The depreciating shilling and Uganda's economic environment

Jul 10, 2015

Uganda runs a floating exchange rate system, where the market forces determine the value of the shilling.


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By Nobert Akantorana Bwana

Uganda runs a floating exchange rate system, where the market forces determine the value of the shilling in relation to other foreign currencies.

This year,2015, Bank of Uganda has had to intervene by selling $200m of its foreign reserves in order to reduce the rate at which the shilling is depreciating against the dollar and meet demand in forex (especially for the US dollar).

The US dollar is demanded by importers as well as big businesses which conduct their businesses in US dollars. To the importer, a depreciated shilling means that they will import their goods expensively. As for the big business whose inputs are imported, a strong dollar would increase operational and production costs.

If the shilling continues to depreciate against the dollar, the prices of goods are generally expected to gradually increase. At the moment inflation is still below five percent. However, Stanbic bank predicted that the inflation rate could go as high as eight percent by the end of 2015.

In his speech to manufacturers, the governor of Bank of Uganda, Emmanuel Mutebile, said that it wasn’t sustainable to prop up the exchange rate at levels not consistent with supply and demand in foreign exchange markets.

A reduction in foreign direct investment and low export in flows are responsible for the widening current account deficient.

Agriculture contributes 80% of Uganda’s total exports, with the European zone being its biggest market. In May 2015, a one month self imposed government ban on fruits and vegetable exports to the European Union led to multimillion dollar losses to exporters, as well as reduced market share during this period. This loss, coupled with reduced global commodity prices is a major setback to the exporters as well as our exchange rate market.

The current ongoing crisis in Europe over Greece’s “No” vote towards austerity policy only creates more uncertainty for our export markets. Greece’s threatening exit from the Euro group could have rippling effects across Europe and this could slow down the economies in Europe.

European investors would likely reduce their investments in highly risky markets (such as Uganda) and instead demand for more secure the US treasury bonds. This trend would only make the dollar stronger.  A slowdown in economic growth across Europe would consequentially lead to reduced remittances from Ugandans working abroad.

Across the Uganda boarders, security concerns continue to threaten our exchange rate markets. In Africa, our biggest export market was originally Southern Sudan, until the war broke out afresh. Security concerns have made it difficult for Ugandan traders to conduct business in Southern Sudan. In Kenya, Al  shabaab militants continue to scare away tourists from coming to East Africa. Uganda continues to suffer from loses in foreign revenue from tourism due to this terrorism threat.

The media has a major role to play in the current exchange rate volatility. Speculative opinion about the depreciating shilling against the dollar, as well as future exchange rates have only caused more un certainty in the market.  T

he governor’s speech to the manufacturers early this month has been greatly debated on social media platforms as well as different news reports. This speculative opinion about market fundamentals only increases the volatility in the exchange rates.

Going into an election year, economists predicted that the shilling would depreciate as indeed has been the case. The ambiguity concerning the NRM party presidential flag bearers has aggravated the political uncertainty ahead of 2016 presidential elections. These political battles fought in the media, increase investor fears. This year has also seen number of foreign owned companies pay off dividend to share holders abroad.

In a floating exchange rate system, monetary policy makers don’t seek to predict exchange rate movements.

However, through tailoring monetary policy to domestic macroeconomic objectives, exchange rates will settle naturally in a state of maximum efficiency.

The writer is a voter in Rukiga County, Kabale



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