What 2023 final monetary stance tells us about 2024

Despite the purchasing power of money increasing and the country’s economic growth on the rise, albeit moderately, economic tightening shows no signs of easing. The central bank believes this is a delicate relief that could not even last long. 

The Bank of Uganda (BoU) just maintained the central bank rate (CBR) at 9.5 percent for the fifth consecutive month this year. This is essentially an economic lever that the financial institution uses to control the demand and supply of goods and services in the economy, and it does so by adjusting the aforementioned rate, which ultimately affects the money commercial banks borrow from the central bank.

Why should one care about the CBR anyway? 

Ultimately, weighted lending rates rise in tandem with the CBR’s rises and fall in tandem with its decreases. The rate dropped from 10 percent, where it was held steady for 10 consecutive months, to 9.5 percent, where it has remained for the past four months, according to BoU official figures. 

There was a slight 0.5 percent ease in this rate to 9.5 percent, where it is still being held, which depicts the central bank’s risk averse move of attempting to control the rate at which price changes occur, as it noted in its last monetary policy statement for 2023. 

“If you closely examine, for instance, the potential continuation of the Israel-Gaza conflict, we are concerned that this could affect the oil supply in the region, which could then lead to an increase in pump prices, which would push up the local commodity prices,” says Mr Michael Atingi-Ego, a Ugandan economist and the deputy governor of the Bank of Uganda. 

In addition, he is concerned that the government would be subjected to expensive foreign borrowing, if the Western economies proceed to tighten their policies by raising interest rates, putting a strain on the country’s budget. 

After being chased out of Uganda’s bond market by portfolio investors seeking higher returns in more lucrative financial markets, the government might raid the country’s banks for credit. 

“And if that happens, you are going to exert pressure on the exchange rate which depreciates the shilling,” Mr Atingi-Ego elaborated. 

What else is exerting pressure on the exchange rate?

Uganda is currently struggling to keep some of its hard-collected dollars within its economy. 

The dollar has been threatened by a hampered tourism sector caused by a terrorist attack in the country’s largest national park, Murchison Falls, which resulted in multiple cancellations of bookings, as confirmed by multiple tour guides.

In addition, the country has faced an uproar by Western governments and NGOs as a result of its recently passed anti-gay law, which includes the death penalty for infecting someone with HIV/Aids as a result of same sex relation.  The US mission noted that this is a move that discriminates against minority groups.

But, most importantly, the government, which has recently been on a borrowing spree to finance its deficit national budgets, is now stepping up efforts to finance its dollar-denominated loan. This has seen it service these loans in amounts close to $1b every year for the past two years, which is expected to rise even more in the next two years. 

“Ultimately, this has reduced the country’s foreign exchange reserves from $4.5b by June 2022 to now $3.9b. We are now trying to stop this fall by limiting our intervention in the forex exchange market where we used to intervene quite significantly in the past,” Mr Atingi-Ego noted. 

So what next?

According to Mr Adam Mugume, the executive director of research at BoU, the central bank now places hope in the increased growth of its regional peers such as Kenya, South Sudan, the Democratic Republic of the Congo, and Rwanda, which is averaging six percent. 

Uganda anticipates that this will strengthen the dollar, which posted an $802m trade deficit in the second quarter of 2023, down from $840m in the previous quarter, but up from $744m in the second quarter of 2022. 

Uganda’s top dollar earners are coffee and base metals, but this is offset by its high private sector’s imports. The government is attempting to close this gap by using tax breaks for manufacturers and expanding special economic zones and industrial parks to increase production of commodities that it has the capacity to manufacture. 

Is the private sector pulling its weight in all of this?

Data from the central bank shows that the private sector has averagely taken about $1.82b from the economy each quarter purchasing supplies. 

In the midst of this, interest rates were skyrocketing, surpassing 20 percent in May. In fact, BoU acknowledges that demand for private credit slowed significantly at the start of 2023 as businesses began to incur rising operating expenses. 

Although the economic outlook for growth and inflation appears stable, the economy managers point out that they have not lowered interest rates as much as they would have liked because of “significant unforeseeable uncertainties.” 

“If you are to lower interest rates in a situation where you have significant uncertainties going forward, in the event that those uncertainties materialise and cause an outsized risk to your inflation, then you need to rethink whether to raise interest rates again or not,” Mr Atingi-Ego explained, adding, “That up and down cycle changes in the policy movement is not good for a central bank.” 

But changes in lending interest rates are influenced by a variety of factors, including the government’s desire to borrow from domestic commercial banks. 

The deputy governor explained that the government issues treasury bills with a 13 percent interest rate, which is even less risky than private borrowers who face high risks and struggle to make payments on time, attracting banks’ lending to them with preference.  

In addition, many borrowers with issues with paying have run to courts to seek court injunctions, barring banks from recouping their money from their given collateral. 

“This money is running in trillions, and this is the depositor’s money. If a loan repayment as scheduled is not done for a year, the banks are required to put additional money on their accounts to cover for it because it will be a loss,”  Mr Atingi-Ego said. 

Bank of Uganda data shows that the amount of money that borrowers have prevented banks from recouping from their collateralised assets has recently increased significantly to north of Shs5 trillion.