Why the persistent depreciation of the Uganda Shilling?

By Prof. Augustus Nuwagaba

Stability of a domestic currency in terms of its price per unit of a hard currency is an important economic fundamental.

The price of 1 unit of the hard currency in terms of the number of units of a domestic currency is what we refer to as exchange rate. This rate is important for an economy because it determines the investment climate as well as the stability of the financial system.

Since 2017, the Uganda shilling has persistently lost ground (depreciated) against the hard currencies particularly the Dollar. In 2008, USD 1 exchanged for UGX 1,635, June 2017, USD 1 exchanged for UGX 3,370 and currently USD 1 exchanges for UGX 3,838, indicating a loss of 134.7%   June 2008 and June 2018. The reasons for the depreciation of UGX are varied but the real problem remains low export sector performance.

The country has high import invoices with corresponding low export receipts; hence the country remains a net importer of goods and services. In 2017 and 2018, the trade deficit (difference in monetary value of imports and exports) was USD 3.5Bn and USD 2.5Bn respectively.

The major bulk of imports comprise motor vehicles, petroleum products, cosmetics, drugs, construction materials, alcoholic products, and clothing among others. Yes, we need our ladies to look marvelous, but remember any importation of these beauty products result in outflow of hard currency. Neither of those products is purchased in UGX. They are all bought in USD, with deleterious effect and pressure on already scarce Dollars, hence driving the price of dollars into the ceiling.

On the contrary, as a country, we do not have many exports to earn us hard currency. The major exports could have comprised tourism, fish, flowers, ‘nkuba kyeyo' and also products like processed coffee among others.

But since January 2017, we have hard persistent low export sector performance, hence low foreign exchange earnings, but remember; the demand for inputs has remained inelastic or even increased arising from a vibrant construction industry and rise in crude oil price on the world market.

Who is the beneficiary of the depreciation of the UGX?

1. Local persons/companies who earn in hard currency.

Once the UGX depreciates, those who gain are the local persons and firms that earn in hard currency, including those who charge for payment of their services in hard currencies and those land lords who are paid rent in USD. Therefore, consultants and expatriates all gain from the depreciating domestic currency.

2. Exporters

If the domestic currency depreciates, exporters are very happy. This is because once they export; the real value earned for the same quantity exported is more because the hard currency earned carries more value in the domestic market. Unfortunately, as I explained in the foregoing, Uganda's economy is a net importer. This means that as a country, there is nothing to gain from depreciation of the domestic currency. Instead, such scenario will fuel what we call imported inflation. Therefore, devaluation of a domestic currency provides serious incentives to economies like Japan and China whose products will become competitive in foreign markets because they are net exporters.

Who is the loser from depreciation of the UGX?

1. Salary earners

The greatest losers from the depreciation of the UGX are the salary earners. This is because though the UGX has lost value by 138.5% between 2008 and 2018, the salary earned is in most cases constant or slightly increased. The implication is that though you may be still earning the same amount in UGX, the real value has been eroded by inflation arising from the depreciation. This is because whenever the UGX loses value against the USD; this causes ripple effect for example on transport costs since petrol/diesel is imported products. Once their price increase, the oil importers do not make any loss, they just displace they would be loss to passengers who then bear the full blunt of the increase in transport faire arising from the hiking price of imported petroleum products.

2. Portfolio investors

Portfolio investors comprise those who purchase government securities-treasury bills and bonds.  When the UGX depreciates, the interest earned on the treasuries is discounted by inflation arising from foreign exchange volatility and subsequent depreciation of UGX. This is because the interest on the government securities is earned in domestic currency which is unfortunately losing value all the time across the gestation period for the bills and bonds. That is why it is important for Central banks to maintain price stability as it guides such investments. The interest rate given on such securities must be positive i.e higher than the inflation rate, lest portfolio investors will cut short their investment which can plunge the monetary aggregates into further jeopardy.

What is the solution to the depreciation of the UGX?

Without being overly pedantic, the only robust solution against the falling value of the UGX is enhancing export sector performance. We must harness our capacity as a country to earn foreign exchange. Every other effort, be it Central Bank intervention in the forex market will be just a stop gap measure. Indeed, the Bank of Uganda has injected more than UGX 300 Bn worth of USD in the forex market in the last 10 days, but this intervention has been quickly thwarted by the sheer pressure for the dollar by importers. The Country ought to adopt strict economic policy comprising the following tenets:

1. Deliberate actions to drastically reduce imports: This can be achieved through heavy taxation of unnecessary imports while regulating those considered essential.
2. Enhance export promotion for a wide range of products particularly agricultural products: This can be done through enhancing value addition to enhance shelf life of the products and increase the real value for the product.
3. Rigorous market penetration and addressing distortions in international trade architecture: Here, there is need for review of instruments of global economic governance including both tariff and non-tariff barriers.
4. Reviewing contracts for international infrastructural companies aimed at enhancing local content in contractual arrangements: It is pertinent that all infrastructural projects include local content closes. The UGX would not depreciate amidst all these infrastructural projects government has undertaken - Karuma Dam, Isimba, and various road constructions among others. Earnings by local partners would enhance dollar inflows, hence significantly contributing to appreciation of the UGX.
5. Supporting a deliberate policy on manufacturing thorough quantitative easing: This can be done through carefully implementing a "quantitative easing" policy through selection of critical manufacturing initiatives based on cottage model. This should be based on SMEs with households that are "functional" with production hubs across the country.
6. Addressing high cost of borrowing: Government needs to establish deliberate long term financing sources. This is because the current interest rates are too prohibitive to investment particularly for sectors such as agriculture and agribusiness. These need relatively low interest rates and longer grace period all which are not tenable with the current financial system in the country based on short term financing sources. 

Writer is an International Consultant on Economic Transformation in the African Region