Weak economic fundamentals explain shillings troubles

Tuesday March 17 2015

By Joseph Mawejje

From the early 1990s when Uganda liberalised foreign exchange market, rates have been determined by demand and supply forces. Whereas on the on the supply side, foreign exchange inflow is determined through exports, aid, remittances and other capital inflows, on the demand side, foreign exchange is used to finance the import bill and pay foreign denominated debt, among others.

Uganda majorly exports primary agricultural commodities such as coffee and tea with low value and volatile prices. Bank of Uganda data indicate that exports have been declining from $2.8m in 2013 to $2.6m in 2014, signifying a 6 per cent fall in one year. The decline in the export sector performance coincides with a manufacturing sector whose contribution to GDP has contracted from 26.3 per cent to 18.1 per cent.

Reducing inflows
Remittances have overtaken exports and aid as the primary sources of foreign exchange inflows. Remittances have not contributed to investment broadly but have majorly facilitated domestic household consumption of mainly imported goods. Even then, the weak global economy, especially in the Euro zone, has led to decreased inflows. Yet Uganda’s import bill continues to rise resulting in a widening trade deficit, increasing from $4.5m in 2013 to $4.7m according to BoU.

Falling oil price
The falling oil prices have resulted in a waning investment appetite in the sector.
While Uganda’s private sector dominates the services sector with businesses such as banks, telecoms and oil importing and distribution companies, majority of these businesses are foreign-owned. These companies collect the money in shilling and expatriate the profits or dividends in foreign currency, further piling pressure on the shilling.

Finally, the dollarisation of the economy has aggravated the situation as some property rents and other bills are paid in dollars. This signals a growing lack of faith in the local currency thus resulting in unhealthy distortions in the markets.

The writer is a research analyst at Economic Policy Research Centre.