Bank of Uganda headquarters in Kampala.
On July 6, Bank of Uganda held an emergency monetary policy committee meeting and decided to increase the central bank rate (CBR) by one percentage point to 8.5%, the highest since the country got hit by COVID-19.
The Bank had in June this year raised the rate by a percentage point. Previously, the Bank had been setting the interest rate signal almost every after three months to direct the movement of interest rates in the market, as a tool to manage inflation.
The main reason for this decision, officials said, was to signal to lenders not to lend money as much as they would, as a way of reducing money in circulation to fight spiraling inflation.
This decision has since sparked debate on whether BoU took the right path given that current inflation is imported and mainly comes from external cost pressures stemming from higher global food and commodity prices, persisting global production and distribution challenges and somewhat rising domestic food crop prices due to dry weather across the country.
There is also a general sentiment that people are ‘broke’ and this would ideally mean, BoU’s monetary policy decisions should work towards putting money in peoples’ pockets.
Data from Uganda Bureau of Statistics (UBOS) released on June 30 indicates that headline inflation increased from 6.3% at the end of May to 6.8% at the end of June. Core inflation, which is the target for monetary policy increased from 5.1% to 5.5% at the end of May and June respectively.
According to BoU data, the rising food and energy prices, intensified by a weaker Uganda shilling, have worsened the inflation outlook for the remaining part of 2022. Headline and core inflation are forecast to average 7.4% and 6.3%, respectively in 2022, slightly higher than the 7.2% and 6.1% that was projected in the June 2022 forecast round.
“The monetary policy committee assessed the uncertainties and risks to this forecast as significant and the balance of risks is tilted to the upside,” said Deputy Governor, Michael Atingi-Ego.
Atingi-Ego said, the main upside risks include; global inflationary pressures amidst persistently higher world food and energy prices, a faster shilling depreciation as advanced economies raise their policy rates to control escalating inflation, higher prices in the global markets that could further increase the demand for foreign exchange (US$ in particular) required to purchase about the same quantity of goods, which may further weaken the shilling. The others are, potential worsening of disruptions of global production and distribution due to stringent controls of Covid-19 outbreaks, especially in Asia and higher domestic food crop prices due to the effect of prolonged dry weather conditions on food harvests.
In a commentary published in one of the daily newspapers, Elizabeth Nuwaha, a research fellow argues that the CBR tool will not address the underlying casual factors.
“With supply driven inflation, monetary policy responses should be complemented by several government response measures within the fiscal framework that focuses on supply,” she said.
Nuwaha added, tightening is happening when government borrowing is up and continues to threaten the private sector that want to borrow. She also said, the poor remain the most vulnerable to emerging inflation risks and slow economic recovery.
She says, it will be imperative that enhanced social protection measures are considered targeting relief for the most vulnerable including youth, women and people living with disabilities in the extreme while continuing to push up reforms aimed at enhancing employment.
The government responses should also be re-prioritised towards projects that have a high potential to unlock the production capabilities of the country.
Nuwaha also said, minimising and curbing public expenditure leakages and enhancing budget credibility through minimized use of supplementary budgets will be the game changer.
In an interview, Fred Muhumuza, a senior economist and lecturer at Makerere University said, the tightening of monetary policy is a signal to the financial institutions to be cautious to who they lend money to so as not to make losses given that demand is subdued.
“The central bank is trying to also tell people that think twice before you borrow,” he told The Independent on July 7. Asked whether this is necessary given that lenders are already implementing strict measures for lending as the economy emerges from the COVID-19 pandemic, Muhumuza said, “BoU is emphasizing the message of risk aversiveness but to even tell them that this is not a risk, it is a reality…that is the space we are in.”
Muhumza said, whereas the poor will be hit hardest, the central bank’s first line of duty is to protect the stability of the financial sector. He also said, the decision on the CBR will support the shilling, in that if people do not borrow to buy imported products, then, there will be less demand for dollars – the shilling will remain stable, strong- so BoU is looking at a multiplicity of parameters.
Augustus Nuwagaba, another senior economist told The Independent that he supports the BoU decision on the CBR “because we don’t have another better option”.
He explained that inflation has to be managed whether it is imported or not, and the only way to do it in our case is to use the CBR. “Of course, whatever the central bank does, comes at a cost and you cannot avoid it because you have to protect the economy,” he said.
However, he said the poor will be hit hardest given that their marginal propensity to consume is higher than wealthy individuals and that the former can still survive even when things get tougher.
Economic outlook
Overall, Ating-Ego said, economic activity is projected to remain modest as the shocks to commodity prices, production, and distribution disruptions and global inflation continue to dim the prospects for domestic economic growth.
He said, economic growth is still projected in the range of 4.5-5.0% in 2022 and rising slightly to 5.0-5.5% in 2023, in part supported by public investments. Weaker external demand, high domestic inflation and resultant tighter domestic financial conditions will constrain exports, consumption, and investment. The Deputy Governor said, BoU remains steadfast to take appropriate decisions to protect the stability of the financial sector.
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