How global shocks are affecting the banking sector

On February 24, Russia launched a war in Ukraine, about 8,000KM away from Uganda.

This set in motion a series of events, including sanctions. The ripple effect of the war sent oil prices rising, surging above $100, the highest since 2014. 

This led to fuel prices rising, including in Uganda, driving up inflation, especially transport costs that are essential for production and supplies. 

Uganda was still reeling from supply chain challenges that had sent prices of essential commodities such as cooking oil and soap rising. There was, however, some optimism that private sector growth was on a positive growth trajectory. 

“In 2022, real GDP growth is expected to be 6.0 percent, driven by a rebound in domestic demand at the back of full reopening of the economy, private and public investments in the oil sector and the full recovery of the services sector. Risks to the growth outlook remain tilted to the downside, especially in the short-term,” reads the Bank of Uganda (BoU) Monetary Policy Statement released on February 14, 10days before Russia invaded Ukraine. 

Central Bank’s ‘war’ against inflation
In the same statement, the BoU used phrases like “inflationary pressures remain modest” and kept the Central Bank Rate (CBR) at 6.5 percent, noting that it was to “support economic growth recovery.” 

Ten days later, a war breaks out. By end of March 2022, the pass-through effects of rising fuel prices emerge. On March 31, the Uganda Bureau of Statistics (UBOS) announced that inflation had gone up to 3.7 percent from 3.6 percent. At this rate, BoU wasn’t worried even though some members of the Monetary Policy Committee (MPC) wanted a rate hike.  

“Even though inflation is forecast slightly above the 5 percent target in the medium term, the initial impact of the recent price hikes has not spread across the basket of consumer goods and services. Indeed, the prices of some components of the consumer basket have fallen. As such, inflation expectations remain contained,” reads the MPS for April 12, 2022. That was before the end of April numbers came through. On April 30, 2022, UBOS announced that inflation had gone up to 4.9 percent the highest since January 2017 (5.3 percent). Throughout the entire time, the BoU was silent on inflation in public even though privately the concerns over inflation escalated. On May 27, BoU’s Deputy Governor Atingi-Ego told a meeting in Jinja City that “the BoU is monitoring inflationary developments very closely and stands ready to take appropriate action to maintain price stability.” 

Three days after his remarks, UBOS announced that inflation had gone up to 6.3 percent, a new five-year high. In response to the rising inflation, the regular MPC faced its first real test since the shutdown of the economy in March 2020 to curb the spread of Covid-19. On June 2, 2022, the MPC made its decision. A rate hike. The MPC admitted that the “inflation outlook remained uncertain with the balance of risks tilted towards the upside.” 

The rate hike(s)
At the June 2, 2022 meeting, there was a rate hike from 6.5 percent to 7.5 percent. The first rate hike in four years. In the statement, Atingi-Ego said the “the BoU will continue to raise CBR until inflation is firmly contained around the medium-term target.” Indeed, just like central banks around the world, the BoU responded by hiking the Central Bank Rate (CBR). There was still no reprieve. 

Inflation hit a new high, reaching 6.8 percent at the end of June 2022. The reaction of the BoU was swift at the time and in July 2022, an unscheduled MPC increased the CBR to 8.5 percent, to “stabilise inflation around the target.” 

BoU also increased the regulatory cash reserve requirement that banks are meant to hold from 8 percent to 10 percent of assets. This was a signal to the banks that they needed to “cut-back” on the lending appetite. 

At the end of July 2022, headline inflation reached 7.9 percent, whereas core inflation – the basis of BoU’s 5 percent target breached the 6 percent mark. 

On August 12, 2022 BoU further increased the CBR to 9 percent. At the MPC meeting held on October 6, the Bank of Uganda (BoU) increased the CBR to 10 percent.

But why would Central Bank be concerned about inflation? 
One of the roles of the Central Bank is to maintain price stability. BoU has a target to keep core inflation at 5 percent. 
“By determining the level of the CBR, the BoU can cause lending interest rates to increase, decrease, or remain broadly the same thereby influencing how much resources are available to boost or moderate economic activities,” Atingi-Ego explained the role of the Central Bank in Jinja on May 27, 2022.

If inflation crops up, the BoU hikes the interest rate so that commercial banks react the same way or get the signal to slow down on lending. 

If rates are kept low as inflation rises above the target, then businesses or individuals keep borrowing, which only keeps inflation rising. 

Slowing down demand works to reduce spending pressures that in turn contribute to slowing price increments. Until the Central Bank achieves inflation within its target, the CBR will keep rising. As the BoU sends these signals, the bankers pick them up. 

Bankers “sniff the danger” 
“We are indeed in a challenging operating environment, and these are tough times for our customers. Our compliance to and alignment with regulatory actions has always been consistent as these actions often reflect the operating environment. Over the past three years, the Central Bank has reduced the CBR, and we have consistently passed this benefit to our customers,” Ms Anne Juuko, the Stanbic Uganda chief executive officer explained in the Half Year Results statement on August 28, 2022. 

She asserts that they will follow the trend of the CBR. Several banks issued notices, with most increasing rates by at least 2 percentage points effective September. By end of July, interest rates were at an average of 15.53 percent, according to BoU statistics, the lowest monthly average since June 1994. Several banks are quoting rates of about 23 percent in anticipation of further increments in the CBR. 

Already, commercial bank lending activity had been subdued by the pandemic, growing below double-digit figures. In the seven months to the end of July 2022, private sector total loans have grown by slightly under 6 percent.

Commercial banks are approving just over half of the loan applications they receive in the seven months to the end of July. 

For several bankers the customers were already risk averse due to the pandemic, and with rising inflation combined with low economic growth, it is only prudent they raise rates and slow down on lending.