The cost of borrowing in Uganda is likely to rise after the Bank of Uganda revised the Central Bank Rate (CBR) for the month of August upwards by 1.5 percentage points to 16 per cent.

The move is part of efforts to relieve renewed depreciation pressures on the local unit that saw it fall to more than Ush3,500 against the US dollar at the beginning of this month.

After the policy rate announcement, the shilling gained slightly on Monday. On Wednesday, it opened at Ush3,560, against the dollar and by midday it registered Ush3,541.

“The new CBR decision clearly met market expectations. Average prime lending rates will rise to a range of 25-26 per cent as banks factor in the latest rate increase,” said George Mulindwa, a portfolio manager at Stanlib Uganda.

Depressed credit growth, on the other hand, is likely to result in weaker economic activity as businesses and consumers cut back on spending, as well as in a slowdown in government procurement expenditure.

“As credit growth shrinks, it will give way to lower economic growth of four per cent by the end of 2015/16,” said Mr Mulindwa.

The latest policy rate rise is likely to steer further increases in interbank rates and yields earned on Treasury bills and bonds, a scenario that could attract an additional supply of dollars in coming weeks and subsequently ease pressure on the local currency, analysts say.

Overnight and one week borrowing rates applied in the interbank market — a credit window used by commercial banks to source funds needed to satisfy short term liquidity demands — directly influence funding costs and market behaviour, experts say.

Therefore, a projected increase in the interbank one week borrowing rate could force banks to offload some dollars in an effort to mobilise the shillings needed to meet cashflow demands from customers.

The overnight and one week interbank rates stood at 14.5 per cent and 18 per cent respectively at the start of this month. But analysts project these rates will hit 20 per cent and 21 per cent respectively in coming weeks as the effects of tighter policy actions begin to be felt.

Tightening liquidity

“As a result, more banks are expected to offload their long dollar positions over the next two weeks so as to acquire the shillings needed in their operations. Higher yields are anticipated to attract more offshore players and this will gradually boost the shilling,” said Daniel Sage, a treasury dealer at Centenary Bank Ltd.

“However, prime lending rates are likely to average 24.5-25 per cent in the near future following the new CBR decision.”

BoU is also banking on tight liquidity conditions in the interbank market to boost the shilling.

“This is an attempt to tighten liquidity in the interbank market in order to minimise speculative actions in the currency market,” said Stephen Mulema, BoU’s director for financial markets. “This new policy rate increase is intended to tighten liquidity further and tame volatility in the exchange rate over the short term.”