Uganda Shilling primed to worsen festive blues

Uganda is bracing for a challenging holiday season as its currency weakens, pump prices rise, and inflation threatens to increase the cost of transport and basic commodities.
This confluence of economic factors is causing concern among Ugandans, particularly as they approach the festive season where spending goes on a spree.
Forex traders anticipate a further decline in the Ugandan Shilling against the US Dollar in coming weeks. This as businesspeople rush to import petroleum products and other goods, fearing a surge in international commodity prices as high traffic looms.

As of Thursday, many forex bureaus were quoted with the exchange rate hovering at Shs3,779.08 for buying and Shs3,789.08 for selling, which is consistent with commercial banks’ rates.
Financial markets experts anticipate the expected marginal depreciation of the US Dollar to drive up the prices of imported consumables that will ultimately increase the cost of living for Ugandans. 
They observed a surge in the demand for dollars, driven by local and interbank players stocking up on the greenback in anticipation of demand from corporations.

In addition, the high demand of the dollar is partially attributed to developments in the US and European markets. 
Interest rates are expected to remain stable there or potentially rise to prompt investors to stock out their greenback to invest in these markets.
“The job markets’ growth and continued inflation control in these regions also suggest that higher interest rates may persist. This, in turn, could deter investors from pouring money into African markets in the near term,” Mr Phillip Ssali, the head of corporate sales of Global Markets at Stanbic Bank Uganda,  told journalists on Thursday.

Uganda is not alone in grappling with currency depreciation. Several emerging and frontier markets, including the Kenyan Shilling, Zambia’s Kwacha, and Nigeria’s Naira, are all expected to face similar currency challenges.
“However, there is a glimmer of hope for the Ugandan Shilling. Seasonal factors, such as the influx of diaspora funds and year-end corporate tax payments in Ugandan Shillings may lead to a gradual easing of the exchange rate. This could see the currency move from the recent highs near Shs3,800 back to the Shs3,750 levels by the end of the year,” Mr Ssali added.

But some economists warn that the demand for the US Dollar is expected to outstrip its supply in the country in the next few weeks. This could further impact the exchange rate, which can only stabilise at the start of 2024.
The decline of the tourism industry towards the end of the year, a significant source of the country’s foreign exchange, has exacerbated the situation.

“Foreign-owned companies are also paying their beneficiaries in dollars, which is more lucrative than other sources like tourism receipts and remittances,” said Prof Augustus Nuwagaba, a Ugandan microeconomist.
The tourism sector in Uganda faced a setback due to an attack on two foreign tourists in the country’s largest national park on October 17. This led to fatalities that prompted numerous cancellations of tourist bookings, according to tourism industry players.
The US government also issued an advisory, discouraging its citizens from visiting Uganda. 

Washington cited the former’s failure to protect humans of all inclination after Uganda passed the Anti-Homosexuality Act (AHA) that entails a death penalty for aggravated homosexuality, an offence that includes transmitting HIV/Aids through gay sex.

The AHA received a lot of condemnation from Western states, with government losing its status in a trade agreement that allows it to export its products to the US market with no taxes.
The depreciation of the Shilling affects manufacturers significantly, as it makes their imported inputs more expensive. Many of these manufactured goods face competition from imports, making exchange rates a critical factor in their competitiveness.

A real depreciation of the Shilling can render Uganda’s traded goods more affordable in foreign markets compared to competitors’ products, boosting demand both domestically and internationally.
This isn’t the first time the Ugandan Shilling has weakened against the US dollar. The central bank’s annual report for the 2022/23 fiscal year reveals that depreciation pressures persisted from the last quarter of the previous fiscal year. 

This was driven by advanced countries opting to curb global inflationary pressures by rising interest rates to reduce money supply in their economies.
The Ugandan Shilling’s woes were further compounded by the spillover effects of the Russia-Ukraine conflict, leading to supply chain disruptions, elevated international commodity prices, and deteriorating terms of trade.

Tight global financial conditions also led to portfolio investors exiting the Ugandan market.

Historically, the Shilling has witnessed depreciation in the run-up to festive seasons. In the final two months of 2022, the demand for the US Dollar among local banks outstripped its supply, with daily averages indicating a demand of $46.36 million versus a supply of $30 million forcing the local currency to lose bits of its value.

This depreciation was mitigated by the central bank’s actions such as tightening liquidity conditions in money markets, much to the chagrin of some economists. 
These contend that such mitigation affects the country’s growth since the central bank touches only the demand side when controlling inflation.

“The central bank sells government paper to remove money from people’s pockets and it also raises the central bank rate, which increases interest rates that commercial banks charge for loans, which reduces appetite for borrowing. When you do this, you harm the private sector,” said Prof Nuwagaba.
“Government needs to touch the supply side as well by reducing taxes to attract investment in the country and creating many special processing zones that can boost the export revenues the country can get from its industries,” he added.

FLEXIBLE EXCHANGE POLICY
Uganda’s flexible exchange rate system allows it to adapt to external shocks and improve the competitiveness of its traded goods industries in the face of negative economic developments. While this flexible exchange rate system has advantages, economists raise concerns about its sustainability in a challenging economic environment.They argue that it risks depleting the country’s foreign exchange reserves as the central bank tries to stabilise the currency at levels that may not align with the demand and supply dynamics in the foreign exchange market.