Uncertain future for shilling

By Patrick Kagenda

A look at the underlying problem

On July 13, the Monetary Policy Committee of the Central Bank met to craft an appropriate response to shocks in the economy presented by the whipping the shilling has suffered in recent months. At that point, the local currency had shade over 27% of its value since the start of 2015.  Earlier, on July 9, the central bank Director of Communications, Christine Alupo had issued a statement that hinted that BoU believes that to some extent the shilling is being undermined by speculative forex trading and indicated that the Central Bank boss, Tumusiime Mutebile is readying to `burn the fingers’ of speculators.

The Uganda shilling is not a one way bet,” the Alupo statement warned, “The BoU is not indifferent to the volatility in the foreign exchange market and stands ready to intervene whenever it is necessary.”

In the same statement announcing the MPC meeting, Alupo said the central bank was raising the Central Bank Rate (CBR), which is the indicative rate for others, one percentage point to 13%. It also confirmed that BoU had intervened on the supply side in the foreign exchange market with an undisclosed amount of dollars. The BoU intervention led to a downward swing of just over 10% and the shilling was trading at about Shs3200 to the dollar on July 10 from Shs3600 on July 09. As they headed into their meeting this time, therefore, the shilling was enjoying a little bit of air. And when they came out of the meeting, the CBR was increased to 14.5% instead.

The MPC comprises the BoU governor, the deputy governor, and directors of supervision, research and operations, statistics, financial stability and communications. Their meetings are usually routine, weekly, and focus on inflation since the shilling trades under a free-floating market exchange rate.

But the urgency of the June 13 meet was indicated in it being brought from its scheduled date in August.

Even after the MPC meeting, the shilling held steady at the Shs3250 mark but it remains unclear where it will swing or whether it will be in the direction the shilling needs to stabilise.

Part of the uncertainty, it appears, is that the sins of the 2011 election-spurred economic volatility are visiting again in 2016. This time in the form of speculation. But you are unlikely to hear that directly from the macro-economic managers in the Bank of Uganda or the ministry of Finance.

Election fever

At around this point in the last 2011 election curve in May 2010, the dollar was trading at a monthly average of about Shs2,170, according to BoU statistics, but swung about 8% to Shs2,350 by the time of the election in February 2011 which was a relative gradual climb.

Unfortunately, the post-election period saw more volatility as protests over the election results swept across the country. As a result the dollar hit a high of over Shs2,800 in October 2011, a spike of over 30% from the May 2010 trading figures. It then started to cool off.

Going by the pace of trading in the current election cycle, the spike of the dollar in 2016 is likely to be higher and more volatile.

The current heat wave can be traced from July 2014, when the dollar, after 15-months of relative stability, swung abruptly up 4% from trading at a monthly average of Shs2,550 in June to Shs2650 in 30 days. It has maintained a determined upward pace and crossed the dreaded Shs3000 mark in May 2015. By end of June it was Shs3,300, which is a 10% jump in one month and about 30% over the 2014 figures.

Although President Yoweri Museveni earlier appeared to be heading into the 2016 election with a strong wind created by a disorganised opposition, the announcement by his erstwhile ally and point man, former Prime Minister Amama Mbabazi, that he would challenge him at the polls has punctured his sails.

The absence of Mbabazi also appears to have thrown the ruling NRM party election strategy room into disarray as critical decision appears to fall in inexperienced hands.

Meanwhile, Mbabazi’s entry appears to have reawakened the opposition side with perennial contender, Kizza Besigye announcing intentions to contest again. He is slogging it out with his FDC party president, Mugisha Muntu for the flag-bearer slot. Then there is the so-called The Democratic Alliance (TDA) of the less significant contenders and Civil Society Organisations (CSOs) hoping to convince the biggies to ally.

The result of all these movement is a high dose of fear, uncertainty, and anxiety. Markets, which dread those moods, have reacted in turn with the shilling coming off worse.

Scramble for dollar

Traders who were badly burned by the 2011 shilling depreciation are taking no chances this time. Some of them, like the spokesperson of Kampala City Traders (KACITA), Issa Sekitto, freely reveal that they are converting shillings to dollars whenever they can and are hoarding them.

The shillings woes could also be worsened by the increased dollarisation of the economy. Anecdotal evidence is abundant. Members of KACITA, for example, have for some time been complaining and at times staging business lock-downs in protest against rent being denominated in dollars.

According to latest figures from BoU released in June 2015, during 2014, foreign currency denominated components of the banks’ balance sheets grew faster than shilling denominated components.  Foreign   currency deposits rose by 16.9% compared to 13.7% in 2013.

Similarly, foreign currency loans grew  by 21.6 percent  in the  year  to  December  2014  compared  to  6.8  percent  in 2013.  As a result,  the  share  of  foreign  currency  loans  to total  loans  grew  from  41%   to  43.7%.

“This may   increase   the   exposure   of   the   banking   sector   to foreign exchange shocks,” the BoU statement warned.

The increased dollarisation can also be partly seen as a result of more international companies setting up shop in Uganda. Most of these usually upset the foreign exchange market as they stock-up the greenback in preparation to repatriate dividends to foreign owners, normally in the first months of the calendar year.

The Deputy Governor of BoU, Louis Kasekende, made the same point when explaining the current depreciation of the shilling albeit with emphasis on external pressures on the shilling.

He said: (in contrast to the past) “We are now interlinked with the developed countries, meaning a shock in a developed country, in minutes and hours, can affect a developing country especially frontier economies like Uganda.”

Kasekende said the main factors underlying the depreciation of the Shilling are mainly external and reflect weaknesses in the Balance of Payments.

He explained that compared to 2013/14, BoU had projected that the net figure from exports minus imports, plus net income from abroad, and net transfers would be about US$500 million larger in 2014/15. He said Uganda was suffering on all these fronts because tourism and commodity exports were performing badly. On the other hand imports, both oil and none oil related, were going up and requiring more dollars.

Kasekende said Uganda exports suffered because of lower global and economic trouble in South Sudan, which is Uganda’s largest export market.

BoU approach could be wrong

However, other experts argue that BoU and Ministry of Finance’s hiding behind the façade of so-called exogenous factors may be unavoidable but it should not obscure the need for a locally more nuanced response.

Fred Muhumuza, an advocacy specialist at Financial Sector Deepening Uganda says based on the interventions so far, including raising interest rates, the economy is likely to experience a decline in consumption and investment.

“This hits the business confidence,” he told The Independent, “in case they see inflation go up, they assume we have too much money and so they raise the interest rate (CBR) to stop us from borrowing and I for one do not trust their strategy.”

Lawrence Bategeka, a former senior research fellow in Economics at the Makerere University based Economic Policy Research Centre (EPRC) says whenever BoU intervenes in the market, it runs down the national reserves – which are not much anyway.

“While the deputy governor Louis Kasekende puts blame on the drop in the balance of payments, the question is why suddenly at the time of elections?” he says.

In any case, he adds, if what Kasekende says is true; then the measures BoU is using are wrong.

But Alpha Capital Partners managing partner Stephen Kaboyo says the current circumstances do not favour strong BoU presence through interventions by selling dollars to stabilise the shilling.

He says other measures by BoU, such as aggressively tightening the shilling liquidity through open market operations, and occasionally letting outstanding maturities touch unprecedented levels are more effective.

“Limiting access to the BoU Lombard window is also another measure that has been used to control liquidity levels. The tightness in the money market by design makes it very expensive for market players to hold long dollar positions and the conditions force them to sell dollars in order to alleviate the shilling tightness. This in turn stabilises the exchange rate,” he says.

Mutebile thinks long-term

When asked to explain what he sees as the way out for the shilling at a joint BoU, Ministry of Finance press briefing to explain the 2015/16 National Budget, Mutebile refused to answer.

“I will not answer questions on the exchange rate because the answers will create speculation,” he said.

Nobody was fooled. Most understood that Mutebile’s bag has only two tools; the Central Bank Rate (CBR) which he fiddles with depending on his perception of macro-economic trends and his objectives, and intervention in the foreign exchange market. On June 9, he nudged the CBR one percentage point to 13% and intervened in the market. His gun was empty.

Although Finance minister Matia Kasaija was more forth-coming, his claim that the government would practice prudent financial discipline and limit our spending in the first quarter of the 2015/16 FY that started July 01 was not convincing. Just a few days earlier, he had announcement the biggest national budget in Uganda’s history at Shs24 trillion. The budget breakdown showed huge expansionary expenditures on energy, infrastructure, and security.

Both Mutebile and Kasaija’s approaches appear to be breaching a cardinal financing principle by banking short-term expectations on long-term transactions. Although prudent now, the impact of the mismatch could be disastrous in the post-2016 election period.

In any case, the combination of foreign currency market intervention, high interest rates, and allowing currency fluctuation are standard fare often prescribed by the IMF. The challenge is how to find the optimal balance of the forces inflation, interest rates, Balance of Trade, budget deficits, the banking and financial sector – and finally, domestic market confidence.

Already Mutebile is failing on some, especially the domestic confidence front. When he met local manufacturers looking for reprieve, Mutebile advised them not to worry – the depreciating shilling is good, he said, because it makes imports expensive and local goods cheaper.

“For example,” he said, “it will be cheaper for tourists to visit Uganda. This should help to bring about a small narrowing of the trade deficit in goods and services.”

The other way out he offered was equally convoluted.

“We are forecasting a rebound in FDI, especially related to the oil industry, and financial inflows for the large energy projects of Karuma and Isimba, which will contribute to a larger financial account surplus,” he said, “Consequently, I hope that we will be able to achieve an overall BOP surplus in 2015/16 and thus accumulate foreign exchange reserves.”

Mutebile is of course one of the most celebrated macro-economic managers in Uganda, but in this case, he sounded like a drowning person waiting for a ship under construction.

Running away from the problem

KACITA’s Ssekito was unimpressed.

“The BoU is running away from the real factors causing the depreciation. The bank is not saying anything on the political climate in the country yet it has a lot to do with the economy. Investors are repatriating their capital leaving very little in Uganda because of political uncertainty yet BoU is not saying anything,” he said.

He added: “The other point that BoU cannot point a finger at is that most forex bureaus in the country are owned by well-connected people who are now preferring to keep money in dollars in their houses than have it in banks, BoU is not mentioning this.”

This is just one of many times that lay people, including traders, farmers, and commentators on talk-shows are putting pressure on BoU to show more vigour in direct efforts to save the shilling.

Some commentators, like Ssekitto, want a switch to a central bank predetermined rate – at least as an interim measure.

Previous interventions by BoU have shown its ability to influence the market. But it appears, at this point, it is leaning back in anticipation of a longer period of volatility. Already, rallies built around its intervention on the supply side in the forex market such as witnessed in early July could be short-lived as in the past, unless the BoU can craft a long term stabilisation mechanism – which is highly unlikely.

This medium term pessimism was fuelled by the monetary forecast made by Mutebile in a June 16 policy statement.

Mutebile said the exchange-rate pass through effect on inflation, which he projected to rise from 4.8% to 8-10% and persist until the 2016/17 FY when it is anticipated to cool off to the targeted 5%. In short; do not expect any good news until after the 2016 elections.