Fundamental issues dog interest rates, inflation

Inflation is notorious - it sticks closer than a skin rash and is difficult to defeat: Germany endured Hitler, costly war defeat, and finally the generosity of its conquerors to shake off inflation and prosper. Zimbabwe suffered the indignity of adapting a foe’s currency, the US dollar, as its official cash when the Zim dollar crashed. Uganda’s inflationary problems are far from the hyperinflation of 1920s Weimar Germany or 1990s-2000s Zimbabwe. But there are lessons.

To tackle inflation, Bank of Uganda has, understandably, used the usual tools – raising the central bank lending rate which, in turn, leads to a rise in commercial bank interest rates. If inflation is too much money chasing too few goods, raising interest rates means that less money is borrowed from banks and injected into the economy, “mopping up” excess money. That is what BoU believes has happened since revising the CBR every month, with the subsequent fall of headline/overall inflation from 30.5 per cent to 27.0 per cent between October and December.

In that sense, maintaining high lending rates has yielded results. But there are other sides to this: first, high (unattractive) lending rates lead commercial banks to ‘store’ their money (that the general public fears to borrow) in Treasury Bills, which are safe, risk-free investments (there is no hassle in collecting them, like the banks would have in recovering loans from you and me). But, while that takes money out of circulation, it stifles productivity, and low productivity is our key weakness.

Secondly, TBs attract offshore (foreign) investors, who have brought in about $222 million recently, flooding more dollars into the economy. On the face of it this is good, for it has contributed to the shilling strengthening against major currencies. But a cheap dollar also encourages importing, resulting in imported inflation. Now people like our traders who feel they have been locked out of internal trade by the high rates of borrowing would be attracted to the import trade, which militates against home –grown productivity. Disillusionment with banks could push traders out of the formal economy and, by implication, reduce an already narrow tax base.

But most fundamentally, BoU’s efforts only target aggregate demand and core inflation, and not the inflation that comes from food, and energy, fuel and utilities (EFU) – Uganda Bureau of Statistics figures differentiate them. Core inflation (from salaries, government spending on goods and services, etc) is easily controlled by BoU (that is why teachers’ salaries will not increase to demanded levels), but food and EFU is beyond the central bank’s jurisdiction. For instance, this week power tariffs will increase, petrol could increase, and food prices will probably increase in the next few months as the dry season consolidates – BoU cannot control these three.

Close scrutiny of UBOS figures shows that while headline/overall (which is core + food + EFU) inflation fell from 30.5 per cent in October to 27.0 per cent in December, food inflation alone fell from 35.3 per cent to 20.4 per cent in the same period (bigger harvests, Christmas sales). This implies that food probably contributed more to the drop than BoU’s core inflation/lending rate control.

The strategy, therefore, should be on controlling food, energy, fuel, and utilities-related inflation. These are poorly managed. Take food: we have no stores/silos to mitigate drought and its inevitable price rises. The banana wilt is being tackled by asking farmers to slash their crops – without a stabilisation fund, what options will farmers be offered if they cut their plantations?

The banana wilt that decimated Masaka in the 1980s will inevitably devastate Bushenyi. I am part of a group that planted cassava in Mubende for food and industrial purposes, but we had to transport cuttings 200km, from Namulonge. If neighbouring peasant farmers want similar cuttings (all farmers need high-yield varieties, but these are not readily available), I cannot supply them, for I am not Government.

The Agriculture ministry is, instead, spending billions on renting in Kampala (leaving free facilities in Entebbe) yet it should be operating strategically placed outposts and giving services that will stabilise food supply and therefore contain food inflation.

Electricity, meantime, has been undermined by the failure to optimise the under-utilised second dam at Owen Falls – Nalubaale Power Station has capacity for 180MW, Kiira Power Station is 200MW; total 380MW but we get only 80-220MW. Something is amiss. The Bujagali delay is not the main energy constraint. We hardly have any strategic fuel reserves to mitigate possible problems that could come this year, like war in the Middle East (if US/Israel fight Iran), or if the Kenyan elections go awry.

We are an agrarian economy and so we need agrarian reform. We have big structural problems, including corruption, in the food, energy, fuel and utilities components, which contribute most to inflation. Sort them out and we’ll finally be on the way to an integrated self-sustaining economy.

dsseppuuya@ug.nationmedia.com