The weakening Shilling: Why your money is losing value

What you need to know:

Weak Shilling. The Uganda Shilling is currently under pressure against other major world currencies such as the United States dollar. We explain why the currency’s value is getting eroded and how you can hedge against its loss.

Money can be anything that can serve as a store of value, which means people can save it and use it later.

When prices go down, it is called deflation. However, if there is more money in circulation but the same level of demand for goods, the value of the money will drop. This is inflation—when it takes more money to get the same amount of goods and services.

The impact of inflation may seem small, but over the years, inflation can significantly erode the purchasing power of your savings.

The executive director of research Bank of Uganda, Dr Adam Mugume says: “Money is a bad store of value. It is a good medium of exchange. Money’s loss of value largely reflects the effect of inflation. If inflation averaged 2.2 percent in 2021, ideally money lost value by the same magnitude.”

Dr Mugume cites an example where if one had Shs100 million, earning zero interest, this would be equivalent to Shs97.8 million after one year.

“Therefore, one ought to minimise holding cash. Instead, you should hold money in an account that earns an interest rate that is higher than inflation. Almost 50 percent of deposits in banks are demand deposits that earn almost zero interest rate,” he said.

As the demand for a particular good or service increases, the available supply decreases. When fewer items are available, consumers are willing to pay more to obtain the item—as outlined in the economic principle of supply and demand.

The idea of saving money or spending it in a number of ways to support your long term or short term goals is a little difficult now.

The diminishing value of the Shilling as a result of rising inflation could mean cash halving in value. If prices increase, it means the value of the currency has eroded and its purchasing power has fallen.

Back in the days, the value of the Uganda shilling was strong. But since the year started, the cost of some goods and services has more than doubled. In an interview with Prosper, Mr Amos Zabaali says a rolex used to be Shs500 but today it is Shs2,000.

“The price of almost all items has increased. The price of a rolex has more than doubled. The size of a rolex (a Uganda delicacy) has been reduced. This is how far we have come and seen the Ugandan shilling lose value,” Zabaali says.

As cited earlier, money exists as a store of value. Employees trade the value of their working labour for a representative amount of money (in wages) and then trade that representative value for other goods and services in the market.

Currency depreciation is a fall in the value of a currency in terms of its exchange rate versus other currencies. Some of the leading causes of currency depreciation are low export earnings (revenues accruing from commodities), surge in imports, high interest rates or reduced monetary policy interest rate, traders and speculators selling currencies on the market.   

A fall in purchasing power due to inflation reduces consumption, hurting industries. Imports also become costlier.

The executive director Uganda Manufacturer s Association (UMA), Mr Daniel Birungi says that when it comes to the shilling losing value, the problem is largely macro- in nature and is determined by a number of factors; case in point is our dependency of imports, the constantly varying interest rates and risk aversion among investors among others.

He however, quickly notes that to ensure that the money gains value, first reduce importation of items especially for sectors where the country has developed capacity to produce finished items and in sufficient quantities.

“This would greatly reduce the import bill and have some control on the shilling value.  We championed the Buy Uganda Build Uganda (BUBU) policy to increase the market for our locally-made products,” Mr Birungi said.

He reveals that they have also engaged the Public Procurement and Disposal of Public Assets Authority (PPDA) to increase the threshold on the reservation guidelines to include sectors that have grown capacity along their various value chains.

Currency hedging

The Western Union global money transfer says Currency Hedging is the act of entering into a financial contract in order to protect against unexpected, expected or anticipated changes in currency exchange rates.

It is used by financial investors and businesses to eliminate risks they encounter when conducting business internationally. Hedging can be likened to an insurance policy that limits the impact of foreign exchange risk.

Due to unforeseeable currency risks, some financial analysts advise people or companies to do currency hedging.

Currency hedging is similar to insurance, which you buy to protect yourself from unforeseeable events. Currency hedging is an attempt to reduce the effects of currency fluctuations on investment performance.  When hedging currency risks, it is essential that businesses protect their bottom line and currency hedging could hold the key to achieving that.

Companies with significant foreign currency risk hedge this risk all the time in a Variety of ways. They may hedge it directly with currency hedges such as futures or options, or they may set up production facilities in a local country to help mitigate currency issues, if the market is significant enough.

In her own perspective, Ms Rachel Sebudde, senior economist at World Bank, says currency investment in a dollar is probably good at an individual level but when you aggregate for the economy, it is not good because it means you are draining or dollarising your economy and that you are no longer investing in your own currency but put more pressure on the local currency.

She further adds that the more demand there is for dollars, the more pressure you will put on the domestic currency. This will further contribute to worsening the situation at the macro level for the country.

“Investing in the dollar at an individual level is your choice. You can decide to buy dollars or land or bonds and treasury bills,” she explains.

However, she quickly notes that investing in dollars is a more stable currency and you are sure that in terms of value, it will still have more or the same value.

Currency pegging

Besides hedging, there is the currency peg. Currency pegging is when a country attaches or pegs, its exchange rate to another currency, or basket of currencies, or another measure or value, such as gold. Pegging is sometimes referred to as fixed exchange rate. A currency pegging is primarily used to provide stability to currency by attacking its value, in a predetermined ratio, to a different and more stable currency.  This has been done in Uganda as well.

For over 30 years now, there has been considerable diversity in the exchange regimes of developing and transition countries, from very hard currency pegs to relatively free floats and with many variations in between. This is not surprising in view of the wide differences among these countries in economic and financial circumstances.

Over the past two decades, many developing countries have shifted from fixed exchange rates (that is, those that peg the domestic currency to one or more currencies) and moved toward more flexible exchange rates (those that determine the external value of a currency more or less by the market supply and demand for it). During rapid economic growth, driven by the twin forces of globalisation and liberalisation of markets and trade, this seems to have served a number of countries well. Uganda has a floating exchange rate.  

Floating exchange rate regimes

The floating exchange rate is mainly market determined. In countries that allow their exchange rates to float, the central banks intervene (through purchases or sales of foreign currency in exchange for local currency) to limit short-term exchange rate fluctuations.

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