Foreign exchange reserve cover in East Africa to drop – IMF
The IMF Resident Representative for Uganda, Ms Izabela Karpowicz
What you need to know:
- The IMF says monetary tightening in the United States and rising risk premiums associated with the war in Ukraine, have placed downwards exchange rates across the region of Sub-Saharan Africa.
The International Monetary Fund has expressed concerns that the foreign exchange reserve cover in the East African Community region is likely to drop this year due to the current global economic hardship arising from the war in Ukraine and the rise in interest rates in the US.
The IMF says monetary tightening in the United States and rising risk premiums associated with the war in Ukraine, have placed downwards exchange rates across the region of Sub-Saharan Africa.
During the regional economic outlook for Sub Saharan Africa at Sheraton Kampala Hotel, on Wednesday the IMF resident representative in Uganda, Ms Izabela Karpowicz said the exchange rate in the East African region is reacting to pressure from the strengthening of the US dollar.
“The exchange rate in the East African Community has been muted and the currencies in the region have experienced depreciation against the US dollar,” she said.
Ms Karpowicz said based on the IMF World Economic Outlook and IMF staff estimates, Uganda’s foreign exchange reserve is expected to drop from 4.0 months of future import of goods and services in 2021 to 3.8 months of import cover, Kenya from 4.4 months of import cover in 2021 to 3.9 months, Tanzania from 4.9 months in 2021 to 4.6 months in 2022, Rwanda from 5.1 months of imports in 2021 to 4.7 months of import cover in 2022, Burundi 2.1 months of import cover in 2021 to 1.6 months of import cover in 2022.
Specific to Uganda’s current situation concerning the high prices, Ms Karpowicz said since this is a supply shock, there is generally not much the monetary authorities can do.
“However, the authorities should be prepared to adjust quickly if inflation expectations risk increasing tangibly to prevent second-round effects on wages and further price increases which, if left unchecked, would increase the potential for inflation to rise persistently above the target. Exchange rate flexibility also remains essential to cushion external shocks and preserve buffers,” she said.
On Uganda’s fiscal policy side, Ms Karpowicz said regardless of the state of social safety nets (SSN) allowing full-price pass-through is preferred while protecting the most vulnerable.
“Price signals are crucial to induce demand responses. Measures aiming at preventing domestic prices to adjust are costly, crowd out productive spending, and reduce producer incentives. Specifically, fuel subsidies and tax cuts are costly, inequitable, and inefficient,” she said.
In the Regional Economic Outlook, the IMF said in the report that for pegged currencies, authorities should find the right balance between monetary and fiscal policy to maintain the credibility of the peg.
For countries with more flexible arrangements, depreciation may help buffer the effects of global tightening. But even for these latter countries, difficult decisions may lie ahead.
The IMF adds that for many, there are clear limits to the near-term benefits of exchange rate depreciation, given sizable currency mismatches and pass-through to inflation.
“A targeted use of foreign exchange intervention may help to lean against excessive exchange rate movements but the scope for intervention is often constrained by low levels of international reserves,” the IMF advised.
