So what if BoU cuts central bank rate?

KAMPALA. In a bid to revamp the private sector credit growth, Bank of Uganda (BoU) yesterday took another big step by reducing the Central Bank Rate (CBR) from 9.5 per cent to a record low of 9 per cent.
This is the lowest CBR [policy] rate that BoU has decided on since it implemented its current monetary policy on July 4, 2011 that targets stabilisation of the market using short term interest rates.
Mr Emmanuel Tumusiime Mutebile, the central bank governor while presenting the monetary policy statement for February 2018 yesterday said the move is aimed at further boosting the private sector credit growth and to strengthen economic momentum.

“Given the objective of keeping inflation close to the target and the estimated spare capacity in the economy, a cautious easing of monetary policy is warranted to further boost private sector credit growth and to strengthen the economic growth momentum,” he said.
The governor said the pace of economic activity strengthened in 2017. According to Bank of Uganda’s Composite Index of Economic Activity (CIEA), the high frequency indicator of real economic activity, economic growth for 2017 is projected to be in the range of 5.0-6.0 per cent compared to 2.5 percent in 2016.

In addition, the governor said there are indications of a revival in private investment activity as reflected by the recovery of Foreign Direct Investment, which grew by 18.5 per cent in 2017 compared to a decline of 30.5 per cent in 2016; improving shilling credit extension by 10.8 per cent in December 2017 compared to 7.9 per cent in December 2016, and an increase of imports of raw materials and capital goods, which grew by 17.4 per cent in 2017 compared to a decline of 21.1 per cent in 2016.
The governor said these developments, coupled with an improving global economic outlook, could strengthen domestic economic activity.

The impact of low inflation
Mr Stephen Kaboyo, the lead partner at Alpha Capital said the policy meeting comes against a backdrop of very low inflation environment with Core inflation the closely watched standing at 2.6%. This scenario creates good headroom for the Central Bank to ease. . However he says there some domestic risks that BOU will have to take into account coming from the volatility of the shilling that was seen in the previous months and it’s vulnerability going forward, high fuel prices that started picking up at the beginning of the year and the weather conditions that may affect food prices down the road.

The inflation data released by the Uganda Bureau of Statistics (UBOS) indicates that inflation remains subdued. Annual headline and core inflation declined to 3.0 per cent and 2.6 per cent in January 2018 from 3.3 per cent and 3.0 per cent, respectively in December 2017.
The decline in inflation is partly attributable to low food prices, as annual food inflation declined to 2.7 per cent in January 2018 from 3.5 per cent in December 2017. For Electricity, Fuels and Utilities (EFU) the annual inflation rate also declined to 9.8 per cent from 12.5 per cent in December 2017.

Who wins and who loses
However, despite the reduction in the central bank rate, the commercial banks’ interest rates has been sticky downwards averaging at 20.28 per cent. The biggest beneficiaries from the drop in the central bank rate are the corporate borrowers who are getting better borrowing rates compared to the micro and small borrowers who are getting rates as high 26 per cent to 28 per cent while the former are getting for as low as 12 per cent.
Statistics from BoU indicate that, non-performing loans as a percentage of gross loans have declined from a peak of 10.5 per cent in December 2016 to 5.6 per cent in December 2017, which should support credit extension.

The upside risks
The growth of private sector credit remains at historic lows with 2017 at annual growth of 5.8 per cent a slight recovery from a negative 1 per cent - a contraction in 2016, even though as recent as 2012, private sector growth was in the excess of 20 per cent.
According to Mutebile, although public investment programmes could substantially raise output and be self-financing in the long run, in the shorter runner, funding these investments may be difficult and since funding them may include local market sourced monies, it may crowd out private sector borrowing, thus delaying the growth benefits of public investment.

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