What makes Uganda a US dollar magnet?     

In reality, the US dollar is the most widely traded currency in the world, with daily transactions in both domestic and international financial markets reaching billions, and even trillions, of dollars.
Uganda and most African countries keep their foreign exchange reserves in US dollars although they have begun supplementing it with currencies and gold lately.

However, due to the tight monetary policy following the sharp rise of inflation globally and the tight global financial conditions, most Africans have faced the problem of US dollar scarcity and domestic currency depreciation.

International multilateral institutions such as the World Bank and the International Monetary Fund (IMF) have often said one of Uganda's more important and successful external sector reforms during 1987–94 was the move to a flexible foreign exchange system. Following the early devaluation of 77 percent in 1987 and a series of mini devaluations through October 1989, a real exchange rate peg was maintained until June 1990.

These adjustments to the official exchange rate reduced the differentials between the official and parallel rates, but sizable spreads persisted. The discount on the parallel rate (that is, the difference between the official and the parallel rates, as a percentage of the parallel rate) averaged about 63 percent between 1988 and the first half of 1990.

The initial devaluations occurred amid a severe shortage of foreign exchange, which compelled the government to strengthen import restrictions in 1986 by implementing a foreign exchange allocation and import licensing system.

Responding to Proper Magazine’s inquiry on why Uganda has enough US dollars compared to other African countries, Dr Adam Mugume, the executive director of research at Bank of Uganda, said Uganda has been a bright spot in economic management.

“It opened its capital account and allowed free movement of capital in the early 1990s and this has ensured the automatic stabilisation of the exchange rate. When forex supply into the domestic market declines, like at the beginning of the year, the exchange rate movement together with monetary policy actions reestablished stability which resulted in continued forex supply into the market,” he says.

Dr Mugume said BoU started tightening its monetary policy, sequentially raising its policy rate from 9.5 percent in February 2024 to 10.0 percent in March 2024 and later to 10.25 percent in April 2024.

Dr Mugume further explains that the BoU also raised its Cash Reserve Requirement (CRR) by two percentage points to 10 percent in June 2022. This increase supported the tight monetary policy stance by locking in additional structural liquidity that was causing volatility in the foreign exchange market at that time.

“In addition, BoU has undertaken several measures over the last few years to reduce segmentation in the interbank money market, foster liquidity and efficiency, and deepen the foreign exchange market. The Uganda Shilling's relative stability over the last year is due to a combination of factors, including various reforms in the interbank market that have improved liquidity and efficiency plus prudent monetary policy,” he said.

Many African countries have continued to face the challenge of US Dollar shortage. But what is causing it?
Dr Mugume says, “Every economy has some uniqueness arising from policies undertaken. True, there has been a dollar shortage in most frontier economies, especially those that appear to control exchange rates. The exchange rate is an automatic stabiliser and avoiding leaning against the wind to control its movements is crucial in having sufficient inflows.”

“Price, which is the exchange rate, will just equilibrate supply and demand. In addition, most jurisdictions took long to tighten monetary policies due to a fear that this would curtail economic growth. There is always a trade-off in policy as every policy action has a cost. Trying to balance the trade-offs is what differentiates good policymaking,” Dr Mugume adds.

The Ugandan economy is severely affected by the Covid-19 pandemic. To avert the negative impact of the pandemic on May 6 2020, the Executive Board of the International Monetary Fund (IMF) approved a disbursement of Special Drawing Rights (SDR) worth Shs361 million (about $491.5 million or 100 percent of quota) for Uganda under the  Rapid Credit Facility (RCF).

They said it would help finance the health, social protection and macroeconomic stabilisation measures, meet the urgent balance of payments and fiscal needs arising from the Covid-19 outbreak and catalyse additional support from the international community.

Before long, again on June 28, the IMF Board approved a Special Drawing Right- SDR722 million (about $1 billion) Extended Credit Facility arrangement for Uganda. Approval of the ECF arrangement enables the immediate disbursement of about $258 million.

On June 29 2020, the World Bank board of directors approved $300 million budget support for Uganda to boost government capacity to prevent, detect and treat the coronavirus, protect the poor and vulnerable population, and support economic recovery.

All these developments have contributed to the availability of the US dollar in Uganda compared to the other African countries.

On the external side, the Permanent Secretary/Secretary to the Treasury, Ramathan Ggoobi says Uganda’s trade balance as of August 2024, Uganda’s merchandised trade deficit narrowed to $314.1 million, down from $342.8 million in August 2023.
“This was driven by export receipts, which more than offset the increase in import bill. Total exports in August 2024 amounted to $789.58 million, implying a 17.9 percent growth on the $669.69 million the same month last year,” he said.      

Mr Ggoobi says the financial year 2023/2024 remittances amounted to $1.292 billion. This performance marks the return to pre-Covid-19 remittance numbers as the global economy continues to recover from the shocks experienced over the past few years.

Mr Ggoobi says Foreign Direct Investment (FDI) inflows to Uganda for the financial year 2023/24 reached a record high of $3.034 billion, an increase from $2.950 billion recorded in the financial year 2022/23.  
“FDI inflows have increased steadily year on year largely reflecting the ongoing activity in the oil and gas sector as the country prepares for first come FY2025/26,” he says.

The IMF on September 9, 2024, said the exchange rate channel plays a crucial role in the transmission of monetary policy in economies with flexible exchange rate regimes, such as Uganda. In small open economies, monetary policy can influence the exchange rate, as suggested by the theory of uncovered interest rate parity (UIP).
They advised the Bank of Uganda to continue keeping monetary policy data dependent and emphasized the importance of continued exchange rate flexibility to build up buffers and improve competitiveness.

The Bank of Uganda in its monetary policy report of October 2024 said the stock of Uganda’s foreign exchange reserves at the end of August 2024 was $3.397 billion, which is equivalent to 3.1 months of future import cover excluding oil project-related imports, an improvement from $3.258 billion, which was about three months of imports excluding oil project imports at end May 2024.

In the sub regional report titled: ”Managing Exchange Rate Pressures in Sub-Saharan Africa—Adapting to New Realities April 2023 Regional Economic Outlook by the International Monetary Fund (IMF): Sub-Saharan Africa Analytical Note reveals that most currencies weakened in 2022 against the US dollar—the dominant currency for trade invoicing and external debt.

In the report, the IMF said official exchange rates in non-pegged countries, where the exchange rate is not fixed to another currency on a de jure basis, depreciated 7 percent on average year over year by the end of 2022, exceeding 20 percent in some cases.

“There were large exchange rate spreads in parallel markets in some countries (Burundi, Ethiopia, Nigeria)—at times, reaching 90 percent. Pegged countries—where the exchange rate is fixed (mostly to the euro or the South African rand)—also saw their currencies weaken against the US dollar,” the IMF said.

“The exchange rate pressures also manifested in the depletion of reserve assets, as foreign exchange inflows slowed, and central banks used their reserves to finance imports and repay foreign debt. An index—combining depreciation against the US dollar and reserve depletion—shows that exchange rate pressures were at a six-year peak in 2022, on average, and were higher in pegged regimes and non-resource-intensive countries,” the IMF added.

The IMF explains that while this note focuses primarily on developments in 2022, pressures against the US dollar persisted in the first months of 2023 in several countries. Exchange rate pressures stem from both global and domestic factors.

Additionally, the combination of monetary policy tightening in advanced economies and increased global risk aversion has led to a decline in net foreign exchange inflows to the region, effectively pricing frontier economies out of the international capital markets.

Higher interest rates in the United States pushed the trade-weighted US dollar index, a broad-based measure of US dollar strength, to a 20-year high in October 2022.

The IMF further states that weak external demand related to monetary policy tightening and economic slowdown in major economies (euro area and China) created headwinds for exports, while higher oil and food prices, partly due to the war in Ukraine, pushed up import costs for net importers.

On the domestic side, fiscal deficits also contributed to external imbalances in some countries. About half of the countries in the region had deficits exceeding 5 percent of GDP in 2022, and countries with larger fiscal deficits tended to face higher exchange rate pressures. In some countries, deficits were monetised, leading to higher inflation, which in turn, weakened currencies further.