BoU: Brace for high interest rates

The financial regulator is in consultation to begin purchasing locally produced gold to bolster its foreign reserves and address challenges in international financial markets

Kampala, Uganda | THE INDEPENDENT | Uganda’s central bank has urged borrowers to prepare for high interest rates due to tightening financial conditions and increased government borrowing on the domestic market.

The Bank of Uganda raised the central bank rate from 9.5% in January to 10.25% in April to combat inflation, a decision that saw commercial banks increase their lending rates by 20 basis points to an average of 20.8% during the same period, according to the Bank of Uganda’s State of the Economy report issued on Thursday.

To worsen the situation, yields on treasury securities in the secondary market and bonds have been on an upward trend, prompting banks to prefer lending to the government to the private sector. Latest statistics indicate that yields on treasury securities in the primary market marginally rose across all tenors in the three months to May as securities issuances increased.

The 91-day, 182-day, and 364-day yields averaged 9.7%, 12.7%, and 13.4%, respectively, in the three months to May, compared to 9.7%, 12.4%, and 13.0% in the three months to February 2024. Yields on the 2-year, 3-year, 5-year, 10-year, 15-year, and 20-year bonds in the three months to May averaged 13.8%, 15.0%, 15.5%, 16.0%, 16.5%, and 16.8%, compared to 13.2%, 14.3%, 14.8%, 15.8%, 16.3%, and 16.8% in the three months to February 2024.

Except for the 91-day treasury bill, yields in May were over 100 basis points higher than a year ago, while bond yields were relatively unchanged, except for the 3-year bonds, which increased by 80 basis points.

“Overall, lending rates are expected to rise and remain elevated owing to tightening financial conditions amid the increasing government issuances of securities in the domestic market,” stated the Bank of Uganda in its State of the Economy report for June 2024.

This comes as private sector credit dropped to 7.8% in the three months to April this year, as commercial banks reduced lending and borrowers stayed away due to increased costs. This represents a 0.6% drop in private sector credit compared to 8.4% in January this year.

The rise in lending rates was most pronounced in the agriculture, manufacturing, trade, and housing sectors. A moderate decrease was observed in personal loans and the transport and communications sectors. The central bank noted that private sector credit growth in shilling-denominated loans at 9.4% remained weak and below historical trends. Meanwhile, foreign currency-denominated loans growth moderated to 3.8% from 6.4% over the same period.

The central bank reported that while both gross credit extensions and recoveries declined, the decline in gross extensions was faster than the decline in gross recoveries during the same period, as banks increasingly cut back on renewing credit lines for borrowers. Credit demand eased from Shs 5.3trillion to Shs 5.1 trillion during the same period under review, while supply remained flat at Shs 3.4 trillion. Government interventions, such as the Parish Development Model (PDM), Emyooga, and fintech financing sources, helped prevent even lower credit growth.

BoU to purchase locally produced gold

Meanwhile, the central bank is in consultation to begin purchasing locally produced gold to bolster its foreign reserves and address challenges in international financial markets. The domestic gold purchase program aims to mitigate declining foreign currency reserves and address associated risks in the international financial markets. As of April 30, 2024, the country’s reserve stock amounted to about US$3.5 billion, or 3.2 months of import cover, slightly lower than the 3.4 months registered in April 2023.

“This initiative is also expected to support the government’s ongoing value addition to the minerals and Import Substitution Strategy by reducing the imports of raw gold into the country,” the central bank said. By purchasing gold directly from artisanal miners, the Bank of Uganda will also support the livelihoods of artisanal and small-scale miners, with positive spill-over effects on other sectors of the economy, in line with the bank’s mission of supporting the government’s socioeconomic transformation, according to the report.

Adam Mugume, an economist and director of research and policy at the Bank of Uganda, told Xinhua news agency that the gold will be purchased from local miners and processed to at least 99.5% purity levels before being converted into monetary gold.

“This is a consequence of the fact that purchasing foreign currency from the domestic market has been constrained by low foreign currency inflows as a result of dwindling budget support,” he said.