The dollar’s continuing rise against the Uganda shilling has led to concerns that the trend may undermine the growth of the country’s construction sector.

The dollar rose by about 2.9 per cent against the shilling during the first two weeks of 2015, according to markets reports, amid significant dollar outflows from several emerging markets to the US.

In less than a year, the shilling has lost roughly 14 per cent in value against the dollar — a pattern demonstrated by a new record low of Ush2,965 posted in the second week of January, compared with the previous record low of Ush2,920 registered in September 2011.

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Market analysts project the shilling will remain weak in the first quarter of 2015 on account of rising import needs pegged to ongoing infrastructure projects.

“The sharp rise in the dollar will directly raise construction costs due to significant importation of building materials. This will discourage many developers from executing planned projects leading to a slowdown in building activity,” said Shakib Nsubuga, Lamudi Uganda country manager.

Mr Nsubuga said construction companies need to find local substitutes for selected materials in order to minimise their exposure to dollar fluctuations. Owners of undeveloped land will also be compelled to sell due to high development costs, resulting in discounted prices and increased demand for such properties.

Widespread importation of building materials has directly exposed the real estate industry to fluctuations in the dollar, with many developers already facing increased prices for various items and higher overall project costs.

Besides construction materials, support services such as architectural work and bill drafting services are also priced in US dollars, a factor that escalates the impact of dollar fluctuations for real estate developers.

About 65 per cent of construction materials are imported, industry sources said, while some key inputs such as cement, roofing sheets, bricks and sand are locally produced. Commonly imported building materials include floor tiles, usually sourced from Italy and China, chandelier lights, glass and toilet seats.

“The sharp rise in the dollar will inevitably affect prices of imported building materials and small tenants are more likely to default or shift to cheaper premises offering lower rates due to existing oversupply of commercial space,” said Moses Lutalo, head of commercial and residential portfolios at Knight Frank Uganda.

As a result, Mr Lutalo said, the trend of dropping occupancy rates in large office buildings will continue, while smaller ones will struggle to achieve the 50 per cent occupancy rates needed to finance annual mortgage payments.

Though shortage of locally produced high quality building materials is blamed for this dilemma, notable increases in construction costs are expected to slow down existing projects and delay commencement of new ones, leading to reduced growth across the real estate industry, observers say. However, revised industry growth forecasts were not available by press time.

Industry analysts also anticipate increased relocation of tenants seeking cheaper commercial space in an attempt to minimise currency-related costs alongside increased appetite for shorter-term rental contracts of three to six months.

Despite worries sparked by dollar appreciation, some economists project significant growth in construction activity within selected Kampala suburbs. Fred Muhumuza, a senior manager at KPMG Uganda, said the surge in the dollar may be temporary but it is already affecting other sectors outside real estate.

Other affected sectors

Dr Muhumuza cites some medical insurance firms that have been forced to reduce the number of service providers because some hospitals have recently adjusted their drug prices due to the impact of the rising dollar on imported health products.

Besides that, he argues that increased relocation of tenants from upmarket suburbs to those that offer lower rental charges is likely to depress demand in certain areas and trigger a boom in new target zones.

Whereas construction companies are traditionally allowed to escalate contract prices by a maximum of five per cent to absorb unexpected changes in prices of affected items, local firms remain vulnerable to currency shocks.

“Most of our building materials are still imported because of low local production capacity. For example, there is no local producer of high quality floor tiles,” said Fred Tumwesigye, a director at engineering firm Babcon Uganda Ltd.

Mr Tumwesigye said most construction firms quote costs in Uganda shillings while price escalation clauses favour increases in market prices and not foreign exchange fluctuations. As a result, contractors will be forced to fore go some of their profit margins in order to absorb currency related costs.