Why the Shilling has been “stable” against the US dollar

There was doom and gloom last year as the Shilling was in free-fall mode with anticipation it would depreciate to Shs4,000. This trend was attributed to a combination of factors, among them the 2016 General Elections and the strong economic environment in the United States would strengthen the dollar further. However, for the last four months, the Shilling crossed the Shs3,400 mark before stabilising at about Shs3,370 last week, according to Bank of Uganda (BoU) statistics. That is still below the target that many bankers and market players had anticipated the exchange rate to be by now.

BoU action
“Stability of the exchange rate is attributable to tightening of monetary policy much early before the instability became a stronghold as many had anticipated. Tight monetary policy in turn constrained domestic demand and consequently has impacted on demand for foreign exchange to import,” Dr. Adam Mugume, the director research at BoU tells the Daily Monitor.
In the best part of 2015, BoU kept on increasing the Central Bank Rate (CBR). At the start of 2015, the rate was at 11 per cent but by the end of the year, it had peaked at 17 per cent. By keeping interest rates up, BoU had tightened the monetary policy.

According to Dr. Mugume, the result has been a 31.5 per cent drop in the value of private sector imports the first seven months of FY2015/16, compared to the same period of 2014/15.
If oil imports are excluded, that decline is at 9.5 per cent, which partly reflects constrained domestic demand as a result of tight monetary policy stance. With fewer imports, this reduces the demand for dollars, which reduces demand for the dollar.

By end of the trading week on Thursday, an Orient Bank currency note read: “With limited corporate or importer demand, the rate was destined for a flat day,” meaning demand for the dollar is still subdued.
Dr Mugume adds that other contributing factors to pressures on the exchange rate have been largely muted.
“This has been supported by a relatively tight fiscal stance than what many people had anticipated. Second, the fact that the just concluded elections did not have a dis-stabilising impact on domestic economy dis-anchored expectations of macroeconomic instability,” he adds.

In fact, immediately after the election, Fitch, a credit rating agency affirmed Uganda’s rating, which offered confidence about Uganda’s economy. In a note written on March 7, Fitch noted a downgrade of Uganda’s rating would result from the increasing debt burden but for now, it was not necessary.
“Uganda’s recent elections, which saw Yoweri Museveni return for a fifth presidential term, are neutral for the country’s sovereign credit rating. They have not resulted in widespread disruption, and fiscal and economic policy continuity is likely,” the note from Fitch reads.

A credit rating often helps investors, donors and fund managers assess the risk of investing their money in a country.
However, it goes on to caution that “one potential longer-term risk from Museveni’s re-election is that the government expends more of its political capital on retaining power than on economic policy.”
Some of the risks for the exchange rate becoming volatile again are external. Dr Mugume points out that they could come from China’s economic growth decline, USA’s Fed monetary policy lift-off and divergent monetary policies in advanced economies.

Too good to be true?
For some in the market, this stability the Uganda Shilling is enjoying is temporary. Stephen Kaboyo, managing partner at Alpha Capital Partners, insists fundamentals in the economy do not support a strong Shilling at the moment.
“Wherever the Shilling is right now for me is an overvaluation. If you take away the portfolio flows, which may not be sustainable in the long run now that interest rates are coming down, you will see a gap starting to emerge,” he says.
The particular concern is Uganda’s expanding current account deficit. A current account deficit when the value of imported goods, services and investment income exceeds the value of exported goods and services. Even with the reduction in imports over the last seven months, exports have not matched that with an improvement.

At the end of 2014/15, Uganda’s current account deficit was an estimated $2.3b up from $2.2bn in 2013/14. The projection is that that deficit will rise as the country embarks on various infrastructure projects. That will push up the demand for dollars because of the import demand.
“We expect the current account deficit to remain wide in 2016, reflecting ongoing infrastructure projects and energy sector developments. Imports to support infrastructure development will remain significant. Uganda is a net importer of most of the inputs required by the oil industry,” reads a report “Retreat, regroup, rebound” from Standard Chartered Bank.

According to Kaboyo, it is only a matter of time before pressure on the Shilling begins building up, weakening the Shilling.
“This honeymoon is good for a while but fundamentally, we do not have a case for a strong Shilling,” he adds.
He admits there have been benefits for the economy.
“In a nutshell, it is good to have this small stability to spill to other things like fuel prices and that has a bigger impact on food prices because of transportation costs,” he adds.

Fuel prices drop
Uganda’s fuel prices have been dropping for the last one month partly owing to the lower global oil prices. Global oil prices at the time had been declining but this was not corresponding with the fuel price drop. This happened as fuel marketers argued that other factors such as the exchange rate were influencing fuel prices.
At the height of the Shilling’s depreciation in October 2015, fuel companies remained hesitant, keeping prices of petrol and diesel above Shs3,700.

By March 2016, this had changed as two of the largest fuel companies, Vivo Energy – a Shell Licensee – and Total who combined control about 50 per cent of the market share, have dropped prices to about Shs3,400. Some other independent market dealers have prices lower than that.
“What we don’t like the most in this business is volatility. We saw some of that volatility in 2015 and it affected our business. Today, there is some stability and as you may have noticed, fuel prices have dropped,” says Mr Hans Paulsen, the managing director Vivo Energy Uganda.

Producer prices still up
However, even with the fuel price drop, input prices for manufactured goods have still been rising, according to the Uganda Bureau of Statistics (Ubos). Statistics released by Ubos indicate that both December and January 2016, producer prices rose by 10.5 per cent and 7.7 per cent, respectively. Producers use various inputs in the process of manufacturing and prices of Sugar, processed coffee, tobacco and cement prices all rose during the same period. Additionally, the construction sector index has been on the rise with prices rising by 5.8 per cent and 4.5 per cent in December and January 2016 on account of rising prices for inputs like roofing sheets, bitumen, equipment hire, wages, electrical wires and cables.
The resultant effect of the higher producer prices is a rise in consumer prices are the costs are passed on to Ugandans. Even as the Shilling remains stable, prices of commodities remain up as the trickle-down effect is yet to be felt.