Why is the shilling in a free fall?

Fuel prices in the country are nearing levels last seen in 2007 at the height of the Kenyan post-election crisis.
At the time prices averaged Shs5,000 for a litre of petrol and Shs4,000 for a litre of diesel. At the time, the price hike was driven by a shortage in fuel supplies from the main import route, Kenya.
Fast forward to 2018 and the prices of fuel are souring. Petrol prices at the largest retailers, Shell (Vivo Energy) and Total are about Shs4,210 and diesel is about Shs3,800. These are the highest prices since 2007.

This time, two main factors are responsible for the price hike. The global oil price – the price at which oil is sold before it is refined into petrol and diesel – which has been rising. The second factor is the depreciation of the Uganda Shilling. Uganda being landlocked and yet-to-be an oil producer means that it is a net importer of fuel.

The Uganda Shilling plays a significant role in ensuring fuel gets to the several fuel stations in the country. Fuel is bought in dollars by the retailers from the Middle East, through the port of Mombasa before it gets to Uganda.
The trend in the Uganda Shilling means retailers need more Shillings to buy the same quantity of fuel they had been buying in 2017. For instance, in 2017, Ugandans were buying petrol at Shs3,500 for a litre. For the same litre, they now need Shs4,210.

Historical depreciation
That is what the depreciating Shilling has been doing to prices of fuel, in part. Bank of Uganda (BoU) has on two occasions in June 2018 intervened, pumping dollars in the market to reduce the demand pressures and slow the depreciation.
“The Ugandan shilling weakened on Tuesday due to demand for dollars from commercial banks, manufacturing and energy firms. Traders said it was headed to a key level that prompted the Central Bank to pump in dollars last week,” reads a financial market report published by Orient Bank last week.

In the last three months, the Uganda Shilling has continued to break historical lows against the dollar. In March 2018, the Uganda Shilling started to depreciate at a slow rate but by April 2018, the depreciation had been much faster – what the technocrats call volatility.
To exchange each dollar into Uganda Shillings, one would need about Shs3,880 by June 28. Compared to the same period in 2017, to exchange a dollar for Uganda Shillings that would have cost Shs3,550.

Why has this been the case?
Mr Emmanuel Tumusiime-Mutebile, the BoU Governor, has admitted that there is pressure on the Shilling, attributing it to the increased demand for imports and the global dollar strength against other currencies.
“The exchange rate depreciation has over the last three months come under pressure, driven by the global strengthening of the US dollar and the weaker current account position due to increased demand for imports, which more than offset the growth in exports,” Mutebile explained in the Monetary Policy Statement for June.

In the three months ending March, imports were valued at $1.2b (Shs4.6 trillion) whereas exports were valued at $915m (Shs3.5 trillion). That leaves a deficit of $300m (Shs1.1 trillion).
According to Enock Nyorekwa Twinoburyo, a Ugandan economist based in Kigali, Rwanda, “imports rising increase demand for the dollar. Our imports last year increased faster than exports – the supply of dollars. This meant excess demand for dollars.”

Implications
As noted, there will be a further impact on fuel prices and this could lead to several ripple effects on the economy.
“The short-term transmission mechanisms include but not limited to: heightened inflation trend is expected to transmit through the high import value which is twice the export value. More than 20 per cent of the Ugandan imports are petroleum products – which are essential inputs for both the production and consumption patterns. This will imply higher transports costs, already rising as reported in the media and certainly production costs will rise,” Nyorweka explains.

The electricity regulator, ERA, is also expected to announce power tariffs for the next three months. One of these factors used in determining the price of electricity is the trend in the Uganda Shilling.
The power generation companies such as Eskom and Bujagali Energy Limited have pricing models in their agreements in dollars. That means with depreciation, the regulator would have to factor this in determining the tariffs.
Additionally, BoU may be forced to slow down in the easing of the monetary policy stance if the threat of depreciation leads to an increment in prices, beyond the projection of BoU.

“Perhaps surprisingly, the UGX comes in at 5th among African currencies, typically depreciating at more than a 10 per cent annualised pace in any three-month period on 36.3 per cent of the time. As with previous episodes, most notably in 2011 and 2015, the BoU would probably tighten the policy stance if it believed that UGX weakness would pass to inflation,” reads a Standard Bank market update on African currencies for June 2018.
Uganda operates a flexible foreign exchange regime where the market trends determine the rate. BoU’s interventions to pump dollars in the economy for now reduce the volatility and would not want to run the risk of depleting foreign reserves if the action only keeps going down the drain.