Shilling Woes Persist

Inflation takes toll as local currency continues to struggle despite Central bank intervention

The pressure on the Uganda shilling against other currencies continues to bite. The most recent Bank of Uganda monetary policy release did not appear to give any respite. The pressures on the shilling started in December last year.

As of March, the shilling had depreciated by about 8.7% on a trade-weighted basis and 16.5% against the US dollar on y-o-y basis to an average of Shs 2,951.74, according to BoU. The depreciation pressures are attributed to the global strengthening of the dollar resulting from the growth of the US economy and likely increase in US interest rates that saw capital flow back to the US in anticipation of higher returns.

Tumusiime Mutebile, the BoU governor told journalists recently that as at end March, the US dollar strengthened by 28% against the Euro, 18% against the Japanese Yen, 12% against the South African Rand and 11% against the British Pound on y-o-y basis “Panic buying and noise in the market on account of expectations about the future direction of fiscal and monetary policy continued exit of offshore players elevated dollar demand mainly from manufacturing, telecom, trading and energy sectors amidst lower inflows partly on account of lower international commodity prices are partly responsible for the depreciation,” Mutebile’s said.

BoU expects core inflation to rise to around 5% by mid-2015 and without changes to the policy stance, it will continue to rise to 7-9% by June 2016.

The balance of risks to the inflation forecast is on the upside due to the potential pressure from the exchange rate, according to the Central bank. Inflation has remained subdued, with core inflation rising to 3.7% in March from 3.3% in February, partly driven by the fall in the shilling’s exchange rate against other international currencies.

The rise in the annual rate of headline inflation from 1.6% in February to 1.9% in March is attributed to both local and external factors – mainly global inflationary pressures and the falling oil prices.

The shilling has been depreciating since early 2014, hitting a low of Shs 3,100 to the dollar on March 12. Since then, it has more of stabilized, helped by the Central bank’s intervention, but the exchange rate is still in the Shs 2,900 – 3,000 range.

Ideally, some analysts argue that a weak shilling is not necessarily a bad thing for a country that depends on exports for its foreign exchange earnings. A dollar earned by an exporter would mean more shillings. But the importers of goods and raw materials are desperate to have the exchange rate tamed as they now need more shillings to import dollar-denominated goods, which eventually makes them more expensive for the final consumer.

However, Mutebile suggested that they will not be too desperate about trying to tame the exchange rate at all costs unless it becomes “disruptive.”

“BoU will intervene in the foreign exchange market to curb disruptive volatility in the exchange rate, as was the case in March, but will not try to impede the real exchange rate from adjusting smoothly where this is needed to maintain external balance,” Mutebile said.

In recent weeks, the Central bank has continued to sell out dollars to bolster the local unit, which has been under pressure on worries that the government would boost spending during campaigns for the 2016 general election, with fears that it could lead to a repeat of the economic crisis witnessed in 2011.

Uganda’s inflation hit the highest ever level in October 2011 when it soared to a whopping 30.5% as the shilling fell to as low as Shs 2,900 to the dollar – a trend that forced the Central bank to push the it key rate (CBR) to as high as 23% in November of that year.

Last month, BoU revealed that it would use interest rates to keep inflation from exceeding its 5% target.

The Central bank has pledged to take pre-emptive measures to ensure annual CPI inflation remains around the 5% target over the medium term. It therefore increased the CBR by 1 percentage point to 12%, a decision that prompted commercial banks to issue a flurry of press releases indicating that they have raised their interest rates to between 20%-22%. That effectively means that borrowers will borrow less for production, while those already servicing loans will have to pay back more.

Consequently, coupled with exchange rate volatility and uncertainties about the election cycle, analysts expect a noticeable weakening in the economy, particularly in the remaining part of the year.

“Nonetheless, substantial risks to growth emanating from both the domestic and external scenes continue to exist,” warns BoU, though the strengthening in the global recovery is expected to have a supportive effect. Indicators show that the best estimate of the output gap for 201415 is positive, by about 0.5-1%, as real economic activity in projected to remain robust in 201516, ironically supported by public investment and a rebound in private sector credit.

Source : The Independent


Namanvebased Industrial Training Centre commissioned

President Yoweri Museveni has hailed the People’s Republic of China for the cooperation and support to Uganda in different projects such as electricity generation, modern railway, airport building, the Entebbe Express way, the underground ICT backbone …