The cost of curbing inflation

Aug 11, 2012

LAST year, economic growth dropped to its lowest in more than a decade to 3.6%. The price cannot yet be quantified, but the anecdotal evidence stares us in the face at every corner

By Paul Busharizi

IN 2010, Jack finally made his big move. He resigned his job and set up shop as procurement consultant. He had it all worked out.

Jack had one client - a government agency, who had committed to throwing work his way, which should have tided him over as he sourced more clients.

Using his savings, but mostly personal loans, to get him over the initial stages of his business, Jack's business seemed to be gathering momentum until 2011.

"Business had dried up coming to the elections but we all hoped when the elections were over it would come back," he said.

"Instead, inflation shot through the roof, which we did not feel immediately, what we felt was the increase in bank interest rates and suddenly with little business coming in the door we could not keep with payments to the bank, landlords."

Jack swallowed his pride and wound up his business and went job hunting.

"My creditors are still on my case everyday. We didn't stand a chance," he says. In 2011, higher food prices driven by regional demand, campaign-related spending and fluctuating currency, inflation hit a record high of 30% in October, the highest it had been since 1993 - almost 20 years.

The Bank of Uganda (BOU) recognizing the danger, jumped into the fray to mop up excess money in the economy, a necessary step seeing as inflation is too much money chasing too few goods.

In July, BOU introduced the Central Bank Rate, an indicative rate against which bankers pegged their own lending rates. Starting off at 13% in July 2011, the rate jumped to as high as 21% in April this year. Bankers followed suit with base lending rates jumping to as high as 30% from an industry average of about 18% at the beginning of 2011.

As a result, the loans applied for slumped to sh562b in May from sh737b in July last year. Stifling credit expansion is one way of slowing the growth of money supply in the economy.

In addition, BOU stepped up its issues of government paper as another way to suck out excess money from the economy, issuing new bonds worth sh1,025b in 2011.

This was almost up twice as much from 2010 when the Central Bank issued bonds worth sh670b. Up to July this year, sh685b in bonds were issued.

The Central Bank’s aggressive action has paid off with inflation now down more than half from its October high to the current 14%.

But the cost to the everyday economy has been steep. Uganda National Chamber of Commerce president Olive Kigongo says her organisation is still getting feedback from its members but the pain is there for everyone to see.

“People are struggling with increased interest payments, some have had to forfeit property, the purchasing power remains low, merchandise is stuck in the factories, on the shelves and the improved inflation is not being felt,” she said.

But BOU says letting prices find their own level was not an option.

“If we had sat on our hands, inflation would have gotten much, much worse and the measures we would have taken to bring it under control would have been much more drastic than the ones we used. The CBR stopped at 23% but if inflation had gone beyond, we would have been forced to have a CBR of more than 30%,” deputy bank governor, Dr Louis Kasekende said.

He added that they did not know the full cost of reining in inflation to the economy, but they had noticed that bad loans had jumped to 4% from 2.6% at the beginning of last year.

“In the long run, inflation is contained by economic growth, but in the short-run, infrastructure needs are massive to support growth and disinflation,” the Central Bank said in a recent publication.

Last year, economic growth dropped to its lowest in more than a decade to 3.6%. The price cannot yet be quantified, but the anecdotal evidence stares us in the face at every corner.

Robert thought setting up a hardware store in his neighbourhood, which had turned into one huge construction site was a good idea. He took out a mortgage on his house to finance the business, planning to start with a bang.

No sooner had he taken the loan last year than interest rates begun to skyrocket. Attempts to negotiate with the bank fell on deaf ears. The business went under and now Robert is trying to stay one step ahead of the auctioneer.

“Some months I take home nothing from my salary. Thankfully, my wife still has a job and she is taking care of the family, but losing the house is not an option, we sold both our cars to keep with payments,” he says.

One thing is clear from his tone; he doesn’t believe he can hang on much longer.

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