For the past three months, Uganda’s trade with its neighbours has been receiving a major boost from the depreciation of the shilling against the dollar, while having to foot an inflated import bill.

A combination of political risks in Uganda and South Sudan, demand for capital from the emerging oil economy, the aftershock of the global financial crisis and trouble in the Eurozone, has fuelled a dramatic weakening of the shilling in the past three years.

Diverting public money to finance the impending election and the slow response to the brewing currency crisis has helped accelerate the shilling’s fall, analysts told The EastAfrican.

Since July 2008, at the onset of the global financial crisis, the Ugandan shilling has lost 44 per cent of its value, which is the sharpest drop among any of the East African Community members, with the Kenyan and Tanzania currencies losing a quarter of their worth respectively.

Two weeks ago, Bank of Uganda Governor Emmanuel Tumusiime-Mutebile sounded a warning after the shilling continued to slide, offering a rare statement explaining his decision to intervene. “I think is it now necessary to state clearly [BoU’s] position on the exchange rate,” said Mr Mutebile.
“We believe that the current level of the Ugandan shilling/dollar exchange rate is undervalued.” According to government statistics, the shilling fell 15.6 per cent against the dollar during 2010, reaching the 2,395/2,400 rate band by mid January, from 1,700 in mid 2008.

Last week, after BoU intervened by selling dollars, the exchange rate improved to 2,300/2,320.
“Pressure on the shilling started some time back,” said Razia Khan, Standard Chartered Bank’s chief economist for Africa.

“In the aftermath of the crisis, when African central banks introduced more policy accommodation, we saw the BoU buying forex (releasing shilling liquidity into the economy) in order to keep market interest rates down.

In part, this was also a reaction to the exit of foreign investors from markets like Uganda that had seen considerable interest.”Ms Khan said that the upcoming elections may have played some role in nervousness about the shilling allied to delays to the oil production timetable, because of the unsettled matter of the amount of tax payable on the Heritage sale.
“Uganda is unlikely to become an oil producer in the next year,” said Ms Khan. “This played further on market sentiment. With much of the market one-way, expectations of shilling weakness became self-fulfilling. The BoU started selling forex again, but it may have been a case of too little, too late.”

Election and oil factor

“My personal opinion is that you have a situation created by an election coming up, and lots of capital expenditure going towards development of oil reserves,” said Eric Musau, an analyst at African Alliance.
“I don’t expect that to persist for too long... more investments into the country and further revenue from oil are likely to cause the currency to appreciate. I wouldn’t be surprised if there is some element of speculation around the currency.”

On the surface, a weak shilling has worked in Uganda’s favour in expanding its trade within the EAC, after global demand flattened, and as its coffee output and exports faltered.

This has, however, come with major pains, namely, imported inflation from a ballooning import bill as global energy and transport costs rose.

Government statistics show that informal cross-border trade, which measures Uganda’s exports to especially member nations of Comesa, increased to $54.5 million in October and $58.36 million in November after trading at a meagre monthly average of $35 million since June 2010.

During the later months of 2009 and early 2010, Uganda’s regional export receipts averaged $76 million a month, but the situations arising especially around South Sudan brought a massive dip in exports.

South Sudan has been Uganda’s biggest trading partner for the past three years, but political uncertainty over the January 11 referendum dampened exports.

The other major reason for the decline in local exports was the cutting off of oil revenues to South Sudan by the government in Khartoum and weak agricultural performance due to poor weather. 

With private sector imports holding at a monthly constant of just above $310 million, the international trade gains realised from the flagging currency have not been proportionate to the pain felt elsewhere as rising inflation started to bite and purchasing power went down.

The import bill did not reduce; instead, it actually grew bigger because government imports grew from $15 million in October to $91.7 million in November 2010.

As one economic analyst explains, “The ideal result of the weakening shilling should be reducing import volumes and increased foreign consumption of local products, but the reverse has held and because Uganda is largely an importing economy, rising import costs against marginal increases in exports further widened the current account gap, leaving the country owing more to outsiders than it did when it was in a stronger currency position.”

Towards the end of the year, expectations were high that Uganda’s trading gap would narrow substantially from the weakening Uganda shilling with BoU expecting the cheaper local unit to go some way towards correcting the current account imbalance.

Unfortunately, it appears this was not the case for, having narrowed by 35 per cent in October; the export-import gap grew 46 per cent to reach $214.5 million in November, the fault mostly lying with local exports, whose performance BoU admits has been “sluggish.”

According to the BoU, the current account imbalance has been a major driver of currency depreciation, and has substantially weakened between June 2009 and November 2010.

Shaky public finances

Any hope of Uganda shrugging off its net debtor status is a long way from being realised, especially after Finance Minister Syda Bbumba’s admission that the government is sitting on shaky finances.

An analysis put out by BoU in November revealed that the government was facing difficulties meeting trade-related tax collections, and also spending what it already had in place on key public infrastructure like building electricity plants and lines and roads that are crucial to sustain Uganda’s fast growing economy.

The government’s inability to spend as fast as anticipated helped to minimise the budget deficit. Some of these savings appear to have been used to help pay for President Museveni’s re-election campaign, given that his government sought permission from parliament for a supplementary budget and raided the coffers to curry favour with key voting blocs.

With the government running out of money, there are fears the shilling will be devalued further in the coming months.

There are less than six months left to the end of the fiscal year, which leaves Treasury with the unpalatable options of either printing more money, borrowing to add onto an already substantive government debt or raiding the foreign reserves at the central bank, the very source of the recent currency stabilisation.

Whichever alternative the Treasury opts for, the end result will be the same — a weaker shilling.
Financing public spending through debt, diverts resources away from the private sector, which needs a robust credit supply system to thrive and thus drive economic growth.

Much of Uganda’s growth has been driven by expansion of credit to business and consumers, with lending growing by as much as 30 per cent by the end of September 2010.

Increasing government borrowing results in higher yields, higher interest rates and therefore higher inflation.As of now, inflation is at four per cent, having reduced from 13 per cent in 2009, and BoU is desperate to keep it from going above its self-defined target of five per cent, which is why the rapid pace of depreciation was so alarming, analysts said.

BoU research director Dr Adam Mugume expects real GDP to grow seven per cent in 2010/11, with robust growth supported by high investment in infrastructure and productivity gains.

“The deficit incurred to support economic recovery after the economy slackened due to the financial crisis is supportive of longer term growth provided it is used to finance infrastructure that eventually increases productivity in the economy,” he said, nonetheless cautioning against excessive borrowing that increases government debt and deters economic growth.

Raised repo rates

In addition to selling $45.3 million two weeks ago and another unspecified amount last week, BoU also raised inter-bank and repurchase agreement (repo) interest rates in pursuit of a tighter monetary policy intended to discourage speculators’ influence over the exchange rate by choking off their profits.

Even with the recent central bank interventions that have seen the local unit gain some ground against the dollar, the shilling remains weak at 2,300/2,320, compared with its January 2010 level of 1,945/50.

All of this in addition to the looming threat of a second Eurozone debt crisis, will most likely find the shilling in an untenable position, fighting to stay strong against attacks from all corners.
“The resolve on the part of the authorities to stabilise the exchange rate more recently is good, but a more consistent approach may be needed.

Volatility may persist until election-related uncertainty passes,” said Ms Khan, “Longer term, with the promise of eventual oil production, and Uganda gaining strongly from trade with South Sudan, fundamentals are likely to support an appreciation of the shilling. Following the referendum, current levels of dollar-shilling exchange rate may be a good level from which to go long on Ugandan shillings.”