communications at Standard Chartered Bank, says banks will continue to react to market conditions considering the central bank has since January been increasing its key lending rate, from 11 per cent at the beginning of the year to 13 per cent in June.

Battered shilling
The shilling has since January depreciated by 20.9 per cent. However, as Adam Mugume, the Bank of Uganda director for research, says: “… currency weakness is not unique to Uganda.”
In East Africa, the Tanzania shilling has lost more ground than any other falling by 25.3 per cent compared to Kenya’s 10.9 per cent and Rwanda’s 5.1 per cent.

Implication and cause of the depreciation
Stephen Kaboyo, the Alpha Capital managing partner, attributes the shilling’s continued troubles to high dollar demand by importers, interbank and corporates demand.
However, he says the demand has not been helped by falling inflows resulting from a cut back in remittances, tourism receipts and export volumes.
This, experts say, will constrain private sector investments, more especially firms that don’t export.
“Uganda being an import-led economy it is going to be very expensive to do business,” Fred Muhumuza, an economist and financial inclusion manager at KPMG opines.

The depreciation, according to Kacita chairperson, Everest Kayondo: “… is a terrible episode to our businesses”, which already punches holes in the recently read budget where Finance minister Matia Kasaija claimed: “We have enough reserves to insulate us against such currency fluctuations. Perhaps we should assume those reserves are not anywhere as they claim.”
In his opinion Amos Nzei, the chairman of Uganda Manufacturers Association, thinks the continued depreciation of the shilling “is killing industries due to increasing cost of doing business. We are likely to see an increase in product prices”.
Production, according to Nzei, might also reduce due to low customer purchasing power as well as implementing the need to cut back on production costs.

Projections
Just like how the central bank projects growth in inflation, Kaboyo predicts the weak shilling is likely to keep inflationary pressures up but might be checked by reducing market liquidity as a result of high interest rates.
The situation, according to Satchu, might be worsened unless government cuts back on its recurrent expenditures.

The deputy central bank governor, Louis Kasekende's take

With the shilling taking a beating, inflation and interest rates have been moving northwards. Martin Luther Oketch caught up with Louis Kasekende, the deputy central bank governor, with a view of understanding what exactly is happening.

The central bank has since the beginning of the year injected more than $129m in foreign exchange market, but the shilling continues to fall. What is really happening?

The depreciation of the shilling mainly reflects fundamental factors. Uganda’s current account of the balance of payments has weakened for several reasons due to lower global commodity prices and a fall in demand in regional markets, falling tourism receipts and increasing private sector demand for non-oil imports. Worth noting is foreign direct investment inflows have been reducing mainly due to a fall in global oil price.
These developments have taken place against a background of a stronger dollar on global markets, with the result that the bilateral exchange rate of the shilling/dollar has depreciated by much more since the start of the year (15.7 per cent) than the trade weighted exchange rate index (12.2 percent) which is based on the exchange rates between the shilling and the currencies of the countries with which Uganda trades.

What are your short-term plans in the event that the local unit continues to fall?
Our policy is to intervene only to smoothen volatility, which means excessively large short term movements in the exchange rate. It is neither ideal nor feasible to try and prevent the exchange rate from adjusting to levels which are necessary to ensure sustainable balance of payments.

Is the Uganda shilling the only currency experiencing depreciation pressure?
No, to a greater or lesser extent many currencies are suffering against the dollar. Since the end of June 2014, the Ugandan shilling has depreciated against the dollar by 23.5 per cent while the Kenyan shilling by 11.3 per cent, the South African Rand by 17.2 per cent and the Tanzanian shilling by 25.8 per cent.

Inflation has been spiralling with the central bank projecting to have increased to between 8 and 10 per cent by the end of 2015/16. This is above the 5 per cent central bank policy target. What implication does this have on the economy?

Inflation is on the rise but is far from “spiraling’. Annual core inflation has increased from 2.7 per cent in December 2014 to 4.8 percent in May. Obviously high inflation has negative effects on standards of living and, if it becomes entrenched it will damage business confidence. That is why we shall not allow it to become entrenched. We are already taking measures to keep it within targets.

What are these measures?

We have increased our policy interest rate – Central Bank Rate to 13 per cent. High interest rates will dampen aggregate demand and so reduce inflationary pressures. By tightening our monetary policy, we expect to bring back inflation within the 5 per cent target during the course of 2016/17.

The interest rates are becoming prohibitive and there is a likelihood they will continue to rise. Aren’t you worried?

The increase in CBR is intended to dampen aggregate demand growth and thus curb inflationary pressures. One of the channels through which this will work is by inducing banks to raise lending rates and thereby reduce credit growth. Credit had grown quite strongly over the past 12 months, by 17 per cent. So, a reduction over the medium term is not necessarily dangerous to the economy.

It is not warranted to describe interest rates as “prohibitive”. The average commercial bank lending rate for shilling-denominated loans over the last three months was 21 per cent. That is the same as the average bank lending rate over the last 10 years, since May 2005. During that period, bank lending to the private sector has expanded four and a half times in real terms. Such a large expansion hardly suggests lending rates are “prohibitive”.

Won’t policy adjustments slowdown economic growth in the short and medium term?
Even though we expect high interest rates to curb aggregate demand in the 2015/16 fiscal year, we still expect demand to be sufficiently buoyant to support growth of close to 6 per cent in the coming fiscal year.

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