In July 2011, the Bank of Uganda reformed its monetary policy
The rise of Bank of Uganda
By Pascal Kwesiga
August 15, 1966 is a signifi cant date in the annals of Uganda's banking industry. It is the day the Central Bank issued the fi rst Ugandan shilling, with sh100 as the largest denomination. Today, the largest denomination is sh50,000.
The day also marked the commencement of the operations of Bank of Uganda (BOU), having been set up by an Act of Parliament on May 24, 1966. The Act received presidential assent on May 28, 1966, four days after its passing by the House.
Although it was apparent even before independence in 1962 that Uganda ought to have an independent Central Bank, for some reasons, BOU was set up four years later. Before 1966, Uganda was a member of the East African Currency Board (EACB), which had been established by the British colonial administration in 1919.
EACB, a single monetary authority for East Africa then, issued a single currency for the three countries - the East African shilling. The main task of the board, which had its headquarters in London, was to issue and redeem the East African currency in exchange for the UK's pound sterling.
The East African shilling was pegged to the British pound sterling and the value was sh20 per pound. The board had initially been set up to serve the British colony of Kenya and its protectorate of Uganda, but its mandate was expanded to include Tanganyika in 1920 and Zanzibar in 1936. The colonial administration later extended its services to Somaliland in 1942 and Eritrea, Ethiopia plus Aden in 1943.
As the independence of the East African states appeared to be on the horizon, the board was repositioned and its headquarters transferred to Nairobi from London. However, after Tanganyika gained independence in 1961, Uganda in 1962 and Kenya in 1963, it became clear that EACB could not serve the interests and aspirations of the newly independent nations.
There was pressure in the new sovereign states to establish independent central banks. A report from the central bank of the Federal Republic of Germany recommended a two-tier system that would see each country set up a state bank to carry out the functions of a central bank.
It also proposed a Central Bank for East Africa to supervise the operations of state banks. But the concept suffered a stillbirth after countries questioned the extent to which national sovereignty could be shared to achieve a coherent policy on monetary matters and rejected the idea of a heavily decentralised bank.
How BOU was set up
According to information from BOU, on February 2, 1965, Uganda indicated its intension to establish several fi nancial institutions, including the BOU to handle central banking functions. A few months later, the three East African countries, on July 10, 1965, offi cially announced their plans to set up independent central banks.
At its inception in Liverpool House on Parliamentary Avenue, the Central Bank had four departments - the general manager's department, comprising banking and currency, accounts and public debt; secretary's department, exchange control and research departments; with a total number of 56 employees. The bank's supervision department was set up in 1968, while the accounts division in the general manager's department was elevated to a department.
The development finance, internal audit, foreign operations, external debt management office, agricutural secretariat, security, management information system and medical departments were created between 1977 and 1987.
The number of staff had grown to about 2,000 and the departments to 14 by 1991. The bank re-organised its departments into six functions, with each headed by the executive director. However, scores of employees who had been recruited earlier were relieved of their duties under the voluntary and involuntary schemes between 1994 and 1995. Yet the number of departments grew from 17 in 1995 to 21 in 2005 for greater efficiency.
In a document published at BOU's 40th anniversary in 2006, Leo Kibirango, who served as Central Bank governor between 1980 and 1986, said that his work at the Central Bank gave him a rare opportunity to participate and contribute to national economic management under four radically different governments.
First, under the short-lived era of the Military Commission, four years under Obote II, a short spell under Tito Okello regime and nine months with National Resistance Movement (NRM). He said one of the regimes had leaders who threatened to invade BOU to deal with ‘Bwana Foreign Exchange' who they accused of causing a public outcry due to his persistent absence from duty.
"In the same vein, Mr. Bank Credit was problematic and not readily accessible, precipitating tension between Bank of Uganda offi cers charged with the responsibility relating to banking credit, leading to gun-trotting and trigger-happy military and intelligence men eager to do target practice on living tissue of those labeled as economic saboteurs at BOU," Kibirango wrote.
He said managers and executives fl ed for their lives in the extreme circumstances. In one of the BOU's documents, the period between 1966 and 1971 is classifi ed as having been characterised by creative exuberance; 1972 and 1979 by the downside, 1980 and 1985 by reincarnation, 1986 and 1988 by experimentation and 1989 and 2006 by the liberal spirit.
The period between 1966 and 1971, described as a time of creative exuberance by the Central Bank, was characterised by the ‘move to the left' ideology and Nakivubo Pronouncements that intended to increase the nationalisation of foreign businesses.
The May 1, 1970, Nakivubo Pronouncement was a commitment issued by the then president, Milton Obote, in which he said his Uganda People's Congress (UPC) government would increase the nationalisation of major industries as part of a move towards socialism which was described in the Common Man's Charter as ‘the move to the left'.
With immediate effect, the president announced that the government would take control of 60%, up from at most 51% of over 80 corporations in Uganda. The pronouncement implied that the foreign businesses that included, among others, banks, insurance companies, manufacturing and mining factories and plantations would be run by state corporations, trade unions, municipal councils and cooperative unions.
The move stopped investment capital inflows and compelled investors to take their money out of the country, leaving disastrous consequences on the economy. Obote's move, however, was a debacle as it did not achieve the intended objectives.
The Central Bank responded by intensifying exchange controls and extended them to the other East African countries. The Uganda Argus March 27, 1971 issue quoted the chairman of Barclays Bank, Sir Frederick Seebohm, as saying: "No one questions the right of governments to nationalise within their territory...But to nationalise by instant decree and without any prior consultation is, to say the least, an unfriendly gesture, which is not likely to create a feeling of confidence among potential foreign investors."
The Asians who were aggrieved by Obote's move supported his overthrow by the then army commander, Idi Amin, in 1971. The distinct characteristic of the 1972 to 1979 ‘downside period' was the ‘economic war'. The policy that ushered in the economic war under Amin, was crafted to deal with what the government called economic agents who ‘milked the cow without feeding it'.
The economic war saw the expulsion of Asian investors, who Amin accused of exploiting the population by hoarding wealth and goods. The property of Asians, including factories, farms and estates, was reallocated to inexperienced Ugandans and government corporations ushering in a period of significant economic collapse. Banking was one of the sectors that were terribly affected by the economic war since Amin's decision struck at the heart of the economic lifeline of the country.
The banking industry contracted significantly, with many of the commercial banks closing their upcountry branches. During this period, BOU established a total exchange control regime, with no foreign exchange, leaving the country without authority from the Central Bank, save for diplomatic remittances from external accounts.
The Central Bank also directed that all expropriated businesses bank with Uganda Commercial Bank (UCB). "In these circumstances, all other foreign banks closed their upcountry branches, which were duly taken over by UCB. The Bank of Uganda protested in writing that UCB did not have the capacity to expand rapidly, as this would stretch its management capacity," the BOU says in one of its documents.
But the government ignored BOU's advice. Against BOU's prescriptions, the government continued borrowing and the debt burden reached 70% of the budget. In a 1975 annual report to finance minister, the BOU expressed reservations about the country's dwindling reserves. But the minister told Amin that the Central Bank was embarrassing the government by publishing information likely to hurt the establishment's credibility.
Bank of Uganda stopped publishing the annual reports. The country was engulfed in a debt crisis during which ministers and other government officials contracted debts without recording them in the national debt register.
It took several years and substantial resources to update the national debt register. "For a long time, the Bank of Uganda was not able to write its books of accounts and it took technical assistance and loss of face to write up the books of accounts," BOU states.
The country was hit by unprecedented levels of inflation during this period, but BOU could not effectively bring it down because its advice was not heeded. However, UCB did not take over the accounts of the commercial banks upcountry because it did not have the resources to offer the badly needed credit to farmers.
The period between 1980 and 1985 (reincarnation), according to BOU, was the time of ‘beginning from where we left off'. The reincarnation episode, according to the Central Bank, was characterised by a return to fi nancial programming, with technical and fi nancial support from International Monetary Fund (IMF), World Bank and other donors. Benchmarks, including the quantitative monetary aggregate and a dual exchange regime consisting of Window I (priority imports) and Window II (luxuries), were established.
The main focus of the bank during this period was to meet the quarterly monetary aggregate benchmarks and budgetary fi nancial limits. As Uganda's journey to economic recovery started taking shape, there was noticeable growth in the investors' confi dence and the banking sector started to get back onto its feet gradually.
The Central Bank says the period between 1986 and 1986 was shaped by point number fi ve of the ten-point programme - building an independent, integrated and self-sustaining economy. The major policy pursued during this ‘experimentation episode, according to BOU, was the currency reform recommended by international and local experts.
Although the number of commercial bank branches, which were around 300 in 1970s, had greatly reduced as a result of tough economic times, about 90 branches had been re-established by 1988. The number of commercial bank branches continued to increase slowly in the years that followed due to increased banking activity.
According to BOU, the time between 1989 and 2006 ushered in what it calls the liberal spirit manifested in the policies geared towards liberalising the markets, prices and monetary instrument.
As a result, in 1989, exporters of non-coffee exports were permitted to retain the proceeds on foreign exchange accounts and in 1990, foreign exchange bureau were licensed to commence business. The ‘liberal spirit episode' saw the progressive dismantling of restrictive quantitative controls as instruments of monetary policy and use of indirect monetary instruments for monetary policy management.
The Central Bank took over several indigenous commercial banks that were declared insolvent during the massive restructuring scheme in the banking sector between 1990s and 2000. Some of them were sold or liquidated.
The banks included Uganda Co-operative Bank, Greenland Bank, International Credit Bank and Gold Trust Bank. Uganda Commercial Bank, which hitherto dominated commercial banking business, was privatised during the same period.
However, from 1986 to date, the country has enjoyed relative political and economic stability for the Central Bank to perform its cardinal activities of issuing the national currency, regulating money supply through monetary policy as well as supervision and regulation of fi nancial institutions.
Other activities are the management of Uganda's external reserves, external debt and advising government on fi nancial and economic issues. Uganda has witnessed exponential growth in foreign exchange reserves due to the liberalisation of foreign exchange markets, introduction of interbank foreign exchange market, fiscal discipline, improve monetary policy formulation and implementation, coordination between fiscal and monetary policies.
These improvements, coupled with sound macroeconomic policies, have attracted substantial donor support in balance of payments and budget support. Bank of Uganda has managed to deal with the infl ationary pressures and maintained controls on money supply.
The money supply has potential to exert pressure on the foreign exchange rate, which automatically affects the value of international reserves. Bank of Uganda now has branches headed by managers in Kampala, Jinja, Mbale, Gulu and Mbarara towns. It also has four currency centres, headed by currency offi cers in Kabale, Fort Portal, Arua and Masaka towns.
Uganda's road to economic recovery
By Edward Kayiwa
In May 1987, the Bank of Uganda embarked on a journey to revive the country's macroeconomic stability, which had been eroded by years of war and business stagnation. The local unit, at the time had been severely downgraded, with inflation shooting through the economy's roof.
There was almost no foreign exchange in the country. The shilling exchanged at 1,450 against the US dollar, before the new National Resistance Movement Government introduced a new shilling, worth 100 old shillings, along with the 76% currency devaluation.
There was an urgent need for an effective monetary policy at the time. "To convert the old currency into the new one, two zeros were knocked off, that is to say, one new shilling was equivalent to 100 old shillings.
The measure helped to reduce excessive liquidity in the economy and restore the value of the Shilling that had been badly battered by the numerous economic distortions of the 1970s and 80s," says Louis Kasekende, the deputy Bank of Uganda governor.
Monetary policy refers to the use of various instruments under the Central Bank's control to regulate and influence the availability, cost use of money and credit in the economy. The goal of monetary policy is to achieve low and stable inflation, maintain a stable competitive exchange rate and support economic growth.
Secondly, a currency conversion tax was also levied at a rate of 30%, which helped to further reduce the supply of money and also availed the Government some quick revenue to finance its budget deficits that had expanded as rapidly as they are doing today.
Soon, both the elite and illiterate citizens started complaining that inflation was still quickly eroding the new currency's value and as a result, it was revised to a rate of sh60 per $1. "After that, the money supply continued to grow at 500% per annum, until the end of 1987. In July 1988, the Government again devalued the shilling by 60%, setting it at sh150 per US$1," he explains. By the end of 1988, further devaluation of the unit had been done, exchanging at sh165 per $1, to sh200 per$1 in March 1989 and sh340 per $1 by the end of 1989.
By late 1990, the official exchange rate was sh510 per $1. In 1995, the new constitution re-affirmed the Bank of Uganda as the county's Central Bank, thus mandating it with macro-economic stability.
In July 2011, the Bank of Uganda reformed its monetary policy framework to meet the challenges of macroeconomic management generated by the transformation of the economy over the previous decade.
"It was then that we introduced the Inflation Targeting Lite (ITL) monetary policy framework, under which we determine a Central Bank Rate (CBR), which is intended to guide short-term inter-bank lending rates and thereby influencing the marginal cost of funds for commercial banks," Kasekende says.
According to Kasekende, the Bank of Uganda uses regular interventions in the money market to ensure that the seven-day interbank rate is as close as possible to the CBR. He says the CBR is set once a month and is publicly announced, so that it clearly signals the stance of monetary policy during the month.
"It is set at a level which is consistent with moving core inflation towards BOU's policy target of 5% over the medium term," he says. The Bank of Uganda, according to Adam Mugume, the BOU executive director for research also employed the inflation targeting tool, which is an institutionalised commitment to price stability as a goal of monetary policy.
"This has helped the BOU in the development of an approach to the conduct of policy that focuses on a clearly defined target that assigns an important role to quantitative projections of the economy's future evolution in policy decisions, and that is committed to a high degree of transparency as to the goals of policy, the decisions that are made and the principles that guide those decisions," he says.
- It preserves the purchasing power of people's money and savings.
- Consumers and businesses are able to make longterm plans and investment decisions because they know that their money resources will not lose purchasing power in the foreseeable future year after year. Low and stable inflation also encourages savings.
- Interest rates, both in nominal and real terms, would be comparably lower, thereby encouraging investment and improved productivity, as well as enabling businesses to prosper in the period of stable prices.
- It enables businesses and individuals not to overreact to short-term price pressures by seeking undue price and wage rises, assuming long-term stability prevails.